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Abstract
Climate change is one of the toughest challenges facing the world today. Putting a price on carbon
emissions is an important step towards climate change mitigation. A cap and trade system is one of
the ways to create a carbon price. The New Zealand Emissions Trading Scheme (NZETS) is the
world’s first economy-wide cap and trade system that covers all sectors and all 6 greenhouse gases.
Forestry is a major part of the NZETS, allowing foresters to earn carbon credits for new forests
planted on and after 1st January 1990 (afforestation and reforestation). At the same time, the NZETS
also makes foresters liable for harvesting new forests planted on and after 1st January 1990, and
deforesting forests existing on and before 31st December 1989. In this paper, we perform an
economic analysis of how a carbon price will likely affect the returns and forestry management
behaviour in new forests in New Zealand.
Previous works have used the NPV/LEV (fixed harvesting) analysis where the forest is assumed to
be harvested (in future) at the estimated optimal rotation age regardless of timber prices at that time.
Other works have employed the Real Options approaches (flexible harvesting) where sophisticated
models such as Partial Differential Equations and simulations analyse the effects of bringing
forward the harvest decision if timber prices are favourable, and deferring the harvest decision if
timber prices are unfavourable. Often, these methods tend to have higher data requirements, employ
different assumptions and are much more complex to estimate. Because of these differences, it may
be difficult to compare the results of NPV/LEV analysis with Real Options.
Our work here applies the binomial tree method, which is a relatively simple method that can
generate both LEV (fixed harvesting) and Real Options (flexible harvesting) results on a common
model with the same data requirements and assumptions. This allows for better comparability of
forestry management behaviour and effects of carbon price. The forestry valuations are analysed
under a stochastic timber price and a constant carbon price. This paper concludes with some
implications on policy in New Zealand.