Economic valuation and option-based payments for ecosystem services

Retaining the option-to-harvest encourages people to cultivate forest stands on private land, and periodic purchases of the option keep the stand intact, thus contributing to a greater good. This paper develops and demonstrates the use of a real-option model to encourage the planting of new biologically-diverse forests, and to help conserve existing forests standing on private land. Payments for ecosystem services (PES) take several forms and several instruments and policies have been designed over the years. This study involves a detailed analysis of literature on PES and of various revenue streams generated by forest stands. It was observed that the option-to-harvest encouraged expansion and conservation of small-scale forests. The methodology adopted and product designed herein involves the purchase of the option-to-harvest at the beginning of each accounting period, especially by timber suppliers, with a view to preventing potentially steep declines in spot timber prices from the potentially excess supply. The incentive structure is simplified to include the interest foregone on the terminal value, reduced by the existential value derived from such delay. The real-option model employing bounded random walk projections is applied to a registered Clean Development Mechanism (CDM) project. Subject to the alternative use of the parcel of land, the option payments are found to represent 3.83–6.57 % of the value of stand conserved. Suitable institutional mechanisms would need to be developed to transfer the option payments to the growers, across large numbers of such projects. Copyright Springer Science+Business Media Dordrecht 2015