REDD-based Offsets: Benefit Sharing and Risks

In this study we apply systems analysis methods to modeling financial instruments supporting the Reduced Emissions from Deforestation and Degradation (REDD) program. We consider a risk-aware forest owner and an electricity producer evaluating the REDD-based offsets with benefit-sharing mechanism under uncertain CO2 prices. For a range of CO2 prices and respective risks perceived by the forest owner (seller) and electricity producer (buyer), we apply a model of fair (indifference) pricing. The decision-making process under uncertainty is formalized in the spirit of Howard Raiffa’s “Decision analysis” (1968). Parties’ risk preferences are reflected by exponential utility functions. The potentially contracted amounts of REDD offsets are analyzed under various risk preferences and for different benefit sharing opportunities and price levels. Our results show that a risk-averse attitude considerably increases the contracted amounts of REDD offsets (compared to risk-neutral case) and, therefore, creates a higher potential for REDD implementation. We demonstrate a possibility of situations, when parties could agree on a certain range of REDD contracts, for example, smaller amounts of REDD offsets are traded for higher prices, and larger amounts for lower prices, but contracting a moderate amount at a moderate price is impossible. Higher benefit-sharing ratios can also increase contracted amounts even in the case of risk-taking electricity producer. Our modeling results highlight two ways to promote higher REDD participation: (i) increasing risk aversion of the energy producers, and (ii) implementing the mechanism of benefit/risk sharing between REDD consumer and supplier