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7 Market mechanisms and assessment methods for environmental services from private forests in Australia

Rodney J. Keenan[8], Stuart Davey[8], Alistair Grieve[9], Brendan Moran[10] and Jim Donaldson[11]


Forest ecosystems provide a wide range of economic, social and environmental benefits and services. In some regions of Australia there have been considerable land and water degradation and loss of biodiversity and other environmental services. The role of forests and trees in mitigating these environmental impacts has been recognized for some time. Governments have implemented a variety of incentive arrangements to encourage private landowners to retain existing forest, replace forests on areas cleared for agriculture and effectively integrate trees with current farming systems. While landowners can make financial profit s from the sale of wood or other commercial forest products, environmental services (clean water, dryland salinity mitigation, soil protection, carbon sequestration or biodiversity conservation) are not effectively valued or traded as market goods. Allowing forest owners to realize financial returns for the supply of environmental benefits could result in improved environmental outcomes and a more sustainable mix of land uses. Australian organizations have been early movers in developing institutional arrangements for trading carbon credits from forests and a variety of approaches are being developed for marketing other forest services and benefits. This paper focuses on approaches to marketing carbon, biodiversity and salinity mitigation from forests and revegetation. We conclude that developing markets for environmental services can provide a basis for harnessing private capital for environmental repair and for more efficient investment of government funds to achieve broader environmental outcomes and to efficiently quantify the benefits of investment. Marketing environmental services needs to be underpinned by a scientifically credible system for assessment and monitoring of the services. Experience gained through pilot schemes for trading, monitoring and reporting is important in creating confidence for public and private investors.


Australia is the world’s smallest continent and one of the most biologically diverse countries in the world. The economy is highly diversified but there is a continuing dependence on the production of agricultural crops and livestock and utilization of forests and other natural resources particularly in regional areas. Australia has experienced considerable environmental degradation of vegetation, land and water resources since the arrival of European settlers just over 200 years ago. These problems are now widely recognized and their causes are largely understood.

Governments at all levels have invested considerable public funds in attempting to reverse declining trends in the condition of natural resources. These programmes have been successful to some extent, particularly in generating awareness of the scale and extent of environmental problems and in changing attitudes to land and consideration of alternative land management practices. The challenge ahead is to build on this awareness and implement wider reaching changes in land management that will result in more sustainable use of natural resources.

Quantifying and marketing environmental services produced from trees and forests could provide a basis for active retention and management of native ecosystems and greater incorporation of trees into land management systems. In this paper we briefly describe the Australian environment and land management problems, outline the Australian experience with quantifying and marketing environmental services, focusing on carbon, biodiversity and salinity mitigation and discuss some implications of this experience for developing countries.


Australia has a land area of 7.6 million km2 and is situated between 10° and 43° S. The population of 19 million is concentrated largely in cities in the east and south around the coast. Australia has the lowest precipitation and run-off of any continent. Climate is highly variable with temperature across a range from tropical to cool temperate and rainfall ranging from per-humid to arid. Rainfall varies considerably from year to year as a result of events such as the El-Nino Southern Oscillation (ENSO), a two-to five-year sequence that causes below-normal rainfall and drought in much of eastern Australia. The geology is generally ancient and heavily weathered; there are uplifted areas forming mountain ranges over 2000 m in altitude and very productive agricultural and forest areas but Australian soils are generally nutrient poor with low productivity. Low and variable rainfall, poor soils and long isolation from other continents have resulted in the evolution of a distinct flora and fauna. Humans have been in the Australian landscape for millennia. Aborigines have been in Australia for at least 40 000 and perhaps over 60 000 years and developed a strong spiritual affinity and attachment to the land. Their extensive use of fire shaped the Australian landscape and the consequences of their removing their influence from much of landscape are still being felt.

European settlers spread rapidly across the continent in the first half of the 19th century, taking up land and often clearing forest and woodland vegetation for grazing and cropping. Clearing of land for agriculture accelerated in the early part of the 20th century and further increased with the development of heavy machinery and population growth following World War II. Significant areas of forest and woodland are still being cleared for grazing and cropping, particularly in northern Australia. Sixty-one percent of the land area is under some form of agricultural management. Depending on the season, between 20 and 25 million ha are sown to crops, and 94 million ha are in improved pastures (with 35 million ha sown to introduced legumes and grasses). The pastoral industry covers about 70 percent of the continent (Hamblin 2001).

Australia is one of the world’s “megadiverse” countries. Eighty percent of flowering plants, mammals, reptiles, frogs and fish and about 50 percent of birds are found nowhere else. Vegetation composition and structure vary considerably with the diversity of climate, geology, landform and disturbance history. Forest cover is dominated by trees from three main genera, Eucalyptus, Acacia and Callitris. Most forests are open (50-70 percent canopy cover) or woodland in structure. The total native forest area (defined as land with actual or potential tree cover greater than 20 percent canopy cover and 2 m in height) is now about 162 million ha (National Forest Inventory 2003). Timber harvesting has occurred since the first days of European settlement and forests provide a diverse range of products. About 13 million ha of native forest are used for wood production and the remainder for other commercial purposes such as grazing and for conservation and recreation. One hundred and eight million hectares of native forest (including lower canopy cover woodlands) are under private ownership or leasehold management and wood from private forests makes a significant contribution to wood supply in a number of regions (Ryan et al. 2002). Plantations have been established since the 1920s and the total area of plantations is now 1.5 million ha (Wood et al. 2001) and they supply over 50 percent of the current forest removals of 23 million m3. About 50 percent of harvest is exported.


Loss of tree cover and inappropriate cropping and grazing practices have resulted in significant degradation of land and water systems (Hamblin 2001). About 50 000 km of streams have been degraded by sand and silt deposition, mainly in southeast Australia. Clearance of native vegetation has resulted in mobilization of ancient salt stores and rising water-tables resulting in salt-affected river and land systems. Impacts of salinity can take 15 to 150 years to develop depending on soil type and regional hydrology. Up to 20 000 km of inland waters could be salt-affected by 2050 with high salt concentrations making river water unsuitable for drinking or irrigation and having significant impacts on stream biota and riparian vegetation. Land can become salt-affected through rising water-tables leaving it marginal or unsuitable for agricultural production. About 5.7 million ha in agricultural regions are currently affected or at potential risk from salinity and 2 million ha of native remnant vegetation could be adversely impacted (NLWRA 2001). Salinity also affects infrastructure (e.g. roads, pipes and house foundations) and at least 200 rural towns could experience salt damage over the next 50 years.

Habitat destruction, fragmentation and introduced predators have resulted in the loss of over half of Australia’s mammals since European settlement. The number of threatened bird, reptile, frog and fish species is increasing with principal threats including forest clearing, salinity, altered fire regimes, climate change, disease and invasive species (Australian State of the Environment Committee 2001).

The severity of the environmental effects resulting from clearing of woody vegetation and unsustainable land management practices has created a national requirement to protect existing vegetation and re-establish tree cover in many parts of the landscape. However, there is a growing recognition that trees do not necessarily have positive outcomes in every situation and the notion that “any tree, anywhere” is automatically a good thing is increasing being questioned (Alexandra and Campbell 2002). Increasing the area of commercial timber plantations can have positive regional financial benefits but negative impacts on downstream water yield, biodiversity values and even soil loss can occur in some locations.


Environmental policy has typically adopted “command and control” procedures involving regulation, zoning or strict agreements with landowners such as covenants on ownership (Bardsley et al. 2002). Under this approach, the “impacter” generally pays for the reduction or loss of prescribed values or services below a certain standard. These requirements need to be clearly identified in the property rights conferred on individuals. Where these rights are changed through government action there is often a demand for compensation from existing owners and the costs of implementing this approach can outweigh the benefits (Aretino et al. 2001).

Government programmes have also fostered development of a conservation ethic in the Australian rural land management community and maintained or expanded woody vegetation cover to address environmental problems. For example, the Landcare Movement ( has promoted participation of rural landowners in networks of local groups to exchange information on sustainable land management practices and undertake voluntary works to mitigate soil erosion or restore vegetation cover. However, it is unrealistic to expect that volunteer efforts of individual landowners and community groups will result in the scale of revegetation required to address Australian environmental problems (Robins et al. 1996). Governments are continuing to invest in knowledge and capacity building through research and extension programmes across a range of disciplines and in supporting community action.

More emphasis recently has been placed on developing ways to mobilize private capital to address environmental problems and alternative approaches that more efficiently allocate government resources to achieve environmental outcomes or to facilitate public-private partnerships that involve a mix of commercial and environmental outcomes.


‘Market-based’ mechanisms are an alternative approach to achieving desired environmental goals at lower cost to government and the community. If well designed and operating efficiently, markets can link values, policy decisions and management actions. Potential sources of capital for investment in such environmental services are government, voluntary private sources, or regulated private investment (Binning et al. 2002).

Quantifying and marketing environmental services can result in improved land management while allowing for private benefits (this could include the sale of wood, or carbon) to accrue to private investors at the lowest cost and allow for efficient allocation of government funds to achieve environmental benefits that accrue to the broader community. Market mechanisms for environmental services can include:

Market-based approaches can also create greater public and land manager awareness of previously unpriced environmental assets resulting in behaviour changes leading to improved environmental outcomes. Markets arrangements can force direction of efforts to where value is greatest and markets for different environmental “products” can reveal opportunity costs in pursuing one value over another (Bardsley et al. 2002).



The Kyoto Protocol sets out legally binding commitments for developed countries to reduce greenhouse gas emissions. Under Article 3.3 greenhouse gas emissions and removals due to afforestation, reforestation and deforestation can be used to meet emission reduction targets. Because the total area that might be converted to plantations is limited, increased carbon storage in forest plantations is generally regarded as a part of transitional strategy to reduce atmospheric concentrations of greenhouse gases over the next 50 years or so. Inclusion of “sinks” in the Protocol has created expectations of increased investment in forest plantations for carbon storage. Ideally investment in carbon credits would be directed at locations where environmental benefits are maximized rather than in plantations that are currently commercially viable, but this is likely to be difficult to regulate in practice.

The market price for carbon credits depends on demand and supply, and the nature of an emissions trading market (Hinchy et al. 1998, Tulpulé et al. 1998, AGO 1999a, b, c, d). The potential for carbon credits from plantations to compete against alternative abatement options will depend on the cost of generating plantation-based credits. Key factors in determining this are the extent, availability and cost of suitable land, tree growth rates, commercial and legal infrastructure arrangements and the nature of supportive government policies, risk factors and transaction costs associated with selling carbon credits.

Australia led the development and implementation of institutional and legal mechanisms aimed at allowing efficient trade in carbon credits. NSW State Forests has been particularly active. After negotiation of the Kyoto Protocol, this state-owned forest management agency decided to become an innovator in the area of climate change business opportunities. As a learning exercise, a financial trade was undertaken with Pacific Power (also a state-owned corporation) purchasing the rights to carbon being sequestered in 1000 ha of newly planted forests, initially for one year, and subsequently for ten years. Concurrently, another trade was set up with Delta Electricity, where the right of State Forests to grow trees on land owned by Delta was exchanged for the rights to the carbon sequestered during the rotation. These trades were based on independent verification, including confirmation that the land was non-forested at the time of plantation establishment and assessment of the methods used for estimating carbon sequestration (Brand 2000).

As a result of these initial trades, it was determined that legislation by the New South Wales Government would be beneficial to the further legal recognition of carbon offsets and future establishment of carbon offset trading. Accordingly, the NSW Parliament passed the Carbon Rights Legislation Amendment Act in November 1998. This Act includes amendments to the Conveyancing Act, the Electricity (Pacific Power) Act, the Energy Services Corporations Act and the Forestry Act.

Under this arrangement NSW State Forests has designed investment packages combining carbon sequestration and timber production. In February 2000, the Tokyo Electric Power Company signed a contract for the carbon rights to 40 000 ha of new plantations over the next decade (Brand 1999). Plantation growers in other states, such as North Forest Products in Tasmania, the Western Australia Department of Conservation and Land Management, and Green Field Resources Options and the Queensland Government have entered into arrangement for plantation carbon rights with petroleum producers or energy generators. The use of carbon sequestration credits by overseas investors while the Australia Government does not ratify the Kyoto Protocol is uncertain.

The “Replanting Victoria” programme provides a different model, with the Victorian Government providing a subsidy of A$600 per hectare to small-scale plantation growers in return for the rights to carbon sequestered in the plantations. This has been an effective way for the government to foster plantation development for regional development or environmental benefits and reduce the transaction costs associated with carbon measurement in small-scale plantings.

In 1999 the Sydney Futures Exchange developed a new carbon sequestration product in new forests established since 1990. The SFE decided not to proceed with the development of this product for commercial reasons and the current policy environment in Australia regarding ratification of the Kyoto Protocol is uncertain. The SFE initiative was intended to provide a risk management product to hedge the effects of the Kyoto Protocol. Trading carbon sequestration credits (CSCs) could help companies manage future permit price uncertainties by enabling them to trade future credits at a price agreed at the time of trade. Suppliers of carbon to the market were to use an agreed standard and adhere to the conditions of a carbon deed. This deed included requirements for risk management, including insurance and demonstration of sound prudential assets and financial liquidity.

Potential benefits from this early trading in sinks included:


In Australia, biodiversity conservation on private land has generally been implemented through land purchases or agreements with the owners of high quality habitats. For example, a private forest reserve programme established under the Tasmanian Regional Forest Agreement has a target of 100 000 ha of private forests reserved through the programme. The programme is spending $A30 million to place voluntary covenants or management agreements over properties containing priority forest types required for protection. An alternative approach is being adopted in the State of Victoria. Called “Bushtender”, landholders are invited to put forward tenders for the provision of alternative management approaches that will provide improved biodiversity conservation, for example, fencing and habitat protection rehabilitation activities, in native vegetation at a given price. Potential benefits are assessed using the “biodiversity benefits index” described below. Successful tenderers are chosen based on an assessment of benefits and price and they enter into a management agreement with the state government to undertake the proposed management for a given period of time.


While the problems of dryland and stream salinity are well-known, causes are complex and processes are incompletely understood. Trading arrangements to mitigate these problems have therefore been limited. In some catchments (such as the Hunter River, north of Sydney) salinity can be treated as a point source and emission “cap-and-trade” arrangements have been implemented to reduce salinity inputs to streams. Across larger catchments, such as the Murray Darling locations of salt stores and inputs to rivers or dryland salinity areas are uncertain (Dent et al. 1999).

Over 10 million ha of land in low to medium rainfall areas may need to be revegetated with woody vegetation by 2050 to halt the spread of dryland salinity and keep stream salinity to levels where water is suitable for agricultural irrigation or urban water use. The investment required to fund such revegetation is beyond the capacity of government. Commercial options are therefore needed to attract private investment into forestry for environmental outcomes.

Environmental service payments potentially provide a means whereby public funds can be invested in commercial projects without violating competitive neutrality principles. By purchasing the salinity mitigation benefits of targeted plantations, public funds can be employed to provide a totally new income stream and thus increase the internal rates of return for low rainfall forestry without directly subsidizing the private investment in wood production.

Using existing and developing salinity hazard mapping, it is possible to quantify to a known level of certainty the impact of plantations on mean annual flow and salt load to deliver a flow weighted salinity effect for afforestation. Applying market mechanisms to salinity mitigation using forest vegetation is complex, particularly when there may be multiple benefits accruing to different parties (Figure 1).

Figure 1. A conceptual model to illustrate how improvements in commercial forestry and environmental credits can together create profit able plantation investments in lower-rainfall environments. Relationships and notional values of IRR are indicative to illustrate trends and aid discussion (C. Harwood, CSIRO, pers. comm. 2002)

State Forests NSW and Macquarie River Food and Fibre have launched a pilot programme to trial salinity control credits in the development of a response to dryland salinity in the Macquarie catchment of the Murray-Darling Basin. In this as in many other salt affected catchments, the salinity impact of land clearing occurs downstream of the clearing activity. There is therefore little incentive for the landowners responsible for the clearing to revegetate. The opportunity costs in lost production as well as the capital costs associated with this revegetation are prohibitive and act as a major disincentive in the adoption of the desired land-use change.

In an attempt to overcome these disincentives, State Forests has entered into an agreement with various landholders to plant and manage native forest on their land. The landholders are paid an annual annuity which is characterized as a “salinity control credit” based on the transpiration level of the planted forest. This transpiration implies a reduction in the water contributing to salt mobilization and hence downstream salinity. The rights to these “credits” are sold to Macquarie River Food and Fibre whose members will be adversely affected by the increasing salt load within the catchment.

In the case of this scheme, State Forests has the right to harvest the timber. It may be difficult in the future to reconcile this right with the need to maintain transpiration for salinity control. A pooled approach as is used in managing carbon sequestration may be applicable.

Other projects underway to develop and test public/private co-investment models include:

  1. The Commercial Environmental Forestry project. This aims to develop a farm forestry investment framework to underpin sustainable land-use change for commercial and environmental outcomes. This toolbox will optimize commercial outcomes in low to medium (500-800 mm) rainfall forestry by assisting species selection, location in the landscape, plantation management and product decisions and assessment of environmental values.
  2. The NSW Government Environmental Services Scheme. Under this scheme, 25 landholders have been selected to take part. Staffs from the Department of Infrastructure, Planning and Natural Resources, State Forests and NSW Agriculture are working closely with these landholders to implement land-use changes aimed at integrating the production of environmental services into more traditional rural production. The land-use changes on the properties involved are funded through an investment of $2 million from the Salinity Strategy’s Environmental Services Investment Fund. The aim of the Environmental Services Scheme is to look at some of the practical issues that will arise in the development of a market to support the environmental services produced on-farm. These include the costs associated with including environmental services within rural production, how to define and create ownership of the services produced, and the type of financial, contractual and incentive arrangements necessary. The scheme will allow the government to work with landholders to identify the practical requirements for environmental service markets and incentive programmes to operate for the mutual benefit of landholders and the community.
  3. Under the National Action Plan for Salinity and Water Quality, the Commonwealth, State and Territory governments will jointly fund $5 million for 10 natural resource management projects under the first round of the National Market Based Instruments (MBI) Pilots Programme. The projects will investigate ways to use innovative financial arrangements to encourage better land and water management and to reduce salinity in irrigation-based agriculture. Pilots are expected to begin operating in June 2003 and be completed in mid2005. For example, one pilot project is a scheme where irrigators can choose the most cost-effective way to manage salinity levels in a river catchment. To ensure salinity levels do not increase, a cap or target is set for the whole irrigation area. The cap or target can be achieved by undertaking activities to reduce salinity levels or by purchasing credits from other landholders who can achieve the same results more cheaply. The Goulburn-Broken Catchment Management Authority in Victoria is implementing a project to extend the auction approach successfully trialled in the Bushtender programme to include salinity, water quality, water quantity and biodiversity. It will consider how intervention in the landscape can cause multiple outcomes. Planting trees, for example, may reduce accessions to groundwater-tables (the cause of dryland salinity) and buffer nutrients from surface water, but trees also reduce the flow of surface water, which can adversely affect water quality in streams. This pilot also intends to address the development of appropriate duty-of-care benchmarks.


Systems for quantifying the environmental value of land-use /management changes on private land are important in generating potentially tradable environmental services. Where possible, the impact of these changes would ideally be measured directly, e.g. the creation of an increased carbon sink through tree planting. In many instances, however, it is not possible to measure directly the value of these changes in contributing to additional environmental service levels, e.g. where the off-site impacts are the product of a large number of individual inputs as in reducing recharge for salinity management, or where the impacts are not evident until long after the original action is taken as in the case of improving habitat for biodiversity. In these cases it is necessary to determine suitable parameters that can be used as a satisfactory indicator of these “environmental services” (sometimes referred to as a surrogate). Suitable parameters should:

Because environmental services are often not “delivered” for some time into the future, systems are required for prediction of potential outcomes (these are usually computer models or tables of values generated from models) and for monitoring the actual outcomes of the investment.


Carbon sequestration in forests is perhaps one of the easier environmental services to measure. There is a reasonably sound scientific base for quantifying carbon stocks in forest types and there is a strong relationship between traditional forest inventory variables and carbon stock. Guidelines for national accounting for greenhouse gas emissions and removals in forests and agricultural lands have been developed by the Inter-governmental Panel on Climate Change (IPCC 1997) and good practice guidance related to implementation of the Kyoto Protocol (including CDM projects) is currently in development. Forest inventory has generally focused on obtaining estimates of timber volume in the bole of the tree. Carbon generally makes up about 50 percent of the mass of most plant material, and carbon is estimated from an inventory of total biomass. In plantations this requires assessment of the biomass stored in other components of an ecosystem, including:

The rate of accumulation of carbon in a plantation established on cleared land generally follows a logistic (sigmoidal) curve, with initial emissions from soils following establishment, slow initial growth, more rapid accumulation after the site is occupied followed by a decline as the trees mature. Changes in carbon stocks in vegetation and soil removed or affected by plantation establishment need to be accounted. Reduction in carbon stocks due to harvest or other natural disturbances will also need to be accounted.

In New South Wales, the Carbon Sequestration Predictor (Montagu et al. 2003) provides a tool for predicting likely changes in both biomass and soil carbon associated with a number of land-use changes at the property scale. The principal focus of the model is on changes from herbaceous (cropping, pasture) to woody vegetation (commercial and environmental tree plantings) in inland regions (<800 mm y-1 rainfall) contributing to dryland salinity in NSW. The tool provides two predictions of changes in carbon stocks (biomass, soil and total carbon). A table presents predicted changes in carbon stocks expressed as tonnes of carbon per hectare, 10 years after the land-use change. Many land-use changes take a considerably longer time to reach a new quasi-equilibrium carbon storage level. A graph of predicted carbon changes over 40 years is also provided to indicate the longer-term benefits.

Few, if any, countries currently perform all measurements required for carbon accounting in forests routinely, particularly soil inventories (Watson et al. 2000). Most countries are likely to adopt a combination of modelling and direct measurement as part of their accounting system. Besides plantation projects developed under joint implementation or the CDM, other issues need to be addressed. For example, a project would need to demonstrate that increased carbon storage resulting from the project is additional to that which would occur without it, and a baseline would need to be developed to quantify these additional sequestration benefits (Brown et al. 2000).


Biodiversity is a more challenging indicator to measure. The Habitat Hectares methodology developed by the Department of Natural Resources and Environment (Victoria) is one approach to quantifying the biodiversity value of a site and how a site value could vary from a change in land management. The methodology has been further developed for application to revegetation (Oliver and Parkes 2003). The biodiversity benefits index is calculated on the basis of three surrogate measures:


CS t0= current conservation significance, that is, prior to land-use change,
CS tn = potential conservation significance, i.e. after land-use change,
LC = landscape context,
VC t0= current vegetation condition, that is, prior to land-use change,
VC tn = potential vegetation condition, i.e. after land-use change and an agreed period of time,
c, d = constants

The biodiversity index is calculated as a change in benefits per hectare during the 10-year period following land-use change. Application of the index to the ESS sites will require that vegetation benchmarks are developed for each relevant vegetation type. This will be carried out using a rapid expert panel based system, pending more comprehensive data becoming available.


The contribution of a particular property and the effects of land-use change on stream salinity is a complex interaction of local and regional hydrological processes. In NSW, the approach used to estimate salinity mitigation benefits arising from land-use change employs models of salt and water flow in the landscape (Herron 2003). The modelling methodology used to determine the potential impacts of the different land-use changes on catchment salt and water exports is a simplification of the CATSALT v1.5 methodology. Mean annual stream flow and salt loads, calculated for the reference period 1975 to 1995, are distributed across their contributing area based on the major factors affecting hydrological behaviour such as land use, topographic position, salt storage and discharge potential (the last two parameters defining salt hazard). Every unique combination of land use, topographic index and salinity hazard is defined in terms of its contribution to total water and salt yields. With these values known, it is then possible to predict the consequence of a land use anywhere in the catchment on flow and salt yield. The salinity benefits index model is used in conjunction with a spatially based platform called the Land-Use Options Simulator (LUOS). The Options Simulator is a GIS based tool designed for:

The tool is designed for use within the office, or to be taken on site visits using a laptop. It is fully scalable and capable of switching scale or area of interest, so individual properties or whole catchments can be assessed. It has been developed to require no previous GIS experience, and to minimize training time for operators.

The salinity benefits model estimates the impact of land-use changes at a site on the average annual stream flow and salt load exported from the catchment in which the site is located. By calculating the ratio of salt load to stream flow for existing conditions and for post-land-use change conditions, the model calculates a raw salinity benefits index (SBI) value. The local catchment outlet is the reference point for this calculation. The SBI value is expressed as a percentage change in stream salinity. To allow for comparison between catchments (which may have significantly different stream salinities), the change is expressed as a percentage of the current in-stream salinity, rather than as an absolute value in tonnes/megalitre.

The percentage change to in-stream salinity is multiplied by -1 so that a drop in in-stream salinity gives a positive (beneficial) value, and an increase gives a negative (detrimental) value. The results can be further scaled to give numbers that generally lie in a reasonable range (say, normally less than 10).

The magnitude of the raw SBI is affected by the size of the land-use change at a site relative to the size of the catchment at the reference point. A given land-use change at a site will have a greater percentage impact on the stream flows and salt load exports from a small catchment than from a large one. Amongst other things, this means that raw SBI values calculated at different reference points are not comparable (they may be reasonably comparable where catchments at each reference point are of about the same areas, but not where the catchment areas differ markedly). In order to allow for comparisons to be made between sites which are located within the same valley, or between sites located in different valleys (state scale), the raw SBI can be expressed in relation to the aggregates of stream flow and salinity loads at these different scales. Care needs to be exercised in interpreting indices derived at these different reference points, as both the magnitude and the sign of the index can change.


Market-based initiatives for achieving environmental outcomes from forests in Australia are moving rapidly from concept to implementation. There are a number of factors that need to be considered if market-based approaches are to widely adopted.

Transaction costs

Transaction costs are part of any business arrangement and are incurred in matching buyers to sellers, negotiating costs and finalizing contracts. They include advertising, tender assessment and the costs of estimating, verifying and certifying the service delivered. Depending on the nature of the market, transaction costs can be borne by the buyer or seller.

In general, transaction costs will raise costs (and lower the net benefit) to each participant in the trade, and may reduce the volume of exchanges. They will be determined in part by regulations established for trading environmental credits, the volume of trading and the degree of certainty required by the purchaser of the service or benefit. In the case of the carbon traded in the CDM, other costs, such as the adaptation levy on CDM projects (set at 2 percent), could affect the volume of trade.

Risks and uncertainties

Institutional risks and natural uncertainties will affect decisions to invest in environmental services. Institutional risks include changes in government policy, or shifts in the price of services. For example, forest growers who sell carbon credits in one market, may have to purchase them in another when they intend to harvest for timber. There are also risks related to shifts in government policies such as pricing and allocation policies for timber, plantation related regulations such as environmental requirements and forest ownership rights, and taxation provisions. Natural risks include impacts of drought, pests, or fire on revegetation projects. Risk can result from asymmetric information. For example, sellers of organically grown produce may not find a market because an uninformed public can be cheated by fraudulent products. This can be addressed through independent certification processes. The general public has often been the uninformed party in environmental policy. Lack of accountability for how money has been spent and what has been achieved on the ground or in environmental outcomes has resulted in a lack of confidence in environmental programmes. This may explain the interest in volunteer programmes, where volunteers can at least monitor their efforts and those of other community participants.

The capacity of landowners to deliver the intended environmental services from existing forest or revegetation will vary. When the processes are well described, management requirements are well-understood and the manager has appropriate experience, then the risk of non-delivery may be low. Carbon stocks and biodiversity habitat can be monitored through a visual inspection to ensure the trees are still in place and well-managed, with less frequent measurement to compare with original projections. For services such as dryland salinity mitigation, the processes are not well-understood and the results may not become apparent for a considerable time after the investment is made. In some cases, unless large-scale land-use change is achieved, the impact may not be detectable. It may be that government investors in these services have to accept some uncertainty in achieving a single outcome. This uncertainty might be balanced by investing in schemes with multiple outcomes.

The level of risk might be reflected in the payment arrangement, with payments made as the service is delivered over time. This will depend on the requirements of the landowner and the initial cost of setting up to deliver the service. In some cases, such as revegetation, upfront costs can be substantial and unless finance is made available to cover these they can be a significant impediment to adopting alternative land uses.

Risks can be covered in a sales contract, but this may add to transaction costs. For instance, a buyer may want compensation for the lack of delivery of a service if a fire or other natural event occurs or if regulations change. Financial risks can be hedged if other commercial products such as wood are produced. Risks could also be managed through the formation of “pool managers” who keep a certain proportion of the service “in reserve” to allow for losses associated with unforeseen circumstances.

Unintended social or environmental impacts

Concerns have been raised about potential social and economic impacts on smaller rural communities and environmental implications of large-scale revegetation programmes such as plantation-based carbon-offsets projects (Bass et al. 2000). These include impeding or removing access to land for traditional uses and sources of livelihood for rural communities, and the inability of small community-based projects to compete in the market with large-scale reforestation activities. In Australia, communities are reacting to the rapid expansion of plantations onto agricultural land, and perceived impacts on community structure and employment (Williams et al. 2003). Individual countries are best placed to assess whether prospective projects for purchasing environmental services such as carbon sequestration will assist them achieve sustainable development objectives. Other solutions to potential community impacts include social and environmental impact assessment of projects, providing incentives for projects with multiple benefits, and reducing transaction costs for community-based projects.

Concerns have been raised about the potential impacts of afforestation on water yield and quality and biodiversity. For example, higher water utilization by trees may have unintended consequences such as reduction in downstream water flows and decreased aquifer recharge (MDBC 2003, Vertessy 2003). There is considerable debate in Australia about how public policy can achieve more sustainable land management through forestation of the lower rainfall salinized catchments to reduce salt accession into rivers and the containment of future plantation development in the higher rainfall areas to maximize high quality dilution flows to salinized catchments. This will require careful planning of plantation location based on a sound understanding of landscape topography, soils and hydrology.

Biodiversity conservation values of commercial plantation projects can be moderated by using native species where possible, retaining and enhancing areas of native vegetation within the plantation development, and incorporating more compositional and structural diversity in the plantation by maintaining a mix of age classes and plantation species (Keenan et al. 1999, Lindenmayer et al. 2002).


It is generally recognized that a combination of market and non-market approaches will be required to achieve environmental policy objectives depending on the value of the resource and the potential number of suppliers of the environmental good or service. Market-based approaches to funding environmental services from forests can take a variety of forms. The appropriateness of implementing market-based approaches will depend on the level of diffusion or scientific uncertainty around cause and effect, the number of potential suppliers of the service and transaction costs.

  1. Developing markets for environmental services can provide a basis for more efficient investment of government funds to achieve broader environmental outcomes and to efficient ly quantify the benefits of investment.
  2. Markets for environmental services can provide a basis for private investment where private benefits can be identified or for joint public-private partnerships if there is a mix of benefits.
  3. Markets for environmental services need to be underpinned by clear and unambiguous property rights for landowners.
  4. Marketing environmental services needs to be underpinned by a scientifically credible system for assessment and monitoring of the service.
  5. This system should be relatively low cost and provide a standard approach for quantifying services across different types of environments and management jurisdictions.
  6. Policy design needs to be system wide and not ad hoc. It needs market mechanisms that reveal information and provide confidence to public and private investors about the likely outcomes.
  7. There is little substitute for experience-pilot programmes and learning by doing in undertaking trading, monitoring and reporting on the result and adjusting the system based on experience.
  8. There may be resistance from decision-makers to adopt approaches that diminish their capacity to appropriate political or institutional “rents” from the allocation of resources for environmental outcomes. Consequently, there needs to be strong institutional support for the development of market mechanisms.


We would like to thank Dr Quentin Grafton and Mr Frank Jotzo for valuable comments on the manuscript.


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[8] Bureau of Rural Sciences;
[9] State Forests of NSW;
[10] Department of Agriculture, Fisheries and Forestry; Canberra, Australia; E-mail:
[11] Department of Agriculture, Fisheries and Forestry; Canberra, Australia; E-mail:

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