Nature plays an important role in maintaining the flow and purity of water. Human activities often degrade the quality and/or quantity of water flowing to downstream users, but the maintenance of natural ecosystems and the sound conservation management by those living upstream in watersheds can help provide a clean, reliable supply of water for downstream water users. Water funds are a way for downstream water users to preserve their water supply, by paying to restore and conserve natural ecosystems. They also enable upstream and downstream communities to work together for mutual benefit, preserving or restoring nature's ability to improve water quality and reliable flow while providing economic opportunities for upstream communities. This case introduces the concept of ecosystem services (the role that natural ecosystems play in sustaining and fulfilling human life) and payment for ecosystem services (PES), in which stakeholders pay in order to preserve or restore the ability of nature to provide these services. It describes water funds and other PES arrangements, as well as some of the challenges that water funds face. Several examples are provided of water funds and other PES programs.

This case focuses on an opportunity that American Electric Power (AEP) has to invest, with The Nature Conservancy (TNC), in one of the world's first projects for Reducing Emissions from Deforestation and Forest Degradation (REDD). The proposed plan was to protect 812,000 hectares of rich, biologically diverse forest land, known as Bosque Rojo, in central Peru. This project would address the two issues targeted by REDD by ending both deforestation from the local communities' conversion of land from forest to farmland and forest degradation from commercial logging. REDD projects offered a substantial opportunity to mitigate climate change, as deforestation and forest degradation contributed approximately 15-20 percent of global greenhouse gas (GHG) emissions. Protecting Bosque Rojo could prevent the release of millions of tons of carbon dioxide (CO2). The project partners and investors would obtain certified offset credits equivalent to the reduction in emissions over the 30-year project lifetime. Among U.S. power companies, AEP had one of the highest levels of CO2 emissions. It estimated its 2009 emissions would reach 150M metric tonnes. With climate change legislation on the horizon, it wanted to set an example for Congress to show that REDD offsets could lead to cost-effective reduction in GHG emissions, and also gain experience in the international REDD scene. AEP expected to have to substantially reduce its own emissions (e.g. by substituting wind power for coal in electricity generation) or obtain offset credits either on the open market or through direct participation in external emission reduction projects. AEP believed that REDD projects would be much cheaper than any of its other options to obtain offset credits. To confirm this belief, the company needed to calculate a net present value (NPV) for the project, understand the project's risks, and determine if Bosque Rojo was, indeed, the best use of company funds.

This case focuses on an opportunity that American Electric Power (AEP) has to invest, with The Nature Conservancy (TNC), in one of the world's first projects for Reducing Emissions from Deforestation and Forest Degradation (REDD). The proposed plan was to protect 812,000 hectares of rich, biologically diverse forest land, known as Bosque Rojo, in central Peru. This project would address the two issues targeted by REDD by ending both deforestation from the local communities' conversion of land from forest to farmland and forest degradation from commercial logging. REDD projects offered a substantial opportunity to mitigate climate change, as deforestation and forest degradation contributed approximately 15-20 percent of global greenhouse gas (GHG) emissions. Protecting Bosque Rojo could prevent the release of millions of tons of carbon dioxide (CO2). The project partners and investors would obtain certified offset credits equivalent to the reduction in emissions over the 30-year project lifetime. Among U.S. power companies, AEP had one of the highest levels of CO2 emissions. It estimated its 2009 emissions would reach 150M metric tonnes. With climate change legislation on the horizon, it wanted to set an example for Congress to show that REDD offsets could lead to cost-effective reduction in GHG emissions, and also gain experience in the international REDD scene. AEP expected to have to substantially reduce its own emissions (e.g. by substituting wind power for coal in electricity generation) or obtain offset credits either on the open market or through direct participation in external emission reduction projects. AEP believed that REDD projects would be much cheaper than any of its other options to obtain offset credits. To confirm this belief, the company needed to calculate a net present value (NPV) for the project, understand the project's risks, and determine if Bosque Rojo was, indeed, the best use of company funds.