* Borneo project meant to be leader in saving jungles for profit
* U.N. project attracts Gazprom, other investors and meets top standards
* But Indonesia forestry ministry hobbles hands land to Palm oil firm
* Ministry officials sceptical about U.N. forest programme
* Parties in dispute to meet this week
By David Fogarty
SINGAPORE, Aug 16 (Reuters) - In July 2010, U.S. investor Todd Lemons and Russian energy giant Gazprom believed they were just weeks from winning final approval for a landmark forest preservation project in Indonesia.
A year later, the project is close to collapse, a casualty of labyrinthine Indonesian bureaucracy, opaque laws and a secretive palm oil company.
The Rimba Raya project, on the island of Borneo, is part of a United Nations-backed scheme designed to reward poorer nations that protect their carbon-rich jungles.
Deep peat in some of Indonesia's rainforests stores billions of tonnes of carbon so preserving those forests is regarded as crucial in the fight against climate change.
By putting a value on the carbon, the 90,000-hectare (225,000 acre) project would help prove that investors can turn a profit from the world's jungles in ways that do not involve cutting them down.
After three years of work, more than $2 million in development costs, and what seemed like the green light from Jakarta, the project is proof that saving the world's tropical rainforests will be far more complicated than simply setting up a framework to allow market forces to function.
A Reuters investigation into the case also shows the forestry ministry is highly sceptical about a market for forest carbon credits, placing it at odds with President Susilo Bambang Yudhoyono, who supports pay-and-preserve investments to fight climate change.
Hong Kong-based Lemons, 47, a veteran of environmentally sustainable, and profitable, projects, discovered just how frustrating the ministry can be to projects such as his.
"Success was literally two months around the corner," he said. "We went through -- if there are 12 steps, we went through the first 11 on time over a 2-year period. We had some glitches, but by and large we went through the rather lengthy and complicated process in the time expected."
That's when the forestry ministry decided to slash the project's area in half, making it unviable, and handing a large chunk of forested deep peatland to a palm oil company for development.
The case is a stark reminder to Norway's government, the world's top donor to projects to protect tropical forests, on just how tough it will be to preserve Indonesia's rainforests under its $1 billion climate deal with Jakarta.
The dispute has turned a spotlight on Indonesia's forestry ministry, which earns $15 billion a year in land permit fees from investors. Indonesia's Corruption Eradication Commission (KPK) said last month it will investigate the granting of forest permits and plans to crack down on corruption in the resources sector.
"It's a source of unlimited corruption," said Chandra M. Hamzah, deputy chairman at the KPK.
Indonesia Corruption Watch, a private watchdog, says illegal logging and violations in issuing forest use permits are rampant. It estimates ill-gotten gains total about 20 trillion rupiah ($2.3 billion) each year.
A forest ministry official connected with the U.N.-backed forest carbon offset scheme was sentenced in April to three years in prison for accepting a $10,000 bribe to ensure an Indonesian company won a procurement tender.
Wandojo Siswanto was one of the negotiators for Indonesia's delegation at the 2009 U.N. climate talks in Copenhagen, despite being a bribery suspect. His case has highlighted concerns about the capacity of the forestry ministry to manage forest-carbon projects.
The forestry sector has a long history of mismanagement and graft. Former trade and industry minister Bob Hasan, a timber czar during the Suharto years, was fined 50 billion rupiah ($7 million) for ordering the burning of forests in Sumatra and then imprisoned in a separate case of forestry fraud after Suharto was toppled from power in 1998.
In an interview in Jakarta, senior forestry ministry officials denied any wrongdoing in the Rimba Raya case and criticised the project's backers for a deal they made with Russia's Gazprom <GAZP.MM>, the world's largest gas producer, to market the project's carbon credits.
Internal forestry ministry documents that Reuters obtained show how the ministry reversed its support for the project after a new minister came in, and a large chunk of the project's land was turned over to a palm oil firm.
The case illustrates how growing demand for land, bureaucratic hurdles and powerful vested interests are major obstacles to conservation projects in Indonesia and elsewhere in the developing world.
That makes it hard for these projects to compete and navigate through multiple layers of government with the potential for interference and delay.
"We have systematically not been able to demonstrate that we can complete the loop to turn projects into dollar investments," said Andrew Wardell, programme director, forests and governance, at the Center for International Forestry Research in Indonesia.
"Which is why the palm oil industry is winning hands down every time."
The Rimba Raya project was meant to save a large area of carbon-rich peat swamp forest in Central Kalimantan province and showcase Jakarta's efforts to fight climate change.
Much of the area is dense forest that lies atop oozy black peat flooded by tea-coloured water. Dozens of threatened or endangered species such as orangutans, proboscis monkeys, otter civets and Borneo bay cats live in the area, which is adjacent to a national park.
Rimba Raya was designed to be part of the U.N's Reducing Emissions from Deforestation and Degradation (REDD) programme. The idea is simple: every tonne of carbon locked away in the peat and soaked up by the trees would earn a steady flow of carbon credits.
Profit from the sale of those credits would go to project investors and partners, local communities and the Indonesian government. That would allow the project to pay its way and compete with palm oil farmers and loggers who might otherwise destroy it.
Rich countries and big companies can buy the credits to offset their emissions.
By preserving a large area of peat swamp forest, Rimba Raya was projected to cut carbon emissions by nearly 100 million tonnes over its 30-year life, which would translate into total saleable credits of about $500 million, Gazprom says.
It would also be a sanctuary for orphaned or rehabilitated orangutans from elsewhere in Borneo. Rimba Raya teamed up with the founder of Orangutan Foundation International, Birute Mary Galdikas, in which OFI would receive a steady income from annual carbon credit sales.
It was the sort of project President Yudhoyono and Norway have pledged to support. Yudhoyono has put forests -- Indonesia is home to the world's third-largest forest lands -- at the centre of a pledge to reduce greenhouse gas emissions by at least 26 percent by 2020.
He tasked a senior adviser to press for reforms to make REDD projects easier and for greater transparency at the forestry ministry.
Rimba Raya was poised for success. It got backing from the Clinton Foundation's Climate Initiative, which helped pay for some of the early costs. Gazprom invested more than $1 million.
It was the first in the world to meet stringent REDD project rules under the Washington-based Voluntary Carbon Standard, an industry-respected body that issues carbon credits. Rimba Raya was also the first to earn a triple-gold rating under the Climate, Community and Biodiversity Alliance, a separate verifier.
Companies including German insurer Allianz <ALVG.DE> and Japanese telecoms giant NTT pledged to buy credits from the project if it gets its licence.
2009, the forestry ministry the now Indonesian-registered company PT Rimba Raya Conservation the licence holder for nearly 90,000 ha, contingent on it passing an environmental impact assessment. It did so a few months later.
The ownership of PT Rimba Raya Conservation is split 70 percent foreign and 30 percent Indonesian, with Lemons and business partner Jim Procanik holding small stakes.
is CEO of Hong Kong-based firm InfiniteEARTH, which is the developer and manager of the Rimba Raya pras investment fund-raiser. Procanik, 44, is the managing director.
In June last year, Forestry Minister Zulkifli Hasan asked for a map that would set the final boundary of the project, according to a copy of the instruction seen by Reuters. This mandatory step normally takes a few weeks. Once the map is issued, a project is eligible for a licence to operate.
But by September last year it was clear , according to Lemons. Despite repeated promises by minisofficials, the final map had not been issued. No explanations were given.
"No one has ever said, 'No'. So that's exhausting," said Lemons.
What followed instead was a series of steps by the forestry ministry that have resulted in the project being undermined.
A ministry review focused on conflicting claims to the land by several companies belonging to palm oil firm, PT B.
PT Best, which is run by Indonesian brotWinarno Tjajadi, had long coveted the peat land within the area the forestry ministry set aside for the Rimba Raya project.
On December 31, 2010, PT Best was granted 6,500 ha of peat swamp land for palm oil development, next to a smaller parcel of deep peat land granted a year earlier -- part of PT Best's broader plan to connect its palm oil plantations in the north with a port on th. The land granted last December was part of the original area set aside for Rimba Raya.
The Tjajadi brothers declined several recomment.
The December allocation to PT Best came despite assurances from Forestry Minister Hasan that he would not allow deep peatlands to be converted for agriculture.
The allocation also came a day before a two-year moratorium on issuing licences to clear primary forests and peat lands was due to start on Jan. 1 this year. The moratorium is a key part of.
After months of delay, the forestry ministry finally ruled that PT Rimba Raya was only eligible for 46,000 ha, a dethat cut out much of the peatlands covering nearly half the original project area.
The case has now been brought before the office of the Indonesian government's Ombudsman. In an interview, senior Ombudsman Dominikus Fernandes told Reuters he believed the forissue the license to Rimba Raya.
"If Rimba Raya has already fulfilled the criteria, there should not be a delay in issuing the licence," he said.
"This is a model project in Indonesia that should be prioritized. If we don't give an example on the assurance of investing in Indonesia, that's not a good thing."
Officials from the forestry ministry, inwith Reuters, said the area was given legally for palm oil development because PT Best had claims to the land dating back to 2005.
Secretary-General of the ministry Hadi Daryanto stressed the peatland areas originally granted to Rimba Raya were on a type of forest called convertible production forest, which can be used for agriculture but not REDD projects. Handing that nearly 40,000 ha to Rimba Raya would be against the law, he said.
Yet in 2009, the ministry was ordered toswitch for this same area of peatland so it could be used for a REDD project. The instruction to immediately make the switch, a bureaucratic formality, was never acted on.
In the Oct 2009 decree seen by Reuters, former Forestry Minister H.M.S. Kaban issued the order as part of a broader instruction setting aside the nearly 90,000 ha for ecosystem restoration projects. Kaban left office soon after.
Indonesian law also bans any clearing ofthan 3 metres deep. An assessment of the Rimba Raya areapeat expert hired by InfiniteEARTH showed the peat is 3 to 7 metres deep, so in theory was out of bounds for PT Best to clear for agriculture.
For Lemons, 47, the mood has switched from exhilaration to bitter disappointment. "We've been here every day pushing like hell from every angle," he said.
Procanik says the disappointment is personal. "Todd and I have both invested what savings we had for our kids'college education in this project," he said.
Gazprom is also upset.
16 to the Indonesian government, the Russian firm criticised the ministry's failure to issue the licence for Rimba Raya and threatened to abandon clean-energy projects in Indonesia estimated to be worth more than $100 million in foreign investment. The government has yet to respond.
Secretary-General Daryanto and Iman Santoso, Director-General for forestry business management, said another major pr's deal with Gazprom, which was made in the absence of any licence.
"We didn't know about the contract with Gazprom. They had no legal right to make the contract," Daryanto told Reuters.
Santoso described it as the project's "fatal mistake".
Daryanto also questioned whether REDD would ever work and whether there was any global appetite for carbon creditsprogramme generates, a view at odds with other parts of the Indonesian government, which has been actively supporting REDD projects.
"Who will pay for the dream of Rimba Raya? Who will pay? Nobody, sir!" Daryanto told Reuters during an interview in the heavily forested ministry compound near central Jakarta.
Lemons said the Gazprom deal was explained in person during a presentation of a 300-page technical proposal submitted to the ministry to prove the project would be financially viable. Darya.
One of their biggest concerns was whether REDD could deliver the same revenues to the state as other land-use permits such as palm oil, logging, mining. We were required to show contracts that demonstrated we could pay the fees and annual royalties," he said.
Gazprom, designated as the sole marketer of carbon credits from Rimba Raya, said it had already agreed long-term sales contracts with buyers at between 7 and 8 euros ($10 to $11.40) per -- contingent on the licence being issued.
"We've sold to four or five companies ar," said Dan Barry, Gazprom Marketing & Trading's London-based global director of clean energy.
Gazprom became involved, he said, because it was a project that looked to have official support. The Russian company agreed to a financing mechanism that ensured the project's viability for 30 years, regardless of the price level of carbon markets.
Those markets, centred on the European a.N. carbon trading programmes, were valued at $142 billion in 2010, the World Bank says. National carbon trading schemes are planned for Australia and South Korea, while California is planning a state-based scheme from 2013. New Zealand's carbon market started in 2008.
"If you ever want a successful REDD scheme, you are going to have to have a process that people believe in," Barry said.
"The Ministry of Forestry ought to be doing everything it can to support a programme that benefits forestry as opposefavour a programme that's there to cut it down and turn it into palm oil."
AHEAD OF ITS TIME"
Kuntoro Mangkusubroto, the head of the REDD task force in Indonesia who is also in charge of the president's government reforms unit, said the Rimba Raya case highlighted deep flaws in the bureaucracy and the need for sweeping reforms to underpin the 40 other REDD projects in Indonesia.
"The core concern is the trust in governreadiness, and responsibility," he told Reuters in an email. "Even with the best of intentions, the unsynchronous action of th's ministry and the district government's action is not conducive for investment, especially in this new kind of venture.
"I can surmise that the case of Rimba Raya is a case of a business idea that is ahead of its time. The government infrastructure is insufficiently ready for it."
Legal action was one solution to this ca, he added.
That is a path Lemons and Procanik may eventually take but for now they have proposed a land swap deal with PT Best in which the firm gives PT Rimba Raya 9,000 ha of peat land in return for a-peat land held by PT Rimba Raya in the north of the project near other PT Best landholdings.
PT Best rejected an earlier offer by Rimba Raya of 9 percent of the credits from the project, Lemons said.
Based on recent satellite images, PT Best has yet to develop the disputed 9,000 ha area.
The delays mean it is too late for Rimba Raya to become the world's first project to issue REDD credits. That accolade has since gone to a Kenyan project.
"Our whole point here is to show host countries that REDD can pay its way," said Lemons. "And if it can't pay its way then we haven't proven anything."
In a sign a resolution could still be possible, Ombudsman Fernandes, Forestry Minister Hasan and PT Rimba Raya are scheduled to meet on Aug 19.
(Additional reporting by Olive Rondonuwu and Yayat Supriatna in Jakarta and Harry Suhartono in Singapore; Editing by Simon Webb, Simon Robinson and Bill Tarrant)