Global Environment Fund Investing in private equity for a cleaner world since 1990
TIMBERLAND INVESTMENT & EMERGING MARKETS SEPTEMBER 2009
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A FRESH RE VIE W & OUTLOOK:
Foreword
By John Earhart, Chairman of the Board & Jeffrey Leonard, Chief Executive Officer Global Environment Fund was founded on the principle of generating significant, risk- adjusted returns by investing in enterprises that appreciably improve the environment with their products and services. In the natural resources asset class, we have focused on sustainable forestry as a private-sector approach to protecting global forest areas while delivering profits to our investors, employees and the surrounding communities. Early on, we teamed with international institutions to help create environmental and social standards that would ensure sustainability and market recognition of the products derived from these well-managed forests. In particular, GEF has had a long-standing relationship with the Forest Stewardship Council (FSC), the Katoomba Group and Forest Trends – taking an important role in shaping the development of the programs of each of these institutions. GEF’s efforts to stimulate sustainable forestry initiatives culminated in 2001, when we created, invested in, and took management control of a new integrated forest products company, Global Forest Products (GFP), in South Africa. From 2001 through 2007, GEF worked closely with the management team to turn the business around to profitability. At the same time, we promoted FSC certification, set aside significant areas of forest in permanent conservation, and improved health, education and nutritional services for employees and nearby communities.
Since the formation of GFP, as our sustainable forestry investment program has grown and broadened, we have assembled an outstanding team of professionals with several decades of combined forestry investment experience. John, a forester by training and leader of GEF’s forestry program, has been deeply involved in the sector for over 30 years. Ken Fenner served as CEO of Global Forest Products, and before that he was a senior executive at one of Canada’s largest forest products companies. Ole C. Sand joined GEF after 19 years at the International Finance Corporation, the last six as the head of the Forest Product Sector team. Over the course of his tenure at IFC, he oversaw the financing of projects throughout the developing world. Gordon Carrihill, our managing director in Johannesburg, worked in South Africa and Europe for more than a decade with Mondi, the forest products division of Anglo American. Through the seasoned eyes of our forestry investment team, we continue to have great confidence in the strength of the forestry sector in emerging markets. As discussed in the following pages, the forces shaping the sector in these growing markets make us excited about the potential for generating superior risk-adjusted returns, while also improving the conditions of people and the environment in target communities.
Table of Contents Foreword Executive Summary........................................................................................................................Page 1 Chapter 1: Forestry as an Asset Class............................................................................................Page 5 Chapter 2: Demographic and Economic Shifts Toward Emerging Markets . .............................Page 11 Chapter 3: Increasing Efforts to Mitigate Climate Change..........................................................Page 15 Chapter 4: Growing Demand for Cost-Efficient Renewable Energy . .........................................Page 19 Chapter 5: Challenges of Investing in Emerging Market Timberland........................................Page 23 Appendix A: Historical Return for Timberland vs. Other Asset Classes.....................................Page 27 Appendix B: Primer On the Link Between Forests and Greenhouse Gasses...............................Page 31 Appendix C: Capitalizing On Wood-to-Energy Potential in Emerging Markets.........................Page 35 Footnotes........................................................................................................................................Page 37
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Executive Summary Emerging market timberland presents a compelling investment thesis for the long-term investor, providing exposure to the long-standing attributes of the forestry asset class while positioning investors to take advantage of three macro trends that are increasingly changing our world: • Rapidly Shifting Demographics • Increased Efforts to Mitigate Climate Change • Growing Demand for Clean Energy
Forestry as an Asset Class
increases the marketable volume of the standing timber, it can also increase the value of the forest as larger diameter logs yield a greater proportion of high-value products. Finally, harvests can be accelerated or delayed based on the market prices for forest products, providing unique inventory flexibility that can mitigate the impact of downturns in business cycles. While data on investments in emerging market timberland are not readily available, investors in mature market timberland have achieved outsized returns in the past two decades. Based on the National Council for Real Estate Investment Fiduciaries (NCREIF)
The timberland asset class boasts strong fundamental attributes demonstrated by mature market timberland’s superior historical Exhibit 1 risk-return profile Developments for $1.00 Invested in Selected Asset Classes at Year End 1986: relative to other asAll figures in real terms (adjusted for U.S. Inflation) set classes. $12
Investors have $10 been drawn to the fundamental $8 characteristics of the asset class: low volatility of returns, $6 low correlation with traditional $4 asset classes, and positive correlation $2 with inflation that provides an effec$0 tive inflation hedge. 1986 1990 1994 1998 2002 2006 The most basic Timberland (NCREIF) Res. Real Estate Stocks (S&P 500) Stocks (NASDAQ) LT Gov't Bonds characteristic of LT Corp. Bonds 3-month T-Bills Crude Oil Gold forest assets – the biological growth index,1 which began compiling data on U.S. timberof trees – supports these investment strengths. And land in 1986, an investment in U.S. timberland in that this growth is uncorrelated with financial markets; it year would have grown at a compound annual return continues as long as there is soil, water and sunlight. of nearly 16% through 2008. Adjusted for inflation, Furthermore, continued biological growth not only
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the real rate of return for this period exceeds 12%, more than twice the real return one would have achieved investing in stocks or residential real estate during the same period, with low variance. In developed markets, timber investing has recently become more dependent on the highest and best use of land (i.e., selling timberland for uses other than log production, such as recreation areas or residential development), as opposed to the ownership and operation of timber assets. It is unlikely that the outsized returns of the past two decades will continue in the coming decades in developed markets, given the high level of efficiency gains that have already taken place and made this market fairly efficient and mature. Some also predict that timberland prices may drop significantly in the near term, with some even arguing that prices could topple 50% in coming years. Even if that were to happen immediately, the returns for the timberland asset class would have significantly outperformed all other major asset classes over the last 22 years.2 Emerging market timberland, however, provides promise for investors, and early entrants in this sector may benefit in the same way that investors in U.S. timberland did two decades ago. Tropical emerging markets, for example, provide higher productivity growing sites and lower establishment and labor costs than the temperate forests of the mature markets. Furthermore, emerging markets investors will be positioned to take advantage of the three significant macro trends described below: rapidly shifting global demographics, increased efforts to mitigate climate change, and growing demand for clean energy.
Demographic and Economic Shifts Toward Emerging Markets Demographic trends suggest that a significant amount of growth in the demand for forest products in the coming years will occur in emerging markets. Emerging markets are expected to make up 97% of the global population growth in the coming two decades.3 Within the same two decades, according to World Bank projections, emerging markets are expected to account for over 55% of global GDP,4 up from 23% two decades ago and 31% today.5 As a result of these trends, global demand for forest products for building materials, bio-energy and paper products will increasingly come from emerging markets. At the same time, raw material supply to the forest products industry will continue to shift to emerging markets, because of their proximity to growth markets and their ability to benefit from lower growing and production costs.
Increasing Efforts to Mitigate Climate Change There is broad scientific consensus that greenhouse gases in the atmosphere are leading to climate change, which could have serious long-term environmental consequences. There also appears to be growing international political consensus that something needs to be done to mitigate the impacts of climate change, although the specific components of any future plan are far from resolved or understood. Forests are one of the world’s most important carbon sinks. The Intergovernmental Panel for Climate Change (“IPCC”) reports that forest conversion, due mostly to the removal of some 10 million hectares annually, accounts for 20% of the world’s carbon dioxide (CO2) emissions and 17% of total greenhouse gas emissions.6 McKinsey & Company estimates that
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Executive Summary one quarter of greenhouse gas mitigation potential will come from tropical forestry, split evenly between avoided deforestation and planting, under the most efficient mitigation strategies.7 McKinsey also calculates that 250 to 400 million hectares of forested area will be needed by 2030 to meet these goals. That means tropical plantation establishments will have to expand roughly 100fold from current levels, to approximately 12 million hectares established per year. The carbon sequestration potential of tropical forestry is significant. For example, based on the conservative IPCC average sequestration rate of 0.92 tons/cubic meters, a 100,000 hectare plantation growing at 21 cubic meters per hectare per year would sequester approximately 2 million tons per year of CO2, offsetting the carbon footprint of about 300,000 medium-sized cars. The future value of policy incentives for forestry activities in emerging markets is difficult to predict, because international climate negotiations remain fluid. However, investors with the expertise, networks and forestry assets to take advantage of incentives for establishing plantations (forestation) and sustainably managing natural forests (avoided deforestation) should be well positioned.
Growing Demand for Cost-Efficient Renewable Energy Wood has always been an important source of energy. Increasingly, though, it is drawing additional attention because of its potential to play a significant role in helping the world shift away from fossil fuels. Indeed, its carbon-neutrality as an energy source could have important implications as the world moves to mitigate climate change. Timberland investors have access to a ready supply of biomass, which can be used in conjunction with existing technology to cost effectively produce energy directly in cogeneration facilities or indirectly
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(continued)
through the production of wood pellets. Sawmills are particularly well-suited to cogeneration – the use of an boilers and turbines to generate electricity and useful heat – since the biomass residues from the milling process provide a ready source of fuel. By burning the wood waste, sawmills can generate heat for their dry kilns and enough electricity to meet their own consumption; and they can also supply surplus electricity to the local grid. This reduces the exposure to costly grid interruptions, which can be frequent in certain emerging markets, and provides additional revenues to the sawmill and its investors. Furthermore, by offsetting grid or diesel emissions, biomass cogeneration projects may be eligible to earn carbon credits through the Kyoto Protocol’s Clean Development Mechanism. Wood pellets, which are used as a heating source in residential and industrial locations, are manufactured through a simple process that dries and compresses the wood into pellets. The market for wood pellets is growing rapidly, particularly in Europe, where demand is expected to increase tremendously by 2020. Timberland owners in emerging markets are well positioned to supply this growing market, since in many cases the cost of producing wood pellets and transporting them from low-cost facilities located in emerging markets will be less expensive than producing them domestically in Europe.
Challenges of Investing in Emerging Market Timberland – and a Strategy to Succeed Although the outlook for emerging market timberland is promising, investors in this sector will face a number of challenges that are not commonly encountered by investors in mature timber markets.
Since “fee-simple” ownership - ownership that is absolute and unqualified, as is standard in common law countries - of forestland is less common in emerging markets, investors must be comfortable negotiating long-term leases or concessions. Social and environmental factors are more critical in emerging markets, where surrounding communities usually depend more directly on the land for their livelihoods than in developed countries. And, because the market infrastructure is typically less developed in emerging markets, investors must have access to the full range of technical and operational skills to handle the entire production process – from planting and silviculture to harvesting, processing, transport and marketing. Finally, investors must feel comfortable with the typical set of country risks that any emerging markets investor would face. Knowledgeable and experienced investors who utilize the right strategy can overcome these challenges and benefit greatly from investing in forestry in emerging market economies for many years to come. Investors seeking long-term, uncorrelated assets may find that emerging markets timberlands present attractive intrinsic risk-adjusted returns based on their natural growth rates alone. In addition, timberland assets present investors with a “triple” option on future macroeconomic trends that could make them even more attractive going forward on a relative returns basis: a natural hedge against high global inflation; increasing demand for wood fiber products in rapidly industrializing countries; and increasing markets for “non-timber” uses of timberland products and services – for biomass energy, climate mitigation and other ecosystem services.
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Chapter 1:
Forstry As an Asset Class Over the coming years, several powerful global trends are likely to make investing in timberland in emerging markets more attractive than in mature markets like the U.S. and Europe. As a first step, analysis of the robust data available on historic timberland performance for the U.S. is helpful in understanding why timberland investing around the world offers attractive and unique exposure for investors seeking long-term returns in uncorrelated assets. This section explores the reasons for strong historic U.S. timberland returns. Timberland investments in the U.S. have yielded superior returns relative to all major asset classes during the past 22 years, the period for which reliable data is available. In addition, there are indications that this superior performance has held true since the early 1900s. An investment in timberland in the U.S. made at the end of 1986 would have grown at a compounded annual return of nearly 16%.8 (1986 is the earliest year for which robust data have been collected, although there are strong indications of similar growth levels much farther back.) Adjusting for inflation, the annualized real return is still over 12%, more than twice the return one would have achieved investing in stocks or residential real estate during the same period. Crude oil, gold and 3-month T-Bills all yielded a real return between 1% and 2% during the past 22 years, while bonds have yielded real returns of about 6%. In addition, timberland investments are characterized by a comparatively low variability of return, limited correlation with other asset classes, and a significant correlation with inflation, suggesting that they serve as an effective hedge against inflation. (See Appendix A for detailed analysis).
What are the reasons behind high timberland returns? Broadly speaking, there are three reasons behind timberland’s excellent performance: 1) fundamentals of the asset class 2) increasing interest in timber as an investment class, and 3) barriers to entry. 1) Fundamentals of the asset class. Timberland combines the traditional benefits of real estate investments with the ownership of a renewable and appreciating asset. Appreciation involves four complementary components: (i) Biological growth (the annual volume growth of the forest) As trees grow larger, the grade of the log improves, increasing the market price per unit of volume. In other words, a bundle of 40 centimeter logs can be worth significantly more than a bundle of the same volume of 20 centimeter logs. Biological growth, therefore, drives both total growth and per unit value. Indufor Oy, a leading global forestry consultancy, has reported that biological growth represents 65-75% of total timberland investment returns.9
Because grade growth is biologically determined, it is derived in isolation from economic conditions impacting the general price of wood; this partly explains the low correlation between returns from timberland and other asset classes.
Jeremy Grantham, Co-Founder and Chairman of the widely respected global investment management firm GMO, has noted that the annual yield on forestry (6.5%) driven by biological growth is also attractive when compared to the dividend yield on the S&P 500 (4.5%) over a 75-year period.10
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(ii) Real price increase of wood Indufor has determined that, after biological growth, the bulk of the remaining contribution to timberland investment return (25-30%) is determined by timber price changes.11 According to Indufor, the changes in underlying land values are typically less significant to timberland return when compared to both biological growth and timber price changes.
Grantham has highlighted the long-term outperformance of real timber stumpage prices vs. the S&P 500 since 1910.12 In Exhibit 2, Grantham’s original comparison has been updated with data from Timber Mart-South to incorporate the 2003-2009 time period.
Grantham noted, “When the stock market rose in the past, timber happily had a slightly positive correlation, rising a little. But in these three great declines, it had a strongly negative correlation, actually rising in all three of these despite 50% U.S. equity declines. Now we have the first great bear market of the 21st century and once again the price of timber stayed steady in a 50% equity decline!13 Although timber prices did not remain stable in the recent 50% U.S. equity decline, they only declined roughly half as much as U.S. equities.
(iii) Unique inventory flexibility Macroeconomic factors influence timber prices, but the harvesting of trees can be significantly advanced or postponed to take advantage of As Exhibit 2 shows, timber prices tend to rise during changes in market conditions. When prices are stock market declines. In his July 2003 newsletter, low, biological growth compensates for the delayed cash flow: nature provides 14 Exhibit 2 a unique warehouse where Real Growth In Wood (stumpage) inventory grows in volume Price vs. S&P Since 1910 and value over time, without suffering the risk of market or 100.0 technological obsolescence.
10.0
1.0
0.1
1910
1920
1930
1940
1950
Southern Pine
1960
1970
1980
1990
2000
(iv) Inflation hedging characteristics In addition to these components of appreciation, it is widely reported that timberland investing has historically been an effective way to hedge against inflation. Analysis of the past 22 years confirms that timberland offers a better inflation hedge than other major as-
S&P 500 Index
6
Chapter 1:
(continued)
set classes such as stocks, bonds, T-Bills, residential real estate, as well as gold and crude oil.
and return on investments.
Governments around the globe have responded to the current global financial crisis with large-scale As the blue bars in Exhibit 3 below show, GEF’s monetary and fiscal stimulation packages in an effort analysis finds that the correlation coefficient between to restore growth and confidence. While the current timberland returns and inflation for the period 1986concern in certain mature markets is deflation, some 2008 was positive (+0.33) and higher than for any of leading economists have forecasted that significant the other selected asset classes. Moreover, the green inflationary pressures could be a delayed outcome of bars show that timberland returns provide an even the combined fiscal and Exhibit 315 monetary policies, once Correlation Between Real Asset Returns and Inflation (Data for 22-Year Period 12/31/1986 to 12/31/2008) growth is restored. 2) Increasing interest in timber as an Bonds (LT Corporate) investment class. Gold The establishment of Residential Real Estate Timber Investment Stocks (Nasdaq Comp.) Management OrganizaT-Bills (3-months) tions (“TIMOs”) in the Stocks (S&P 500) early 1980s, as well as Crude Oil the subsequent rapid Timberland (NCREIF) growth in forestry -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4 0.5 assets under management, has helped Inflation (same year) Unexpected Inflation (next year) dissociate timberland assets from specific manufacturing operahigher correlation coefficient (+0.45) if charted with a tions while unlocking additional value. By divesting timberland assets and negotiating long-term raw one-year lead to inflation. In other words, timberland material supply arrangements with TIMOs and other seems to provide an even better hedge against unexinvestment groups, the forest products industry has pected inflation. (See Appendix A for more informabeen able to focus its scarce resources on manufacturtion.) ing operations. During the inflationary period of the 1970s, most major asset classes such as stocks, bonds, T-bills and Forest investment groups such as TIMOs, on the real estate performed poorly. Since then, most major other hand, focus on improving the value of forest economies have experienced relatively low inflation. assets through species selection, genetic improveThe question is whether inflation will remain tame for the next 10 years or come again and hamper growth
Bonds (LT Government)
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ment, improved silviculture practices, and sale of the various log/lumber grades to appropriate end-users. Additionally, selling land for higher and better use (HBU) as real estate has added to timberland returns. In 2007, Merrill Lynch concluded that top U.S. pension and endowment funds anticipated increasing timber investments, mostly through TIMOs, by an estimated $4 billion over the subsequent three-tofive-year period. The study also found that 52% of endowments and 37% of pension funds are invested in timber. Despite recent economic events and any short-term implications for timberland investment, investors should be heartened by the long-term trends these plans signify. While 57% of fund managers planned to maintain their current timber allocations, 34% of respondents said they planned to increase, or possibly increase, their timber investments in the subsequent three to five years for “diversification, low correlation or inflation-protection reasons.”16 The trend of increased investment in timberland seems likely to accelerate. Increased investor interest in timberland has resulted in more liquidity for the overall asset class and, consequently, more exit opportunities for investors. 3) Barriers to entry. There are important factors specific to the timberland industry that restrict investments to certain types of investors. To be effective as a forestry investor, one must have some tolerance for illiquidity and access to specific, highly proficient management skill sets.
The relatively illiquid and exclusive nature of timberland probably contributed to the high historical returns. Timberland is generally sold in large blocks and typically requires a long holding period. Grantham has identified illiquidity as a key barrier to entry to timberland investing, along with the “career risk” associated with it. He concludes that, “Each of these characteristics is worth a couple of extra points of return. So an asset class with highly desirable portfolio attributes yields 8% or 9% real instead of the 4% to 5% real that finance 101 … would suggest. So for those with both a long time horizon and a willingness to have some illiquidity, it seems as close to a free lunch as exists.17 Lloyd Raynor, an investment consultant at Watson Wyatt, believes that the governance needed to implement timberland investment is the biggest obstacle to investing in it. Raynor states that exposure to this asset class is too expensive and time-consuming for most investors to manage on their own: “The reason investors have historically reaped an unfamiliarity premium from timberland (a reward for taking on unfamiliar risk) is that the vast majority simply do not have the capacity to take on the challenges of implementation.”18
Will Timberland in Mature Markets Continue to Outperform? During the second half of 2008, stocks, residential real estate, commodities and all measurable asset classes except the lowest risk bonds performed poorly due to the economic crisis. The S&P 500 and NASDAQ Composite indices were down 38.5% and 40.5%, respectively, for 2008. So far, U.S. timberland assets are faring considerably better, up
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Chapter 1:
(continued)
nearly 4% in the second half of 2008 and 9% for the full year.19 There are both fundamental and technical reasons to believe timberland returns in mature markets like North America will not outperform other asset classes during the coming years. Driven by weak markets for housing and wood products like paper, the demand for wood is low. Furthermore, timberland values have not yet fallen significantly and are considered inflated by many. James W. Sewall Company, a leading natural resource consultancy based in the United States, forecasted in the first quarter of 2009 that, “As the sector in the U.S. has matured, we expect lower, more consistent returns moving forward from timberlands across all regions [of the U.S.] if land is changing hands from investor to investor.”20 Some even feel U.S. timberland prices could fall by as much as 50% in coming years.21 The near term outlook for U.S. timberland prices may also be weak on a technical basis. The National Council for Real Estate Investment Fiduciaries (NCREIF) timberland index is considered to be “backward looking” since it is based on completed transactions, of which there have been relatively few since the onset of the global recession in the fall 2008. Indeed, the NCREIF timberland index fell 1.2% in the second quarter of 2009, the first quarter with negative return since the fourth quarter of 2001. Moreover, timberland returns display a high serial correlation, further suggesting that the asset class might be a lagging indicator rather than a leading indicator of overall market performance compared to more liquid markets like stocks and bonds, and that it may now register a string of low returns.
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Beyond the Mature Markets Whether or not U.S. timberland maintains its value relative to U.S. stocks and bonds in the near future, it is useful to compare future risk-adjusted returns on U.S. timberland investments to timberland investment opportunities in other regions of the world. Since biological growth constitutes 65-75% of timberland returns, a major component in the comparison is how emerging markets measure up against mature markets in terms of tree growth. Most mature markets are in temperate regions, and hardwood plantations are not common. But in tropical countries, where many emerging markets reside, hardwood plantations are an increasingly important source of forest products. Thus, a good way to weigh mature markets against emerging ones in terms of tree growth is to contrast native forests in temperate regions with plantations in tropical regions. Exhibit 4 illustrates the dramatic difference in productivity per unit area and shows clearly that timberland investors in emerging markets should expect far higher biological growth rates than their mature market counterparts. Given that wood fiber costs are such an important variable cost in forest products production, these growth rates help explain the recent and growing shift of production away from mature markets toward emerging markets. According to James W. Sewall Company, “The ‘lowhanging fruit’ associated with the timberland investment sector has already been picked in the U.S. In effect, early entrants to the timberland markets in the 1980s and 1990s captured outsized returns during a
Exhibit 4
Hardwood Mean Annual Increment (MAI) 2006 cubic meters per hectare per year
40 35 30 25 20 15 10 5
Native
Plantation
period of lesser liquidity and transparency.�22 With the appropriate team and strategy, however, there is an opportunity for investors to capture an earlymover advantage and benefit from these higher biological growth rates by committing to timberland investments in emerging markets now. The aforementioned Merrill Lynch Timber Survey reveals that very few timberland investors have ventured beyond North America and other developed markets. Ninety-one percent of worldwide institutional timberland investments are in North American assets, while Oceania (mostly Australia and New Zealand) accounts for another 5%. Emerging markets, then, currently account for less than 4% of timberland investment in the world.23 However, as the projected slowdown in developed markets occurs, emerging markets are expected to outpace mature markets in both forest products
Brazil
Mozambique
Uruguay
Indonesia
South Africa
Australia
India
China
Germany
Finland
Russia
US
Canada
0
supply (the availability of low-cost productive land and significantly higher biological yields) and demand (demographic growth and increasing per capita wealth.) This would also suggest that early movers into such markets will be afforded liquidity opportunities as the more traditional investment capital seeks access
in the coming years. A period of lesser liquidity and transparency in these emerging markets as demand and supply dynamics shift should yield opportunities for attractive returns. Furthermore, emerging opportunities to monetize ecosystem services – discussed in Parts 2 and 3 of this paper – may materially improve the return on timberland investments in emerging markets over the long term.
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Chapter 2: Demographic and Economic Shifts Toward Emerging Markets Exhibit 6
Demographic Shifts Demographics play an important role in driving overall
9000 8000
Emerging Countries
Developed Countries
7000 6000 5000
3000 2000 1000
11
1920
1940
1960
1980
2000
Mozambique
south Africa
India
World
economic growth because population trends influence savings patterns, investments and consumption. For example, high population growth is generally related to high economic growth and appreciating asset prices. While emerging market population growth rates have decreased, emerging markets continue to have an increasingly larger share of global population. In fact, emerging markets will make up about 97% of global population growth during the next two decades, an increase from 93% this decade.24 Exhibit 5 shows the dramatic population growth in emerging markets vs. developed countries.
4000
0 1900
Brazil
China
US
UK
Germany
Median Age
Japan
In addition to the fundamentally attractive characteristics of tim50 ber as an asset class – it combines investment 40 in real estate with an appreciating renewable 30 natural resource – there are key macroeconomic 20 drivers that will fundamentally impact invest10 ment performance over the long term. 0 This section highlights how demographic and economic growth will make emerging market timberland investment especially attractive over time.
2020
Another important demographic factor is the age profile of a population. In much of the developed world, a large proportion of the population is entering retirement age, a dynamic that should lead to a negative impact on consumption, savings,
investments and economic growth. Exhibit 6 illustrates the dramatic differences in median ages between mature and emerging market countries.
emerging markets. Based on expected demographic and economic trends, the GDP in emerging markets will be greater than in mature markets within 20 years.
Economic Shifts
Impacts of Global Population Growth on Natural Resources and Employment Needs
Two decades ago, non-OECD countries accounted for about 23% of the global GDP. Today, they account for about 31%. This is the result of an average GDP growth rate of approximately 8% over the past two decades, compared with a growth rate of about 5% for mature (OECD) economies.26 Within the course of the next two decades, emerging markets are expected to account for over 55% of the global GDP.27 Furthermore, although emerging market countries accounted for about one third of incremental global GDP during the last two decades, these countries should account for greater than 50% of incremental global economic activity over the next 20 years. When adjusted for purchasing power parity, the global share of economic activities will be even larger in emerging markets. Exhibit 7 summarizes the transition of economic activities toward
100% 90%
23%
80%
Population growth in emerging markets will increase pressure on natural resources and increase the demand for new jobs. Pressure on forests will increase even further as population growth occurs primarily in poor countries, where the reliance on forests for basic needs such as fuel is quite high. More than 50% of all wood harvested worldwide is used for fuel wood. There are 1.6 billion people directly dependent on forests for food or fuel, and many of them are considered the poorest of the poor.29
Development of unused and underutilized agriculture and degraded lands should provide jobs and increase the value of land and its products. Sustainable forestry is highly labor-intensive – the development and management of a plantation creates on average one full-time job per two to Exhibit 728 four hectares,30 without Distribution of Global GDP taking into account jobs produced through the forest product value chain. 31% 56%
70% 60% 50% 40%
77%
30%
69% 44%
20% 10% 0%
1988
2008
Non-OECD (Emerging Markets)
Effects of Demographic and Economic Shifts on Emerging Market Timberland Because of demographic trends, emerging markets are likely to offer an increasing share of global investment opportunities
2030 OECD (Developed Countries)
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Chapter 2:
(continued)
during the next decades. And these trends should shift global demand for wood to emerging markets. Currently, the demand for forest products in Europe, North America and Japan is stagnant and even decreasing for many goods, including newspaper and packaging paper, while demand in emerging markets is accelerating, as shown in Exhibit 8. Supply in the forest products industry is clearly shifting to emerging markets, because of their proximity to growth markets and because these areas benefit from lower growing and production costs. The pulp and paper industry in North America and Europe is already suffering from mill closures and weak demand. In general, growth in demand for forest products begins
to decline when a country reaches a certain level of development. Paper consumption has remained the same in developed countries over this past decade while growth in paper demand in emerging countries has increased. According to the widely respected Pรถyry multi-client report on world paper markets, emerging markets will surpass mature markets in terms of absolute volume of paper and paperboard consumption within approximately five years.31 As Exhibit 8 below illustrates, paper and paper product consumption leveled off in mature markets at the turn of the 21st century, while developing
Exhibit 8
Thousands
World Paper Market 1980 - 2025 (in tons per year)
350 300 250 200 150 100 50 0 1980
1990
2000
Emerging Markets
13
2010
2020
Mature Markets
markets continue to grow. In fact, actual growth in consumption in emerging markets has been higher than previously projected. Exhibit 9 delineates wood consumption per capita vs. GDP per capita. As the global trend line shows, wood consumption tends to increase as a country gets wealthier. The line levels off at a plateau point when increasing per capita wealth no longer significantly increases demand; this is the situation in most mature markets. In contrast, as GDP increases in emerging markets, explosive growth in demand is expected. With GDP growth rates in emerging markets expected to be roughly double those of mature markets, it is easy to understand
how providing forest products to emerging markets will become more attractive over time. Despite the present global economic crisis, which is negatively impacting timber prices around the world, the long-term outlook for industrial round-wood demand in emerging markets is excellent. Consumption of timber products will continue to increase in conjunction with population growth. Moreover, it is clear a shift in economic growth from mature to emerging markets is occurring, and this should benefit investments that cost-effectively meet the increasing demand.
Exhibit 9
Round Wood Consumption Per Capita vs. GDP Per Capita (2006), Excluding Firewood 1.6
US
1.4 World cross section curve
1.0
Portugal
0.8
45 000
40 000
35 000
30 000
25 000
Uruguay
20 000
0.0
Spain
15 000
0.2
Brazil
10 000
0.4
Australia Germany
South Africa
5 000
0.6
India Indonesia China
m3 per capita
1.2
GDP(USD) per capita Source: Poyry World Bank and CIA Factbook
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Chapter 3:
Increasing Efforts to Mitigate Climate Change Climate Change Over the past two centuries, the use of fossil fuels and deforestation has caused the concentrations of heattrapping “greenhouse gases” to increase significantly in the earth’s atmosphere. These gases prevent heat from escaping to space, similar to the effect of glass in a greenhouse. While these gases are necessary to keep the earth at a temperature that supports life, as greenhouse gases in the atmosphere increase significantly, the earth’s temperature climbs above past levels. Indeed, the earth’s average surface temperature has increased by about 1.2 to 1.4º F in the last 100 years. The eight warmest years on record (since 1850) have all occurred since 1998, with the warmest year in 2005.
to increase, climate models predict the average temperature of the earth’s surface could increase between 3.2 to 7.2º F above 1990 levels by the end of this century. While most scientists agree that human activities are changing the composition of the atmosphere and that increasing the concentration of greenhouse gases will alter the climate, there is not yet scientific consensus about how much climate will change and at what rate, or what the exact effects will be.33
Forestry’s Role in Mitigating Climate Change Terrestrial systems play a key role in maintaining the earth’s carbon balance, removing 3 billion tons of carbon produced by humans every year. The 4 billion hectares of forest ecosystems on earth store large reservoirs of carbon. All together, these forest resources hold more than twice the amount of carbon in the atmosphere.34 Exhibit 10 shows the power of an undisturbed tropical forest to act as a carbon sink. The earth’s ecosystems, particularly its forests, are not being managed in a way that supports their immense ability to capture and store carbon from the atmosphere. The Intergovernmental Panel for Climate Change (IPCC) reports that forest conversion, mostly due to the deforestation of about 10 million hectares annually, accounts for 20% of the world’s carbon dioxide (CO2) emissions and 17% of total greenhouse gas emissions globally.35 Exhibit 11 shows how the ability of a tropical forest to act as a carbon sink is weakened after deforestation.
Rainfall patterns, snow and ice cover, and sea level are also changing noticeably.32 Human activities are the likely cause of the warming in recent decades. If greenhouse gases continue
15
Leading organizations from around the world are starting to focus on the opportunity forests present in mitigating climate change. Just recently, a group of leading international corporations in the paper industry, environmental groups, academics, and private forest owners came together as part of a group
Exhibit 1237
Total Abatement Opportunities Under €40/t CO2 Equivalent in 2030 (Gigatons CO2e Per Annum)
called The Forest Dialogue to discuss whether forests can play a serious role in addressing climate change, and, if so, how. The group concluded that forests have a unique ability to simultaneously reduce greenhouse gas emissions, capture carbon, and reduce the vulnerability of people and ecosystems to climate change.40 According to McKinsey, forestry represents about a quarter of the total climate change mitigation potential. Exhibit 12 summarizes the mitigation potential for the major sectors in the global economy. Forestry’s role in mitigating climate change is almost entirely focused in the tropical zones. Mitigation potential is split evenly between avoided deforestation and forestations (afforestation and reforestation). Most of the current deforestation, as well as land available for forestation, is found in the tropical regions of Africa, South America and Asia.
“Afforestation is the direct human-induced conversion of land that has not been forested for a period of at least 50 years to forested land through planting, seeding and/or the human-induced promotion of natural seed sources;38 and “Reforestation is the direct human-induced conversion of non-forested land to forested land through planting, seeding and/ or the human-induced promotion of natural seed sources, on land that was forested but that has been converted to non-forested land.”39
The targets for climate change mitigation related to forestation would necessitate a dramatic escalation in the establishment of plantations in emerging markets. Exhibit 13 illustrates the challenge. According to the
Exhibit 1136
Disturbed Tropical Forest: A Carbon Source
Afforestation / Reforestation and Climate Change Afforestation and reforestation are important concepts that help us understand the potential of forests worldwide to act as a significant carbon sink. According to the UN Framework Convention on Climate Change:
16
Chapter 3:
(continued)
previously mentioned McKinsey analysis, forestry will play a key role in attaining climate change mitigation goals. McKinsey calculates that 250 to 400 million hectares of forested area will be needed by 2030 to meet the goals. Tropical plantation establishments will need to expand roughly 100-fold from current levels, to about 12 million hectares per year, to meet the 2030 goal. Fast growing and commercially efficient plantations (i.e., those that utilize the wood fiber for products and/ or energy with minimal waste) are powerful sources of climate change mitigation. A 100,000 hectare plantation in Mozambique growing at a mean annual increment (MAI) of about 21 cubic meters hectare per year, for example, would sequester about 2 million tons of CO2 per year until the forest is mature;42 after that, it would provide wood (for products or energy) containing 2 million tons CO2 equivalent per year, while also retain-
300,000 medium sized cars. Because of its natural ability to absorb massive quantities of greenhouse gases, it seems clear that reforestation and plantation establishment will be central components to any international climate change mitigation plan. While there are signs that investors are allocating more funds to emerging market timberland, the total so far is only a small fraction of what would be needed under any of the leading climate mitigation frameworks currently being considered.
Avoided Deforestation and Climate Change
Deforestation accounts for about 20% of CO2 emissions and 17% of greenhouse gas emissions globally today, with most deforestation resulting from landuse change.43 Deforestation is problematic because 41 Exhibit 13 1) it releases CO2 when the forest is Historical & Target Growth in Tropical Planted Forest Area removed by burning, and 2) the remain(Millions in Hectares Planted) ing area is then typically converted to other land uses that are not as good carbon sinks. Reducing deforestation has high potential for cost-effective climate change mitigation. As Josep Canadell and Michael Raupach wrote in Science Magazine, even in the face of continued large-scale deforestation, the mitigation potential is tremendous. Indeed, if deforestation only slows by a rate of 50% by 2050, and is stopped once countries reach 50% of current forested area, global emissions would still be reduced by 50 billion tons of carbon.44
ing a steady stock of about 28-32 million tons CO2 on the timberland. An annual sequestration of 2 million tons CO2 would off-set the carbon footprint of about
17
Exhibit 14 summarizes the historical links between deforestation and carbon emissions by region. It shows that the temperate forested regions (mostly developed countries) have turned into net
carbon sinks, starting around about 1985. Deforestation is now an issue of the tropical zone – which contains mostly developing countries – although the cumulative contributions to the atmospheric CO2
can be an effective tool to improve local livelihoods, maintain the integrity of the ecosystem and generate positive returns for investors.
In addition, there is currently a voluntary “offset” market, under which buyers can Exhibit 14 displace their carbon-emitting Carbon Emissions from Deforestation activities by buying credits in projects that avoid deforestation. Deforestation Tropics Non-Tropics The portion of the graph in red While this voluntary market grew Long-term 50% 50% denotes the 1998 emissions 1990’s 100% 0% from $335 million in 2007 to $705 from forest fires in the Amazon and Borneo = 1.5-2.0 PgC. million in 2008,46 it is still small compared to the capital invested in forestry around the world. Chart shows 1/3 of all global n Forest Fires in Amazon Borneo n Tropical Africa emissions. Paige et al. 2003 n Tropical America The markets are also plagued by Science; Alencar et al. 2006 n Tropical Asia n Non Tropical Regions Earth Int. accusations of manipulation and questions of credibility related Source: Nepstad, 2008 (Houghton et al. 2005 in Moutinho and to the long-term verification of Schwartzman, Eds.) trees as carbon sinks; and there -0.6 1850 2000 is an acknowledgement that in most places in the world reliable load from deforestation over the past 200 years total monitoring does not exist today. Indeed, a non-volunis about evenly split between temperate and tropical tary carbon emission reduction scheme, with forestry regions. as a component, will have to be put in place to get most forest owners and operators to consider avoidCurrently, deforestation’s negative impact on the ing deforestation. This type of program will need to atmosphere is rarely factored into decisions by individual operators and owners because there is no contain uniform standards and provide clear, compelling financial incentives to operators and owners for significant economic value for the decision-makers the market to grow significantly. themselves in doing so. Research conducted by the Center for International Forestry (CIFOR) The future benefits that will flow to forest owners and concluded that about 40% of the deforestations in operators for avoiding deforestation and expanding Indonesia generated economic returns of less than $1.00 per tons CO2 for the alternative land-use, and their forests are hard to predict. But even with modest carbon prices, the implications – especially in tropithat ~92% of all deforestation yielded economic cal regions – could be significant because of the huge benefits of less than $5.00 per tons CO2.45 Brazil and Indonesia, with their high biomass density, have amounts of carbon that forests sequester. Given that sustainable forest practices, when practiced skillfully the highest deforestation related emissions today, but Africa has the highest rate of deforestation and by experienced managers, usually don’t detract from a forest’s long-term economic value, prescient investors forest degradation measured in terms of total area. can view forest carbon legislation as a free option with a potentially worthwhile upside. (For more informaThe relatively low value of converting natural tion and analysis, please see Appendix B). forests means that sustainable forest management Annual Flux of Carbon (PgC/yr)
4
0
18
Chapter 4: Growing Demand for Cost-Efficient Renewable Energy The Implications of Climate Change on Energy Usage Current energy trends are economically, socially and environmentally unsustainable. The International Energy Agency’s (IEA) World Energy Outlook 2008 highlights the problems of continuing our heavy dependence on fossil fuels.47 The world lacks enough fossil fuels to continue on the path indefinitely, and even if reserves were more plentiful, continuing down the path for much longer has dangerous social and environmental consequences. In IEA’s business-as-usual prediction scenario, future global energy demand will increase 45% by 2030, equivalent to an increase of 1.6% per year. Renewable energy will only account for about 23% of new electricity supply. With this trajectory, global emissions of CO2 will increase in line with energy consumption, meaning energy-related emissions will increase from the current level of 27 gigatons CO2 per year to about 40 gigatons CO2 per year by 2030. IEA estimates that 97% of the additional emissions will be from non-OECD emerging markets.48
because of how fast we are depleting reserves, their cost, and their global locations. Exhibit 15 summarizes the current mix of primary energy sources and the number of years remaining before the reserves are depleted. In addition, this consumption aids and abets excessive greenhouse gas emissions, which lead to climate change. The World Energy Outlook 2008 presents scenarios for attaining global CO2 atmospheric concentrations of both 550 and 450 parts per million. Scientists predict that staying below these CO2 levels will allow us to mitigate the worst impacts stemming from climate change. Both of these scenarios involve a menu of costly policy measures, including conversions to various forms of renewable energy sources, energy efficiency policies, carbon capture and storage (CCS), and greater reliance on nuclear energy.
IEA estimates that under the 550 parts per million CO2 scenario – with global temperatures increasing on average +3° C – additional investments equaling 0.25% of GDP will be required, with a CO2 price Exhibit 1549 of $90 per ton in 2030 in OECD Current Mix of Primary Energy Sources and Number of Years Remaining countries. This indicates that these countries should have some incentive for offsetting their emissions through emerging market solutions. For the 450 parts per million CO2 scenario – under which global temperatures would increase on average +2° C – additional investments equaling 0.60% of GDP will be required, with an OECD CO2 price of $180 per ton in 2030 in OECD countries. The business-as-usual path of fossil fuel consumption represents financial and national security threats
19
Exhibit 16 charts the rates of CO2 emissions needed over the next several years for each of the three
Exhibit 1650 Energy-Related CO2 Emissions in Three Climate Policy Scenarios (In Gigatons)
scenarios to be achieved. It makes clear that even under scenarios where the earth’s temperatures increase at material levels, significant CO2 reductions will be necessary, and alternative energy sources and efficiency will play a major role.
Wood as a Fossil Fuel Substitute Wood has always been an important source of energy. Increasingly, though, it is drawing additional attention because of its potential to play a significant role in helping the world shift away from fossil fuels. Its carbon-neutrality as an energy source could have important implications as the world moves to mitigate climate change. Wood as a fuel source in emerging markets is significant for several key reasons: • Each ton of dry wood has the same energy content as 3.36 barrels of crude oil.
• Wood fuel is an important primary energy source in many emerging markets, where more than half of total global wood consumption is used for heating and cooking. • The forest products industry is a leader in the use of biofuels – energy from wood waste – and meets more than half of its significant energy needs with energy from wood waste. • Emerging markets represented 46% of global energy consumption in 2004 and this figure is expected to increase to 58% by 2030.51 In Africa, for example, wood fuel makes up about 40% of primary energy.52 Indeed, Africans burn approximately 735 million cubic meters of wood each year to produce energy – about twice the total consumption of wood fiber by the European wood processing and paper industries combined.53
20
Chapter 4:
(continued)
Wood fuel consumption in Africa is based on simple technology, and it has significant potential to scale up as a primary energy source, but it is limited by two factors: 1) the efficiency by which the wood energy is converted to usable energy, and 2) the area required for plantations relative to the area available. The conversion efficiency of wood using most traditional methods is very low. For example, open fireplace for cooking has a conversion efficiency of ~ 5%, while conventional means of producing charcoal only yield 8-11%.54 Low conversion efficiencies mean more area is needed to establish forests to supply sufficient volume of wood on a sustainable basis. In addition, although wood stores energy well, it is not economical to transport it over long distances unless it is first concentrated – converted into liquid or pellet form. Conversion of wood to liquid fuel is only in its first generation and will need to be further developed before widespread deployment.55 However, cogeneration technologies and wood pellets are in wide use, and robust markets currently exist for both. There are several short-term opportunities for using wood as energy. Longer term wood-to-energy solutions, while intriguing and possibly lucrative, will take longer to develop, and this time line is probably not one that most institutional timber investors can reasonably rely upon.
Current Wood-to-Energy Opportunities Cogeneration. Often referred to as Combined Heat and Power (CHP), cogeneration is widely used by municipalities and the forest product industry in many countries. Cogeneration involves burning wood or other biomass in boilers connected to turbines to
21
generate electricity and thermal energy. Often, it is a commercially viable way of achieving energy self-sufficiency at forest industry facilities such as sawmills. Conversion efficiency of the energy can be as high as 70%, and the cost of feedstock is low because the raw material is a low-valued waste product and readily available. In addition, since biomass energy often offsets carbon emissions from fossil fuel sources, it may be possible to earn carbon credits through the Clean Development Mechanism (CDM) or similar international carbon trading markets, thus providing opportunities to augment the return on investment. Wood pellets. Wood pellets, which are used as a heating source in residential and industrial locations, only require a simple process for drying and compressing the wood into pellets. The cost of setting up a greenfield manufacturing facility to produce wood pellets is also low. Besides the wood feedstock, the two key expenses are logistical and transportation costs. In many cases, the cost of producing wood pellets and transporting them from low-cost facilities located in emerging markets will be less expensive than producing them domestically in Europe. One implication of this is that European demand for wood could double by 2020 – growing from 380 million cubic meters annually to between 720 and 800 million cubic meters per year, according to Confederation of European Paper Industries (CEPI).56 Indeed, Europe has set a goal of delivering 20% of total energy consumption from renewable energy by 2020, with 13% of the total renewable energy and 24% of the renewable electricity coming from biomass.57 Even assuming higher
levels of local harvesting in Europe, realistic sources of additional imports, and additional recycling, CEPI concludes that Europe would face a supply deficit of 200 to 260 million cubic meters by 2020. This dramatic increase in demand would force
Exhibit 1759
hectares each in Latin America and Asia.61 • The price of land and cost of establishing plantations are much lower in emerging markets than in developed countries.
2020 Projected Wood Demand / Supply Balance in Europe All Estimates in Million Cubic Meters (under bark)
• Potential growth rates for the forests are also higher in developing countries, offering further advantage to emerging market countries. • The demand for wood for both industrial and energy purposes is shifting toward emerging markets.
Europeans to look farther afield for their supply. This supply deficit is shown in Exhibit 17.58 Beyond Europe, biomass could play an increasingly important role in global energy production. Because of its competitive costs, biomass could account for almost two-thirds of all renewables in this fast-growing sector.60 This potential presents compelling opportunities for investors in emerging markets for three main reasons:
The potential long-term upside of wood-to-energy in emerging markets is significant. Investors in these markets will benefit from closely examining ways that wood-toenergy opportunities can be integrated into an overall timberland investment strategy for emerging markets. (See Appendix C for more information.)
• There is an estimated 500 million hectares of degraded land in the world – forested tropical land not currently being used for agriculture, settlement of other purposes – and 300 million hectares are found in Africa, with 100 million
22
Chapter 5:
Challenges of Investing in Emerging Market Timberland Despite the trends favoring timberland investments in emerging markets, successfully executing on this strategy is, and will continue to be, complicated. There are several challenges worth noting: 1) land tenure 2) social and environmental issues 3) operation and infrastructure factors, and 4) general country risks. 1. Land tenure. In many developing countries it is not possible to buy “feesimple”ownership - ownership that is absolute and unqualified, as is the standard in common law countries - forestland. For example, in most of Africa and Asia, the only way a company can “own” land over a long time-frame is through a long-term lease or concession right over the timberland. The exception is Latin America, where it is common to buy private plantation timberland on a fee-simple basis. If, however, one looks across the world at the total area of new potential agriculture or forestland available for planting, the reality is that long-term leases and concessions will become increasingly common for timberland investors. As noted earlier, almost all land for new potential agriculture or forestland is located in emerging markets, mostly in countries where fee-simple ownership of forests or plantation land is not common. As a result, the major opportunities in emerging market countries exist for investors prepared to make long-term leasing arrangements for timberland. Most governments, along with leaders in the international environmental community, now recognize that sustainable forest management can lead to sustainable development and protected intact forests, and they are making the sector a priority. For this reason, emerging
23
market governments are increasingly opening up access to forest assets through long- term concession or leasing arrangements. 2. Social and environmental factors. Timberland investments in emerging markets often involve a broad spectrum of sensitive environmental and social issues. Managing large tracts of land generally means that many communities are affected and involved. Care is also needed to mitigate any adverse impacts on natural ecosystems, especially in terms of road-building and harvesting practices. Furthermore, institutional investors are increasingly focusing on environmental stewardship, with organizations like the International Finance Corporation leading the way with the creation of environmental and social safeguards that have now become the gold standard in the industry.62 As a result of these factors, investments need to be evaluated using strict environmental and social criteria. A critical component of any due diligence requires an understanding of potential adverse impacts as well as plans to mitigate them as the project develops. Internal standards, active management, industry best practices and achieving third-party certification all combine to assure that the owner and operator can achieve social and environmental sustainability. 3. Operational and infrastructure factors. In emerging markets, it is often not possible to outsource services and sell timber on the stump as traditional TIMOs are able to do in mature markets. This reality often requires operators to “in-house” silvicuture, harvesting, processing, transporting and marketing in order to capture full stumpage
value. Investors need to be sure that they have solid management teams with a wide range of technical and operational skills. Development of the local industrial capacity for timber, as well as the market for it, has the potential to significantly impact success. Many emerging market country governments require in-country milling or provide incentives for investors to process wood domestically. 4. Typical emerging market risks. In addition to the issues described above, there are typical emerging market risks – those that an investor in any asset class in emerging markets would need to consider – including a range of political and economic risks, as well as those related to non-transparency and other corporate governance issues. Each country has its unique policies and obstacles related to operating a business. Licensing, taxes, exporting, investor protection, employment regulations, etc. all need to be understood prior to making any investment decision. Because of these challenges, timberland investment in emerging markets is still in its infancy. Thus far, most investments in emerging markets have been focused on traditional and liquid asset classes, such as stocks and bonds.
What Does It Take to Succeed? Capable management teams that have on-theground experience and an appropriate strategy can help mitigate these risks for investors.
Proven Strategy and On-the-Ground Experience For investments in emerging market timberland to
be successful, managers must have fundamental private equity skills. These include an ability to mitigate market and currency risks, diversify investments (especially by country), and understand exit options from the time of acquisition. The best investors are characterized and distinguished by several other components of successful investment: • First rate management teams. The pool of experienced management talent is relatively small in many emerging markets. Great investors are able to draw on networks developed through years of investing in emerging markets and on-the-ground experience with managers who know how to build strong management teams. GEF, for instance, is able to attract the best local or international managers to successfully build businesses and provide the timber operation with up-to-date knowledge and networks related to markets and technology. People are the ultimate determinate of the success of any plan. • Forest Management Proficiency. Expertise in key forestry management areas like genetics, site and specie matching, silviculture, harvesting techniques and technology, growth and yield forecasting, and database management are all critical components of harnessing biological growth to drive financial returns. • Investments in value-added processing. In many emerging markets, a market for logs on the stump does not exist. In order to capture value from plantations or natural forest concessions, it is usually necessary to own or build the manufacturing capacity to process raw logs into marketable value-added wood products. GEF has a successful history of doing this with its timber operations.
24
Chapter 5:
(continued)
• Employee training. Investors who add significant value provide extensive training to employees at all levels of the business; they also build human capital, improve product quality and the efficiency of production, groom future management talent, and build pride and a sense of ownership in the business. GEF considers serious employee investment and training an imperative from the beginning of the investment, and a key success factor for any operation to succeed.
• Biomass energy and other diversified products. In areas with significant energy supply challenges, the use of biomass residues from forest thinnings and sawmill operations to generate renewable electricity provides an opportunity to generate additional revenue while mitigating the unreliability of grid electricity supply. Supplying regional and international markets with wood pellets is often another profitable option for residual biomass.
• Environmental sustainability. Successful investors in emerging markets need to have environmental management in their DNA, particularly when it comes to forests. GEF was founded on a commitment to environmental sustainability, and it operates each of its forest enterprises around the world so they comply with the standards of the Forest Stewardship Council, which provides an internationally recognized benchmark for environmental and social sustainability of forestry operations. In addition, GEF believes it is prudent to set aside significant conservation reserves within each managed forest.
• Community investment. If properly executed, emerging market forestry investments drive economic development through direct job creation, as well as through an economic multiplier that some have estimated is as high as 20-1. Over its history, GEF has made further investments in the basic needs of company employees and their communities; indeed, GEF has invested in schools, health clinics, housing, clean water and HIV prevention. In addition, smart managers often seek to develop opportunities for community businesses that take advantage of the forest resource, such as agro-forestry intercropping or the development and marketing of non-timber forest products. Sometimes these relationships can pay off in ways that are hard to predict or calculate. For example fire, which is most commonly started by humans, is one of the biggest risks in forestry investing. Having good relationships in a community is one way to mitigate this real risk.
• Strategic partners. Strategic partners can help improve the prospects of success in emerging market timberland. Such partners include local allies, financial or strategic, who can help mitigate market and project risks by navigating local regulations and processes. Regional or international partners, such as major pulp and paper companies, or marketing and remanufacturing groups, can provide important outlets for sales and distribution. Both types of partners can become part of attractive exit options.
25
26
Appendix A
Historical Return for Timberland vs. Other Asset Classes Data and Methodology
Commodities
While timberland investment has a long history of being a source of global wealth creation, limited data exist to compare its returns to those of traditional asset classes such as stocks, bonds, T-bills, bank deposits, and commodities such as gold and crude oil. Timberland only started gaining recognition as a separate asset class in the mid-1980s, with the establishment of Timber Investment Management Organizations (‘TIMOs’) in the United States. The asset class was later formalized when the National Council of Real Estate Investment Fiduciaries (NCREIF) started reporting quarterly returns for U.S. timberland in 1987. 63
• Crude Oil65 • Gold66
The following historical return analysis is based on annual return data spanning the 22-year period from December 31, 1986 through December 31, 2008. The nominal and real (inflation-adjusted) returns for the NCREIF Timberland index are compared to returns for other major asset classes and commodities. The return calculations for each asset class take into account both nominal and real prices. For this analysis, conventional methods were used to determine relative risk and return parameters for each of the following asset classes.
Stocks • Standard & Poor’s S&P 500 Index (total return, including dividend) • NASDAQ Composite Index (total return, including dividend)
Bonds 64 • Long-Term U.S. Government Bonds • Long-Term U.S. Corporate Bonds
27
Deposit Rate (risk-free return)67 • 3-Month U.S. Treasury Bills
Residential Real Estate • Freddie Mac Conventional Mortgage Home Price Index (CMHPI) for the U.S.68 The CMHPI was adjusted by adding a fixed rate of 4% to the indexed return to reflect the value (“dividend”) of living in the home. This is consistent with the ~5% average historical rent-to-value ratio for U.S. residential real estate minus 1% for homeowner costs such as property taxes and maintenance. 69/70
Inflation • U.S. Consumer Price Index Urban Area (CPI-U)71
Results: Timberland Investments Offer a Superior Risk-Return Profile Exhibit 18 summarizes the results for $1.00 invested in each of the nine asset classes as of year-end 1986. As the graph shows, over the past 22 years, North American timberland investments have significantly outperformed those of conventional asset classes. While these results mirror those of previous reports, the updated data show that timberland has realized an even higher degree of superior performance when compared to the core asset classes in the recent past.
vestment in timberland for the period provided a real (inflation-adjusted) return of 12.34% per year. This return is more than twice the real return for stocks and bonds.
$20
$15
Timberland (NCREIF)
Res. Real Estate
Stocks (S&P 500)
LT Corp. Bonds
3-month T-Bills
Crude Oil
Each $1.00 invested in timberland in 1986 would be worth approximately $22 today after having realized a compounded annual nominal return of nearly 16%. During the same period, $1.00 invested in the main stock or bond indexes would have compounded to between $5 and $7, yielding nominal returns between 7.7% and 9.9% per year. Investments in crude oil, gold or 3-Month U.S. Treasury Bills would have yielded nominal returns of ~4-5% per year, or inflation-adjusted returns between 1% and 2% per year. Long-term bonds (U.S. Government and/or Corporate) provided annualized nominal returns of 9% to 10% for the 22-year period, or about 5.5% to 6.5% when adjusted for inflation (3.1%) for the period. Exhibit 19 summarizes the results of the return analysis for the aforementioned nine asset classes. An in-
2008
2007
2006
2005
2004
2003
2002
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
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1986
$0
2001
$5
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$10
Note that annual timberland returns seldom fall below zero. In fact, returns were negative only twice during the 22-year period. Moreover, timberland investments produced a Sharp Ratio of Stocks (NASDAQ) LT Gov't Bonds more than Gold Inflation (CPI) 1.0, suggesting that the return over and above the risk-free return (T-Bill in our analysis) is higher than the standard deviation of returns. Timberland’s combination of a high return over the risk-free return and low variability is not matched by any of the traditional asset classes such as stocks and bonds. One word of caution when comparing timberland and residential real estate to other core asset classes: both timberland and residential real estate display a strong serial correlation, suggesting that they react slowly to current financial conditions. Timberland returns have a significant second and third order lag effect. This implies that the current crisis and its strong asset devaluations will likely affect these two asset classes longer relative to stocks and bonds, which are discounted
28
Appendix A:
(continued)
more quickly in response to bad news and serve more as “leading indicators.” As such, it would not be surprising to see stocks outperform U.S. timberland and residential real estate during the next few years, despite the superior historical track record for timberland.
The analysis in Exhibit 19 illuminates the risk-return parameters for each of the nine assets in isolation, or as a “one-asset portfolio.” In reality, the attrac-
Exhibit 19 Key Return Parameters for Select Asset Classes (Based on Nominal and Real Prices for a 22-Year Period 12/31/1986 to 12/31/2008)
29
tiveness of any one investment also depends on how it relates to other assets. Exhibit 20 below provides a complete cross-correlation matrix for all nine investments and inflation. The cross-correlations are
given for both nominal returns (yellow) and real returns (green). In short, the low correlation of timber returns with other asset classes, combined with the high correlation between timber returns and inflation (suggesting an inflation hedge) provides strong evidence of timberland’s attractiveness in a portfolio context.
Exhibit 20 Cross-Correlation Matrix for Selected Asset Classes (Based on Nominal and Real Prices for a 22-Year Period 12/31/1986 to 12/31/2008)
30
Appendix B
Primer on the Link Between Forests and Greenhouse Gases Forests play a central role in the global carbon cycle. Through photosynthesis, trees absorb CO2 while growing.72 This carbon is stored in the forest until an event, such as a harvest or fire, releases the carbon. When a forest is harvested, the wood removed still contains the carbon, which is either further stored in the form of a forest product such as lumber, or immediately released back into the atmosphere when burned as carbon-neutral biomass fuel.73
critical role in determining the magnitude of impact on climate change mitigation. Below is a high level summary of the carbon impact related to (a) sustainable management of natural forests, (b) the establishment of plantations, (c) industrial processing, and (d) the substitution effect of using wood as an energy source.
Nearly all wood harvested for industrial purposes in developed countries ends up being used in products, or as carbon-neutral bio-fuel while in developing nations the bulk of the harvested wood is used as carbon-neutral biomass fuel. As long as the forests where the wood was harvested are allowed to grow and regenerate, the CO2 contained in the wood removed represents a potential net reduction of carbon footprint. The growing global pool of forest products represents a carbon “sink,” (i.e., a net removal of atmospheric CO2). This effect is even more significant when forest products are compared to other alternative building materials such as metals, concrete, plastic or bricks.
A sustainably managed forest (natural forest or mature plantations) should, in principle, imply zero impact in terms of the CO2 level (“stock”) in the forest, (i.e., the wood (and CO2) removed represents a potential carbon sink since additional carbon will be sequestered as the forest regenerates). In a sense, sustainable management of natural forests involves “anticipating nature” by carefully removing a small share of the forest that would otherwise decompose (and return carbon to the atmosphere as a greenhouse gas) as part of the natural cycle of the forest.
There is, however, an enormous opportunity to better utilize wood resources in emerging markets. Perhaps the most significant possibility, as discussed throughout this paper, is to develop opportunities to use wood wasted in processing as a feed stock for energy production. A strategy that focuses on sustainable management of timberland resources in emerging markets makes good sense both from the perspective of return on investment as well as climate change mitigation. Key strategic considerations are discussed in Appendix C. Naturally, the specifics related to where and how wood is harvested, as well as how it is processed, play a
31
Carbon Impact from the Sustainable Management of Natural Forests
Since the growth rates in tropical natural forests typically are low (a 30-year rotation and a growth rate of 8 to 12 cubic meters per hectare per year is a common estimate), the potential sustainable carbon benefit would be around 10 tons CO2 per hectare per year. Sustainable management of natural forests is a potential deterrent to deforestation when the value obtained is greater than the alternative land use considered following forest removal. In essence, deforestation often results when the forest is considered to have a negative value. Establishing a positive stumpage value through sustainable management of tropical natural forests raises the opportunity cost of forest clearing and reduces the incentive to convert the land to non-forest uses such as agriculture.
The National Council for Air and Stream Improvements estimates that carbon sequestered in managed forests is equivalent to at least 60 million metric tons CO2 per year.74
previously degraded, deforested, or of low value is paramount to realizing the climate change mitigation
Exhibit 21
Representative Aboveground Biomass in the Americas (IPCC 2003)
The Intergovernmental Panel on Climate Change has concluded that, “In the long run, a sustainable forest-management strategy aimed at maintaining or increasing forest carbon stock, while producing an annual yield of timber, fiber or energy from the forest, will generate the largest sustained mitigation benefit.�75
Carbon Impact of Forestation (plantations) The key determinant of the climate change mitigation impact of a plantation is the land cover prior to the establishment of the plantation. If a natural forest is converted to a plantation, there would likely be a loss of CO2 storage since there is usually more biomass (and thereby more CO2 sequestered) in a natural forest than in a plantation (this is particularly true in tropical regions). However, if the previous land cover was grassland, previously deforested land or heavily degraded land, there will be a large gain in biomass and carbon sequestered. The U.N. Food and Agriculture Organization has reported that during the 1990s, nearly half of all plantations established were converted natural forests.76 In addition to the negative biodiversity consequences and other environmental issues, such plantation development likely exacerbated climate change. Focusing plantation establishment on sites that were
potential of plantations of low agricultural value. Additionally, given that carbon sequestration is closely aligned with tree growth rate, another key factor that determines the potential of climate change mitigation is the rate at which the forest is growing. Since most plantations utilize fast growing species, the potential here is tremendous. A natural forest may, for example, produce only 2 cubic meters of wood per hectare per year while plantations often reach levels of production in excess of 20 cubic meters of wood per hectare per year.
Carbon Impact of Industrial Processing of Wood The connections between climate change and the forest products industry are perhaps more complicated than with any other industry. The greenhouse gas profile of the global forest products industry is composed of (a) emissions, (b) sequestrations, and (c) avoided emissions. Thus, the net greenhouse gas profile of any individual forest product industry project is composed of a
32
Appendix B:
(continued)
number of greenhouse gas positive and negative components, some of which are very difficult to measure.
Several product studies (including for housing) have shown that the carbon substitution effect often is larger than the direct carbon storage in wood products. Exhibit 22 highlights the emission and storage of CO2 for various kinds of building beams, including steel, concrete and aluminum. As can be seen, the wood beam stores more carbon than emitted during its production, thereby representing a carbon sink as opposed to the other building material (e.g., steel, concrete, and aluminum) that leaves a carbon footprint behind.
National Council for Air and Stream Improvements has done extensive research on this topic for over a decade and developed a state-of-the-art methodology to estimate the greenhouse gas footprint along the value chain. In short, National Council for Air and Stream Improvements has concluded that on a global basis the forest products industry is, on balance, carbon neutral despite its energy intensive nature. While the greenhouse gas profile of this Exhibit 2278 industry is better than one might expect, Comparison of CO2 Emissions of Beams Made of Different Materials there is room for significant improvements, particularly in emerging markets. A better managed forest and integrated Wood industrial operation will result in higher forest growth rates, lower levels of waste, Steel less power per unit output, exploitation of wood-to-energy opportunities, and more. In general, each of these elements Concrete improves the profitability of the industrial operation while improving the greenhouse Aluminium gas profile of the project.
Carbon Impact from the “Substitution Effect” of Wood (products and energy)
-150
-100
A final important component of the carbon profile of the forest products industry is the “substitution effect.” Whenever the fossil fuel-based energy required to produce and transport forest products is less than that needed for the manufacture of alternative products, CO2 emissions will be avoided by using forest products. For example, when wood is used for building construction in place of brick, aluminum, steel, and concrete, there can be substantial net savings in CO2 emissions.
33
-50
0
50
100
150
200
250
300
350
While an estimate of how much carbon sequestered in forest products is available, (~540 million tons CO2 equivalents per year) a reliable estimate of the avoided emissions of this substitution of wood for other materials is not yet available.79 The magnitude of the substitution effect as it relates to energy is easier to measure, given that one can estimate the emissions of the fossil fuel replaced. Wood energy is, by definition, carbon
neutral. In this context, National Council for Air and Stream Improvements estimates that, on a global basis, the industry’s use of biomass fuels and combined heat/power avoids emissions of ~270 million metric tons of CO2 equivalents each year.80 The World Resources Institute has recently concluded that, because of climate change awareness and policy, sustainable forest products will increasingly be distinguished from other materials on their “low-carbon merits.” In addition, “Under sustainable practices, the forest products industry is one of the least carbonintensive manufacturing sectors, and with broad-based incentives to reduce greenhouse gas emissions, such as a carbon tax or a cap-and-trade system, the relative prices of and demand for forest products will likely improve.” 81
34
Appendix C
Capitalizing on Wood-to-Energy Potential in Emerging Markets The overall return on timberland investments can be enhanced by targeting projects with wood-to-energy production potential. The key success factors are 1) availability of cheap feedstock, 2) limited technical risk, and 3) value of the energy generated to meet one’s own needs.
Cheap Feed-Stock Most of the wood harvested in emerging markets is wasted somewhere along the value chain. While there are still opportunities to better utilize waste wood in developed countries, the best opportunities are in emerging markets. Exhibit 23 below illustrates the potential by showing the share of wood fiber wasted at various stages along the value-chain in the Brazilian forest industry. In summary, only 10-20% of the wood fiber from the harvested volume in natural forests will end up in final wood products. The ratio retained in final product from plantation-grown wood is higher, but still only achieves 30-40%. It is generally difficult and uneconomical to capture the waste wood from the harvesting operations as it is spread out over large
and distant areas. The wood waste generated at or near the mill, however, is essentially “free feed stock” since it is already paid for by the mill’s raw material and transportation costs. The yield in sawmills typically runs well below 50%, which means the amount of waste wood in any sawmill is very significant and often sufficient to provide energy to both run the mill and dry the lumber. It is not uncommon that sawmills in emerging markets run at yields below 30%. Ironically, this is often because the mill does not have a reliable source of power and experiences power outages.
Limiting Technical Risks The forest products industry is a leader in the use of biofuel from wood waste. As shown in Exhibit 24, the National Council for Air and Stream Improvements estimates that, on a global basis, the pulp and paper industry covers about 48% of its own total energy needs. The share for the solid wood industry (i.e., sawmills, panel board, and furniture) is the highest, at 64% of its energy needs. This is based on proven, tested and reliable technologies, most
Plantations
Natural Forests In Forest Wood harvested in natural forest
Harvesting Product 30-40%
Processing
Final Product
Product <50%
Retained 10-20% Final Share of Wood Wasted
Waste 60-70%
In Forest Wood harvested in plantations
Harvesting
Processing
Final Product
Product 80-90%
Product <50%
Retained 30-40%
Final Share of Wood Wasted
80-90%
(During harvesting)
Processing Waste Processing Waste
>50%
35
Harvesting Waste
10-20%
>50%
60-70%
notably cogeneration and kraft pulping; the usage of biofuels in relation to the total energy needs is increasing in line with the forest products industryâ&#x20AC;&#x2122;s focus on reducing cost and enhancing overall sustainability.83
Exhibit 24
energy prices and project needs. In general, energy represents the second highest variable cost at most mills after the cost of wood. Moreover, in cases where the mill suffers from frequent power-outages, such as in many African countries. To the extent that a project generates excess energy (e.g., by installing a larger CHP than required for its needs and utilizing low-cost fuel feed stock from its own or neighboring operations), it is a question of the willingness of the local power company to pay a fair market rate. The general global trend is that power companies are prepared to sign rea40% 50% 60% 70% sonable Power Purchase Agreements (PPAs) and facilitate access to the grid for CHP projects.
Percentage of Total Energy Needs Met by Biofuel, by Industry Mining & Quarrying Transport Equipment Machinery Iron & Steel Non-Ferrous Metals Chemicals/Petrochemicals Constructions Textile & Leather Non-Metalic Minerals Food & Tobacco Pulp & Paper Solid Wood
0%
10%
20%
30%
Reliable data are not available for emerging markets, but the National Council for Air and Stream Improvements estimates that the industry in developing countries is well behind in terms of the percentage use of the waste wood to generate renewable energy. GEFâ&#x20AC;&#x2122;s experience at the project level in Africa, Latin America and Asia, as well as from discussions with industry experts, suggests that the opportunity to transfer tested and proven technologies from mature markets to emerging markets is very significant.
Finally, the Clean Development Mechanism (CDM) under the Kyoto Protocol provides an opportunity for CHP projects to receive carbon credits. Depending on circumstances - including the alternative disposal of the waste wood and proportions of various fossil fuels used to generate electricity in the country where the mill is located - such credits can add significantly to the returns.
Value of Power Generated The circumstances of how the produced energy will be used vary from case to case and depend on local
36
Footnotes 1 http://www.ncreif.org/indices/timberland.phtml 2 Barry, Andrew, “Trouble in the Forest”, Barron’s, August 10, 2009. 3 Groningen Growth & Development Center at the University of Groningen. http://www. ggdc.net/maddison/ Note that the population figures are closely aligned with the United Nation’s “World Population Prospects: Medium variant.” 4 Bew, Robin. “Focusing on the horizon: the world in 2030.” Economist Intelligence Unit, Nov. 2005. Online PowerPoint. http://www.queenslibrary.org/UserFiles/File/EIU_The_ World.ppt, accessed August 7, 2009. 5 World Economic Outlook Database. IMF, 28 July 2009. Web. http://www.imf.org/external/pubs/ft/weo/2009/01/weodata/index.aspx, accessed August 7, 2009. 6 “Mitigation of Climate Change”, Fourth Assessment Report, Working Group III, IPCC, 2008, http://www.ipcc.ch/ipccreports/ar4-wg3.htm 7 “Options for avoiding deforestation in tropical countries” McKinsey & Company and the Clinton Climate Initiative, Increasing Investment in Tropical Forestry Conference. May 28, 2008 8 According to National Council for Real Estate Investment Fiduciaries (NCREIF) index http://www.ncreif.org/indices/timberland.phtml 9 Seppänen, P. and Dr. Olli Haltia. “Determinants for Investments in Tropical Forests,” West and Central Africa Forest Investment Forum, Accra, Ghana. August 2007. 10 Grantham, Jeremy. “GMO Quarterly Letter,” July 2003. 11 Seppänen, P. and Dr. Olli Haltia. “Determinants for Investments in Tropical Forests,” West and Central Africa Forest Investment Forum, Accra, Ghana. August 2007. 12 Grantham, Jeremy. “GMO Quarterly Letter,” July 2003. 13 Ibid. 14 1910-1964 data: The Demand and Price Situation of Forest Products-1964 by Dwight Hair and Alice H. Ulrich. USDA miscellaneous. Publication no. 983. Washington, GPO, 1964. 1965-1975 data: Howard, James L. U.S. Timber Production, Trade, Consumption, and Price Statistics 1965 to 2005. USDA Forest Products Lab, Research paper FPL–RP–637. 2007. Page 47. 1976-2009 data: Timber Mart-South. Southeastern US Pine Sawtimber Stumpage Prices. ISSN 0194-5955. July 24, 2009. Timber Mart-South data was used from its first publication in 1976 to present day because of its position as an industry guide and due to the lack of consistent U.S. Forestry Service records post-2005. Data prior to Timber Mart-South publication was gathered from USFS archives and had a consistent reporting methodology from 1910 through 1975. 15 GEF original research. For methodology, refer to Appendix A. 16 “Timber Survey: What will institutional investors do next?” Merrill Lynch, September 6, 2007 17 Grantham, Jeremy. “GMO Quarterly Letter,” July 2003 18 Raynor, Lloyd. “Opinion: Inside View – Seeing the wood for the trees with timberland funds.” Pensions Week, August 7, 2006 19 National Council for Real Estate Investment Fiduciaries index. 20 James W. Sewall Company, “Pacific Northwest Timberlands: Transactions Slow, Attractiveness Remains,” Timberland Report, Vol. 11, No. 1, 1st Quarter 2009 21 Barry, Andrew, “Trouble in the Forest”, Barron’s, August 10, 2009.
37
University of Groningen. http://www.ggdc.net/maddison/ Note that the population figures are closely aligned with the United Nation’s “World Population Prospects: Medium variant.” Projections for 2008-2030 are GEF internal projections and broadly in line with the UN Population projections Median variant.
26 World Economic Outlook Database. IMF, 28 July 2009. Web. http://www.imf.org/ external/pubs/ft/weo/2009/01/weodata/index.aspx, accessed August 7, 2009. 27 Bew, Robin. “Focusing on the horizon: the world in 2030.” Economist Intelligence Unit, Nov. 2005. Online PowerPoint. http://www.queenslibrary.org/UserFiles/ File/EIU_The_World.ppt, accessed August 7, 2009. 28 Bew, Robin. “Focusing on the horizon: the world in 2030.” Economist Intelligence Unit, Nov. 2005. Online PowerPoint. http://www.queenslibrary.org/UserFiles/ File/EIU_The_World.ppt, accessed August 7, 2009. 29 “Global Trends in Forest Sector Development, the Private Sector and the Role of the World Bank” Gerhard Dieterle, The World Bank, April 27, 2009. 30 Sources: (1) APRIL reports 1 full-time job is created per 3 hectares of plantations in Indonesia, (2) YueYang Paper in Hunan, China reports 1 full-time job per 2-4 hectares depending on area and specifics, and (3) in India the “farm forestry” program run by the large pulp and paper companies boasts that on average the participating farmers on a part-time basis derive 25-50% of their income based on 1 hectare of marginal land. 31 “World Paper Markets 2025,” Multi-client report, Pöyry (2008). Mature markets are defined to be North America, Western Europe, Japan and Oceana for the purpose of the paper markets, with emerging markets accounting for the balance. 32 U.S. EPA, based on data from the U.S. National Oceanic and Atmospheric Adminstration and the U.S. National Aeronautics and Space Administration. http://www. epa.gov/climatechange/basicinfo.html, accessed July 20, 2009. 33 U.S. EPA, based on data from the U.S. National Oceanic and Atmospheric Adminstration and the U.S. National Aeronautics and Space Administration. http://www. epa.gov/climatechange/basicinfo.html, accessed July 20, 2009. 34 Canadell, Josep G. and Raupach, Michael R., “Managing Forests for Climate Change Mitigation,” Science Magazine. June 13, 2008. Volume 320. 35 “Mitigation of Climate Change”, Fourth Assessment Report, Working Group III, IPCC, 2008, http:// www.ipcc.ch/ipccreports/ar4-wg3.htm 36 Trumper, K., Bertzky, M., Dickson, B., van der Heijden, G., Jenkins, M. Manning, P. United Nations Environment Programme, “The Natural Fix? The Role of Ecosystems in Climate Mitigation.” June 2009. 37“Options for avoiding deforestation in tropical countries” McKinsey & Company and the Clinton Climate Initiative, Increasing Investment in Tropical Forestry Conference. May 28, 2008 38 “Decisions adopted by the Conference of the Parties serving as the meeting of the Parties to the Kyoto Protocol” UN Framework Convention on Climate Change, March 2006. pg 5. 39 Ibid. 40 “The Forest Dialogue, “Beyond REDD: The Role of Forests in Climate Change.” Number 3, 2008” 41 “Unlocking climate change mitigation potential of sustainable commercial plantations” McKinsey & Company and the Clinton Climate Initiative, Increasing Investment in Tropical Forestry Conference. May 28, 2008
22 Ibid.
42 Assume IPCC average sequestration rate of 0.92 tons CO2/m3 and 16 years until maturity.
23 “Timber Survey: What will institutional investors do next?” Merrill Lynch, September 6, 2007
43 “Mitigation of Climate Change”, Fourth Assessment Report, Working Group III, IPCC, 2008, http://www.ipcc.ch/ipccreports/ar4-wg3.htm
24 Data through 2008 are from the Groningen Growth & Development Center at the University of Groningen. http://www.ggdc.net/maddison/ Note that the population figures are closely aligned with the United Nation’s “World Population Prospects: Medium variant.” Projections for 2008-2030 are GEF internal projections and broadly in line with the UN Population projections Median variant.
44 Canadell, Josep G. and Raupach, Michael R., “Managing Forests for Climate Change Mitigation,” Science Magazine. June 13, 2008. Volume 320.
25 Data through 2008 are from the Groningen Growth & Development Center at the
46 Hamilton, K. et. al. “Fortifying the Foundation: State of the Voluntary Carbon Markets 2009.” Ecosystem Marketplace and New Carbon Finance. May 20, 2009
45 “Less than $1.00 per ton of CO2,” Kate Langford, cited in Center for International Forestry Research News, December 2007, Number 44.
47 “World Energy Outlook 2008, Options for a Cleaner, Smarter Energy Future”, International Energy Agency, OECD, 2008.
75 “Climate Change 2007, Mitigation”, IPCC, Working Group III, Chapter 9, Forestry, Executive Summary, page 543
48 / 49 Ibid.
76 FAO. 2001. Global Forest Resources Assessment 2000. Food and Agriculture Organization of the United Nations, Rome, 2001.
50 / 51 “World Energy Outlook 2008, Options for a Cleaner, Smarter Energy Future”, International Energy Agency, OECD, 2008. 52 “State of the World’s Forests,” Food and Agriculture Organization of the United Nations. Rome, 2009 53 According to CEPI, the PPI and WPI in Europe consumes about 380 million m3 per year. 54 ”The Art, Science, and Technology of Charcoal Production,” Antal, M. and Grønli, M., Industrial Engineering Chem. Res. 2003, 42, pp 1619-1640. 55 Notably the Fisher-Tropsch synthesis for conversion of biomass to liquid (diesel fuel). 56 “Policy at a Cross-Road, Renewable Energy Policy in Europe,” M. Mensink, Confederation of European Paper Industries (CEPI). Virkesforum. (September 2007). 57 European Renewable Energy Council, “Renewable Energy Target for Europe 20% by 2020.” Specifically, 205 Mtoe from biomass out of 1,576 Mtoe total energy consumption projected for 2020. 282 TWh out of 1166 TWh total electricity consumption projected for 2020.
77 “The greenhouse gas and carbon profile of the global forest products industry.” Special Report No. 07-02, NCASI, February 2007. pg. 27 78 “Roadmap 2010 for the European Woodworking Industries”, INDUFOR for CEI-Bois, February 13, 2004 79 “The greenhouse gas and carbon profile of the global forest products industry.” Special Report No. 07-02, NCASI, February 2007. pg. 27 80 Ibid. 81 “Trees in the Greenhouse: Why Climate Change is Transforming the Forest Products Business.” Aulisi, A. et. al. World Resources Institute. June 2008. pg. 4. 82 Adapted from “Forests and Energy: Key Issues” FAO Forestry Paper 154. Rome, 2008. pg. 29 83 World Business Council for Sustainable Development, with technical content developed by the National Council for Air and Stream Improvements. “The Sustainable Forest Products Industry, Carbon and Climate Change: Key messages for policy makers.”
58 / 59 “Policy at a Cross-Road, Renewable Energy Policy in Europe,” M. Mensink, Confederation of European Paper Industries (CEPI). Virkesforum. (September 2007). 60 Frost & Sullivan, “Biomass Market to Thrive as Europe Looks for Secure and Eco- friendly Energy Sources,” Business Wire, June 16, 2008. 61 Field, C. et. al. “Biomass energy: The scale of the potential resource” Trends in Ecology and Evolution Vol. 23, No. 2. 62 International Finance Corporation Environmental and Social Standards. August 21, 2009. 63 http://www.ncreif.org/indices/timberland.phtml?type=total 64 Ibbotson SBBI, “2009 Classic Yearbook: Market Results for Stocks, Bonds, Bills, and Inflation 1926–2008” 65 “History of Crude Oil Prices”, www.ioga.com/Special/crudeoil_Hist.htm 66 “Historical Gold Prices – 1833 to Present”, National Mining Association, http:// www.nma.org/pdf/gold/his_gold_prices.pdf 67 Ibbotson SBBI, “2009 Classic Yearbook: Market Results for Stocks, Bonds, Bills, and Inflation 1926–2008” 68 Freddie Mac, http://www.freddiemac.com/finance/cmhpi/ 69 “Are Housing Prices, Household Debt, and Growth Sustainable?” Papadimitriou, et. al., 2006, The Levy Economic Institute of Bard College. 70 “What Moves Housing Markets? The Trend and Variance Decomposition of the Rent-Price-Ratio,” Campbell, et. al., 2006, Federal Reserve Board. 71 US Department of Labor, Bureau of Labor Statistics 72 Specifically, 6H2O + 6CO2 + Sunlight => C6H12O6+ 6O2, i.e., six molecules of water plus six molecules of carbon dioxide produce one molecule of sugar plus six molecules of oxygen. Trees sequester carbon at an average rate of about 0.92 tCO2 per m3. The molecular weight of one CO2 equals 3.664 C. Pp. 548, Chapter 9, “Contribution of Working Group III to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change, 2007.” B. Metz, O.R. Davidson, P.R. Bosch, R. Dave, L.A. Meyer (eds). Cambridge University Press, Cambridge, United Kingdom and New York, NY, USA. 73 The carbon content of wood represents about ½ of the dry wood mass, or about ¼ of the green/wet wood mass since about 50% of the wood is water. 74 The greenhouse gas and carbon profile of the global forest products industry.” Special Report No. 07-02, NCASI, February 2007. pg. 27
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â&#x20AC;&#x153;Emerging market timberland presents a compelling investment thesis for the long-term investor, providing exposure to the long-standing attributes of the forestry asset class while positioning investors to take advantage of three macro trends that are increasingly changing our world: rapidly shifting demographics, increased efforts to mitigate climate change, and growing demand for clean energy.â&#x20AC;?
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