The market value of forest concessions in the Brazilian Amazon: a Real Option approach [An article from: Forest Policy and Economics]

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Description:
The Brazilian government currently implements a concession policy to exploit timber harvesting on national forestry reserves in the Amazon region. This paper applies Real Options to appraise the market value of these forest concessions and quantifies the economic benefits of forest management and regulatory policies. Timber prices are assumed to follow two hypotheses regarding the stochastic process, i.e., Geometric Brownian and Mean Reversion. Corresponding estimates and the implications for the concession market value are analyzed. Biomass volume follows the standard stochastic differential equation from the population ecology literature. For the base case parameters, the market value of forest concession under option pricing is at least 50% higher than the traditional discounted cash flow approach. A lifetime longer than 15 years does not show a significant increase in the concession value. Forest management increases the market value of the concession by at least 30% according to Real Option approach, while the traditional technique fails in quantifying a gain and hence discourages forest management. Since forest concessions are public resources, differences of that magnitude are not negligible. Therefore, the market value of a forest concession given by Real Option arises as an important element for the bidding process and for government policy regarding forest concessions.