BC And The Baseline Brouhaha: Dissecting The Darkwoods Documents

28 March 2013 | British Columbia’s Auditor General last night released a damning audit of the province’s Carbon-Neutral Government program and the Pacific Carbon Trust, a government-owned entity that buys carbon credits on the open market and then sells them to government agencies within the province.

Embedded within that report was a condemnation of the Nature Conservancy of Canada’s (NCC) Darkwoods Forest Carbon Project and, indirectly, the Verified Carbon Standard (VCS) that recognized it. Specifically, Auditor General John Doyle says the VCS-approved process over-estimated the number of trees the project saved by at least 30%.

VCS officials, on the other hand, accuse Doyle of writing his own rules and giving short shrift to established standards that represent the consensus thinking on carbon accounting to date. In so doing, they say, he not only got it wrong, but re-introduced the very element of risk that standards were created to eliminate.

Both sides have offered to speak with us now that the report is out, but before we dive into that can of worms, we thought we’d offer a simple breakdown of the issue through the prism of two readily-available documents: the auditor’s report, An Audit of Carbon-Neutral Government, and the Darkwoods Project Description Document that 3GreenTree Ecosystem Services Ltd and ERA Ecosystem Restoration Associates Inc provided for NCC as part of the verification process. If the hyperlinks don’t work, both documednts are also available under the “Related Documents” tab to the right.

The Baseline Challenge and the Role of Standards

A project baseline represents the consensus agreement of what probably would have happened if the carbon project hadn’t been created. Project developers create a baseline by modeling different scenarios, determining which is most likely, and then subjecting that determination to the wringer of peer review. If it survives the process, it can then be used to both demonstrate that the carbon credits actually caused the emission-reduction to take place (called “additionality”), and to measure the amount of reduction that the project should get credit for.

The trouble with baselines is that, by their nature, they will always be subject to debate. Anyone who was around a decade ago can recall the chaos that ensued when different projects tried to establish their own rules for establishing baselines: it was not only a mess, but an expensive one as each project developer had to re-invent the project-development wheel. That’s why standards emerged to establish agreed-on procedures for establishing baselines. To the carbon community, a project baseline determined through agreed-on procedures is, therefore, something like the outcome of a democratic election: we may not like it, but for society to function, we must accept it. The key is to make sure the process itself is trustworthy.

The procedures are clearly laid-out and involve peer review by scientists, environmentalists, and businessmen accredited by various entities, depending on the standard. On top of that, the market provides additional differentiation as buyers presumably purchase the offsets they have the most confidence in. This also creates an incentive for standard-creators to create a vigorous process. To-date, VCS is the most widely-used standard for the voluntary carbon market, which is why PCT chose to follow it for its purchases.

The auditors clearly understand both the challenge and the importance of developing a baseline that is widely agreed-on.

“A baseline is always a hypothetical scenario, therefore establishing a credible baseline is critical,” they state. “If the emissions baseline is overestimated, the project would claim an artificially high number of offsets, a portion of which are not real greenhouse gas reductions.”

Not so explicitly stated is the converse: if the emissions baseline is underestimated, the project might not get done at all. The reality of forest carbon is that it will probably never be as lucrative as logging, and it will always be more complex. While philanthropic money has long gone into conservation, that pool of money is small and shrinking. Forest carbon projects are designed to scale up funding for forest protection by charging for an ecosystem service   – namely, carbon sequestration. This means the projects must demonstrate real value.

The challenge is finding that sweet spot where environmental integrity, economic viability, and social equit overlap. This involves creating standards that are good enough to be trustworthy as commercial ventures, but not so costly that the perfect becomes the enemy of the good.

The Project Description

Every project that goes through the VCS process generates a Project Description Document, which lays out the reasoning behind the project. For our purposes, the most relevant section runs from page 21 through 28 and explains how NCC established a baseline and determined that the project was, indeed, additional. The Project Description then offers a deeper analysis on pages 67 through 80.

It shows that they examined five different scenarios that could play out on the land under different buyers, and then tried to determine which was most likely given the asking price, the potential buyers, and the economics of maintaining the land. It then uses a clear methodology laid out under the VCS to determine which scenario is the most likely.

Here are the five scenarios and what they concluded:

Scenario One: The Buyer Keeps the Harvesting Rate the Same as the Previous Owner The previous owner was a company called Pluto Darkwoods, which was in turn owned by Duke Carl von Wí¼rttemberg, a German nobleman who harvested an average of just 57,000 cubic meters per year. The Project Description concluded that the odds of finding another person with his unique set of goals and deep pockets was slim. The Auditor General agreed. Neither of them felt this should be the baseline scenario.

Scenario Two: The Buyer Follows a Market-Driven Logging Program NCC concluded this would be the most likely scenario and chose it as its baseline, in part because the asking price was based on a 2004 assessment by timber evaluation consultants Jim Thrower & Alec Orr-Ewing. This is where the Project Description and the Audit most strongly disagree: the Auditors General concluded that Scenario Three (below) was the most likely and should therefore be the baseline scenario, while NCC concluded that Scenario Two was most likely. NCC used a step-by-step reasoning process under VCS  rules to reach its conclusion, and that process is outlined on pages 21-28 of the Project Description.

The Thrower & Orr-Ewing appraisal was based on three commercial scenarios that differed only in how long it took for the new owners to deplete the older trees on the property. The most aggressive scenario said the old trees would be gone in ten years; the middle scenario said 15; and the most docile scenario was 20. NCC settled on the middle scenario, and VCS agreed.

Scenario Three: The Buyer Employs Sustained-Yield Harvesting. Using financial modeling based on the Thrower & Orr-Ewing data, NCC concluded that a sustained-yield approach wouldn’t generate enough income to cover the cost of the acquisition. The modeling was posted for public opinion, and VCS reviewers concurred. The auditors, however, contend this is the most likely scenario and should have been the one chosen as a baseline.

Scenario Four: The Buyer Converts it to Real Estate. The Project Description says real estate developers did, in fact, to buy the property – a scenario the description also says would have generated far more carbon emissions than would logging – although it’s not clear that Pluto Darkwoods would have been receptive to such an offer. NCC, however, chose not to use it as a baseline for two reasons: one, it was too difficult to accurately project and two, they deemed it too aggressive.

Scenario Five: The Buyer Sets the Land Aside for Conservation. This was NCC’s mission, and is what they did in the end. It would not have been viable as a commercial venture, but it’s by comparing the number of trees under this scenario to the number of trees under the baseline scenario that they come up with the number of carbon credits.

The Forcasting Tools

To develop their projections, the teams from   3GreenTree Ecosystem Services Ltd and ERA Ecosystem Restoration Associates Inc used two well-known tools: an ecosystem simulator called FORECAST and a harvest-simulation model called FPS-ATLAS. The Auditors do not appear to be questioning the veracity of the models, but rather the project’s basic assumptions.

The Points of Contention

In a nutshell, NCC recognized Scenario Two above as the baseline, and they were able to make their case using VCS rules. The Auditor General, on the other hand, recognized Scenario Three, using rules that VCS officials have dismissed as arbitrary. This debate is likely to continue for quite a while, and we’re hoping to build a summary page here that can serve as a reference for others looking to understand it. We welcome feedback, and – unlike normal articles – plan to add to and subtract from this page as comments are received.

Here are the basic points of contention:

The Value of the Land Both documents agree that an initial assessment took place in 2004, when Thrower & Orr-Ewing were hired to appraise the value of the timber on the land. The two documents appear to differ, however, on what could be concluded from that appraisal.

NCC says that the timber and land appraisals used to set an asking price “inherently drove the type of forestry practice that would be necessary to achieve a reasonable investment return on that investment capital,” and concluded that Scenario Two was the fate they were saving the property from.

The Auditors reached a different conclusion. “We found that aggressive assumptions around the harvesting practices under the baseline scenario resulted in 30 percent more harvestable wood than was projected in the timber appraisal used for establishing the property purchase price (emphasis added),” the auditors wrote, implying that the appraisal assumed less-aggressive logging than NCC did. We have requested a copy of the initial appraisal report.

Role of Credits in Supporting the Purchase VCS and the auditors also differ in their views of the role that carbon offsets played in helping NCC purchase the property. Although not explicitly stated in the Project Description, NCC has long said that carbon credits were the final piece in the funding puzzle and made it possible for them to purchase the property. The Auditor General, however, takes a different view.

“The Nature Conservancy of Canada (NCC) decided to purchase the Darkwoods property in 2006, but the transaction did not close until April 1, 2008,” the auditors point out. “For the NCC, offsets were not a critical factor in the decision to acquire the Darkwoods property (emphasis added).”

While NCC has always said that carbon credits were part of the financing pool, the auditors imply that carbon credits were an afterthought.

“A carbon offsets feasibility study was not completed until January 2009,” they write. “The NCC did not approach the Pacific Carbon Trust about offsets until late 2009.”

That timeline, however, is not inconsistent with the way NCC has characterized the project in the past. Still, it will be more helpful to get some insight into NCC’s decision-making process.

What Would a Different Buyer Do? This is the core question, and here the two documents differ considerably. Both documents examine the possibility of the land being purchased by someone who would sustainably harvest it for tax purposes. The Auditor General, however, chooses this as its baseline scenario, while NCC says it would be a losing proposition for a commercial logging operation.

“The project assumed a ‘liquidation logger’ would not follow the requirements of the Private Managed Forest Land Act (PMFLA), even though the project plan identified that most private forest land owners in the area followed these requirements,” the auditors write. “The project documentation provided no explanation for omitting such registration from the baseline calculation.”

Here there is some confusion, because the Auditors’ description of the “project plan” is different from what’s written in the Project Description. While the auditors say “the project plan identified that most private forest land owners in the area followed these requirements,” the Project Description says no such thing and implies the opposite (see “What Would the Neighbors Do?”, below).

Furthermore, the Project Description says that sustained-yield harvesting would not generate enough income on this property to cover the cost of acquisition and maintenance. Specifically, using the Thrower & Orr-Ewing data, it concluded that a market-driven logger could achieve an internal rate of return of between 8% and 12%, while a sustained-yield harvester would achieve an internal rate of return of between 2% and 6%.

“…it is relatively easy to infer the implications of a reduced-harvest level from the timber valuation reports which drove the property valuation at sale,” the Document Description says. “Any significantly lower harvest level in the first 30 years than contemplated in the valuation scenarios, assuming the final sales price was close to the asking price, would necessarily have difficulty covering the capital cost of the acquisition and would not achieve the basic return levels used in the valuation appraisal.”

It also lists a document called “Darkwoods Carbon Model – Baseline Valuations” that is “available to auditors but confidential due to previous owner financial information.”

Based on this analysis, NCC concluded – and, again, VCS concurred – that it would make more economic sense for a new owner to drop the property’s PMFLA status and shift to more aggressive logging.

What do the Neighbors Do? The two documents also have different views of how surrounding properties are treated, and here the difference is material rather than philosophical and can be easily verified. The Project Description says liquidation logging is common in the area, while the Audidors’ Report says that most properties are managed sustainably.

“Recent liquidation logging activities on a large adjacent property and other regional evidence of private forestland liquidation reinforced this threat assessment,” the Project Description states. “Liquidation logging with little regard for basic environmental protections or sustainable timber production is legal and not uncommon in BC on private land.”

The Project Description also says that many of the adjacent properties are crown lands, which are publicly-owned forests on which logging is not permitted.   “Further details on regional comparables are available upon request,” the Project Description says. “They are not listed here for privacy reasons.”

The Auditor General, by contrast, says that most surrounding landowners follow sustainable practices dictated by internationally-recognized forest certifications.

“Most logging companies in the province are certified and sawmills in this region are also certified,” they wrote. “Forest companies that do not preserve environmentally sensitive areas can face public pressure to do so.”

It also says that many local properties do, in fact, have PMFLA status.

“(PMFLA management) is common practice in the area, as significant tax benefits are gained by registering a forest under the Act,” the auditors say.

On their own, neither document provides enough information to tell us who is right and who is wrong on this one – but it should not be difficult to find out what the common practices are in the area, which could provide insight into the probability of a good steward buying a property the size of Darkwoods. (The property’s size was also a factor in NCC’s calculations.)

Competing Bids The two documents also differ in their treatment of competing bids.

“We found limited support for a ‘liquidation logger’ scenario,” the ausitors wrote. “No such companies bid on the property, and it was widely reported at the time of sale that the owner’s preference was to sell to a buyer who would appreciate or maintain the area’s forest and wildlife values.”

The Description Document is vague on who bid for the property, but it does allude to a bidder who wanted to develop the land for real estate – a scenario with substantially higher greenhouse gas emissions than logging. Media reports say that von Wí¼rttemberg wanted to see the property cared for in a sustainable way, but there is no indication he made that a condition of sale.

“The property was offered for a sealed bid sale, first to a selected group of bidders, of which NCC was one,” the document states. “NCC viewed the Darkwoods property as under immediate threat of liquidation logging and other industrial logging practices and/or extensive real estate development.”

The reference to a real-estate bidder comes later, in the section describing various baseline scenarios, when it refers to “the real-world bidder interest alluded to by Pluto Darkwoods”.

Regulatory Surplus The two sides also differ on whether the project was trying to earn credits for doing something it was already required to do by law.

“The Nature Conservancy of Canada acquired the Darkwoods property using a Natural Areas Conservation Program grant of $25 million and a donation of a major portion of the property through the federal Ecological Gifts Program,” the auditors write. “These two sources accounted for the majority of the property’s purchase price of approximately $100 million. Under the Ecological Gifts Program, the Nature Conservancy of Canada becomes legally obligated at the time of purchase to manage these lands for conservation.”

Although the Project Description is vague on this, VCS Association Chief Executive Officer David Antonioli told us in an interview that the Gift – like the carbon credits – were part of a complex web of interdependent mechanisms that NCC used to finance the deal.

“The Eco-Gift was just another piece of the financing puzzle, and the conditions simply said that (NCC) had better do what they say they will do with (the Darkwoods property),” he said. “The fact, however, is that if NCC had not purchased the land, then the grant would not have been given, and if they didn’t have the carbon component, they would not have purchased the land.”

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