In March 2023 Scotland’s nature agency, NatureScot, announced a new private finance pilot  that aims to mobilise £2bn private investment in new woodland creation. Described as a ‘national first’, the agency signed a Memorandum of Understanding with three private financial institutions: private bank Hampden & Co, asset management firm Lombard Odier Investment Managers, and ‘global impact firm’ Palladium. 

Under the scheme, the financiers will provide loans to land managers to fund tree planting, and generate profits from the sale of carbon credits based on the carbon sequestered. According to NatureScot, the scheme could create around 185,000 hectares of native woodland and sequester 28 million tCO2e over the next 30 years. 

The initiative aims to deliver on the Scottish Government’s ambition to develop a “values-led, high-integrity market for responsible private investment in natural capital.” This formed a key part of its National Strategy for Economic Transformation (NSET), which put a strong emphasis on attracting inward investment. 

The partnership between NatureScot and private financiers raises an obvious question: why do we need private finance to help us restore nature? According to the Scottish Government and NatureScot, it is because the scale of investment needed far exceeds what the public purse can afford. As Lorna Slater, the Minister for Green Skills, Circular Economy and Biodiversity, stated when announcing the pilot:

The £20bn ‘finance gap’ for nature has been quoted extensively by ministers and in government publications. With the figure amounting to around a third of the Scottish Government’s annual budget, closing the gap with public funds alone would be highly challenging. As NatureScot states on its website: “There is simply not enough public money to fill this gap, nor would it be fair to use public money in this way. That’s why responsible private finance is needed to fill that gap.”

But where did the £20bn figure come from – and how credible is it?

Avoidable costs

The source of the £20bn figure is a 2021 report published by the Green Finance Institute (GFI) called ‘The Finance Gap for UK Nature’. The GFI is a non-profit organisation that was established by the City of London Corporation and the UK Government in 2019 to promote  the UK as the world’s leading green finance centre. 

 

The GFI report concluded that “the finance gap to meet the UK’s nature related outcomes is at least between £44 billion and £97 billion over the next 10 years, with a central estimate of £56 billion.” For Scotland, the gap was estimated to be between £15 billion and £27 billion – with a central estimate of £20 billion.

The gap reportedly reflects the shortfall in funding required to meet a wide range of nature-related outcomes, ranging from clean water to restoring seafloor habitats. While Scotland has clear targets in some of the outcomes covered, in other areas no such targets exist. As such, many of the figures are highly speculative. 

However, £9 billion – or nearly half – of the £20bn gap relates to investing in “land use to reduce greenhouse gas emissions and increase carbon sequestration as part of the UK’s Net Zero commitment by 2050.” This is the single biggest contributor to the gap, and relates to activities such as woodland creation and peatland restoration. In these areas Scotland does have clear targets – and this is also the element of the finance gap that the NatureScot pilot seeks to address. 

The only reference provided to back up the figures is a 2020 report written by consultancy firm Vivid Economics for the Climate Change Committee (CCC), which assesses the costs and benefits associated with changing land use to meet the UK’s net zero goals.  

The report estimates the cost of woodland creation by calculating the net present value (NPV) of future costs and revenue streams. Because the large costs far outweigh the negligible revenue streams, the resulting NPV is negative – and this is assumed by the GFI report to be the ‘finance gap’. 

But as Jon Hollingdale outlines in a new report for Community Land Scotland and the Forest Policy Group, a majority of the costs identified in the report relate to land acquisition costs. The report assumes that all land must first be purchased for tree planting to take place, and that the money to do so must be borrowed at an interest rate of 7%. Given how expensive rural land has become, this assumption accounts for around three quarters of the costs associated with woodland creation in the report. 

Crucially however, land does not need to change ownership for tree planting to take place. As Hollingdale puts it: “Acquisition is not a prerequisite for woodland creation, the majority of which is being done by existing owners.” In addition, NatureScot has been clear that the private finance pilot does not involve land acquisition, noting that “this project is not about acquiring land, or changing ownership, it’s about working with existing owners.” 

When land acquisition costs are excluded, only the relatively small costs associated with planting and establishment remain. Much (but not all) of these costs are already funded by the taxpayer through the Forestry Grant Scheme (FGS). As such, the multi-billion pound ‘gap’ identified in the GFI report, and cited repeatedly by policymakers, appears to be a significant overestimation. 

The inclusion of land acquisition costs is not the only contentious assumption in the Vivid Economics report. Unlike operating costs, buying land involves acquiring a capital asset which can be sold in future. In NPV analysis, this is usually accounted for by including a ‘terminal value’ (or ‘salvage value’) reflecting the price the asset could be sold for at the end of the project. 

But while the analysis included land acquisition costs, it did not include terminal values to reflect the fact that a valuable asset had been acquired. In practice, this means the land was assumed to be worthless at the end of the project. Of course, it is impossible to predict what land values will be in 30 years time – particularly in the context of a rapidly changing land market. But the prospect of land values falling to zero would be unprecedented. Land values typically increase naturally over time as economic growth increases demand for a resource that is inherently fixed in supply. In addition, land’s unique properties – scarcity, permanence, irreproducibility, immobility – make it a very desirable asset class for investors. 

According to the ONS, the value of agricultural and forestry land across the UK increased by 544% between 1995 and 2016. Since then, the value of rural land in Scotland has skyrocketed, driven in part by growing demand from institutional investors purchasing land for natural capital projects. Investment funds that focus on land acquisition highlight “long-term capital appreciation in a sustainable and tax-efficient manner” as a key marketing hook. As a recent report published by the Scottish Land Commission noted: “There is understanding amongst these investment funds that land is a good long-term investment and that over a longer timeframe outperforms other asset classes.”

It is clear that investors do not believe that the land they are buying will be worthless in 30 years time. Instead, they believe that the land will substantially increase in value, as the race to net zero fuels demand for carbon credits and natural capital projects. This does not mean it will happen – and there are good reasons to hope that land values do not continue to soar. However, if the Vivid Economics report assumed that land values would double, rather than fall to zero, the resulting ‘finance gap’ figure would be materially smaller. 

The point here is not to say that we need more accurate predictions about land price inflation. Such prophesying is a fool's errand. Instead, it is to highlight the folly of calculating the ‘finance gap’ using a methodology that is sensitive to something as uncertain as the trajectory of future land values. 

Given the materiality of the above issues, it can safely be assumed that the £20bn ‘finance gap’ amounts to a significant overestimate. However, it is clear that Scotland does need much more investment to meet nature targets. But exactly how much remains to be seen. 

Calculating a precise estimate of the finance gap is beyond the scope of this blog. And given the absence of clear targets for many of the outcomes covered in the GFI report, any attempt to replicate the scope of that report is unlikely to succeed. However, it is possible to sense-check the magnitude of the GFI figures in areas where Scotland does have well-defined targets, such as woodland creation and peatland restoration. 

The Scottish Government recently stated that it believes the gross cost of meeting woodland creation targets for the next decade is £1.3bn, or £130m a year. The source of this figure is a report written by Rayment Consulting. 

The Forestry Grant Scheme currently dispenses around £40m per year, which suggests there is a ‘finance gap’ of £90m a year. However, landowners can also generate revenue from the trees by selling carbon credits and timber, and so in practice the true gap will be lower. As these revenue streams do not materialise for many decades, and depend on future timber and carbon prices, they are difficult to predict.  

What about peatland restoration? The same report estimated that the gross cost of meeting Scotland’s peatland restoration targets by 2030 is £534m, or £53m a year. However, the Scottish Government has already committed a ten-year funding package of £250m to meet these targets through the Peatland Restoration Fund. The gap between the estimated costs and committed funding amounts to £28m per year. 

Combining the figures for woodlands and peatlands together, the result is a ‘gap’ of £118m per year. This is by no means a trivial sum. But at just 0.2% of the Scottish Government’s annual budget, it would not seem impossible to fund this through public spending. This is particularly the case given the large scope for reforming taxation and subsidies in Scotland. Importantly, public investment in nature restoration is not a ‘sunk cost’ – evidence shows it can generate large macroeconomic multipliers, providing opportunities to create well-paid, green jobs in rural Scotland as part of a just transition. 

The point of this exercise is not to claim that this is the correct ‘gap’, however. Instead, it is to highlight that £20bn and £118m per year are worlds apart. Depending on which figure is more accurate, the optimal policy solution could be very different. 

In Scotland, policymakers have moved swiftly to embrace private finance as the solution, based on figures with shaky foundations. While it is commendable that the Scottish Government and NatureScot want to act quickly, it is crucial that policy choices are based on robust evidence. 

In addition to establishing an accurate assessment of investment needs, there also needs to be a robust appraisal of different investment models. Scotland is not just committed to achieving net zero – it is committed to delivering a just transition. As such, the focus should not just be on mobilising investment, but doing so in a way that shares costs and benefits fairly. 

While luring private finance might seem like an attractive way to ease the burden on the public purse, it is not cost free. As Scotland found out by embracing private finance initiative (PFI) contracts for infrastructure projects, private financiers are not charities. Although PFI deals reduced up-front public expenditure, they ended up being much more expensive due to a higher cost of capital, profiteering, and large legal and consultancy fees. While these contracts were incredibly lucrative for investors, they imposed large costs in the longer term on everyone else. 

In addition, designing private finance contracts for nature restoration is much more complex and uncertain than infrastructure projects. Under the NatureScot MoU, the financiers aim to generate profits by generating and selling carbon credits. However, it remains unclear how the model can satisfy the risk-return requirements for investors under current market conditions. In practice, the Scottish Government may have to assume significant contingent liabilities to protect private investors from downside risks. If attracting private finance involves socialising risks and privatising rewards, it could end up being substantially more complex, expensive and time consuming than direct public investment. 

Going forward, there needs to be a clear assessment of what the costs associated with private finance are – and who will bear them. There also needs to be transparency around how benefits will be shared, including with local communities. The costs and benefits of private finance should be weighed up against a public-led approach, funded by reforming taxation and subsidies. In appraising different models, it is important to ask: who wins, and who pays? 

Future Economy Scotland will be exploring these issues in more detail in the coming months.