Investing in energy forestry under uncertainty

• We provide a real option model framing the decision to invest in energy forestry.
• We analyze the establishment of SRC willow stands in Central East Sweden.
• We discuss how government subsidies to energy forestry may accelerate investment.
• Compensation for sewage sludge management stimulates investment in new willow stands.

Farmer's decisions to invest in renewable energy sources can contribute to lower greenhouse gas and mitigate climate change. However, it remains unclear how associated high sunk establishment costs, long-term commitment, highly uncertain net returns, and policy induced incentives could drive farmer's decision to afforest agricultural land. A real option model is used to theoretically frame the decision to switch from agriculture to energy forestry. Optimal investment timing is modeled and the functioning of government subsidies offered to speed up the switch to energy forestry is analyzed. The empirical analysis examines the establishment of new short-rotation coppice willow stands in Central East Sweden. It is shown that in the presence of volatile agricultural profits and high establishment costs, subsidies are needed to accelerate investment. We then examine the case of the municipality of Enköping and show that the combination of governmental subsidies for energy forestry with compensation for sewage sludge treatment provides an effective stimulus to investment in new willow stands which also has environmental benefits.