Real Options Analysis of Carbon Forestry Under the New Zealand Emissions Trading Scheme

Abstract

In 2008, the New Zealand government passed climate change legislation called the New Zealand Emissions Trading Scheme (NZETS), designed to create a carbon price in the economy. Under the NZETS, new forests planted on and after 1st January 1990 (known as post-1989 forests) are eligible to earn carbon credits and sell them domestically and internationally, with a condition that the credits will have to be repaid back upon harvest of the forests. The amount of credits that have to be surrendered is proportionate to the extent that carbon stocks decrease in the forest land. This research explores the effects of the NZETS on new post-1989 forests. The NPV/LEV and the Real Options valuation methods are respectively employed to analyze fixed harvest and flexible harvest forest management decisions. This approach is applied to study the cases of timber-only forestry (i.e. no NZETS) and carbon forestry (i.e. with NZETS). The major advance of this research is the development of a double Random Variable Real Options methodology that incorporates both stochastic timber and stochastic carbon prices into the calculation of the bareland forestry investment opportunity under the NZETS. Through the work of this thesis, it is shown that the NZETS increases the valuation of bareland on which radiata pine is to be planted with a single rotation or a perpetual series of rotations, especially for the case of flexible harvest forest management. The NZETS will very likely lengthen the rotation age of forests and increase forest carbon sequestration, which contributes positively towards climate change mitigation in New Zealand. The Real Options valuation method can generate optimal harvest price thresholds that help forest owners to decide when to harvest. This thesis concludes with a scenario analysis of potential implications of lengthening the forest rotation age on carbon stock management in New Zealand.