Groundwater Protection and Forest Management — an Option Value Analysis

Abstract

Non-contaminated drinking water may become a scarce resource in the future. In that case, forest watersheds may play a significant role in ensuring the supply of clean drinking water. However, forest management may affect this supply considerably. Christmas tree production is an important income generator in the Danish forestry sector but may contribute to non-point contamination of groundwater resources because Christmas tree production involves the application of significant amounts of fertiliser and pesticides. This paper addresses the decision to convert a natural forest into Christmas tree production when groundwater contamination is irreversible, and future values of non-contaminated groundwater and Christmas tree production are uncertain. It is concluded that solving the decision problem as an optimal stopping problem, which takes advantage of information obtained by delaying irreversible resource commitments, implies that a more conservative conversion strategy is optimal. It is also shown that the expected value of the natural forest may increase when the optimal stopping rule is applied instead of a conventional expected net present value (NPV) analysis. Traditionally, NPV analysis treats the decision as a ‘now or never’ decision and ignores therefore the option to wait and the value of new information. These results are pertinent and may contribute with substantial information for forest management planning and water resource policy.