Opportunity Cost: concept and application

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4.6 Opportunity Cost: concept and application

Strategic interventions to divert pressure on natural forests and reduce deforestation need to rest on reforms that would lead major actors - industry, local communities, loggers and so on – to switch to economic uses of the land which favored carbon retention. The concept of opportunity cost provides an economic instrument by which the value of preserved carbon can be compared with the value of using other forest resources such as the timber or the land on which the forest is growing. Opportunity cost is defined as the cost incurred by choosing one option over the next best alternative. Assessing opportunity costs is fundamental to assessing the true cost of any course of action. Box presents an example of how opportunity costs could be applied to demonstrate the value of carbon versus the value of an alternative use. Managing a forest to preserve its carbon resource implies a sacrifice of benefits that could have been materialized if REDD were not the management objective. For example to persuade loggers to abandon logging of natural forest, would require offering them production options that would be at least as attractive as the benefits they sacrifice by not engaging in activities leading to deforestation. Opportunity cost can also be calculated for other, broader decision-making purposes: for example, to determine the impact on the economy as a whole, of reducing deforestation. n this case the sacrifice may include several economic dimensions not normally translated into financial equivalents. Land uses leading to deforestation may generate local employment and the value of the social and economic impacts which need to be evaluated against a decision to change the land use. This situation existed in Australia in the s when the decision was taken to eliminate the timber industry from the Wet Tropics region of North East Queensland in favor of establishing a new development focus on tourism. Provisional data derived from the literature on estimated opportunity costs of deforestation and equivalent breakeven values expressed as net present values NPV, i.e. with future values discounted to the present under various land use options are presented in Table . These values provide a comparative scale of magnitude of the cost to the country of stopping or reducing deforestation . f the REDD initiatives generate international carbon credit payments that exceed these opportunity costs, ndonesia would have the financial incentive to adopt REDD. Land uses that have the highest NPV are oil palm and timber plantations. Using a discount rate of over four rotations, spanning years, the estimated NPV s of Acacia timber plantations, range from , on peat soils to , on mineral ] The costs and benefit of an activity are normally distributed over several years, for example, an oil palm plantation has costs and benefits distribute over a year period, assuming that it is replanted after years. The NPV basically yields the net value of the cash flow, which measures the difference between the future revenues and the costs of production. The NPV approach was also used in the Stern report to assess the potential cost of avoiding emissions from deforestation. ] The data presented in Table are provisional and do not fully represent the significant variation in economic returns from land uses and carbon stocks. 130 soils. Because plantations are largely established by pulp and paper companies that use the logs in their mills, there is no established market price for those logs in ndonesia. The NPV estimates are based on a sale price of per tonne, which industry sources suggest is a reasonable estimate of production costs. Plantations on peat soil have a lower NPV than those on mineral soils because timber yields are lower. The NPV s of oil palm plantations range from , on mineral soil to , on peat soil. The NPV on peat soil is higher because oil palms on peats have higher yields than on mineral soil and the establishment and maintenance costs increase less than proportionally with respect to the higher yields. The other land uses reported in the table represent typical agricultural activities carried out by smallholders. They have significantly lower NPVs. The NPV s which have been estimated translate to a similar broad range of break- even values for the tradeable carbon credits, which would be required to prompt an economic reason to retain the forest vegetation and its carbon resource stock. Table 23. A provisional analysis of opportunity costs and break even prices for CO in relation to a range of forest land uses. Land use Opportunity cost of deforestation ha Forest type Soil type Emissions t CO2e Break even price of CO2e t Timber extraction Primary . Timber plantation , Degraded Mineral . Degraded Peat . Timber + Timber plantation , Primary Mineral . Primary Peat . Oil palm plantation , Degraded Mineral . , Degraded Peat . Timber + Oil palm plantation , Primary Mineral . , Primary Peat . Rubber Degraded Mineral . Timber + Rubber Primary Mineral . Rice fallow Degraded Mineral . Timber + Rice fallow Primary Mineral . Cassava Degraded Mineral . Timber + Cassava Primary Mineral . Assumptions: • Primary mineral forest has a carbon stock of tC ie tCO , primary peat forest tC ie tCO 131 • Degraded forest has a carbon stock of tC ie tCO on mineral and peat soil • Timber extraction leads to a loss of tC ie tCO • No carbon loss from mineral soil is included • Carbon in peat soil is lost at an annual rate of . thayr ie tCO . over yr period

4.7 A phased approach to achieving REDD targets