Converting or Conserving the Forests

Converting or Conserving the Forests:

A Cost-Benefit Analysis of Implementing REDD in Indonesia Erry Prasetyo School of Public and International Affairs, Columbia University May 2013

 

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Table of Contents

I. Indonesia’s Palm Oil Dilemma …………………………………………………….. II. Structure of the Paper ………………………………………………………………… III. The Costs of Implementing REDD in Indonesia …………………………… Opportunity Costs of Foregone Land-Use REDD Development Costs REDD Implementation Costs Transaction Costs Other Non-Market Costs IV. The Benefits of Implementing REDD in Indonesia ……………………….. REDD Credit Benefits International Aid for REDD Readiness Other Benefits of Non-Use Value of Forests V. Methodology and Estimation of Costs and Benefits ……………………….. Opportunity Costs of Foregone Land-Use REDD Program Costs Components Indirect Costs: Other Non-Market Costs REDD Credit Carbon Revenues International Aid for REDD Readiness Non-Use Value of Forests Conserved Costs and Benefits not Estimated VI. Analysis ……………………………………………………………………………………. Profitability Comparison Cost-Benefit and Sensitivity Analysis VII. Concluding Analysis ………………………………………………………………….. Bibliography ……………………………………………………………………………………

 

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Converting or Conserving the Forests: A Cost-Benefit Analysis of Implementing REDD in Indonesia I. Indonesia’s Palm Oil Dilemma With 240 million people, around US$ 850 million GDP, and economic growth of more than 6%, Indonesia is one of the most dynamic nations in the world. However, in terms of GDP/capita Indonesia is still a lower middle-income country with 12% of its population live below the poverty line. With this combination of facts, if we ask 100 random people in Indonesia if they think that it is a good idea to conserve the forest and mitigate climate change, most likely the majority of them will say yes. If we ask that is important to keep the pace of economic growth to make sure that there will be no more poverty, a better education system, and no more children working and/or going hungry, the same 100 people will also answer yes. Hence the dilemma of converting or conserving the forest in Indonesia. Forestry and related industries are directly responsible for 600,000 jobs and approximately $18 billion of Indonesia’s GDP, 3.3 percent. That’s more than triple the 1.1 percent average across Asian countries (Gunawan, 2011). Indonesia’s forests represent 10% of the world’s remaining tropical rainforests. The current rate of forest loss is accelerating. Indonesia’s forests are the second largest in the world after the forests of Brazil. Unfortunately, over the years Indonesia has lost up to 80% of its original forest habitat and continues to lose 6.2 million acres (2,509,051 hectares) a year. Deforestation is still happening in Indonesia due to the highly demanded and highly profitable commodities such as palm oil. The benefits of the palm oil plantations are difficult for Indonesia to ignore. Palm oil trees can produce fruit for more than 30 years, providing much-needed employment for poor rural communities. And their oil is highly demanded, due largely to the fact that the plant yields more oil per hectare than any other major oilseed crop. Indonesia is now the leading supplier for the global market demand for palm oil, thanks to its versatile use for products ranging from low trans fat cooking oil, cosmetics, to biofuel. However, palm oil plantations lead to deforestation, which made Indonesia the third largest emitter of greenhouse gases after China and the United States. Indonesia entered the Guinness Book of World Records in 2008 and 2009 for having the highest rate of deforestation of any country in the world (Orangutan Foundation, 2013). Recent estimates suggest that the carbon released from deforestation activities in the tropical region accounts for approximately 15–17% of anthropogenic emissions of carbon dioxide (CO2) every year (Van der Werf et al., 2009). This dilemma of converting or conserving the forest is not unique to Indonesia, there are at least 34 other developing countries facing the same problem including Brazil, Papua New Guinea, and the Philippines. Given this situation, it is critical to find a balanced solution that could solve the

 

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dilemma where developing countries can still growing without the adverse effects of deforestations. One of the initiatives to address this problem is the United Nations’ Reducing Emission from Deforestation and forest Degradation (REDD) program. REDD is a mechanism to create an incentive for developing countries to protect, better manage and wisely use their forest resources, contributing to the global fight against climate change. The program aims to make forests more valuable standing than they would be cut down, by creating a financial value for the carbon stored in trees. REDD also includes the private sector as part of the solution by providing the kinds of market signals, mechanisms and incentives to encourage investments that manage and conserve the world’s nature-based resources rather than exploiting them. So it is about making money and conserving the planet too and if REDD can be structured right, the money will be made not just by carbon traders, but also by developing countries and communities for providing the forest-based carbon storage service. It is predicted that financial flows from North to South for GHG reductions from REDD could reach up to US$30 billion a year (UN-REDD, 2013). With a market being built for REDD carbon credit, and with REDD pilot projects implementations already going on in Brazil, Indonesia, and Cambodia, it is necessary to asses further the benefits of implementing REDD in Indonesia. There are opportunity costs involved, and not insignificant development, implementation, and transaction costs of the REDD program itself. This paper aims to analyze whether or not REDD is able to strike an economic balance inthe management of forests so that their formidable economic, environmental and social goods and services benefit countries, communities, biodiversity and forest users while also contributing to important reductions in greenhouse gas emissions. II. Structure of the Paper This paper conducts a cost-benefit analysis comparing two scenarios: Converting 18 million ha of forests into palm oil plantations or conserving the same area (leave the area undisturbed, preserving the concessions for REDD program). The concession area of 18 million ha is based on the area of forests that are suitable for palm oil plantations (Indonesian Palm Oil Association/GAPKI, 2009). There are various stakeholders involved in the implementation of the REDD program in Indonesia ranging from indigenous people, private sector, local government, national government, to the global community since reduction in greenhouse gasses emission benefits the whole world. However, since the objective of this paper is to be able to outline a preliminary and general finding of program implementation for the national Government of Indonesia in negotiating and shaping the development of REDD, this paper will focus on the aggregate costs and benefits for Indonesia as a whole economy to present a society wide-picture. The paper will try to identify the underlying prospective and realized costs and benefits from implementing REDD program in Indonesia. It will be followed by explanations of the methodology used in estimating the most relevant costs and benefits identified in the previous section. The paper will then outline the ideal estimation of all the most relevant costs and benefits based on the data and information available from the literature review and various data sources. A sensitivity analysis will also be presented focusing on the sensitivity of the cost-benefit analysis to the discount rate, and price of REDD credit in the carbon market. The paper then concludes with policy recommendation, possible improvements of policy, and the needs for further study.

 

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III. The Cost of Implementing REDD in Indonesia There are at least four main cost components in REDD program implementation: opportunity costs of land use, development of REDD readiness, implementation of REDD, and transaction costs of REDD carbon credit market. We will refer to these four main costs as market costs in this paper. Aside from the market costs, there are also non-market costs involved in REDD implementations such as cultural and psychological impact and the perceived restrictions of the use of the forests. Opportunity Costs of Foregone Land-Use (Profitability of Palm Oil) The biggest cost component of REDD implementation is the opportunity costs of foregone landuse. This paper will focus only on the profitability of palm oil plantation as the opportunity cost of foregone land-use since it is the highest in terms of profitability compared to other major land-use for cash crops in Indonesia (see table 1). Also, compared to other oil producing crops, palm oil also scores the highest in terms of productivity in land use (see table 2). In 2009, the Indonesian Palm Oil Association (GAPKI) stated that there were at least 18 million hectares of forests in Indonesia that were suitable for palm oil plantation. Based on the focus of palm oil as opportunity cost, this paper will use 18 million hectares as the concession area for the purpose of the cost-benefit analysis. Table 1. Net Value of Select Agricultural Production in Indonesia in 2011 (in million US$)

Cassava   Cloves   Cocoa  Beans   Soyabeans   Palm  Oil  

$2,457   $167   $739   $217   $9,331  

Source: FAOSTAT, FAO Statistics Division 2013, 22 April 2013

Table 2. Productivity of Oil Producing Crops in 2005

    Soybean   Rapeseed   Sunflower   Coconut   Oil  palm  

Productive  Area   Oil  Production     Productivity    (million  ha)   (million  tons)   (ton/ha)   92.5   33.5   0.36   26.6   15.99   0.60   21.3   9.7   0.45   9.4   3.3   0.35   9.2   37.6   4.09  

Source: CIRAD, Agricultural Research for Development, 22 April 2013

REDD Development (Readiness) Costs REDD development costs are all costs related to the readiness of Indonesia to implement the REDD carbon credit mechanism to meet the standards of the World Bank’s Forest Carbon Partnership Facility. Examples of these costs are including (but not exhaustive to) funding the project design document, governance and acquisition, monitoring and measurement, surveying and research, and other costs (Eggleston et al. 2006). REDD Implementation Costs

 

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REDD Implementation costs are the costs associated with actions to reduce deforestation. Examples of such costs are (but not exhaustive) of guarding a forest to prevent illegal logging, relocating timber harvesting activities away from natural forests to degraded land due to be reforested, agricultural intensification (Pagiola and Bosquet, 2009). Transaction Costs Transaction costs differ from implementation costs in that they do not themselves reduce deforestation or forest degradation, but are needed to establish the transparency and credibility of REDD programs. Transactions costs are additional costs to be paid by parties (buyers, sellers, donors, recipients) to a transaction involving a REDD payment, as well as external parties such as market regulators or payment system administrators to ensure a certain amount of emissions reduction has been achieved (Pagiola and Bosquet, 2009). Activities which are components of transaction costs include identifying REDD programmes, negotiating transactions, and monitoring, reporting and verifying emissions reductions. Other Non-Market Costs Other non-market costs experienced by local communities are the foregone freedom of accessing the forest at any time of the day, presence of external police and controls which may limit their ability to go to the forest, reduction in time spent with the rest of the family if alternative job opportunities are available (outmigration), and impact of losing cultivable land and so changing their livelihood (Caravani, 2011).   Table 3. Summary of Benefits and Costs

COSTS Opportunity cost of foregone land-use for palm oil plantations (palm oil profitability) REDD Development (Readiness) Costs REDD Implementation Costs REDD Transaction Costs Other Non-Market Costs

BENEFITS REDD Carbon Credit Revenues International Aid for REDD Readiness Non-Use Value of Forests Conserved

IV. The Benefits of Implementing REDD in Indonesia REDD Credit Benefits Revenues from REDD Credit is the biggest and most relevant benefits of the REDD program. The program aims to make forests more valuable standing than they would be cut down, by creating a financial value for the carbon stored in trees. REDD Credit is sold in the market with ton of CO2 saved as a unit.

 

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International Aid for REDD Readiness In supporting the global climate change mitigation, developed countries pledge aid assistance for developing countries in the development of REDD program since this is part of the costs component of REDD. Indonesia has a fund established for the sole purpose of climate change mitigation, which already received pledges and aid from various sources. The biggest pledge is from Norway in the amount of 1 billion US$ for the special purpose of REDD program development in Indonesia. Other Benefits of Non-Use Value of Forests Conservation Aside from REDD revenues and international aid, there are also various non-market benefits from implementing REDD in Indonesia. Conservations of the forests will also conserve the ecological system of Indonesia natural rainforest, which means ensuring the Indonesia’s biodiversity remains intact. Indonesia is one of the five most species-rich countries in the world, with a high rate of endemic species. Twelve percent of all mammal species, 16% of reptile and amphibian species, and 17% of bird species are found on the 17,000 islands that constitute Indonesia. It is the third highest number of threatened species of any country in the world. V. Methodology and Estimation of Costs and Benefits The Opportunity Cost of Foregone Palm Oil Plantations Opportunity costs are considered in the literature as the most important component of costs a country or a group of people would incur when reducing its rate of forests loss within REDD+, so an accurate estimate of such costs is very useful. As outlined in the previous section, this paper focuses on foregone opportunity of palm oil plantations establishment in Indonesia for conserving the forests. The opportunity cost of foregone palm oil plantation is measured in the profitability of palm oil plantations for the concession area of 18 million ha of forests that are suitable for palm oil plantations (Indonesian Palm Oil Association/GAPKI, 2009). This paper makes a couple of assumptions based on literature review of precious research done on palm oil yields, prices, revenues, and the costs of setting up and operating the plantations to estimate the profitability of palm oil plantations. This paper assumes a constant deforestation/conversion rate of 900 thousand ha per year over the duration of 20 years (20 phases of planting). To measure the revenues of plantations, this paper assumes a constant palm oil yield of 3.89 ton/ha (Indonesian Palm Oil Commission, 2010). Since this paper use a constant palm oil yield based on average lifetime productivity, the model starts accounting yield from year 1 (newly planted trees are considered yielding 0 ton of palm oil on its first year) over the period of 25 years1. In measuring revenues, the revenues of planting will also account for the income for logging the forests in clearing up the area for plantations, which is $1099 per ha (Tomich et al, 2002). The base scenario for price is the average price of palm oil from January 2006-Novermber 2008 at $749/ton (World Bank, 2008). For costs measurement of setting up and operating plantations, this paper assumes a $3.800/ha set-up cost and operation cost of $281/ha. Both assumptions are based the mid point of extreme values for set-up and operation costs of palm oil plantations in Indonesia (Rotheli, 2007).

                                                                                                           

Average lifetime of productive years for a palm oil tree is 25 years (FAO, 2013). Therefore the model will also treat the 26th years of plantation as yielding 0 ton of palm oil. 1

 

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Table 5. Summary of Assumptions for Palm Oil Plantations Profitability (Base Scenario)

OIL PALM MODEL ASSUMPTIONS Variable

Unit Concession area

Proportion converted to oil palm plantations Conversion period (years) Average Yield (tons/ha) Discount rate

Value

million ha %

18 100%

year

20

ton/ha %

3.89 5.75%

Oil palm plantation setup cost ($/ha)

$/ha

3,800

Plantation annual operations cost ($/ton)

$/ton

280

Logging income ($/ha)

$/ha

1,099

Average Price

$/ton

749

Note: A change in one (or more) variable(s) will result in different outcomes of profitability.

Using all the assumptions outlined above, this paper calculates the profitability of palm oil plantations (subtracting costs from revenues) for each year starting from 2013 to 2038, then take the present value (PV) of profit accumulations over the period of 25 years as estimation of the Palm Oil Plantations profitability with 5.75% discount rate (the current Indonesia Central Bank’s discount rate). Table 6. Summary of the PV of Palm Oil Plantations Profitability (25 years) REVENUES

UNIT

PV Accumulation

Logging  Revenues   Palm  Oil  Revenues   COST   Set  up  costs  (site  selection,  tenure,   operations)   Annual  maintenance  costs   (maintenance,  harvesting,  transport)  

million  $   million  $      

$12,244     $345,011        

million  $  

$42,337    

million  $  

$128,976    

    Total  Revenues   Total  Costs  

    million  $   million  $  

    $357,256     $171,314    

PROFITABILITY  

million  $  

$185,942    

PV  Profitability  per  ha  

   

$10,330    

Note: See “Appendix 1 Palm Oil Profit” for detailed methodology of estimation

REDD Program Costs Components

 

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There are three main costs associated with the REDD program, these costs are the REDD Development/Readiness costs, REDD Implementation Costs, and REDD transaction costs2. This paper use assumptions from different sources gathered through literature review. This paper estimates each cost component based on the following assumptions: • Development/Readiness Costs: one time $25/ha of concessions area (Eggleston et al, 2006). Eggleston et al estimated REDD development costs based on project design, governance and planning, land tenure and acquisition, zoning, institutional set-up and reform, research, and other costs that are most likely not recurring cost. • Implementation Costs: $.051/tCO2 of avoided emissions (Boucher,2008, citing Nepstad et al, 2008). Doug Boucher summarizes the finding from Nepstal et al (2007) of implementation costs per tCO2 avoided emission based on research in Amazon for year 10. • Transaction Costs: $0.38/tCo2 of avoided emissions (Boucher citing Antonori and Sathaye, 2008). • Doug Boucher summarizes the finding from Antonori and Sathaye (2007) of transaction costs per tCO2 avoided emission which is the mean of the transaction costs of 11 forestry projects. Table 7. Summary of Assumptions and PV of REDD Costs Components

Annual  Cost  of  Readiness  and  Implementation  (Assuming  5  years  to  get  Ready)   Cost  Variables   Unit       Cost  of  Readiness  (Development/Start-­‐Up)   /ha   $25.00   Transaction  Costs   /tCO2   $0.38   Implementation  Costs   /tCO2   $0.51   Discount  Rate   %   5.75%   PV  Accumulation  of  REDD  Costs  Components   PV  Readiness  Costs   million  $   $450.00   PV  Transaction  Costs   million  $   $21,023.64   PV  Maintenance  Costs     million  $   $9,952.41   Note: See “Appendix 2 REDD Costs” for detailed methodology of estimation

Indirect Costs: Other Non Market Costs3 Caravani (2011) acknowledges that opportunity cost analysis is a useful tool for measuring the market costs of avoiding deforestation, but she also acknowledges that it does not capture all the locally relevant costs of REDD+ since it fails to quantify non-market costs. To fill this gap the she conducted Contingent Valuation (CV) research of non-market costs of REDD by directly interviewing forest dependent communities. This paper uses the result of Caravani’s CV of non-market costs based on the willingness to accept (WTA) with the mean of $130 per ha of forest area destroyed. Based on this data, the non-market costs estimated is $2,3 billion ($130 times 18 million ha of concessions area). REDD Carbon Credit Revenues

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 Detailed  explanations  of  these  costs  are  outlined  on  Section  III  page  4-­‐5  

3

 

 Detailed  explanations  of  these  costs  are  outlined  on  Section  III  page  5  

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The largest benefit of REDD program is the revenues from the sale of REDD Carbon Credit. REDD Credit Revenue is measured based on the same the concession area of 18 million ha as in palm oil plantations scenario. In estimating REDD, this paper makes a couple of assumptions based on literature review of precious research done on carbon stocks of forests and palm oil plantations, as well as the price of REDD Carbon Credit in the market. This paper assumes a constant certification/conservation rate of 3.6 million ha/year starting from year 1 over 5 years (5 phases of REDD certification). To measure the revenues from the sale of REDD credit, this paper uses the estimate of carbon stocks of forests at 225 tCO2/ha and carbon stocks of palm oil plantation at 76 tCO2/ha (Butler et al, 2008). Based on the carbon stocks of forests and palm oil plantations, we can then derive the Net Carbon Savings of Avoided Emissions at 146 tCO2/ha. Table 8. Summary of REDD Revenue Assumptions (Base Scenario)

REDD REVENUE ASSUMPTIONS Variable

Unit

Value

Concession Area

million ha

18

Carbon Stocks of Concession Area

tCO2/ha

225

Oil Palm carbon Stocks

tCO2/ha

76

Net Carbon Savings of Avoided Emissions

tCO2/ha

149

Conversion period (years)

year

5

Average Carbon Price/tCO2

$

7

Discount rate

%

5.75%

Note: A change in one (or more) variable(s) will result in different outcomes of revenues

Based on all the assumptions above, the PV of accumulated revenues are calculated by deriving each year’s revenue from tCO2 saved (Net Carbon Savings times area certified/conserved) times the price of REDD credit in the market (the base scenario price is $7/tCO2 – the mid-point of REDD credit price range). Table 9. Summary of Total Carbon Saved, Revenue, and Revenue Accumulation Total  Avoided  emissions  (tCO2)   million  ton   $75,096    Total  Carbon  Revenue  

million  $  

$525,672    

PV  Revenue  Accumulation  

million  $  

$231,855.89    

Note: See “Appendix 3 REDD Revenues” for detailed methodology of estimation

  International Aid for REDD Readiness and Implementation For international aid estimation, this paper uses the current balance of Indonesia Climate Change Trust Fund (ICCTF, icctf.or.id) with $1 billion addition from the Norwegian Government pledge in supporting REDD development in Indonesia. From there, this paper then assume an additional $250 million of aid each year combined with 6% growth rate (return from the fund investments), and then calculates thePV of aid accumulation over the 25 years period. Table 10. Summary of International Aid for REDD Projections Balance as of 2012

$0.80

Norway Pledge

$1.00   $1.80  

Total  Aid  as  of  2013  

 

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Additional  Annual  Aid   PV  Total  Additional  Aid  

$6,083    

Assumptions   Annual  Additional  Aid  

$250  million  

Growth  Rate  

6%  

Discount  rate  

5.75%  

Note: See “Appendix 5 Aid Projection” for detailed methodology of estimation

Non-Use Value of Forests Conserved A method frequently used by environmental economists to estimate non-consumptive use values and existence values is to estimate people’s willingness to pay to protect or conserve. A survey among US citizens revealed that they are willing to pay about US$ 110 to US$ 230 as a one-time payment (Kramer & Mercer, 1997), to permanently protect 10% of the world’s tropical forests that is the exact portion of Indonesia’s forest area. This paper assumes a $230 per ha in valuing the non-use value of forests. Based on the assumptions, the indirect benefit of non-use value of the forests is $4.14 billion for 18 million ha of forest area conserved. This estimate is different from the cost component of ‘nonmarket cost’ presented in the previous section. The non-market costs are the indirect cost felt by indigenous people given the implementation of REDD so that they could no longer access the forests. While in this estimation, it is the willingness to pay of conserving the forests for its nonuse value. Costs and Benefits not estimated   1. The Positive Externalities of Palm Oil Plantations In Indonesia, palm oil is cultivated and produced by large private estates (50 percent of total production), smallholders (40 percent), and large public estates (10 percent). During the past decades, plantations and production have especially expanded among the large private estates and smallholders. In the early 2000s palm oil contributed 1.5-2 percent to the Indonesian GDP and in the late 2000s the corresponding figure was 4.5 percent (Barlow et al. 2003). There are no accurate statistics about the employment effects, but according to one estimate palm oil industry employed approximately 1.2 million laborers in early 2000s (Barlow et al., 2003). We can see that there are positive externalities of Palm Oil Plantations that will be foregone due to the implementation of REDD.     2. The Extended Potentials Benefits of Biodiversity and Forest Conservations Even though this paper includes the estimation of non-use value of forest conservation as part of the benefit, there are further extended benefit of biodiversity and tropical ecosystem that are not included due to the difficulty of measurement. However we can see that the additional benefits from biodiversity and ecosystem could be substantial given its potential as genetic resources that are very important and valuable for science and medical research.

VI. Analysis

 

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Based on the assumptions and estimations outlined in the previous section, we conduct an analysis of the total costs and benefits and a sensitivity analysis for REDD implementation in Indonesia. This section will be divided into two parts, the first part is an overview of market costs profitability comparison which then followed by analysis detailed analysis of the idenitified costs and benefits and sensitivity analysis varying prices of REDD as well as varying the discount rate. Cost-benefit analysis is this whole study not just the analysis part. Profitability Comparison Comparing the market costs and benefits only (without the indirect costs and benefits) and without PV of revenues and profits accumulation (using base scenario with average price of Carbon Credit at %7/tCO2, average price of palm oil at $749/ton, and 5.75% discount rate), we can see that for the first five years the revenues from Palm Oil and REDD are almost identical. However, after all 18 million ha of the forests are REDD certified (by the year 2017), the carbon credits that can be sold at the market remains constant while the palm oil plantations’ yield keeps on growing up to the 20th year (See graph 1). In terms of costs, we can see that cost of implementing REDD program is much lower compared to the cost of setting up and operating palm oil plantations (See graph 2). Graph 1. Revenues Comparison (in million $) $60,000.00   $50,000.00   $40,000.00   $30,000.00  

Palm  Oil  Revenues   REDD  Revenues  

$20,000.00  

$0.00  

2013   2015   2017   2019   2021   2023   2025   2027   2029   2031   2033   2035   2037  

$10,000.00  

Note: See Appendix 4 for Details.

When we compared for profitability, even after reaching its peak at year 5 and then flat, REDD is more profitable for the first 10 years, but then palm oil plantations become more profitable up to the 25th year (see graph 3). As we can see, palm oil profitability takes quite a while to surpass REDD credit profitability. When both benefit streams are discounted over the years, we can see that the profitability gap is not as wide as it appears on the graphs (see Table 11).

Graph 2. Costs Comparison (in million $)

 

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$25,000.00   $20,000.00   $15,000.00   Palm  Oil  Costs   $10,000.00  

REDD  Costs  

$0.00  

2013   2015   2017   2019   2021   2023   2025   2027   2029   2031   2033   2035   2037  

$5,000.00  

Note: See Appendix 4 for Details.

Graph 3. Profitability Comparison (in million S) $35,000.00   $30,000.00   $25,000.00   $20,000.00   Palm  Oil  Profitability  

$15,000.00  

REDD  Profitability  

$10,000.00  

$0.00   -­‐$5,000.00  

2013   2015   2017   2019   2021   2023   2025   2027   2029   2031   2033   2035   2037  

$5,000.00  

Note: See Appendix 4 for Details.

Table 11. PV of Profit Accumulation over 25 years (in million $)

PV  Palm  Oil  Profitability   PV  REDD  Profitability   Profitability  gap  

$197,238   $165,951   $31,287  

To be more accurate, the next section will include the indirect costs and indirect benefits (including international aid benefits) in the calculation. It will also present a sensitivity analysis varying prices for REDD Credit as well as varying the discount rate.

 

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Cost-Benefit and Sensitivity Analysis To have a better picture of the benefits of implementing REDD in Indonesia it is necessary to conduct a sensitivity analysis varying prices and discount rate. In varying discount rates this paper uses 5.75% for the base scenario, the latest recorded discount rate by Indonesian Central Bank (tradingeconomics, 2013). The high discount rate scenario uses the average rate from 2005-2013 at 7.83% (tradingeconomics, 2013, while the low discount rate of 3% is set arbitrarily as consideration for social discount rate. 1. Varying REDD Credit Prices and Discount Rate In varying the REDD Credit Price, this paper uses three different prices: $5/ton(low), $7(base), and $10(high). The low price scenario is set arbitrarily, while the base price is based on the average of Carbon Credit Prices in 2012, with the high price set based on the price of carbon credit for large package of more than 10,000tCo2 (Bloomberg, 2011). In this analysis, price of palm oil is set at base scenario assumption at $749/ton while discount rates and prices of REDD credit changes. Table 12. Varying REDD Credit Prices (all else constant, base discount rate 5.75%) Varying%REDD%Credit%Price%(Base%Discount%Rate) Base%Discount%Rate 5.75%

Price%of%Palm%Oil/ton $749 Base

Low

REDD Credit Price/tCO2 Variables OPPORTUNITY COSTS REDD Development (Readiness Costs) REDD Transaction Costs REDD Maintenance Costs Other Non-Market Costs REDD Credit Profitability International Aid for Implementation Biodiversity Conservation (non-use value) NET BENEFIT BCR

$5 Present Value COSTS $182,253 $450 $30,316 $15,459 $2,340 BENEFITS $151,554 $6,083 $4,140 ($69,041) 0.70

$7 Present Value

High

$10 Present Value

$182,253 $450 $30,316 $15,459 $2,340

$182,253 $450 $30,316 $15,459 $2,340

$212,176 $6,083 $4,140 ($8,419)

$303,108 $6,083 $4,140 $82,513

0.96

1.36

Based on the results on Table 12, 13, and 14 we can see that when REDD credit price is at $5 the implementation of REDD resulted in net costs regardless of the discount rate used. At the price of $7, the program will only yield net benefit at high discount rate. However, at all discount rate the program shows net benefit at price of $10/tCo2. In terms of benefit to cost ratio, at $5 and $7 the program’s BCR are essentially lower than 1, only at $10 BCRs are greater than 1. We can see that the price of REDD credit has to be higher than its current average of $7 in order to justify the implementation of REDD program in Indonesia.

 

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Table 13. Varying REDD Credit Prices (all else constant, high discount rate 7.83%) Varying%REDD%Credit%Price%(High%Discount%Rate) High%Discount%Rate 7.83%

Price%of%Palm%Oil/ton $749 Base

Low

REDD Credit Price/tCO2 Variables OPPORTUNITY COSTS REDD Development (Readiness Costs) REDD Transaction Costs REDD Maintenance Costs Other Non-Market Costs REDD Credit Profitability International Aid for Implementation Biodiversity Conservation (non-use value) NET BENEFIT

$5 Present Value COSTS $135,082 $450 $24,428 $12,456 $2,340 BENEFITS $122,121 $4,758 $4,140 ($43,737)

BCR

$7 Present Value

0.75

High

$10 Present Value

$135,082 $450 $24,428 $12,456 $2,340

$135,082 $450 $24,428 $12,456 $2,340

$170,970 $4,758 $4,140 $5,112

$244,242 $4,758 $4,140 $78,384

1.03

1.45

Table 14. Varying REDD Credit Prices (all else constant, low discount rate 3%) Varying$REDD$Credit$Price$(Low$Discount$Rate) Low$Discount$Rate 3.00%

Price$of$Palm$Oil/ton $749 Base

Low

REDD Credit Price/tCO2 Variables OPPORTUNITY COSTS REDD Development (Readiness Costs) REDD Transaction Costs REDD Maintenance Costs Other Non-Market Costs REDD Credit Profitability International Aid for Implementation Biodiversity Conservation (non-use value) NET BENEFIT BCR

$5 Present Value COSTS $278,647 $450 $41,650 $21,238 $2,340 BENEFITS $208,219 $8,750 $4,140 ($123,216) 0.64

$7 Present Value

High

$10 Present Value

$278,647 $450 $41,650 $21,238 $2,340

$278,647 $450 $41,650 $21,238 $2,340

$291,506 $8,750 $4,140 ($39,929)

$416,438 $8,750 $4,140 $85,003

0.88

1.25

2. Varying Palm Oil Prices and Discount Rate In varying the Palm Oil Price, this paper uses three different prices: $684/ton(low), $749(base), and $931(high). The low price scenario is based on the average price of palm oil from 2002-2011, while the base price is based on the projected price of palm oil (World Bank, 2008), with high price set based on the average price of palm oil from 2008-2013 (FAOStat, 2013). In this analysis, price of REDD Credit is set at base scenario assumption at $7/tCO2 while discount rates and prices of REDD credit changes.

 

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Table 15. Varying Palm Oil Prices (all else constant, base discount rate 5.75%) Varying%Palm%Oil%Price%(Base%Discount%Rate) Base%Discount%Rate 5.75%

REDD%Price/tCO2 $7 Base

Low

Price of Palm Oil/ton Variables OPPORTUNITY COSTS REDD Development (Readiness Costs) REDD Transaction Costs REDD Maintenance Costs Other Non-Market Costs REDD Credit Profitability International Aid for Implementation Biodiversity Conservation (non-use value) NET BENEFIT

$684 Present Value COSTS $152,824 $450 $30,316 $15,459 $2,340 BENEFITS $212,176 $6,083 $4,140 $21,010

BCR

1.10

$749 Present Value

High

$931 Present Value

$182,253 $450 $30,316 $15,459 $2,340

$264,657 $450 $30,316 $15,459 $2,340

$212,176 $6,083 $4,140 ($8,419)

$212,176 $6,083 $4,140 ($90,823)

0.96

0.71

Table 16. Varying Palm Oil Prices (all else constant, high discount rate 7.83%) Varying%Palm%Oil%Price%(High%Discount%Rate) High%Discount%Rate 7.83%

REDD%Price/tCO2 $7 Base

Low

Price of Palm Oil/ton Variables OPPORTUNITY COSTS REDD Development (Readiness Costs) REDD Transaction Costs REDD Maintenance Costs Other Non-Market Costs REDD Credit Profitability International Aid for Implementation Biodiversity Conservation (non-use value) NET BENEFIT BCR

$684 Present Value COSTS $112,748 $450 $24,428 $12,456 $2,340 BENEFITS $170,970 $4,758 $4,140 $27,445 1.18

$749 Present Value

High

$931 Present Value

$135,082 $450 $24,428 $12,456 $2,340

$197,616 $450 $24,428 $12,456 $2,340

$170,970 $4,758 $4,140 $5,111

$170,970 $4,758 $4,140 ($57,423)

1.03

0.76

As we can see from table 15, 16, and 17,when we vary the price of palm oi,l we can see that at high REDD program shows net costs with BCR lower than 1 at high price ($931/ton). Under the base price of $749/ton, only at base discount rate the program shows net benefit while at low and high discount rate the program still yield net costs. Essentially only when palm oil sells at low price ($684/ton), REDD implementation will result in net benefits with BCR of around 1 or more. If we combine our conclusion from varying REDD credit prices and Palm Oil Prices analysis, we can make a general conclusion that REDD credit has to be high with relatively low palm oil prices to be able to generate a net benefit from the implementation of the REDD program.

 

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Table 17. Varying Palm Oil Prices Prices (all else constant, low discount rate 3%) Varying$Palm$Oil$Price$(High$Discount$Rate) Low$Discount$Rate 3.00%

REDD$Price/tCO2 $7 Base

Low

Price of Palm Oil/ton Variables OPPORTUNITY COSTS REDD Development (Readiness Costs) REDD Transaction Costs REDD Maintenance Costs Other Non-Market Costs REDD Credit Profitability International Aid for Implementation Biodiversity Conservation (non-use value) NET BENEFIT

$684 Present Value COSTS $234,866 $450 $41,650 $21,238 $2,340 BENEFITS $291,506 $8,750 $4,140 $3,852

BCR

$749 Present Value

High

$931 Present Value

$278,647 $450 $41,650 $21,238 $2,340

$401,234 $450 $41,650 $21,238 $2,340

$291,506 $8,750 $4,140 ($39,929)

$291,506 $8,750 $4,140 ($162,516)

0.88

0.65

1.01

Table 18 and 19. Summary of Sensitivity Analysis Results

Discount.Rate Low Base High Mean.BCR 0.92 1.01 1.08 Mean.Net.Benefit :$26,047 $1,684 $13,253

Varying.REDD.Credit.Price

Discount.Rate Low Base High Mean.BCR 0.85 0.92 0.99 Mean.Net.Benefit :$66,198 :$26,077 :$8,289

Varying.Palm.Oil.Prices

VII. Concluding Analysis Based on the results of the analysis it (both in terms of BCR and Net Benefit) The problem is the discount rate is just a theoretical concept so it’s not something that can change in real life – like CO or palm oil prices. Your conclusion should be: It appears that REED only makes economic sense when prices of palm oil are at the low end of the spectrum and CO prices are at $10. As we can see from profitability comparison, REDD profitability is flat after year 10 while palm oil profitability is growing, this suggests that price changes will affect net benefit of REDD program. If the price of REDD credit cannot match up with the rising demand and price of palm oil, the program will yield a net cost. Looking at price sensitivity, holding price of palm oil constant, we can see that only 4 out of 9 scenarios result in net benefit (we also have to not that net cost are not very significant when compared to the results of changing oil prices), this suggests that the price of REDD really matters, once again back to the argument of constant revenues after year 10. Without price appreciation, it is hard for REDD profitability to keep up with the profitability of palm oil. However, as we can see in table 18 and 19, the BCR range is very close to 1 in most of the scenarios (ranging from 0.85 to 1.08) this suggest that the net costs or benefits are not that different for the two alternatives (either implementing REDD or expanding palm oil plantations). Given the fact the fact that palm oil yields the highest productivity and profits compared to other major landuses in Indonesia, the benefits of implementing REDD program might outweigh the costs if we replace the component of ‘foregone opportunity of land-use’ from palm oil to other crops.

 

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Table 20. Summary of Cost-Benefit Analysis under Base Scenario

Variables

Present Value COSTS

OPPORTUNITY COSTS REDD Development (Readiness Costs) REDD Transaction Costs REDD Maintenance Costs Other Non-Market Costs BENEFITS REDD Credit Profitability International Aid for Implementation Biodiversity Conservation (non-use value of conservation) NET BENEFIT BCR

$182,253 $450 $30,316 $15,459 $2,340 $212,176 $6,083 $4,140 ($8,419) 0.96

Even though implementing REDD will not always result in net benefit (under the scenarios in this paper), it is still worth pursuing. The government of Indonesia can design and implement a better forestry and agricultural management nation-wide. It is true that the growing demand for palm oil, the versatility of the use of palm oil products, and the fact that palm oil can only grow in tropical climate is an opportunity for Indonesia. But we have to note that it is also true that Indonesia with its 10% of world’s forest have a new opportunity since the launch of the REDD program. Before REDD, these forests have no financial value and will be converted into other more productive uses with financial value. Now with REDD, Indonesia government can actually reap benefits from doing nothing and just let the forests be. To minimize the opportunity costs of foregone other land use (such as palm oil plantation), the government and the private sector can implement a better management of plantations and increase productivity from land other than forests. Currently the average yield of palm oil in Indonesia is 3.89ton/ha while the highest potential yield is 7 to 8 ton/ha. The analysis with assumptions made in this paper suggests that the benefits do not always outweigh the costs with a worst case net cost of $165 billion. However if we use the base scenario, the net cost of implementing REDD in Indonesia is not that significant ($8 billion). If the government of Indonesia can combine the policy of improving the productivity and management of forestry and agriculture together, Indonesia can still meet the growing demand of palm oil in the global market while at the same time benefitting from hosting 10% of the world’s forests which never have any financial value before REDD. Thus, this paper suggests that REDD should be implemented combined with policies of improving the forestry and agricultural sectors in Indonesia.

 

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