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Management in Practice

Where's the profit in nature?

One study in 1997 estimated the value of all the functions performed by ecosystems at $33 trillion per year — substantially more than the entire world economy. But in most instances, functions such as purification of water and air, nutrient cycling in soil, or the resilience created by biodiversity don't have a clear economic value. A number of firms around the world see opportunity in monetizing those functions.

By Ted O'Callahan

Biodiversity Banking

Workers carrying saws on long poles move through rows of perfectly spaced 30-foot-tall oil palm trees. They cut bunches of fruits, which will be processed into palm oil that in turn makes its way into countless foods, cosmetics, soaps, and industrial lubricants. The plantation on the Malaysian island of Borneo is dry, hot, and quiet, according to David Brand, founder of the investment management firm New Forests.

Brand goes on to describe the wall of greenery along the edge of the plantation. The native rainforest's contrast with the plantation couldn't be sharper. Under a canopy of 220-foot-tall trees covered in epiphytes, it is cool and noisy with calls from gibbons, macaques, and hornbills. The ecosystem is crucial habitat for the endangered orangutan, pangolin, civet, sunda-clouded leopard, and pygmy elephant. What value to put on this sort of biodiversity compared to the productivity of the plantation has been a long-standing problem. "Effectively, nature is unpriced, and therefore is used wastefully as a low-cost input to production," Brand says.

The oil palm plantation's developer knows the costs as they stand now. "This man was absolutely laser-focused on commercial outcomes. He could quote me the cost per hectare, how much he was producing, how much he was selling it for, and how much money he was making. Everything was in his head," Brand says. "But try to talk with him about saving the orangutan and all he sees is that you can’t make money doing that."

Australia-based New Forests, which was founded in 2005, is part of a vanguard of companies built around the idea that the right market signals can make it economically worthwhile to save the orangutans and the rainforest they live in. The firm oversees $250 million in sustainable forestry and environmental assets, including a $50 million fund (which it co-manages) that invests in a portfolio of ecosystem-based credits.

The land dedicated to oil palm production in Malaysia and Indonesia, the top producing countries from 1990 to 2005, has more than doubled over that period, resulting in the destruction of rainforest and peatland. Particularly in Europe, consumers have begun to call for products that address the environmental impacts of their supply chains, and a number of projects are underway to meet that demand. One such endeavor, the Malua Biobank, an approximately 80,000-acre reserve managed in a public-private partnership by the Sabah state government and New Forests, sells Biodiversity Conservation Certificates to support ongoing habitat protection and restoration in an area degraded by previous logging and encroaching oil palm plantations. At the forest reserve, patrols and education programs help reduce poaching and illegal logging, while the replanting of native trees provides food for animals.

"We need to internalize the cost of consumption into every product," Brand says. He believes this model is scalable. "Biobanks could be embedded in all markets where production and protection need to co-exist."

Ecological Value

In the United States, clean water and endangered species legislation passed in the 1970s led to perhaps the most mature ecosystem services markets, including wetland protection. For a time, when a wetland was damaged by development, the developer was typically required to create an equal-size wetland on site. This mitigation seemed straightforward, but the pockets of installed wetland too often had essentially no ecological value. Opening up offsite mitigation as an option allowed third parties to pool funds from multiple developers to support large-scale wetland restoration that could have important ecological functions. The idea of a wetland bank was created.

A similar process has happened with endangered species protection. In the U.S., biodiversity banking is estimated to be a $3 billion industry. California has the most developed market.

"Biodiversity banking provides a product that is required by existing regulations," says Steve Morgan, the founder and CEO of Wildlands Inc., one of the nation’s oldest conservation banks, started in 1991.

Wildlands' various projects cover more than 35,000 acres, primarily in the West and Southeast. If a developer or landowner must mitigate for wetland, stream, or nutrient impact, or if a project happens in habitat for endangered species, Wildlands helps them meet regulatory requirements and takes over liability for outcomes.

One new approach they've taken can be seen at their Sacramento River Ranch in Yolo County, California. It sits in one of the most productive and intensely cultivated parts of the country. Seen from above, the ranch's 4,000 acres are a patchwork of fields, pastures, and wild land, producing tomatoes, corn, walnut, wheat, hay crops, and functioning ecosystems. An arcing bend in the river forms the northern and eastern boundaries of the ranch and provides five miles of shaded riverine habitat planted in willows and cottonwood, which makes it eligible for credits for salmon conservation. The ranch's 600 head of cattle are managed with grazing practices that protect the habitat for Swainson's hawks, qualifying the pasture for endangered species conservation credits. Elsewhere there is a nursery for various native plants, including elderberry, oaks, cottonwoods, and wild rose, which Wildlands uses in restoration projects.

Morgan explains that the ranch is a money-making venture, but it is also a demonstration of the sort of multiple-function agriculture that can have significant conservation importance while adding valuable revenue streams. Purchased in 2002, it has shown a 400% increase in wildlife present on the land with the modified practices.

Theoretically, these multi-purpose practices could be common. But whether it's farmland, wetlands, forests, or other environments, the barriers to participation can be high. Each habitat type on a property has different regulations and opportunities. Varying federal, state, county, and even municipal rules each add to the difficulty. Upfront costs for evaluation, restoration, and certification can be significant. Wildlands' business comes from providing expertise to those prepared to make the investment either because of a need for regulatory compliance or through interest in the long-term opportunity.

Exceeding Compliance

"The money people are spending on regulatory compliance is not yielding the ecological benefits it could," says David Primozich, the executive director of the Willamette Partnership, an organization working to support development of an integrated ecosystem services market in Oregon's Willamette Basin, where 75% of the state’s economic activity takes place. The partnership is looking for a more strategic and effective use of those dollars. "Investing in restoring an ecosystem’s functions is much more sustainable than keeping up with the growing expense of continually more rigorous regulatory compliance due to degrading ecosystems," Primozich says.

For example, in 2004, Clean Water Services (CWS), a county wastewater management agency, received permitting that allowed it greater flexibility in meeting its regulatory requirements. Permits from five facilities were rolled into one integrated permit. The Tualitin River watershed, where these facilities are located, is habitat for cold-loving salmon, so water temperature is regulated. CWS was investigating building a cooling facility that would have cost $150 million to build and operate. "We would have been 100% sure we would have complied with the regulation," says Bobby Cochran, project manager at CWS. "We also would have been 100% sure we weren’t doing anything good for the fish we’re hoping to help in the first place." He explains that with the new permitting, CWS was able to buy water temperature credits. The company paid landowners to plant 150-foot-wide bands of trees along 35 miles of the watershed. Shading the river, coordinated with water flow regulation from dams, produces the same temperature outcome as a cooling facility. It also sequesters carbon and restores habitat, so now the city of Beaverton again has beaver, river otter, and cut-throat trout. The final cost is expected to be $6–9 million.

The co-benefits from that project weren't counted, but in 2009 Oregon passed legislation that aims to promote better integration of state activities to protect and restore ecosystem services. "The law comes at a good time because stakeholders and regulatory agencies in Oregon just agreed on a first-of-its-kind package of credit calculation and issuance procedures," says Primozich. The law allows landowners to have all potential ecosystem services assessed and choose the most valuable credits. This should align environmental priorities with economic incentives.

"What we have is as good as it can get on paper. It's a huge milestone, but now we need put it to the test," says Primozich.

Crossing Borders

Oregon's efforts are all within state borders. On the East Coast, efforts to clean up the Chesapeake Bay watershed involve six states. Since 1990, the blue crab population has fallen 70%, dropping commercial harvests to historic lows. Oyster harvests are off 90% from the 1950s despite decades of effort and billions of dollars spent to restore the bay. Overharvesting is a problem, but so is the impact from nutrient-rich runoff. The 200-mile-long bay suffers from a quirk of geography that gives it the largest land-to-water ratio of any watershed. But the bay coped effectively before there were 17 million people sharing the 64,000-square-mile watershed that stretches from Paw Paw, West Virginia, to Cooperstown, New York.

"What we do on the land has great implications for the bay," says Eric Sprague, the program director for Bay Bank. "An entire economy has tanked because the bay has tanked." Bay Bank, a program coordinated by the nonprofit Pinchot Institute, seeks to lower the barriers that prevent millions of private farm and woodland owners from engaging in land management practices that qualify for payments for carbon sequestration, water quality and habitat protection, or forest conservation.

Whereas Wildlands works with commercial endeavors in which the large acreages involved reduce the cost per acre and deliver returns that justify paying for Wildlands' expertise, Bay Bank works in a market where landowners typically have 20 acres or less. "Bay Bank is trying to get the transaction costs as low as possible by explaining the programs to people, facilitating project development, or helping with paperwork," says Sprague. Details vary so much county by county that it is hard to generalize, but land-owners willing to plant forest or put a conservation easement on existing woodland in Maryland, where land development pressures are highest, might earn one-time payments of $10,000 to $15,000 an acre. The watershed-wide impacts of many small parcels changing practices would be significant.

A Functioning Market

Across the spectrum of ecosystem services markets, the science, the policy, the institutional knowledge within agencies, and the market mechanisms all are shifting as test projects deliver results that can be evaluated and improved. Elements of the infrastructure are coming together. The Markit Environmental Registry is widely used as a certifier of credits. And a company called Mission Markets is launching an online trading platform for a range of environmental and social investments in a single marketplace.

Mike Van Patten, CEO and cofounder of Mission Markets, comes from a background on Wall Street working on illiquid markets. "Right now these markets are fragmented and separate. As the market matures, and hopefully our organization will be a part of that, they will be seen as more interrelated and linked," he says. "The depletion of fishery stocks is not only an environmental issue; it is an issue that affects fishing communities, even to the retailer or store owner in the community." The market will let capital connect with a range of sustainability-related programs focused on issues such as fisheries, climate change, and renewable energy.

"Institutional investors are carving out portions of the portfolio for these asset classes they see as impact investing categories, which include both social and environmental areas. Community development banks are looking at carbon, brown field redevelopment, and fisheries trusts as ways to invest in their communities," Van Patten says.

The exchange looks to put local, regional, national, and international transactions in one place. It is structured with two tiers. One is SEC and FINRA compliant, and deals in regulated securities. The second tier is for credits that are not regulated as financial products. They fall under clean water, endangered species, or fisheries protections. Both seek to provide liquidity through opening a secondary market.

Van Patten is building a business on the bet that as environmental risk mitigation becomes increasingly common, involvement in these markets will become best practice for many businesses. He thinks that if the experiment shows proof of concept, there will be support for growth. "When public-policy makers see private markets effectively deploying capital, they are more willing to help scale the process," he says. "The regulated and private markets together can be very effective."