Katoomba and the Stratosphere
"Under the general name of Commodity, I rank all those advantages which our senses owe to nature. This, of course, is a benefit which is temporary and mediate, not ultimate, like its service to the soul. Yet although low, it is perfect in kind, and is the only use of nature which all men apprehend."
—Ralph Waldo Emerson
ADAM DAVIS STRODE PAST the doily-covered parlor sofas at Lilianfels Blue Mountains, an elegant hotel in the New South Wales resort city of Katoomba. He'd arrived in Sydney two days earlier from San Francisco and was still jet-lagged, but you couldn't tell that from looking at him. Davis had the laser gaze of a gambler, and the grin of a man who feels the odds are with him.
This was doubly impressive, considering the wager. Davis was out to save the world from environmental catastrophe, and to make some money in the bargain. The son of an impassioned wilderness photographer and the product of a highly liberal education (bachelor of arts, cum laude, in Africana Studies, Cornell University, 1983), he was also the child of a peculiar place and time: the fringe of California's Silicon Valley in April 2000. The Nasdaq Stock Market was flirting with its 5,000 peak, and the romance of financial innovation was never keener nor more widely shared. Davis was zealous in his quest to rescue Nature, but unlike his mother, back in Baltimore, he didn't think the Audubon Society could do the job. He wanted, instead, to give Wall Street a shot.
After a stint in an Ithaca, New York, commune, Davis had an epiphany while working for a compost company. He was thrilled by the idea of turning waste into something useful, creating value where none existed before. He went on to make his career in waste management, rising high in the recycling ranks before starting his own firm to counsel corporations on their environmental policies and marketing. He was skilled at writing business plans and had been working furiously on a particularly bold one in recent months, in the hours he could spare from his clients. He carried several copies of it, printed on recycled paper, in the canvas briefcase slung over his shoulder.
He called his plan The Conservation Exchange. Although it remained little more than a theory, Davis was sure it would eventually have global ramifications. He'd made the long trip to Australia that week to see whether he could create a buzz.
The occasion was an extraordinary conference sponsored by a Washington, D.C., think tank called Forest Trends. It brought together from four continents about 150 economists, scientists, investors, and professional conservationists who shared an interest in creating new financial incentives for conservation. The meeting opened with a series of lectures at Sydney's Taronga Zoo, after which a select group of four dozen conference-goers took a bus to Katoomba, in the stunning, 250-million-year-old Blue Mountains. There, they'd spend two days contemplating ways to transform the world's economy to support the increasingly urgent needs of the besieged environment. Davis thought Katoomba the perfect venue to debut his Conservation Exchange. He networked with a vengeance, beginning the night he arrived in Sydney, when he held forth to a small group of conference-goers at an open-air wharfside café.
"Some $600 billion changes hands each year in international gambling," he said, running a hand over his close-cropped, graying hair. "We have to add some of that excitement, some of that gaming element, to conservation."
Davis spoke fast and with assurance, outlining his plan. The Conservation Exchange would be a World Wide Web site that people all over the world could visit, logging on to trade new commodities called ecosystem service units. The ESUs, as Davis called them, would be different from any stocks ever sold.They'd be based not on products of humankind or Nature but rather on Nature's work. Each ESU would represent a precisely measured quantity of a vital environmental service. Included would be the manner in which water is purified by watersheds, the way forests help regulate the climate by absorbing—or, in scientists' lingo, becoming "sinks" for—heat-trapping carbon dioxide, and even the way healthy ecosystems provide habitats and preserve biodiversity. Scientists would help certify the ESUs, and accountants would parcel them out for sale.
The sellers, at the start, would be landowners marketing the rights to services from their property.The initial values of the ESUs would be partly determined by perceived supply and demand: the rarity of the ecosystem type involved, be it rain forest, desert, savanna, or wetland, and the demand for services from such ecosystems.
Buyers of the shares might at first include businesses trying to find ways to comply with environmental regulations. Already, some rules in the United States allowed companies to "trade" in habitat. In wetlands mitigation banking, for instance, a "bank" of wetland habitat is established, consisting of newly created or restored wetlands. Property developers who are required to make amends for wetlands they destroy may then pay money to fund or enlarge the bank. Davis' plan would simply extend that concept.
Initial purchasers might also include wealthy conservation organizations. They might buy environmental conservation from a private landowner, as spelled out in a contract, without actually buying the land, thus saving money. Yet in time, Davis felt certain, speculators would enter the market and investors would trade ESUs just like shares in Amazon.com or Cisco Systems.
He realized the scheme was audacious. He also knew "green" purists might challenge him for having the anthropocentric nerve to try to commercialize Earth's basic life-support systems. But Davis was sure of his own good intentions. As far as he was concerned, he was as devoted an environmentalist as any member of Greenpeace. Profits and glitz were just the means to a worthy end. The time was ripe for thinking outside the box about Nature and markets. Besides, he had come to believe—along with a number of mainstream economists of various political persuasions—that establishing property rights to ecosystem services and a market for trading in them was the way to create financial value where none existed before. He'd seen the instant creation of value in Silicon Valley with Netscape's stunning initial public offering and the skyrocketing stock values of JDS Uniphase Corporation and other telecommunications companies. If all this were possible, why shouldn't people be able to trade in the perceived worth of Nature's labors, which, after all, were more precious than diamonds, given that human life depended on them?
His six-page business plan explained the reasoning, with liberal use of italics. Just like the "new-economy" stocks, his ESUs would be valued less on current earnings than on future potential. In the case of the ESUs, it was a simple question of supply and demand, something people had never truly applied to Nature because Nature's bounty had generally been just that—bountiful. Yet as the scale of the human enterprise grew, with more people crowding Earth and greater levels of consumption per person, the supply of "free" services, such as natural detoxification and recycling of wastes, would inevitably dwindle just as demand for them reached historic peaks. Market forces would have to apply.
"The key to understanding The Conservation Exchange is understanding that these services were once free and unlimited in relation to human population," read the executive summary of Davis' plan. "As human population doubles and doubles again, the flow of services provided by intact ecosystems becomes increasingly scarce in both absolute terms and even more so in per capita terms." It was inevitable, he was convinced, that the scarcity would cause a major shift in people's perceptions about Earth's assets. In time—in a short time—people would simply have to recognize their intrinsic worth.
"I know these things are valuable," Davis said, talking eagerly at the café between bites of angel hair pasta. "Ecosystem services are valuable. Not tree-hugging valuable but economically valuable."
Overhead, in the balmy subtropical night air, a fruit bat abruptly relieved itself, soiling the white shirt of a foundation executive who was listening in. Davis kept right on talking. His intensity, combined with the truly astonishing nature of his plan, was mesmerizing.
There was quite a lot of work still to do, he conceded. Fundamental was the effort to figure out how to quantify these new commodities. How would he parcel off an "ecosystem service flow"? And how would he quantify biodiversity? These questions were unanswered in his business plan, though Davis noted he intended to address them by hiring "topnotch credible scientific talent" with recourse to "satellite and air observation, direct measurement and peer-reviewed publications."
The plan, in fact, was meant to raise money for such research and recruitment, as well as the "spectacular high-speed graphics and state-of-the-art information presentation features" Davis wanted for his Web site. Yet even with so much to be done, he assured his small audience at the café that he'd have the site up and running within the next six months. The Conservation Exchange, his plan said, would then be marketed "with a major national splash, aimed square at the heart of Wall Street."
Davis had learned about the Australia meeting just two weeks earlier in California, when he first met Michael Jenkins, the director of Forest Trends. Jenkins' think tank was dedicated to finding market-based ways to save imperiled timberlands, and in the course of his work, Jenkins had heard of Davis' new consulting firm, Natural Strategies, which was dealing more and more with corporate purchases from certified sustainable forests—forests in which selective harvesting is practiced to ensure that they will yield timber into the future. The two men ended up having lunch at a Palo Alto bookstore-café, after which Davis drove Jenkins to the airport. On the way, Davis broached the subject of his Conservation Exchange.
Jenkins was taken by Davis' energy. But his first impression of the Conservation Exchange was that it was "too stratospheric and dot-com." Jenkins didn't move in dot-com circles. His milieu was the much more reserved world of East Coast philanthropy. He'd grown up a Foreign Service brat, born in Bangkok and reared in Moscow and Caracas, and he'd chosen a career that kept him close to the developing world, with its burden of poverty and debt.
He'd loved trees ever since spending childhood afternoons playing in the Russian countryside and the woodsy hills behind his home in Venezuela. But it wasn't until later, while living for three years in northwestern Haiti and working for a private philanthropy called Appropriate Technology International, that Jenkins dedicated his career to forests. Haiti is one of the world's poorest and most heavily deforested countries—two characteristics Jenkins came to see as inextricably linked. Most of the world's remaining tropical forests are found in developing countries, inhabited by the world's poorest people. In Haiti, as in other impoverished areas, trees were a precious but easily squandered wealth. And it was useless to try to save them without helping the people who lived in their shadows. You couldn't blame people for cutting down forests if they had no alternative income.
If financial markets could offer a solution to this dilemma, Jenkins certainly wanted to hear it. Still, he felt uneasy with Davis' emphasis on profits. Flush with enthusiasm, Davis was constantly saying things like "There's a huge opportunity for somebody to make a ton of money off this stuff!"
Jenkins, in contrast, feared the profit motive was to blame for most of the world's environmental degradation to date. He didn't believe markets could ever seek social welfare; left alone, they'd simply make rich people richer. All the same, he sensed he needed pragmatic, dogged people like Davis to take some of the creative ideas about Nature and finance that had been floating around for the past few years and make them real. Davis clearly knew how the business world worked. And Jenkins had come to share the view that it was time to try to harness people's self-interest in the quest for environmental protection. "Envy trumps guilt," as Davis liked to say. Regulations hadn't worked, nor had moral appeals. So Davis may have been in the stratosphere, but Jenkins was now ready to admit he wanted to follow the same path.
It had been barely a year since Jenkins, then forty-five, founded Forest Trends with the help of some like-minded friends from the World Bank and the Rainforest Action Network. Before that, he'd spent ten years at the John D. and Catherine T. MacArthur Foundation, growing ever more frustrated. For each of those years, he had helped choose recipients for millions of dollars in forest program grants. Yet each year, he had watched forest destruction around the world accelerate. It came down to a question of values, he decided. Cut timber was worth money. Standing forests weren't. Global markets were rewarding short-term more than long-term returns, with the result that the world's largest ecosystems had been reduced to being providers of a single commodity whose price was falling. There was every incentive to clear-cut timberlands and sell the land for other uses, but it was all but impossible financially to engage in sustainable forestry, which preserves the asset of the forest itself. As Jenkins would warn in his welcoming speech at the zoo, people were missing the forest for the trees.
Even so, Jenkins could see there were all sorts of interesting ideas bubbling up in academic circles about how to use financial incentives to spur conservation, despite the fact that precious few of them were being put to use. It was all ecologists talking to ecologists about theoretical solutions that were never really tested. Jenkins decided his role should be that of a matchmaker, bringing together experts of diverse talents with potential financiers to work on crafting actual deals. He envisioned what he called a "skunk works" project—a focused effort to solve a specific problem—in which a team of eggheads would work in isolation and with minimal supervision on a common, urgent mission. His plan was to convene at least four high-intensity meetings over two years, in different cities around the world, during which participants would be charged with coming up with concrete products, including a new "green" mutual fund.
Jenkins had taken much care with the guest list for that first meeting in Katoomba, calling on his long-cultivated international network of colleagues and acquaintances and emphasizing diversity. Thus it was that at Lilianfels, a trader from Sumitomo Mitsui Banking Corporation would be found having cocktails with a Greenpeace activist and a World Resources Institute analyst. All would come to refer to themselves as the Katoomba Group in the months to come. Most remarkable of all, however, was that Jenkins had managed to secure cosponsorship from the Sydney Futures Exchange, the clearest sign that major money might be poised to flow into the contemplated conservation projects. A few brave executives at that institution thought they recognized lucrative opportunities in some potential new "green" products, and that year they were trying to promote the exchange as a global nexus for "green trading."
Their main source of inspiration was an innovative young market in pollution permits then flourishing in the United States. It was in fact the same market that had engendered Davis' grand dream of a Conservation Exchange.
Since the early 1990s, U.S. businesses and individuals had been buying and selling rights to emit sulfur dioxide (SO2), a contributor to acid rain. The trade was made possible by the 1990 Amendments to the Clean Air Act, signed by President George Herbert Walker Bush, and it got under way in earnest five years later in annual auctions at the Chicago Board of Trade. The United States Environmental Protection Agency (EPA) unleashed the market by giving electrical utilities across the country permits to emit SO2 in their combined operations (in other words, a property right to SO2 emissions) and the ability to trade these permits with other utilities. The cleaner, more efficient companies could meet their targets inexpensively, but others, with older equipment, would have to pay a lot more. This motivated the efficient companies to reduce emissions below their targets so that they could sell their unused permits. The less efficient firms found it more economical to buy permits than to replace older equipment with a lot of life left in it. Eventually the permits were being traded much like pork bellies, with speculators entering the market to bet on future prices.