Insight: Carbon Price Uncertainty Hinders Investment in New Forest Areas

13 December 2013

Climate policies that encourage afforestation based on a stochastic carbon price could result in a smaller forest area when compared with deterministic policies. The uncertainty in carbon price resulting from a cap-and-trade policy makes investment decisions concerning carbon mitigating and sequestering practices more complex. Landowners who need to decide whether to convert cropland to forest in order to receive carbon payments might find it more advantageous to delay afforestation so that they can obtain more information about the future evolution of carbon price. This finding, published in Environmental Research Letters (ERL), indicates an impact on the effectiveness of certain policies to combat climate change.

The issue is illustrated for the US but could be valid for other locations and, more importantly, to other investments based on stochastic carbon offset payments. In the US, the American Clean Energy and Security (ACES) Act of 2009 and the American Power Act (APA) of 2010 established a cap-and-trade policy, and allowed the agricultural sector to provide offset credits from carbon mitigating and sequestering practices such as afforestation. Forest offset credits are particularly interesting because large-scale afforestation of cropland could increase commodity prices thanks to a reduction in cropland.

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