Alternative Approaches to Addressing the Risk of Non-permanence in LULUCF Activities

Informal workshop on Non-permanence #The Subsidiary Body for Scientific and Technological Advice to initiate a work programme to consider and, as appropriate, develop and recommend modalities and procedures for alternative approaches to addressing the risk of non-permanence under the clean development mechanism with a view to forwarding a draft decision on this matter to the Conference of the Parties ;

Decision 2/CMP.7 Land use, land-use change and forestry. ContextInformal workshop on Non-permanence #In response to the decision.2/CMP.7, BioCarbon Fund in September 2011 initiated analytical work on the topic in collaboration with Duke University, USATwo expert workshops were organized in Washington DC during November 2011 and April 2012 to discuss the analytical workPeer reviewed report was finalized in November 2012Print copies are available Electronic version of the report is available at the website noted below

Analytical work

https://wbcarbonfinance.org/Router.cfm?Page=BioAltARInformal workshop on Non-permanence #Alternative ApproachesInformal workshop on Non-permanence #Reversal risk profile that contributes to non-permanence can be assessedRisk profile can be used to identify different approaches or their combinations Risk pooling and risk management adequately address reversal risksSellers and buyers can choose from a menu of approaches to address reversal risksApproaches to address reversal risk can be integrated into monitoring systemEnvironmental integrity and economic viability of land use mitigation activities can be balanced

Rationale for Alternative ApproachesInformal workshop on Non-permanence #Unintentional ReversalRisks: Natural disturbances - Fire and windData: Data on fire events and area affected in ChileGeographic: Comuna-level fire event data Time period: Fire events from 1984-85 Loss estimates: Field research data on fire effectsModel: LANDCARB Ecosystem simulation model

Intentional ReversalRisks: Conversion to agriculture; Project abandonmentData : Yield (tonnes/ha/yr) and price ($/tonne) data of A/R and commodities of alternative land use; site productivity; other economic factorsTime period: Cost and revenue data annualized over a 40-year period

Modeling Reversal Risk

Fire event data in Chile from 1964-65Informal workshop on Non-permanence #Credits are issued incrementally over time upon meeting permanence requirements

FeaturesCredits are issued for a portion of carbon pools that meet permanence requirements Avoids the need to reclaim credits after they are issued and subsequently reversedProject length and permanence influence the number of credits.Translates into lower NPV relative to other approachesNo residual liability for credits, e.g. credits are not issued before permanence requirements are met

Implementation issuesWhat is the project length? What is the permanence period? e.g. permanence period of 100 years result in issuance of 1% of permanent credits per year from cumulative carbon storedWhether the approach is viable for implementation?

Tonne Year ApproachInformal workshop on Non-permanence #Permanence period (N) in years; Permanence factor = (1/N)Annual carbon storage (tonnes CO2)Cumulative tonne years of carbon storage = [n*(n+1)]/2*Annual carbon storedPermanent emission reductions = Cumulative tonne years * permanence factor Variables Influencing Tonne Year Approach

Example : Tonne year with a permanence period, N = 100 years (permanence factor = 0.1)Informal workshop on Non-permanence #Buffer set aside of a percentage of credits issued in a separate account to address risk of reversal

FeaturesBuffers are generally effective in addressing unintentional reversals.Project length and withholding rates affect buffer integrity and financial return. Buffer pool through aggregation can reduce the risk of buffer failure.Buffer performance in relation to intentional reversal depends on replacement requirements

Implementation issuesWhat percent of buffer to set aside?How to manage buffer to avoid being overdrawn?What types of reversals are to be covered (unintentional, intentional, both) ?What scales of activity are to be considered - project or program level?How to replenish buffer if it runs low?

Buffer ApproachInformal workshop on Non-permanence #Entities: Project/program implementing entities Risk: Type and magnitude of reversal risk influence buffer sizeProject stage : Risk of loss is low in early stages of forest growth translating in a small buffer sizeUse: Can be used as stand alone or in combination with other approaches, e.g. Insurance, guaranteeProject period: Short duration projects may need small buffer amounts relative to projects of long durationWithholding rate: Periodic risk screening/assessment needed to assess the adequacy of buffer withholding rateManagement: Project specific buffer vs. program or system wide buffer may have different management needs. Management of pooled buffer may be cost effectiveRobustness: Buffer approach is effective against unintentional reversals. Measures to deal with the risk of intentional reversals need to be adopted to avoid run on buffer due to intentional reversals

Variables Influencing Buffer ApproachInformal workshop on Non-permanence #

Effectiveness of Buffer Approach to Intentional ReversalsInformal workshop on Non-permanence #Premiums are paid to an insuring entity that guarantees against reversal risk by replacing credits affected by reversal.

FeaturesLiability for loss transferred to a third-partyCovers one or more categories of unintentional risks and loss magnitudesUnlikely to cover intentional reversal risksPremiums linked to type of risk, deductible and loss limits

Implementation issuesWhat are the enabling factors for use of insurance ?What characteristics of insurance products suit project/program contexts?How to get insurers into the market?What measures are needed if insurers withdraw from market, cancel policies?

Insurance ApproachInformal workshop on Non-permanence #Entities: Third parties that collect premium to underwrite coverageCoverage: Can be full value replacement, catastrophic loss limit; buffer insuranceUse: For use as stand alone or in combination with other approaches, e.g. buffer, guaranteeProject stage: Projects in early stage may have lower premium as magnitude of loss is lowProject period: Premiums increase with project period as risk of loss increasesPremium and deductible: Depend on multiple factors influencing riskPolicy length: Insurance policy is short - annual or periodicPolicy renewal: Premium and deductible are subject to review and revision at policy renewal

Variables Influencing Insurance ApproachInformal workshop on Non-permanence #Host country acts as a fiduciary backstop to address reversals unresolved at the project or subnational levels.

FeaturesHost country or an authorized third party can guarantee or backstop project against reversal risksImproves flow of credits to projects as risk is shared by host country or authorized entitiesCan be combined with other approaches buffer, insurance Lowers reversal risk impacts on projectsInstitutional failures or lack of funds can prevent a country from realizing its guarantee

Implementation IssuesWhat factors influence host country guarantee?What are ways to promote host country capacity to support guarantee?How to ensure the credibility of host country guarantee?How can external guarantees complement host country guarantee e.g. Partial risk guarantee?

Host Country GuaranteeInformal workshop on Non-permanence #Entities: Host country or third parties that provide similar guaranteeCoverage: Losses beyond those covered under other approaches Risk profile: Projects with diverse risk profile maximize the effectiveness of guarantee Policy and legal: Existence of policies and legal measures to implement guaranteeCapacity: Institutional and financial capacities needed in support of guaranteeMonitoring: National accounting and monitoring systems needed to track performance of activities in order to trigger guarantee against reversal riskImplementation: Terms and conditions that support implementation of guarantee

Variables Influencing Host Country GuaranteeInformal workshop on Non-permanence #Categorical exceptions for certain low risk activities result in issuance of permanent creditsFeaturesRisk analysis based on historical data to demonstrate low risk Exceptions are defined based on a range of criteria - project type, risk profile, geographic variables etc. Low risk of activities to be confirmed through risk screening tools and independent audit Low monitoring burden for activities that are identified as having low risk Implementation issuesWhat are the criteria for defining low risk activities? What are the safeguards to minimize the impact in case risks materialize, e.g. management plans for addressing relevant risks? How can national guarantee include provisions governing exceptions for low risk activities?Exceptions to Low Risk ActivitiesInformal workshop on Non-permanence # Prevailing Approaches to Address Non-permanence risk under UNFCCC : Case of Carbon Capture and Storage (CCS)Modalities for Addressing Non-permanence riskPotential Applicability to LULUCF contextPlacement of 5% of credits in a reserve account (buffer)Risks may require buffer withholding rates, customized to the risk. Permanence after 20-year monitoring periodMonitoring periods for forests are typically longer than 20 years.Host country guarantee of reversals in excess of the reserve (optional) or Annex I country responsibility for reversals if host country does not guaranteeHost or Annex I country guarantee may be feasible if countries assess risks, their capacity to back risks, and to determine type of guarantee to back the project. Pool reserve across multiple projects or projects within the umbrella of an ER program Diversification by pooling credit reserves from projects may make them collectively more resilient than managing them separately. Informal workshop on Non-permanence #

Comparison of ApproachesApproachNature of LiabilityAddressing Unintentional risksAddressing Intentional risksRisks to ProjectRisks to SystemFeasibilityTemporary Credits (tCERs/lCERs)Buyer liabilityYes, as temporary creditsYes, as temporary creditsLower market value, but no long-term liabilityLittle or none long-term (default scenario assumes loss of carbon)Limited feasibility on financial groundsTonne-year/ RentalNo residual liabilityYes, upon meeting permanence criteriaYes, , upon meeting permanence criteriaSlow to credit, but no long-term liabilityLow economic viabilityLimited feasibility on financial groundsBuffersProject must contribute to bufferYes, depends on size of buffer

Variable, depends on reversal and replacement provisions; and back up in case of defaultMay require replenishment of bufferBuffer may be overwhelmedFeasible in situations with institutional capacity to manage effectivelyInsuranceProject must purchase insurance; Insuring entity liableYes, depends on the capacity of insuring of entity Generally not cover intentional risks

Limited coverage or poorly capitalized insuring entity could prevent repaymentMoral hazard; poorly capitalized insuring entity could prevent repaymentFeasible with strong financial and legal institutionsHost Country Guarantee

Sovereign or third party liabilityPotentially effective, depending on type of guarantee Policy and legal provisions to limit the risk of intentional riskLow as risks are shared by host country or third part guarantee Providing guarantees that are difficult to implementFeasible with strong policy, legal and institutional capacityExceptions to low risk activitiesNone for certain low risk categoriesAdditional safeguards requiredGenerally not cover intentional risks

None - provided projects comply with relevant provisionsProviding exceptions for activities that have substantial risksLimited to situations with very riskInformal workshop on Non-permanence #Approaches Adopted in Different StandardsStandardIntentional v. Unintentional ReversalsReversal MechanismMechanism DetailsMinimum Contract PeriodVCSNo Catastrophic vs non-catastrophic usedPooled Buffer AccountProjects are required to guard against reversals by withholding 10%-60% of their credits in a Pooled Buffer Account based on project-specific risk evaluation using project-specific risk factors (e.g., clarity of land tenure, local deforestation pressure, financial viability). 20100 yearsCARIntentionalImplementation AgreementProject CAR credits account debited to compensate for avoidable reversals (negligence, gross negligence, or willful intent).100 yearsUnintentionalCAR Pooled Buffer AccountProjects required to guard against unavoidable reversals (fire, pests) by withholding a certain percentage of their credits in a Pooled Buffer Account based on project-specific risk evaluationACRDistinctionPooled Buffer AccountSimilar to VCS including use of VCS risk analysis and buffer tool. a) Intentional reversals- must all be replaced by the project entity; b) Unintentional reversals are covered by the buffer pool like an insurable risk, though project must re-establish buffer after conversion. 40 years, opt-out allowed if credits replacedPlan VivoNo DistinctionBuffer AccountAll projects must withhold minimum of 10% of credits. Must (1) undertake comprehensive analysis of reversal risks, (2) implement risk management and mitigation measures, and (3) withhold credits in a buffer to compensate for unexpected losses based on a project-specific assessment of risks. Not specified . CDM No DistinctionTemporary credits for A/R project activities A/R projects are issued either temporary certified emission reductions (tCER) that expire each subsequent commitment period (e.g., after 5 years) and must be replaced. lCERs expire after crediting period of either 30 years or 60 years and require full replacement. Credits expire after 5, 30-60 years No DistinctionHost Country Guarantee for Carbon Capture and StorageIntroduced in the context of CCS activities; either host countries (if accepting obligation to address reversals) or Annex 1 Parties holding CERs issued by the project (if host country does not accept obligation) must address reversals unmitigated by project participants. 20 years after last crediting periodInformal workshop on Non-permanence #Approaches for Addressing Reversal and ScaleNationalProjectSub-nationalProjectBufferInsuranceTonne-yearTemporary credits

Sub-national & NationalPooled buffersInsuranceHost govt. guarantee

Informal workshop on Non-permanence #20Location matters

Scale matters

Diversification matters

Type of risk matters

Policy Insights

Informal workshop on Non-permanence #Extensions of AnalysisImproved data on risk profilesMultiple scales of coverageRisks from different disturbance typesOther LULUCF examplesREDDAgricultureExtension to multiple land usesLandscape contexts REDD, A/R, SFM, Agriculture

Informal workshop on Non-permanence #Rama Chandra ReddyEmail: Rreddy1@worldbank.org

For more information on the BioCArbon Fund, please contact:Ellysar BaroudyEmail: Ebaroudy@worldbank.org

www.carbonfinance.orgThank youInformal workshop on Non-permanence #Additional Slides: ExamplesInformal workshop on Non-permanence #Example: Modeling Unintentional Reversal

Ratio of reversals to credits issued in a 20,000 ha project implemented over 40 years without approaches to address reversalInformal workshop on Non-permanence #

Mean buffer balance as percent of credits earned in a 20,000 ha project with 10% buffer

Example: Buffer ApproachMean buffer balance as percent of credits earned in a 20,000 ha project of 40 year duration with 10% buffer Informal workshop on Non-permanence #Example: Insurance

Insurance coverage of a 20,000 ha project of 40 years length full value coverage, catastrophic loss limit, and buffer insuranceInformal workshop on Non-permanence #