WORLD: Investors Risk Losing Billions on Environmentally Destructive Pulp Mills

Incorrect assumptions about the origins and the cost of wood used in emerging market pulp mills has led international investors to channel tens of billions of dollars worldwide into financially risky and environmentally destructive ventures, finds an analysis of 67 pulp mill projects released Thursday by the Indonesia-based Center for International Forestry Research (CIFOR).

The CIFOR report, entitled "Financing Pulp Mills: An Appraisal of Risk Assessment and Safeguard Procedures," was funded by the European Commission and the United Kingdom's Department for International Development.

"Financial institutions have shown a surprising lack of interest in understanding how the pulp companies requesting loans are going to get all this cheap wood," said David Kaimowitz, director general of CIFOR. "In reality, some of these mills have vastly overestimated what's legally available from timber plantations. So the only way they can meet production targets is through unsustainable logging of natural forests or by shipping in wood from distant sources at a much higher cost."

The study warns that a lack of due diligence in the expanding global pulp sector may lead to a new wave of ill-advised projects, setting up investors, forest-dependent communities, and the environment for a precipitous fall.

CIFOR's researchers found that two companies in Indonesia, Asia Pulp & Paper (APP) and Asia Pacific Resources International Ltd. (APRIL), are clear instances in which financial institutions failed to conduct proper due diligence on fiber supply.

Christopher Barr, CIFOR senior scientist and coordinator of the study said, "During the 1990s, APP and APRIL borrowed over US$15 billion from international capital markets by telling investors that they have sustainable supplies of very low-cost fiber. However, both companies continue to rely on the clearing of natural forests in Sumatra for 60-70 percent of their wood supply, and each is still years away from meeting its own plantation development targets."

Ongoing efforts by Singapore-based United Fiber System (UFS) to purchase and expand the PT Kiani Kertas pulp mill could place similar pressures on remaining natural forests in Indonesian Borneo, Barr says.

Merrill Lynch, ANZ Bank, and Cornell Capital are now working with UFS to secure financing for the deal, which will have a total value of US$400-600 million.

Over the last decade, leading financial institutions and international investment banks have poured over US$40 billion into pulp mill projects, aimed at increasing capacity in the developing world. To meet growing global demand for paper, analysts expect companies to invest another US$54 billion by 2015, much of it in Brazil, China, Indonesia, Uruguay, and the Baltic States.

Low wood costs are a major factor driving expansion of the sector in these countries, as wood fiber can account for up to 60 percent of pulp producers' cash costs in North America and Europe.

The CIFOR report finds that the scale of pulp mills has grown over the past decade and that individual mills now have a "voracious appetite for wood."

"A single large mill with an annual capacity of 1.0 million tonnes requires the equivalent of 15 percent of the Brazilian Amazon's annual timber harvest," the study states.

When this wood is not available from plantation forests, the demand for pulp can drive illegal logging and clearing of natural forest ecosystems. Plantation development itself often displaces forest communities and fuels social conflicts.

Pulp mills can also generate water and air pollution if not operated with proper effluent and emission controls.

CIFOR's report, which builds on eight years of study, shows that banks and other financial institutions often conduct only minimal due diligence to assess the sources of wood for pulp projects, in spite of the fact that mills can involve investments of US$1.0 billion or more.

Most banks have little in-house forestry expertise and rely heavily on data provided by the pulp producers themselves and on projections of global paper demand. The study concludes that pulp mill projects often carry significantly higher degrees of financial risk than investors realize.

The CIFOR study finds that the International Finance Corporation (IFC) - the World Bank Group's private sector lending agency - is playing an increasingly important role in financing pulp and plantation projects in emerging economies.

Over the least few years, the IFC has aggressively expanded its lending for forestry-related investments, including pulp and paper mills. It now has a forestry portfolio of over US$1 billion, and has helped to attract billions of dollars of additional loans from private banks.

IFC policies require Environmental Assessments for socially and environmentally sensitive projects. CIFOR reports that these assessments are often "overly general, and sometimes they even discourage private banks from assessing a project's impacts when they believe the IFC will be doing so."

Conflict has erupted between Uruguay and Argentina over two massive pulp mills under construction in Uruguay on the Uruguay River near the border between hte two countries, creating regional tensions and disrupting trade. The CIFOR studay faults the IFC for approving funding for the mills "without adequate environmental and social assessments."

"These projects have triggered blockades and months of protests sparked by concerns about environmental pollution and impacts on local economies. As a result, investors stand to lose hundreds of millions of dollars," CIFOR warns.

The CIFOR report points out that the environmental assessment submitted to the IFC by Finland's Metsä-Botnia Group "falls far short of what a proper assessment of the mill should consider."

"Lenders to these mills clearly did not anticipate the major problems they are encountering," said Kaimowitz. "The projects were well advanced with World Bank and IFC participation before those institutions ever required an Environmental Assessment. And the private banks apparently relied on the multilaterals to do the job of assessing the financial risks and environmental impact of these projects."

Investor enthusiasm for pulp expansion is increasingly driven by China's seemingly insatiable demand for paper products, which is projected to reach 68.5 million tonnes in 2010.

According to the CIFOR report, "this enthusiasm has led investors to ignore egregious misstatements by companies seeking to raise funds to feed this demand."

The report cites Sino-Forest, a company listed on the Toronto Stock Exchange with plantation holdings in China, reported that it had access to 232,600 hectares of timber plantations when, in fact, it had secured only 34,000 hectares, the CIFOR report states.

The IFC failed to catch the misstatements when it made loans to the company in 2000 and 2002. But even after the problem became public, investors continued to flock to Sino-Forest and its subsequent equity issue was fully subscribed.

On the positive side, CIFOR's report highlights the fact that a growing number of banks are now adopting policies that require better social and environmental assessments of their forest-related investments.

For example, Dutch banks ABN AMRO and Rabobank agreed not to finance the clearing of primary forest or the purchase of illegally harvested timber.

In addition, since 2003 some 41 of the world's largest lending institutions have endorsed the IFC-sponsored Equator Principles, which commit them to meeting enhanced environmental and social standards in their loans for specific types of projects.

The report applauds these advances, but notes that the Equator Principles fail to cover most of the loans and bonds used to finance the expansion of pulp mills.

"The Equator Principles are an important first step towards raising accountability among global financial institutions for assessing the impacts of the projects they fund," Barr says. "However, to have a meaningful effect on pulp mill financing, the Equator Principles must be broadened to cover syndicated loans, and issues of notes, bonds and equity, as well as project finance."

CIFOR maintains that regardless of whether they have endorsed the Equator Principles, financial institutions have a responsibility to improve their capacity to assess the financial, environmental and social risks of investing in the emerging pulp market.

At a minimum, banks and investors must insist that pulp producers provide better data on the sources of their raw material and should conduct independent assessments of fiber supplies and environmental and social impacts.

For their part, CIFOR recommends that pulp and paper companies foster better understanding by being more transparent in disclosing information on operations, and by establishing a common, industry-wide reporting standard. The Global Reporting Initiative sponsored by the UN Environment Programme offers an institutional framework within which such a reporting standard could be developed.

CIFOR is a Future Harvest Center. Future Harvest supports 15 food and environmental research centers that are primarily funded through the Consultative Group on International Agricultural Research.

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