economics of forest management decision making

Economics of Forest Economics of Forest Management Decision Making Management Decision Making

in Today’s Worldin Today’s World

Cheryl TalbertCheryl TalbertDirector of ForestryDirector of ForestryWeyerhaeuser Company Weyerhaeuser Company Western TimberlandsWestern Timberlands

Economics of Forest Management Decision Economics of Forest Management Decision Making in Today’s WorldMaking in Today’s World

Wood products and timber are increasingly global commodities – puts a Wood products and timber are increasingly global commodities – puts a ceiling on long-term log values and quality premiums.ceiling on long-term log values and quality premiums.

Advances in technology have reduced the value premium for large logs, older Advances in technology have reduced the value premium for large logs, older logs and higher-end quality.logs and higher-end quality.

Timber producers now are competing with pension and real estate investors Timber producers now are competing with pension and real estate investors for investment results – returns must be higher to compete.for investment results – returns must be higher to compete.

Costs are high and payback-period long compared to other tree growing Costs are high and payback-period long compared to other tree growing regions and other investments -regions and other investments - and the gap is growing as other regions and the gap is growing as other regions more aggressively implement yield-improving and cost-reducing more aggressively implement yield-improving and cost-reducing technologies.technologies.

We enjoy some unique advantages with our species and relative proximity to We enjoy some unique advantages with our species and relative proximity to major North American and Asian markets...major North American and Asian markets...

……..but those advantages will not be enough to maintain our species’ but those advantages will not be enough to maintain our species’ competitiveness – and investment dollars for forest management - competitiveness – and investment dollars for forest management - unless we can grow high-value stands faster, and at a lower cost.unless we can grow high-value stands faster, and at a lower cost.

…….this does NOT mean ‘lowest cost forestry’. Within bounds, .this does NOT mean ‘lowest cost forestry’. Within bounds, intensive management generates higher returns than low-intensity intensive management generates higher returns than low-intensity management.management.

Economics of Forest Management Decision Economics of Forest Management Decision Making in a Global ContextMaking in a Global Context

Foresters can no longer afford to focus just on full stocking, dead weeds and high yields…

Nor can we just focus on cost cutting….

We must be effective Investment Portfolio Managers!!


You must make decisions every day.

“Investment thinking” means making those decisions based on the expected timing and financial benefits, compared to the timing and magnitude of costs and expected risks.

This talk highlights some key concepts, methods and considerations to help you integrate investment thinking into your tree-growing decisions.

Portfolio:

Low-elevation, dry site Ponderosa

pine sites

Mid-elevation, N/E slope Larch/

white pine sites

High elevation lodgepole pine sites


Investment Options:Investment Options:

Planting stockPlanting stock

Vegetation control (spot, Vegetation control (spot, broadcast)broadcast)

Burning, scarificationBurning, scarification

ThinningThinning

FertilizationFertilization

Harvest ageHarvest age

Available cash

Economics of Forest Management Decision MakingEconomics of Forest Management Decision Making “First Principles” for Forest Management Investments“First Principles” for Forest Management Investments

1.1. Money costs money (“cost of capital”).Money costs money (“cost of capital”).

There is an opportunity cost to invest money in a plantation, There is an opportunity cost to invest money in a plantation, defined by what your owners-shareholders-investors could defined by what your owners-shareholders-investors could make if they put that money into the best alternative investment make if they put that money into the best alternative investment of the same risk level.of the same risk level.

In effect you are ‘borrowing’ money from an investor for a In effect you are ‘borrowing’ money from an investor for a defined period of time, and they want to make a defined period of time, and they want to make a competitive ‘interest’ on their money.competitive ‘interest’ on their money.

Compound interest formula = $$ Compound interest formula = $$ x x (1 + i )(1 + i )tt

The longer your organization must wait for The longer your organization must wait for ‘payback’ from an investment, the greater the ‘payback’ from an investment, the greater the ‘interest cost’ and the final benefit required to ‘interest cost’ and the final benefit required to generate an attractive rate of return.generate an attractive rate of return.

Early-rotation investments must have Early-rotation investments must have much greater impact than later investments much greater impact than later investments to provide an attractive return.to provide an attractive return.

Cost of Capital Illustration

Initial Investment

Carried for 25 years




25$ 107$ 461$ 171$ 1,173$ 50$ 215$ 921$ 342$ 2,345$

100$ 429$ 1,842$ 685$ 4,690$

6% 8%

Another way of looking at this is the ‘discounting’ of Another way of looking at this is the ‘discounting’ of future values: those values are worth less to you future values: those values are worth less to you today the further out in time that you expect to realize today the further out in time that you expect to realize them.them.

Discounted Future Value = $$ / (1 + i )Discounted Future Value = $$ / (1 + i )tt

Prescriptions that save you money early or Prescriptions that save you money early or generate earnings sooner will have higher generate earnings sooner will have higher investment returns.investment returns.

Example using 6% interest rate

Cost Saving Year 0

Thinning Earnings Year 25

Clearcut Earnings Year 40

Extra Value in Future Year 25$ 90$ 260$ Value in Today's Dollars 25$ 25$ 25$ Discounted Value of Future $1 1.00$ 0.23$ 0.10$


2.2. Investment options need to be compared Investment options need to be compared integrating the relative size and timing of integrating the relative size and timing of costs and payback, including cost of capital.costs and payback, including cost of capital.

Would you rather have…Would you rather have… $100 today or $1500 in 25 years?$100 today or $1500 in 25 years?

If your cost of capital (alternative rate of return) is If your cost of capital (alternative rate of return) is 11% or less, you’d be better off waiting for the $1500 11% or less, you’d be better off waiting for the $1500 than saving the $100 and putting it into the than saving the $100 and putting it into the alternative investment – as long as that alternative alternative investment – as long as that alternative investment has the same or lower riskinvestment has the same or lower risk


2.2. Investment options need to be compared Investment options need to be compared integrating the relative size and timing of costs and integrating the relative size and timing of costs and payback, including cost of capital.payback, including cost of capital.

Would you rather have…Would you rather have… $100 out-of-pocket today for $1000 earnings in 10 $100 out-of-pocket today for $1000 earnings in 10

years, or $500 out of pocket today for $20,000 years, or $500 out of pocket today for $20,000 earnings in 40 years?earnings in 40 years?

– If your alternative rate of return (cost of capital) is 8% or less If your alternative rate of return (cost of capital) is 8% or less you’d rather invest the $500 to make $20,000 you’d rather invest the $500 to make $20,000

– If your alternative rate of return is 10% or more, you’d rather If your alternative rate of return is 10% or more, you’d rather pocket the $400 difference and put it in the alternative pocket the $400 difference and put it in the alternative investmentinvestment as long as that alternative investment has the same or lower riskas long as that alternative investment has the same or lower risk


Tools for comparing investment options Tools for comparing investment options with variable timing of costs and with variable timing of costs and payback:payback:

Financial Life CycleFinancial Life Cycle

““Discounted Cash Flow Analysis:Discounted Cash Flow Analysis: Return on Investment (ROI)Return on Investment (ROI) Net Present Value (NPV)Net Present Value (NPV)

Wood growing cost per ccfWood growing cost per ccf

Example Of A Financial Life Cycle Of A Commercial Forest Acre*

1 5 9 13 17 21 25 29 33 37 41 45

Year

$/A

cre

After-tax stand investmentAfter-tax return-to-acre

Plant

Pre-CommercialThinning

FertilizationYear 20, 30 yrs.

CommercialThinning

Roads

FinalHarvest

* Examples of some of the forestry practices employed by the industry

Example Of A Financial Life Cycle Of A Commercial Forest Acre*

1 5 9 13 17 21 25 29 33 37 41 45

Year

$/A

cre

Assuming an average interest expense of 6%After-tax stand investmentAfter-tax return-to-acre

Plant

Pre-CommercialThinning

FertilizationYear 20, 30 yrs.

CommercialThinning

Roads

FinalHarvest

True Profit

Cost Curve

* Examples of some of the forestry practices employed by the industry


““Discounted Cash Flow Analysis:Discounted Cash Flow Analysis:

Net Present Value:Net Present Value: The difference between all positive and The difference between all positive and negative cash flows (costs and revenues) for a particular negative cash flows (costs and revenues) for a particular investment option, discounted back to the current year using investment option, discounted back to the current year using your defined alternative rate of return.your defined alternative rate of return.

Represents the $$ you could put into a 40 year CD today with your Represents the $$ you could put into a 40 year CD today with your defined alternative return, and break even with the forestry investment.defined alternative return, and break even with the forestry investment.

If negative, you don’t expect to make your alternative rate of returnIf negative, you don’t expect to make your alternative rate of return Can compare NPV for multiple optionsCan compare NPV for multiple options

ROI:ROI: The percent return on investment that results from the string The percent return on investment that results from the string of positive and negative cash flows for a particular investment of positive and negative cash flows for a particular investment option.option.

Compare against your organization’s target rate of returnCompare against your organization’s target rate of return Compare ROI for multiple optionsCompare ROI for multiple options

Economics of Forest Management Decision MakingEconomics of Forest Management Decision Making NPV and ROI - ExamplesNPV and ROI - Examples

Can do these with NPV and IRR functions in EXCEL – requires a table with every year of cash flow listed. =NPV(C1:C40,6%) =IRR(C1:C40,X%)

100 / (1.06)15 = 42

Sum of discounted cash flows

Year Action Cash FlowDiscounted

to Yr 0 at 6%

0 Site Prep and Plant (200)$ (200)$ 1 Release Spray (40)$ (38)$ 5 Treat Brush (20)$ (15)$ 15 PCT (100)$ (42)$ 25 Fertilize (150)$ (35)$ 60 Harvest 8,000$ 243$

(95)$ 5.3%

NPV (6%)ROI


Higher returns in this stand if you spend a little more up front, wait and commercially thin to bring in mid-rotation cash rather than thin-to-waste, even if the final harvest volume and earnings are reduced.


to Yr 0 at 6% Year ActionCash Flow

Discounted to Yr 0 at 6%

0 Site Prep and Plant (200)$ (200)$ 0 Site Prep and Plant (280)$ (280)$ 1 Release Spray (40)$ (38)$ 1 Release Spray (40)$ (38)$ 5 Treat Brush (20)$ (15)$ 5 Treat Brush (20)$ (15)$ 15 PCT (100)$ (42)$ 25 Fertilize (150)$ (35)$ 25 Fertilize (150)$ (35)$ 40 CT 1,200$ 117$ 60 Harvest 8,000$ 243$ 60 Harvest 7,000$ 212$

(95)$ (54)$ 5.3% 5.6%

NPV (6%)ROI

NPV (6%)IRR


Thinning decisions also should consider the expected impact on harvest volume and earnings compared to an unthinned case.

Some species will show drastic negative impacts on harvest value and yield if left unthinned, while in other species thinning can reduce harvest volume.


to Yr 0 at 6% Year ActionCash Flow


0 Site Prep and Plant (305)$ (305)$ 0 Site Prep and Plant (280)$ (280)$ 1 Release Spray (50)$ (47)$ 1 Release Spray (40)$ (38)$ 5 Treat Brush (20)$ (15)$ 5 Treat Brush (20)$ (15)$ 15 PCT (100)$ (42)$ 25 Fertilize (150)$ (35)$ 25 Fertilize (150)$ (35)$ 40 CT 1,200$ 117$ 60 Harvest 8,000$ 243$ 60 Harvest 7,000$ 212$

(203)$ (54)$ 4.8% 5.6%

NPV (6%)ROI

NPV (6%)IRR


Even better if you can get the stand off to a fast start and thin early, enabling an earlier clearcut.

Note that you can accept much lower final harvest earnings if you can get your earnings much sooner.

These are just examples – every stand will be different!

Year ActionCash Flow

Discounted to Yr 0 at 6% Year Action

Cash Flow


0 Site Prep and Plant (180)$ (180)$ 0 Site Prep and Plant (400)$ (400)$ 1 Spot Release Spray -$ -$ 1 Release Spray (50)$ (47)$ 5 Treat Brush (20)$ (15)$ 2 Release Spray (50)$ (44)$ 25 Fertilize (150)$ (35)$ 5 Treat Brush (20)$ (15)$ 60 Harvest 5,500$ 167$ 25 Fertilize (150)$ (35)$

(68)$ 30 CT 1,200$ 209$ 5.3% 45 Harvest 5,500$ 400$

10$ IRR

NPV (6%)

NPV (6%)


In practice you will likely wait to a reasonable thinning age and compare your options given the better estimate of future price and volume at that time, rather than at year zero.

In this case, you expect a reduction in final harvest earnings due to the thinning but would be financially better off taking it anyway (NPV is higher) because of the earlier positive cash flows.

Year ActionCash Flow

Discounted to Yr 40 at 6% Year Action

Cash Flow


0 Site Prep and Plant (350)$ 0 Spray and Plant (350)$ 1 Release Spray (50)$ 1 Release Spray (50)$ 5 Treat Brush (20)$ 5 Treat Brush (20)$ 25 Fertilize (150)$ (150)$ 25 Fertilize (150)$ (150)$ 40 CT 1,200$ 1,200$ 40 NO CT -$ -$ 60 Harvest 7,000$ 2,183$ 60 Harvest 9,000$ 2,806$

3,191$ 2,647$ NPV (6%)NPV (6%)


Another approach is a ‘marginal cash flow’ analysis, where you calculate the NPV and ROI on the CHANGE in cash flow you would experience with a new treatment.

• This approach allows you to easily adjust the discount rate for higher risk or uncertainty. (More on this later)

Action

Difference in Cash

FlowDiscounted

to Yr 0 at 6%Discounted

to Yr 0 at 8%

Larger stock, extra site prep (100)$ (100)$ (100)$ More intensive release spray (10)$ (9)$ (9)$ Second year release (40)$ (36)$ (34)$ Treat Brush -$ -$ -$ Fertilize -$ -$ -$ CT 1,200$ 209$ 119$ Harvest 1,500$ 45$ 15$

90$ (111)$ 7.5%

NPV ROI

3.3. Wood growing cost in dollars per CCF is a useful Wood growing cost in dollars per CCF is a useful metric to describe the financial competitiveness of metric to describe the financial competitiveness of the stands you’re managing in a ‘commodity’ the stands you’re managing in a ‘commodity’ marketplace.marketplace.

““Commodity”: not much differentiation in price based on qualityCommodity”: not much differentiation in price based on quality

Wood growing cost = Total compounded cost through Wood growing cost = Total compounded cost through the rotation / Total merch volume producedthe rotation / Total merch volume produced

Economics of ForestEconomics of Forest Management Decision MakingManagement Decision Making “First Principles” for Forest Management Investments“First Principles” for Forest Management Investments

Harvest Volume Increment by Treatment Example - Not a real scenario

0

20

40

60

80

100

120

Natural RegenUnmanaged

Site Prep & Plant 1st Gen Genetics Fertilization

Har

vest

Vo

lum

e (C

CF

/Acr

e)

$400/ac initial land cost

Cumulative Growing Costs without cost of capitalExample - not a real case

$-

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

UnmanagedNatural Regen

Site Prep Plant 435 Genetics 3 Fertilizations

$/A

cre

Total Growing Cost including Cost of CapitalExample - not a real case

$-

$5,000

$10,000

$15,000

$20,000

Unman

aged

Nat

ural

Reg

en

Site P

rep

Plant

435

Gen

etics

Fertili

zatio

n

Land

Ren

t OnlyC

um

ula

tiv

e C

os

t ($

/Ac

re)

Base

4%

6%

8%

Wood Growing Cost Per CCF for this example

$-

$50

$100

$150

$200

$250

UnmanagedNatural

Site Prep & Plant First GenerationGenetics

Fertilization

$/C

CF

4 % 6 % 8 %

Well-chosen incremental treatment Well-chosen incremental treatment investments can investments can improve wood growing improve wood growing costscosts per unit of harvest volume. per unit of harvest volume. This results when you choose treatments that This results when you choose treatments that

increase yields more than they increase total costs increase yields more than they increase total costs (including cost of capital).(including cost of capital).

Economics of ForestEconomics of Forest Management Decision MakingManagement Decision Making “First Principles” for Forest Management Investments“First Principles” for Forest Management Investments

4. The higher the risk or uncertainty in your final payout, the higher the return that an investor will expect for their money.

Risk and uncertainty: Probability (predictable or not) that results will be different from expectations

Factors increasing risk or uncertainty: Longer time from investment to payout Size of assumed market premium Higher assumed volume benefit, or breadth of sites you assume it

will apply to Site stress level, exposure to damage Strength of data and past experience

Economics of ForestEconomics of Forest Management Decision Making Management Decision Making

“First Principles” for Forest Management Investments“First Principles” for Forest Management Investments

5. Attractive returns are not an assured proposition 5. Attractive returns are not an assured proposition for every treatment on every site.for every treatment on every site.

Treatments must be targeted carefully to sites where they Treatments must be targeted carefully to sites where they can be expected to provide good returns.can be expected to provide good returns.

particularly critical for stand establishment treatments because particularly critical for stand establishment treatments because of their long holding period.of their long holding period.

Examples:Examples: More expensive planting stockMore expensive planting stock ScarificationScarification Intensive vegetation controlIntensive vegetation control FertilizationFertilization

Economics of ForestEconomics of Forest Management Decision Making Management Decision Making “First Principles” for Forest Management Investments“First Principles” for Forest Management Investments

6. The worst investment of all is the one that does 6. The worst investment of all is the one that does not achieve the desired result – rework and not achieve the desired result – rework and delays cost money!!delays cost money!!

GOOD EXECUTION is the #1 investment GOOD EXECUTION is the #1 investment priority.priority.

Plan wellPlan well Adjust your treatments to the conditionsAdjust your treatments to the conditions Calibrate your equipment Calibrate your equipment ahead of timeahead of time Pick a good contractor, and INSPECT!Pick a good contractor, and INSPECT! Measure what you’re getting, including variabilityMeasure what you’re getting, including variability

Economics of ForestEconomics of Forest Management Decision Making Management Decision Making “First Principles” for Forest Management Investments“First Principles” for Forest Management Investments

It can be considerably worse to spend too It can be considerably worse to spend too little than to spend too much!….IF the result is:little than to spend too much!….IF the result is: Significant land out of production or a significant yield falldownSignificant land out of production or a significant yield falldown A delay in the payout from your investment in the stand (increases A delay in the payout from your investment in the stand (increases

your cost of capital)your cost of capital) Spending more money to correct a problem Spending more money to correct a problem A much higher risk that the stand value will be lostA much higher risk that the stand value will be lost

The margin for error is much narrower the more The margin for error is much narrower the more stressful that the site is.stressful that the site is.

Economics of Forest Management Decision Making Economics of Forest Management Decision Making “First Principles” for Forest Management Investments“First Principles” for Forest Management Investments

Right the First Time

2 years intensive veg control 60$ Plant 350 trees 182$ * 32 cent trees* 20 cent plantingTotal 242$ Revenue to make 6% ROI in 50 years 4,458$

The 'Cheap' Way

Spot weed control 16$ Plant 300 trees 120$ * 20 cent trees* 20 cent plantingTotal 136$

Replant 200 TPA 124$ * 32 cent trees* 30 cent plantingRespray 16$ REAL Total 276$ Revenue to make 6% ROI in 52 years 5,548$ Extra Cost of Money at 6% 1,091$

But Then, One Year Later….


It ALWAYS pays to GET IT RIGHT THE FIRST TIME.

Cost of Non-Stocked ‘Holes’

CV = “Coefficient of Variation” (standard error / mean)

You could afford to spend up to $100 per acre up front to avoid these yield losses (not counting value degrade from the open-grown trees around the holes).


HarvestAvg TPA CV of TPA P<100 TPA P<150 TPA Value Loss

300 20 0% 1% 0-$75/ac50 9% 16% $600-1200/ac

400 20 0% 0% 050 7% 11% $500-800/ac

% Non-Merch Space

Foresters must be effective investment portfolio Foresters must be effective investment portfolio managers!managers!

This requires:This requires:

Working knowledge of financial concepts, tools and methodsWorking knowledge of financial concepts, tools and methods

A model or other method to forecast growth and yieldA model or other method to forecast growth and yield

Up to date price and market forecasts (e.g. RISI)Up to date price and market forecasts (e.g. RISI)

Data on treatment response that relates to your site typesData on treatment response that relates to your site types

Detailed forester knowledge of sites and conditions:Detailed forester knowledge of sites and conditions:– Productive and value potentialProductive and value potential– Stress level and survival riskStress level and survival risk– Soil and slash hindrances, vegetation communitiesSoil and slash hindrances, vegetation communities

Do your homework – it’s a matter of competitive Do your homework – it’s a matter of competitive survival!survival!

Economics of Forest Management Decision Making Economics of Forest Management Decision Making “First Principles” for Forest Management Investments “First Principles” for Forest Management Investments

Questions?Questions?

economics of forest management decision making

Documents

intensive management

investment thinking

investment results

investment dollars

best alternative investment

higher investment returns

lowintensity management

opportunity cost