CIFOR report: How investors ignore serious problems with pulp mills

29 May

A new report by CIFOR analyses risk assessments and safeguard procedures carried out by financial institutions before investing in pulp mill projects. Despite the large amounts of money involved, the report concludes that assessments are far from adequate.

By Chris Lang. Published in WRM Bulletin 106, May 2006.




In the last decade, financial institutions and investment banks have handed out more than US$40 billion for new pulp projects in the South. Analysts expect another US$54 billion to be invested in pulp mills in the South by 2015 much of it in Brazil, Uruguay, China, the Mekong Region and the Baltic States.

We might assume that given the large amounts of money involved, the banks would carry out careful analysis before investing. Not so, according to a new report published by the Centre for International Forestry Research (CIFOR), “Financing Pulp Mills: An Appraisal of Risk Assessment and Safeguard Procedures“. Inadequate research into proposed pulp projects “may lead to a new wave of ill-advised projects, setting up investors, forest-dependent communities and the environment for a precipitous fall,” according to CIFOR.

Asia Pulp and Paper’s default on the US$14 billion that the company and its subsidiaries owed affected financial institutions around the world, but as CIFOR’s Chris Barr pointed out to the Financial Times, “the financial sector has been reluctant to look at what the lessons of APP’s collapse have been.”

CIFOR’s report is based on eight years of research, looking at the financing of 67 pulp mills. The author of the report, Machteld Spek, is a financial analyst with more than 20 years’ experience.

Spek notes that the importance of raw material supply is often underestimated when pulp mills are financed or in analysts’ reports on pulp companies, despite the fact that it accounts for a large percentage of the costs of pulp production. When Indonesia’s four major pulp producers started operations in the 1980s and 1990s they all predicted that within eight years they would obtain all their raw material from their own plantations. Today Indonesia’s pulp industry “still relies on wood from the natural forest for 70 per cent of their fibre needs,” CIFOR’s report points out. However, this failure to secure raw material supplies did not affect the companies’ abilities to continue raising finance.

Spek’s report found that “Most financial institutions and ECAs still lack in-house capacity to assess a project’s likely social and environmental impacts.” Instead, they rely on information from companies and from multilateral agencies such as the World Bank’s International Finance Corporation (IFC).

IFC has given loans to a series of environmentally and socially damaging pulp projects, including Arauco in Chile, Aracruz in Brazil and Advance Agro in Thailand. IFC is currently considering whether to finance two massive pulp mills in Uruguay.

IFC, of course, states that it does not finance projects without an environmental and social impact study. Spek’s report explains why this not enough: “A structural weakness in the application of safeguard policies is that they are guided by Environmental Assessments that are typically commissioned by the project sponsor. At present, Environmental Assessments are often of mediocre quality that goes undetected in the absence of review by informed parties.”

When IFC’s board agreed to lend Aracruz US$50 million in November 2004, the Bank’s environmental and social studies failed to alert the Bank’s board to a serious, on-going land dispute between Aracruz and Tupinikim and Guarani Indigenous Peoples in the State of Espírito Santo. In May 2005, six months after IFC’s board approved the loan, Tupinikim and Guarani people reclaimed just over 11,000 hectares of their land from Aracruz and built two villages on the land. In January 2006, Aracruz was involved in a violent police action aimed at evicting people from the villages. Aracruz’s machinery was used to destroy the villages.

Shortly afterwards, IFC issued a statement saying that Aracruz had “opted to pre-pay the loan it had with the IFC,” which “ends the relationship of the IFC with this client”. Clearly Aracruz felt that the IFC’s loan risked putting the company in the spotlight. But IFC’s analysis and safeguards should have prevented the loan in the first place.

In Uruguay, the Spanish company ENCE and the Finnish conglomerate Botnia are separately planning to build two pulp mills with a total capacity of 1.5 million tonnes a year. IFC is considering loans totalling US$400 million to the two projects. IFC’s involvement has helped encourage a series of commercial banks and ECAs to support the projects.

CIFOR’s report comments that Botnia’s environmental impact assessment produced as part of the process of applying for an IFC loan failed to deal adequately with issues of raw material supply, land use and infrastructure. Major protests in both Uruguay and Argentina have led to project documents receiving more scrutiny than would otherwise have been the case. IFC has recently drawn up an action plan which is supposed to address the weaknesses of the previous studies.

“The conflict over the Uruguayan pulp mills has brought into focus important social and environmental issues,” comments CIFOR’s director general David Kaimowitz. “One key issue that has largely been ignored, however, is whether the pulp mills will have enough wood. Not having a secure and sustainable wood supply poses huge financial risks.”

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