Studies and pilot project experience indicate that the net costs per ton of carbon of LULUCF mitigation activities in developing countries can be relatively modest or even negative (i.e., such projects may be profitable) in some projects and conditions (e.g., Makundi and Okiting'ati, 1995; Masera et al 1995; Ravindranath and Somashekhar, 1995; Wangwacharakul and Bowonwiwat, 1995; Xu, 1995). Annex I country estimates of LULUCF activities are generally found to be relatively higher per ton of carbon, but a substantial supply of sequestration or GHG reductions may be available at less than $20 per t C (Brown et al., 1996).
Only a limited number of potential projects are likely to be funded and implemented, however, as a result of community, investor, and national government priorities and cost-effectiveness (Mulongoy et al., 1998; Smith et al., 1999). The cost-effectiveness of LULUCF project activities will compete with the costs of achieving emissions reductions in other sectors-domestically within each country and internationally-under continual technological innovation in the energy sector, as well as the development of the GHG emissions reduction market.
Pilot projects in Annex I and non-Annex I countries commonly face high transaction costs (e.g., for implementing, monitoring, and reporting project activities) (World Bank, 1997; UNFCCC, 1999a). One key uncertainty is how transaction costs will be affected by the implementation of any eventual standardized guidelines for monitoring and verifying project emissions reductions and associated impacts on sustainable development. Transaction costs and risk may decline as carbon markets develop and standard financial techniques to spread risk and reduce uncertainty evolve (e.g., diversified portfolios, futures options contracts, and project performance insurance) (Frumhoff et al., 1998; Smith et al., 1999).
The types of future projects financed may not reflect patterns to date because economies of scale may favor larger scale activities with low costs (Smith et al., 1999). Investors with substantial near-term carbon liabilities may have a strong incentive to invest in projects that have the potential to provide carbon credits quickly though at a net cost (such as forest conservation). By contrast, investors with relatively modest near-term liabilities may have a strong incentive to invest in projects that provide carbon credits relatively slowly, but at a net profit-such as managed plantations (Frumhoff et al., 1998; Smith et al., 1999).
An example of how mixed incentives for LULUCF activities could occur has been raised by critics of the Kyoto Protocol. Non-Annex I countries would not have commitments to meet assigned amounts of GHG emissions, hence would not have emissions from deforestation or forest degradation counted against their assigned amounts. Financial incentives might exist to harvest or degrade forest lands to receive revenues from the timber products produced and the CERs generated if such lands were eligible for reforestation as project-based activities (Greenpeace, 1998; Chomitz, 2000). This situation could produce tensions for Parties between objectives of the UNFCCC and the Biodiversity Convention. At least two options exist to address this concern. First, the definition of reforestation activities selected by the Parties could limit reforestation to lands deforested prior to the commencement of non-Annex I project-based activities (Chapter 3 discusses this approach for Article 3.3 reforestation). Second, individual Parties could use the sustainable development conditionality of Article 12 to preclude eligibility for projects that reforest recently deforested lands-on biological diversity, conservation, or other grounds. The economic benefits to the host country of large-scale projects could be a disincentive for countries to limit LULUCF investments in any way, however, eroding their ability to manage such investments and their associated socioeconomic and environmental impacts (Smith et al., 1999).
Integrated projects or portfolios may offer potential synergies that address several technical issues. A sequestration component could provide sustainably managed forest products and reduce leakage from a conservation component, and a bioenergy component could provide jobs and low-cost power that is important to the sustainable development priorities of host countries, as well as enhanced profitability for investors (Niles and Schwarze, 2000). This approach has not been widely experimented with to date.
The public policy environment for the agriculture, forestry, and industrial sectors varies across countries and may facilitate or inhibit the penetration rate of LULUCF projects. Such policies could address tax incentives or subsides for afforestation, reforestation, or deforestation; land conversion to agriculture or alternative agricultural practices; land tenure; agrarian reform; and sustainable development more generally (Repetto and Gillis, 1988; Smith et al., 1999). A review of the feasibility of significant levels of project-based LULUCF activity in non-Annex I countries under the Kyoto Protocol argues that the removal of distortionary national policies that promote forest degradation and land-use change may be a prerequisite for projects in some developing countries (Smith et al., 1999).
A major potential limitation on LULUCF project penetration into the market for CERs and ERUs is the perception that LULUCF projects are less likely to produce credible, real, additional reductions. Two major perceptions are often advanced: the perceived difficulty of establishing the additionality of project benefits versus baselines and the claim that LULUCF projects are more difficult to measure and monitor and have greater leakage of GHG benefits than energy sector projects (Greenpeace, 1998; Trexler and Associates, 1998). A review of projects in the energy and LULUCF sectors (Chomitz, 2000) assessed five critical technical issues: additionality, baseline and systems boundary issues (including leakage), measurement, duration, and local social and environmental impacts. This assessment found that LULUCF and energy projects face parallel, comparable issues in measurement and in ensuring social and environmental benefits. In general, it is not possible to assert that energy projects are superior as a class to LULUCF projects on these grounds. The one significant difference identified between projects in these two sectors is the issue of project duration: LULUCF activities can be halted or their emissions reductions emitted. Similarly, a review of eight commonly raised technical issues in 12 CDM-like projects or activities in Brazil, India, Mexico, and South Africa (including seven LULUCF projects) found that about half of the concerns were minor or well managed by the project developers. Additionality, host country institution capacity, and baselines and leakage were the main concerns that needed more effort to be adequately addressed (Sathaye et al., 1999).
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