The land-use, land-use change and forestry (LULUCF) sector comprises of activities related to utilization of land (such as agriculture or urbanization), changes in land-use (such as converting forested areas to urban areas), and management of forests (such as afforestation or deforestation). LULUCF is a critical sector in climate action as it pertains to greenhouse gas (GHG) emissions and removals facilitated by land-use and forestry. For instance, afforestation and ecosystem restoration sequesters carbon while croplands or settlements lead to carbon emissions. LULUCF is also closely interrelated with the agriculture, forestry, and land-use (AFOLU) sector as they share the same characteristics, benefits and impacts.
LULUCF is intricately linked to ecosystem maintenance, carbon sinks, vegetation, and human sustenance. Resultantly, the IPCC has consistently identified LULUCF as an important sector for climate change and action. LULUCF is responsible for ~11% of net global GHG emissions, mainly driven by anthropogenic activities such as deforestation, conversion of forest land into grazing land, and urbanization, amongst others. However, by virtue of its nature, LULUCF has emerged as the predominant sector with potential to be a net carbon sink. For instance, LULUCF was responsible for removing 20% of 2,647 MtCO2e of India’s GHG emissions in 2019. According to the IPPC, LULUCF has substantial climate mitigation potential. For example, practices that result in an average increase of one percent in soil organic carbon storage in croplands, pasture and irrigated fields could potentially sequester 311 GtCO2-e, equivalent to over a decade of emissions reductions. It would increase the chances of staying below 2°C temperature by 66%. The IPCC estimates the AFOLU sector to have the largest mitigation potential, averaging 14.5 GtCO2e by 2030.
Since insurmountable climate impacts are already underway, it is imperative that the climate mitigation potential of LULUCF/AFOLU is leveraged to reduce climate risks to ecosystems and human systems, and achieve net-zero targets, globally and nationally. Towards this, ensuring adequate financial support is critical. Despite possessing largest mitigation potential, AFOLU is severely underfunded at an annual average of US $6.5 billion in 2021-2022. Resultantly, funding for AFOLU needs to increase by over 180 times to reach optimal mitigation potential. Historically, public capital has been at the forefront and private capital has been hesitant in financing LULUCF/AFOLU. This may be due to high-risk perception that stems from several challenges, including:
• Difficult to quantify and monetize cross-cutting benefits, due to underdeveloped natural capital accounting frameworks
• Low creditworthiness due to social challenges such as unpredictable incomes, unsure land ownership and conflicts
• High dependency on nature-related externalities and variables, that may result in surprise trade-offs
• Risk of reversibility and uncertain future of carbon stocks as carbon sinks may reverse due to human activities, natural disturbances or climate impacts
• Need for long-term, patient capital to serve longer gestation periods of projects, deterring potential financiers that look for short-term returns
Since finance towards LULUCF remains severely lacking, there is an urgent need to remedy the above risks and pool in additional public and private capital to close the financing gap. Towards this, sustainable finance products that mitigate, manage, eliminate or transfer risks associated with LULUCF/AFOLU are critical. These include alternative financing instruments, linked to blended finance, co-financing, guarantees, green/sustainable bonds, carbon finance, and innovative bonds to draw in the needful capital to LULUCF projects, including public and private, international and domestic capital.
• Blended finance mechanisms blend public and private capital, thereby reducing risk for private financiers and enabling larger ticket-size deals of LULUCF projects. Blended finance may also include other financing instruments, such as insurance, off-take arrangements, first-loss default guarantees, credit enhancements, amongst others. For example, a project termed Tambopata-Bahuaja REDD+ and Agroforestry Project, was designed by Althelia Ecosphere, an environmental asset manager, to achieve long-term restoration of the buffer zone around a Peruvian national park, leading to 570 million hectares of protected land, avoided emissions of 4 million tonnes from 12,000 hectares of avoided deforestation. The blended finance mechanism includes a ~US $6 million loan by Althelia to the execution agency, blending a partial guarantee of US $133 million by USAID, and US $60,000 co-financing from the Peruvian government. Moreover, the mechanism also involves carbon finance as the avoided emissions are certified as carbon credits. The proceeds from the sale of the carbon credits are used as repayment and collateral for the loan from Althelia, thereby diversifying investments and attracting private capital
• Co-financing on the back of grant capital by multilateral development banks and/or multilateral funds, could be utilized to ensure mitigation of political risk and alleviate the burden on public sources of capital. For instance, a forest landscape restoration project in Rwanda leveraged a Global Environment Facility grant of ~US $6 million and an UNDP grant of ~US $1 million, plus an additional US $25 million in co-financing by the Rwandan government. The project proposes to initiate participatory forest management on 300 hectares, establish 1000 hectares of plantations through co-financing, restore 555 hectares of natural forests, and conduct capacity building on implementing gender sensitive forest landscape restoration strategies
• Innovations such as Forest Resilience Bonds and Environmental Impact Bonds (EIBs) are also viable to accelerate ecosystem protection. Through EIBs, the issuer raises risk capital from investors on a pay-for-success basis. In emerging markets, where the success of the proposed interventions is often uncertain or untested, these types of outcome-based financing instruments can be a practical route to raising private capital
• Sustainability bond in the forestry/plantations sector could be leveraged to rectify deforestation and social conflict. For example, Southeast Asia’s first sustainability bond by BNP Paribas was issued by the Tropical Landscapes Finance Facility in 2018, to fund Indonesia’s first sustainable natural rubber plantation. The project raised institutional capital from ADM Capital, a Hong Kong-based private sector asset manager, and was backed by a partial guarantee by USAID that was instrumental in raising commercial interest and allowing greater flexibility in structuring. It also included an off-taker arrangement with Michelin of up to 75% of rubber production, alleviating investor concerns on future cashflows and loan repayments. It is estimated to positively impact employment, welfare, and other livelihood opportunities for 50,000 people of the local community, apart from addressing issues such as land degradation, deforestation, and building biodiversity buffer zones
Evidently, there is great scope for innovation in financing climate-vulnerable sectors such as LULUCF. Importantly, it is crucial to adopt innovation in financing LULUCF projects in order to maximize their potential to combat climate impacts while maintaining the natural equilibrium and improving human wellbeing at scale.
Bibliography:
https://www.theccc.org.uk/wp-content/uploads/2013/03/LULUCF.pdf
https://www.ipcc.ch/site/assets/uploads/2023/03/Doc5_Adopted_AR6_SYR_Longer_Report.pdf
https://unfccc.int/documents/636235
https://www.forest-trends.org/wp-content/uploads/2018/04/doc_5721.pdf