JOINT COMMITTEE ON CLIMATE CHANGE AND ENERGY SECURITY debate -
Wednesday, 1 Dec 2010

Sustainable Forestry and Forest Carbon Sequestration: Discussion

Chairman

Members are reminded of the long-standing parliamentary practice that they should not comment on, criticise or make charges against a person outside the Houses or an official either by name or in such a way as to make him or her identifiable. By virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of the evidence they give to the committee. If you are directed by the committee to cease giving evidence in relation to a particular matter and you continue to so do, you are entitled thereafter only to a qualified privilege in respect of your evidence. You are directed that only evidence connected with the subject matter of these proceedings is to be given and you are asked to respect the parliamentary practice to the effect that, where possible, you should not criticise nor make charges against any person, persons or entity by name or in such a way as to make him, her or it identifiable.

I welcome Mr. Paul Harris, head of natural resources risk management in global markets, Bank of Ireland and Mr. Tony Lyttle of EcoSecurities Group. The committee has met other stakeholders in this area including Coillte, the IFA, the Irish Timber Growers Association and representatives from the private sector. We will meet the Minister of State, Deputy Seán Connick, on 15 December. The committee is interested to hear presentations by today's witnesses, which will be followed by a question and answer session. We aim to conclude as soon as possible after 6.30 p.m. I am sure the witnesses have to make their way home as well. I invite Mr. Harris to begin.

Mr. Paul Harris

I thank the Chairman and the members of the committee for the opportunity to address it this afternoon. I have followed the work of the committee for some time and I congratulate it on the quality of its output and the contribution it makes to the climate change debate, an area many of you know I am passionate about. I have been involved in the carbon area since 2004, when I launched Bank of Ireland's presence in the market. We remain the only domestic bank with a dedicated capability in the carbon markets and we have a reputation as an innovative niche player, having been the first bank to transact an emissions-related derivative with a corporate customer and the first bank to offer a carbon-linked deposit to Irish investors. We do not engage in proprietary activities in the carbon market.

In addition to the carbon activities of the bank, I am the chair of the expert carbon group of the Clearing House Group, which is tasked with the development of carbon-related initiatives in the context of the green IFSC. The range and reach of the carbon markets covers several diverse sectors that are at varying stages of development. I have ensured I am well versed in the areas that offer the greatest potential business opportunity and, for that reason, in an Irish context I have paid close attention to the emerging carbon removal capacity of forestry. I hope to offer an insight into how the application of carbon offsets to forestry transforms the investment potential of the sector, which could be of significant benefit to Ireland. My contribution to this committee is based on my experience of carbon markets in a broad industry context. I propose delivering a short presentation outlining the scope of forestry offset investment potential and I will be happy to answer any questions committee members may have on the subject matter.

I wish to set the scene in terms of the current situation and the structure of the existing forestry investments before reviewing the key components of investment criteria and considering the value of carbon in this respect. I will offer an insight into how forestry investment can use the value of carbon sequestration to transform the nature of capital raising, providing cost-efficient ways of implementing afforestation.

Ireland has a low percentage of forest cover relative to the European average. Conversely, we have an extremely high agricultural emissions rate. As part of a commitment to EU targets, we must reduce non-traded emissions by 20% by 2020. Our current sequestration rate is a net 2.4 million tonnes per year. Given the efficiency of forestry to act as a carbon sink, it is clear that increased afforestation in Ireland would make a contribution to meeting our non-traded sector target. It is important to find a way to encourage afforestation in a viable way, which will entail strengthening the investor proposition. The benefits of increased afforestation are well documented. In addition to the increased sequestration potential, biomass capacity will be enhanced, the tourism proposition will be developed and direct and indirect employment prospects will be improved. The opportunities in the forest tech sector, for data analysis products in particular, are very strong and are often overlooked. I have in mind TreeMetrics in Cork, which represents a prime example of a young exciting company with a business model based on technical forestry analysis.

I will move on to an examination of traditional forestry investment. Forestry investment is a distinct asset class with unique features. The land element, on which the timber is grown, represents a larger percentage of the value during the early phase of the investment. The timber crop will generate a large percentage of overall investment value towards maturity. The value of incentives and allowances at the commencement of the investment and tax relief or exemption on disposal of the asset, will shape returns. Forestry investment is by definition a long-term, principally illiquid investment with an average life of between ten and 12 years. The associated cash flow is back-ended, with balloon repayment on maturity at the disposal of the timber harvest and, in many cases, land transfer. Minor cash flow may be generated from the proceeds of thinnings throughout the life of the investment but, for the purposes of calculating overall yield, this is marginal. The long-term nature of the investment, with uncertainty over timber yield and the final saleable value of the crop and land values over the period, means that the returns are difficult to calculate. This is a factor that discourages investors. Further risks to the investment return centre on natural risks such as damage from wind, frost, disease and fire although in the overall context, this can be neutralised by insurance cover.

All investment decisions are dependent on the required rate of return comprising five main elements. The first is the risk-free interest rate, the rate of return an investment can earn without any risk. This is illustrated in the slide, showing the 20-year euro interest rate curve. The second element is the inflation premium, the rate added to an investment to adjust it for the market's expectation of future inflation. The liquidity premium compensates the investor for being unable to realise the value of an asset before maturity. Forestry investment is typically illiquid and the premium for the inability to exit the investment is high. This aspect remains the single biggest deterrent to potential investors. The default risk premium is the risk that the investment will not deliver on its obligations. In the forestry context, this refers to the risk inherent in the variability of the timber crop price and the risk that wind, fire and disease will reduce the projected harvest yields. There is an element of risk associated with adverse future land valuation. The final aspect is the maturity premium. The longer the maturity, the greater the risk of capital loss. With forestry investments of between 12 and 20 years, the maturity premium will be substantial. Unsurprisingly, traditional offerings in forestry investment carry a significantly greater weighting of the last three elements. Applying these elements to the risk-free return, the investor return curve is deepened dramatically. This is reflected in the columns across the maturity curve in the slide. This calculator curve reflects the current required return of more than 7% for 20-year forestry investment, which is consistent with current market offerings. The key issue for those seeking to raise money in the sector is that the maturity profile of forestry investments, with all the returns back-ended into balloon repayment, means investors will continue to demand a high risk premium adjustment, making capital raising expensive relative to other sectors. The ability of the forestry business to vary or modify cash flow to deliver coupon-type returns unlock the potential for cheaper funding. This point makes the application of carbon sequestration rights so interesting. The graph on the slide being shown illustrates the current projected forward prices of carbon beyond phase 3 of the EU emissions trading scheme. It assumes an increasingly lower cap in Europe and the emergence of a linked market in the US, Japan and Australia. Current pricing is available up to and including 2020 and the price curve beyond that point is based on the aforementioned assumptions, adjusted volatility and the future interest rate curve.

The graph now being shown illustrates the current value of projected carbon sequestration under various scenarios using data from the committee's report on the EU Green Paper on protecting forests against climate change. If the current long-term carbon prices are applied to the various scenarios one can see the annual euro value after ten years is a minimum of €80 million and as much as €120 million.

The availability of a stream of forestry credits issued annually presents an opportunity for the transformation of the forestry investment offering. This transformation of the cashflow architecture opens up the possibility for forest owners to be able to diversify their investment offerings and cheapen the overall cost of capital. The additional flow of funds from the periodic disposal of carbon offsets could most effectively be used to address the key issue that has been identified as a barrier to investments, namely, liquidity. The prospect of a cashflow that facilitates coupon payments to investors over the life of an investment would have a positive effect on the composition of the investor return premium referred to previously.

The most efficient way of utilising prospective cashflow is for the forestry company to issue a range of investment opportunities through a special purpose vehicle, SPV. Such an SPV would be likely to hold a portfolio of various forests. Investments could vary in structure to appeal to the widest range of investors and include bond equities and deposit products. The advantage of using such a structure would mean the company could utilise various maturities to reduce its risk profile and thereby cheapen the capital cost. The inflow of credits when monetised could cover debt servicing. A contingency or buffer pool of credits must be maintained to ensure the cashflow is maintained in the event of non-performance of any of the plantations in the SPV. This could happen if the plantation were hit by fire, disease or other yield constraints. Any assumption regarding the future price of carbon should be reinforced with long-term hedging of the market risk. This could be achieved either through forward sale agreements or through the purchase of floors.

It is undeniable that the forestry credits concept is in its infancy but like many features of the carbon market there is a rapid rate of development globally as these points illustrate. lnterestingly last week the Chinese state forestry administration announced plans to launch an afforestation monitoring centre with a view to including forestry in its domestic voluntary market. I believe the demand for forestry credits is set to increase, in common with other carbon-linked assets, and my experience of the investor asset class suggests that demand for carbon-related investment opportunities is growing. If one considers a domestic offset scheme, the availability of forestry offsets may make a very strong contribution. This is my vision for the Irish non-traded sector which clearly shows the input that forestry carbon could have in a commercial application in such a system. Demand to purchase forestry offsets may well emerge from non-traded sector businesses in Ireland.

I hope I have shown how carbon sequestration rights can be used to transform forestry investments in such a way as to make afforestation an attractive proposition. This would benefit the country on many levels, support the farming community and encourage the financial sector to develop structures facilitating this aspect of the carbon market and attract investment funds into Irish forestry.

Chairman

I thank Mr. Harris. I invite Mr. Tony Lyttle to make his presentation.

Deputy Simon Coveney

This is the first time I have seen a disclaimer on the back of a presentation being made to the committee. It is a changed world.

Mr. Paul Harris

Yes, a brave new world.

Mr. Tony Lyttle

I thank the Chairman and members of the committee for the opportunity to make a presentation on such an exciting and important topic for Ireland. We have just heard from Mr. Harris on the investment opportunities that exist through trading carbon credits generated from forestry. I will now explain the structure and platforms of the markets that exist. As we are all aware, every investment, security and product requires a platform for the settlement, transfer and trading of units.

To set the scene and to better understand my area of expertise and where it fits into carbon forestry sequestration, it makes sense to explain a little about EcoSecurities and what I have achieved during my time there. I will then describe in detail the two markets I believe Ireland can utilise to monetise and trade any credits generated via carbon sequestration. For the purposes of this presentation I will refer to these two markets as the "compliance" and "voluntary" markets. For the compliance market I will detail the market structure and flows and then move on to describe the specific example of the New Zealand trading system and how it taps into this market to trade its forestry-based credits on the international markets.

While I believe our focus should be on utilising the compliance market structure it is important to remember the voluntary and domestic markets also allow for the trading of such units and we should at least touch on the structure and possibilities in this marketplace. With this in mind, I will describe how a proposed Irish domestic market would work and suggest how it could fit into the wider voluntary domestic global market.

During my time with EcoSecurities, we have been involved in numerous milestones in global carbon market developments, many of which are clear from the slide in the presentation. I will not read through all of them but the statistics are in front of us. The point to be taken from the slide being shown is that EcoSecurities has been at the forefront of the clean development mechanism, CDM, process since inception.

Having worked for EcoSecurities for more than three and a half years I have been instrumental in establishing its back office and settlements and treasury departments. I have been actively involved in trading and settling some of the first CDM credits on the community international transaction log, CITL, and the international transaction log, ITL, as well as effecting the first transactions in several voluntary domestic schemes, including the Californian climate action reserve and APX. I was also involved in managing some of the first internationally-traded New Zealand credits generated from forest sequestration. It is with this experience that I will discuss the potential methods by which Ireland can tap into the existing infrastructure and platforms for the purpose of monetising and trading carbon credits generated from forest sequestration.

For the purposes of this presentation, the compliance market refers to all schemes implemented to ratify and support the Kyoto Protocol such as the EU emissions trading scheme, ETS. The market can be split into three tiers as per the diagram on the slide being shown. Starting at the top we have what is referred to by many as the primary market. The primary market refers to carbon units known as certified emission reductions, CERs, which are units generated via carbon reduction projects in developing, or non-annex 1, countries. These units are accredited by the executive board of the United Nations Framework for the Convention on Climate Change, UNFCCC, through a rigorous monitoring and verification process. Once verified and issued by the UNFCCC the units flow into the secondary market and into one of the national registries supported by the CITL and the ITL. These consist of a series of national registries maintained and administered by the relevant government department in each country. In Ireland, the EPA maintains the national registry. Each of these national registries can hold a multitude of various carbon credits. However, today we will focus on allowable amount units, AAUs, and certified emission reduction units, CERs.

The division between the ITL and the CITL is created by the different schemes under the Kyoto Protocol. The CITL is the platform for the EU ETS and the ITL is the linking mechanism between the CITL and the other Kyoto-based schemes that exist outside of Ireland, such as the schemes in New Zealand, Switzerland and Japan. While these accounts are segregated, there is a certain amount of fungibility between them, which allows CERs and AAUs to be transferred between different schemes, as represented by the middle of the presentation. Other flows of units into the secondary market come in the form of AAU, allowable amount units, a Kyoto Protocol unit equal to one metric tonne of CO2 equivalent. Each annex 1 party issues AAUs to the level of the assigned amount as dictated by the EU-ETS or the relevant scheme in which it is involved. Once issued, these AAUs can also flow freely between the ITL and the CITL. Emissions trading in the secondary market is further supplemented with the growth of several different private exchanges and platforms. These platforms are ultimately reliant on the CITL and ITL structure described above physically to transfer, retire and settle the transactions. No AAUs are currently traded on these new platforms.

To the left and the right of the middle section in the presentation I have identified the current New Zealand scheme and the potential Irish scheme which allows for another flow into the secondary market from forestry-based projects. The next slide considers this process in more detail. Articles 3.3 and 3.4 of the Kyoto Protocol deal specifically with carbon sinks, including forestry. They state: "the net changes in greenhouse gas emissions by sources and removals by sinks resulting from direct human-induced land-use change and forestry activities ... shall be used to meet the commitments under this Article of each Party included in Annex 1". This means it is possible for a country to reduce its national carbon inventory via forestry activity and to create internationally tradeable units for the benefit of the landowner. New Zealand has implemented such a scheme.

On the slide, we can see how the units generated by forestry can ultimately be traded on the international compliance market. This slide shows land use and land use change by forestry. This creates a sink which generates a removal unit, RMU, which can be used for the benefit of the national inventory of the country in which the forestry was generated. The RMU in national inventory frees up the country's allowances or its AAUs. The Government can then ring-fence the AAU that was freed up by retiring or moving to a segregated account. This means that the New Zealand unit the landowner has generated through forestation can be converted to an AAU and traded internationally via the platforms and exchanges described previously through the ITL and CITL. There is a growing voluntary market, which refers to the amalgamation of smaller domestic schemes, attracting attention from the corporate social responsibility buyer as opposed to the compliance buyer. Ireland is examining proposals to implement such a domestic scheme. It is important to ascertain how carbon credits from forestry could fit into such a scheme and then consider how this scheme could tap into the wider global voluntary market.

The next slide suggests a possible structure for a domestic offset scheme in Ireland. A domestic offset market is a financial market where Irish firms create carbon credits through the abatement of missions by their commercial activities and can sell these credits to Irish firms required to purchase carbon credits. The driver of this action can be caused by legislative requirements to reduce Ireland's net emissions or by voluntary commitment to achieve a carbon neutral scenario in their business operations. The top of the slide indicates the different sectors incorporated in the scheme and the green box refers to the verifier or monitor, an independent body verifying the scheme and monitoring the emissions reductions generated. Once these are issued, in a manner similar to the Kyoto Protocol scheme, there must be a registry - the equivalent of a stock bank account - in which one can lodge and register these units. Each client will have a segregated account within the system which will allow for the transfer and trading of the credits created in the domestic scheme.

The previous slide showed how the domestic offset scheme in Ireland would work and how the credits could be traded through an Irish account and registry. We should bear in mind that there exists a series of domestic schemes and voluntary schemes. At the top of next slide we have a series of domestic and voluntary schemes, including a proposed Irish domestic scheme. Each of these schemes has links to specific registry for recording and retiring their units. In recent times, many of these registries have allowed the transfer of different units from the different schemes into a registry which ultimately allows for the joining together of what was previously a disparate marketplace. Markit, APX and Californian Climate Action Reserve, CCAR, all allow for the flow of certain units from different schemes between themselves.

Deputy Simon Coveney

What is CCAR?

Mr. Tony Lyttle

It is a specific voluntary scheme in California that I believe will be implemented in law. It is a localised version of the Kyoto Protocol, a voluntary scheme for cap and trade.

Deputy Simon Coveney

Is APX the same?

Mr. Tony Lyttle

APX is effectively a registry that allows for the recording of particular voluntary units, usually those created through the CDM process. While the CDM process creates compliance units, it is also feasible to create voluntary units depending on the time at which they are created. Those voluntary units are traded not in the compliance market but in the voluntary market. A series of registries and private industries have been set up to facilitate the transfer and trading of voluntary units as opposed to compliance units. APX and CCAR are two small examples of localised schemes that exist. It is my suggestion that any domestic scheme in Ireland should seek to affiliate itself with a series of markets and to ensure the fungibility of forest units across as many registries as possible.

The market platforms and structures currently exist to support an Irish forestry-based scheme. There are current examples that Ireland can learn from and mimic. The issue is to identify the market most suitable or advantageous to Irish forestry owners. As with the New Zealand example, it is possible that Irish forestry credits could be part of a domestic offset scheme and still be tradeable in the compliance market. To identify which market is most suitable, the following points should be taken into consideration: the price of the units within each market, the liquidity of the market and the existing platforms and structures.

We must also consider the Government participation in property rights. There needs to be a change in property law to implement this in order that the ownership of units created can pass from the Government to the landowner. I will let legal experts comment on that matter. We must consider the extension of the Kyoto units into phase 3. After the current meeting in Mexico, the markets will be unclear as to what phase 3 will look like and whether Kyoto style units will be transferred into the new period. The lack of certainty is having a negative impact on the price and needs to be considered when identifying the process for Irish forestry credits.

Chairman

I thank the two delegations for their presentations. Deputy Sargent has indicated that he must leave at 6 p.m. so we will allow him to ask questions first.

Deputy Trevor Sargent

I beg the indulgence of my colleagues. I thank Mr. Harris and Mr. Lyttle for their presentations. Regarding Mr. Harris's slides and the implied forward curve, why does the curve tail off? Is this a disincentive if people expect the curve to go upwards in a straight line? Is this linked to risk later in life of the forest or is it linked to slower growth? Perhaps Mr. Harris can remind me of this point because I missed it. Does the investment generally favour an end use of the forest? Timber and biomass can come out of the same forest. In overall planning terms, given the amount of work needed to ensure a forest is managed to the best and highest standard, is that investment in timber reflected at the end of the project?

I would be interested to know whether the delegates have any expectations of the Cancun intergovernmental conference. If so, they might pass them on to us. Has the recent coverage, including an article by Frank McDonald in The Irish Times last Monday on the fall-off in interest in climate change-related initiatives, had any impact on investments of the kind mentioned? Is there anything in the delegates’ activities that might help people to understand the importance of this issue? I noted in today’s Irish Independent a remark, typical of what I regard as flippant journalism, stating the more climate change there may be the better because then we would not have the snow to worry us. God help us if the Gulf stream switches off, if that were to be the case. Does Mr. Harris recommend a response to that type of journalism?

Chairman

Perhaps Mr. Harris might care to respond in brief because the Deputy must leave. We can then bring in the other members.

Mr. Paul Harris

I am not sure I follow Deputy Sargent's point. Perhaps I was not clear about the curve.

Deputy Trevor Sargent

When I look at the curve as shown on some of the slides it appears to flatten out. It goes up-----

Mr. Paul Harris

That is a reflection of the demand and supply and the fact that in 20 years' time there will be a much thinner market. Therefore, the risks of non-delivery of an investment in 20 years would be largely the same as that of non-delivery in 25 years.

Deputy Trevor Sargent

It is a projection and is not necessarily true.

Mr. Paul Harris

Yes. For the purpose of illustration, however, it reflects the risks further into the future. For example, if the Deputy were to lend me €10 and I told him I would repay him tomorrow that would be a lesser risk than if I were to repay him after Christmas.

Deputy Trevor Sargent

I see.

Mr. Paul Harris

That was an interesting question about investment use. Obviously, forestry management is key to the quality of the timber yield, in terms of quantum and the actual timber produced. I take the Deputy's point about biomass. If one takes a carbon approach to afforestation certain species have a greater sequestration capability than others. Any approach we would take in Ireland would consider broadleaf varieties over Sitka spruce which seems to prevail at present, even though the spruce is faster growing. It might well be that if sequestration rights were given to forestry owners one would see a diversification of the types of species established in plantations that would reflect the increased carbon value as opposed to the underlying timber value at the end of the investment.

I realise the Deputy is under time pressure. In brief, my expectations of Cancun are much the same as those of everybody else. In the conversations I have been having with counterparts in London, Paris and the United States, we have decided by and large that there will not be anything of great importance in Cancun. To take the initial coverage, it seems the divisions that were apparent in Copenhagen have been revisited to date. I am a great believer that it is better to work to a deadline. We may expect something more concrete in Africa next year as we come up to the wire, so to speak.

I turn to the idea of appetite for climate change. In recent times, particularly if one looks at matters such as the carbon disclosure project, what has been most successful is the message getting through to business that going green and being more efficient is better in pounds, shillings and pence terms. A report came out today in the UK underlining that businesses understand being green and being efficient is better for the bottom line. That plays a huge part in getting the hearts and minds of people on board.

As to people looking forward to climate change, basking in sun instead of walking through slush, that is a matter of public perception. Again, I am a great believer in having a centralised Government investment scheme such as a green SSIA or something similar whereby people might have a vested interest because it would be about the euro in their pocket. They might then have a greater propensity to understand the issues around and benefits from renewable energy. The energy security question is different again. I suspect that one will just have to wait until energy supply becomes more constrained for the penny to drop with the general public in that respect.

Deputy Trevor Sargent

Does Mr. Harris have a leak to disclose? We would all be interested to know which species are better, proportionately, from the sequestration point of view.

Mr. Paul Harris

I am sure there has been significant research on that by the Crawford group.

Deputy Trevor Sargent

We can get that research..

Deputy Simon Coveney

I welcome the delegation. For policy makers, this committee is very educational. Today I learned a little more about how we might construct a new marketplace based on voluntary demand for carbon credits or AAUs. The terminology tends to confuse people who do not work with it every day. That is why Mr. Harris would have seen some people smiling as he went through his presentation. Some of the acronyms are difficult to follow.

Deputy Bobby Aylward

One tends not to ask about it.

Deputy Simon Coveney

I followed the gist of it very clearly but want to get an understanding about the voluntary market. I believe I have a good understanding of how the ETS works in the European Union, the commitments to which Ireland has signed up in terms of reduction in emissions, the traded and non-traded sectors, the responsibilities and how it all works. I do not, however, have a good understanding of how the voluntary market functions. I understand we have been successful at persuading businesses that it makes sense for them to be more efficient at reducing the cost of heating in their buildings by putting insulation in the ceilings and walls, changing the doors and windows, reducing energy usage, switching to more sustainable forms of fuel and so on. Does that also translate into a willingness by a company to invest in forestry abroad or elsewhere in the home country to bank carbon credits ? That is a cost which does not have an immediate bottom line return for a business. I am trying to get an understanding of what motivates the voluntary market. What sets the price? I understand the carbon price within the EU and why it fluctuates up and down. However, there is a broader market for the price of carbon outside the European Union. The delegation referred to applying the New Zealand model in Ireland. Presumably, this involves inviting investors in afforestation, that is, new forestry in Ireland. This is the only type of forestry for which one can get credit. Will the delegation explain in a language I can understand why this marketplace has value if it is not being driven by targets which, if they are not met, result in consequences in terms of having to purchase credits?

It is encouraging that Bank of Ireland has taken a deep interest in this area. Ireland has the potential for a carbon or green element in the financial services sector. Will the delegation offer some background on the preparations large banks such as Bank of Ireland are making to facilitate this move, despite the obvious problems the large banks have at present?

It would be useful to have on the record an explanation in simple language of how the proposal would work. Let us suppose Coillte were to plant 15,000 hectares of forest per year. In simple terms how would it go to the market, whether the voluntary or compliance market? Would Coillte go to a finance house or bank and propose its intention to plant 15,000 hectares next year and then call on the bank to go to the markets and seek interest in purchasing 5,000 hectares in either the voluntary or the compliance carbon markets? Will the delegation explain how this would work? How then would a finance house such as Bank of Ireland Global Markets go to the international markets to seek investment in such an opportunity? I understand the structures which must be put in place in terms of setting a standard and having a registry. However, once a unit is registered on the basis of planting trees, how does one then go to the market to sell it? Is it the same as in the case of the units an energy company could trade if it switched from an oil-powered generator to a gas-fired generator with spare credits as a result, or is it a different market altogether? I hope my questions make some sense.

Deputy Seymour Crawford

I thank the two speakers for briefing the committee on this issue. I freely admit I find the issue complex. Two things are very clear. We are an agricultural country and the emissions from that sector will continue unless we divest ourselves of cows. We should accept that the number of acres available to plant from the Government budget is somewhat limited. We have moved from a high of 25,000 hectares in the mid 1990s to 7,000 hectares this year. Another group discussing the issue with the committee indicated that the optimum was between 15,000 and 20,000 hectares. In blunt language, how does the delegation envisage the proposal transferring to farm level?

How would Coillte or another party go about planting? How would such a proposal be funded initially? Some planting would have to be carried out first before one is in a position to sell anything as a credit. I do not fully understand the process. However, I welcome the fact that Bank of Ireland is interested in this area because if we do not find some other source of funding apart from Government funding then we will not reach the targets we had hoped to reach. The issue is not limited to carbon credits. We must also consider employment potential and everything that goes with it. I have taken quite an interest in the biomass area throughout the years. We should utilise the biomass we have to develop alternative energy. However, today we are discussing carbon credits. In simple language how can this be transferred into increased forestry development?

Deputy Bobby Aylward

I found the presentations rather technical, especially the second presentation, and I became somewhat lost along the way with regard to how the system would work. Like Deputy Crawford, I am keen to know how the proposal would work from a farming point of view, which is where I come from. How would the proposed system be set up in Ireland to gain financial benefits from a carbon credits point of view? Timber and biomass are involved from the moment a plantation is sown. However, most plantations take between 20 and 40 years. Some native species, including oak, may take 40 or 50 years to mature. How do the credits accrue every year? Will the delegation explain how the system would work from year 1 to year 2 and through to year 20 and year 30? How do the credits work? What money would be realised from current credits?

I understand carbon is currently priced at €14.70 per tonne? Does the delegation envisage this price will rise in future? How will the system work? Will the EPA be involved? I presume there will be a national system in place whereby there will be a national allocation of carbon credits which could be sold on the world market if a demand exists. I am keen to get a grasp of and to understand better how the system would work. What are the benefits? Let us suppose a farmer has 40 hectares. What moneys would he realise from this? Would the proposal involve amalgamations? If there were a target of 15,000 hectares per year would this be amalgamated and then divided among farmers? I am keen to get a grasp on this proposal in layman's terms.

Deputy Michael Fitzpatrick

Usually, when we discuss forestry we refer to Coillte and private forestry. However, in recent years Coillte has not expanded its forestry operations. This has been left to private individuals. What is the delegation's view on this as a policy for the future? Does the delegation believe private forestry interests will plant enough trees or acreage in the coming years to allow us to develop the carbon sinks we require? The delegation stated that it was essential to establish distinct carbon property rights in law. Will the delegation expand on this point and what this means?

Mr. Paul Harris

I will make some remarks on Bank of Ireland and the financial sector. Bank of Ireland is very active in green finance. We have a well-known project finance team involving one person based in Dublin, another in London and myself. We are involved in the carbon transactions area. It is a matter of public record that earlier this year the private client arm launched a carbon investment product. It is incumbent on all financial institutions wherever they are to ensure they meet business needs. In many respects the whole area of green finance is just another type of business and it is fortunate that Bank of Ireland has a better and closer understanding of the sector. As a bank we are fully behind the clearing house group initiative to explore the green IFSC. I am aware the Deputy has been briefed on that by my colleagues. It has been ongoing for 18 months. There has been a great deal of commitment in that area from the bank in terms of contributions and man hours.

Purely from a business proposition, there is talk that there has to be upwards of $650 billion invested in green technology for several years to ensure we address climate change. There are significant sums in the United States, China, India and Europe focused on that investment, which starts with financial institutions. I do not think there is anything unusual in any financial institution focusing on it as a potential growth area because it is; I am convinced of it. That is the financial perspective of Bank of Ireland which I hope answers the question.

In terms of how farmers get investment and the point on the private sector versus Coillte, if one is to assume that a domestic offset scheme along the lines about which I hypothesised occurs there will be a need for forestry and other agriculture to be generated. One would clearly expect an agency such as the EPA to be the arbiters of that. It is a tremendously professional organisation and runs the emissions trading scheme on an EU basis. It has all the tools at its disposal to be able to operate a domestic offset scheme.

There cannot be any doubt that private investors would be attracted by the additional benefits of carbon for the forestry proposition. By the same token, the proposition of a number of farmers grouping together - which historically they have done through the co-operative structure or an IFA vehicle - to bulk up the offering on carbon is something I would not discount. It would be a new departure.

In terms of how the money accrues to the farmer, from the tree to the pocket, it will be done on an annual basis and I envisage the EPA would monitor the sequestration value according to the species which has been planted, come up with the value for the offset and that offset would then be tradeable in the market, which goes back to the Deputy's point about where the money goes.

The Deputy made the point about the difference between the voluntary and compliance market which Mr. Lyttle has very clearly explained. If there was a domestic scheme there would be an obligation among businesses and perhaps the transport sector to offset their emissions which would create a market because forests would produce forestry credits for purchase by businesses to meet their obligations within the domestic scheme.

Deputy Simon Coveney

I know what Mr. Harris is saying but one will have to set up a domestic scheme outside of the traded sector. One would put emissions quotas on businesses and if they go over the quotas they would be required to offset them by purchasing credits. Is that correct?

Mr. Paul Harris

It is very challenging for Ireland to meet the targets laid down for the non-traded sector without that sort of structure. It has been proven to be very efficient.

Deputy Bobby Aylward

Would the nitrates structure be available on the world market? Could one sell outside Ireland or would one be confined to the home market?

Mr. Tony Lyttle

I apologise if my presentation was a little technical but it is very difficult to cram all the information in within ten minutes as it is a very technical area. The point I tried to make in my presentation was that the creation of a domestic scheme does not close off the opportunity to trade internationally. The opportunity to trade internationally currently exists. The structure and platforms are out there. We do not need to set up a domestic offset scheme for Ireland to take advantage of forestry carbon credits. We do not have to do anything.

We currently have a national registry covered by the EPA which will go some way to answer the Deputy's question. Each country within the ETS has a national cap on how much carbon it can produce. It was given to them in the form of allowances. Ireland will be given X amount of allowances. The calculation of what those allowances are for each year is based on historical and projected emissions. Another factor which is taken into consideration is how much forestry currently exists.

We are given allowances for the next year, for example 2011, which is based on our current afforestation levels. If we can increase forestry over the next year it effectively allows us to reduce the offsets of carbon that Ireland producers by X amount. For example, if a particular forest growth offset 10 tonnes of carbon it effectively means that the allowances given to the Government are now freed up due to the increased growth in forestry because it creates a removal unit which means that the units which are produced in Ireland for that year are offset by the units created in the growth of forestry.

Therefore, it frees up ten tonnes of the inventory of allowable amount units which was given to Ireland because they do not need to go to the market to offset what was produced as forestry has done that for them. That system currently exists. The Government is getting the benefit of any growth in forestry because it will have additional AAUs it did not expect to have as it did not know we would increase forestry.

Deputy Simon Coveney

It does not have any monetary value unless it requires companies to buy units to compensate for their emissions.

Mr. Tony Lyttle

I will use a simple mathematical example. For example, if Ireland is given 100 units-----

Deputy Simon Coveney

If Ireland incorporated does not meet its targets the alternative is that we would have to purchase carbon credits on the open market to balance that.

Mr. Tony Lyttle

Correct. Even if we do not exceed our targets we have free units which we can trade and get an income from, which are tradeable on the international market through the systems which I have explained.

Deputy Simon Coveney

What about the forester, to which Deputy Aylward referred? Currently, they do not see that.

Mr. Tony Lyttle

That is the part that needs to change, which I mentioned in my conclusions. The ownership of the units effectively lies with the Government and it would need to ring-fence those, take them out of its inventory and pass the benefit of it on to the landowner, who would then have it in the form of an AAUs which it could trade on the international market.

Deputy Bobby Aylward

What is the balance in Ireland for 2010?

Mr. Tony Lyttle

I have to be honest, I do not know.

Deputy Bobby Aylward

Is the information available?

Mr. Tony Lyttle

It will not be available for 2010 until after 2010. The amount of allowable units which we were given was available last year. We know what our units are and the NTMA has already purchased them. Ireland is effectively long and has more credits than it needs. That is due to the fall in industrial output, and so on. At present, we have a long inventory. Any additional forestry will leave us with extra units which we can trade in the market.

Deputy Bobby Aylward

At present, therefore, we could sell units on the international market.

Mr. Tony Lyttle

We currently have additional certified emission reduction units on our inventory. We can retain these and carry them forward into another phase. This would allow us to offset in the future or we could trade the units.

Deputy Bobby Aylward

That is good to hear.

Deputy Simon Coveney

Are we to have credits for the several years?

Mr. Tony Lyttle

I believe so. It is difficult to foresee what will happen post-2012 because we do not know exactly what will be introduced or what we will be allowed to carry forward. The current position is that we are long up to 2012. Forestry will increase that long position because we will have additional units to trade.

Deputy Simon Coveney

Is there a market for private pension funds to invest in? Would it be possible to create a market for private investors to purchase the carbon element relating to afforestation? This would allow foresters to continue to grow trees and harvest them for use as timber or in biomass production but there would also be a separate income stream from this afforestation which could be packaged by, for example, Bank of Ireland to make it attractive for foreign investment funds to invest here in respect of the carbon element to which I refer.

Mr. Paul Harris

That is really the point. There is the traditional investment in forests - that is, in respect of timber production, and so on - and there is an option whereby the carbon value can be stripped out and sold. As the Deputy is aware, there are numerous carbon funds already in existence. The length of investment involved would probably suit insurance companies and pension funds which have a much longer time horizon in respect of investment. There is also the possibility of tapping in to new markets and attracting new types of investors by issuing, for example, short-term, five-year securities relating to forestry. People would be happy to invest in those with a shorter maturity.

It is a question of crafting an appropriate offer for different types of investors. There are three main types of investors, namely, retail, individuals of high net worth and institutions. The application of carbon to forestry opens up the prospect for foresters to tap each one of these types of investors. In the past, investment in forestry on the part of retail has been quite small. In the main, long-term institutional investors have been involved.

Mr. Tony Lyttle

One of the aspects that has been noticed since the introduction of the domestic offset scheme in New Zealand, which, under the Kyoto Protocol, is subject to exactly the same scheme as the EU-ETS, is the growth in investment from the outside. It is important to address a point the Deputy made previously. Those who invest in the start-up or in the structured product that will create the forestry which will give rise to the credits are not the same end-users, nor are they the people who will buy the credits at the conclusion of the process. The former are purely involved from an investment perspective and to obtain a return. The credits will be sold to someone who has a mandatory obligation to buy and to comply with the scheme.

Deputy Simon Coveney

Essentially, they will become a type of credit wholesalers and will sell credits on to those who need them.

Mr. Tony Lyttle

Yes. That is exactly what EcoSecurities does. It goes out and sources the projects that create the units, which we then bank and forward sell to compliance buyers. Another very important point about the voluntary market - Mr. Harris touched upon this - is that use of the term "voluntary" is somewhat misleading because it suggests that the participants are involved on a voluntary basis. However, those participants may well be required to be involved by law. The voluntary aspect relates to the additional end-buyer who purchases for the purposes of corporate social responsibility. That is one of the biggest growth areas we have noticed in recent years.

It is not just compliance buyers, it is also voluntary buyers who want to purchase for the purposes of corporate social responsibility. If they are considering their options and are presented with a price for a compliance unit of €15 and then examine the option of a voluntary unit, which effectively does the same thing but which just has not been certified by the UNFCCC, at between €5 and €7 - it is not a very transparent market in the context of understanding how it is priced - they will obviously pick the voluntary credit because it is cheaper. We have noticed that very large institutions are beginning to buy these volumes in wholesale to ensure they are carbon neutral, purely just for the purpose of corporate social responsibility and marketing themselves in that way. It is referred to as the voluntary market because the number of voluntary buyers involved is growing.

Deputy Bobby Aylward

Under the Kyoto Protocol, are credits available in respect of existing forestry or does this relate to new afforestation products? Compared to Ireland, with its 15,000 hectares of forestry, the US and countries in South America which have large existing areas of forestry and which are signing up to this would have a fantastic level of credits if it were based on existing forestry. What is the position with regard to existing forestry?

Mr. Tony Lyttle

As far as I recall, it relates to forestry planted since 1999. It will be new forestry that will generate the credits. In respect of South American forestry, the Kyoto Protocol splits the world into developing and developed countries. It is only the developed countries which have targets and which, therefore, obtain the advantage of removal units through reforestation. To the best of my knowledge, there are no forestry projects which allow developing countries to create carbon compliance credits. It is really only the developed countries that are allowed to reduce their inventories for that purpose.

Deputy Simon Coveney

That is one of the major disputes that will be debated in the coming weeks.

Mr. Tony Lyttle

Correct.

Deputy Simon Coveney

I wish to pursue a matter raised by Deputies Aylward and Crawford. If a farmer or a group of farmers - in a co-op structure - decide to commit a large quantity of land to forestry, what would be the value per hectare with regard to the carbon sink effect of planting, for example, 200 hectares of broadleaf trees? Would there be a unit per hectare calculation? It was stated that the carbon sink effect varies as a forest grows. When a new forest is planted, it is initially the case that carbon emissions are probably released into the atmosphere as a result of the planting process, including breaking the soil, and so on. As the foliage develops and trees grow, I presume there is a maximum carbon sink effect and that this then begins to die off as a forest reaches full maturity.

How does the payment structure relating to the actual financial value of a carbon sink work in the context of investment? If someone plants 200 hectares of trees and if a structure such as that proposed by our guests - and involving a certification process and a tradeable product for carbon for the individual farmer or for the co-op of farmers involved - is put in place, what would be the timeframe and what level of payment would apply?

Mr. Paul Harris

It would be extremely difficult to project the value of carbon. As the Deputy-----

Deputy Simon Coveney

If one assumes that it will rise from €15 to €30 per tonne, what would be the position? Two years ago, the price was more than €20 but it tends to fluctuate depending on demand. Let us assume an average price of €25 to €30 per tonne during the average lifetime of a forest. In that context, I would like to obtain an understanding as to what would be involved, from an investment point of view, for a group of farmers? What would be the carbon sink value for the first two years? If one develops a broadleaf forest, the plants will be quite small for the first three to four years and, therefore, the carbon sink value would not be that great. Is it the case that it is just measured by hectarage of forestry?

Mr. Paul Harris

In terms of the methodology that I am aware of, they would be looking at hectares and there is an assumption according to species type. Every species type has a profile of the carbon it releases. When they are saplings, there is no sequestration to think of but the more they grow in their youth, the more they operate as an efficient carbon sink, then they level off and they either get harvested or they decay or maintain a carbon value. If there was a co-operative that wanted to put together their acreage and use the future carbon value as a collateral tool, that would be one way to have a collateralised loan based on the projected future value of carbon.

Deputy Bobby Aylward

Would that not take significant monitoring of growth rates and so on?

Deputy Simon Coveney

I understand the carbon sink effect as trees grow but I am unclear about how that is converted into value. How is the carbon value of a plantation calculated? For example, is it sold to an investor for a lump sum? Can the units be sold annually?

Mr. Paul Harris

I understand from where the Deputy is coming. There are numerous approaches to that. One could agree to sell the entire sequestration rights of a particular plantation from the outset to an investor and he or she would take the risk that the sequestration rates were achieved. One could retain the rights and sell into the market through a bank or intermediary the received carbon offsets annually and use those to offset one's interest payment for the loan one has to take out. In terms of quantum, it is impossible to say.

Deputy Simon Coveney

Who measures the offset annually? For example, the offset in the first year will be much less than in the tenth year. If one approaches EcoSecurities Group with 200 hectares of forestry, which have only been planted this year, and wants to sell the offset value this year, who measures it? Has the EPA a formula whereby, for example, a broadleaf forest for the first two years has X amount of carbon sink or offset value?

Mr. Tony Lyttle

For the purposes of the compliance market, there is a designated operational entity or DOA and its job is to monitor, verify and calculate the amount of carbon offsets produced-----

Deputy Simon Coveney

On an annual basis?

Mr. Tony Lyttle

One can pick the crediting period for any timeframe one wants. The traditional way is that one picks a year - it does not have to be a calendar year - one monitors at the start and at the end, calculates the difference and the credits are issued on an annual basis. One of the beauties about forestry is that because it involves such a long timeframe and because the values fluctuate over time, there are plenty of opportunities for Bank of Ireland and other institutions to structure a product around that and, ultimately, that will be based on what is verified over the term. For example, we have recently noticed forestry credits coming out of Canada. Until recently one would have waited until one's crediting period was up, had credits issued and gone to one's broker to sell them on the market.

We have noticed that investors are buying ex ante credits. They are, therefore, coming in at the beginning of the period before any trees are planted and they are buying the future flow for ten years up front. They are taking the risk up front. Each term sheet and each product will be different according to the investor and somebody will have to write it but, ultimately, the risk one is taking will becoming apparent when the verification and monitoring period has taken place and one is able to quantify how many units were generated. There are a multitude of ways and products through which one can get up front investment, flows annually or a flow at the end of the term.

Deputy Seymour Crawford

Anyone who planted under the Government's scheme knew exactly what he or she was getting. The grant was available for plantation and there was so much headage annually for 20 or 25 years. If somebody wants to avail of a private investment scheme, they need an idea of what the returns will be.

Deputy Simon Coveney

Even if one benefits from the normal grant process, there is an added opportunity for new plantations. That is the issue we are addressing.

Deputy Seymour Crawford

We need to be geared towards new plantations, otherwise we will never reach our targets.

Deputy Simon Coveney

There is no carbon sequestering value for existing plantations.

Deputy Seymour Crawford

I accept that.

Mr. Paul Harris

To get back to the issue of how carbon realises value, there are different methodologies and they are fiercely debated in academic and scientific circles. I am neither an academic nor a scientist. This is a great opportunity for an additional business stream to be developed in Ireland because we have people who are technically brilliant when it comes to information systems and we have a strong agricultural background. There is a great opportunity in Ireland to develop this data monitoring technology that is growing globally. It would be a great export in a carbon market.

Chairman

This is an interesting and informative discussion. I am a lay person. Is it correct that the land or the trees belong to the farmer but the value of the carbon belongs to someone else?

Mr. Tony Lyttle

That is correct.

Chairman

There will be some sort of bank. If a facility is not carbon neutral, and is therefore producing pollutants, it can buy credits to make up the shortfall. Is that correct?

Mr. Tony Lyttle

Yes, it does not necessarily have to be completely carbon neutral but it must at least hit the targets that are accepted.

Chairman

Currently, does the value of the carbon belong to the State?

Mr. Tony Lyttle

That is currently what happens given the way the structure is set up. It is a little complicated in that the Government gives allowances every year and the companies are allowed to emit up to that level of allowance. They have to pay the offset for anything over that. There are several ways they can reduce the volume of carbon they produce in order that they do not exceed their allowances. One of the ways is to create a sink. If the farmer creates a sink, he owns the land and the forest but the benefit of the carbon is automatically retained in the Government's inventory.

Chairman

We are entering a new area and it is something we are trying to get to grips with. Will there have to be legislative changes?

Mr. Tony Lyttle

I imagine the Chairman is right. The property right and ownership of the unit-----

Chairman

We are taking submissions from delegations such as those before us and eventually we will prepare a report and make a submission to the Government about what should be done.

It has been interesting and I thank both Mr. Harris and Mr. Lyttle for their submissions and the discussion that ensued. We have other groups before us and more will appear in future. It is interesting that financial institutions are taking a keen interest in this area, which is encouraging. Their submission will be of benefit to us when we prepare our submission for the Minister and the Government.

Deputy Simon Coveney

I was asked by Mr. David Taylor to explain he could not attend the meeting because he is working on the biogas in transport report, on which he is working with me.

The joint committee adjourned at 6.50 p.m. until 2. p.m. on Wednesday, 15 December 2010.