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The share contract and silviculture in British Columbia McQueen, James Robert George 1996

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The Share Contract and Silviculture in British Columbia by JAMES ROBERT GEORGE MCQUEEN B.Sc. (Agr.) The University of British Columbia, 1992 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE in THE FACULTY OF GRADUATE STUDIES (Department of Forest Resources Management) We accept this thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA July 1996 ©James Robert George McQueen, 1996 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. rt The University of British Columbia Vancouver, Canada DE-6 (2/88) ABSTRACT The forest industry is a very important part of the economy of British Columbia. A peculiarity of B.C. is the large percentage of forest land under government control. This situation creates difficulties when trying to attract private investment in forest management. Currently, tenure holders have no equity in future timber and only have rights to harvest timber, therefore, there are no voluntary incentives to invest and to manage the land well. The sale of Crown land to private interests on a large scale is likely not acceptable to the people of B.C. and so an alternative must be found. As the structure of the commercial forest land in B.C. undergoes the transition from old-growth to second-growth, the relationship between the Crown and tenure holder begins to resemble that of landlord and tenant farmer in agriculture. A sharecropping contract may have attributes that are desirable for managing forests. Several examples of silvicultural regimes in both the Interior and Coastal regions of B.C. are used to demonstrate how share contracts can be applied to B.C. forestry. The flexibility of ' share contracts allows the risks of forest management to be shared by both parties and they also provide the incentives to perform that the current command and control approaches do not. The calculations in the examples show positive net present values when discounted at 4% on the Coast and 3.5% in the Interior in real terms. Regimes that do not have positive NPVs with these discount rates may still be viable if non-market benefits are included and the equity shares of each party adjusted accordingly. In this way, government can internalize the benefit to the company of producing these goods. Share contracts also allow the Crown to accept logs as payment for use of the land and those logs could be used to supply provincial log markets. iii TABLE OF CONTENTS ABSTRACT ii TABLE OF CONTENTS Hi LIST OF TABLES v ACKNOWLEDGEMENT vi 1.0 INTRODUCTION 1 1.1 Current Situation 1 1.2 Policy Background 2 1.3 Research Plan 8 2.0 THEORETICAL CONSIDERATIONS 10 2.1 Factors Affecting Silvicultural Investment in B.C 10 2.1.1 Survey Studies 11 2.1.2 Empirical Studies 13 2.1.3 Monte Carlo Simulation of Impact of Certain Policies on Silvicultural Investment Decisions 14 2.1.4 Other Studies Regarding Silvicultural Investment 16 2.2 Policy Alternatives 19 2.2.1 Public Corporations 19 2.2.1.1 United States 19 2.2.1.2 New Zealand 21 2.2.1.3 British Columbia 22 2.2.2 Land Rent and Long-Term Leasing Contracts 23 2.2.3 Allowable Cut Effect 24 2.2.4 Sharecropping 26 2.3 Sharecropping in Economic Theory 26 2.4 Sharecropping versus Other Contract Types 29 2.5 Content of Sharecropping Contracts 33 2.5.1 Share Contracts in Chinese Agriculture 34 2.5.2 Share Contracts in North American Agriculture 36 2.6 Sharecropping in Forestry 37 2.6.1 Increment Contract 37 2.6.2 Royalty Based Leases in New Zealand 42 2.6.3 New Zealand Royalty Formula 43 2.6.4 Share Contract 44 2.7 Determination of Land Rent 47 2.8 Indexing of Economic Variables 50 2.9 Biological Risk 52 3.0 RESULTS 54 3.1 Reforestation and Treatment Scenarios 55 3.2 Calculation of Net Present Value 57 3.3 Calculation of Equity Shares 58 3.4 Non-Market Benefits 59 3.4.1 Carbon Sequestering 61 3.5 Adjusting Economic Variables During the Contract Period 62 iv 3.5.1 Choice of Index 63 3.5.2 Real Product Price Increase 65 3.6 Cash Flow Implications for each Party 68 3.6.1 Cash Flows for the Crown 68 3.6.1.1 Expenditures 69 3.6.1.2 Revenue 70 3.6.2 Cash Flow for the Firm 71 3.6.2.1 Expenditures 72 3.6.2.2 Revenue 73 4.0 Summary and Conclusions 74 4.1 Crown 74 4.1.1 Pros 75 4.1.2 Cons 76 4.2 Firms 77 4.2.1 Pros 77 4.2.2 Cons 79 4.3 Implementation Issues 80 4.4 Areas for Further Study 82 5.0 LITERATURE CITED 83 APPENDIX 87 V LIST OF TABLES Table-1 Items included in Share Contracts 88 Table-2 Sample Calculation of Equity Shares for a Fertilization Project 89 Table-3 Sample Calculation of Equity Shares for a Planting Project 90 Table-4 Biological and Economic Data for Scenario-11 91 Table-5 Biological and Economic Data for Scenario-21 92 Table-6 Biological and Economic Data for Scenario-31 93 Table-7 Biological and Economic Data for Scenario-41 94 Table-8 Present Value of Scenario-1 per Hectare 95 Table-9 Present Value of Scenario-2 per Hectare 95 Table-10 Present Value of Scenario-3 per Hectare 96 Table-11 Present Value of Scenario-4 per Hectare 96 Table-12 Contributions and Equity Shares for Scenario-1 97 Table-13 Contributions and Equity Shares for Scenario-2 97 Table-14 Contributions and Equity Shares for Scenario-3 98 Table-15 Contributions and Equity Shares for Scenario-4 98 Table-16 Contributions and Benefits for Crown and Firm 99 Table-17 NPV of Scenario-1 with Real Timber Price Increase 99 Table-18 Calculation of Adjusted Lease Payments. 99 ACKNOWLEDGEMENT I would like to thank my parents George and Janet M cQueen who provided unlimited support for my academic endeavors without which I would never have reached this point. It is to them I dedicate this thesis. I would also like to thank Lorie Srivastava who will continue to guide and support me. Finally I would like to thank my supervisor Dr. David Haley and my supervising committee for all their ideas, comments and guidance. 1.0 I N T R O D U C T I O N 1.1 Current Situation In British Columbia, 96% of inventoried forest land is provincially owned and 91% of the volume of wood harvested comes from Crown land. The timber harvesting and processing sectors generate much of the financial and social benefits enjoyed by British Columbians by providing employment and income, as well as being large contributors to government revenue. In 1993, forest products comprised 53.5% of B.C.'s manufacturing shipments and 15.6% of Gross Domestic Product. In addition, the industry contributed $1.6 billion to the three levels of government plus another $1.6 billion related to employment (Price Waterhouse, 1993). Therefore, the continued profitability of these activities is very important to the well-being of British Columbians. The maintenance or enhancement of this contribution is closely linked with the volume of wood harvested. The Annual Allowable Cut, (AAC) is the volume of wood permitted to be harvested within a given administrative unit be it a Tree Farm License or Timber Supply Area. The AAC is set by the Chief Forester and is meant to account for biological, environmental, social and financial objectives. One of these objectives is to be able to maintain a constant annual harvest, that is, a sustainable yield. The long run sustainable yield (LRSY) is expected to be 52 million m 3 per year (Price Waterhouse, 1995). The current AAC is 71 million i n 3 . The reduction, or falldown in harvest volumes to a sustainable level will have a major impact on employment and income over the longer term. An important factor, among others, in maintaining and enhancing the profitability and stability of the forest industry in B.C. is the ability to regenerate harvested areas in a manner such that the benefits of regeneration outweigh the costs. A constraint on ensuring that the financial benefits outweigh the financial costs is the demand placed on the forest resource to provide many other goods besides timber. In any case, there is concern in B.C. that there is sub-optimal investment in silviculture and this is partly a result of the structure and content of forest tenures in the province. 1.2 Policy Background There have been four Royal Commissions on forestry in British Columbia beginning with the 1910 Commission chaired by F.J. Fulton. Other Royal Commissions followed in 1945,1956 and 1976. Major changes in forest policy have followed each of these commissions. In April of 1991, the Forest Resources Commission released their report entitled "The Future of Our Forests". Although prior to 1910 land was granted outright to private interests, the granting of land was done primarily for the purposes of building railroads and for settlement. However, as far back as 1865, the Land Ordinance called for government to retain ownership of forest land and to grant only the right to harvest timber. That aspect of the tenure system remains today. Following the 1910 commission, the first Forest Act came into being in 1912. The Forest Branch, later to become Ministry of Forests, was spawned out of this commission. A recommendation that was not adopted was the establishment of a fund from the royalties collected on timber harvests to be used to maintain the health and productivity of the forest land base. As pressure on the timber supply increased during the 1940's, a second Royal Commission was established to confront the emerging problem of securing timber to supply the increasing number and size of mills in the province, mostly in the coastal areas. It was the 1945 Sloan Commission that proposed the management of the forest land base to provide a sustainable yield. In 1978, a new Forest Act was adopted following the recommendations of the 1976 Pearse Commission. Many of the recommendations were adopted and one of the more notable changes included converting all existing TFLs to 25 year evergreen TFLs. Prior to this, TFLs granted after 1958 had 21 year terms and TFLs granted prior to 1958 had perpetual terms. Of the 23 perpetual term TFLs, seven had been revised to 21 year terms at the time of the Pearse Commission. Timber Sale Harvesting Licenses and Timber Sale Licenses were replaced with Forest Licenses and the Public Sustained Yield Units were replaced with a much smaller number of Timber Supply Areas (TSAs). The quantity of wood available to competitive bidding was doubled in recognition of the problem of suppressed timber markets in B.C. due to the historical allocation of timber and consequent concentration of the manufacturing sector. Other changes in the Forest Act occurred in 1978 and in 1987. Until 1978, costs of silviculture and other forestry activities were approved costs and taken into account by the stumpage appraisal system. After 1978, under Section 88 of the Forest Act, those costs became a credit against stumpage paid . In 1987, the Comparative Value Pricing system was used to assess stumpage. This system eliminated the credits against stumpage payable for forestry costs. In order to aid the development of small business, there was a 5% cutback in the AAC of major licensees and this volume was transferred to the Small Business Forest Enterprise Program. This brought the total volume administered under the program to 15% of the provincial harvest volume. There was also a stipulation for a further 5% reduction when a license is transferred from one party to another. In addition to the insecurity these changes engendered in license holders, there were other effects as well. The removal of reimbursements for silvicultural expenditures affected the investment behaviour of firms in ways that are not optimal for the Crown (Haley and Luckert, 1991). Under the current tenure system, licensees are responsible for the costs of basic silviculture and stand management so the trees reach the "free to grow" stage of development. However, there is still an impression in industry and government that more should be spent on silviculture (Haley and Luckert, 1989). The problem is that there are no incentives to voluntarily undertake intensive management practices to maximize the land expectation value. Licensees seek to minimize costs subject to fulfilling the requirements of the tenure (Haley and Luckert, 1991). Besides there being a lack of incentives for silvicultural investment, there are in fact many disincentives including suppressed markets, tax disincentives, restrictive harvest regulation policies and ignorance on the part of the general public regarding forest management (Pearse, 1985). Therefore, there may be investment opportunities that are being forgone. Part of the argument for different arrangements between the Crown and tenure holders for financing silviculture is based on the difficulty of prescribing and enforcing compulsory silvicultural standards on Crown lands. Part of the desirability of voluntary investments versus compulsory investments regards the heterogeneity of site conditions and therefore optimal silvicultural prescriptions. The tenure holders are in a better position to know what the best regimes are for sites within their tenure area given the close contact they have with it. Another advantage of voluntary investments is the commitment they imply on the part of the tenure holders towards the land on which they make their investments. In a situation where the tenure holders propose investments on their own initiative, they have the incentive to make those investments pay. The incentive is to manage the land so that good growth occurs and a healthy crop of trees results. This reduces the supervisory responsibility of the Crown. The Ministry of Forests has undergone large reductions in staffing over the last fifteen years or so and it would be very difficult for it to prescribe and enforce optimal treatments. However, with the introduction of the Forest Practices Code, staffing is increasing again. What is lacking at this stage is the incentive for the tenure holders to make the most of their lands. Some jurisdictions in Canada have attempted to provide incentives for voluntary investment by tenure holders. One of the most common ways to do this is to make use of the Allowable Cut Effect (ACE). That is, if a firm can demonstrate that its treatments will increase the volume of wood available in the future, it is able to add a portion of that increment to its AAC immediately. This can cause distortions in investment behaviour (Bell et a]., 1975). Other problems with ACE will be noted later. Other incentives include reduced or zero stumpage on the increment over and above that produced by the compulsory treatments. As far as the tenure holders are concerned, the benefits of increased harvests in the future are not enough incentive to induce more investment in intensive or incremental silviculture. Licensees are responsible for reforestation to a regulated standard. These expenditures are compulsory and comprise "basic" silviculture. Any expenditures not required to reach the free-to-grow stage are considered incremental and are voluntary. Licensee perceptions about the probability of changes being made in their tenures make them feel insecure about reaping the benefits of their investments (Luckert, 1991). In fact, under current arrangements tenure holders have no equity in future timber crops. The rights granted in forest tenures in Canada go only as far as providing rights to harvest existing timber. The timber resulting from a firm's reforestation activities is not automatically allocated to that firm when it is ready to harvest. As a result, it is reasonable for it to use discount rates that include a risk premium to account for that insecurity. Few silvicultural investments will be financially viable with real discount rates above 5%. Even on the best coastal sites, return to reforestation is only 5-6%. Heaps and Pratt (1989), estimate the social discount rate for silvicultural investments in Canada to be between 3% and 7%. Therefore, it seems that some system of sharing the risks of silvicultural investments between government (the landowner) and industry (the tenant) would make more silvicultural investments financially viable (at least as far as industry is concerned). Considering the fact that reforesting after harvest provides more benefits than just future timber supplies, it is reasonable to expect that government would want to ensure that this takes place and in fact there may be justification for public subsidy in some cases. The tenure system in B.C. is geared towards the regulation and allocation of the old-growth forest resource and not the management of second (and third and so on) growth forests (Pearse, 1976). Forest tenures provide the rights to harvest timber but not the rights to grow timber (Haley and Luckert, 1990). As the available old-growth timber is depleted, the relationship between government and the tenure holder will resemble that of landowner and tenant farmers in agriculture. The sharecropping model of the landowner/tenant relationship in agriculture may have an application in B.C. In that system, the tenant supplies the labour and pays a portion of the harvest as rent to the landowner. Other inputs may be provided by either party. In agriculture, the sharecropping arrangement acts as a method of allocating resources in the most efficient manner. When private property rights are assumed and only goods for which there are markets are produced, the sharecropping model does in fact allocate resources efficiently (Cheung, 1969). This is however not an undisputed point. Adam Smith himself viewed sharecroppers as slaves. His thinking was that the rental share amounted to nothing more than an ad valorem tax on the output, thereby reducing the incentive to produce (Smith, 1776). This is a view shared by other economists as well. Cheung points out the flaw in this reasoning, at least when the assumption of perfectly competitive input and land markets holds. The rental share and input levels are determined in the marketplace and not dictated by the landowners, therefore they represent the most efficient solution under the prevailing conditions. Besides all that, sharecropping remains a persistent contract type in agriculture all over the world. The question remains whether the sharecropping model will work when applied to B.C. forest tenures. As the B.C. forest industry undergoes the transition from old-growth to second growth, the relationship between government and tenure holder may resemble the agricultural landowner/tenant relationship but three major differences exist. First, the rotation length of a forest in B.C. is not likely to be much less than fifty years, even on the best coastal sites, which introduces a level of risk and uncertainty greater than that for agricultural crops that may be harvested up to three times per year. Second, the forest land of B.C. is under control of government that does not act like a private individual. Third, the forest resource in B.C. is required to produce non-market goods and other market goods besides timber. This poses a problem when determining the optimal allocation of resources because the benefits and costs of producing non-market goods are not clear. The ultimate goal would be to induce increased investment in silviculture with minimum transaction costs while at the same time fulfilling the demand for non-market goods. That is a tall order but the first step would be to determine if sharecropping provides a viable model for inducing increased investment in silviculture. 1.3 Research Plan This study will examine the theory of sharecropping as applied in agriculture and forestry to see if it provides some alternatives for forest tenure reform in British Columbia. Presuming it is possible to induce increased silvicultural investment with the share contract, the benefits may accrue to all British Columbians. By increasing the productivity of forest land through intensive management, government revenues may increase instead of decreasing as harvest levels decline. Increased productivity also removes some pressure from lands that are deemed too important to log but which are currently scheduled to be logged, e.g., Clayoquot Sound. In addition, as government takes possession of its portion of the harvest according to the shares determined in the tenancy contract, the logs may be auctioned off and a more competitive log market may result. Clearly, if the risk and costs of undertaking intensive forest management are shared by government and industry and they are willing participants in such agreements, there must be a net benefit to both parties. The first step in determining the applicability of sharecropping to forestry is to review the current theory of share tenancy and related topics as they exist in agriculture and forestry and attempt to adapt them to the B.C. situation. Sharecropping arrangements in forestry exist in New Zealand and the U.S. south and so an examination of the types of contractual agreements in those areas may provide insights into how such systems could be adapted to B.C. forestry. Once the general framework of sharecropping arrangements in other parts of the world has been examined, work can begin on creating a rental formula applicable to forestry in B.C. The structure of the thesis will be as follows: The current situation and reasons for studying sharecropping are discussed in Chapter 1. Chapter 2 is a review of the theory of share tenancy and related topics in agriculture and forestry. In addition, management options other than share contracts are discussed with regards to their ability to increase the productivity of commercial forest land. A methodology for implementation of share contracts in B.C. forest tenures is developed in chapter 3 . Also in chapter 3 , four examples are worked out based on the previous methodology to show how share contracts could be constructed. The calculations provide a rough guide to the cash flows that could be expected by government and industry from such contracts. Chapter 4 summarizes the results from chapter 3 and identifies areas of further study. This study will seek to provide the answers to some of the issues raised here, and in so doing, determine the viability of pursuing alternative arrangements between government and the forest industry to achieve the financial and social goals of British Columbians. 2.0 THEORETICAL CONSIDERATIONS This chapter is part literature review and part consideration of the issues raised by that review. In agriculture, there exists a wealth of literature related to contractual arrangements between landlords and tenants. The key is to isolate the important concepts of share contracts and try to determine their relevance to the B.C. forestry problem. This chapter exists to answer the following questions: 1) What factors significantly affect the level of silvicultural investment in B.C.? 2) What are some of the policy alternatives to increase silvicultural investment? 3) How is sharecropping explained by economic theory? 4) What are the relative benefits and costs of share contracts as opposed to other contract types and why are share contracts chosen over alternative arrangements? 5) What form do share contracts have in agriculture and forestry? 6) What considerations will need to be made when attempting to use share contracts in forestry? 2.1 Factors Affecting Silvicultural Investment in B.C. The major assumption of this thesis is that there is rent from forest land, that is currently being forgone, which may be captured by implementing a sharecropping type of contract between the Crown and tenure holders. To justify this assumption, it is necessary to provide evidence that there is rent being forgone (investments with potentially positive NPV are not being undertaken) and that a sharecropping contract will create the conditions within which the rent may be captured. The addition of share contracts to forest tenures calls into question the effect of forest tenure on silvicultural investment. Empirical studies of the effect of forest tenure on silvicultural investment in B.C. are not only rare but almost non-existent. Luckert (1988) and Luckert and Haley (1990) conducted surveys to determine tenure holders beliefs regarding the effect of various tenure characteristics on their firms. The study by Zhang (1994) provides some indirect evidence that share contracts may help increase investment in silviculture. Weetman, (1987) identifies seven important factors that have determined the nature and quantity of silvicultural practice in Canada. One determinant identified by Weetman, and indeed identified as an important determinant by all the studies discussed here, is the problem of encouraging private investment on publicly owned land. Pearse (1985) discusses impediments to silviculture in Canada. Removal of these impediments could be as important to increasing investment in silviculture as addition of incentives to invest in silviculture. 2.1.1 Survey Studies Luckert (1988) conducted surveys of tenure holders to determine the effects that various tenure characteristics have on the distribution of economic rents and the allocation of resources. The allocation of resources to silviculture is the primary allocative issue of interest here. Data on tenure holders' perceptions of the likelihood of changes in their tenure characteristics was also collected. Finally, the effect of tenures on investment in silviculture was investigated. The characteristics of each tenure which were investigated included duration, operational stipulations, operational control, transferability, use restrictions, comprehensiveness, allotment type and exclusiveness. What follows is a discussion of Luckert's results with an eye to how share contracts may help to increase investment in silviculture. The tenure holder's perceptions about the relative cost of attenuations in certain tenure characteristics show that holders of Tree Farm Licenses feel AAC reductions, increased stumpage fees, increased license replacement insecurity and elimination of management expenditure reimbursements represent the most damaging changes that could occur to their tenures. Indeed, these were changes that occurred with the announcement in 1987 of "New Directions for Forest Policy in British Columbia" or are now occurring in many areas under the Timber Supply Review. As far as investment in silviculture goes, Taxation Tree Farms (TTFs)1 were the only tenure type to show voluntary expenditures significantly greater than zero. Tree Farm License Schedule B Lands had significant reimbursed silvicultural expenditures. TFL Schedule A Timber License Lands had significant non-mandatory investments on a province-wide basis but when the coast and interior were looked at separately, only the coastal expenditures were significant.2 This is also true of the TTF expenditures. This makes intuitive sense due to the more favourable growing conditions on the coast and, therefore, greater possible returns. The perceptions of tenure holders towards the risk, benefits and costs of the various characteristics of their tenures, combined with 1 Taxation Tree Farm was a special classification of private land that received special tax treatment if the owner managed the land according to approved sustainable yield regimes. These lands are now called managed forest lands and are dealt with in Sections 1 and 29 of the Assessment Act. 2Schedule A lands are private lands and Timber Licenses (Old Temporary Tenures) within a TFL and Schedule B lands are Crown owned but managed by tenure holders in conjunction with their Schedule A lands (if any). 13 the above information regarding silvicultural expenditures, provided the basis for determining which tenures should be developed in the future with the aim of increasing investments in silviculture. This led Luckert to the conclusion that "tenures specified so that their holders have available and secure economic rents are creating incentives for more silvicultural investments than tenures relying on reimbursed and mandatory expenditures determined by government". 2.1.2 Empirical Studies Zhang (1994) conducted an empirical study on the effect of tenure on forest land value and management. One section of the study focused on tenure and silvicultural investment. An econometric model was used to determine the level of silvicultural investment by tenure type including private land and to determine the significance of other variables thought to affect the silvicultural investment decision. Not surprisingly, private land (Schedule A) within Tree Farm Licenses received the greatest dollar value of investment at an average of $1349.87 per hectare. The averages for Tree Farm Licenses, Timber Licenses and Forest Licenses are $950.64, $859.71 and $745.95 per hectare respectively. The real point here is not exactly how much is spent, but whether tenure type significantly affects investment and the ranking of tenure types from high to low. In fact, sixteen of the eighteen parameters estimated were found to significantly affect silvicultural investment. However, only tenure type can be significantly manipulated by provincial government policy as the natural attributes of the forest land comprise eleven of the independent variables and can be assumed to be exogenous to the policy process. 14 2.1.3 Monte Carlo Simulation of Impact of Certain Policies on Silvicultural Investment Decisions Luckert (1994) conducted Monte Carlo simulations of alternative silvicultural policies in order to derive some conclusions on the efficiency implications of those policies. He conducted the simulations on three categories of policies. The first included full reimbursement of silvicultural expenditures and complete equity for the firm in the future timber crop. The second category requires the firms to conduct silviculture necessary to produce a specified quantity of timber with no reimbursements and no equity in the future timber. The third category includes partial reimbursements and partial equity in the future timber. This third category is the one of interest here because it amounts to a sharecropping agreement between the Crown and tenure holder. That is, the costs are shared by both parties and the benefits shared on the basis of the proportion of total costs incurred by each party. One of the aspects of Luckert's simulation was that there may be errors in the Crown's reimbursement of tenure holder's expenditures. That is, the reimbursement does not equal the expenditure. This affects the efficiency somewhat because the likelihood of errors in reimbursements increases with the level of reimbursement, that is, the percentage of expenditures that will be reimbursed. The simulated NPV of each of a series of policies that are variants on the above three categories were determined. Two policies, inexact reimbursements and inexact reimbursements with production requirements had negative NPVs. Reimbursements with full equity in future timber and the production requirement policy had NPVs very close to one another. Of most interest are the policies of granting full equity in future timber with no reimbursements and the "sharecropping policy". The full equity policy produced the greatest NPV ($166.10) and the sharecropping policy resulted in an NPV of $165.16. The important aspects of these results include the fact that the sharecropping policy produced almost as large an NPV as the full equity policy and that the Crown retains a portion of the equity in the future timber with the sharecropping policy. This would allow the Crown to pursue other policy avenues such as the creation of provincial log markets without significantly reducing the incentives of firms to invest voluntarily. Another simulation involving inexact reimbursements based on the benefits produced combined with production requirements produced an NPV of $162.24, still very close to the previous two policies. However, transaction costs were not included in the simulation, and one feature of specifying production requirements is the need for auditing and monitoring of performance. This is a requirement that is not as necessary for the full equity or partial equity policies. From these simulations, Luckert concludes that: "Pulling together considerations discussed thus far, the state of silvicultural policies in Canada seems far from optimal. Reimbursement and requirement policies which predominate Canadian provinces may not only perform poorly with regards to expenditure incentives, but they are also likely to produce high transactions costs." He goes on to state that the obvious alternative to those policies is to introduce policies that provide equity to the tenure holder in the future timber. Based on the findings of the Monte Carlo simulations, there is little difference in terms of net production of wealth between the full equity and partial equity policies but the partial equity proposal gives the Crown a greater share of the wealth than the full equity policy and also provides the Crown with flexibility in other forest policy areas (log markets, small business). With that being the case, it makes further investigation of sharecropping contracts in forestry a logical step in attempting to improve the level and quality of silvicultural practices in Canada. 2.1.4 Other Studies Regarding Silvicultural Investment Both Weetman (1987) and Pearse (1985) discussed factors affecting silvicultural investment in Canada. A summary of their ideas on the subject will add to the understanding of what could be done to alleviate the problem and clarify the role of the share contract in the solution. Pearse identified a number of barriers or disincentives to silvicultural investment in Canada. The first of these is suppressed timber markets. This is considered an obstacle because the greatest incentive to invest is assumed to be higher timber prices. The relative concentration of the forest industry in many parts of Canada, including B.C., has led to timber markets that cannot be considered competitive and, therefore, the full value of the timber is not being realized. A further impediment to competitive timber markets is the existence of log export bans in many jurisdictions, including B.C. A second impediment to investment is property tax disincentives. This applies to private lands and, although that is not necessarily significant in B.C., it is a concern in the Maritimes where there is a much greater proportion of private ownership of forest land. This impediment is not addressed by the share contract which, of course, only deals with Crown land, but it still must be considered if the goal of government is to induce investment in silviculture. Simplistic harvest regulation policies constitute an impediment in that they distort the returns to silviculture through the allowable cut effect. The main concern is that the returns to silviculture are not based on the value of the wood actually produced by the activity but by the value of the immediate increase in allowable cut attributable to the treatment. This means that funds for silviculture are not necessarily being applied in a way that will give the largest increase in value as a result of the volume of timber produced by the investment. The Forest Practices Code exacerbates this distortion by encouraging management that reaches free-to-grow status quickly, regardless of whether this is the optimal long term management decision or not (B.C. Ministry of Forests, 1993). The final major obstacle identified by Pearse is the lack of knowledge on the part of private forest landowners and the public in general regarding forest management. Again, private lands in B.C. are not significant and those private lands that are used for timber production receive a high level of investment compared to Crown lands (Zhang, 1994). Of more importance is the lack of knowledge on the part of the public that may be resistant to forest management because of perceptions of environmental degradation as a result of forest operations. A further area where lack of knowledge is considered significant is the lack of economic evaluations of forest policies and silvicultural investment. This is due probably to the historical lack of necessity for this information because of the availability of ample quantities of economic timber. Weetman (1987), discusses seven factors that have an effect on silvicultural activity in Canada. Two of these factors are related to the ecology of the existing forest land and the others concern institutional factors, such as make work programs and forest tenures. The institutional factors are of most relevance to this discussion and will be summarized below. 18 The eternal conundrum for forest policy makers in Canada has been the problem of inspiring private investment in public land. That is the entire thrust of this thesis, and of the seven determinants of Canadian silviculture identified by Weetman, the most important. He notes that improvements have been made in structuring agreements between the Crown and tenure holders and cites the examples of Tree Farm Licenses in B.C. and Forest Management Agreements in Ontario. There are however weaknesses in these plans, particularly TFLs. The identified weakness is the now eliminated practice of crediting costs of silviculture to stumpage payments. The amount of funds allocated to silviculture was very sensitive to market fluctuations and this is not conducive to the long-term planning required for management of a forest industry. Since this article was published, these credits to stumpage were eliminated in B.C. further dampening industry's desire to fund silviculture in good or bad markets. Weetman sums up perhaps the biggest single obstacle to voluntary investment in silviculture: "The sad consequence of the historical lack of firm agreements with licensees about silviculture costs and responsibilities has been lack of industrial interest in forest management in much of Canada." Another determinant identified by Weetman is the implementation of temporary make-work programs. There have been significant sums of money provided to carry out silvicultural activities not required by law, that is, intensive silviculture. These types of activities may still have a place if silvicultural contracts are implemented. Tenure holders require a certain minimum return to their capital employed in forest management and there may be many sites where that minimum cannot be met. In these cases, it may be necessary to consider subsidizing the operation to a certain extent. This possibility is discussed in a later section. 2.2 Policy Alternatives Alternatives put forward for changes in forest tenure or policy include sale of forest land to forest products companies (Haley, 1985), sale of options on capital markets (Olivotto, 1987) and presumably, at the other extreme from privatization, complete nationalization of the forest products industry. Somewhere between the privatization-nationalization extremes lies the publicly owned-privately managed compromise that we have in B.C. 2.2.1 Public Corporations 2.2.1.1 United States Teeguarden and Thomas (1985) proposed a public corporation model for management of federal forest land in the United States. These corporations would be responsible for the management of a single national forest and would function similarly to other public corporations in the U.S. Some uniformity in corporate policy would be insured through creation of a Public Corporations Board to regulate the National Forest Corporations. The Board would also set minimum profit and performance standards. The advantages of this system include the flexibility of local managers to react to their own conditions relatively unconstrained by the policies of a centralized authority. This flexibility combined with hard and fast measures of performance may lead to greater efficiency of management. Secondly, it is presumed that there would be less turnover in personnel and, therefore, an increase in "indigenous" knowledge about the particular forest for which the corporation is responsible. The third advantage is that management of federal forest land would be less affected by changes of government and federal budgetary decisions because the management of these lands would be driven more by the marketplace and consumer "dollar votes". The disadvantages of this proposal include the charge that operating the corporations based on profit criteria will lead to the destruction of the resource without consideration of non-market values or future generations. Perhaps the greatest disadvantage is that while the funds available to the corporations to operate are not politically determined, the low rates of return on investments in forestry may seriously constrain the corporations' ability to finance themselves. The first disadvantage is rationalized by the fact that the current federal land management system is subject to the same criticism. Furthermore, the Public Forest Corporation (PFC) Board has the power to ensure that non-market goods are included in the output mix of the PFC to the extent that the public wishes. Some of the concepts outlined by Teeguarden and Thomas are incorporated to a certain degree in B.C. forest management. Currently the Ministry of Forests legislates minimum performance requirements regarding forest practices and regeneration, but there are no bottom line performance requirements on the industry. Presumably this isn't necessary because the tenure holders are assumed to be profit maximizing. An advantage of this proposal compared to the B.C. system (as far as the forest companies are concerned) is the existence of clearly defined performance measures for resource outputs. The PFC, on entering forest land leasing agreements with private forest companies, does so in order to fulfill these goals. Therefore, it is in the interest of the PFC to honour these commitments thus providing increased security to the forest company over the duration of the lease agreement. If there is a reduction of risk from the private forest companies perspective, increased investment is likely to follow. The assumed outcomes of this system are, in the main, a result of a goal-oriented planning approach that is missing in the current federal land system in the U.S. The flexibility in planning provided by the PFC concept is no doubt an advantage but the actual shift in the planning and management responsibility down to a more local level along with strict accountability would surely streamline the decision making process. This would allow more resources to be directed towards the business of forest management as opposed to managing the planning process. 2.2.1.2 New Zealand In 1984 a labour government was elected in New Zealand at a time when the commercial forestry division of the Forest Service was losing money and there was little sympathy for government inefficiency (Birchfield and Grant, 1993) From this, the New Zealand Forestry Corporation was created and officially began operations April 1, 1987. Slightly over a year later, the announcement was made that the land held by the corporation would be sold to private buyers. The sale proceeded and the corporation ceased operations on November 30, 1990. Although the corporation was short-lived it made a strong point about the advantages of financial incentives. In the first year the corporation had an operating surplus of $NZ 63 million as opposed to a $NZ 71 million deficit under the forest service. Even this intermediary step between public management and private ownership and management demonstrated some of the efficiencies possible with privatization. Stories of logging crews getting five days of work completed in four days and contractors using one quarter the number of graders that the Forest Service used to maintain the roads in the Kaingaroa forest showed the difference that financial incentives make (Birchfield and Grant, 1993) Although the subsequent sale of forest land to private buyers would probably not sit well with the people of British Columbia, there may be lessons for B.C. from the New Zealand experience in the corporatization of the Forest Service. 22 2.2.1.3 British Columbia The 1991 report of the B.C. Forest Resources Commission has a number of recommendations regarding a public forest corporation. In addition to the creation of a Ministry of Renewable Natural Resources to replace the Ministry of Forests, the Commission recommends the creation of a Forest Resources Corporation. Its role would be similar to the previously mentioned Public Forest Corporation suggested for the U.S. It would collect revenue and manage the forest land with potential for commercial timber production as identified by the Land Use Plan for the province. The main purpose of establishing this Crown corporation would be to provide secure funding for forest management. This would be ensured by comprehensive legislation that would need to be created to form the corporation and define its objectives and responsibilities. The major responsibility of the corporation would be to maximize the economic benefit provided by commercial uses of the working forest land base. This involves forest management, particularly silviculture. To that end, the corporation would be empowered to enter into Resource Management Agreements (RMAs) with the private sector. These would be legally binding contracts that stipulate the responsibilities of each party, including the management regime to be practiced, form and level of payment for resource use, dispute mechanism and so on. As will be seen later, the items in the proposed RMAs are very similar to those items commonly found in share contracts negotiated for agricultural land. The share contract, as proposed here, could be a specialized form of RMA or simply an RMA that includes the special form of payment and other stipulations that the share contract represents. 2.2.2 Land Rent and Long-Term Leasing Contracts It is probably not necessary to approach either of the two extremes of resource ownership (complete privatization and complete nationalization), but to simply manipulate various aspects of the current paradigm. One such manipulation, which this thesis incorporates to a certain degree, calls for a tenure system and method of payment based on forest land rent (CIF, CPPA, 1991). The gist of this proposal includes recognition of the need to provide a good investment environment for forest companies, thus inducing voluntary investment as opposed to the command and control approach necessary in the absence of incentives. This favourable environment is achieved by basing fees for use of Crown land on forest land rent calculated using a formula which includes important economic, environmental and management variables. An example of this method is demonstrated in Grainger (1969). Other formulas for determining maximum lease payments and the value of a long-term contract from both landowner's and lessee's perspective are shown in Shaffer (1984) and Shaffer et a! (1985). An interesting method of accounting for the uncertainty in valuing long-term cutting contracts is proposed by Shaffer (1982). This idea also involves some of the concepts from the options world, but not as extensively as the method proposed by Olivotto (1987). Shaffer's idea, called the "Recurring Option Contract" uses the Black-Scholes Option Pricing Model to attach an "option premium" to the rights to purchase a specified volume of timber at a specified price. This type of contract is meant to be of use to private forest land owners and forest companies in the United States where there is not the extent of public ownership of forest resources and where competition for timber amongst processors makes it necessary to propose creative deals to gain advantage. 24 2.2.3 Allowable Cut Effect Simple changes to forest tenures designed to encourage silvicultural investment have been applied in B.C. and other Canadian provinces. The specification that all timber production over and above that resulting from the specified minimum level of silviculture be stumpage free is in use in Forest Management Agreements (FMAs) in Alberta (Carroll, 1977; Haley and Luckert, 1990). Presumably, the fact that tenure holders receive the extra wood "free" means they will have greater incentives to invest in silviculture over and above the mandatory amount. Unfortunately, this specification does not address the lack of security caused by the land being held by the Crown and subject to all the vagaries of public policy over the long rotation period. Ontario FMAs have a similar specification, the only difference being the incremental timber is charged one tenth stumpage as opposed to being stumpage-free. In neither of these provinces has this provision led to a substantial increase in voluntary investment. Another specification in the Alberta FMA, and in many other tenure types across Canada, recognizes the Allowable Cut Effect (ACE) (Schweitzer et al, 1972). The ACE means that if a treatment can be shown to increase yields, a portion of that increase will be added to AAC immediately. There are also some modifications to the basic ACE for many tenures such as those above.Luckert and Haley, (1995) conducted a study to determine whether the ACE was an effective means of increasing voluntary investment in silviculture. The conclusion was that it is not an effective way of achieving the professed management goal of increased voluntary silvicultural expenditures. Several possible reasons are cited and some of these may affect the proposal in this thesis. The first factor contributing to the failure of ACE in encouraging investment (at least in B.C.) is the method of rent collection. The normal methods of charging stumpage are designed to allow the landlord to fully capture the economic rent from the land. Any increase in rent through productivity gains is fully captured by the landlord, not the tenant. Therefore the tenant has no incentive to invest. The logical conclusion is to allow the tenant to capture some or all the rent available from their investment. However, this too has been insufficient to induce voluntary investment. A further hindrance to the use of ACE is the nature of the harvesting regulations for most forest tenures. The restrictions placed on volumes harvested may not be the binding constraint on the actual amounts harvested. The actual constraint on harvest volumes may be the capacity of the firm's processing facilities. This, in combination with log export bans, further reduces the impact of ACE provisions. Also, the harvest regulations themselves provide some leeway in volumes harvested. This may provide enough flexibility to the firm to make the ACE unnecessary for meeting their timber supply needs. The following two possible reasons for failure of ACE to induce voluntary investment in silviculture are both largely concerned with uncertainty. Firstly, firms are required to demonstrate that their treatments will increase future yields but this is costly and there is no guarantee that an increase in AAC will be granted. The second uncertainty, and a very major factor affecting firms' investment decisions, is the uncertainty of future unfavourable changes in the specifications of their tenures by the Crown. In any case, ACE has not proven to be an effective means of inducing voluntary investment in silviculture and so alternative means must be found. 26 2.2.4 Sharecropping Yet another option, which will be elaborated on later, is to include sharecropping contracts in forest tenures. This is a widespread and ever-present contract in agriculture and may be applicable to forestry in B.C. 2.3 Sharecropping in Economic Theory Cheung, in his book "The Theory of Share Tenancy" (1969), develops a share tenancy contract model from standard economic principles. Share tenancy is defined as a lease under which the tenant is granted use of the landlord's land in return for a percentage, or share, of the output. The tenant supplies the labour, but the other inputs are provided by either party based on a negotiated contract. All resources are assumed to be privately owned. Other assumptions include wealth maximization, zero transaction costs and exclusive and transferable resource rights. Given a rental share r, the tenant's marginal income is defined as farm. (1 - r) where: q = quantity of output per tenant farm and h = area per tenant In this model, the landowner will maximize wealth by raising the rental percentage r, to the point where the tenant's income matches his next best opportunity. Besides rental percentage, the landowner controls the number of tenants farming on his land holding. All the landlord's land need not be contracted to just one tenant; he may divide his land into a number of parcels. The parcels need not be equal and the production function of each tenant need not be equal. To maximize his wealth, the landowner maximizes the difference between the marginal products of land and tenants' incomes. This is the landowner's rent. When the tenants' production functions are identical, the area of land cultivated by each tenant and the rental share paid by each tenant is the same. Each tenants' production function is: q = q(h,t). Where h is the area of land cultivated and t is the amount of tenant labour per farm. In turn, Where H is the total area held by a landlord and m is the number of tenants. Total rent R, is number of farms times rent per farm: R =m r q(h,t) Under competition, the tenant's income from farming is equal to his alternative earnings, holding t constant; that is, Wt = (1 - r) • q (h ,t) where W is the market wage rate. The objective function of the landowner then becomes: max.R=m-r-q(h,t) {m,r,t} subject to: Wt = (1 - r ) -q(h,t) In Lagrangian form: I = m. rq (h , t ) -A [Wt - ( 1 - r ) -q (h , i ) ] The first order conditions are therefore: dL .... dq dh ... . dq dh . = r q(h,t)-i-m r ~ - - — + A ( l - r ) ^ - 1 - — = 0 dm dh dm dL dr dq dh dm = m-q(h,t)-Aq(h,t) = 0 ^ = m - r . ^ - A W + A ( 1 - r ) ^ = 0 dl dl d\ dL dX - lWt-(1-r)q(h,t)] = 0 (D (2) (3) (4) Rearranging (2) gives: X = m In addition, dh d ( % ) - H dm dm m Equation (1) then becomes: dq(-H\ r q + m - r - - ^ - — dh \ m ) + m(1-r)^- 0 Therefore, in equilibrium, the rent per unit of land equals the marginal product of land. That is, hc9q rq dq r q - —— = 0 or -1 = -^ -c9h h c9h This is also true of fixed-rent contracts. From equation (3), 29 =W That is, the marginal product of tenant labour equals the market wage rate. Using equations (1) and (4) to solve for r, This says that the rental percentage, in equilibrium, equals both the elasticity of output with respect to the amount of land employed and the total yield net of tenant cost as a portion of the total product. This model of sharecropping shows that the rent from land will be the same under both sharecropping and fixed-rent leases. Land rent is ultimately constrained by land productivity. The above model of share tenancy assumes zero transaction costs and no risk aversion. Cheung later incorporates these elements into his theory to further explain the existence and choice of share tenancy over alternative contractual arrangements. 2.4 Sharecropping versus Other Contract Types Cheung identifies two reasons for the existence of different contractual arrangements given the same competition and set of property rights: 1) natural risk, defined as the effect of exogenous variables on the variance of the output value; and 2) transaction costs. 30 Transaction costs will differ among contract types and resources. These different costs of bringing resources into production under alternative contract types result in two types of marginal inequalities. One type is among firms. Due to varying transaction costs, there may not be perfect markets for inputs. If firms experience different factor input costs, the result is different marginal products for each firm. The other type of marginal inequality, which Cheung attributes to transaction costs, is found within firms. He gives an example of a lump-sum payment entitling unlimited water use. The costs of monitoring the tenant's water use are high enough to make a lump-sum payment more attractive to the landowner. Cheung then states: "Under this form of contractual payment, the water resource will be used by the tenant until its marginal product is zero, even though the marginal factor cost of the water is positive." Having paid a lump-sum for the right to use a non-zero quantity, the marginal cost of using additional units of water is zero. The important point here is that the marginal inequality does not necessarily mean inefficient resource use. The resources are simply being allocated with the costs of allocation in mind. Thus, Cheung identifies three effects of transaction costs. First, transaction costs reduce the volume of transactions. Second, they will affect the level of resource use and hence the marginal product of a resource. Third, they will affect the choice of contractual arrangement. The three main forms of contracts considered by Cheung are fixed-rent per acre, share contract and wage contract. Transaction costs can be divided into negotiation costs and enforcement costs of contract terms. The terms of share contracts include rental percentage, intensity of non-land input use and type of output (crop). Because the assumption is perfect competition, these terms are accepted by the two parties. In addition, the landowner must take steps to confirm the actual yield to determine each party's share. These two activities seem to make share contracts less attractive in relation to wage and fixed-rent contracts. Other considerations are the landlord's need to monitor the tenant's soil management in fixed-rent and share contracts. Presumably this is necessary in both the agricultural and forestry context. Risk aversion then becomes the likely explanation for why share contracts are chosen in some cases over wage and fixed-rent contracts. The majority of the risk in agriculture is caused by the exogenous factors that can affect the crop value. In that case, tenants bear most of the risk in fixed-rent contracts and the landowner bears some of the risk in wage contracts. Share contracts divide the variance of output value between the two parties. The existence of each of these contract types is then explained by the combination of transaction costs and risk aversion. Under certain conditions the risk dispersion of share contracts outweighs the higher transaction costs and they are chosen in favour of fixed-rent or wage contracts. Share tenancy, for example, was more common in the wheat region of China than the rice region. The variance of wheat yields being much greater than for rice. It would seem that the relatively large variance of wheat yields makes it necessary for contracting parties to seek a more stable income. Without transaction costs, the above neo-classical model becomes indeterminate. All arrangements are equally efficient assuming zero transaction costs and so they are all equally attractive. A model of tenancy choice including non-linear transaction costs avoids the problem of indeterminacy (Alston et aj. 1984). Transaction costs consist of the negotiation, supervision and enforcement costs of a contract. In studies of southern U.S. agriculture from 1930-1960, little evidence was found to show that negotiation costs were significantly different among contract types (Alston, 1981). This is contrary to what Cheung states, but nevertheless, transaction costs in total vary among contract types. In Alston et a]. (1984), non-linear supervision costs are included in a standard neo-classical model of tenancy choice. They found supervision costs to be the most powerful explanatory variable of the different types of transaction costs. Labour input is to be decided by the tenant. He, therefore, has the opportunity to shirk, but is constrained by supervision. The penalty for shirking goes beyond simple dismissal to include legal action for the violation of contract. By having labour input decided solely by the tenant as opposed to mutual negotiation, the model presented by Alston et a], substitutes supervision costs for negotiation costs. In that case, it is understandable that they found little difference in negotiation costs among contract types. The supervision costs included in the model are those related to the supervision of both labour intensity and the use of assets supplied by the landowner. Supervision of other inputs is also done to determine if any shortfalls in production are the fault of the tenant or exogenous factors. Cheung states he found that the measure of output was used as a proxy for determining input intensity. The agents he describes are supposedly aware of the growing conditions in that season and of expected output given the input intensity. Data from a 1911 study by the U.S. Census Bureau of cotton plantations in Georgia are used to derive the nonlinearities of supervision costs. The data are used to solve for the parameters in the following equations using two-stage least squares: P F = a 0 + a ^ + a 2 p C A + a 3 POWS (I > P S - ^ 0 + A | + A P C A + A P O W S (2) | = r o + 7 i P F + 7 2 P s + r 3 ^ - (3) where: PF = fixed-rent contracts as a % of all contracts PS = sharecrop contracts as a % of all contracts S/A = number of non-owner supervisors per 100 improved acres PCA = cotton acreage as a percentage of all improved acreage POWS = owner's work stock as a percentage of all work stock OS/A = number of owner-supervisors per 100 improved acres The results of a regression using these equations shows Y210 D e negative, and indicates nonlinearities in supervision costs with respect to area under sharecropping contract. The more land under fixed rent and sharecropping, the less non-owner supervisors required per 100 acres. This is an interesting rendition of Cheung's basic model. It shows how different conditions encountered in the real world may be incorporated in more detail than just as unspecified "transaction costs". 2.5 Content of Sharecropping Contracts Sharecropping contracts are much like other land leasing agreements in many respects, the specifics of methods of payment being the major point of differentiation. Cheung (1969) analysed fixed-rent and share contracts in China 34 from 1925 to 1940. At this time, 93% of farmland was under private ownership. From this analysis he determined details of the terms of each contract type. The University of Florida Agricultural Experiment Stations and the Alabama Cooperative Extension Service of Auburn University provide guides for tenants and landlords showing examples of what a good share contract should include in order to avoid conflict (University of Florida Agricultural Experiment Stations, 1955 and Hurst, J.R., 1987). From these sources the items to be included in share contracts are outlined. 2.5.1 Share Contracts in Chinese Agriculture A typical fixed-rent contract with a definite lease duration would specify the area and location under lease, the amount and form of rental payment, timing of payment, duration of lease and a stipulation for reducing rent in a famine year. Some other fixed-rent contracts would specify a price at which the landowner would purchase certain crops from the tenant and some would include no provision for rent reduction in a famine year. Other variations include leases of no fixed duration and leases with the landlord providing non-land farming inputs. Share contracts also exhibit variations on the major terms of the contract. Some contracts will specify uniform rental percentages across crops and others will combine shared crops and unshared crops (or outputs). Other terms included in share contracts are the size of cultivated area, crop rotation, intensity of non-land inputs provided by each party and terms for the termination of the contract. In China, according to Cheung (1969), the only enforcement that typically took place with share contracts was at harvest when the actual yield was estimated by an agent of the landowner. These agents in Chinese agriculture were very experienced and by simply measuring the output were able to tell if non-land inputs were applied to the contracted intensity. It is at this point that the intramarginal tenant is able to hide some output while still presenting an acceptable yield to the agent. The duration of leases encountered in Chinese agriculture were chosen in order to minimize the transaction costs associated with transference of resources and renegotiation of contract stipulations. Leases of long duration tend to exist when there are substantial tenant assets attached to the land. The transference or determination of a transfer price for attached assets may be difficult and, therefore, long contract duration minimizes transaction costs when these assets are present. Leases of short duration seem to be chosen when tenants' assets attached to the land exhaust their useful life in a short time or as a means to facilitate contract renegotiation. Share contracts may require renegotiation when relative product prices change or the production technology changes. In fixed-rent contracts and wage contracts, the decision on which crops to grow and the level of non-land inputs is made by only one party. When both parties in a share contract agree to the terms of resource reallocation, termination of the contract is irrelevant. However, parties may disagree on the appropriate reallocation. The short lease duration then allows timely renegotiation of the entire contract with the existing tenant or with one whose ideas on resource allocation more closely match those of the landowner. In the case where income distribution is affected over time, termination of the contract is essential. In this case, it is not possible for both parties to win and so termination is necessary to achieve renegotiation. Without transaction costs, contracts would be set so as to allow for daily adjustment of rental percentages and other contract terms as market conditions change. 36 In closing, Cheung notes that transaction costs and risk may result in different intensities of resource use. However, there is no evidence to show large differences in intensity of resource use for different leasing arrangements. Therefore, one would conclude that all arrangements are efficient, given private resource ownership and full transferability of resources. The ultimate choice of contract type will depend on the transaction costs associated with an enterprise and the risk averseness of the contracting parties. 2.5.2 Share Contracts in North American Agriculture The share contracts described by Cheung, although considered to be formal agreements in the environment of rural China, do not provide the legal security one would expect when entering into leasing agreements in late twentieth century British Columbia. However, some authors have found that in many instances the fear of a acquiring a bad reputation is enough to make people adhere to the terms of a contract, even if that contract is nothing more than a short discussion over a cup of coffee (Allen, 1992). Of course, this only applies in rural settings where news travels fast and "everybody knows your name". Most agricultural extension agencies would not recommend a strictly verbal contract and they provide guidelines for both leasee and lessor on what information a good sharecropping contract should include in order to avoid misunderstanding. Share contracts in forestry would have to include much of the same information. The Florida Agricultural Experiment Station and the Alabama Co-operative Extension Service of Auburn University both provide guides to assist landowners and lessees create sharecropping lease contracts. Table-1 shows the items that must be included in a share contract and a short description of each. Most of these items should be included in share contracts for forestry. The items in Table-1 3 are common to almost all land leasing contracts, the peculiarity here being the method of payment to the landlord. The Forest Resources Commission has already proposed Resource Management Agreements (RMAs) as a means of delineating the management responsibilities of the Crown and resource users, be they forest products companies or fur trappers. These agreements can be easily adapted to accommodate the peculiar provisions of share contracts. 2.6 Sharecropping in Forestry Share contracts in forestry are less common and less thoroughly investigated than in agriculture. There are, however, some examples of sharecropping-like contracts in forestry and some work has been done to explain the pros and cons of such contracts. 2.6.1 Increment Contract Zinn and Miller (1982), propose the increment contract as a means of increasing production from non-industrial private forests (NIPF's) in the Central Appalachians of the U.S. They interviewed foresters and forest industry executives to examine the factors affecting the feasibility of implementing increment contracts in this region. The results are very interesting and it is possible to see more clearly how share contracts may work in the British Columbian context. 3AII tables referred to in the text can be found arranged consecutively in the Appendix The three main objectives of the study were to define the key provisions of increment contracts, outline the advantages and disadvantages of increment contracts for both landowners and forest products companies and, finally, to suggest modifications to the general increment contract format that would aid its adoption in the study region. Four primary types of contract used to secure wood supply are described by Zinn and Miller. One of these is the cutting contract. In cutting contracts, the landowner is paid as timber is harvested or at regular intervals for harvests during that period. Payment is made based on volume cut and the lessee is allowed access for management and harvesting. There is no land rental fee. Increment contracts are a refined form of cutting contract. Payment is based on the annual volume increment achievable under management. This increment is based on site index, species composition, stocking, etc. and is agreed to by both parties through negotiation. The landowner is then paid a percentage of the value of this increment. An account of the volume paid for and removed is necessary to determine the lessee's standing at all times. Payment is made for all harvests, although the timing of the payments will vary among contracts. Usually there are payments at regular intervals and any time harvests exceed payment, there are additional payments made to zero the account. Other distinguishing features of increment contracts in the U.S. south include: 1) Regular payments are set at 65-75 percent of the value of the average annual growth and made quarterly. 2) Timber prices are agreed upon at the start of the contracting period, usually with an adjustment mechanism based on the U.S. Producers Price Index. 39 3) Contract lengths are typically 60 years or more. 4) Income from increment contracts is more subject to capital gains taxation than other contract types because the landowner retains an economic interest in the timber until it is cut. Increment contracts possess some features that may be attractive to landowners. For instance, the delay between investment and return is greatly reduced. This is an important factor for investors because the risk of an investment increases the further into the future the benefits are realized. Recurring transaction costs related to sales and marketing efforts are avoided by the length of the typical contracting period. Prior to this study, increment contracts had been used in the most competitive pulpwood markets in the South. The estimates of the area of NIPF brought under more intensive management through increment contracts varied between 350,000 acres (Greene, 1979) and 500,000 acres as surmised from information from Southern interviewees, (Zinn and Miller, 1982). Zinn and Miller then use the interview responses to suggest changes in the contract that would make it acceptable to the parties in the Appalachians. The increment contract in Southern forestry did not arise from the desire of landowners to increase the value of their land through intensive silviculture. It arose from the need of a large forest products firm to secure pulpwood supplies before a proposed kraft mill expansion could go forward. Unfortunately, there was not enough capital for the firm to choose their preferred option, which is to purchase land outright. A similar situation occurred in Alabama with a proposed linerboard mill. Increment contracts were used to secure access to timber without the large, up-front outlay of land purchase. These same firms at the time of 40 writing were able to purchase land outright and so were retiring their increment contracts. In B.C., it is not a question of capital availability, but land availability, that prevents the option of fee simple ownership. The increment contract may still be used in the South for securing particularly desirable land when outright purchase or lease are not options. Desirable land is defined as 500 acres or more, a piece that adjoins already held lands, one with existing good roads or with a species and age class profile of high value. Of course, there must be a net benefit to the firm if an increment contract is offered. Basically, the increment contract offers reluctant landowners an option more desirable than selling outright or leasing. Considering that the increment contract is the third best option from the point of view of forest companies and a preferred option to some landowners, the increment contract represents concessions from the forest companies which are compensated for by the relatively high profitability of these desirable tracts. Problems with the original increment contracts included the product pricing schemes and the contract length. In some agreements, the price of pine pulpwood was the only one agreed upon even though there were other kinds of wood being cut. Also, some were adjusted using the U.S. Department of Commerce Producer's Price Index. At times, this did not reflect changes in pine pulpwood prices. The obvious solution is to be more specific when determining product prices and adjustment schemes. The contract length is another matter. In the South, contracts were 60-90 years in length, that is, 2-3 rotations. The suggestion is to shorten this to 30 years in order to provide landowners with more flexibility to dispose of the land in the future. The landowners in the study region in general were receptive to the idea of an increment contract. The features that attracted them most were the prepayments (which take care of the capital shortage) and a guaranteed market for their timber. Tract size is the major factor that forest companies consider when determining whether increment contracts are viable on a certain piece of land. Tracts of 500 acres or more are generally most desirable. The average size of NIPF holdings in the study region is considerably smaller than this. Therefore, a smaller piece of land would have to be highly productive/profitable in order to be considered for increment contracts. The price paid to access these desirable properties then comes in the form of transaction costs of negotiating with many small landholders. Some firms believe the increment contract may aid in gaining access to many small, adjoining properties to create an area more efficiently managed. Apart from the improved pricing mechanism needed for future increment contracts, forest industry representatives felt that the percentage of mean annual increment used to calculate prepayments should be reduced to the area of 50 to 60 percent. For the tenant, this reduces the cost of time lags between outlay and return. It also reduces the risk associated with inaccurate estimates of growth and hazards to the timber. This adjustment makes sense in the context of share tenancy theory. If, in general, the land under increment contracts in the South is more productive than in the Central Appalachians, the landowner will be able to charge a higher rental percentage while still allowing the tenant to equal his alternative earnings. Presumably the alternative earnings would be similar for forest companies in the two regions. The length of contract would need to be reduced in order to give the firms flexibility in responding to changing markets and reduce the risk associated with inaccurate growth estimates. Methods of resolving any disputes between the contracting parties must be in place before any agreement is finalized. This may mean an arbitrator needs to be specified. At least some mechanism for conflict resolution is required. It may be possible to simply use the methods laid out in Sections 154, 155, 158 and 159 of the Forest Act for this purpose. Adoption of the increment contract is predicated on strong competition for timber. This makes sense given that most firms rank it third in preference to other contract types. This is true in a market of private landowners, unlike B.C.'s situation. However, the risk reducing aspects of the increment contract may be well received by the B.C. forest industry. Zinn and Miller then list many questions that need to be answered before the increment contract's ultimate usefulness in the study region becomes apparent. These relate to the quantitative issues of tract size, rental percentage, rotation length, etc. 2.6.2 Royalty Based Leases in New Zealand In New Zealand, leasing of forest land on a royalty basis (sharecropping) has been used to bring previously unproductive land into production (Grainger, 1969). The concerns which prompted the adoption of royalty based leasing agreements are also concerns to forest companies and government in British Columbia. These include the uncertainty of future yields and prices, and the long lag between investment in planting and receipt of income after harvesting. The 43 uncertainty of prices and yields is handled by changing the method of payment from an annual per acre charge to a predetermined percentage of the future stumpage value of the timber. The latter concern was addressed by applying only a minimal rent of five cents per acre per annum until the first marketable products were harvested and income earned. At this point, the previously determined royalty formula is used to determine each party's share of the income. The major difficulties with implementing this scheme were related to the determination of the economic rental for each tract of land. The areas where this leasing scheme was to be applied had never been used for commercial timber production. There were very few roads and the costs of delivering logs to mills, not yet in existence, were unknown. These difficulties do not exist to this degree in B.C. The purpose of pursuing this scheme in B.C. would not be to bring unproductive areas under intensive forest management but to intensify management thereby increasing the productivity of existing commercial forest land. 2.6.3 New Zealand Royalty Formula The forestry model used by Grainger took account of a number of factors important in determining the economic rent available from a tract of forest land. These include initial vegetation, topography, location, intensity offending, and cost of roading. Even this small list presented considerable problems when it comes to applying them in a forestry model. There is much uncertainty related to several of these items such as roading and location when referring to distances to mills and price-points that do not yet exist. The terms of reference for the study included the phrase "rough justice for all". This seems to have been necessary to keep the model tractable. The steps taken to determine the economic rent of 44 forest land included the determination of planting and management costs based on terrain and vegetation cover. All revenues and costs were discounted using a rate of 6^% per annum which was the opportunity cost of the land under agriculture as opposed to the capital used to invest in forestry. The data regarding revenues and costs from a particular tract were then used to determine the rent available and each party's share of the stumpage value. Land rent was calculated as follows: Land Rent = (Total Income)-(Operating Costs)-(Logging Profit)-(Interest on Capital) The annual stumpage value was calculated as such: Stumpage = (Total Income)-(Logging Costs)-(Logging Profits) The stumpage calculated this way, after Land Rent is subtracted, returns to the firm their operating costs plus interest on capital employed. In this study, the stumpage value was divided on an 80% lessee, 20% lessor basis. The conclusion of the study was that if the landowner charges a royalty of 20% of the stumpage value of all produce removed from the land, he will have received the full economic rental of the land. 2.6.4 Share Contract The following is a proposal for a sharecropping contract that may be useful in B.C. and is the starting point of this study. Haley and Luckert (1989) proposed silvicultural contracts as a means of sharing the costs of silviculture and providing equity in the future timber, therefore reducing the risks to the tenure holder. They include silvicultural contracts among their recommendations for Tree Farm Licenses and methods of funding silvicultural investment. 45 A silvicultural contract is a proposal to undertake some silvicultural activity in old-growth, second-growth or plantation forests. Areas under silvicultural contracts would have all stumpage charges and rental fees replaced by an annual payment to be determined through negotiations. In lieu of an annual rent, the Crown may accept an equity share in the timber. All, or part, of the annual rent may be forgone. The Crown's equity share is calculated as follows: (PV Crown Inputs) (Crown Equity Share) = (PV Total Inputs) Tables 2 and 3 (from Haley and Luckert 1989) show sample calculations of equity share for two hypothetical silvicultural projects. The fertilization project involves an initial outlay of $300/ha and annual overhead of $8/ha/annum. In this example, the Crown is charging $200/ha/annum for the right to use the land. The equity shares for no rental payment and y2 rental payment are also calculated. No physical inputs other than land are supplied by the landowner (Crown), although other inputs such as growing stock could be supplied by the Crown. The equity share calculation shows the portion of benefits each party receives from the treatment. In the case of the fertilization procedure with no rental payments, the Crown is entitled to 80.2% of the value of the increment in timber volume resulting from the treatment. In share tenancy theory, 80.2% is the rental share. As in agrarian share tenancy contracts, the landowner may accept 80.2% of the value of the crop, or the corresponding quantity of the crop. An additional feature of silvicultural contracts is the option of the landowner to vary the ratio of equity share to rental payments over the contract period. Tree Farm Licenses are replaceable every ten years and at this time the landowner may opt for a different ratio of rental to equity for the next ten year period. This option is worked out in 46 table-3. This project involves $500/ha initial outlay with $8/ha/annum overhead costs. The rent is $12/ha/annum. The silvicultural contract would be a part of a management plan for an entire Tree Farm License. The procedures outlined above would apply only to areas for which a silvicultural contract has been negotiated. All other requirements and provisions of Tree Farm Licenses as they exist today would still apply to areas not under silvicultural contracts. What has to be kept in mind is the opportunity cost of forgoing silvicultural investments that yield a net benefit. Large reductions in the AAC are imminent in many areas of B.C. so it is clear that timber supply is a problem (Price Waterhouse, 1995). With silvicultural contracts, the effort put into negotiations buys security through accountability. This doesn't eliminate the fact that governments have the power to change the rules, but it is in the B.C. provincial government's interests to establish a stable investment environment given the extremely long length of time a forest takes to grow. Luckert (1991), concluded that holders of Tree Farm Licenses felt least secure about the stability of stumpage fees, silviculture expenditure reimbursements and chances of recovering accumulated Section 88 credits4. In all three cases, tenure holders felt the instability would have a negative effect on their firm. Silvicultural contracts reduce the concern for fluctuating stumpage charges. The issues of silviculture expenditure reimbursements and accumulated Section 88 credits are no longer applicable. 4Section 88 of the Forest Act which provided credits against stumpage payments for approved forestry costs was repealed in 1987 and so is no longer applicable. 47 2.7 Determination of Land Rent A prerequisite for maximizing forest land rent in B.C. is a formula for calculating that rent. This is a necessary step for implementing share contracts because the returns available from a tract need to be quantified before they can be divided between the two parties. The schemes proposed by Grainger (1969) and by Haley and Luckert (1989) include an actual formula for calculating land rent and a value for land rent, respectively. In the latter case, hypothetical examples of how silvicultural contracts would function are given and include an annual charge to tenure holders, which constitutes the Crown's contribution to the forestry operation if foregone. Underlying that figure is a calculation of returns to forestry operations which will be discussed here. In addition to the formula used by Grainger, other authors have presented a methodology for calculating the value of long-term leases. Shaffer (1984) describes a methodology to value long-term contracts using an option pricing model and Shaffer et a]. (1985) use simple financial discounting of cash flows from forestry operations to determine the initial annual payment for a long-term lease from both the landowner's and forest company's perspective. This latter method is an example of the type of calculations that will be required to implement share contracts in forestry. The calculation conducted from the landowner's perspective compares two options: tending, harvesting and marketing the timber on his own or leasing the land to an existing forest company to conduct the same operation. Leasing the land is assumed to be the less risky option and consequently the risk-adjusted discount rate is lower than for the former option. The situation is that there is mature timber already on the site that will be harvested and sold by the leasee through a separate transaction. The leasee is then responsible for reforestation and is again responsible for 48 reforestation at the end of the rotation at which time the lease is terminated. The calculation for the forest company looks like this: [After Tax PV of Harvest Income]-[PV of Initial Reforestation Costs] -[After Tax PV of Final Reforestation Costs] -[After Tax PV of Annual Management Costs] = [After Tax PV of Lease Payments] The calculation is similar for the landowner's situation but includes some tax credits that are not significant in the firm's case. The equation is then solved to determine the minimum lease payment the landowner would be willing to accept. These calculations are done with the assumption of profit maximization; clearly the B.C. government is not concerned solely with this goal. Although forest companies will only be considering financial criteria in their evaluations, the Crown has many non-financial goals for forest management. These include wildlife and fish habitat, biological diversity, soil conservation, water conservation, recreation and environmental amenities, and employment (Brumelle et al. 1991). The Crown may achieve these goals through control over the types of activities authorized in silvicultural contracts. All approved projects must comply with the province's new Forest Practices Code and, therefore, represent activities acceptable to the government. Approved projects must satisfy the criteria of financial efficiency (positive NPV) and all regulations regarding forest land use. More specifically, the Crown may approve projects that do not show a net financial benefit when non-market benefits are considered. However, forest companies will reject any project which does not yield a net financial benefit to their firm. By adjusting the amount of rent payable to the Crown by forest companies, projects that would not be financially viable under one level of rent may become viable at lower rental rates. For more extreme cases, the Crown 49 may opt to subsidize a project to the extent that not only is rent reduced to zero, but payments are made to the licensee to undertake the project (Haley and Luckert, 1995). The determination of financial efficiency involves several steps. Cash values must be determined for all market inputs and outputs. The uncertainty attached to these values generally will increase the further into the future one must predict. Once the timing and amount of cash flows related to a project are determined, they must be discounted to calculate the NPV. The choice of discount rate is equally important, or more important, than the initial estimates of input and output values. With cash flows extending many decades into the future, small adjustments of the discount rate can have significant impacts on NPV. Each party will conduct their own appraisal of each project based on their assumptions of future benefits and costs but equity shares will be calculated based on a mutually agreed cash flow profile. The discount rate used to calculate the present value of the cash flows must also be agreed upon, but that should not prove to be a major stumbling block in negotiating silvicultural contracts because the equity shares of both parties will be affected (Haley and Luckert 1989a). The choice of discount rate for the tenure holder's appraisal will reflect the desired rate of return on silvicultural investments including a risk premium. The rate of return calculated from the negotiated cash flow profile will be greater than or equal to the tenure holder's private discount rate. Clearly, the tenure holder will not agree to projects that do not provide the required rate of return. The explicit terms of a silvicultural contract will presumably reduce risk to the tenure holder and therefore a smaller risk premium is required. The lower the discount rate, the greater the number of projects become viable. Also, the silvicultural contract may be applied to projects with short planning horizons such as late rotation fertilization, and so the risks associated with predictions far into the future are reduced. The return from silvicultural investment is ultimately limited by the rate of growth of the trees, but if the risk related to uncertain prices and management responsibilities is reduced, a more profitable investment environment ensues. 2.8 Indexing of Economic Variables In the case of silvicultural contracts, indexing systems are required if the Crown elects to receive an annual rent as opposed to a share of the output. However, the Crown has the opportunity to mix rent and equity share during the contract period and so a mechanism must be in place regardless of whether the Crown elects initially to receive an equity share. As noted earlier, schemes for adjusting product prices must be set out in detail in an increment contract. Essentially, the value of the land changes with the price of its output and the costs of production. If, for instance, the product price increases more than anticipated, the indexing system would adjust the lease payments upwards. Therefore, unexpected real increases in the land value due to product price increases would not result in a windfall gain to the tenure holder, nor would the Crown be completely shielded from product price decreases. That is, an unexpected decrease in the product price would result in decreased lease payments. A common method is to use the Wholesale Price Index (WPI). Hotvedt and Tedder (1977) describe the use of the WPI in adjusting future stumpage prices under long-term leases. The WPI is calculated from a sample of 2,700 commodities sold in primary markets in the U.S. Stumpage payments are adjusted by the following formula: WPI of Adjustment Year Year 1 Stumpage Price x WPI at Year 1 Clearly, an index of 2,700 commodities is unlikely to closely match the price movements and production costs of specific forest products. In the U.S. South, problems were caused in areas under increment contracts because the WPI did not accurately reflect the value of pine pulpwood. Also, the price of pine pulpwood did not accurately reflect the value of the timber being removed from some areas (Hotvedt and Tedder, 1977). In addition to the problems caused by inaccurate measurement of relative price changes for sawtimber stumpage, there is often a contractually stipulated ceiling on the WPI to be used in the above formula. It is possible for the contracted ceiling to be reached soon into the contracting period and this will result in a windfall for the timber buyer if the price of stumpage continues to rise. What is needed is a more reliable measure of the value of standing timber over the length of a typical contract. Hotvedt and Tedder (1977) propose several alternative indices that more closely reflect the value of the resource. The WPI for softwood lumber, WPI for southern pine lumber, and an index for southern pine sawtimber stumpage sold from private lands in Louisiana (SPI) were all greater than the WPI for all commodities from about 1968 onward. In B.C., Vancouver Log Market prices may be used in determining the extent of price-changes for timber harvested under silvicultural contracts on the coast. An index for the interior is a little more elusive; however, the Ministry of Forests is currently experimenting in sale of logs as opposed to timber in the interior. If the project expands to a sufficient degree, the prices realized there may be used as an index. In any case, the index must be useful in reflecting price changes of the products produced in the area covered by the particular silvicultural contract. Klemperer (1986) proposed two lease payment schemes with different characteristics regarding the indexing of stumpage prices. In Case 1, lease 52 payments are corrected for inflation only. Real stumpage price-changes are not considered until the end of the rotation at which time the landowner is compensated for any changes in stumpage prices over and above the general inflation rate. Paying out this compensation at the end of the rotation avoids the problem where the real stumpage price is lower at the end of the rotation than at some point during. When this occurs, the leasee is paying for price increases that will not be realized when the timber is harvested. Case 2 adjusts lease payments by setting a rate of increase of stumpage prices for the contracted term and lease payments are adjusted annually. This is riskier for both parties given the unpredictability of prices so far into the future. 2.9 Biological Risk Biological risk is also involved in silvicultural investments. A forest stand is subject to many perils during its growth such as fire, insects, blowdown and disease (Weetman, 1991). All of these factors may affect the quantity and quality of wood available at rotation's end. Also, growth may simply not match predictions made when a share contract is negotiated. This is one of the reasons for adopting share contracts. Although predictions are made about future growth, the important point is not how much wood is available at harvest time, but how the wood is to be shared. If the volume and quality at harvest does not match predictions, it does not alter the proportion that each party receives. This is true whether actual volume and quality is greater or less than predicted. Although there is nothing in share contracts that can actually reduce the occurrence of these risks, the method of sharing the benefits and costs of silvicultural activities helps defray the risk borne by one party. As with the affects of changes in product price, each party is partly shielded from yields that fall below expectations but also will not capture the full benefits of yields that exceed expectations. 3.0 RESULTS This chapter attempts to show how the costs and benefits of forest regeneration and stand tending can be divided between the Crown and tenure holders in B.C. by using a sharecropping model. The method of describing how share contracts would work in B.C. begins with a few examples of the cash flows related to growth and harvest of second-growth stands on the Coast and in the Interior. The major assumption is that there are silvicultural prescriptions that will result in positive net present values given the assumptions of future costs, product prices and discount rates. However, there may be situations when the direct financial benefit is negative, but it is still desirable to carry out the silvicultural treatments due to enhancements to non-market benefits of forest growth, e.g. carbon sequestration (Haley and Luckert, 1995). A discussion of this possibility will follow in a later section. To illustrate the implementation of share contracts, the cash flow profiles of several silvicultural regimes on the Coast and in the Interior will be used. Initially, only those treatments which result in positive net present values will be used. This is because, as previously stated, forest companies will not desire to enter into investments which they know will not provide an adequate rate of return. Following this analysis, an example will be given of a case where the Crown subsidizes the tenure holder's activities in order to achieve a socially desirable outcome. Once the NPV of reforestation and intensive silviculture for a stand have been determined, the process of determining how that value is to be divided between the Crown and tenure holder may begin. That is, the amount of the payment to the Crown for the use of the land may be determined. 3.1 Reforestation and Treatment Scenarios The methodology followed by FRDA Report #014 (Nawitka Resource Consultants, 1987) to determine NPV for various silvicultural treatments mimics that followed by Grainger (1969) in calculating a royalty formula for use on Crown land in New Zealand. Of course, the basic situation is the same: cash out for forest management and harvest, cash in for sale of timber. Planting costs are not explicitly stated in the FRDA report because the emphasis was on the incremental change resulting from an intensive treatment and planting costs are assumed to be the same for the treated and untreated stands. The incremental change from an intensive treatment was calculated for both planted stands and naturally regenerated stands. Although some of the treatments evaluated by Nawitka (1987) are described as intensive treatments, the changes made to the Forest Act in 1987, make them part of basic silviculture required for the stand to reach the "free-to-grow" stage. The particular treatments considered in that category are planting, brushing and weeding, and juvenile spacing. Fertilization is still considered an intensive treatment. Nevertheless, whether a treatment is considered intensive or basic, the same principle of discounting applies. Forest companies are required, by law, to perform the basic silvicultural treatments but those treatments must be lumped in with the intensive treatments for purposes of determining the NPV of forest operations on a given tract. Recall that one of the reasons for examining share contracts is to preclude the need for legislated basic silviculture. Although the following examples deal with a silvicultural regime beginning with bare land through to harvest, a share contract may be negotiated at any point during a rotation in order to fund silvicultural activities not mandatory under the free-to-grow legislation. For instance, a firm may wish to undertake a pruning or fertilizing operation on an existing stand but is unwilling to do so under the normal terms of the tenure. If a share contract provides the proper incentives for them to do so, one may be negotiated at that time. The shares of each party are then calculated based on the increment in volume and/or value attributable to the treatment. This case is worked out in Scenario-4. Scenarios 1-3 begin from bare land and include all the basic treatments commonly required to reach the free-to-grow stage of development. Scenario-4 is an example of the application of a share contract to a late rotation stand. A fertilization project on timber near it's rotation age is worked out to show how share contracts can be applied to existing timber. Tables 4-7 contain the biological, operational and economic variables for each scenario. The data sources are noted below each table. Scenario-1 is a coastal Douglas fir plantation on a good site. The silvicultural treatment includes surveying, planting, brushing and weeding, juvenile spacing and fertilization. The pertinent information for this example is summarized in Table-4. Scenario-2 involves an interior white spruce plantation. The silvicultural activities include site preparation, planting, brushing, and pre-commercial thinning. The third scenario also involves a coastal Douglas fir plantation, but there is the addition of a commercial thinning at age 50. Scenario-4 also involves coastal Douglas fir. Unlike the other scenarios, the treatment is made to an existing stand with the equity shares of the project 57 calculated based on the costs and increment produced from the treatment without including previous treatments and costs. Now that the relevant biological, operational and price data are defined, the numbers must be converted into a common form. This can be either future dollars or present dollars. NPV will be calculated based on the values in tables 4-7. The results of the discounting process are presented in tables 8-11. 3.2 Calculation of Net Present Value In practice the following financial analysis would represent a compromise between the Crown's view of the costs and benefits of the operation and the firm's. The purpose of these calculations for each party is to determine how much they are willing to pay for the right to use the land, on the part of the firm, and what they can realistically extract in rent, on the part of the Crown. Costs and prices are assumed to be constant in real terms and a discount rate of 4% is used except for Scenario-2 which used a discount rate of 3.5% The lower the discount rate, the higher the net present value and therefore, the higher the rent. The interior case, with a 4% discount rate has a negative NPV and could be used as an example of the non-market benefits of reforestation justifying a public subsidy of silviculture. Given these values, the Crown could charge a maximum of $1,313/ha (a rent of $56/ha/annum over the period of the rotation) and the firm would recoup their operating costs and overhead plus 4% annual real rate of return before taxes. The negotiation of a share contract replaces all stumpages and fees with a rental payment. The rent itself is negotiable, but calculations like those above 58 would be necessary to determine realistic payments. The calculations are also necessary if the Crown elects to take a portion of the harvest in lieu of annual or periodic rent payments. The Crown's percentage share in the project is based on the ratio of their inputs to the total inputs. Their input in the above case is the land used for timber growing and the value of that input is the residual of the harvest revenue less the costs of reforestation, stand tending, harvest and transport. As stated, the residual or rent is the equivalent of $56/ha/annum. This would be the amount paid to the Crown by the tenure holder every year for the duration of the rotation. There is flexibility here in that the Crown may wish to receive only a portion of the $56 annual rent each year with the balance made up by an equity share in the timber at harvest time. This would be desirable if the Crown wishes to make more timber available to small operators or to simply increase the volume of timber available for competitive bidding by all operators. 3.3 Calculation of Equity Shares At this point, the equity shares of each party in the future crop may be calculated as per the formula given previously. Tables 12-15 show the contributions of each party and their respective equity shares. Shares for zero rental payment and half rental payment are given. The zero rental case means the firm does not make any payments to the Crown for the use of the land during the course of the rotation. The Crown's payment comes at the end of the rotation. In Scenario-1, the Crown is entitled to 29% of final harvest volume or 29% of the value of the final harvest. Accepting payment in the form of logs would allow the Crown to pursue the development of competitive log markets, while taking the cash would more immediately satisfy the fiscal goals of government. Any combination of cash rental payments and equity share in the timber crop could be negotiated along with the other aspects of the contract. The 1/2 rental case is an example. In this case the Crown receives $28/ha/annum, half of the full annual rental rate, and then retains a 15% share of the final harvest. When accepting a share of the harvest volume as payment, the actual wood delivered should be a representative bundle of species and grades. For Scenario-2, under the zero rental case the Crown would receive a 6% share of the final harvest. Under the half rental case they would receive half of that (3%) plus a rental payment of $3/ha/annum. With the Crown accepting the full rental they would receive $6/ha/annum. The full rental case for Scenario-3 gives the Crown $25/ha/annum. The zero rental case gives them a 17% equity share in both the commercial thinning harvest and the final harvest. The half rental case gives a rent of $12.50/ha/annum and an 8% equity share in both the commercial thinning harvest and the final harvest. The increment from the treatment in Scenario-4 results in an NPV of $233/ha. For the zero rental case, the Crown has an equity share of 45%. The annual rent equivalent of the NPV over the eighteen year period of the contract is $18/ha/annum. 3.4 Non-Market Benefits As stated earlier, there are many benefits to reforestation that do not accrue to the tenure holder and/or are not measured by prices in a marketplace. In cases where the NPV of a reforestation project as calculated above is negative, there is no financial incentive for the tenure holder to carry out the 60 project. However, from the Crown's point of view it may be desirable to carry out the project because of non-market benefits of the project. Haley and Luckert (1995) show how these benefits can be incorporated into share contracts and used to adjust the equity shares of the project accordingly. Following their method, the example below shows how the inclusion of carbon sequestration affects the equity shares of the Crown and tenure holder and hence the viability of an otherwise unviable project. A prerequisite for performing these calculations is to assign a dollar value to the non market benefit being included as an output of the project. In the case of carbon sequestering, that value to the Crown could be the cost per unit of carbon sequestered by the least expensive alternative means. The carbon does not have to be sequestered, it could be prevented from being released into the atmosphere in the first place by reduction of fossil fuel consumption for instance. In any case, a value to the Crown for the benefit of increased carbon sequestration need not be determined precisely, it is really only necessary to determine if the benefit derived from carbon sequestration is at least equal to the shortfall of the NPV for the project. That is, if a project has a NPV of -$100/ha, the benefit of carbon sequestration need only be $100/ha for the project to be viable. It is only necessary to be more specific about the value of carbon sequestration if there is a need to choose between a number of competing projects as opposed to simply determining if a project is viable in its own right. The benefit of this approach is to internalize the benefits of silvicultural investment from the firm's perspective. As a business entity, the firm is not concerned with sequestering carbon, or water quality or biodiversity. Therefore, these values are only coincidentally enhanced by their investment decisions. This method accounts for these values in the investment decision process by 61 determining what share of the costs of each project should be borne by the Crown. The inclusion of these values also affects which projects are most desirable for the people of B.C. as a whole insofar as the values placed on these non-market benefits reflect their value to the people of B.C. 3.4.1 Carbon Sequestering As an example of how these additional benefits can be worked into share contracts, the numbers used in scenario-2 are used with the exception that the discount rate used is 4% per annum and a present value of $1000/ha will be used as the benefit to the Crown for the carbon sequestered as a result of the project. The value of $1000/ha is not meant to imply that this is really what the carbon sequestration is worth but is merely used to facilitate the explanation of the technique. Table-16 shows the relevant values for the reworked scenario-2. See Haley and Luckert, (1995) for more similar examples. Due to the negative NPV without including carbon sequestering (-$513), the firm would be unwilling to undertake the project. But, if the Crown feels that it derives a benefit of $1,000/ha as a result of the project it would be willing to pay up to that amount to the firm to undertake the project. The firm's contribution to the project is $2,413. The benefit that the firm can derive is only $1,900. Including the benefit of carbon sequestration, the total benefit of the project is $2,900. Of this, the Crown receives $1,000 (34%) and the firm receives $1,900 (66%). The share of the costs of the project are based on the share of the benefits each party receives. In this case, the total costs of the project including the return to capital employed is $2,413. Based on the benefits received, the Crown should contribute $820 and the firm $1,593. The Crown may contribute it's share by providing the growing stock to the firm as well as a cash reimbursement to make up the $820 contribution or simply make a reimbursement of $820 up front. In terms of provincial cash flow, subsidizing silviculture for the purposes of sequestering carbon may indeed have a positive impact. B.C. has entered into international agreements for the limitation of greenhouse gases and there may be direct financial costs of upholding these agreements, i.e. stricter vehicle emission standards requiring increased vehicle maintenance or early retirement of older vehicles. It may well be that we can reduce our net carbon emissions more cheaply by sequestering carbon in growing timber than by reducing emissions. 3.5 Adjusting Economic Variables During the Contract Period Over the course of the rotation, the financial variables may change. In fact they are almost certain to change and may differ markedly from predicted values. The changes in the financial variables can be of two types. The first is the change in prices and costs simply as a matter of inflation. The second is real changes in prices and costs which can affect the fairness of the negotiated rent. If the price of the product falls, or the costs of management increase more than anticipated, the negotiated rental rate may be unrealistically high. The opposite is true if product prices increase and/or costs decrease. Therefore, a means of indexing these variables must be agreed upon. Also, the actual growth of the trees may differ from the predictions. Even though prices and costs may match predictions, the volume of merchantable timber at rotation's end may not. The nature of the contract is such that it is in the best interests of the party responsible for growing the trees to ensure that work carried out is of high quality and actually result in a healthy stand. The following indexing system protects both parties from movements in costs and price but does not adjust for variations in end volume. There is no stipulation that a certain volume must be produced but there are requirements for input intensity. Once again, the incentive is to produce as much as possible given the negotiated level of inputs. By tying the annual lease payment to an index of some sort, the tenure holder and the Crown are shielded somewhat from the vagaries of the input and output markets. The simplest index to use would be the Industry Product Price Index (IPPI). This index can be used to adjust the annual lease payment for inflation but any change in the lease payment due to real changes in input and output prices would not be included. One scheme is to adjust lease payments annually for inflation only. At the end of the rotation, when the actual harvest income is realized, compute the real change and settle any balance at that time. If the price of wood increased over and above any assumed amount, or the costs fall, the tenure holder makes a "balloon" payment to the Crown. If the opposite occurs, the Crown refunds the tenure holder the difference. The problem with adjusting lease payments annually for changes in the real product price is that the final real product price may be lower than it was at some time during the rotation. Therefore, the tenure holder is paying for gains that are not realized. A variation of the above scheme could be used to correct for this. Annually, lease payments could be adjusted for inflation using the IPPI. At the end of the rotation, any real changes in price could be calculated and paid. Most projections of product price levels assume real increases, but if there are real decreases in product prices, this indexing system would account for those also. 3.5.1 Choice of Index A characteristic feature of many long-term forest land lease agreements is the linking of lease payments to an index such as the consumer price index or wholesale price index. The purpose of this is to account for changes in stumpage prices over the length of the contract. A good index would accurately reflect the actual changes in the profitability of commercial timber production and be agreeable to both parties. The index used below is the IPPI for all commodities except food and beverages. It does not differ markedly from the index of all commodities but it is reasonable to use because the price of food and beverages is not likely to be of direct importance to the value of timber growing operations and it is conveniently calculated as a separate index by Statistics Canada. The lease payments, that is the land rent, originally calculated are a residual of the harvest revenue less management and harvesting costs and the cost of capital. Depending on the index used to adjust the periodic lease payments for inflation there may be an inequity in the lease payments if prices and/or costs changed in a way not reflected in the chosen index. A general industry price index may not accurately reflect the price changes of the forest products covered under the silvicultural contract. There are more specific price indices such as those found in Statistics Canada publication #62-011. These include a lumber and timber index as well as a lumber index for interior SPF and a lumber index for coastal Douglas fir. Although with silvicultural contracts we are dealing with logs and not lumber or pulp, most B.C. forest products companies are vertically integrated and, combined with restrictions on export of logs, the relative changes in lumber and pulp prices could reasonably reflect the relative changes in profitability of timber growing activities. The use of one of the more specific price indices would closely match the changes due to inflation and any real changes. The advantage of the more general index would be that it would reflect changes in the costs to the tenure holder. Perhaps the difference between the general index of which the price of coastal Douglas fir lumber is a small component and the index for coastal 65 Douglas fir could be used to index the lease payments for real changes in the profitability of the timber growing operation. That is, if the index for coastal Douglas fir is increasing at a greater rate than the general industry price index, lease payments would be adjusted upwards in real terms because output price is increasing more than input prices. This is an important feature of long-term contracts of all kinds and the choice of a good index is something that must be investigated further. It may also be desirable to construct indices specifically for use with silvicultural contracts in B.C. Although the specific product price indices provided by Statistics Canada are probably satisfactory for determining changes in lease payments based on output price changes, an index of input price changes may be useful. 3.5.2 Real Product Price Increase In Scenario-1, no real changes in costs or timber prices were assumed. It was also assumed that the Crown had the option of receiving an annual lease payment negotiated based on the cash flow profile of the operation. If the Crown elects to receive an annual lease payment, that payment will continue to be fair to both parties only if the assumptions regarding cost and price changes hold. The following is an example of how an indexing scheme could be implemented to account for inflation and unexpected real changes in prices. Scenario-1 will be used with the exception that the timber price will increase by 0.3% per annum in real terms. This results in a real timber price of $89/m 3 instead of $72/m 3 at rotation's end. Table-17 shows the calculation for the new NPV given the timber price increase. Under the old cash flow profile, the Crown was entitled to 3 7 % of the revenue from the sale of the logs. This amounted to $1 ,643. With the increased timber price, 3 7 % means a revenue of $2,032. The firm receives 6 3 % or $3,459. Recall that the NPV represents the maximum amount the Crown could charge for use of the land while allowing the tenure holder an adequate return on their capital. In the above case this means that the Crown could charge $2,681 /ha and the tenure holder would still get an acceptable return to capital because their required return has already been deducted to calculate the NPV. Notice that the Crown receives an increased return over the original scenario and the firm also receives more. In this case, the unexpected real price increase does not result in a windfall gain to the tenure holder although they do benefit from the price increase. Also, the benefits of the rental share system are evident from the fact that the price movement rewarded both parties. In the case of fixed real lease payments, the Crown would not be able to benefit from the price increase. Obviously, if the price had decreased, both parties would share the decreased returns. If the Crown is electing to receive periodic lease payments, those payments will need to be indexed to remain fair over the duration of the lease. The calculation for indexing lease payments using the Industrial Product Price . _. /,i-,r^.x • x x r- . 'PP' of adjustment year Index (IPPI) is: Adjustment Factor = IPPI at year zero For example, assuming the previous lease arrangement for coastal Douglas fir had been negotiated in 1986 and an annual lease payment is to be made to the Crown. The originally calculated annual payment is $70/ha/ann. The results of applying the above calculation to the annual lease payments are shown in table-18. The problem of which index to use is apparent when the index for coastal Douglas fir is examined in comparison to the overall IPPI. Over the period shown in the example, the index for coastal Douglas fir lumber went from 100 in 1986 to 208.5 in 1995. The actual real change in profitability of the timber growing enterprise is further dependent on what happened to input prices over this period. If they closely matched the movement of the all-inclusive IPPI and the index for coastal Douglas fir lumber prices is used, then the lease payments calculated above underestimate the maximum rent the Crown could charge. The change in the price of coastal Douglas fir lumber over this period is quite spectacular and not many people would expect those kinds of gains to continue indefinitely; however, this example does serve to point out the pitfalls of the all-inclusive index. To account for real changes in product price, the above calculations need to be carried out using an index that closely matches the price movements of the product in question. The IPPI for coastal Douglas fir lumber would accomplish that in this case and so would represent a good index. The drawback of indexing payments continuously throughout the length of the contract has been pointed out earlier. The drawback is that the index may be larger at some times during the rotation than at the end of the rotation when the benefits are realized. This effect is accentuated with the more specific indices which have a larger variance. From the tenure holders' point of view it does not benefit them that the price of Douglas fir lumber doubled from one year to the next if the stand that the lease payments are being calculated for is only ten years old. It may be necessary to employ a formula to "smooth" the price increases and decreases over the course of the rotation to eliminate any problems with cyclical swings in the chosen index during the rotation. This would be desirable if the index was at a very high level for a time early in the rotation and then fell, only to climb steadily back up to the early high level towards the end of the rotation. In this case, although the index ends up being at its highest at the end of the rotation, the "loading up" of lease payments early on because of the high level of the index at the beginning of the lease doesn't represent the trend in real prices over the rotation as a whole. These kinds of peaks (and valleys) can cause problems with regards to the cash flows of both parties and including the time value of money can significantly change the NPV of benefits to each. 3.6 Cash Flow Implications for each Party The intent of adopting share contracts in B.C. forestry is to increase the quantity and quality of silviculture practiced on Crown land. The success of these contracts depends on support from both the Crown and tenure holders. An important factor in determining the benefit of these contracts to each party is the impact they will have on the cash flows of each. Despite any long term benefits these contracts may generate, if the short term cash flow changes they produce are unacceptable, there will be little enthusiasm for their adoption. The following two sections discuss the impact of share contracts on the nature of the cash flows of each party in relation to the status quo. 3.6.1 Cash Flows for the Crown The Crown currently collects the majority of its direct revenue from its forest land in the form of stumpage. The determination of stumpage rates is made by applying detailed formulas including variables such as timber quality and operating costs. Approximately two thirds of the direct revenue to the Crown from forestry is in the form of stumpage. Other sources of revenue are the rents and royalties attributable to various tenures and revenue from the Small Business Forest Enterprise Program as well as minor contributions in the form of export fees, scaling fees, range fees and interest (Ministry of Forests Annual Reports, various years). Expenditures of the Ministry of Forests include a wide range of activities including silviculture, research and development, enforcement of forest practices, valuation, inventory assessment and others. 3.6.1.1 Expenditures The adoption of the share contract is meant to have a favourable impact on the level of enforcement and auditing of silvicultural performance required on those lands covered by share contracts. The granting of equity in future timber should decrease incentives for tenure holders to perform below standard and hence decrease the need for supervision. The opposite effect of adopting the share contract would be the need to establish a department responsible for negotiating these contracts. It may be possible to have that responsibility taken on by existing employees however the addition of this new contract would likely require increased staffing. The inclusion of the share contract in tenures does not eliminate the current provisions of a tenure. A share contract is negotiated on a stand by stand basis and so all requirements on the part of the Crown and tenure holder remain intact for the remainder of the land included in the tenure. Therefore, the bureaucracy required to manage those provisions must also remain intact. Expenditures on growing stock or other silvicultural activities may also be included in the Crown's responsibilities as part of a share contract. Currently, the costs of basic silviculture are the responsibility of the tenure holder and any part of that responsibility taken on by the Crown as part of the share contract would constitute a new expenditure on their part. Of course, with increasing share of the costs of silviculture comes a corresponding increase in 70 the share of the benefits. From this/it seems that the Crown expenditures are likely to increase with the adoption of share contracts, at least in the short term. 3.6.1.2 Revenue Under the provisions of share contracts as outlined here, the negotiation of a share contract would eliminate all existing rents, royalties, stumpage and other fees attributable to the area covered by the contract. In their place, an annual rent and/or share of the harvest revenue is paid to the Crown by the tenure holder for the use of the land. In a case like Scenario-4, the stumpage and other fees applicable to the volume existing without the fertilization treatment are still collected. The special payment provisions of the share contract only apply to volume produced as a result of the treatment. As stated earlier, the purpose of adopting share contracts is to increase the quantity and quality of silvicultural effort on Crown lands in comparison to the current system of mandatory performance standards with no equity in future timber for tenure holders. Even with an improved tenure system that provides incentives for increased investment in silviculture, there will be a reduction in the provincial AAC. The hope is that the falldown can be lessened by an improved tenure system. The amount of revenue the Crown can earn from timber production on its lands is directly proportional to the quantity and quality of the timber being produced. If share contracts have a positive impact on that, the amount of revenue available to the Crown will be increased in relation to the status quo. The disposition of that revenue may differ from the current situation however. Revenue from share contracts can be received in two ways: annual lease payments and/or a share of the harvest revenue. The determination of these revenues has been discussed earlier. In terms of cash flow, the Crown could opt for a steady stream of revenue by choosing to accept annual lease payments or it could forgo those payments and receive a lump sum when timber is harvested and revenues are realized. Currently, the annual rental payments made by tenure holders are a small part of the revenue of the Crown. Stumpage is the major revenue source and is realized when harvested timber is scaled. In this sense, the option of receiving a portion of the harvest revenue or a portion of the harvest itself is no different from the status quo. The decision whether to accept annual lease payments or a share of harvest revenue is a question that would have to be answered within the context of provincial budget planning. The desire of the Crown to establish a provincial log market would also have a bearing on the decision to accept rent or equity as would the desires of the firm with which the Crown is negotiating the contract. What share contracts provide is flexibility in the method of payments so that the method most acceptable to both parties can be chosen. 3.6.2 Cash Flow for the Firm To firms, the length of time capital is tied up in growing trees is a major factor affecting the profitability of silvicultural activities. Given such long time frames, small changes in the discount rate used to calculate present values of cash flows can have a major impact on the financial viability of forestry projects. The factors determining the discount rate include the rate of return desired by the firm on the investment and the risk associated with the investment. The greater the risk the greater the potential returns desired. One effect of the share contract is to hopefully reduce the risk to firms and hence the size of any risk premiums included in their discount rates. The risk present in investments with benefits so far into the future and the consequent length of time capital is tied up represent the major financial hurdles as far as the firm is concerned. Share contracts have an impact on these concerns to one degree or another depending on the particulars of payment and responsibility negotiated in each contract. 3.6.2.1 Expenditures The specific terms of the individual share contract can greatly affect the expenditure cash flow of the firm. There may be a considerable sharing of initial management costs with the Crown which would certainly, in itself, be a benefit to firm over the current situation where they are fully responsible for the costs of regeneration. The sharing of costs, of course, goes hand in hand with the sharing of benefits but with decreasing up front expenditures comes decreased risk. The method of payment for use of Crown land also has an impact on the cash flow of the firm. There is basically the choice of relatively small annual payments to the Crown or lump sum payments at the time of harvest. This includes commercial thinnings as well as the final harvest. Depending on the number and size of share contracts entered by the firm, the method of paying annual lease payments may or may not be viable. If the firm wishes to enter into a large number of agreements and there is little sharing of management costs with the Crown, they may not be able or desire to finance annual payments on all the contracts. In this case, the method of ceding a portion of the value of the future timber to the Crown, in lieu of annual lease payments, is an option. In the case of annual lease payments, the firm would have to be prepared for the contingency of increasing payments if the index to which lease payments are tied increases sharply. Although the annual lease payments are not large relative to the costs of site preparation and planting, there would have to be some internal planning to account for this possibility. Overall, firm expenditures could increase and indeed this is the goal of share contracts, to increase investment in silviculture, but of course benefits must increase as well. The share contract provides the firm with flexibility, much iri the same way as it provides the Crown with flexibility in methods of paying for use of the land and for sharing management costs and responsibilities. 3.6.2.2 Revenue Overall, revenue for the firm should increase with share contracts relative to the status quo if they result in increased silvicultural activity and consequently more timber. We assume that the adoption of the share contract will have no impact on world lumber prices and so increased AAC relative to current projections should mean increased revenue. The fact that firms currently have no equity in future timber means that the adoption of share contracts can only mean an improvement in their cash flow situation considering that they are already responsible for costs of basic silviculture. Apart from the revenues generated from harvest of final timber crops and perhaps from commercial thinnings, there is an additional revenue source that was discussed in section 3.4. The provision of share contracts to include benefits formerly external to the firm's investment decision as a portion of the Crown's benefits of the project means that the firm has available to it a greater portion of the cash benefits of the project (timber) and/or a smaller share of the direct costs of the project. 74 4.0 Summary and Conclusions The timber supply in British Columbia is decreasing and the AAC is expected to drop to 52 million m 3 over the long term from the current AAC of 71 million m 3 . Part of this decrease is unavoidable as the transition from old growth to second growth is made. Other factors, including the recent CORE process and Forest Practices Code, affect the available timber supply and some people would say that these measures were long overdue and should proceed. Another factor, the one addressed in this thesis, is the quantity and quality of silvicultural practice on Crown forest land. There are many factors affecting silviculture in B.C. but the particular one addressed here is the nature of forest tenures in B.C. and the incentives, or lack of incentives, that they provide tenure holders to invest in silviculture. This topic was addressed by identifying the shortcomings of the current tenure system as perceived by the Crown and tenure holders. Then, a sharecropping type contract as an adjunct to current forest tenures was proposed to help mitigate these shortcomings. This was followed by a discussion of the mechanics of the contract with examples. Based on the foregoing discussion of the share contract and how it could be included in B.C. forest tenures the following pros and cons for the Crown and tenure holders can be derived. Following that, areas for further study identified by the discussion will be outlined. 4.1 Crown The pros and cons of this proposal can only be discussed relative to the goals of the Crown. The stated goals of the Crown are to foster a sustainable, diverse and healthy forest products industry that will be a major employer for the people of B.C. as well as provide revenue from the use of Crown forest land (Ministry of Forests Act, Section 4; 1978). 4.1.1 Pros There are a number of advantages to the share contract over the current system of mandatory performance standards with no equity in future timber for the firm. If share contracts are successful, they will help mitigate the negative effect on timber supply of the falldown as well as the recent land use initiatives of the provincial government. As the study by Zhang (1994) indicated, the investment in silviculture on private industrial forest land is significantly higher than on Crown lands of higher quality and so any changes that increase the rights of tenure holders on Crown land should hopefully increase the firm's desire to invest. It should be pointed out that although there is controversy regarding the effects of silvicultural practices on final merchantable volumes, if the application of more and better silvicultural practices can at least reduce the rotation age, in effect the volume of timber available per time period has increased. Hand in hand with a relatively greater timber supply comes relatively greater revenue to the Crown. This comes about both through the direct revenue from the firms' use of Crown land and through taxes on wages and profits. The changes in tenure arrangements to provide more incentives for voluntary investment (equity in future timber) should bring with them decreased need for strict monitoring and auditing of silvicultural performance. The current command and control approach provides little incentive to perform "above and beyond the call of duty" and in fact leads firms to adopt a cost minimization approach to silvicultural expenditures (Haley and Luckert, 1993). A further benefit of share contracts is the flexibility they provide the Crown in mixing cash lease payments or cash from sale of timber and receipt of actual timber as payment for their share in the enterprise. The forest industry in B.C. has been criticized repeatedly for the lack of competitive timber markets and the stipulation of share contracts to have payment made in the form of logs makes the creation of a provincial log market possible. With the creation of a timber market comes the ability to diversify the manufacturing sector. An impediment to entrepreneurs in the manufacturing sector is the inability to secure wood for their products. This market would allow them to get that wood if theirs is the highest and best use. That is, assuming the bidders at a timber auction are rational people, those able to extract the greatest value from the wood will be able to bid the highest. The Crown and tenure holders do not always have the same goals with regards to forest land management. The firms, by and large, are only concerned with financial goals. The Crown on the other hand is concerned with additional benefits from forest land such as water quality, biodiversity, aesthetics and air quality. The addition of these benefits to share contracts provides the Crown with a way to internalize these positive externalities of silviculture to the firm's investment decisions. 4.1.2 Cons The cons of this proposal, as far as the Crown is concerned, are basically that it decreases the flexibility for altering land use plans without compromising the rights of tenure holders as outlined here. On the other hand, alterations may be possible but it would be necessary to have some method of compensation in place in order to preserve the terms of the previously negotiated share contract. Also, the recent CORE process and regional land use plans have more clearly defined the areas to be used primarily for production of timber so hopefully the granting of equity in the future timber will not conflict too often with the needs of the Crown to manage the land base for other uses. Another drawback to this proposal for the Crown is the increase in bureaucracy required to manage this new contract. The overall effect may be to reduce management expenditures of the Ministry of Forests, but in the short term much effort will have to be put in to deciding exactly how these contracts are to be implemented. This task may fall under the mandate of Forest Renewal B.C. or under the Forest Resources Corporation as proposed by the Forest Resources Commission if such an organization should emerge. 4.2 Firms As stated earlier, firms are primarily concerned with the financial implications of their tenures and their goal is profit maximization. Therefore, any pros and cons of tenure changes are determined in relation to that goal. 4.2.1 Pros The major advantage of the share contract and the provision of equity in the future timber to the firm is the greater security for their investment and the protection from unpredictable product price movements. The removal of all stumpage charges, rents and royalties as currently applied and replacement with the negotiated rent or share of the output also removes the firm's uncertainty regarding those aforementioned charges. The advantage of equity in future timber is that investments can be made with regards to the benefits that will be attributable to them. A major assumption of this thesis was that there are investment opportunities being foregone because of the institutional disincentives to such investment. The major disincentive is the fact that firm's do not have the right to capture the benefits of their investments. The share contract provides that right. Also, the method of calculating and indexing lease payments removes a portion of the risk of negative price movements. If the future price is lower than anticipated, lease payments are lowered. The converse is also true. This protects both parties. There is a further advantage to share contracts besides the increased security of timber supplies. If the granting of equity and delineation of each party's responsibilities helps to encourage investment in silviculture, the firm can look forward to having a greater amount of timber available to them than if silviculture continues at its current, relatively low level. Also, the grounding of these agreements in contract law, as opposed to simply a part of the provisions of various provincial tenures, gives a certain increase in security. If the Crown feels that the contract must be altered at some point, it is much easier to calculate any compensation that may need to be paid as a result of those changes. But, as stated earlier, the C O R E process and regional land use plans hopefully will address the needs of British Columbians with regards to environmental amenities and so conflicts over industrial forest land should be reduced. The share contract replaces mandatory basic silviculture defined in a relatively non site specific way with prescriptions put forward by the firms themselves. This allows them to use the knowledge of their tenure area to best advantage when proposing silvicultural activities. There is more flexibility and incentive to optimize opportunities when creating silvicultural prescriptions. 7 9 Silvicultural activities will no longer be carried out with cost minimization as the goal but rather based on the benefits that will accrue from them. Like the Crown, the firm also benefits from the inclusion of non-timber and/or non-market goods as outputs of silvicultural activities. The firm is encouraged to include the production of those goods in their silvicultural plans through the mechanism outlined in section 3.4. Currently, there is no reward for the internalization of these benefits and therefore they are created only coincidentally. A further benefit of providing equity in future timber is the incentives it gives for research and development activities. Without equity, there is no way for firms to capture the benefits of their research expenditures and so they have very little reason to undertake such operations. 4.2.2 Cons The cons of the share contract, as far as the firm is concerned, are similar to those of the Crown. Entering into a legally binding contract such as this limits the flexibility of their capital expenditures. If a firm ever wants to exit the forest products industry and is unable to sell and/or transfer its assets and tenures to another party they are stuck with their obligations as outlined in the share contracts. Presumably though, sale and transfer of assets and tenures would be legal so all that would be required is a buyer. Again, also like the Crown, the addition of share contracts to forest tenures requires a shift in the thinking and effort of the silvicultural and financial planners of the firm. As with any change there would be a transition period while the firm develops the knowledge and expertise to deal with this new contract. Therefore, in the short term there would be increased overhead costs to the firm, but, as with the Crown, there are advantages to the share contract and hopefully these outweigh the disadvantages. 4.3 Implementation Issues This section discusses issues regarding the implementation of share contracts. It goes without saying that the adoption of share contracts would represent a major shift in provincial forest policy and there are a few barriers to their adoption. Perhaps the largest barrier would be unfavourable public opinion regarding the granting of equity in future timber. Although the land would be retained by the Crown, some may feel that granting equity severely limits the Crown's leeway in making future land use decisions. While it is true that the granting of equity precludes other land uses (unless there is a mechanism for compensating tenure holders for land withdrawn from share contracts) it is possible to minimize this conflict by the existence of a provincial land use plan that clearly delineates areas to be used primarily for timber production. If public concerns about conservation and the environment are well met by such a plan, the concern of tenure holders' over the loss of timberland should be reduced. Indeed, tenure holders' may not have much confidence about receiving the benefits of their forestry investments if such a plan is not in place. Therefore, some protection of areas to be used for timber production is a prerequisite for the granting of equity. It may be some time before this is possible in some areas of the province due to the uncertainty of ongoing native land claims negotiations and other unresolved land use issues. The share contract will only work with area based tenures. Volume based tenures do not work because it is necessary to grant rights over a specific area 81 covered by the contract. Therefore, in B.C., TFLs are suitable for share contracts but FLs are not. It would be desirable to experiment with share contracts on a small scale to help determine if they are feasible or beneficial. It might be possible to allow a small area within a TFL the possibility of negotiating share contracts. An interesting possibility is to allow share contracts to be negotiated by small land holders, communities, and native bands on lands adjacent to lands granted under the present land claims negotiations. Of course the present disposition of those lands would determine whether they are available for that purpose. In addition to this option, other small scale implementations may be possible. For small operators that have woodlot licenses, share contracts may help overcome capital constraints and risk aversion that reduce more intensive management. Another issue, not a barrier as such, is the existence of Forest Renewal B.C. (FRBC).This Crown corporation is funded by stumpage fees from licensees and the money is used for environmental rehabilitation, silviculture, research and training. While this is directing more money into silviculture, it is only temporary. The existence of FRBC does not make the adoption of the share contract redundant. The important aspect of share contracts is that they are entered into voluntarily. Tenure holders do not have the same degree choice when it comes to making stumpage payments. Also, with FRBC there is the added difficulty of allocating the money once it has been collected. Share contracts give the tenure holders the ability to invest their money to give them the greatest return. They also provide the incentives for the tenure holder to manage the forest well because they can benefit from their actions. The share contract and FRBC are certainly not mutually exclusive given the broad range of responsibilities of the corporation. 4.4 Areas for Further Study The implementation of share contracts in B.C. forest tenures will require a more extensive study of all the important points raised here. A greater understanding of the biological and economic impacts of silvicultural practice would probably be required for people to enter into share contracts with some certainty of the scenario that will unfold. Perhaps this information exists, but it will have to be gathered in order to efficiently use it in the negotiation of individual contracts. The relative merits of alternative price indices will have to be investigated to find one that is acceptable to both parties. A schedule of values for non market goods and non timber goods will need to be created if they are to be included in the output mix of forest management. One of the benefits of the share contract is the ability to provide wood for provincial log markets. To take advantage of this benefit, a plan for instituting a market should be in place. There is currently an experiment in log markets for the interior of the province being carried out by the MOF and this should provide the basis for creating a more extensive market. Of course there would need to be planning for both parties on how to adapt their organizations to deal with the addition of share contracts to forest tenures. 5.0 LITERATURE CITED Allen, D.W., and Lueck, D., 1992. "Farmland Leasing in Modern Agriculture". Choices. First Quarter: pp. 30-31. Alston, L.J., Datta, S.K. and Nugent, J.B., 1984. 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Luckert, 1989. "Funding Mechanisms for Silviculture on Crown Land: Status, Problems and Recommendations for British Columbia". FEPA Working Paper 131-A: 59 pp. Haley, D. and M.K. Luckert, 1990. "Forest Tenures in Canada: A Framework For Policy Analysis". Information Report E-X-43. Forestry Canada. Haley, D. and M.K. Luckert, 1995. "Tenures as Economic Instruments for Achieving Objectives of Public Forest Policy in British Columbia". Prepared for an Executive Workshop on Economic Instruments for the Protection of Forest Resources. Faculty of Law, University of Victoria, June 22, 1995. H.A. Simons Strategic Services Division and Cortex Consultants Inc., 1993. "Historical and Future Log, Lumber and Chip Prices in British Columbia". FRDA Report #207. Forestry Canada and B.C. Ministry of Forests. Heaps, T. and B. Pratt, 1989. "The Social Discount Rate for Silvicultural Investments". FRDA Report #071. Forestry Canada and B.C. Ministry of Forests. Heath, L.S., H.N. Chappell, 1989. "Growth Response to Fertilization in Young Douglas-Fir Stands". Western Journal of Applied Forestry. 4(4): pp. 116-119. Hotvedt, J.E. and P.L. Tedder, 1977. "Use of the Wholesale Price Index for all Commodities in Determining Future Stumpage Prices Under Long-Term Leases". Southern Journal of Applied Forestry. 1(3): pp. 16-18. Hurst, J.R., 1987. "Crop Share Lease Form". Alabama Co-operative Extension Service, Auburn University. Circular ANR-499: 4 pp. Klemperer, W.D., 1986. "Adjusting Timberland Lease Payments for Stumpage Price-Changes". Northern Journal of Applied Forestry. 3: pp. 22-25. Luckert, M.K., 1988. "The Effect of Some British Columbia Forest Tenures on the Distribution of Economic Rents, the Allocation of Resources and Investment in Silviculture". Unpublished Ph.D. thesis. University of British Columbia. 238 pp. Luckert, M.K. and Haley, D., 1990. "The Implications of Various Silvicultural Funding Arrangements for Privately Managed Public Forest Land in Canada". New Forests. 4: pp. 1-12. Luckert, M.K., 1991. "The Perceived Security of Institutional Investment Environments of some British Columbia Forest Tenures". Canadian Journal of Forest Research, vol. 21: pp. 318-325. Luckert, M.K. and Haley, D., 1993. "Canadian Forest Tenures and the Silvicultural Investment Behaviour of Rationale Firms". Canadian Journal of Forest Research, vol. 23: pp. 1060-1064. Luckert, M.K. and Haley, D., 1995. "The Allowable Cut Effect as a Policy Instrument in Canadian Forestry". Canadian Journal of Forest Research, vol. 25: pp. 1821-1829. Luckert, M.K., 1994. "Efficiency Implications for Silvicultural Expenditures from Separating Ownership and Management on Canadian Forest Lands". FEPA Working Paper 208. pp. 28. Nawitka Resource Consultants, 1987. "Impact of Intensive Forestry Practices on Net Stand Values in British Columbia". FRDA Report #014. Canadian Forest Service, Victoria. Olivotto, G.G., 1987. "Finance for Silviculture in British Columbia". Unpublished M.Sc. thesis. University of British Columbia. 109 pp. Pearse, P.H., 1976. "Timber Rights and Forest Policy in British Columbia: Report of the Royal Commissioner on Forest Resources". Queen's Printer, Victoria, B.C. Vols. 1 & 2. Pearse, P.H., 1985. "Obstacles to Silviculture in Canada". Forestry Chronicle. April: pp. 91-96. Price Waterhouse, 1993. "The Forest Industry in British Columbia". Price Waterhouse. 33 pp. Price Waterhouse, 1995. "An Analysis of Recent Forest Policy and Land Use Initiatives in B.C." Forest Alliance of British Columbia. 6 pp. Schweitzer, D.L.R., Sassaman, R.W., and Schallau, C.H., 1972. "Allowable Cut Effect: Some Physical and Economic Implications". Journal of Forestry, vol. 70 pp. 415-418. Shaffer, R.M., Jr., 1984. "Valuation of Certain Long-Term Timber Cutting Contracts". Forest Science, vol. 30 no. 3: pp. 774-787. Shaffer, R.M., Klemperer, W.D. and Meyer, R.D., 1985. "Determining the Initial Annual Payment for a Long-Term Timberland Lease". Southern Journal of Applied Forestry, vol. 9 no. 4: pp. 250-253. Siegel, W.C., 1973. "Long-Term Contracts for Forest Land and Timber in the South". USDA. Forest Service Research Paper SO-87. 14 pp. Smith, A., 1776. "Wealth of Nations". Knopf, New York., 1991. vol. 1: 441 pp., vol. 2: 181 pp. Statistics Canada. 1986-1995. "Industry Price Indexes". Prices Division, Statistics Canada. Catalogue No. 62-011. Stone, M., 1993. "An Economic Evaluation of Commercial Thinning Douglas-Fir in the Coastal Region of British Columbia". FRDA II Working Paper WP-6-002. British Columbia Ministry of Forests and Forestry Canada, Victoria, B.C. Teeguarden, D.E. and Thomas, D., 1985. "A Public Corporation Model for Federal Forest Land Management". Natural Resources Journal, vol. 25: pp. 373-387. University of Florida Agricultural Experiment Stations, 1955. "Florida Share-Tenant Lease Guide". Circular S-81: 19 pp. University of Florida Agricultural Experiment Stations, 1955. "Florida Sharecropping Agreement Guide". Circular S-82: 18 pp. Weetman, G.F., 1987. "Seven Important Determinants of Canadian Silviculture". The Forestry Chronicle. December: pp. 457-461. Weetman, G.F., 1991. "Biological Uncertainty in Growth and Yield Benefits of Second-Growth Silviculture Actions and Old-Growth Protection and Liquidation Strategies in British Columbia". FEPA Working Paper #148. 23 pp. Zhang, D., 1994. "Implications of Tenure for Forest Land Value and Management in British Columbia". Unpublished Ph.D. thesis. University of British Columbia. 131 pp. Zinn, G.W. and Miller, G.W., 1982. "The Increment Contract: A Potential Means of Increasing Timber Production from Non-industrial Private Forests in the Central Appalachians". West Virginia University Agricultural and Forestry Bulletin no. 675: 26 pp. 87 APPENDIX Table-1 Items included in Share Contracts ITEM DESCRIPTION Names of Principals Identification of landlord and tenant Description of Property Boundaries of area to be covered under contract including any reserves within the described area. Duration of Lease In the case of forestry could be set to be the rotation age with some flexibility to allow for changes in biological or market circumstances or could be 90 year evergreen with replacement every 30 years. Method of payment This is the share of output that each party receives and stipulates whether the share is received in product or its cash equivalent; these are the equity shares described and calculated in a later section. Working Capital and Expenses The costs of proceeding with the enterprise are divided between the parties and set out in this section; the proportion of the costs borne by each party are used to calculate the equity shares; the management regime, level and timing of application of inputs is also included here. Maintenance and Repairs Responsibilities of each party for repair and maintenance of capital fixtures; in forestry will include primarily roading. Credit Arrangements Stipulations for cash advances from landlord to tenant including maximum amounts and interest terms; not likely relevant to the application of these contracts to forestry in B.C. when dealing with large integrated firms but may be desirable when dealing with small community holdings or small private stands. Other responsibilities and restrictions for each party For agricultural share contracts these stipulations include agreements on use of the land for other purposes such as hunting and fishing and condition of the land and buildings upon occupation by the tenant; in forestry carried out on Crown land, this section could provide for environmental requirements and access by the public for recreation. Arbitration Despite meticulous wording of contracts there may be disagreement, ambiguities or unforeseen circumstances and this section sets out a method of resolution should such conflict arise. Annual Supplements This stipulation allows for the creation of supplements to the original contract if the original has a duration of more than one year; the supplement covers management items that are likely to change from year to year such as acreages in each crop and provides an easier alternative to negotiating the entire lease year after year; these supplements are not really necessary in forestry because the contract will likely cover only one production cycle. This section could however include a method for indexing lease payments based on product prices using a producer's price index. Table-2 Sample Calculation of Equity Shares for a Fertilization Project Inputs ($/ha) Discounted [Nominal] Project Year Discount Factor Tenure Holder Crown Total 1 1 308.00 [308] 200.00 [200] 508.00 2 0.9259 7.41 [8] 185.18 [200] 192.59 3 0.8573 6.86 [8] 171.46 [200] 178.32 4 0.7938 6.35 [8] 158.76 [200] 165.11 5 0.735 5.88 [8] 147.00 [200] 152.88 6 0.6806 5.44 [8] 136.12 [200] 141.56 7 0.6302 5.04 [8] 126.04 [200] 131.08 8 0.5835 4.67 [8] 116.70 [200] 121.37 9 0.5403 4.32 [8] 108.06 [200] 112.38 10 0.5002 4.00 [8] 100.04[200] 104.04 TOTALS i=8% $357.97 $1,449.36 $1,807.33 Equity Share Payment Status Project Years Tenure Holder Crown Total No Rental 1-10 19.8% 80.2% 100% Payment 1/2 Rental 1-10 59.9% 40.1% 100% Payment S o u r c e : H a l e y and Luckert, 1989 TabIe-3 Sample Calculation of Equity Shares for a Planting Project Inputs ($/ha) Discounted [Nominal] Project Year Discount Factor Tenure Holder Crown Total 1 1 508.00 [508] 12.00 [12] 508.00 2 0.9259 7.41 [8] 11.11 [12] 18.52 3 0.8573 6.86 [8] 10.29 [12] 17.15 4 0.7938 6.35 [8] 9.53 [12] 15.88 5 0.735 5.88 [8] 8.82 [12] 14.70 • • • • • • • • • • • • • • • 66 .0067 0.05 [8] 0.08 [12] 0.13 67 .0062 0.05 [8] 0.07 [12] 0.12 68 .0058 0.05 [8] 0.07 [12] 0.12 69 .0053 0.04 [8] 0.06 [12] 0.10 70 .0049 0.04 [8] 0.06 [12] 0.10 TOTALS i=8% $607.51 $161.26 $768.77 Equity Share Payment Status Project Years Tenure Holder Crown Total No Rental 1-70 79.0% 21.0% 100% Payment No Rental 11-70 90.3% 9.7% 100% Payment 1/2 Rental 1-70 89.5% 10.5% 100% Payment Source: H a l e y a n d L u c k e r t , 1 9 8 9 Table-4 Biological and Economic Data for Scenario-11 Species: coastal Douglas fir Site Quality: Good Harvest Age: 70 Harvest Vol. (m3) 963 DBH (cm) 51.1 Product Price 72 ($/m3)2 Activity Timing (yrs. from present) Cost S/ha (nominal) surveying^ 0 14 planting^ 0 951 brushing (chem) 5 340 surveying^ 15 18 spacing 15 575 fertilizing 15 225 Logging Cost 70 12.65 ($/m3) Transportation 70 8.20 Cost ($/m3) (36-40km haul) Overhead Costs Annuity 6.50 ($/ha/annum) Sources: (1) unless otherwise noted, all data comes from FRDA Report #014 (2) FRDA Report #207 (3) MOF Annual Report 1992/93 Table-5 Biological and Economic Data for Scenario-21 Species: Interior White spruce Site Index: 22 Harvest Age: 80 Harvest Vol. (m3) 450 DBH (cm) 37.0 Product Price ($/m3)2 97.32 Activity Timing (yrs. from present) Cost $/ha (nominal) surveying3 0 12 site preparation3 0 443 planting3 0 844 brushing (chem)3 5 367 surveying3 20 11 spacing 3 20 692 Logging Cost ($/m3)4 80 8.25 Transportation Cost ($/m3) (71-75 km haul)4 80 8.95 Overhead Costs Annuity 6.50 ($/ha/annum)4 Sources: (1) unless otherwise noted, all data comes from WinTIPSY version 1.3 (2) Lumby Log Market (3) MOF Annual Report 1992/93 (4) FRDA Report #014 Table-6 Biological and Economic Data for Scenario-31 Species: Coastal Douglas Fir Site Index: 30 Harvest Age: Commercial Thin 4 50 Harvest Vol. Com Thin (m3)4 142 Product Price ($/m3)2 60 Harvest Age: Final4 75 Harvest Vol. (m3) Final4 614 Product Price ($/m3)2 72 Activity Timing (yrs. from present) Cost $/ha (nominal) surveying3 0 14 planting3 0 951 brushing (chem)3 5 340 surveying3 16 18 spacing3 16 575 Logging Cost ($/m3) Com. Thin 4 50 19.65 Logging Cost ($/m3) Final 75 12.65 Transportation Cost ($/m3) (36-40 km haul) 50 and 75 8.20 Overhead Costs ($/ha/annum) Annuity 6.50 Sources: (1) unless otherwise noted, all data comes from FRDA Report #014 (2) FRDA Report #207 (3) MOF Annual Report 1992/93 (4) FRDA II Working Paper 6-002 Table-7 Biological and Economic Data for Scenario-41 Species: Coastal Douglas Fir Site Index: 30 Initial Basal Area (m2/ha) 22.5 6 year PAI (m3/ha)4 4.9 Product Price ($/m3)2 72 Harvest Age: (years after treatment) 18 Total Increment (m3/ha) 14.7 Activity Timing (yrs. from present) Cost (nominal) fertilization ($/ha)3 0 137 Logging Cost ($/m3) Final 18 12.65 Transportation Cost ($/m3) (36-40 km haul) 18 8.20 Sources: (1) unless otherwise noted, all data comes from FRDA Report #014 (2) FRDA Report #207 (3) MOF Annual Report 1992/93 (4) Heath, L.S. and Chappell, H.N., 1989. Table-8 Present Value of Scenario-1 per Hectare Treatment Timing (yrs from present) Nominal Value Present Value1 surveying 0 ($14) ($14) planting 0 ($951) ($951) brushing (chem) 5 ($340) ($279) surveying 15 ($18) ($10) spacing 15 ($575) ($319) fertilizing 15 ($225) ($125) Logging Cost 70 ($12,182) ($782) Transportation Cost 70 ($7897) ($507) Overhead Cost Annuity ($7) ($152) Harvest Revenue 70 $69,336 $4,453 Net Present Value $1,313 (1) Real discount rate of 4 % Table-9 Present Value of Scenario-2 per Hectare Treatment Timing (yrs from present) Nominal Value Present Valuel surveying 0 ($12) ($12) site preparation 0 ($443) ($443) planting 0 ($844) ($844) brushing (chem) 5 ($367) ($309) surveying 20 ($11) ($6) spacing 20 ($692) ($348) Logging Cost 80 ($4,028) ($257) Transportation Cost 80 ($3,713) ($237) Overhead Cost Annuity ($520) ($174) Harvest Revenue 80 $43,794 $2,794 Net Present Value $165 (1) Real discount rate of 3.5% Table-10 Present Value of Scenario-3 per Hectare Treatment Timing (yrs from present) Nominal Value Present Value1 surveying 0 ($14) ($14) planting 0 ($951) ($951) brushing (chem) 5 ($340) ($279) surveying 16 ($18) ($10) spacing 16 ($575) ($307) Logging Cost Comm. Thin 50 ($2,790) ($393) Transportation Cost Comm. Thin 50 ($1,164) ($164) Harvest Revenue Comm. Thin 50 $8,520 $1,199 Logging Cost Final 75 ($7,767) ($410) Transportation Cost Final 75 ($5,035) ($266) Harvest Revenue Final 75 $44,208 $2,333 Overhead Cost Annuity ($488) ($154) Net Present Value $585 (1) Real discount rate of 4% Table-11 Present Value of Scenario-4 per Hectare Treatment Timing (yrs from present) Nominal Value Present Value1 fertilizing 0 ($137) ($137) Logging Cost 18 ($186) ($92) Transportation Cost 18 ($121) ($60) Harvest Revenue 2 18 $1,058 $522 Net Present Value $233 (1) Real discount rate of 4% (2) Attributable to increment Table-12 Contributions and Equity Shares for Scenario-1 Party Contribution/ha1 Zero Rental 1/2 Rental Crown $1,313 $656 Tenure Holder $3,140 $3,796 Total $4,453 $4,453 Equity Share Zero Rental 1/2 Rental Crown 29% 15% Tenure Holder 71% 85% Total 100% 100% (1) F i g u r e s m a y not a d d d u e to round ing Table-13 Contributions and Equity Shares for Scenario-2 Party Contribution/ha1 Zero Rental 1/2 Rental Crown $165 $82 Tenure Holder $2,629 $2,711 Total $2,794 $2,794 Equity Share Zero Rental 1/2 Rental Crown 6% 3% Tenure Holder 94% 97% Total 100% 100% (1) F i g u r e s m a y not a d d d u e to round ing Table-14 Contributions and Equity Shares for Scenario-3 Party Contribution/ha1 Zero Rental 1/2 Rental Crown $585 $293 Firm $2,947 $3,240 Total $3,532 $3,532 Equity Share Zero Rental 1/2 Rental Crown 17% 8% Firm 83% 92% Total 100% 100% (1) Figures may not add due to rounding Table-15 Contributions and Equity Shares for Scenario-4 Party Contribution/ha1 Zero Rental 1/2 Rental Crown $233 $117 Firm $289 $405 Total $522 $522 Equity Share Zero Rental 1/2 Rental Crown 45% 22% Firm 55% 78% Total 100% 100% (1) Figures may not add due to rounding Table-16 Contributions and Benefits for Crown and Firm Firm Crown PV of Contribution $2,413 PV of Cash Benefit $1,900 PV of carbon sequestering $1,000 % Share of Benefits1 66 34 PV of contribution based on share of benefits $1,593 $820 (1) Share of total benefit of $2,900 Table-17 NPV of Scenario-1 with Real Timber Price Increase Nominal Present Value Costs/ha ($21,878) ($2,810) Harvest Income/ha $85,707 $5,491 Net Present Value $2,681 Table-18 Calculation of Adjusted Lease Payments Year IPPI1 Adjustment Factor New Lease Payment 1986 100.0 1 $70 1987 102.7 1.027 $71.89 1988 107.4 1.074 $75.18 1989 109.4 1.094 $76.58 1990 109.4 1.094 $76.58 1991 108.0 1.08 $75.6 1992 108.3 1.083 $75.81 1993 111.9 1.119 $78.33 1994 119.0 1.19 $83.3 1995 129.5 1.295 $90.65 (1) Statistics Canada #62-011 

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