Commentary

Tiny Window for Pension Funds on Forestry

Large scale afforestation needs deeper roots in net zero investment strategies, according to Julian Poulter, Head of Investor Relations at the Inevitable Policy Response.

Trying to dig into how any company is dealing with its climate issues is difficult. Investors still complain that it is difficult to get some fossil fuel power companies to reveal their total emissions even when their engagement discussion just needs to start with ‘Have you tried putting the sensor at the top of the chimney?’

For other companies matters are a little trickier, particularly when you move beyond what they do as a company to how their suppliers behave.  When emissions reporting initially appeared a few savvy professional service companies realised that their car fleet was their biggest emission number, and that if they outsourced the fleet to a supplier their total emissions miraculously fell in their ESG report.

The whole pesky Scope 3 emissions issue grew and now companies are being asked to take responsibility for issues in throughout supply chains. Generally, for companies, procurement is a difficult enough competency that represents around 50% of the profit equation. To then have to pressure suppliers to deliver on quality and price but also in a sustainable manner is a long journey for most and too hard for some.

Nonetheless, the increased recognition that land use and deforestation are now right up there with power and transport as priority sectors for emissions reduction has spurred key initiatives from organisations like WWF and Moore Foundation to focus on the end-to-end of the food supply chain.

Pushing hard on deforestation is  an ‘easy’ win for everyone now that forestry has increasing value in voluntary carbon markets in that it primarily requires a cessation of an activity, more than the complexity of an entire industry re-engineering challenge.

Additionally, the policy lever is comparatively simpler to implement than the transition in industrial sectors like steel, chemicals, cement and plastics, and delivers a major bounty on a nations’ emissions score. However, being disaggregated and also key influencers, farmer/producer resistance to ceasing deforestation is still tough for governments to overcome.

Furthermore, whilst strong engagement by companies is the moral thing to do, showing a positive return for shareholders for this engagement effort on land use and associated agricultural supply chains is not easy. So we cut them a little slack, whilst not letting them off the hook and pointing to the leaders who like Nestle and Unilever who have made the effort.

Reforestation and afforestation

However, on the re-forestation and afforestation levels, there is no excuse for inaction on increasing investment. An increasing number of markets are providing value for investors in this area through voluntary and regulated markets. Investing giants like Mitsui and Nomura have started to snap up forestry funds and some climate leading pension funds have started to weigh in.

The Inevitable Policy Response (IPR) published its first transition Forecast Policy Scenario (FPS) in 2019 and its conclusions were communicated to virtually all the major investors on the planet including most of the large pension funds. The message back then was clear – markets have not priced in the acceleration of the transition, so it was time to cracking.

In particular, additional to the aforementioned and reasonably well understood themes of power and transport, it was time to urgently expand into whole land business, as the elephant in the global emissions room. There’s no net zero without it.

This is a message that in the last three years has seeped out past climate science gurus and policy makers but is yet to be matched with sufficient dollars. On one aspect of land use, IPR analysis estimates tropical afforestation and reforestation offer inexpensive sequestration at a large scale up to 1Gt CO₂, a not inconsiderable benefit.

With IPR’s 2nd forecast policy scenario in 2021 and the subsequent geopolitical events of 2022, net zero hangs by a thread so thin you can hardly see it. Whilst the 1.5°C overshoot is a Hollywood blockbuster with an all-star cast coming to an economy near you very shortly.

As a CIO of a pension fund or a member of an investment committee, you are in neglect if you do not have a position on net zero and overshoot. If you agree with the IPR FPS thesis, that climate events will force a rapid acceleration in policy maker responses, with all the volatility this entails, then you’ve already started to discuss the portfolio implications while your stewardship engagement teams are pushing the policymakers to limit the extent of this overshoot.

Trees: Proven NETS technology

An inevitable overshoot means an inevitable panic by governments to limit it, now that the physical impacts at a mere 1.2°C temperature increase are increasingly visible and less than pleasant.

Limiting the overshoot means one thing – negative emissions technologies (NETS). Followers of sci-fi and fantasy may find that reality will begin to merge with the fantastic as academics and scientists start to seriously debate some of the scarcely believable technologies that might be needed.

If you are an asset allocator and discussions of giant machines sucking out greenhouse gases on the ground whilst supersonic aircraft scatter particles in the stratosphere are likely to see the company drug testing policy used for the first time at an investment committee meeting, then consider the more proven and closer to earth solution of forestry, large scale afforestation, as an agenda item.

For the time being, the trusted tree with leaves and a trunk represents the cheapest form of negative emission for years to come and the science is staggeringly simple – stop cutting down as many of them and start planting some more. Nobel prizes await.

One estimate sees that the climate forestry market will reach over US$800 billion by 2026, larger than the current entire global forestry and logging market.

If you are an insurance company, especially one committed to a net zero initiative, forestry is now as core business as underwriting, particularly given that the asset and liability side of the business are exposed equally to the present and coming climate disaster.

So, what excuses do we hear for not allocating to a currently small but inevitably huge market where early adopters stand to gain significantly? Deal size? We don’t understand the space? Specialist managers in this areas have higher fees?

The time to build understanding of the investment opportunity around forestry was yesterday but there is still window for pension fund CIOs and investment committees. Larger forestry allocations will be standard fare by 2025.

Post the Paris Ratchet at COP30 where the gap between temperature projections and nationally determined contributions will be on stark display, governments will be urging investors to find, buy or support new forestry in the many 1000s of hectares.

But by then the smart money will be deeply invested.

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