- Global climate change is broadly recognized as one of the defining economic, social, and environmental risk factors of this century, and efforts to halt the further buildup of GHG emissions in the atmosphere are triggering an increasing number of public policy initiatives and corporate commitments to prioritize emissions abatement, promote carbon removals, and facilitate a transition to a net zero emissions world.
- The ability of trees to naturally capture CO2 from the atmosphere and provide long-term storage in secure carbon sinks has moved forestry into the forefront of climate change mitigation strategies and simultaneously opened new timberland investment opportunities.
- Manulife Investment Management is drawing on our deep experience in timberland investment to develop natural climate solutions strategies that seek to deliver high-quality, high-integrity carbon benefits to investors and the environment while at the same time generating competitive financial returns.
Understanding carbon markets
Carbon markets channel capital to finance the development of projects that can help to remove or avoid greenhouse gas (GHG) emissions and speed the transition to a low-carbon future. By determining prices on emissions, carbon markets provide companies with valuable information, enabling businesses to decide how to best comply with regulations to reduce GHG emissions or to meet their internal emissions goals. The use of carbon credits—each representing one tonne of CO2 or equivalent GHG that's been either removed from the atmosphere or whose emission into the atmosphere has been avoided—is one available tool for organizations to meet their climate goals.
In our view, companies should:
Prioritize direct abatement in their own operations and supply chains
Recognize a tail (~5%–10%) of corporate emissions will likely be too difficult or costly to abate with current technologies
Consider carbon offsets or insets—sequestration embedded within a company’s supply chain or investment portfolio, including natural climate solutions (NCS)—that can serve to neutralize remaining emissions, with a focus on removals
Go above and beyond net zero targets by sourcing high-quality carbon insets and offsets to benefit the planet and not count carbon credits toward net zero goals
There are, broadly, two types of carbon markets: compliance and voluntary. Compliance markets are government regulated, setting caps on total carbon emissions for the largest-emitting sectors. Individual companies subject to these emissions caps must make economic decisions about whether to:
- Reduce output
- Invest in emission abatement technology
- Change to less carbon-intensive processes
- Purchase carbon allowances from regulated auctions or companies that have been able to emit less than their specified caps
- Buy carbon credits generated by approved projects—Many compliance carbon markets permit companies that emit more than their regulated limit to trade allowances with companies that have excess allowances and to purchase approved carbon offsets from project developers
The compliance carbon market is largely driven by nonmarket public policy forces and is administered by various national, regional, and state organizations. These government and regional authorities set demand for tradable carbon allowances, or the right to emit one tonne of CO2, by designating which sectors in the economy are subject to regulation and by setting the individual caps on a company’s emissions. The supply of offsets is also policy controlled by specifications on what qualifies as a tradable credit—the number of credits that can be used as a substitute for emissions reductions—and under what circumstances they can be applied. Compliance market rules vary by jurisdiction, and not all compliance markets allow regulated entities to purchase carbon offsets to meet their emissions targets.
In the voluntary carbon space, carbon credits exist outside of regulatory requirements and frameworks and are often used to meet the internal goals of corporations to reduce the carbon footprint of their operations and/or products. In the absence of regulatory oversight, voluntary carbon credit markets are typically more varied and fragmented than the compliance markets, with a broader range of carbon project types permitted. The reduced oversight and adherence to strict definitions in the voluntary markets compared with compliance markets are reflected in a broader range of prices and credit quality and lower market transparency.
Carbon insets offer optionality:
The role of forests in carbon markets
The ability of forests to naturally remove CO2 from the atmosphere and store it within the biology of trees and forest soils in a relatively efficient, low-cost manner has been widely recognized. A paper released in 2017, "Natural Climate Solutions," highlighted the potential for nature-based solutions as a tool for combating climate change. The research showed that NCS could deliver one-third of the cost-effective carbon sequestration and mitigation needed to meet the Paris Agreement goal of limiting warming to 2˚C (and ideally to 1.5˚C). Forest pathways represent two-thirds of cost-effective NCS.
Management practice changes result in greater carbon sequestration than traditional commercial forest management. Additional benefits include clear air, clean water, economic opportunity, recreational access, biodiversity, and improved wildlife habitats.
Carbon credits can be generated by removing GHGs from the atmosphere (carbon removal credits) or by reducing the amount of carbon that would have otherwise been emitted (carbon avoidance credits). Direct air capture (pulling CO2 directly from the atmosphere), renewable energy, and forestry projects are all examples of activities that can generate carbon credits, and each has distinct advantages and associated risks that need to be considered to achieve proper alignment with investors, climate goals, communities, and nature. Although carbon credits generated from renewable energy projects possibly reduce the volume of GHG emissions that would have been released in their absence, they don’t actually remove CO2 from the atmosphere and, in many geographies, are already cost competitive with traditional energy generation. Direct air capture is a promising technology that, if scalable and successful, could have massive implications for reducing atmospheric GHGs, but the technology is still expensive and only just beginning to be deployed on a pilot scale.
Carbon credits from forestry may include both carbon removals achieved by planting new forests, rehabilitating cutover forestlands, or boosting the carbon capture of existing forests with improved forest management and avoided emissions resulting from changing the forest management regime or preventing the conversion of forestland to other uses such as farming, pastureland, or industrial/commercial development. Over the past 20 years, carbon markets and the mix of credits offered have shifted from being dominated by renewable energy projects to more of a focus on high-quality nature-based solutions, including those generated by forestry. From 2017 to 2019, compliance markets across the globe recorded over $2 billion in forest carbon offset issuance, and forest carbon projects represented nearly 70% of offset credits retired from 2004 to 2021 in the California Air Resources Board compliance market. In voluntary carbon markets, forestry and land use represented 35% of total voluntary carbon offsets generated in 2019 and led the voluntary market by value at $159 million transacted. Since 1996, improved forest management projects have represented approximately 63% of forest carbon credit issuance and retirements. Carbon credits generated through forestry projects have a proven track record at scale, an established infrastructure, are comparatively low cost, and provide a range of other ecological and social benefits lacking in other carbon credit generation methods.
What about REDD+?
|Reducing emissions from deforestation and forest degradation plus support for conservation, sustainable forest management, and enhancement of forest carbon stocks (REDD+) is an important approach intended to address the forest loss that accounts for 8% to 10% of the world’s carbon emissions. REDD+ projects are a major component of voluntary carbon market activity, representing over 10% of issuances on average from 2016 to 2020. While REDD+ is an important tool for advancing global climate goals, several factors limit its potential as an institutional investment opportunity: REDD+ projects are typically complicated initiatives that involve local landowners, indigenous groups, nonprofits, and various government entities. Efforts to scale REDD+ have encountered issues that include land title insecurity, indigenous rights, funding gaps for local capacity building and monitoring, illegal deforestation, questions over additionality, inflated avoided emissions assumptions, and leakage—or shifting of deforestation to neighboring areas. Perhaps due to these issues, REDD+ credits have typically transacted at significant discounts compared with other types of forest carbon offsets.|
Implementing carbon-focused timberland investments
Carbon changes the dynamics of timberland investment: The growing use of forestland as a climate change mitigation tool, coupled with deeper and more standardized markets facilitating the monetization and trading of forest carbon, has added a new dimension to timberland investment. Traditionally, commercial timberlands have been primarily valued using a discounted cash flow approach focused on the expected streams of revenue generated from the sale of future timber harvests. The possibility of deferring harvests of timberland to accumulate carbon value opens an additional aspect of timberland valuation and introduces new optionality in the management of forests.
The ability to capture new tiers of carbon-related value from forests is determined by a range of factors. Deciding whether a carbon-oriented investment strategy is appropriate for a timberland property starts with an assessment of the biological capability of the property to capture and store carbon and its associated risk profile for physical losses such as fire and extreme weather events. The choice as to whether a property is better suited for commercial timber production or carbon capture and sequestration is also heavily affected by the financial comparison of value generation between the two strategies. At the average price levels for forest carbon offsets that prevailed in the 2016 to 2020 period, a shift out of traditional timber production into the generation of carbon credits would have been difficult for most commercial timberlands to justify solely on a financial basis. However, if the price of traded carbon continues to increase at a faster rate than the revenue streams generated by the sustainable harvesting of timber followed by the associated replanting of trees, more and more timberland owners are likely to recognize carbon capture and storage as a viable management option for their properties.
Tailwinds, potential asset value support, and risks
Traditional timber tailwinds
Carbon market tailwinds
Carbon market and traditional timber:
Manulife Investment Management analysis estimates that of the over 120 million acres of commercial U.S. timberland suitable for institutional investment—approximately 50 million acres, or $25 billion of assets—would overlap with carbon-focused opportunities with carbon pricing at $8 per tonne. This analysis presents a basic acquisition entry point for carbon-focused investments and doesn’t consider specific required rates of return. This overlap is concentrated in regions such the U.S. Northeast and Lake States, which are characterized by relatively low land and timber values and less concentrated markets for harvested logs. We believe these regions represent attractive carbon-focused investment opportunities and can attract significant investor interest even at projected carbon prices between $20 and $30 per tonne. In contrast, regions such as the U.S. Pacific Northwest, which are characterized by deep timber markets and high land and timber prices, only start to become viable for carbon-focused investments at projected carbon prices above $75 per tonne.
In addition to this overlap with institutional-grade timberland, the Manulife Investment Management study estimated more than 15 million additional acres of U.S. timberland that would have potential for investment in carbon-focused forestry projects, at a carbon price of $8 per tonne. The total investable universe for carbon-focused timberland in the United States at a carbon price of $8 per tonne is estimated at over 65 million acres, representing over $50 billion in value, or one-third of our estimate for institutional-grade timberland value in the country.
The ultimate supply of forest carbon projects will be a function of the growth in demand for carbon credits and the associated trajectory of carbon prices. If climate policy remains supportive of the use of forestry carbon credits and demand continues its anticipated growth, carbon prices should continue to maintain forward momentum and the investment rationale for carbon-focused timber management strategies will become more compelling. Should carbon prices increase to $40 per tonne, for example, we’d expect the size of U.S. carbon-focused timberland investment opportunities to nearly double to over 115 million acres, representing over $100 billion in value, or two-thirds of our estimate of current institutional-grade timberland value in the country. We’d also expect the overlap between carbon-focused and traditional timber markets to increase significantly to over 80 million acres, or approximately $50 billion in value. We’d expect higher carbon prices to open new carbon-focused investment opportunities in various regions, particularly private noncorporate timberlands in the U.S. South.1
Looking forward—carbon credit demand is anticipated to grow
Over the past several years, carbon markets have entered a period of rapid growth and change. As of 2021, 45 countries employed carbon pricing mechanisms. The EU Emissions Trading Scheme—the first, and previously largest, cap and trade system—is developing protocols to allow for forest carbon offset trading expected to be implemented in 2023.
In addition to compliance market evolution, the most dramatic developments are occurring in the voluntary markets. Responding to public concerns about the potential threat of climate change to society and the environment, increasing numbers of corporations and organizations have made commitments to reach net zero GHG emissions by specified dates in the future. The UN Race to Zero Campaign—just one of several net zero alliances that have emerged over the last few years—counts 5,235 businesses, 441 of the biggest investors, and 1,039 higher education institutions among the organizations committing to net zero by 2050. Twenty-one percent of all global corporates have made some form of commitment, and 136 countries, covering 88% of global emissions, have pledged to reach net zero.
Achieving net zero is a worthwhile goal, especially if it’s approached with the intention of curbing emissions as much as possible. The Science Based Targets initiative (SBTi), a partnership between leading global think tanks, has released sector-specific net zero standards that include guidelines on how to reach net zero responsibly and sustainably in line with Paris Agreement climate targets. SBTi advocates first for the abatement of emissions as far as possible, followed by neutralization of the hardest and costliest to abate emissions,2 and, finally, compensation using verified, high-quality carbon offsets. More than 2,000 businesses and financial institutions are working to align their climate commitments with SBTi guidance.
Private sector net zero commitments are leading to an anticipated boom in voluntary carbon credit demand. The Taskforce on Scaling Voluntary Carbon Markets (TSVCM) and McKinsey estimate that carbon credit demand could increase 15x by 2030 to a market value of more than $50 billion and that demand could increase by more than 100x by 2050. Further, nature-based solutions such as forestry can account for between 28% and 37% of the total carbon credit supply (65%–85% when avoided nature loss is included) by 2030 at approximately one-tenth of the cost of technology solutions. These positive demand trends are contributing to a number of carbon market participants forecasting significant increases in carbon credit pricing, as shown by voluntary market forecasts.
Carbon markets are maturing with increased regulation, transparency, and standardization
Across the voluntary and compliance markets, there are efforts to enact regulation to increase transparency and integrity as more and more organizations and individuals look to carbon credits as a core component of climate action. The EU’s Sustainable Finance Disclosure Regulation and taxonomy for sustainable activities are quickly becoming the model for how investors define and categorize sustainable investments and climate mitigation intentions. Article 6 of the Paris Agreement, only just defined at the Glasgow COP 26 in November 2021, will set the rules for how carbon credit trades can take place between countries to meet their climate goals and avoid double counting.
Voluntary frameworks are leading the way for setting standards for carbon markets and ensuring higher-integrity carbon crediting and climate outcomes. SBTi and the GHG Protocol are establishing standards for companies setting net zero commitments—including the use of carbon offsets and insets—and GHG accounting, respectively. The Integrity Council for the Voluntary Carbon Markets (IC-VCM), the governance body that evolved out of the TSVCM, a multistakeholder initiative launched by former Bank of England Governor and UN Climate Envoy Mark Carney and sponsored by the Institute of International Finance, is developing a detailed set of carbon principles to define the attributes of high-quality carbon credits. The Voluntary Carbon Markets Integrity Initiative, another multistakeholder alliance, is building quality standards for credit buyers. Manulife Investment Management has adopted carbon principles for our timberland and agriculture businesses that are aligned with IC-VCM's high-level core carbon principles to ensure that we’re generating high-integrity, high-quality credits for investors and the environment.
Carbon credits have received substantial criticism and are often blamed for enabling companies to continue polluting, but as both economies and companies continue to grow, they’re still a key part of the solution. High-quality carbon credits have a key role to play in both neutralizing residual emissions that are the hardest or most expensive to mitigate and for bridging the transition to net zero as companies prioritize direct emissions abatement. Not all carbon credits are created equal, and it can be difficult to discern between high-quality and other types of credits. Forest carbon credits can range in price from approximately $4 to $14+ per tonne depending on the market, geography, type of project, and whether the credit represents avoided emissions or removals. There’s an increased demand for high-quality carbon sequestration credits as companies are keen to avoid scrutiny over credit integrity. Forest carbon credits can also provide additional benefits such as increased biodiversity and funding for land conservation that commands premium pricing in carbon markets.
Manulife Investment Management’s strategy for driving impact
For over 35 years, Manulife Investment Management has invested in and operated timberland and farmland around the world on a sustainable basis. Our investments in traditionally managed timberland have always sequestered carbon through biological tree growth, and we’ve reported on our emissions and removals according to the GHG Protocol for over 10 years. In addition, we’ve managed carbon projects in both the compliance and voluntary markets on traditionally managed timberland properties in order to generate climate and other co-benefits, as well as incremental financial value for our clients. As carbon market opportunities evolve, we continue expanding our carbon capabilities by embedding carbon valuation into our standard underwriting processes, deepening our carbon analytics and forecasting, and screening all new carbon project opportunities against our carbon principles.
We've established natural climate solutions strategies for timberland, which expand on Manulife Investment Management’s decades of timberland management experience and focus on sustainability to forest portfolios primarily managed for carbon value rather than timber value. These solutions aim to provide investors with the option to select their preferred mix of carbon offset sales and in-kind carbon credit distributions (insets) for use against their carbon footprints and climate goals. We will prioritize contiguous tracts of land while actively protecting highly sensitive areas and habitats through conservation easement sales. Additional value-added strategies, including recreation leases, mitigation banking projects, and renewable energy siting, should further support impact and financial outcomes. Diversification and additional cash yield can be achieved through a subset of traditional sustainable timber management.
These solutions will be the first of many new approaches Manulife Investment Management integrates into our sustainable timberland investment strategies to sequester carbon more intensively and drive broader impact. The world is at an inflection point with respect to climate change, and responsible commitments to reducing and removing emissions, inclusive of high-quality forest carbon credits, are a critical part of the solution. Manulife Investment Management will continue to develop tangible NCS strategies to help investors meet their climate and financial goals.
All currency is shown in U.S. dollars.
1 Manulife Investment Management analysis assumes average timberlands in various regions, and individual property characteristics and economics are essential in determining a timber-focused or carbon-focused strategy. 2 Neutralization of emissions includes reducing emissions in your own value chain through the use of insets or making more sustainable choices across your supply chain.
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