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5.3.5. Risks
Quantification of GHG emissions or removals in LULUCF projects is subject to
a variety of risks and uncertainties. Some of these risks and uncertainties
are inherent to certain land-use activities (particularly forestry); others
may be generic and applicable to any GHG mitigation project in the energy and
LULUCF sectors.
Risks refer to events that negatively affect the expected GHG benefits of the
project. Land-use projects are exposed to a series of risks, such as natural
risks (e.g., rainfall, sunlight, pests and diseases, reductions in growth rates,
fire, climate change); anthropogenic factors (e.g., encroachment, fires, theft);
political risks (e.g., non-enforcement of legally binding contracts between
project partners, noncompliance with guarantees, expropriation, uncertain property
rights, policy changes); economic risks [e.g., exchange rate and interest rate
fluctuations (Shapiro, 1996), changes in the prices of the relevant factor and
product markets (Janssen, 1997), changes in the opportunity costs of land];
financial risks; institutional risks (e.g., land tenure); and market risks.
Not all of these risks are exclusive to land-use activities. Because land-use
activities have strong social implications; rely on a land base; and depend
on natural factors such as rainfall, sunlight, pollinators, and exposure to
natural and anthropogenic factors, however, such activities are particularly
exposed to these risks.
Risks of project failure because of fire, climatic variations (e.g., drought
or storms), and pests also entail potential negative environmental and social
impacts associated with failed projects. Implementation of large-scale teak
plantation projects in India, for instance, may have led to cultivation of monocultures,
that are susceptible to pest infestation, loss of timber affecting local timber
markets, and associated release of sequestered carbon (Ravindranath et al.,
1998). Because carbon mitigation projects also have to address issues of sustainable
forest management, the risks associated with these new endeavors-where there
is less experience and infrastructure to draw on-may not realize the full potential
of co-benefits. In the Salicornia project (Box 5-1),
for instance, a new concept is being tested to evaluate the cultivation possibilities
and commercial uses of a previously uncultivated crop. The entry of Salicornia
straw to wood markets could lower the price of wood, reducing the incentive
for forest plantations locally (Imaz et al., 1998). Project developers
will have to establish procedures to deal with extra costs in the event of such
impacts. For example, the Costa Rican government has committed to find replacement
farmers if targets are not met in the PFP project. Another example is the contractual
obligations required by the FACE Foundation, which require project implementers
to replant any forests that are lost during the project's time frame (Verweij
and Emmer, 1998). Alternatively, in the context of a growing trend in trading
in carbon credits, management can be expected to seek to lay off these risks
in conventional insurance and reinsurance markets.
Risk mitigation can be accomplished through a variety of internal and external
mechanisms to the project. Internal methods include the following:
- Introducing good practice management systems to control the occurrence
of damaging events.
- Project design, aiming at diversification of activities within a project
and spreading of projects in different areas, reducing the risks that damage
(e.g., fire, pests and diseases, flood) will spread.
- Maintaining self-insurance reserves or keeping a portion of the project's
benefits as a reserve to insure against any shortfalls. This reserve could
be financial or in-kind (GHG benefits). This approach was used by the national
program of the Costa Rican Office for Joint Implementation, which placed about
40 percent of credits derived from the PFP project in a self-insurance buffer
reserve (SGS, 1998). If damage does not occur, this reserve can be used at
the end of the project lifetime.
- Diversification of sources of funding, reducing financial dependency on
a single source.
- Involvement of a wide range of stakeholders, through consultation and participatory
management.
- Creation of positive local side effects from hosting the project, such as
transferring needed technologies, fostering local social developments (e.g.,
job creation), or creating positive side effects on other local or regional
environmental goals in the host country (Janssen, 1997).
- Project auditing and external verification, which may serve as a way to
highlight project risks early on.
- Timed allocation of GHG benefits. If GHG benefits are credited to project
partners only after they are fully realized, there will be less need for long-term
guarantees and a lower perception of risk. This allocation could be accomplished
by staggering sequestration and crediting or by only allowing crediting according
to a ton-year factor calculated according to an equivalence factor between
CO2 sequestration and emissions (Moura-Costa and Wilson, 2000).
External methods include the following:
- Cross-project insurance through direct arrangements in which projects would
guarantee each other.
- Regional carbon pools-a similar approach in which "carbon banks" are established
with contributions from a diversified pool of projects to insure contributing
projects.
- Financial insurance. Some insurance companies are already offering services
related to risk mitigation for carbon offset projects. It is important to
note that a series of project risks are common to non-GHG specific activities
and traditionally have been covered by standard insurance schemes (e.g., crop
or timber insurance).
- Portfolio diversification in terms of placing different projects in different
locations [e.g., the FACE Foundation's portfolio (Verweij and Emmer, 1998)].
There are still issues related to liability, such as allocation of responsibilities
for ensuring compliance and deliverables. The UN Conference on Trade and Development's
Emissions Trading Forum has raised issues of responsibility such as "buyer beware"-in
which buyers are responsible to ensure that offsets are valid-or "seller beware,"
in which an exporting country would have the entire transaction invalidated
if projects do not deliver (Tietenberg et al., 1998). This approach has
different implications for countries with and without emissions limitation caps.
Additional issues raised during the meetings of the Ad Hoc Working Group on
CDM included allocation of liabilities between nations, individuals, and certifiers
(Stuart, 1998; Stewart et al., 1999).
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