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II. Brazil: CDM Opportunities and Benefits

18 Financing Sustainable Development with the Clean Development Mechanism II. Brazil: CDM Opportunities and Benefits Ronaldo Seroa da Motta and Claudio Ferraz* Instituto de Pesquisa Economica Aplicada
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18 Financing Sustainable Development with the Clean Development Mechanism II. Brazil: CDM Opportunities and Benefits Ronaldo Seroa da Motta and Claudio Ferraz* Instituto de Pesquisa Economica Aplicada and Universidade Santa Ursula, Rio de Janeiro and Carlos E.F. Young* Universidade Federal do Rio de Janeiro, Rio de Janeiro Summary Brazil s forestry and energy sectors both present opportunities for Clean Development Mechanism (CDM) projects. With Brazil s vast forest resources and the present emissions trends associated with deforestation, forestry opportunities offer enormous potential. Which forestry options are possible, and how profitable they will be depend heavily on land prices. Government-supported concessions could be instrumental in providing large-scale, reduced-impact logging opportunities. In the electricity sector, supply is dominated by hydroelectricity, although business-as-usual trends indicate a greater role for fossil fuels, particularly natural gas and fuel oil. Various forms of energy cogeneration and the use of renewables could limit this expansion. Project options are evaluated against 12 different environmental and development criteria to assess how well they overlap with Brazil s domestic objectives. For forestry sector options, the major positive impacts include soil preservation, improvements in water quality and availability, and protection of biodiversity. For energy projects, the main benefits include improved urban air quality, some degree of avoided fossil fuel imports, and protection or enhancement of employment opportunities in low-income groups. Various administrative and policy solutions are proposed to help Brazil manage CDM activities so as to glean the greatest domestic benefit from this new investment source. Development Trends and Priorities Over the last two or three decades, Brazil s economy has alternated between periods of fast growth and high inflation. Past economic difficulties have created structural problems, including rising unemployment and sizable income disparities. Personal income and land ownership has become highly concentrated. In just 30 years, Brazil has also undergone a rapid transformation from agrarian economy into a highly industrialized society. The urban share of population has increased from 30 to 70 percent (IBGE). The overall trend has been toward market-based policies, as evidenced by trade liberalization and numerous instances of privatization and deregulation. Current political debate centers on the appropriate balance between free market and social safety net strategies. The resumption of stable economic growth and the reduction of social gaps remain national priorities across the political spectrum. Although deforestation captures global attention, policymakers in Brazil, as in all countries, often view environmental issues through a domestic lens first. Polls identify urban problems water pollution, sanitation, and waste disposal as being as important as deforestation (e.g., Crespo et al., 1998). There is less concern for global issues, which may be partly due to a lack of understanding about the connection between deforestation and climate change, and almost certainly a lack of appreciation of how remedies for global problems might confer local benefits. Development priorities can be partly discerned from the current Brasil em Ação [Brazil in Action] program, which channels investments toward a mixture of activities. Projects aim to improve health * The opinions expressed herein are those of the authors and do not necessarily reflect the positions of their institutions. Financing Sustainable Development with the Clean Development Mechanism 19 care, irrigation, sanitation, transport, and energy distribution. They include constructing gas pipelines across the Amazon to handle imports from Bolivia, and building waterways and ports in all regions; and irrigation programs for the semiarid areas of the Northeast. Energy investments are driven by the persistent growth in energy demand. With most feasible hydropower sites already exploited, Brazil s future energy supply will rely more and more on fossil fuels gas and fuel oil. With little or no domestic fossil fuel reserves, Brazil will have to import these fuels, with implications for the trade balance. In addition, transitioning to fossil fuels, even relatively clean natural gas, will introduce a new source of urban air pollution. Wind and solar electricity options, though on the agenda, are still relatively undeveloped. Biomass electricity is already established in the form of Brazil s two decades-old ethanol program. This program has become increasingly uncompetitive in the face of high production costs and low global oil prices. However, it still provides important social benefits in the form of employment opportunities for low-income and rural sectors, particularly sugarcane growers. Maintaining the program would also avoid fossil fuel use with both local and global benefits. Energy conservation is improving, at least by major users, following increases in energy costs under macroeconomic stabilization programs. Further efficiency and conservation improvements would slow the expected increase in energy demand with positive impacts on anticipated imports and growing sources of air pollution. Despite obvious interactions, energy priorities are still viewed separately from environmental issues. Although the federal government requires a detailed analysis of the ecological impact of projects, this is not always realized. In some cases, planners have had to bow to environmental concerns, and projects have been cancelled (e.g., the proposed Paraná Waterway, crossing the Pantanal a 3 million hectare (Mha) wetland in Central Brazil). In other cases, accounting for environmental impacts is done through ad hoc adjustments in the economic analysis of projects, with uncertain consequences. Environmental licensing and supervision is often informally relaxed for political reasons. Within the government, environment-related projects are not unified under a single agenda, nor are they articulated at the same level. To some extent, project choice probably reflects the priorities of the main multilateral financing institutions. 1 Generally, although social and growth objectives need not conflict with environmental goals, synergies are not always understood, and there is still a perception that economic development constitutes a higher priority, especially among lower income classes (Crespo et al., 1998). Environmental priorities can be identified from the projects carried out by the federal government, states, and municipalities. Brazil s main priorities appear to be addressing local environmental problems, particularly in the urban context; its management of forest areas where deforestation, water and soil protection, and biodiversity are all key issues; and its management of water resources generally. Elsewhere, the experience of the ethanol program points to a desire to provide and maintain employment opportunities for particular groups. If activities under the CDM are to appeal to Brazilian decisionmakers, they will need to generate concrete benefits for these and other priority areas. Climate Change Response Options Potential abatement options in Brazil comprise both energy- and forestry-related projects. Of the two, forestry projects promise to be more financially attractive, despite their unresolved legitimacy as CDM projects. Forestry Options Brazil s forestry sector provides excellent project opportunities for both carbon sequestration and enhancement of natural sinks. Brazil s climate and abundance of land create ideal conditions for silvicultural plantations. Though already profitable, their development has been limited by capital constraints and a lack of long-term financing mecha- 20 Financing Sustainable Development with the Clean Development Mechanism nisms. Preventing deforestation, through protection of native forests, could have an even greater impact by avoiding the release of more carbon to the atmosphere than could be absorbed by sequestration activities. Nevertheless, curbing deforestation is no easy task. It would require addressing pervasive economic structural problems and devising a program broad enough to eradicate, not relocate, illegal logging. 2 Also, CDM doubts are greater regarding protection of existing forests than they are for sequestration activities. Much of Brazil s timber is harvested on an illegal and non-sustainable basis, particularly in the Amazon, where timber production takes advantage of land-conversion laws. 3 Land clearing for agricultural purposes generates a cheap supply of timber without any investment in land by the logger. Wood production is consequently highly profitable, and timber exploitation often drives land conversion, not vice versa (Seroa da Motta and Ferraz, 1998). Nonsustainable logging activity generates estimated rates of return of 30 percent up to 100 percent, if timber processing is included (Almeida and Uhl, 1995). Production in the Amazon region has increased by 172 percent during the last decade, compared to 16 percent growth in total national wood production (Prado, 1995). Weak and poorly funded public agencies are almost powerless to prevent illegalities. Reduced-impact logging, as practiced in National Forests (FLONA) could reduce environmental losses considerably compared to exploitation at the frontier (e.g., Amaral et al. 1998). However, it cannot compete with illegal timber practices. Sustainable logging entails large investments in land, auditing, and certification expenditures and compliance with taxes. These costs outweigh the small benefits of reduced production losses and increased tree growth. Moreover, implementing sustainable logging, project by project, merely encourages illegal logging to move elsewhere. This threatens the viability of reducedimpact projects and constitutes an important leakage problem for the CDM market. Core elements of the FLONA concept are, however, very appealing. Applied broadly, in tandem with national parks and biological and extraction reserves, it could create a quasi-sustainable pattern of land use in the Amazon. But to succeed, it has to be as profitable as illegal logging, which current enforcement efforts are powerless to curtail. As seen below, profits earned by CDM credits could make a difference. Review of Forestr estry y Options Six forestry response options are reviewed three plantation options and three sustainable forest management options (Table 2-1). The financial viability of forestry options is most sensitive to land prices, particularly for reduced-impact logging, with its long rotations. After a period of price escalation in the early 1990s, land prices have been declining but are expected to rise in the future. Here, it is assumed that land prices will return to their previous highs. Two other assumptions are important. First, only the extraction phases are analyzed. Wood processing and manufacturing are not accounted for, since this activity involves a great variety of technologies and products, beyond the scope of a preliminary study. In any case, carbon releases occur mostly at extraction. Second, learning costs are assumed to be minimized for plantations since they are already widespread in Brazil. Because native forest management is not yet undertaken in Brazil, analysis is based mostly on field surveys. Silviculture e Plantations Silvicultural plantations are a thriving business in Brazil. Industrial wood production from planted forests increased by 53 percent between 1990 and 1995, to about 107 million cubic meters (Mm 3 ) (Prado, 1995). Brazil has ideal conditions for plantations: the tropical climate allows for short rotations (6 to 12 years), land is abundant, and there is a wealth of experience to draw on. Almost 60 species are grown for commercial use (Fearnside, 1995). Plantation developers face two main problems: price volatility in a very competitive international market and credit requirements for long-term investments, particularly in land. The grace period for funding from governmental credit agencies is still too short to address the industry s inherent long- Financing Sustainable Development with the Clean Development Mechanism 21 Table 2-1 Forestry Response Options in Brazil Silvicultural plantation for pulp Silvicultural plantation for charcoal Silvicultural plantation for sawlog Private sustainable forest management for sawlog Public concession forests for sawlog Average carbon benefit/ha a Internal rate of return (percent per annum) b Excluding land costs Including land costs Concession forests as part of a conservation program Implied carbon price (US$/tC) c a. The carbon benefits from plantations are measured as the difference between the carbon stock of plantations and the carbon stock of degraded land. Carbon stock estimates consider live and dead biomass, soil, and wood products. For sustainable timber management, the carbon benefits are measured as the difference between the carbon stock of sustainable logging and nonsustainable logging plus wood products, soil carbon, and fossil fuel substitution (in the case of charcoal), according to estimates from Fearnside (1995). b. Estimates for plantations without land costs are taken from Fearnside (1995) and sustainable management values in column 4, for the case without land, are taken from Almeida and Uhl (1995). Land costs are assumed to be US$200/ha. Calculations do not properly account for scale effects on input and land markets. All values are in 1992 U.S. dollars. c. Measured as the net present value divided by the carbon benefit for each option. Values are the carbon break-even prices required to make the internal rate of return equal to 12 percent per annum. A negative value indicates that the investment is already profitable. term maturity of investments. Although silvicultural plantations are one of Brazil s most dynamic sectors, revenues from the CDM could be crucial in overcoming these barriers. Plantations differ widely. Here, estimates of profitability and carbon benefits are developed from a range of existing projects. Fearnside (1995) has estimated net present values per hectare and rates of return for pulp, charcoal, and sawlog plantation, excluding land costs. 4 These costs were $13.60, $3.47, and $14.45 per ton of carbon (/tc) for pulp, charcoal, and sawlog plantations, respectively. 5 As shown in Table 2-1, all three plantation types offer high financial returns. With an internal rate of return (IRR) of 17.6 percent, the sawlog option is the most profitable, followed by pulp (14.6 percent), and charcoal (13.3 percent). Land costs were also factored in at a price of US$200/ha consistent with future expectations. 6 Even including high land prices, all options are still profitable. The high financial returns will allow plantations to provide CDM credits at very low cost. The carbon price for pulp and charcoal plantations would be less than US$1.50/t whereas sawlog plantations are already profitable and would take any positive carbon price. Of course, profitability is sensitive to relative factor prices, which are hard to forecast. Hence, in the plantation sector, CDM revenues will act as an additional source of income to hedge against land cost and fiber price oscillations, not as a prime motive for investment. Sustainable Forest Management for Sawlog Production Reduced-impact logging aims to minimize ecological damage to forests and to reduce wood losses. However, it imposes a land-management burden. While illegal loggers harvest wood at a rate of 38m 3 / ha at the forest frontier, reduced-impact logging generates a typical yield of 1.3 m 3 /ha. Therefore, to achieve the same output per hectare as open-access activity, sustainable loggers require 30 times as much land, operating on a 30-year rotation (Amaral et al., 1998; Almeida and Uhl, 1995; and Veríssimo et al., 1992). Comparisons must be made between sustainable logging with land investment and a 30-year 22 Financing Sustainable Development with the Clean Development Mechanism rotation and unsustainable logging without land purchase. Furthermore, although certification programs would ideally create premiums for sustainable wood, poor institutional capacity, combined with international market forces, means that higher prices cannot be assured. In this analysis, we assume a constant price for wood irrespective of management practice. We analyze three sustainable forest management options: a project-level approach where land is available at market prices, and two related possibilities of procuring cheaper public land under concessions as part of a sustainable timber program in the Amazon. Private Land Option. Sustainable logging, excluding land costs, generates an annual net income of US$28/ha on an initial capital cost of US$83 a 33 percent rate of return (Almeida and Uhl, 1995). This is higher than the 30 percent return estimated for non-sustainable logging due to increased tree growth and less wasteful extraction processes. However, the rate of return falls to 0.5 percent when land costs are folded in. 7, 8 Sustainable logging saves 18 tc/ha compared with non-sustainable logging (Fearnside, 1995). Based on these estimates, private sustainable timber management with land costs would require a carbon price of about US$9 to make it viable higher than plantation options. But the higher carbon price would buy significant ecological and social benefits. (See below.) Also, for reduced-impact logging, the carbon revenue will be a key determinant of project viability and not just a hedging mechanism as with plantations. Concessions for Public Land. The National Forest Program, designed by the current government, has proposed concessions for between 40 Mha and 60 Mha for sustainable management practices. With government support and public acquisition of land, the land costs for the sustainable logger may be sharply reduced. 9 Here, it is assumed that land costs will be US$69.50/ha. Applying this price to the sustainable management figures above, generates a rate of return of 1.3 percent and a carbon break-even price of US$1.80. This concession program would be more profitable than private sustainable management and at a lower carbon price. However, distinct from the private option, it requires government commitment and initiatives. In Brazil, that will put pressure on scarce budget resources. CDM credits could relieve this pressure. A key benefit of this proposal comes from its scale. Practicing reduced-impact logging, project by project, does little to dampen incentives for nonsustainable logging elsewhere. The leakage problem is large. However, under a national plan of concession forests, sustainable logging could eventually provide an annual output of between 50 Mm 3 and 70 Mm 3 of roundwood, completely displacing current unsustainable production (Ferraz and Seroa da Motta, 1998). Concession Forest and Conservation Program. Another proposal would integrate concession forests with a broader conservation program by applying proceeds from concessions toward natural capital investments. A conservation program set out by Funatura (1992), of which concession forests are part, is based on the conversion of 30 percent of the Amazon into conservation unit areas at a total cost of US$7.65 billion. 10 If this 30 percent share of conservation land were added to the current 16 percent of indigenous reserves, an impressive 46 percent of the Amazon would be controlled. This 30 percent increment would represent a significant contribution to the preservation of natural capital, particularly in marginal terms, since it may constitute closure of the frontier. If concession forests on this scale could eradicate unsustainable logging, the whole conservation area will generate at least enough carbon benefits to change the pattern of use from nonsustainable
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