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Valuing the impact of climate change policies on forestry
Authors: Richard MeadePublication: New Zealand Journal of Forestry, Volume N.Z.J.For. 2006, Issue N.Z.J.For. 51(1) 2006, pp 14-18, May 2006
Publisher: New Zealand Institute of Forestry
Abstract: Conventional forest valuation approaches do not account for discretions foresters have in making key irreversible decisions, such as when and if to harvest in the light of uncertain future decision variables. Furthermore, where they are sufficiently sophisticated as to make explicit forecasts of future valuation parameters such as log prices at harvest date, as is the case for discounted cash flow (DCF) analysis, they do so with unavoidable imprecision. These shortcomings - as well of those of even less sophisticated methodologies such as cost- or transaction-based valuations - become telling when attempting to assess the impacts of long-term climate change policies on forest values. This paper presents an alternative approach using real options analysis that captures enough complexity to meaningfully model the impacts of climate change policies on forest value, while remaining relatively straightforward to implement using Monte Carlo simulation. It shows that foresters’ discretions as to when and if to harvest, or to convert to non-forest land uses, give rise to real options whose value is captured by real options analysis but ignored by conventional forest valuation methodologies. It furthermore shows how forest values differ, and conversion rates vary over time, depending on which climate change policies or policy uncertainties are assumed. In short, Kyoto forests (those first planted after 1989) are more valuable when carbon credits and harvest liabilities under the Kyoto Protocol are devolved by the Crown to their owners. Non-Kyoto forests (those planted before 1990) are more valuable when deforestation liabilities are not devolved to their owners. Current New Zealand policy, under which deforestation liabilities are retained by the Crown only within limits, encourages the early conversion of Non-Kyoto forests into non-forest uses.