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Greens take a cue from financiers

Environmental ‘derivatives’ encourage creative, proactive conservation.

(Page 3 of 3)

That’s a bad idea for several reasons, says Professor Sugihara. Shutting down the pollock fishery – America’s largest by volume – would hurt the state’s entire economy. Hard caps might also provide a “perverse incentive,” he says: Fishers will hit the cap only during years of abundant chinook, when the fish don’t need protection. But when the salmon are having a bad year and need protection, pollock fishers will never reach the cap. A hard cap might further degrade an already weakened stock.

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A better idea, he says: Issue bycatch credits that fishers can trade among themselves. Fishers who can easily lessen bycatch will earn more by selling credits. Those who can’t will fish, but at a price set by the market.

“What you want is a price signal of what is the real cost of bycatch,” he says. “Ultimately, the cost of bycatch is not being able to harvest the pollock you’re allowed.”

In a recent paper in the journal Frontiers in Ecology and the Environment, other scientists propose using a derivative for conserving threatened species. Josh Donlan, coauthor on the paper and director of Advanced Conservation Strategies in Midway, Utah, gives the example of a hypothetical solar company. The company wants to install panels on a swath of Nevada desert. But that land is home to a rare tortoise. How do you encourage the company to conserve the tortoise?

Either the government or a nongovernmental organization issues an “extinction derivative.” The solar company pays $100, say, with the agreement that, after a certain interval, if tortoises remain on the land, the company gets that $100 back, plus interest. The company can positively affect the outcome of its investment, and ultimately profit from more tortoises.

Either way, the hypothetical tortoise wins
If the tortoises vanish, on the other hand, the company loses its money. In that case, the issuer applies the funds to conservation – before the species is on the brink of disappearing. In either case, the tortoise benefits.

“You want to compensate people for preemptive conservation and penalize them when the government has to assume the cost of conservation,” says Mr. Mandel. “You figure the government is on the hook for conservation either way.”

Several analogs to this approach exist. Weather derivatives – companies insuring themselves against lower profits brought on by weather events – have grown into a multibillion-dollar industry in the past decade. (After reaching $45.2 billion in 2006, the value of weather derivatives traded was $19.2 billion in 2007.)

Perhaps more relevant, derivative-like tools are being used in humanitarian efforts.

In 2006, the World Food Program (WFP) issued “drought derivatives” to Ethiopia, a pilot project. If rainfall remained below a certain threshold by a given time in the growing season – meaning crop failure was imminent – insurance would kick in. The scheme would make money available for aid before drought led to humanitarian disaster.

“In the traditional approach, you wait for drought to occur, see what losses have occurred in the country, and apply aid,” says Richard Wilcox, WFP’s director of Business Planning in Rome, who dreamed up the idea. But “by the time those funds have been mobilized, we’re four or five months into” the crisis, he says.

The World Bank has adopted the idea. Last year, for the first time, it offered drought derivatives to Malawi.