May 11, 2010
I'd like to draw your attention to one aspect of evaluating the economic feasibility of forest management focused on growing older, bigger trees: discounting future values. There will be some numbers involved. For some of you this will be overly simplistic, for others it may seem counter intuitive. And, of course, financial analysis will never capture all that we value in our forests. But, I hope you will bear with me. This is an important concept for understanding what it will take to increase inventories, stand ages and ultimately conservation values in working forests on the north coast.
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So if managing for older, bigger trees will both optimize biological productivity and increase economic value why doesn't everybody manage for older age classes?
Everyone knows that economic considerations shape and limit management options for forest landowners. Some forest advocates interpret resistance to more conservation oriented and more biologically productive forest management options as evidence of greed. Yet even forest managers and investors committed to sustainability face significant challenges in prioritizing management strategies that rapidly transition from young stands to older more productive forests. What's going on?
The Concept of Discounting
Timberland values are established through an appraisal process that includes a Discounted Cash Flow analysis or DCF. When harvested timber is sold it generates income. The year-in year-out variations in projected harvests generate a projected cash flow over time. To assess the value of those future cash flows for today's landowner (or a prospective buyer) a discount rate is applied to projected future cash flows generated by the sale of timber.
Imagine you have a friend with $200,000 in a trust fund that s/he will receive in 10 years. The money is secure--there is very little risk--but until then s/he can't touch it. Yet your friend needs cash today, not 10 years from now. How much would you be willing to lend your friend today in exchange for $200,000 in 10 years? Would you be willing to lend $100,000 today in exchange for that future payment of $200,000 in 10 years? If so, then you will earn 7% interest annually on the money you lent to your friend. Seems reasonable, nothing wrong with that. In this example you applied a discount rate of approximately 7% to that $200,000 future value and thereby established a present value of $100,000.
The implications of Discounting
Applied discount rates have important implications for the economic assessment of forest management scenarios. Different management options produce different harvest levels at different times. Forest management options that increase rotation age will generate higher harvest volumes in the future, but lower harvest volumes and cash flows in the near term.
Following the above example postponing today's $200,000 harvest for 10 years--using a 7% discount rate--reduces the present value of that harvest to $101,000. Postpone your harvest for 30 years and the discounted present value of that future harvest is $26,000. A binding commitment to extend rotation ages and limit harvests to a percent of inventory reduces the appraised value of the forestland on which those commitments are made. A significant sacrifice that many landowners find difficult to ignore.
Uncounted Benefits of Extended Rotations
Yet, over time, standing inventory will increase. Per acre growth in volume will increase. The potential for future harvests will increase. Sawlog quality will increase. On-site carbon storage will increase. Each of these elements brings the potential for concrete future economic benefits to landowners who can afford to forgo short-term income.
In addition, public trust values will be protected. Habitat values will increase. Open space will be preserved. The potential for future resource-based economic activity on the north coast will increase--as will the local tax base. These public benefits will be, in part, subsidized by those landowners who make a binding commitment to grow bigger, older trees.
These concepts aren't new. Hans Burkhardt pointed out these dynamics in his analysis Maximizing Forest Productivity back in the early nineties. In response he advocated for harvest limits--based on growth--at 2% of inventory.
Paul Krugman, in his recent article Building the Green Economy, also addresses the issue of discounting in a somewhat different context: his comparison of two strategies for reducing carbon emissions.
I find it easiest to make sense of the arguments by thinking of policies to reduce carbon emissions as a sort of public investment project: you pay a price now and derive benefits in the form of a less-damaged planet later... So if you want to assess whether a given investment in emissions reduction is worth making... you also have to decide how much weight to place on harm that will take a very long time to materialize.
The policy-ramp advocates argue that... the cost will not get really large until there is a lot more carbon dioxide in the air, and that won't happen until late this century. And they argue that costs that far in the future should not have a large influence on policy today....
The big-bang advocates argue that government should take a much longer view than private investors. Stern [an economist at the London School of Economics], in particular, argues that policy makers should give the same weight to future generations' welfare as we give to those now living... .
Personally, I lean toward the big-bang view. Stern's moral argument for loving unborn generations as we love ourselves may be too strong, but there's a compelling case to be made that public policy should take a much longer view than private markets.
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Discounting future values is an effective tool for guiding investment decisions. It provides an accurate method for assessing the potential benefits of allocating financial resources towards meeting societies needs as expressed by market demand. We have all, as a society, reaped the benefits of a market based system that rewards innovation and rapidly responds to changing market conditions. Yet, in certain cases biological realities require a longer view.
Let me draw a parallel. As families and as a society we invest in education. We don't invest in education because we personally net a 7% return on our investment, but because education enables our children to reach their full potential. The benefits of our investment do not accrue to us directly; they accrue to future generations--our children and their children. Investing in education helps our children to stand on their own without our support--to achieve and to excel in a sometimes challenging and competitive environment--and society as a whole reaps the benefits of their initiative.
Investments in extended rotations, in growing bigger, older trees enable north coast working forests to achieve their full potential: to excel in terms of productivity and quality and to compete in a sometimes challenging environment - both ecologically and economically.
The question we need to answer is this: how can we bring future values forward in time to guide investment decisions we make today?
John Rogers is a 35 year resident of Southern Humboldt whose involvement with forestry issues emerged through his role as a woodworker and sustainability advocate. A member of the founding Institute for Sustainable Forestry board in 1991, John's writing focuses on the economic nuts and bolts of walking the talk of long-term sustainable forest management.
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TOC for Forest & River News, Spring 2010