A real options framework for reducing emissions from deforestation: Reconciling short-term incentives with long-term benefits from conservation and agricultural intensification

Tropical forests provide enormous ecological and economic value. The potential is rapidly growing for carbon markets to deliver private and public compensation for emissions reductions from forest protection at national and subnational scales. Nevertheless, monetization of forest ecosystem services remains scant, leaving forests vulnerable to conversion to other land uses in the short run. We develop a real options framework for a representative farmer's land-use decisions, identifying a value gap between private short-term incentives versus long-term benefits from carbon market compensation, given uncertainties over future values for emissions reductions from forest protection. A quantitative illustration of this framework for Mato Grosso, Brazil, demonstrates that forest conservation coupled with cattle ranching intensification is competitive with the predominant practice of extensive cattle production, but is hindered by landholders' perceptions of the relative option values to different land uses. We show how bonds, call and put options allow for early monetization of part of potential future carbon revenues, even under uncertainty, changing incentives at the landholder level and jumpstarting conservation and more efficient models of agricultural production. These approaches provide a model for addressing the financial needs of farmers on the ground to accelerate the transition towards low-deforestation rural development at large scales.