Land Use, Land-Use Change and Forestry

	Other reports in this collection

5.3.5. Risks

Quantification of GHG emissions or removals in LULUCF projects is subject to a variety of risks and uncertainties. Some of these risks and uncertainties are inherent to certain land-use activities (particularly forestry); others may be generic and applicable to any GHG mitigation project in the energy and LULUCF sectors.

Risks refer to events that negatively affect the expected GHG benefits of the project. Land-use projects are exposed to a series of risks, such as natural risks (e.g., rainfall, sunlight, pests and diseases, reductions in growth rates, fire, climate change); anthropogenic factors (e.g., encroachment, fires, theft); political risks (e.g., non-enforcement of legally binding contracts between project partners, noncompliance with guarantees, expropriation, uncertain property rights, policy changes); economic risks [e.g., exchange rate and interest rate fluctuations (Shapiro, 1996), changes in the prices of the relevant factor and product markets (Janssen, 1997), changes in the opportunity costs of land]; financial risks; institutional risks (e.g., land tenure); and market risks. Not all of these risks are exclusive to land-use activities. Because land-use activities have strong social implications; rely on a land base; and depend on natural factors such as rainfall, sunlight, pollinators, and exposure to natural and anthropogenic factors, however, such activities are particularly exposed to these risks.

Risks of project failure because of fire, climatic variations (e.g., drought or storms), and pests also entail potential negative environmental and social impacts associated with failed projects. Implementation of large-scale teak plantation projects in India, for instance, may have led to cultivation of monocultures, that are susceptible to pest infestation, loss of timber affecting local timber markets, and associated release of sequestered carbon (Ravindranath et al., 1998). Because carbon mitigation projects also have to address issues of sustainable forest management, the risks associated with these new endeavors-where there is less experience and infrastructure to draw on-may not realize the full potential of co-benefits. In the Salicornia project (Box 5-1), for instance, a new concept is being tested to evaluate the cultivation possibilities and commercial uses of a previously uncultivated crop. The entry of Salicornia straw to wood markets could lower the price of wood, reducing the incentive for forest plantations locally (Imaz et al., 1998). Project developers will have to establish procedures to deal with extra costs in the event of such impacts. For example, the Costa Rican government has committed to find replacement farmers if targets are not met in the PFP project. Another example is the contractual obligations required by the FACE Foundation, which require project implementers to replant any forests that are lost during the project's time frame (Verweij and Emmer, 1998). Alternatively, in the context of a growing trend in trading in carbon credits, management can be expected to seek to lay off these risks in conventional insurance and reinsurance markets.

Risk mitigation can be accomplished through a variety of internal and external mechanisms to the project. Internal methods include the following:

• Introducing good practice management systems to control the occurrence of damaging events.
• Project design, aiming at diversification of activities within a project and spreading of projects in different areas, reducing the risks that damage (e.g., fire, pests and diseases, flood) will spread.
• Maintaining self-insurance reserves or keeping a portion of the project's benefits as a reserve to insure against any shortfalls. This reserve could be financial or in-kind (GHG benefits). This approach was used by the national program of the Costa Rican Office for Joint Implementation, which placed about 40 percent of credits derived from the PFP project in a self-insurance buffer reserve (SGS, 1998). If damage does not occur, this reserve can be used at the end of the project lifetime.
• Diversification of sources of funding, reducing financial dependency on a single source.
• Involvement of a wide range of stakeholders, through consultation and participatory management.
• Creation of positive local side effects from hosting the project, such as transferring needed technologies, fostering local social developments (e.g., job creation), or creating positive side effects on other local or regional environmental goals in the host country (Janssen, 1997).
• Project auditing and external verification, which may serve as a way to highlight project risks early on.
• Timed allocation of GHG benefits. If GHG benefits are credited to project partners only after they are fully realized, there will be less need for long-term guarantees and a lower perception of risk. This allocation could be accomplished by staggering sequestration and crediting or by only allowing crediting according to a ton-year factor calculated according to an equivalence factor between CO2 sequestration and emissions (Moura-Costa and Wilson, 2000).

External methods include the following:

• Cross-project insurance through direct arrangements in which projects would guarantee each other.
• Regional carbon pools-a similar approach in which "carbon banks" are established with contributions from a diversified pool of projects to insure contributing projects.
• Financial insurance. Some insurance companies are already offering services related to risk mitigation for carbon offset projects. It is important to note that a series of project risks are common to non-GHG specific activities and traditionally have been covered by standard insurance schemes (e.g., crop or timber insurance).
• Portfolio diversification in terms of placing different projects in different locations [e.g., the FACE Foundation's portfolio (Verweij and Emmer, 1998)].

There are still issues related to liability, such as allocation of responsibilities for ensuring compliance and deliverables. The UN Conference on Trade and Development's Emissions Trading Forum has raised issues of responsibility such as "buyer beware"-in which buyers are responsible to ensure that offsets are valid-or "seller beware," in which an exporting country would have the entire transaction invalidated if projects do not deliver (Tietenberg et al., 1998). This approach has different implications for countries with and without emissions limitation caps. Additional issues raised during the meetings of the Ad Hoc Working Group on CDM included allocation of liabilities between nations, individuals, and certifiers (Stuart, 1998; Stewart et al., 1999).