House of COMMONS







The international context for progress on climate change



Tuesday 11 March 2008


Evidence heard in Public Questions 105 - 138





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Oral Evidence

Taken before the Environmental Audit Committee

on Tuesday 11 March 2008

Members present

Mr Tim Yeo, in the Chair

Mr David Chaytor

Mr Nick Hurd

Mark Lazarowicz

Dr Desmond Turner

Joan Walley


Memorandum submitted by Sustainable Forestry Management Ltd


Examination of Witness

Witness: Mr Eric Bettelheim, Founder and Executive Chairman, Sustainable Forestry Management Ltd, gave evidence.

Q105 Chairman: Good morning and welcome to the Committee. Thank you for coming in at relatively short notice.

Mr Bettelheim: My pleasure.

Q106 Chairman: Would you just like to introduce yourself - we do not all know you - and tell us a little bit about your background.

Mr Bettelheim: Yes, of course, Mr Chairman. My name is Eric Bettelheim and I am the Executive Chairman of a company called Sustainable Forestry Management, which was established about nine years ago. My co-founder in that effort was Richard Sandor, who is now the Executive Chairman of Chicago Climate Exchange and I think widely regarded as the father of emissions trading, particularly having established the efficacy of emissions markets through the sulphur dioxide market, which solved the acid rain problem in the United States. Our company is focused entirely on forestry in the tropics and subtropics, particularly on the environmental services they provide, the key one of which, I suppose, for current purposes is carbon sequestration and storage. I think the regime that we have had to operate under has not exactly been the most encouraging and I would like to say, if I may - I know the Committee has a number of questions but just by way of opening remarks - that I think this topic the Committee is now addressing could not be more important and could not be more timely. What is clear over the nine or ten years of experience that we have had in this is that the architecture for the post-Kyoto world has to be very different from that which has prevailed up until now if we are really to solve the problem of climate change over the next few decades. I have asked that your staff hand up to you a document which I would like to refer you to. I would like to commend this to the Committee. It is a working paper - not my testimony - prepared by your colleague, Stephen Byers, in his capacity as Chairman of the Working Party on Market Mechanisms for Globe 8. This came out following their recent meeting in Rio. If I can just draw the Committee's attention to a few of its recommendations, if you would turn to the third page in the document, there are four recommendations which I think are of the utmost salience in this discussion. The first - and this is recommendation number one at the bottom of page 3 - is to start any new regime with a level playing field. In our context what I would emphasise is that it is a level playing field between the developed world and the developing world. The Kyoto Protocol, as I think the written evidence which I submitted demonstrates, is biased against the developing world, certainly against that part of the developing world which is not rapidly industrialising. Almost all the benefits of the Clean Development Mechanism have accrued to just a handful of countries, basically, China, India and Brazil, and the rest of the developing world, and in particular the least developed countries, have received virtually nothing and are outside of the system and do not benefit from it. Of course, that has significant implications for any new treaty which needs their support as we look forward into those negotiations. So I think the bias against the South needs to be removed. The second of the recommendations is to set clear long-term targets for carbon dioxide emissions or greenhouse gas emissions reductions. The systems now in place, particularly EUTS and the Kyoto process, have a little bit of the old Soviet five-year planning approach to this. Investments that are to pay off over decades cannot possibly be made if there is regulatory and political interference every five years, changing the goalposts, moving the target. I think in the next round of negotiations it is critical that the world set long-term targets, hopefully 30 years or 40 years into the future. Of course, those targets could be revised, made more stringent, as time goes on but it would at least give a clear, simple direction to the market which investors can rely on. The third item is number four in the document, which I think is very important to change for any new architecture if a treaty is to be successful, and that is to move from prescriptive regulation to principles-based regulation. This is the evolution which I am sure members of this Committee have seen in the Financial Services Authority over the last ten years or so. This has made a significant difference; indeed, the United States financial regulatory system is now seeking to imitate the development towards principles-based as opposed to prescriptive regulation in financial markets. The fourth item is number five in the document, which I think is absolutely essential for any new architecture, which is the creation of a new independent regulatory body for the carbon markets. The Prime Minister, as you know, has suggested this and I think it is an opinion increasingly shared by those of us in the markets that the Clean Development Mechanism is not functioning as an effective regulator, that it is unrealistic to expect the United Nations to serve as a regulator of what is essentially a financial market, and that there are other bodies, like the European Central Bank in the case of EUTS, and like securities regulators and central bankers, who are more appropriate regulators for such a market and are experienced in that. There are two last items I would add, and then I will finish my introductory remarks. Although they are implied in this, they are also dealt with in other papers published by Globe at the same time, in particular Lord Jay's report. One is to create a multilateral fund of some sort, whether run by the World Bank or otherwise, which will build capacity in those countries, particularly in the developing world, in the least developed countries, who do not have the infrastructure necessary for private sector investment and participation in the carbon markets. They need help with measuring, monitoring and verifying their carbon and their emissions; they need help with administration and so on. These are not particularly expensive items but they are essential to the countries, many of whom cannot afford this capacity. That is a vital area, I think, for public sector involvement. Finally - and this, I suppose, leads on to my particular focus, which is carbon sequestration - it seems to me essential that the developing world be given credit for their biomass if we are to have a successful negotiation. I notice that very recently India and China have made it clear that they will demand that increases in their biomass through reforestation and afforestation be included. By the same token, those countries that have existing forests that are being degraded or deforested will also demand such compensation if they are to participate in the market, all of which I happen to think would be a very good thing. In conclusion I would say - and I know this may sound heretical - that I think we have our priorities wrong. I think we are trying to force technological change before it can happen and we are not taking up the biological mechanisms which are available now. We seem to have got that inverted. We are delaying in dealing with the one system we know works, which is photosynthesis, and trying to force an early transition technologically. It is probably more logical at least, even if politically difficult, to take up the opportunity which the forests of the South offer us in terms of mitigation of climate change while industry makes the adjustments over time and the investments over time that it can take up the running thereafter. Mr Chairman, thank you for that. I am sorry if I have overstayed in my initial remarks but I thought it was very important for this Committee and for political leaders generally to start focusing on a new regime and not simply an extension or modification of the old regime.

Q107 Chairman: Thank you. We would like particularly to focus on forestry and forestry-related issues this morning but, just responding to a couple of things you said, I am interested in your view - I think I have got this right - that you think central bankers might be better regulators than the UN of a new system. That I find interesting given your concern about recognising the importance of developing countries. I did not realise that central bankers were particularly expert in that area, or indeed that developing countries would necessarily see them as a better holder of the ring than the UN. In relation to long-term targets, the question that arises in my mind is that since the science is changing steadily, long-term targets that might have been set five years ago are clearly going to be grossly inadequate in the light of our present knowledge, and it seems to me that what we actually want is tougher short-term targets. The problem is we set all these targets for 2050 and keep making them tougher, and actually that ignores the fact that we may use up the whole of our budget by 2030 in terms of emissions, and even if we had a 100 per cent cut by 2050, it might be too late. I would slightly take issue with this prescription.

Mr Bettelheim: Let me respond to the second point first. As I said, I think if you set a long-term target, that does not mean you cannot make it more stringent over time as science improves and as urgency may become more manifest. Climate effects may come faster than we expect them to; they also may be delayed longer than we expect. I think what is important for business is to know that there is at least a minimum line, if I can put it that way, which is a trajectory which will not be changed. It may be to make more stringent but it is not going to be relaxed, and that gives integrity to planning. As for the point about central bankers and the United Nations, I was not suggesting that central bankers understand the developing world. I think the rules, the principles, need to be set by a United Nations-type negotiation and discussion. That would be the principles base, but when it comes to implementation of those principles, it seems to me firstly, we should be able to allow nation states to regulate their own affairs in meeting their national targets, whatever those are, as agreed under a new treaty. Secondly, that when it comes to the detailed, day-to-day management of the market place, of the regulation of the market place, that should be in the hands of financially trained and market-trained individuals as opposed to those who do not have that kind of background. One of the fundamental flaws has been that regulations have been impossible to comply with, at least, certainly in my sector.

Q108 Joan Walley: May I just follow that up? I was interested in what you are saying about an independent regulatory body for the carbon markets and, just adding to what the Chairman has just said really, how that would fit in. I would not see bankers as the right people to do that but presumably you would have to work out very clearly as well how that sits with the WTO specifically. I was interested in your thoughts on the interface with the WTO.

Mr Bettelheim: Let me take that in two parts, if I may. The first is the reality is there is not going to be a single global market called Kyoto or anything else. The reality is that there are regional and national markets emerging all over the world: in Australia, New Zealand, the United States, and Europe of course, and that will continue. It will be just like other commodity and financial markets. It is like that now. It increasingly means that different countries are taking different trajectories to reaching whatever targets they set themselves or which will be set in a treaty context. Therefore, you have to look at any international oversight or any international role in that as being one essentially of connecting those things up in a fungible way, that is, creating a common standard against which they will measure themselves. Some credits will meet that standard and some will not. I think it is nave to continue a debate on the basis that the entire world is going to sign up to a single carbon market run by the United Nations. That is not going to happen. It is not happening. If you accept that, then you have to look at how those national regimes should be regulated and how there should be common principles of regulation for those regimes. I am suggesting that the common principles should be established by, say, the United Nations international treaty obligations but that the implementation of those should be left to national regimes which are capable of handling those issues. That includes, by the way, adding other expertise, not just financial expertise. I did not mean to exclude other participants. Right now we have the reverse situation, where no financial expertise and very little private sector expertise is being brought to bear within the regulatory system. As for the WTO, I think there are some very serious issues as to how that will integrate, particularly if you are talking about carbon being a commodity that is available to everyone. You are talking about affecting the fundamentals of each country's economy - you cannot escape that - and you start to get into debates such as the one in the European Union, which I find extremely troubling, where the view is taken "If we have a high price for carbon and other countries have a low price or no price for carbon, we will impose a tariff law; we will create a trade barrier." As I mention in my written submissions, that is the kind of thinking that I would have thought became obsolete in about 1935, but it has reared its head again because the European view seems to be that a high carbon price is the solution. My view - and I understand people may think that that will work - is that whether it will work or not, it is not going to work in the real world, that the rest of the world is not going to impose a high carbon price, is certainly not going to enforce 40 or 50 or 60, which is what the European Union is now suggesting by its recent stance, on carbon. If you look at what is being proposed in Australia or the United States, you are talking about $10 or $15, which I appreciate has depreciated somewhat recently. There is no chance that the rest of the world is going to go the extremely high carbon price route. Therefore you do end up with very serious potential trade issues and I think you will find debates which could be extremely destructive, not just about climate but about international trade generally, which would naturally be something the WTO would become involved in, and there would be a very complex series of disputes as a result.

Q109 Chairman: Do you not think that one consequence of a lower carbon price might be to delay or deter investment in low carbon technologies?

Mr Bettelheim: On the contrary, I think that everyone realises that markets have a tendency to take the low-hanging fruit first but, once they know they can calculate that, they also know what is coming further out and they take steps to anticipate that. In the example I mentioned to you, in the sulphur dioxide market experience, which is the precedent for carbon trading, the predictions by all the think-tanks - Harvard and others - was that what companies would do when they were given a trajectory of reduced emissions over a decade or so was to track just below that line, to just meet compliance obligations. In fact, they did nothing of the kind. The curve of compliance went like this (indicating). In other words, they over-achieved by having a lower price form of compliance. I have a feeling that, if you look at the global situation and the global demand for this under potentially a new treaty and a world in which the Americans - which I believe they will - will have a carbon programme, I think you will find that what business will do is it will over-achieve; it will anticipate what is coming five or ten years from now, even if the low-hanging fruit helps them cope in the short term, which I think is the right approach to market economics. To create a spike in the price now does nothing except seek evasion, and even the European Commission in its recent recommendation says, "If we do this, industry is going to leave." All right, it will leave. Where will it go? It will go to those places where they are effectively unregulated. I think it is wiser to have industry stay and innovate under a current low but gradually increasing cost, because the low-hanging fruit is being exhausted, than to have it effectively being told "If you stay here, you are uncompetitive." I think that is foolish and I do not think it stimulates the kind of investment that you consider. Businessmen are not as short-sighted as they sometimes are depicted. In the sulphur dioxide market they over-achieved dramatically. Once they knew what the cost was going to be over a decade, they knew how to cope with it and they cut costs much faster, because that is what businessmen are very good at, than anyone ever predicted and I think you will find the same thing in the carbon market.

Q110 Mark Lazarowicz: On that point the Chairman has raised, do you really think, for example, technologies like carbon capture and storage are really going to driven forward without a fairly high carbon price to encourage investment, one in which there is a fair degree of certainty behind a relatively high carbon price fairly soon and which will stay at a high level over a period of time?

Mr Bettelheim: There is a lot of debate about carbon capture and storage. I am not a technology expert but those in the energy industry who have been involved in it are pretty much of the opinion that this is 15 to 20 years away in terms of commercialisation. In that ten, 15 or 20 years that it takes not only to develop into a commercial product that can be distributed but actually to distribute it, which also takes enormous investment, I think you are going to waste a lot of time waiting for it, and the price is not what is going to drive it. What is going to drive it is the expectation of a rising price, the expectation that coal is going to be used until the end of the century. They know that; we all know, if we are rational, if you look at the International Energy Agency predictions, that coal is going to have to be used by mankind to meet its energy needs for as far as anyone can see. There may, of course, be a technological breakthrough of some kind - fusion or what have you - but if you are not betting on that, if you are betting on relatively gradual increases in efficiency and introduction of technology over the coming decades, you know that coal has to be dealt with, whether you call it clean coal or you call it carbon capture and storage, but in both cases that technology is not going to happen tomorrow, no matter how high the price is.

Q111 Mark Lazarowicz: It is going to take even longer to start, is it not, if the price is low?

Mr Bettelheim: No, I disagree. Businessmen and financial markets anticipate what the price is going to do. They know it is going to rise. They know this is coming, so they will invest now to be prepared in ten or 15 years to roll out that technology. I think it is unwise to try and force technological change by a price mechanism. What you are doing is you are inverting the priorities of businessmen to look for low-cost solutions. Carbon capture and storage in coal-fired power plants may not be a good solution. It may sound like it now but it may not be. What you really want people to do - and this is what I find rather odd about this debate - the purposes of markets, the reason emissions trading has been adopted by everyone is to drive down the cost of compliance, not to increase it. This is somehow being lost in this debate, particularly in Europe. If there is a better technology, a cheaper technology than carbon capture and storage, we should adopt that, not carbon capture and storage. This kind of debate smacks very much of picking industrial winners. We have had a long track record of governments betting on this or that technology and finding out, lo and behold, that there is someone in a garage in California who wipes the floor with IBM. I think that impulse should be resisted. In the last ten years in which I have been deeply engaged in this I have seen a fashion for about a dozen different technological solutions and if you really examine them, if you really examine how fast they can develop, how much they will cost to distribute, you find out that there are enormous difficulties and they are very unexpected. A recent study by Berkeley Department of Economics showed that solar power in California, where the sun does shine, is 600 times more expensive to distribute to households than natural gas-fired power plants. That is not intuitively obvious, and a lot of the solutions that people find fashionable at any particular time in the debate - solar, wind, tidal, carbon capture and storage - will not be the technologies that actually solve this problem, and in fact innovation will occur because people anticipate that steady price rise over time and will adjust themselves to that. Trying to force this or that technology as the solution I think would be a bad mistake. It will be a mistake for any economy that adopts it.

Q112 Chairman: Let us get back on to forestry, if we may. Do you think it is getting the attention that it should have in relation to the negotiations on post 2012?

Mr Bettelheim: I think, Mr Chairman, since Bali - and Bali was quite a turning point when it comes to forestry, and tropical forestry in particular - it is attracting much more attention than it had prior to that. Whether or not some of the proposed solutions or approaches to dealing with it will be effective I think remains to be seen. Certainly I am very sceptical of some of the approaches that have been floated of parallel markets and separate treaties and so on and so forth. As far as forests are concerned, it is really very simple. You just need to integrate them into the market place, where they have been excluded previously by regulation, and once that happens, you will find they are credited and that the benefits of tropical and subtropical forests accrue not only in terms of carbon sequestration but in all of the other co-benefits, not least of all adaptation by poor people, who are dependent on those forests. When their environment deteriorates, they become migrants. They become internal migrants and also international migrants. When the soil has gone, you do not eat; when the fresh water has gone, you do not drink. Those are pretty fundamental needs, and I think that is beginning to be appreciated, but again, we seem, in the Kyoto context at least, to be drifting into a CDM-like negotiation of detailed prescriptive rules, of the same sort of approach to regulation which I am afraid will probably have the same effect: it will kill the investment in that sector and we will again have a broken promise to the developing world, particularly that part of the world which is not rapidly industrialising, and I think you probably will not have a treaty at all because it will become obvious that no-one is going to invest in the sector. I think it is relatively common ground that private sector investment is essential and that the public sector is not going to pick up the burden of $15-$30 billion a year of investment in this one area.

Q113 Chairman: Even before Bali, of course, Nick Stern had highlighted the contribution that curbing deforestation could make in part of the solution.

Mr Bettelheim: Indeed he did.

Q114 Chairman: Given that we have pretty broad agreement that global emissions are going to have to be reduced to half 1990 levels by 2050, do you have any sense of what contribution avoiding deforestation could make to that?

Mr Bettelheim: Yes. Mr Chairman, you may recall the last submissions I made to this Committee when it considered the voluntary market. The McKinsey cost curve and the Stern report are more or less aligned and subsequent studies confirm that it is about 20-25 per cent of emissions reductions which can be contributed and it is about a 50-50 split between afforestation and reforestation on the one hand and some new trees, and avoiding deforestation and forest degradation on the other. It is about 3 billion gigatons per annum by each sector, so 6 billion altogether, and that roughly accumulates to the percentage reduction in emissions that forestry can contribute.

Q115 Dr Turner: You are in a particularly good position to assess the costs involved in achieving the reduction and elimination of deforestation, and reforestation as well preferably. Have you any handle on what the global cost of doing this really effectively, achieving the sort of carbon reductions that you have just been talking about, are and how they can be raised and delivered?

Mr Bettelheim: Yes. I think you will find in recent research done by the Woods Hole Institute in the United States on what is essentially the opportunity costs for avoiding deforestation and forest degradation, prices vary but I think, to be conservative, and our experience would verify this, you have to anticipate an opportunity cost of $5 a tonne. So you have to pay forest owners, whether they are public or private or communal owners, about $5 a tonne to avoid converting tropical forest into agricultural or timber use. If you take the 3 billion tonnes that is probably available per year - and that is, of course, the maximum, which is probably not achievable in the real world - the Woods Hole analysis in Brazil shows that you can probably get 90 per cent of deforestation compensated at $5 a tonne. The remaining ten per cent, of course, is the area which is much higher marginal cost because it has very much higher value uses, maybe in an urban area, for example, that will have development opportunities, so you get a 90-10 return, and if you assume it is $5 a tonne, you are something in the order of 3 billion tonnes, $15 billion for avoided deforestation and reduced degradation of forests. That is consistent with Nick Stern's analysis of that subject. When you come on to afforestation and reforestation, of course, that is more expensive because it is much cheaper to hold something intact than it is to actually prepare land, to plant it and so on, which is a significant part of our business. Even under the best circumstances, you have to assume that the minimum cost of that is about $10 a tonne, so if you take that multiple times 3 billion, you are at $30 billion for the other half of the 6 billion tonnes per year of avoided deforestation and re-absorption of carbon that is potentially possible. You can make some more sophisticated analysis of what land can be used in spatial terms and so on, but I think the order of magnitude is something north of $30 billion a year, and that has to be maintained. It is very important to understand that it is not a one-off payment; it is an annual payment, it is a rent, because as soon as the rent stops being paid, it is going to be converted again or the investments are not going to be made. Certainly, in most terms of international aid flows, you are talking about quite a significant flow and of course, it has to be managed into these economies, many of which do suffer governance problems, do have high political risk and so on, and some of them are in extremely remote areas. That having been said, it should be calculated that you are looking at something north of $30 billion, probably closer to $40 billion a year flow of capital from North to South essentially in order to make forests make that contribution of 20-25 per cent to emissions reduction. In my view, and I think that of most objective observers, there is no source for that kind of payment and, more importantly perhaps, no more efficient source than the private sector, and that means carbon markets. Generally speaking, businessmen are better at allocating capital than governments to this kind of investment, and they are more likely not to get involved in activities which are opaque, because they cannot deliver opaque credits. If the credit is from bad land, if it is illegal, if it is not traceable back to its source and to a property register and so on, it cannot be sold; it is worthless. If you want to the inefficiency of that $30-$40 billion a year to be at its highest, it needs to come from the private sector. With the proviso I mentioned in my opening remarks, many of these countries do need capacity building in order to get private sector investment. They do need land registration systems, they do need administrative systems and so on, which the private sector is not good at implementing. You have a free rider problem that the private company that pays for that benefits everybody, so this is a public sector issue. There is a transitional period. This is one of the points I would like to make that I think is very important. When I was at law school I was always taught by my trial practice seminar that when your opponent gets to the "floodgates" argument, you know you have won. The floodgates are not going to open but it is going to take five to ten years to prepare many of these countries to the point where they can actually measure, monitor, verify, and reliably deliver to the carbon market credits from their forests because there are serious infrastructure issues that have to be addressed, so this is going to be a gradual process. Even if you said everything that is credited today in the forests, only a very small proportion of that would actually be available over the next five to ten years.

Q116 Dr Turner: So you think that basically this will be delivered through market mechanisms. Which market mechanisms in particular? Do you see this as a function of an international emissions trading scheme? Can you be more specific?

Mr Bettelheim: Yes, I do, but not a scheme. This is what I was trying to explain. We are participants in these debates and in these developments around the world. National and regional markets are developing independently of Kyoto. The countries may or may not be an annex one country already bound by Kyoto. I am absolutely confident, working closely with Congress, that the United States will have a carbon trading system under the next administration. My bet is 2010. Maybe it will be delayed by politics or maybe accelerated by politics. I do not know, but, in one form or another, the Lieberman Bill will be adopted, and I do not think there is much doubt about that when you review any of the presidential candidates. That system will not be Kyoto but it will include forestry, both domestic and international forestry. The precise rules as to that are still being worked out and are being debated by Congress and by regulatory authorities but I have absolutely no doubt that that is the case. In Australia and in New Zealand it is already clear that forestry will take the lead position in their trading markets. You may have observed that Australia is only meeting its Kyoto target because of forestry. It is way over its industrial emissions. The reason it is meeting its somewhat increased cap - I think of 103 per cent over 1990 - is because of forestry. These countries understand the enormous impact that forests can have to meeting whatever targets they have set themselves or which they have agreed to under the Kyoto process. So yes, I think those markets will be the place at which money will be generated and transferred for the preservation and restoration of forests around the world. That is where the demand will come from.

Q117 Dr Turner: But clearly, regulation of this activity is going to be absolutely crucial, otherwise somebody will make a lot of money and nothing will actually happen.

Mr Bettelheim: That is absolutely right.

Q118 Dr Turner: Mechanisms like the Clean Development Mechanism do not seem to be adequate to this task. Greenpeace suggests that a brand new stand-alone mechanism should be set up to regulate this process. What are your thoughts on how it should be regulated?

Mr Bettelheim: The reason I am smiling, sir, is that I am delighted that Greenpeace has come to the view that these forests are important. Greenpeace is one of the organisations that has spent the last decade fighting tooth and nail to keep them out of the Kyoto system and to keep them out of the European Union system, so I am delighted that they have joined in our opinion that these forests are worth preserving and restoring. Secondly, I am also pleased, reading their position paper or their proposal that they realise that the markets have some role to play in this. However, if you go on and look at their proposal, you will see that they are going over the same ground yet again that we had with the CDM, a whole list of issues which have been resolved long ago, some of them under CDM analysis but most of them independently but, even worse, you are creating another unaccountable body like the CDM which will go through a CDM-like process and stifle just this kind of activity. I am afraid that creating things out of whole cloth at this stage in the game is too late. It is 2008. We have 40 years. If you are going to get this kind of investment, $30-$35 billion moving every single year for the next three decades to these countries, we do not have time for another five years of negotiating what is a forest: is it additional, and will it be permanent? All of this mediaeval theology that has developed under this process needs to be done away with. Let us get rid of it and let us move on. That is why I think is so important that the next treaty, if it is to be acceptable and if it is not to be immediately obsolete, does approach this in a much simpler fashion: set long-term targets, admit biomass as long as it is verified, let national governments and nation states make their own decisions about the sovereign use of their land, and allow the capital markets and the financial markets to finally start spending money where it is really needed and where you get a very quick return on the money in terms of climate mitigation that do not have to wait ten years for a forest to do its work.

Q119 Dr Turner: How would you audit this process?

Mr Bettelheim: First of all, as in any commodity market - and I think it is high time we looked at this as a commodity market or a hybrid between financial and commodity markets - the way in which things are audited is through exchanges and clearing houses and securities regulators, in the ordinary way. Buyers and sellers are very sensitive to what they are delivering and what is being delivered and the price they are paying for it. Market discipline is remarkably efficient, and they can tell the difference and adjust the price for the quality of the thing being delivered and, if there is doubt that the carbon credit came from a place that is legitimate or from a legitimate system, that credit is either unsaleable or at a very steep discount. So you can have pretty good confidence that self-interest, not to mention the profit motive, of businesses and investors is going to impose governance and rules which are already being developed substantially in the voluntary sector. This Committee will be aware of the number of regimes, including most recently the voluntary carbon standard, which was developed under the auspices of the International Emissions Trading Association, with wide consultation with the NGO community and developing countries, which is a very rigorous process of regular intervention by third parties to determine the veracity and the permanence and the additionality of each credit that comes out of a particular area or project. So we have the tools. We do not need to invent anything new. The tools have evolved over the last ten years and are ready for use.

Q120 Mr Hurd: Can I just probe a little on the fundamental assumption that is underlying this exchange, which is that this is inevitably going to be done through some sort of market mechanism? I happen to agree with you because of the flows of money that are involved but what I want to probe is this. I have just come from a meeting with the head of Friends of the Earth in Brazil and the Prime Minister's envoy on forests, and we were talking about Brazil's position. What I understood was that actually Brazil's position is that they are not a believer in a market mechanism, and in addition to that they continue to peddle the fantasy that somehow this is going to be done through a flow of funds from government to government, and actually the international process of trying to reach a deal here is going absolutely nowhere, or is certainly not going much further beyond the rhetoric, and that the chances of getting a deal done in Copenhagen are frankly pretty faint. Do you have any comment on that?

Mr Bettelheim: First of all, Brazil is a very interesting situation. It is very much a federal state, rather like Australia, and what you will find if you look below the surface of the Foreign Ministry's position - and it is pretty isolated even at the federal level in its position about this topic - is that the states are moving ahead anyway. This is what has happened in the United States; the states moved ahead regardless of Bush in California, New Jersey, all over the United States. In Australia the states did the same. Under the previous administration New South Wales and Victoria started moving ahead on this regardless, and that is what is happening in Brazil. Then you find the federal system moves because it is a kind of grassroots effort. The Brazilians have also moved considerably from their original position, which was that they did not want anything to count, because the Amazon is regarded as an important natural resource for their development, there are issues of political sovereignty and security and so on, but we are doing business in Brazil on a very large scale and everyone in Brazil assumes, including, may I say, the head of Greenpeace in Brazil, who asked us to help develop the carbon market to save the forests. So yes, there are negotiating postures here but the fact of the matter is that Brazil, chief among, I think, all countries, is a huge net beneficiary from these flows and to suggest, as has been its position over the last year or so, that it should come from some grand international fund generating $35-$40 billion a year, first of all, no-one believes that money would reach the right people if that were the case, that it would not reach the communities on the ground, it would not reach indigenous people but would end up in general government proceeds and there would be endless debates about whether it was or was not meeting its targets, but I think that approach can be summarised and was summarised very eloquently by Kevin Conrad of the Rainforest Nations Coalition, when he said that approach is "ODA and pray". I think that sums up that kind of an approach in terms of its realism or its efficacy.

Q121 Dr Turner: We have all had our vocabulary extended this morning by a word that is new to us but is apparently fashionable in your business: "fungible". It has been suggested to us that there would be a problem with how fungible, or interchangeable, which we understand rather better, avoided deforestation credits would be and therefore a suggestion that it would be better to keep forestry in a separate market. Do you agree?

Mr Bettelheim: I could not have disagreed more. A separate market for forestry is a hopeless enterprise. The demand for business is compliance credits. They need to meet their compliance obligations and they are not going to have any patience with the development of a parallel credit which may or may not comply in the same way as another credit that they can purchase. Inter-exchangeability as opposed to fungibility is essential if you are going to deal with this in a market-based way. Credits from avoided deforestation and for afforestation, reforestation, sustainable forestry management and so on, do need to be identical in value and in use to other credits from other kinds of energy or other derived credits. These concept proposals are a hiding to nowhere.

Q122 Dr Turner: See you calculate everything by the tonne of carbon?

Mr Bettelheim: Exactly. A tonne of carbon is a tonne of carbon anywhere in the world and everybody buys it and sells it, and as long as it has been subject to an appropriate regulatory system - I take your point exactly; there is no such thing as an effective financial market without regulation, and appropriate regulation - then businessmen need to know and investors need to know it does not matter where it came from.

Q123 Dr Turner: Do you think a mechanism to prevent carbon leakage in avoided deforestation should be done on a national basis rather than as it is now, on a project base?

Mr Bettelheim: Firstly, avoided deforestation is not subject to anything right now, projects or national baselines. It is not recognised. I think it is almost inevitable that you have to set national targets. Any treaty negotiation is not going to go forward unless nation states undertake either binding or other targets for their emissions reductions, and I think it is up to each nation state to decide how they are going to do that. I do not think they can be dictated to and I think it is unfair to try, and it is probably counterproductive to try. Once that is set, any nation state, except perhaps a totalitarian dictatorship, has to find ways to implement, to achieve its targets, and that invariably means finding people willing to invest in projects, whether they are forestry or otherwise, which will help them do that, to stimulate business to make those investments and stimulate markets to provide the capital necessary. I think it is a false dichotomy that a national target, or baseline, if you want to talk in Kyoto-speak, once it is established, then it has to be projects or business investments, discrete investments in projects that actually implement it, unless of course everything is state-owned and it is a state responsibility, and I suppose there are still countries in that position but they are very rare. So I think it is a combination of both, is the answer; it is not one or the other.

Q124 Dr Turner: Do you think there is a minimum critical mass for the market to operate properly in terms of numbers of countries signed up? Are there going to be start-up problems?

Mr Bettelheim: I think those are probably passed. The Kyoto Protocol did the world a great service in that it convinced just about everybody that this is a problem that has to be dealt with. Its failure is as a market mechanism, and that is understandable. I do not know why anybody expected the United Nations to understand how to regulate a market place. That is passed, I hope, and what we need to do is to take the lessons we have learned from Kyoto, from the various failures of the European Union trading system, biofuels policy and all of that, and apply those lessons to a new regime. What we have learned is you have to keep it simple, you have to have principles-based regulation, and you must let nation states independently decide how they are going to meet the targets they agree. That is all that is necessary. You do not need any new mechanisms. You do not need anything other than a change in approach to regulation and respect for nation states' choices. I think part of the problem with the CDM is that it is dictating: "You can do this but you cannot do that." The atmosphere does not care where the carbon goes up or where it comes down. All it cares about is the level in the atmosphere. As long as countries are making their targets, whether they do it through forestry or whether they do it through energy projects, it has to change from place to place because they are all at different levels of development. You cannot skew the marketplace and say avoiding deforestation is valuable because we like forests; we like rainforests and they are important, but we are not going to pay for afforestation or reforestation. To put it in simple political terms, that is the dichotomy between Brazil, which has huge intact forest, and India and China, which are reforesting. Both serve the climate, and it is pointless, in my view, to try to create a set of rules, as the CDM did, that say "That has no value, that has some value, and that may have value in the future." It is a pointless exercise. If it is a tonne of carbon coming out of the atmosphere, it should be the same as a tonne of carbon that is kept in the ground, and it should be the same as a tonne of carbon avoided from some industrial installation. That is my view. That will mean there is - and I know this phrase has been used many times; we confront these people every day as potential investors and so on - a wall of money for this. There are billions of dollars ready to come into this kind of investment as soon as the regulations are settled, are predictable and are user-friendly from an investor's point of view. If we can achieve what I have just described, complete fungibility - I am sorry to use that phrase but it is the phrase known in the markets - for all these credits, you will find much greater investment than has been achieved so far and very much faster.

Q125 Joan Walley: Can I just turn to afforestation and reforestation and look at the CDM mechanisms that there are. I would like you to explain for me how you think that the current CDM mechanisms can make sure that we have enforceable standards, not just of sustainability but of issues to do with human rights, land use and all of those issues. Obviously, if you are going to plant monoculture plantations, that is not necessarily going to have regard to sustainable communities and where people live.

Mr Bettelheim: Let me shock you - and it should not. You should not try to dictate. Do you tell a farmer that his wheat field has to have other plants in it? You are not going to get avoided deforestation, which is the vast majority of timber in the world - it comes from native forests, 80 per cent of it. You cannot change the laws of supply and demand about timber products and forest products.

Q126 Joan Walley: No, but you have to have regard to human rights.

Mr Bettelheim: I am sorry. Let me come back to human rights, because that has nothing to do with afforestation. Afforestation is planting trees on farmland, on wasteland. There are very few indigenous people living in such circumstances.

Q127 Joan Walley: You referred earlier on to Australia. There has just been a recognition and an apology that has been given by the Australian government about rights to land, and just because land has no forest on it, you have to start somewhere with your human rights aspects. You cannot just discount them.

Mr Bettelheim: Yes, let me address that. We are engaged in probably the most important aboriginal programme in Australia, so we are exquisitely sensitive to that situation. It is a programme of 40 million hectares, putting aboriginal people back on to their land to manage their forests in a traditional way which reduces the amount of carbon dioxide which is emitted. Do not allow what I am about to say to distract you from the question of human rights, which I will come back to. The critical point to understand is that you cannot stop harvesting from native forests unless you massively increase the amount of afforestation and reforestation. Afforestation is fundamentally farming; it is the production of timber on agricultural land, wasteland, in order to provide supply. That is supply for the paper and pulp industry, it is supply for the building industry, it is supply for the furniture industry. Just because we stop forests being harvested, or if we stop forests being harvested that we think are very valuable, every tree that is grown in afforestation has an enormous value because it allows us to have policies which keep people from cutting down the native forests. If there is no alternative supply, if there is no afforestation or reforestation, the conversion of natural forests will continue because the demand by human beings in a rapidly growing population is not for less timber and forest products; it is for more. There is nothing wrong with farming timber. It is essential that we farm timber in an efficient and, may I say, sustainable way.

Q128 Joan Walley: Can I just ask, does that include biodiversity?

Mr Bettelheim: It may or it may not. My point is that biodiversity will never be recreated by mankind. We cannot create a forest. If you ask Wangari Maathai, she will say you cannot do it. A forest is an intricate ecosystem that human beings barely understand, let alone could possibly recreate. If your question is can you do afforestation and reforestation in ways which enhance biodiversity beyond being a wheat field, the answer is yes, and we do that, but you have to do it in a way that is cost-effective. You cannot rebuild a rainforest. No-one knows how and I do not think anyone will as long as we are alive.

Q129 Joan Walley: My question was what safeguards are in the CDM to ensure that plantations do not damage local communities?

Mr Bettelheim: To tell you the truth, there are none, but then the CDM rules have made it impossible for afforestation and reforestation to occur. There is one AR project approved in the entire world. One afforestation programme in the world approved by the CDM - one! - and it is for 320,000 tonnes - meaningless!

Q130 Joan Walley: What about reforestation?

Mr Bettelheim: Not one. There is only one AR project in the world which has been approved by the Clean Development Mechanism. You ask me what does the Clean Development Mechanism do about human rights? Absolutely nothing. It has created safeguards that are so stringent that no-one can invest, aside from the World Bank, and that includes me. We have tried. So when we move on, I do think the question of human rights is critical in all of this, and it is critical in a number of ways. First of all, no-one wants credits that have been stolen. No-one wants credits that have the result of dispossessing people or in conflict with their rights to the land. As a matter of principle, we will never engage in any activity where there is a dispute over land ownership, and there is a very simple, hard-nosed commercial reason: the credit is no good. I cannot sell it. Even if I were crass enough to try and steal such credits from indigenous people or native communities, which we are not; on the contrary, we work everywhere in the world with indigenous people with communal land rights, with the Maori people in New Zealand, with the aboriginal people in Australia, with black communities that are recovering land under the post-apartheid regime in South Africa, and with indigenous Amerindians in the Amazon Basin. All of these people are encouraging us to help them get their land back, because we will help them establish title, because until they get the title, I cannot sell the credits. By the way, just to be absolutely clear, we always have a sharing arrangement of the profits and proceeds of the carbon sales with those indigenous people, who, by the way, are pretty sophisticated bargainers. My point is that nothing in the CDM deals with this because the CDM has killed afforestation and reforestation. This is one of the reasons, I hope, that the post-2012 settlement will in fact create rules which will allow investment, which do respect the rights of indigenous people and communal people and insist on making sure that the land owner is entitled to transfer to create the credit which is in fact being transferred. This is part of the regulations integrity which is essential to us and, I think, to the world at large. I have the utmost respect for that. Indeed, we are doing our best in a world in which CDM will not give us any credit even if we are working with indigenous people. We can get them nothing right now from the Clean Development Mechanism.

Q131 Joan Walley: If I can come back to that, my point was about sustainable development in its entirety. I see that as including human rights issues and indigenous peoples issues, but also the biodiversity aspects. You referred just now to post 2010. Are you saying that between now and post 2010 we should be looking to see how we can get a set of standards for the wider aspects of sustainability incorporated into any future CDM mechanisms and, if so, what is your view of what that baseline should be? Presumably, whatever it was, there should then be provision for it to be enforced.

Mr Bettelheim: I think that is correct. By and large, there are already internationally accepted standards for human rights, for example, ILO 162, which deals with the rights of indigenous people and how they are to be treated. We consult, for example, with NGOs around the world who represent these people to ensure we do not do any harm. Our first principle is not to do any harm; it is a kind of Hippocratic oath. Some indigenous people are prepared for this and some are not. We have uncontacted tribes within reasonable distance of some of our projects and the advice is to leave them uncontacted. There are a whole variety of different issues which arise but I agree with you; any new mechanism, any new set of rules - and I beg you not the CDM; anything else - that actually allows investment in these areas must have regulations both in respect of human rights and in respect of sustainability. There are plantations - I know they seem to have a bad name, for some reason, because of the debate - in which you can enrichment plant. You can help remnant vegetation recover. We have such a programme in South Australia whereby by replanting eucalypts we are also preserving and allowing the re-establishment of remnant vegetation that has otherwise been wiped out. Those kinds of standards can be created but, as I say, they should be created as matters of principle with differing approaches to implementation in different places and under different regimes.

Q132 Mr Chaytor: If I can return to the question of quality and the audit mechanism that Desmond raised earlier, to what extent is the issue of auditing a question of the availability of satellite data, and do we have in all countries, i.e. across the world, the appropriate infrastructure and the right quality of satellite data?

Mr Bettelheim: The satellite data has improved enormously. If you want an example, look at the sequence of improvements in the FAO reports. The technological capacity is now not only to be able to measure deforestation but also forest degradation, which is much more subtle because the canopy is still closed, but new satellite technology allows us to even register reductions that are short of deforestation. The answer to your question is the satellite information exists but satellite information usually also, particularly in countries that have intense cloud cover or do not have an infrastructure of carbon or forest inventory, requires ground proofing. You have to go out there and you have to check that the information has not been distorted. This is why there is a series of steps, which includes everything from groundproofing, overflights and satellites technology and very sophisticated computer modelling, which allows us to come very close to an understanding within a very small margin of error of exactly what is happening on the ground. In terms of audit and so on you still need infrastructure in these countries to make sure for example that the credit is not sold twice. This is what I was referring to earlier as an important role for the public sector, which is to provide the money to pay for the consultants and computer engineers and the others to create the infrastructure in countries which cannot afford it or do not otherwise have it. Brazil for example has a very sophisticated monitoring system and there is very little going on in the Amazon that we do not know about. The same is not true of The Congo; it is an entirely different situation.

Q133 Mr Chaytor: How long would you anticipate getting all countries with tropical forests to the appropriate level of monitoring? Given the political instability in Congo where you have got countries recovering from a long period of civil war, where there may well be a further civil war in the future and given the fragility of the government, can you say, hand on heart, that within five years or ten years all countries with tropical forests will have these systems in place and the quality of their governance will be up to international standards?

Mr Bettelheim: The experience today is that that is expensive. The experience of Papua New Guinea, which is not a situation of war but a situation of very large and complex forest areas that have not been disturbed, is that the Max Planck Institute was retained to do the inventory for that country and the total cost was hundreds of thousands of dollars. Even spread around 100 countries that is an enormous amount. I appreciate that there will be some countries, for example The Congo, in which far greater expenditure will be required simply because of the difficulties of conflict areas and governance and so on, but how fast can it happen? It can happen as fast as the public sector provides the funding for it, because those countries otherwise cannot pay for it in most cases. Of course in the case of Brazil and India they can, but in many countries, particularly the least developed countries, they do not have the funds and they certainly do not have the internal expertise in their country and it needs to be brought in from Europe or America or from neighbouring states. If the public sector, if the world decided to take a proper inventory of the entire planet in terms of carbon, it could certainly be done within five years.

Q134 Mr Chaytor: Earlier you drew the analogy with other commodity markets in terms of the verification of quality and suggested that this would apply to carbon as it develops as a commodity market, but surely there is a distinction here between the point at which the commodity is consumed, because if you are buying copper or sugar, you understand pretty quickly at the point of consumption what the quality of that copper or sugar is and that will underpin the price, but in terms of emissions avoidance, we are talking about a timescale of 30, 40, 50, 100 years, so how do you explain the discrepancy there? Surely it is less easy to verify because we are verifying the quality of something many, many years in the future?

Mr Bettelheim: All commodities are priced into the future. If you have a copper mine or if you have a coal mine, you are valuing it and you are selling forward delivery, sometimes over decades. Typically mining or other products like that require ---

Q135 Mr Chaytor: But the commodity that is being consumed is being consumed in the here-and-now, is it not?

Mr Bettelheim: Well, there are short-term deliveries, that is all you are saying. There is delivery over long periods of time, which is what a mining or similar natural resource project is. When people buy copper a year forward, they cannot touch it or feel it until delivery is made. I appreciate the carbon market is an intangible and that makes it different in a sense, but we have lots of intangibles. We trade interest rates, there is a huge market in all kinds of stock market indices and so on. You cannot touch them, you never get delivery of the shares. What you get is regulatory confirmation, typically verified by third parties, that you are entitled to something, and that you can get it when you want it. The same way with carbon in forests, yes, it is a commodity-like thing, except you do not actually physically deliver it, you deliver verification of it. You can call it a certificate if you like although this is all done by computer now. You are not given the bricks of a company when you buy shares in it, you are not given the bricks of a factory, you are given a certificate that says you own a proportionate interest in this, and in the same way you are being given a certificate that you own a proportionate interest in a forest measured in terms of its carbon. The certificate can be forged, it can be fraudulently obtained, but it is still just a certificate of ownership. That is what this fundamentally is all about; this is about the transfer of ownership of carbon in a forest.

Q136 Mr Chaytor: But you accept that the monitoring and the verification would need to continue throughout the lifetime of the forest?

Mr Bettelheim: That is absolutely right. Just as payments have to continue throughout the lifetime. That is what I am saying. This is an annual process, it is an annual counting, it is an annual audit, if you like, and it is an annual payment process. When there are problems with any of that, payments usually stop or are reduced or improvements in regulation have to occur for those payments to resume.

Q137 Mr Chaytor: Can I ask you what you think about the World Bank's project, the Forest Carbon Partnership Facility? The UK has contributed 50 million to that. Is that worthwhile and likely to be effective?

Mr Bettelheim: My feeling is that part of it may be and part of it not. The part of it which is focused on capacity building I think could be very effective and is very much needed, as I have said and, whether it is the World Bank that does it or someone else, I think that is a very valuable contribution because it creates the infrastructure for private sector investment for markets to operate. The other part that it has been pursuing is trying again to re-create the wheel of how do you regulate this kind of forest activity, and it is CDM gold-plated. It is completely unworkable. Everyone who has examined it and been briefed on it in the private sector just throws up their hands and says that is the World Bank doing it again and they are not interested. There is that sense about the European Union and there is certainly that sense about any continuation of the CDM. No-one will have any confidence in it and the markets will simply move on. The national and regional markets will simply go right past all this, which I think would be a pity.

Q138 Mr Chaytor: Finally could I just ask about temperate forests. Everything you have said has been with reference to tropical and subtropical forests. Do the same arguments apply to temperate forests?

Mr Bettelheim: Under the Kyoto Protocol all temperate forests count. This is one of the discrepancies that I find very disturbing. What the Kyoto Protocol did is it divided the world in half, basically north and south, and if you are an annex one country all your forestry, reforestation, afforestation, stable forestry management, avoiding deforestation, count for your Kyoto obligations. If you are in the south none of it counts and none of it has any value. As a result you might not be surprised to hear - although there are other drivers for this and I am not trying to oversimplify - temperate forests are increasing, they are growing. If you look at the FOC report you will see that what we have done by way of policy (and certainly carbon is a driver for this although not the only one) is we have created incentives to regrow northern forests, which are the least important in terms of biodiversity, and to continue to rapidly deforest in those areas which have the highest biodiversity, which is the tropics and subtropics. This is a perverse outcome if you ask me. So temperate forestry does indeed (just like tropical forestry but at a slower rate) absorb carbon dioxide through photosynthesis, it stores it in the mass of the plant and it transfers the carbon into the soil in exactly the same scientific way as a tropical tree does, like a eucalypt or a mahogany or whatever. It just does it more slowly and it is not as interesting or as important biologically. In terms of climate value a tonne of carbon absorbed by a pine tree is as good as a tonne of carbon absorbed by a dipterocarp. The critical thing is that those forests in the north do not have the other values and they certainly do not have as many poor people dependent on them. Forestry in North America is hobby farming to the extent it is not industrial; in the south it is life and death, it is fresh water, it is food and it is fuel. In Africa most fuel comes from food, they are not even in the fossil fuel age. We are now getting into the charcoal business (sustainably) to stop people going into the native forest to cut down the trees to turn into charcoal so they can heat their houses and cook their food. There is no point talking about giving them solar energy; they do not even have an electric appliance. In those circumstances what does it mean, what is the value of growing temperate forests increasingly and allowing these people to exhaust the very resource on which they survive. This to me is madness and that is what the Kyoto Protocol encourages under its current terms and that is what the CDM encourages under its current terms. Everything biological in the north counts, including agricultural land, and everything in the south is valueless. If I was a southern land owner (and in some cases I am) my reaction is very simple: I will continue to convert that resource into what I need until somebody pays me enough money to stop doing it and to get that resource whether it is food, fuel, medicine, or whatever it may be, from another sustainable source. That is the dilemma that has not been addressed in any way by the Kyoto Protocol and is completely rejected by the European Union trading system. As I said to the European parliamentarians, in my view, whatever your concern about the climate, that is fundamentally immoral.

Chairman: Okay, we have covered a lot of ground in an hour and ten minutes. Thank you very much for coming in.