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Finance for silviculture in British Columbia Olivotto, Giuseppe Gerrard 1987-12-31

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FINANCE  FOR SILVICULTURE IN  BRITISH COLUMBIA By GIUSEPPE CERRARD OLIVOTTO B.A., The University of Victoria,  A THESIS SUBMITTED  1979  IN PARTIAL FULFILLMENT OF  THE REQUIREMENTS  FOR THE DECREE  MASTER OF SCIENCE  in THE FACULTY OF GRADUATE STUDIES THE FACULTY OF FORESTRY Department of Forest Resources We  Management  accept this thesis as conforming to the required standard  THE UNIVERSITY  OF BRITISH COLUMBIA  September  1987  ® Giuseppe Cerrard Olivotto,  1987  In presenting  this thesis in partial fulfilment of the  degree at the  and  study. I further agree that permission for extensive  copying of this thesis for scholarly purposes may or  by  his or  her  representatives.  be  permission.  ^oCZG^STfZ^  The University of British Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3 Date 7  DE-6G/81)  granted by the head of  It is understood  publication of this thesis for financial gain shall not be  Department of  advanced  University of British Columbia, I agree that the Library shall make it  freely available for reference  department  requirements for an  that  copying  allowed without my  my or  written  Abstract  Government  funding  for  silviculture  in  British  Columbia has expanded recently, but remains well short of  the  thesis  level  recommended  contains  funding  with  describes  a  proposal  investment  the  by  many  to  replace  from  funding  foresters. This government  capital  mechanism,  markets. analyzes  It the  implications to government, and introduces a method of distributing  investment  competitive  bidding  funds  through  between  a  system  forest  of  management  companies. In return for their participation, investors and forest companies would timber production. The of  foregoing  government  50% might  both receive equity in future thesis concludes  of  its future  replace  its  that at a cost  stumpage  current  spending  intensive forest management with a funding capital year.  markets of  $500  million  to  revenue, on  level from  $800 million  per  iii  TABLE OF CONTENTS  PAGE  Abstract  1 1  ',  Acknowledgement  vii,  Table of Contents  iii  List of Tables  v  List of Figures  vi  Chapter One: Introduction  1  Sources 1, Organization  of the Thesis 2, General Comment  4  Chapter Two: Background  5  British Columbia Forest  Status 5,  Crown Corporation 9, (c)  Funding: (a)  Privatize  Status Quo 7,  (b)  Land 9, (d) Timber Equity 10  Chapter Three: Investors Security Size  12,  of  12  Liquidity  12,  the  Capital  Stumpage vs.  Products  Duration  Market 15,  13,  20,  Exchange  Legal  1986  Considerations  Types  Type  The Wood  the Wood Unit with Gold 17, Unit  13,  of  Unit  Tax  Investors  Participation  16,  Study 18,  21,  of  14,  Comparison  Pricing the  Treatment  13,  of  Wood  22,  Stock  Trading 22  Chapter Four: Government Capital Diagram Green  Return 27,  26, The  Reserve  33,  25 The Harvest Forest  House 38, The Silviculture  P/L  Diagram  and  Mill  Growth  27,  Regions  of  the  P/L  Reserve  32,  The  Standing  Estimation  36,  The  Clearing  Fund 39, Government  Benefits 40  iv  Chapter Five: Forest Companies Distribution  of  TFL's  FL's  and  41  Silviculture 43,  Dollars  Stumpage-Free  Contract: TFL 45, Discussion of Appraisal: FL's  50,  The  Distribution  Corporate  Outputs  42,  Timber  44,  Inputs  Shareholders  49, Volume  56, Transfer  Unit  42,  Management  Bidding 46, Appraisal of  Template  56, C o m p a n y Buys a W o o d Operations  41,  Bids 48,  Based Licences: H&M  Contracts  57, Utility Aspect of  Company  58, Individuals and Contractors  of  59  Chapter Six: Discussion Recent  60  Policy Changes 60,  Contractual  Risk  62,  Political  Yield  to  Feasibility  Maturity  64,  61,  Price Risk 62,  Marketability  Silvicultural Yield 66, Experimental Controls 67, Inventory 68, Stumpage-Free Timber 69, Applicability Limit to  to  68, Tenure  Security  69,  65,  Structure  Legal Aspects  Private Land 70, Comparison with Mining 71,  Issuance 72  Chapter Seven: Conclusion Implications 73, Viability  73 74  Bibliography  76  Appendix A: Portfolio  Analysis  83  Appendix  B.1: Real Lumber Price Cains  Appendix  B.2: Real Returns: Canada: 1914 to  Appendix  C: Hedgers  91  Appendix  D: Silviculture  94  Appendix  E: Table of Conversion Factors  98  Appendix  F.1: W o o d  99  Appendix  F.2: Pulp and Paper Prices  102  Appendix  G: W o o d  103  Appendix  H: Harvest and Mill Reserve  Appendix  K: Glossary  Quality  Unit Guiding Silviculture  89 1986  90  106 108  V  LIST OF TABLES  TABLE  Table I: British Columbia Forest Activities Since  Table II: Yield Examples  PAGE  1984  37  LIST OF FIGURES  FIGURE  Figure 1: Government  pledge to  Figure 2: P/L Diagram  ,  Figure 3: Regions of the  Figure 4: Amended  Investors  P/L Diagram  P/L Diagram  PAGE  28  30  31  34  Figure 5: Distribution Template  51  Figure 6: Growth Probability Distribution  52  Figure 7: Completed  53  Distribution Template  Acknowledgement  Many people on British Columbia's  roads have a keen  interest in some  aspect of forestry. 1 wish to thank these people for their generosity in offering a lift and conversation on my many trips hitchhiking about the province. The proposal detailed herein was refined from rough concepts through the discussion  of particulars with knowledgeable  foresters who  contributed  people. I would  like to thank the  advice and criticism, including Doug Ausman, Jack and  Dave Bakewell, lack Biickert, David Boulter, Ted Caldwell, Roy Cullen, John Cuthbert, Russ Jones, Martin Luckert, Al MacPherson, Brian  McCloy,  Rhinehart Muller, Bob  Nixon, Cheryl Power, Les Reed, Steve Toinai, Mike Wyeth, and Paul Wooding. Some people not in forestry  also  contributed, adding  business or layman's point of view. Those  deserving thanks  criticism  include Jill Bodkin,  Richard Chappie, Bob Hager, Shirley Haun, Russ Issac, Donald Marchand,  Brian  Parrott,  John  Reynolds,  Bill  from the  van Cuylenborg,  MacFayden, Randy and  Marty von  Otherloo. This paper benefitted from  David Haley's editorial criticism of several early  drafts. Discussions with Rob Heinke! on finance theory and with Bart van der Kamp on social implications have helped to round out the presentation. I hope these supportive individuals will take an active interest in what has evolved.  CO.  1  CHAPTER ONE INTRODUCTION This  thesis discusses  a means of financing  intensive silviculture in British  Columbia. It proposes that capital for the undertaking internationally, rather than being provided that  certain arms-length  investors  be attracted nationally or  by British Columbia society. It is reasoned  are more suited  to provide  an ample, steady  stream of investment capital for forestry than is the provincial government. Forest management requires four types of input: land, capital , expertise, and 1  coordination.  This  thesis describes  an organization  in which  government  would  contribute land and coordinate the enterprise, investors would contribute capital, and forest companies would contribute their expertise. There would be some overlap of contributions. The thesis seeks to describe forest production  among the three  a means of sharing  the benefits of  contributors in such a way that the benefits  anticipated by each would provide an incentive appropriate to that contributor's particular needs and desires. The hope is that each will consider  himself better off  than he is under present management arrangements. Sources Literature consulted  is cited in an attached  bibliography. The main research  for this thesis, however, was conducted through an extensive The  scope  of these interviews  series of interviews.  was broad, including meetings over an hour in  length on six occasions with Ministry of Forests staff, many interviews with foresters in industry, and meetings with lawyers and influential individuals in the investment community. The financial discussions were supplemented  by the writer's  personal  experience of five years in the investment business.  Some readers might consider labour inputs, however for the sake of this list it is assumed that labour is purchased with capital. 1  In addition, extensive personal correspondence economists,  and financiers  across  Canada  and  was exchanged with foresters,  in the U.S. and  New  Zealand.  Relevant published works of some correspondents are cited in the bibliography. Organization of the Thesis It is recommended that the reader begin with Chapter Chapters Three through  Six. This will allow  Five to be approached with some scattered curiosity and  understanding. Following  this  introduction, Chapter  Two  statistics for British Columbia, and a conceptual  presents  background  silvicultural  discussion of alternative financing  techniques. The main body of the thesis is contained in Chapters Three, Four, and Five. These three chapters discuss the involvement  of investors, government, and forest  companies in the proposed financing arrangement. The discussion develops in a logical sequence in that some terminology employed in the latter sections is defined in earlier sections, lf readers wish to approach these sections out of order they may benefit by referring to Appendix K, 'Glossary'. Chapter Six, 'Discussion', consists largely of points raised in interviews during the development of the thesis. These points are pertinent to an appraisal of the overall infrastructure, but are of too specialized those chapters. Chapter  a nature  to be incorporated in  Seven presents a summary and conclusion which discusses  the implications and viability of implementing this proposal. A informed appendices summary  number of Appendices containing technical reading  of the thesis  follow the body  information pertinent to an  of the text. The first three  support the discussion of investor participation. Appendix A presents a of the results of an empirical analysis by the author  benefits of forest  products  certificates. Appendix  of the financial  B.1 discusses real lumber price  gains, while B.2 presents Canadian bond yields and inflation rates for the past 72  3  years.  Appendix  C  discusses  interest  rate  hedger  participation  in  the  investment  certificate.  Appendix treatments  for  estimation  of  D discusses silviculture. It contains: the  information of  silviculture  those  worker  readers  productivity  (D.1) a description of cultural  unfamiliar with and  costs,  forestry,  and  (D.2) an  (D.3)  a  rough  quantification of growth reponses which may be expected in British Columbia.  Appendices table  of  presents  E and  F deal  conversion  factors  a  method  logical  for  with  logs,  of  forest  products. Appendix E gives  lumber,  equating  chips,  volume  and with  treatments serve mostly to increase forest volume (eg. a small effect a forest  pulp, value.  silvicultural  spacing and pruning). The framework in Appendix F presents  Appendix C demonstrates  analysis  Some  fertilization) while others have  common basis for analyzing the two types of forest management  may  alternative to  Appendix F  on volume production but instead increase the merchantable value of  stand (eg.  certificates  while  a short  be  used  to  using discount  pertinent  to  forest  a  response.  how the market prices of a series of issued wood  guide rates  the  decisions  for forest  company  of  forest  management  involvment  in  the  managers.  This  is an  decision-making. Technical scheme  is  contained  in  Appendix H.  Finally, which  is  which  do  Appendix K is a glossary to  described not  in  this  presently  collected, with definitions,  thesis  exist.  requires  These  have  the  thesis. The contractual infrastructure  the  creation  been  given  of  a  number  appropriate names  in Appendix K. Also included are references  in the text where these terms are used.  of  entities and are  to the pages  General Comment This thesis presents an interwoven set of very specific recommendations. It is expected  that very few, if any, readers will agree with the entire set. There may  be some readers who agree with none at all. This thesis is not presented to form a concensus but rather is presented as a full set of preliminary recommendations by one individual, lt was felt in presenting this innovative proposal that a broad set of specific  suggestions  would  be preferable to a general theoretical  discussion. By  being specific, this thesis may, even if not accepted for implementation, stimulate discussion of many points relevant to forest management in British Columbia.  5  CHAPTER T W O  BACKGROUND  The intensive.  Ministry of Forests and Lands defines two types of silviculture: basic and Basic silviculture is the  set  of treatments  (site preparation, planting, brush  control) required to restock recently denuded land to a free-growing state. Intensive silviculture is the set of further treatments which serve to guide forest  growth from  the juvenile stage to  volume and  quality of in  harvest age .  growth desired. Brief  Appendix D.I. The tables  Columbia in 1984,  treatments  descriptions of  below  describe  vary with the  silvicultural treatments the  status  of  forest  are presented land  in  British  and the silvicultural activities undertaken since that time.  British Columbia Forest Status: 1984  There  Intensive  2  are 26.2  million  3  hectares  of  land  potentially productive, available, and  suitable for timber production in British Columbia. Of that:  3.2 million hectares are decadent (timber growing slowly or reducing due  to  decay).  2.0 million hectares are stagnant (extremely dense immature timber stands not expected  3.6  to become merchantable without juvenile spacing).  million  hectares  are  NSR (not  sufficiently  restocked).  Of this  total  1.2  million hectares are good and medium sites.  The  Resource  Analysis of  productive forest land (good by  nonforest  vegetation.  1984  pointed  out  that  "2.9  million  hectares  and medium sites) are partially or completely occupied  That total is expected  to  increase  by 48,000 hectares  year if no proper management action is taken." The Ministry definition of intensive silviculture also refers to restocking the backlog of not satisfactorily restocked land. 2  3  Ministry of Forests,  1984  of  per  Table 1  British Columbia Forest Activities Since  Resource  1984 1  5  Degradation  Area in Hectares  Logged: Clearcut Selective Cut Timber Area Burned Area Under Pest Attack Resource  1984/85  1985/86  187,023  204,504  29,394  27,226  28,606  134,998  678,930  612,170  100,035  101,442  14,493  16,039  Enhancement  Planted Site Rehabilitation Conifer Release  181  1,195  5,615  Spacing  10,872  Fertilization  0  17  Pruning  0  0  86  196  Commercial Thin  The  low  denudation areas  which  is  would  be  years,  of  of  the  scheduled  province to  be  forest  management  relative  a  large  harvested  inventory before  the  of  mature  products  not  Ministry of Forests,  1986,  timber  deficits  expect  within  'falldown'  is relatively slow in British Columbia when  1985  Part of the areas in Table 1 under 'Timber Area Burned' and 'Area Under Pest Attack' may fall outside the 26.2 million hectares defined as potentially productive, available, and suitable for timber production. 5  of  intensive management  there are remote areas of the (2) Tree growth  rate  overmature  supply  province which do  the  (1) There remains in  and of  to  required. While some Timber Supply Areas expect  for fifty years or more.  4  intensive  in British Columbia is due to a number of factors.  some  ten  level  compared with the U.S.  South, Brazil, New  Zealand, and  other timber producing  regions of the world. Economic analysis of the benefits and costs of intensive management in British Columbia generally demonstrate that very low may  be anticipated. (3) Forest management spending  financial returns  is a government responsibility,  and government budgets are limited. Given a perceived lack of urgency to address timber supply deficits, and the lack of profitability of forestry investment, government makes forestry  expenditures  for social welfare purposes.  means that forestry must compete  for funding with  Also, it means that the limited spending undertaken  Such  political motivation  other social welfare causes.  tends to be equitably distribu-  ted between regions, rather than being directed to the most productive growing sites. Jack  Walters  (1984) estimated  spent on the best 28%  that an  annual  investment  of $660 million  of the Crown land base would permit eventual expansion  of harvest rates by 20%. Reed (1985) estimated that annual forestry expenditures of $300 million would and  provincial  Columbia  has  be  required to replace current denudation. Combined federal  spending been  on  basic  increasing  in  and  intensive  recent  forest  years,  and  management is currently  in  British  running  at  approximately $200 million per annum. Funding A number of approaches to provide increased funding for intensive silviculture in British Columbia  have been  discussed recently. Four approaches are described  here, with comment as to the suitability of each. (a) Status  Quo  Opposition parties in the provincial legislature, forest management companies, forest  workers  government increased  unions  spending  silvicultural  and  environmental  for forest funding  groups  management  must  come  from  be  all recommend increased. While  alternate  social  that  direct  noting that  programs, these  8 interest groups feel that a sacrifice should be made by present society in order to provide security and a flow of forest benefits to future generations. An  outline  of the  present  government  (federal and  provincial) sources of  funding for silviculture on provincial Crown land follows. The  figures in parentheses  refer to the funding level in 1986/87 . 6  (i) Ministry Operations Vote (administration; nursery and seed operations; $61.2 million) (ii) Section 88 (basic silviculture; $66.6 million) (iii) Small Business Enterprise Account (roads and basic silviculture; $7.4 million) (iv) Forest Resource Development Agreement (research and intensive silviculture; $44 million) (v) Forest Stand Management Fund OobTrac: general silviculture; $15.5 million) Total silviculture funding in British Columbia has increased rapidly in recent years, as  evidenced  1984/85:  $111  by  the  million,  following series  1985/86:  $136  of  million,  figures : 7  1983/84: $88  1986/87:  $195  federal/provincial combined total of $249 million is budgeted to be  million,  million.  A  spent in the  1987/88 fiscal year. An  important question regarding government spending  which rarely rises is 'how  on forest management  will the growth increment these expenditures are creating  be distributed?'. If the status quo  is maintained, and future timber is distributed as  it is currently, then the direct expected return to the current government investment in silviculture may  be  nil, or even negative (eg. according to Ministry officials it  costs $3 to $7 of current dollars to produce one rotation, however meter).  There  recent  are  other  provincial values  stumpage which  cubic meter of wood over a  rates have averaged  government  expects  $2  per cubic  its management  expenditures to produce, such as employment creation and tax revenue generation,  6  British Columbia, 1987  7  Op. cit.  9  but these other values arise from any creation of economic activity, and would exist regardless of who funded the forest management activities.  (b) Crown Corporation  Another the  silviculture is through  creation of one or more Crown corporations. The various permutations of this  option were of  possibility for organizing funding for intensive  1983  thoroughly investigated  and presented  to  by the  B.C. Ministry of  Cabinet. The sketches were  Forests in the autumn  turned down flatly by then  premier Bill Bennett. The reasons for rejection are not crucial to this analysis, it is sufficient  to  note  that  the  option  has  been  studied  and  was  found  to  be  unsatisfactory.  Crown  corporation  models  for  forest  management  exist  in  New  Zealand,  Australia, and in Canada in Quebec. Due to economic and cultural disparities, none could  be  transposed intact to  British Columbia.  basis  for  public corporations,  including a  profit  motivation,  the  reader  is  For a discussion of the theoretical  discussion  directed  to  of  preferential  Teeguarden  and  treatment Thomas'  and  (1985)  discussion of their possible role in Federal forest land management in the U.S.  An  observation  oscillate  from  reached  where  regarding Crown  conservative to it  is  deemed  Corporations is that  wholesale  entity  (Crown  political preferences  liberal and back again a point in the expedient  to  privatize many  corporations. The packaging of forest management corporate  as  Corporation)  may  be  activities  the  first  of  the  into  cycle  is  often  existing  public  a semi-autonomous  step  en  route  to  their  transfer to the private sector.  (c) Privatize Land  A fairly radical recent Dr.  David  Haley (1984)  is  suggestion that  the  best  forest land be sold to private interests. tem  does  not  give  forest  by University of 25  to  30  percent  Haley observes  companies  the  British Columbia  security  of  professor  British Columbia's  that the existing tenure systhey  require  to  recoup  management  expenditures,  and  believes  that  if  the  companies  owned  outright this obstacle would be removed, resulting in optimal economic of  the  forest  incumbent  land  licensees  base.  Under  could  be  subject to legislation designed  his  plan  a  sale  devised,  and  the  mechanism  lands  so  the  land  management  which  protected  transferred  would  be  to control forest practices potentially damaging to the  broader public interest.  It should  be  noted  that  stumpage  is  land. This privatization would imply that the forever  its  direct return from  That foregone  be  land,  charged  government  on  timber from private  doing so  along with its  would discharge  management  responsibilities.  return might be capitalized into the sale price, but it may be a hard  sell, politically, to would  the  not  convince the public that the one-time  adequate  recompense  for  the  revenue  opportunities  from such a sale  foregone.  Also,  the  public  would likely wish guaranteed free access to the land for recreation purposes.  (d) Timber Equity  An  alternative  to  the  options  (ownership)  in timber which will  those who  help to  may be sought the  create  in the  peculiar nature  of  the  discussed  exist in the  above  is  to  define  future, and share that  an  equity  equity among  timber. ( 1 ) Timber growing requires investment.  This  capital markets by offering an instrument which incorporates timber  production with  markets. (2) Timber growth is very dependent companies,  the  strengths  and  needs  of  those  on astute cultivation and tending. The  forest  management  in their various forms and with their various tenure  types,  are best suited to this role, possibly with technical support from  government  and private research agencies. (3) Timber requires land on which to grow. This is a government fertility  of  contribution, and should result in an equity share a particular site.  ( 4 ) There are  risks,  both  proportionate to  physical (losses to  the  fire and  pests) and financial (market fluctuations) to be considered while the timber is under production, and to be recognized in the equity distribution.  This  thesis  presents  the  results  implications of financing intensive to  future  investors created  timber. be  for  exposure  The  attracted  main at the  conscientious  of government  Concern  (i)  and  by  investors.  The second  process  through  tenured  areas.  be  concerns  of  developing rate  management  addressed  defining  concern forest  standing  the  resulted  into  the  of  this  proposal  structure  were  return, (ii) that  by  industry,  and  through  ensuring  investment  'Wood  Unit'  in the  companies  Concern (iii) was  comprised  in  lowest possible  and by a proposal to establish other  investigation  and rights  (i)  incentives  (iii)  that  that be  the  risk  security  and  be minimized.  carefully  which  an  silviculture through the distribution of equity  concerns  forest  would  liquidity,  of  which  description  might  draw  of  would  Reserves,  timber  have been well addressed,  one  inventory.  silvicultural  a cash deposit  The  writer  sold  a competitive funding  dealt with through a clear definition two  be  feels  of  although peripheral concerns remain.  bidding to  their  'stumpage',  account that  to  the  and the primary  12  CHAPTER THREE  INVESTORS  All securities  must offer a potential yield in order to  be  attractive to capital  markets. The appropriate yield of any particular security may be analyzed through an inspection  of  (i)  market, (ii) the holding  that  components:  the  prevailing  expected  and  anticipated  duration of the  particular security.  The  risk-free  investment,  risk  of  returns  and (iii) the  holding  may  available  the  perceived risk of  be  divided  into  two  liquidity and security.  It would be desirable to attract investor participation in forest the  in  lowest possible  rate of  return. This would be  accomplished  management at  by offering a very  secure, totally liquid investment opportunity.  Security  Obligations presently  issued  considered  the  market. It is therefore government,  and  guaranteed  most  secure  type  politically  of  concept  was  governments  asset  available  in  are the  instrument should be issued by  companies.  discussed  stable  investment  proposed that the investment  rather than by individual forest  whom this investment  by  Pension fund managers with  were strongly in favor of  government  issuance.  Liquidity  Liquidity is  that  the  may be  created  government  could  through two offer  alternative  investors  the  techniques.  opportunity  One  to  possibility  redeem  their  holdings at any time, or at periodic intervals. The two problems with this technique are: asset,  (i)  difficulties  and (ii)  may be  a flood  of  encountered redemptions  government credit and reserves.  in  determining  in any one  the  periodic  period could put  value  of  the  a strain on  The  other  transferable, market  or  way  and to  create  liquidity  is  to  permit  provide for transfer through the  through  recommended  to  a  Stock  Exchange.  and fully discussed  A  Stock  the  facilities  Exchange  asset  of  to  an  listing  be  freely  over-the-counter  is  the  technique  in this paper.  Duration  The time  from investment  very long. Tree growth, years  to  beyond  eighty the  investment  years  to  realized  from planting to or  more  contemplation  in  of  return (harvest) in forestry  final harvest,  British Columbia.  ordinary  capital  opportunity to  participate in forest  years.  Such  markets.  has a duration of twenty or twenty-five  Rotation' as a period of twenty-five  requires  one  or more  UR's to  long  time  from fifty  periods  a  long  are term  years. This paper defines a 'Unit that investors  be sold an  on a Unit Rotation (UR) basis; they  would provide funds today in return for a payout at the It will require two  anywhere  Currently,  It is proposed  management  is generally  actually manage  end of the  Unit Rotation.  a typical forest  stand through  physical rotation.  Types of Investors  By investors.  definition, These  plained later,  a  Unit  investors  Rotation  would  gain  investors  corporate  conglomorates,  and possibly  resources  of  Some  attracted,  balances  maximum  would benefit  be  sold  from  to  long  participation,  term  as  ex-  if they hold a large portfolio of non-forestry assets. Large, long term,  diversified  be  opportunity  may be  their own. depending  in the forestry  sought in the  on  form of  foreign  pension  governments  smaller individual investors their  individual  perceptions  funds, without  insurance  trusts,  adequate  timber  and speculators of  future  may also  supply/demand  sector.  Size of the Capital Market  Aware European  of  pension  the  inflation  funds  have  hedge been  and  diversification  investing  in forestry  aspects for  of  forest  holdings,  many years.  In North  America pension funds have traditionally minimized the real asset component  of their  portfolios. The inflationary decade  of the 1970's altered this perception however, and  forestry  gaining  investments  forest  syndicate  pension  are  rapidly  managers  funds  currently  in  the  acceptance  U.S.  recommend  who  that  5%  here.  market of  a  Tarver  forest  (1982)  land  fund's  says  that  participation  assets  be  placed  to in  forestry.  Canadian pension figure  suggests  investment  that  funds  over  $10  control $220 billion in assets .  Five percent  8  billion would  be  available  domestically  for  if the correct opportunity were offered. The assets of foreign  of  this  forestry  investment  entities are several orders of magnitude larger.  Type of Participation  Forest  product markets  are cyclic in nature,  and other consumption variables in the economic Columbia  the  Crown)  would  wish  to  maintain  responding  to  cycle. The forest harvesting  housing  demand  owner (in British  flexibility  in  order  to  maximize its return from these cycles. Trees are wonderful assets in that they may be stored on the stump, increasing in volume, during periods of unfavorable prices. To maintain flexibility, the government for  the  delivery  of  dollars,  should offer an investment  rather than  physical  products,  at  contract providing  the  end  of  a Unit  Rotation.  The  specific  government  investment  contract  might be varied from year to year, but the contract issued to arms-length  investors  in any given year (the ized,  obligation  supposition  here  associated  with  the  is of annual issuance) should be standard-  an identical opportunity being offered  to  all investors.  This is as opposed  to  marketing different types of participation for different regions of the province, or for investment contract  on would  lands  managed  minimize  the  under different  tenure  marketing  administration  and  types.  A standardized annual costs  associated  Trusteed pension funds controlled $121.5 billion in the third quarter of 1986. This represents 55% of total public and private pension assets in Canada. Statistics Canada, 1987. 8  wiith  15  issuance,  and facilitate  the  transferability (liquidity) of  the  contract once  it is listed  for Stock Exchange trading.  Investors value  supplying forest  their investment  helps  growth as (a) a percentage a  fixed  (positive  volume  of  to  create  capital might  in one  of  two  participate in the  ways.  They  might  wood  share in  of the actual growth increment which is created, or (b)  growth,  with  the  forest  manager  absorbing  any  difference  or negative) between realized growth and the volume obliged. Sharing actu-  al growth on a percentage  (1) volume  management  The investor's  and  quality  of  basis is not advisable since then:  expected  return would be  timber.  He  would  uncertainty in the form of higher expected  (2)  The investor  would wish  want  a share  of  to  compensated  for  of  forest  be  an uncertain future  returns.  input into  the  decision  how  managed and protected, encroaching on the autonomy of the forest  (3)  Detailed  growth  response  this  records would  be  the  is  manager.  required. This  would  place  an added cost on the investment infrastructure.  It is therefore  recommended that investor participation be on a fixed  basis. The Crown would experience record-keeping this method forest  on  a provincial  economies through being able to pool risks and  (or Timber  Supply Area) basis.  A major benefit  of dividing the increment is that it provides a strong incentive  manager to  manage  well.  volume  Using the  investor's  capital, he  will  of  for the  benefit  on a  one-to-one ratio with all growth in excess of the fixed obligation.  Stumpage vs. Products  The  invested  funds would  promote  forest  growth, creating stumpage  value.  Stumpage is the net value of standing timber. It is classically defined as the gross value of products which may be produced from timber, less the costs of harvest, transport, and manufacture. 9  9  Common sense would therefore  suggest that the investor return be expressed  as a  certain quantity of stumpage. This is not feasible for a number of reasons: (1)  Stumpage  impossible  to  values  describe  promising stumpage  vary widely  an  by region  'average'  stumpage  value would therefore  need  and timber type. for  to  British  It would  Columbia.  be site specific,  be  Contracts  an impediment  to both ease of issuance and contract liquidity.  (2) Stumpage values are negotiated termined alerted  by most  open  bidding. The  potential  investors  low in British Columbia.  recent to  in British Columbia rather than being decountervail  the  fact  that  duty  case  stumpage  with  the  U.S.  has  rates may be artificially  It is unlikely that investors would be willing to  base their  future returns on such a factor.  Investors equity  for which free  question. an the  would  likely wish  market prices  Logs might be  artificially low level investor  their return to  return be  domestic  by log export restrictions. on  based  are readily available.  considered, however  based  be  the  prices  on  a type  Stumpage  log  prices  It is therefore  of  is  of timber out  of  the  are protected at recommended that  manufactured  products  (specified  lumber grades, chips and pulp, plywood, newsprint or paper) as they leave the mill or  at some major distribution point such as f.o.b. Vancouver Harbour. This type of  equity  contract  would  create  greatly increase its acceptance  The  for the  forest  manager but  by investors.  stream of rationalization to this point may be summarized in the  statement:  obligation  a  complications  Wood Unit  The ing  conversion  specified  'Wood  the  representing  government the delivery  mix of manufactured  would in  sell  to  twenty-five  forest  investors years  products.  Unit'. Since the principal manufactured forest  This  time  a  freely of  contract  transferrable  the cash  is  follow-  here  value  of  called a  product (highest value per unit  volume  of  fibre)  is  lumber,  and  since  lumber  recommended that the Wood Unit be expressed  Pension multiples  of  participation, one  funds  and other  thousands it would  of be  large  investors  Mbf, but for the preferable to  Mbf. It should then trade in the  trades  in  in Mbf units  Mbf  1  of  denominate  10  the  Wood  is  Units in  divisibility, and small  the  it  .  1  may purchase  sake  units ,  Wood  Unit as  investor  representing  $100 range, comparable with listed corporate  stock prices.  The assets  Wood  available  Unit  for  should  inclusion  prove  in  relatively bulky and heavy for its holding  of wood  compete  with  to  be  investment  bullion  and  portfolios.  addition to  Wood  as  a  the  set  of  commodity  is  dollar value. The Wood Unit would facilitate  in a portable, transferable,  gold  an important  other  real  store-of-value assets  in  form.  As such  the  it would  providing investors  with  an  inflation hedge and cyclic price diversification.  Lumber and plywood futures  are presently available to  investors  through the  facilities of the Chicago Merchantile and Montreal Exchanges. These contracts are for durations of three a vehicle  for  months to  investor  a year. There does not exist anywhere  participation in forest  products  as  a long  in the world  term  commodity  holding. The cost of storing lumber is very high in relation to the value represented. The only route forest  land  currently available is through direct, site specific  enhancement.  The Wood  Unit would  therefore  create  investment  its  own  in  market  niche.  Comparison of the Wood Unit with Cold  Gold security  as  bullion is a value  of  held last  by  investors  resort,  and  for its  its  status  historic  as  an  inflation  hedge,  record  of  cultural  acceptance.  An Mbf is one thousand board feet. One board foot measures one foot by one inch. 1  0  1  1  one foot by  Refer to Appendix E for log, lumber, and pulp conversion factors.  its  Recently, it has become certificates  popular among gold investors to hold bank issued demand  rather than the  physical commodity.  bullion trading in Canada occurs  in certificate  the  and,  investor  shipping 1/2%  a  'refining  charge  as  charge'  well.  However  per annum) to the certificate  lawyer's  affidavit,  but  if  lost  can  if  the  Gold form.  outside bank  dealers  estimate  Purchase  the  charges  of  that  60% of  a certificate  Toronto  area,  a storage  fee  saves  saves him a  (approximately  holder. Certificates are non-transferable without a be  cancelled  and  replaced  by  the  bank,  upon  payment of a fee.  The at  least  government  as  secure  issued Wood Unit should be regarded by investors as being  as  bank  issued  gold  transferable, and would not require the an  implicit dividend. It should  certificates.  The  Wood  Unit  payment of a storage fee.  therefore,  depending  on  relative  be very attractive to the gold-holding segment of investment  would  be  It may also pay  price  expectations,  portfolios.  1986 Study  A Wood  study was  Unit  should  Portfolio Theory  undertaken by Olivotto (1986) to offer  to  12  in  order to  analyze  attract  investigate the  a capital  changes in wood  flow.  compared  with  (PPI), during the  interest  rates  period 1960  to  (U.S. 1984  Government  weighted  1  2  prices  of  three  and  the  =  25% LOGS +  W2  =  50% LUM +  hypothetical  25% LUM + 50% PULP  Markowitz, 1959; Sharpe,  1970  lumber, pulp,  inflation  inclusive. The theory on which that  Wood  Units  25% PULP +  rate  analysis  in Appendix A.  were  considered,  combinations of individual product prices, as follows:  W1  employed  Composite Index (S&P)),  Bonds)  was based, and the results of the analysis, are presented  The  study  product prices (logs,  newsprint) and stock market prices (Standard and Poor 500 as  The  return that a  25% NEWS  formed  as  19  W3  =  Computer  50% LUM +  analysis *  was  1  each  hypothetical  with  stock  and  bonds  and  Wood bond  alone.  35% PULP +  then  performed  Unit to  holdings  It was  15% NEWS  the  were  found  to  market.  3  inspect  the  Portfolios  compared  that W1  1  with  historic  combining  portfolios  required  attractiveness each  Wood Unit  consisting  a dividend  of  of  2%  stocks  to  be  attractive holding during the period, while W2 and W3 required dividends of  Bond yields  averaged  7.3%  to  period. The Wood Units were found  be attractive at 2% to 2.5% for two  (1)  for  the  Wood  period. This resulted  Units. These  (dividends to  main reasons:  Price Appreciation: Forest product prices rose 5.4%  per year during the  2.5%.  S&P averaged  1984  per year  an  and the  plus capital gains) during the 1960  8.9%  of  (pulp)  in average annual gains of  increases were  .8% to  1.3%  greater  to  8.1% (logs)  5.7% to  than the  6.2%  inflation  rate (4.9%).  Historically, forest product prices have risen faster than the graph in Appendix B.1 illustrates in real terms,  on  average,  inflation rate. The  that lumber prices have increased  since the year 1800.  Recent  1.7%  per annum  price histories for pulp and  paper products are illustrated in Appendix F.2.  (2)  Zero  with changes  correlated  that there attractive  Beta:  is to  no  Changes  in  prices  were  found  to  be  not  in stock market prices. The lack of correlation (|3 = 0) means  systematic risk to  investors  wood product a Wood  at an expected,  Unit holder; Wood  Tate of  return equal  to,  Units  or lower  should  be  than,  the  risk-free market rate.  The period was  lack  of  verified  correlation  demonstrated  by inspecting  by  changes in log  W3 roughly parallels the current composition by value, from British Columbia. 1  3  1  4  White,  1978  the  study  prices  of  relative  the to  1960  to  1984  changes in the  of primary forest product  exports,  Dow Jones  Industrial Average over the  75 year period 1910  to  1984.  This  analysis  produced a beta of -.08.  It has  been  suggested that the  quality of  lumber (or fibre)  represented  by  the annual Wood Unit issue be varied from year to year. Appendix F illustrates that recently the  prices of various grades  In particular, the logs  has  of  lumber have  appreciated  price of a lumber mix which might be  been  rising  1%  to  2%  per  annum  at different  rates.  produced from high-grade  faster  than  the  price  commodity-grade lumber. Investor expectations regarding future price increases  of  of the  Wood Unit will depend on the product mix which is represented.  A studied  matrix of is  correlations  presented  between  following  the  price changes of  'beta'  discussion  in  the  four forest  Appendix  A.  products  Changes  lumber prices are not well correlated with changes in pulp prices. Investors stability  may  prefer  a  Wood  Unit  which  combines  lumber  with  seeking  pulp,  while  speculators  may prefer only lumber or only pulp. The product mix represented  the  Unit  Wood  issued  in any  given  year should  reflet  investor  in  sentiment  by  at  that  time.  Pricing the Wood Unit  Currently, approximately  government  9%,  of  which  return. To attract investment with  /3 = 0)  should  offer  bonds  trade  in  5% is  inflation  the  expectation  a  comparable  per annum, the return necessary  an  expectation  expected  (5%),  compound  return.  a discount  would  be  to  of  current cash  computed  by  a  and  rate  4%  is  of  return of  expected  real  to  example, increase  if  commodity  in real terms  grade  by  1.3%  to attract Wood Unit holders would consist of the  anticipated rate  By  real gains  increase  to  in the  prices  compounding  for  price of wood  maturity adequate  risk-free market rate of return. A Wood Unit without at  at  capital, the Wood Unit (a government issued obligation,  lumber prices are $250 per Mbf, and expected  inflation  market  the  current  match  the  dividends would tend  product prices  to  (1.3%), and  mix at  represented.  their  expected  9%  to sell  Its  price  rate  of  increase  for twenty five years, and discounting that figure to the present  at the re-  quired market rate of return.  example (i): commodity grade $250 compounded at 6.3% $1151  =  discounted at 9% =  $1151  $133  example (ii): premium grade $360 compounded at 6.9% $1909 discounted at 9% =  All  returns would  at any time.  In example  $250, inflation adjusted,  be  in the  $1909  $220  form of  (i) an investment  =  15  capital gains  of  $133  realizeable  in the  would be expected  plus match any real wood  price gains  market  to grow to  which occur in the  interim.  A  comparison  of  bond  and  Wood  Unit  price  responses  to  changes  in  activities  of  interest and inflation rates is included in Appendix C.  Legal Considerations  The pension  funds,  investment all  Pension  Benefits  lt  was  Standards  inspected  Act  for  regulates  limitations  with  in the Wood Units. It appears that no  indebtedness  of,  or  guaranteed  by,  .  .  a  the  investment  respect  to  problem would be  province  of  Canada  pension  fund  encountered; are qualifying  investments under the Regulations attached to this Act.  Legislation would need to be written governing the listing of the Wood Unit on  a  Stock  Exchange.  commodity futures is not between  1  5  however two  Reflects  The  contracts,  although none  a commodity  parties  Vancouver  futures  regarding the  Stock  is  approved  to  trade  are listed at this time. The Wood Unit  contract.  price which  higher price gain expectations;  Exchange  A futures will be  contract  is  an  agreement  paid at a future date  refer to Appendix F.  for  delivery  of  agreement  a  quantity  of  products.  No  dollars  are  exchanged  when  a  futures  is struck, although both parties place a surety deposit with the Exchange.  The Wood Unit is quite different for future value  delivery,  in that it would represent  ln this  sense  it is more  a fully paid obligation  like a bond than a commodity  •contract.  The likely  Wood  require the  Unit  is  an  writing of  entirely  a new  rights and obligations associated  new  type  of  Act permitting  with its  financial its  contract,  existence  and  and would defining  the  development  in  issuance.  Tax Treatment  The Canada,  Federal  and  has  government over  time  were contemplated,  very  created  forestry activity. Two years ago, incentives  is  supportive  many  special  of tax  early in the development  some modelled  on  the  forestry  arrangements  to  support  of this thesis, various tax  'flow-through  share'  treatment  of mining exploration expenditure.  It has to  stand  reasonable p  a  capital  on  since its  been  own,  decided without  that  special  this  proposed  tax  support.  infrastructure should The  only  tax  be  request  able is  a  one; that the investor return from holding the Wood Unit be treated as gain  rather than  payable either when  as  ordinary income.  sale through the  The tax  on  this  gain  would  be  Stock Exchange occurs, or on redemption at  the end of the Unit Rotation.  Stock Exchange Trading  A Stock Exchange listing does not in itself the  long term purchasers to whom  viable market must  the  guarantee  liquidity. In addition to  initial Wood Unit issue would be  involve the participation of  participants are identified in the following list.  hedgers  and speculators.  sold, a  Some  such  (1) The study of the 1960 to 1984  period showed that forest product prices  were much better correlated than stock prices to the inflation rate: p Periods  of  =  W1,INFL  high  .4;  p  inflationary expectations  S&P,INFL  should  =  attract  -.2 secondary  market purchasers  to the Wood Unit. (2) Examples in Appendix C demonstrate that, if real interest rates and wood prices  remain constant,  changes  in the  the  Wood  Unit  price  should  not  change  inflation rate. This fact should attract hedgers  in response  interested  to  in inflation  protection.  (3) Wood  Appendix  C  demonstrates  Unit. These hedgers,  sponding interest  short rates  position  while  how  interest  in lumber (or pulp?) futures,  being  the  remaining  sensitivity.  Interest  term  unaffected  to  hedgers  by taking a long position in Wood  by changes  sensitivity of this hedge position (percentage of  rate  maturity.  would  in wood  would  term  rate hedgers would therefore  Wood  concentrate  the  Units and a corre-  profit from  a fall  product prices.  profit per dollar invested)  Long  use  Units  in  The  1 6  is a function  have  the  their activities  highest  on  newly  issued Wood Units, aiding market liquidity for the first few years.  (4) Wood  Forest product consumers  Unit to hedge expected  such  Forest product companies  raise capital for the positions,  spread  publishers and builders may use  consumption needs. These hedgers may be  to mainly take long positions in Wood  (5)  as  a series of  might  use  annual Wood  short of  positions  processing Unit  issues,  in Wood facilities.  An opposite  position would hedge against increases  might be  in interest rates.  Units to  These  production from the improved facilities as each Wood Unit issue matures.  6  expected  Units nearing maturity.  construction and expansion  over  the  short  retired by  (6) Forest Units  at  cyclic  companies  lows.  holding  By turning  a  Management Unit  in  for  receive a refund of its H&M deposit plus 4  (7) International arbitragers and speculators Wood  Contracts  may  purchase  Wood  cancellation  the  company  would  of stumpage-free  timber equity.  may be expected  Unit trading once the market has developed  to participate in  a sizeable outstanding float.  CHAPTER FOUR GOVERNMENT The  provincial government,  Columbia's forest  land.  that  land,  and the  that  land produces.  It also  In  government's adequate  owns all the  fish, wildlife, water,  return  Crown, owns 95% of British  timber growing and to  be grown on  minerals and other natural resources  Government provides  reap commercial benefits resources.  in the name of the  licences  to  which  individuals and companies  to  from the use of the land and from the exploitation of its  the  government  collects  rents  and  royalties.  It  is  part  of  social responsibility to ensure that the rents and royalties collected are  compensation  for  the  values  removed  and for  the  alternate  social  uses  foregone.  This chapter of the have  to  thesis analyzes  assume  under  that  government  assumption  timber management.  this  financing  wishes to  The chapter goes  previous section  obligations  which government would  proposal.  The  analysis  realize the  full  economic  on  be required to implement the investment  The  the  to  describe  two  is  based  on  the  rent  produced by  'reserves'  which would  scheme.  suggested that investment  funds for forest  management  would best be attracted by offering the value of a fixed volume of forest products to  be  delivered  at  a  future  date.  Assuming  this  would  be  acceptable,  the  government needs to consider (i) the application of the funds to the land, and (ii) the  future conversion  of stumpage  government would  need  It would  do  level use  of of  resources.  wish  to  to so  profitability while its  land  resource  into  products. For both these  rely on the on  a basis  allowing and  the  involvement  which  government  permits to  exploitation  of industrial forest those  collect of  requirements  its  the  companies  companies. a  true value  timber,  water,  the  sufficient from  and  the other  Capital Return  It is necessary to  make clear exactly  what  the  government  would  deliver  to  investors.  (1) The government would not deliver a cutting right.  (2)  The  investment  government  would  not  deliver  the  stumpage  value  which  produces.  (3) The government would not physically deliver a mix of forest  Instead,  the  amount  of dollars would  government  mix of forest  It  has  manufactured  would  promise to  depend  on the  deliver a quantity future  products.  of future  market value  dollars. The  of a clearly  specified  products.  been  proposed  products.  that  Present  the  investor  lumber recovery  feet per cubic meter (m^) of log i n p u t . of  the  lumber. The conversion  of  logs into  17  1  8  return be rates  expressed  are  in  approximately  Mbf's 225  of  board  Thus 4 m^ of logs produce .9 Mbf  lumber creates residues  (sawdust,  shavings,  and slabs) which have value as inputs to pulp and paper manufacturing. The residue from  converting  equivalent,  of  or approximately  expressed as residue.  4  As  "one already  logs  into  .4  BDU's  Mbf equivalent", discussed,  should vary from year to  year.  the  .9  Mbf of  (bone  dry units).  meaning precise  For the  lumber  .9  Mbf of  product  sake of  mix  is  1.9  of  The Wood Unit might lumber plus backing  this discussion  the  therefore  be  to  pledge to investors,  provide 4  of  raw material (of  8  of  Unit  it is assumed  that  of logs.  minimum quality) plus the  factors.  Lumber recovery varies both with sawing technique therefore differ between regions of the province. 1  BDU's  per Wood Unit of capital raised, would  See Appendix E for a table of conversion  1  .4  be  Wood  the raw material required to produce one Wood Unit of product is 4  The government  solid-wood  and log size, and would  cost  of  converting  that  material into  manufactured products. To do  so  the  must ensure that the application of the investment funds to its forest vide  a growth  additional  increment,  growth to  in twenty-five  provide adequate  years,  of  stumpage  four cubic meters  receipts  to  government  land will proplus  enough  pay for conversion of  the cubic meters into products.  The P/L Diagram  The  implications  to  government  analyzed through use of the  of  undertaking  P/L (Profit/Loss) Diagram.  this  obligation  may  be  Four important variables need  to be defined in order to pursue the discussion:  CP =  the value of the Wood Unit at maturity (equals the cash price of  one  Mbf of product mix at that time), H&M  =  the future cost of harvesting and milling 4 m^ of logs into one Mbf equivalent of product.  Cr =  the growth increment in m^ created by the investment (realized growth after twenty five years, less what would have occurred without  P/L =  investment),  the net profit or loss to government (per Wood Unit) of inviting investor participation in forest  Stumpage  management.  is generally realized through the  sale of  standing timber; it is the  economic value of the harvest potential of trees in the forest, and is classically defined as the value of manufactured products less the  cost of harvesting and milling  those  investment  products.  The  stumpage  expressed  as the difference  has  created. The pledge  been  revenue  from  the  may  between CP and H&M, multiplied by the per Wood  Unit to  the  investors,  therefore  be  growth which  meanwhile,  is  to  deliver the value of one CP.  Figure 1 illustrates that as CP increases, the  Wood  Unit  rises  equally.  H&M will  locate  the  cost to  somewhere  The location of H&M determines the harvest threshold.  government on  the  of retiring  horizontal axis.  FIGURE  ±  Government Pledge to  Investors  Illustrated as a function of future product prices.  Profit  ($) Harvest  Government Revenue  Government Obligation  Loss ($)  (1) If CP < and  government  from the  would  pay investors  the  value  harvest would not. o c c u r , 1 9  CP without  receiving  any  revenue  receive  revenue  forest.  (2) If CP = (3) If CP > of  H&M stumpage would be negative,  CP-H&M  from  H&M harvest may or may not occur.  H&M harvest would occur. Government would all  growth  which  the  investment  had  produced,  while  paying  investors CP for the pledged portion of the growth.  The (CP-H&M)  algebraic derivation which follows to  arrive at the  net  government  incorporates growth (Gr) with  stumpage  profit or loss (P/L) on the Wood Unit  pledge:  Harvest decisions are here assumed to be based only on timber values, ignoring (i) other forest values, and (ii) social externalities (ie: employment creation). 1  9  Stumpage  =  Product Price minus Processing Cost  (1) Stumpage per Mbf =  CP - H&M  Assuming one Mbf equals 4 m : 3  (2) Stumpage per m  =  3  (CP - H&M)/4  Multiplying by the volume present: (3) Total stumpage produced =  [(CP - H&M)/4]-Gr  Subtracting the investor obligation: (4) P/L =  [(CP - H&M)/4]-Cr - CP  Transposing this equation into a usable format: P/L =  (5)  CP-Cr/4 - H&M-Cr/4 - CP  =  CPGr/4 - CP - H&MGr/4 +  H&M - H&M  =  (Gr/4 - 1)CP +  =  (Gr/4 - 1)-(CP - H&M) - H&M =  (Gr/4 - 1)-(- H&M) - H&M mx +  b  where: m  =  (Gr/4 - 1) =  growth in Mbf less one Mbf to investors,  x =  (CP - H&M) =  b  (- H&M) =  =  Equation (5)  cost of processing the investor obligation  is plotted  possibilities.  stumpage per Mbf, and  on the  In equation (5)  P/L Diagram,  'm' is the  Figure  2, showing  slope of the  a range of  growth  P/L ray, 'x' is the market de-  pendent variable, and 'b' is the harvesting threshold.  The  expected  P/L line for a growth  future product prices (CP), has been need  to  be  twice  the  cost  of  projection of  8 m , 3  as a function of  highlighted. In this case the future CP would  H&M in order that  stumpage  receipts  would  be  sufficient to pay the cost of processing the pledged Wood Unit.  Regions of the P/L Diagram  Figure feasible  3  regions.  production  and  shows Region future  the  P/L Diagram  1, prices  the  profit  which  shaded  so  region,  indicates  would  provide  as  to  highlight those  government  four  distinct  combinations with  of  sufficient  30  FIGURE _2_ P/L Diagram Illustrating the expected  government profit or loss on Wood  Unit  issuance as a function of future prices and growth response.  Cr =  expected growth increment  = number of cubic meters in twenty five years.  31  FIGURE 3^ Regions of Illustrating the four  distinct  the  P/L Diagram  feasible regions of the  P/L Diagram.  Profit ($)  Government Revenue  ($) Loss  N  s/Cr<4  /  v  s  REGION  %  revenue to 2  retire the investment  represents  should  be  the  emphasized  magnitude  is  poor  of  processing  of  inadequate  management,  the  fixed  (one  Mbf) volume  Region 2 lies between two  that  independent  losses due to to  cost  obligation and have some dollars left  price  or  investment  of  product. It  parallel horizontal lines; its  considerations.  3  Region  represents  productivity. This underproduction may be  catastrophic  magnitude of this loss increases  growth  over. Region  losses,  or  poor  investment  as product prices increase,  since  due  selection.  stumpage  The  receipts  would be insufficient to match the increasing value of the Wood Unit pledge.  Region 4 is actually an extension  Region 2 , and would  of  be  provided for  by  the precautionary measures advocated for Region 2 . The reader should recall that  in  the  event the  government  accepts  a loss  by locating  in Region 4 the  timber  remains in the forest, uncut and free of lien.  It  is  recommended  Harvest and Mill  should  provide  contemplate very  Reserve, the  the  the  the  most  other the  cautious  financing scheme  speculative  government  2 , 3 , or 4 by establishing  locating in Regions the  that  government  indeed  which  two  for  reserves.  the  eventuality  of  One would be called  Standing Green Reserve. Together they  government described  provide  with  herein. would  enough  security  Without them  enter  the  to  seriously  it would  scenario  be  a  portrayed in  Figure 2 .  The  Harvest and Mill Reserve  In volume  order to  of  forest  provide for the  products pledged  future to  expense  investors  the  of  harvesting  government  and  milling  should establish  the a  cash reserve. This reserve would be in the form of a conservatively managed capital pool, expected  to earn a market rate of return comparable to mutual fund,  pension  fund, and insurance trust capital pools. The Harvest and Mill Reserve would be tablished  at the  time  as  present  cost  the  discounted  at the  investment of  funds  processing  are raised with an initial deposit the  current market rate of  volume interest  of  future  products  over twenty-five  years.  es-  calculated promised, Each year  the  growing asset level  the  then-current cost  return  for  the  asset  level  in the  of  processing,  number of  may be  Reserve would  years  in excess,  discounted  left in  be  until  other  inspected  at the  the  then-current market rate of  obligation  years  it  may  processing,  and the  indicated  the H&M Reserve would be $29 that  under  present Unit.  market If  $29  rate of  is  placed  in the  would  Harvest  the  pay  Wood  Wood  Unit pledge would be available for forest enhancement  the  point  possibility  product  be  deposit  and  Mill  per  to  estimated commodity  Reserve,  $104  per  activities.  processing  obligation  Units mature. It's existence would eliminate Region 2 from the P/L  On that  vertically to  it would  initial  $133  The level in the H&M Reserve would exactly equal the  Diagram.  the  if $200/Mbf is the current  grade  when the Wood  years  The earlier example  20  investors  Some  deficient;  return is 8%,  per Mbf p l e d g e d .  conditions  is due.  be  drawn down or topped up accordingly. As an example, cost of  by comparing it with  of  diagram, it would A, as  illustrated  locating  in  lift  point  in Figure  Region  4.  4.  If the  B, with This  come  a time  before the twenty-five  H&M  Reserve  will  exceed  the  set  Reserve  price  prices, and product prices are less than the  its  of  the  of  would  also  Wood  eliminate  Unit  reflects  cost of processing, there will  years have passed when the  value of the Wood  radiating rays,  cash level in the  Unit. The Unit would  then  be  purchased in the market with funds from the Reserve, cancelling the obligation.  The Standing Green Reserve  Region investment  3 of the  funds  material for the m3  in  twenty-five  will  P/L Diagram represents not  investor years).  produce  return (eg.  enough that  Most foresters  however major insect infestations  the  possibility that the  physical  growth  an investment would  consider  of  to  $104  this  provide will  the raw  grow  4  possibility,  or several bad fire seasons may cause it to occur.  Processing cost inflation is addressed in the following chapter 'Forest Companies' and in Appendix H. 0  of the  not  a remote  Government may make a number of provisions for this contingency.  2  use  FIGURE  4  Amended P/L Diagram Illustrating the effect on expected government  profit/loss  of a Harvest and Mill Reserve.  of the  creation  (1) in  Investment  order that  the  funds  should  plentiful  growth  be  placed  on  on  some  the  sites  best growing  may  be  sites  used  to  made  to  possible,  compensate  losses on other sites. (2) Efforts, forest.  Such measures (3)  conjunction  and  should  industry,  should  of  investment  in  of  be  protect  the  established.  take  a self-insuring  This means that investments should be over timber stands  segments  with  are already well  The government  investments. land,  in  varying species  contiguous  blocks  view  diversified  types  of  in placing  and  its  forestry  over a wide  area of  ages.  homogenous  To place  timber  type  major is  an  invitation to disaster. (4) It through the  may be  possible  federal government.  to  re-insure  the  investments for catastrophic  This possibility should be  explored if the  losses  financing  plan is considered for implementation. (5) To reserves,  self-insure,  based  cross-referenced establishing  on with  its  the  government  estimation  the  of  probability  this reserve would  be  might  the of  set  aside  probability  very  high  of  quantity  production  future  subtracted from the  a  prices.  revenue  of  cash  deficiencies  The  cost  of  raised by the initial  sale of the Wood Units. (6) existing  Instead  timber  harvested  in the  of  cash  inventory  reserves, from  future to  the  current  replace  opportunity cost of current revenue  government harvesting.  The  any inadequate foregone  to the consideration of the overall investment  might reserve reserved  growth  by such  of  a portion of its timber  managed  would  be  stands. The  reservation should  be  added  scheme.  Such timber reserves (Standing Green Reserves)  should be diversified by area,  perhaps located on a Regional or Timber Supply Area basis. They would not be required in a one-to-one ratio with the volumes ate ratio could be computed production fixed  deficiencies.  forever  to  specific  contracted to investors; the  using conservative  estimates of the probable extent of  The Standing Green (S.G.) Reserves locations.  What matters  appropri-  is the  would  not  need  physical volume  to  present  be in  relation to the investor volumes pledged.  If stumpage Rotation,  (CP - H&M) values  insufficient  are relatively low  growth would not be too  expensive  at the  end  of  for government,  investor return (CP) would be very nearly matched by the  existing  the  Unit  since  the  deposit  level in  the H&M Reserve. The real risk of underproduction is if it occurs at the same time as very high real Green of  Reserves  which  prices  may  (moving  therefore  British Columbia  to  the  right on  incorporate  the  P/L Diagram). The Standing  'economically  has a plentiful store.  inaccessible'  The cost of  timber stands,  accessing  this timber  would be affordable in the case of very high future prices, when it would be most needed. Alternatively, the a  stand,  with  the  Reserves might be comprised of certain described trees in  possibility  of  selectively  removing  other  (mature)  trees  silvicultural  treatment  and  establishing an appropriate understory.  Forest Growth Estimation  Information  regarding  growth  response  to  Columbia is largely unavailable; a wide range of intensive management only  recently  been  species have been may  be  undertaken  an  organized,  to  British  Columbia,  fashion.  British  activities have Our  domestic  and data from Europe  making adjustments  Reliable estimates of growth response  would be needed  recorded  grown in Europe for a century, however,  transposed  differences.  in  in  for  soil  and climatic  to a variety of silvicultural regimes  to thoroughly appraise the viability of this investment  scheme.  The earlier example suggested that the issue of commodity-grade Wood Units should  provide  $104  ($133  pledged.  A number of  response  per $104  on  invested.  government  Douglas-fir (Pseudotsuga  $29  H&M deposit)  silvicultural treatments  1985/86 provincial average  published  less  are  per  4  inspected  m^ here  The appraisal is made using sample  of  raw material  for  their growth  calculations  based  costs (Appendix D.2), and yield estimates taken from  sources  (Appendix  menziesii  (Mirb.)  D.3).  Franco)  The  examples  management.  are  based  on  Table H_ Four Yield Examples (i)  Backlog Reforestation  Cost : 2 1  Plant  ($267  labour,  $200  seedlings),  brushing and weedings (1.5 X $375) = Incremental  Yield:  4.2  m /ha/yr good 3  plus  an  average  one  and  a  half  $1030/ha. site; 4.2  X 60%  2  =  2  2.5  m /ha/yr medium 3  site. Yield  per  Wood  Unit  =  ($104/$1030)  X 2.5  =  .25  m /haA/r 3  or  6.6  m  3  in  25  years.  (ii)  Rehabilitation  Cost: Salvage scrub and burn ($300), prepare site ($196), plant ($467) = Incremental Yield: 5.8 m /ha/yr good site; 5.8 X 60% =  3.5 m /ha/yr medium site.  3  Yield per Wood Unit =  (iii)  ($104/$963) X 3.5  =  $963/ha.  3  .38 m /ha/yr or 9.5 3  m  3  in 25 years.  Conifer Release  Cost: Remove overtopping brush ($435), spot plant ($150) = Incremental Yield: 3.7 m /ha/yr good site; 3.7 X 60% =  2.2 m /ha/yr medium site.  3  Yield per Wood Unit =  (iv)  Space and Fertilize  ($104/$585) X 2.2  =  3  .39 m /haA/r or 9.8 m 3  21 meters at 50 years)  3  Unit  in 25 years.  $775/ha.  Incremental Yield: 3.5 m /ha/yr low site. (Douglas-fir SI = per Wood  3  2 3  Cost: Space ($575), fertilize ($200) =  Yield  $585/ha.  =  ($104/$775)  X 3.5  =  .47  m /ha/yr or 3  11.7  m  3  in  25  years. 2  1  Average cost, British Columbia, 1985/86.  Figures in Appendix D.3 (good site) are reduced in examples (i), (ii), and (iii) by 40% to be indicative of medium site productivity. This is a generous reduction based on Ministry of Forests and Lands yield tables, which give top heights for coastal Douglas-fir at 50 years of age as: High site = 50 to 42 meters; Medium site = 42 to 30 meters. 2  2  The effects of fertilization taper off over time. This treatment however provides quality as well as volume increment, by concentrating growth on fewer stems of larger size. 2  3  These pledge  of  medium  examples  4  indicate  may be  to  matched  Coastal site. These  or 220  that  the  with  growth  best  growth  increments  of of  our  from  current  knowledge  6 m-* to  are in addition to  11  the  the on a  8.9 m^/ha/yr  m3 which would grow in an unmanaged stand. Growth rates in the central  Interior (Prince George area) are less than on the  Coast. The table at the  end of  Appendix D.3 suggests that natural growth in the Interior occurs at half the rate of the Coast. The Interior region is relatively flat compared to the however,  and management  comparison of the  two  is  therefore  less  regions should also  expensive  on  consider the  mountainous Coast,  a per  hectare  basis. A  present value of  expected  lower harvest costs in the Interior.  The numbers in Table II have been verified with the Forest Service as being accurate and representative. assuming that there in twenty  Later examples  is a 50% chance  five years or .36  of  in this thesis illustrate growth distribution achieving a mean growth increment of 9  m^/ha/yr, per Wood  Unit of  investment.  This is a  conservative figure for medium Coastal sites.  The Clearing House  The  government  management  activities  under  maintain  records  Reserves  and Standing  product  markets  of  would  need  the  investments Green  and forest  to  establish  investment and  growth  the  It would  response  body  program.  monitor  Reserves.  a  to  This  administer  'Clearing  corresponding need  to  in order to  be  its  forest  House'  would  Harvest  aware  balance  new  of  and  Mill  trends in  Wood  Unit  issues. It might also act as a market-maker for the listed Units. The Clearing House would necessarily act in close association with the Forest Service.  The investment private  Clearing funds  entity,  are  profit  House  may  prove  economically motivations  to  raised  might  be  and  stimulate  the  driving  efficiently efficient  force  spent.  behind  whether  If structured  as a  activity. Governments wish  to maintain flexibility, however, and it is likely that the Clearing House would be a government agency or commission.  In  order  to  provide  recommended  that  representative  elected  and  a  forester  the  checks,  Clearing by the  employed full time  House  Wood  representing  counsel, be  Unit  democratic  governed holders,  Management  managing the  and  representation,  by a tribunal  consisting  an appointment  Contract  holders.  The  is  of a  by government, three  House; their salaries would most  it  would  be  appropriately be  paid by the organization whose interest they represent.  These may  be  interested  activities, tribune use,  such may  to  interests  be  brokerage  as  be  would  in  be  product  different. quality  over-issuance,  expected  to  watchful of the  commissions  and  For example,  and  insurance  which  depress  promote  efficient  Wood forest  H&M Reserve account, social  welfare  the  reserves, Unit  and  prices.  activities,  and to  expenditures.  investor  such  representative work  against  The company as  herbicide  argue against excessive  The government  appointee  would be most concious of environmental and distributional considerations.  The Silviculture Fund  Revenue  from  the  annual Wood  Unit  issue  would  be  initially placed  Silviculture Fund, from which it would be distributed over time to the  in a  land by the  Clearing House. It should be emphasized that there is no urgencey to this distribution;  monies  interest, ment  might  be  wisely  while investment  infrastructure is set  held  projects in place  in the  Fund  are selected, and tested.  for two  people  or three  years, earning  are trained, and a manage-  The benefits  of  taking  a cautious  approach should outweigh the two or three years worth of growth foregone.  Government  Benefits  The government  may expect  the proposed silvicultural investment  a number of  direct and indirect benefits from  scheme.  (a) Social:  (i) Employment would be created (silviculture is very labour intensive). (ii) forester (iii)  Implementation  would  employ  legal,  actuarial,  and  professional  services. Remote,  economically  depressed  communities  generally located adjacent to the denuded forest (iv)  computing,  The  improved  raw  material  supply  would  benefit.  They  are  lands requiring management.  would  provide  industrial  growth  and  security. (v) A healthy forest is a valuable strategic asset.  (b) Economic:  (i) Stumpage  receipts  designed  to  replace  the  lumber exports to the U.S. would remain in general  current 15% tariff  on  softwood  revenues.  (ii) Personal income taxes (with a 2.5 times multiplier) would recapture some of the  investment. (iii) Corporate tax revenue may increase in the future. (iv) Timber growth which will bear stumpage  in the future would be initiated.  CHAPTER FIVE  FOREST  COMPANIES  The  government  undertake  the  Management stumpage' ing  to  date  has  Columbia  management been  relies  heavily  required  primarily  financed  on  on  forest  their  through  of  administrators and checkers,  contractors  is essential  The  have  developed  while  technical  the  companies  tenured  Section  or direct Ministry contracts. This has resulted in the  silvicultural  to  British  site-specific  a network  expertise  of  88  expertise.  lands. * 2  'credits  government  integrated A  companies  contribution  of  and this  to the implementation of the finance proposal described herein.  government, as owner of the capital pool (Silviculture Fund), would need  create  some  incentives  guarantees),  incentives  might  and  silvicultural  to  attract  provide  entrepreneurial  competitive  regimes).  They  corporate  section  management  of  the  stability  opportunity might  be  participation.  paper describes  modeled on an incentive  (through  (through  designed  material supplies, and would necessarily This  to  develop-  The  incentives  should be designed so as to stimulate voluntary participation in an efficient The  to  to  the  timber  freedom  promote  volume to  promote the enhancement  a method  of  corporate  or  select  efficient  manner. price  alternate  use  of  raw  of those supplies.  involvement  in  forest  the  most  of  input.  basis.  Distribution of Silviculture Dollars  It  would  be  productive  treatments  Productive  output  the  quality of  dollars invested,  desireable and  sites  from forest  growth  to  silvicultural  investments  available,  maximizing  output  management  increment.  and expertise  place  is  measured  per  by both  Productive inputs are the  area of  contributed. A company wishing  to  into unit the  volume  and  land employed, attract silviculture  * This reliance is to be continued, as evidenced by the creation, in 1986, of the first "Tree Farm Subsidiary Agreement". This agreement gives Crestbrook Forest Industries (TFL 14) the right to deal directly with all government Ministries. Replacing continual supervision, the agreement provides for a single annual audit of operations by the Forest Service, with cash or AAC penalties levied for poor performance. 2  dollars  to  its  tenure  would  together with a specified  therefore  need  to  demonstrate  that  its  expertise,  quantity of dollars from the Fund, would produce a speci-  fied quality and volume of timber on a described area of land.  (a) Outputs: Quantity and Quality  An  analysis  comparing the  historic prices  of  a range  of  Douglas-fir lumber  grades is contained in Appendix F.1. The analysis shows that product prices tend to fluctuate together,  and that the prices of superior products always  exceed those of  lower grade products. When lumber prices are proportionately grouped into log-sets representative form  of  distinct  different  bands  levels of  relative  to  silvicultural management,  each  other.  A  MEDIUM  it is found that log  set  is  prices  defined  as  containing 70% dimension lumber and 30% higher grades. Average prices per cubic meter  of  HIGH  ($1.30), and PRUNED ($1.70). It is also found that relative prices have  diverging  other  log  sets  in recent years,  relative  to  the  MEDIUM  probably due to  In order to analyze the returns to  ($1.00)  grade  increasing scarcity of  are:  LOW ($.70), been  higher grade  different types of silvicultural management,  logs. these  relative price levels, and price trends, would need to be recognized.  (b) Inputs: Land, Dollars, and Expertise  Land productivity  may in  be  growing  forest  management,  would  be  quantifiable  measured various  and the  as  to  tree  cost  known  by  is the  contribution of  its  species.  (in  government.  area and  The quantity  terms  The  calibrated  of  product  management  expertise  of  to  its  dollars  pledge  input  by integrated  as  per  which  companies  is  potential  available  for  dollar raised) not  explicitly  and silvicultural  contractors.  This expertise Other  expertise  may  be  expertise  contributes to  is  a  required  purchased with may  be  attracted  create. A choice  component  dollars, by  an  by  of  the  letting  offer  between these two  of  management  plan.  silvicultural contracts a  means  share of  of  the  Some  for bid. growth  it  attracting participation  would and  be  made  with  consideration  to  the  present  costs,  ongoing  responsibilities,  the desires and needs of the companies involved.  TFL's and FL's  There are two distinct types of major forest tenure in British Columbia.  A  Tree  Farm  Licence  (TFL) gives  its  holder  the  exclusive  right  to  harvest  timber from an area of land. Cutting plans and Management and Working Plans are developed  on a five-year rotating basis. TFL's are for a period of twenty five years,  replaceable in the tenth year with a new twenty five year licence. Most TFL's were replaced shortly after the up  new  for replacement in the  Forest Act was  next few  proclaimed in 1978,  years. Approximately 30% of  and are coming British Columbia's  timber harvest currently comes from TFL areas.  A  Forest  Licence (FL) gives its  holder the  right to  cut  a specified  annual  volume from within a Timber Supply Area (TSA). Several operators may be harvesting anywhere have  within  resulted  growth  in the  the  in  TSA at  one  mutually agreed  TSA is  seen  to  time, 'chart  be  areas'  less  Annual Cut (AAC) of the TSA may be  although  negotiations  being  than  the  assigned  rate  of  between to  each.  harvest,  companies If timber  the Allowable  reduced by making proportionate reductions  to the AAC of each operator in the TSA. An FL is granted for a period of years, replaceable after five years for an additional fifteen  fifteen  year period. Approximately  60% of British Columbia's harvest is cut under Forest Licences.  Forest companies agement holders  may be  expected  to  respond differently to  funding, depending on whether their tenure would  expect  to  harvest  Forest Licence holders however  the  resultant  intensive man-  is area or volume  increment  have no assurance that the  on  their  based. TFL  tenured  lands.  increment would be of  benefit to themselves at harvest time. Their cutting rights may be granted elsewhere in the TSA while a competitor harvests the intensively managed stand.  Stumpage-Free Timber  Biological  growth  estimation  is  project a base growth level, needed  very  a certain treatment may be expected  four  cubic meters  would  be  of  this  available for the  to  best/worst  14  would  forest  is  accurate  enough  to  case scenarios.  For example,  to produce 9 m^ in 25 years, but experience  6  growth  It  to undertake the pledge to investors, but any  prediction is bracketed by a wide range of  suggests that anywhere from  imprecise.  might actually result. The value of be  managers  pledged  to  (government  investors,  the remainder  and companies)  to  share.  There are three distinct ways in which the corporate share might be allocated:  (i) response In the  Ceiling:  A company  might  in excess of a specified example  be  assigned  a contract  whereby  all  growth  level is its to harvest free of stumpage payment.  a company may wish to  specify  all growth  in excess of  10 m^.  This type of 'ceiling' contract would provide incentive for use of management funds in such a way as to stretch volume production as much as possible above 10 m^, if stumpage prices are expected  to be significant.  (ii) Window: A more conservative company may wish to specify growth in a certain range (eg:  8  to  stumpage-free  12 m^) and be willing to  pay stumpage  on the 4 m^ below and all growth above that range. This contract would have the effect  of  stimulating  quality  production; growth  would  be  held  near  12  m^ and  higher value per cubic meter would be sought.  (iii)  Percentage:  Some  companies  may  timber harvested  in excess of the  is a fraction of  the  prevailing rate. To be  described above,  the  company might seek to  then-prevailing be  a  function  stumpage  rates  stumpage  rates  rates. of  The incentive the  and collect  magnitude  the full  be  willing to  investor pledge,  to of  expected economic  actual rent,  stumpage  provided the  stumpage  roughly comparable with the pay future stumpage  management the  pay  of  perceived value the  of  of  difference  between  incentive  right would  to be  charged contracts  at only 40% of  this type  the  on all  contract would  harvest  expected (i.e.  if  minimized and  only the  company's  depressed,  mill  management  requirements would  be  would  be  intensified  considered;  to  produce  if stumpage more  rates are  relatively  low-rent  timber).  These  three  attractiveness prediction  of  of  types  each  to  growth  of  contract  any  relative  one to  might  company  the  be  mixed  would  'official'  in  depend  prediction  many on  accepted  ways.  that by  The  company's government,  through the Clearing House.  Management Contract: TFL  It is proposed  that integrated  forest  companies  with Tree Farm Licences  offered an opportunity to bid for Management Contracts on the following  be  basis:  (1) describe a forest stand or area of land within the TFL area,  (2) describe the silvicultural activities  intended  to be undertaken on that area  (this would be a tentative plan to final harvest),  (3) quote the cost of this activity to the Silviculture Fund,  (4)  provide  an  in  current  undertaken  the  comparison of expected  outline  of  the  period  yield curves  growth  response  is  expected  to  of  specified  log  which  produce  the  (this  quality for the  silviculture  would  be  a  managed and  unmanaged stand),  (5) stumpage-free  based  on  growth  (4), specify  the  that is considered  Ceiling,  adequate  Window,  or  compensation  Percentage  of  for undertaking the  Management Contract,  (6) provide a single timber  from  the  site  described,  anticipated (this figure would Reserve),  figure  quotation transporting  determine  the  of it,  the and  current cost milling  initial deposit  to  it the  of into  harvesting the  the  products  Harvest and Mill  (7) agree  to  maintain the  once the initial deposit  (8) agree are  undertaken  government  to  Harvest  and  based on (6) has been  responsibly supervise  (records  might  be  Mill  Reserve  an  adequate  level  made,  and record the  kept  at  private,  but  silvicultural activities which  would  be  turned  over  to  if the company elected to default).  In return the company would receive:  (1)  a significant  asset (when  share of the  probable growth increment  as a  stumpage-free  realized), and  (2) a government  processing  contract, to be paid at the  rate of the  level in the H&M Reserve. This Reserve is largely under the company's  deposit  influence.  Discussion of Bidding  On managing  adjacent its  performing either  holdings  forests  for  silviculture  type  of  on  Vancouver  maximum  directed  management  fibre  at  be  Macmillan  production while  higher  would  Island,  quality  available  sawlog  Bloedel  is  B.C. Forest  Products  production.  through  this  currently  Funding  'bidding'  system  is for of  distributing dollars from the Silviculture Fund.  Since management,  dollars the  from  forest  the  Fund  company  are  expected  would  itself  pay  supervising, and recording the silvicultural activities. nized  in  dollar terms;  Ceiling, or Percentage rectly  from  silvicultural  its  rather they  would  of stumpage-free  expertise,  organization  as  (saving  such costs)  be  to  be  the  spent  costs  on  physical  related  to  land  planning,  Such costs would not be recog-  compensated  for  with  the  Window,  timber. The company would thus benefit diexpertise and  should greater  produce growth  a  more  response  efficient (increasing  benefits).  The  company  also faces  costs with  respect  to  maintaining the  Harvest and  Mill Reserve. While planning and supervision costs would be undertaken at the time  of  initial  investment,  the  H&M costs  would  be  a series  of  small  occasional withdrawls) over the twenty five year period. The financial  deposits  (and  implications of  this maintenance function are discussed in Appendix H. The discussion suggests that companies would view the maintenance cost as having a present value of $46 per Wood  Unit  of  investment.  The  effect  of  these  costs  may  be  reduced  by  considering H&M contributions as a business expense for tax purposes.  The reasons that companies should be responsible for maintaining the Harvest and Mill Reserve are twofold. First, once an initial deposit is made, the balance of the Wood were  Unit revenue would be spent  subsequently  government.  No  required  they  provision has  on forest  would  been  need  made  management. If further  to  in this  come  from  the  deposits  pockets  of  proposal for extra contributions  from government.  Secondly,  and  more  importantly, companies  their current H&M costs. At the end of the would  be  paid  to  the  company to  natural tendency for these paid  as  much  as  possible  countered somewhat that  overstatement.  costs to for  do be  its  the  would  be  voluntarily reporting  Unit Rotation the  level in the Reserve  actual processing. There  overstated,  processing  in order that the  service.  This  tendency  then  would  be  initially, drawing a large contribution from the Wood  to  Unit  issuance,  but  as  report  inflated costs (for new  time  goes  by  a  balance  funding) and the  overstate  would  be  adjusted value of the  H&M costs  Unit revenue, and then gradu-  ally 'become more efficient'. This ploy would be effective Wood  company be  tendency  by the requirement that companies pay the The  would be a  for the first few years of between  tendency to  the  tendency  report efficient  to  costs  (regarding maintenance of existing contracts) should develop a reasonable balance.  In difference  the  preceding  between  the  chapter, cash  price  'Government', of  maturing  stumpage Wood  converting trees into products. Stumpage =  CP - H&M  is  Units  defined and  the  as  the  cost  of  In  order  to  incentive interim  minimize  for the  its  future  company to  contributions to  the  stumpage  charges,  over-report its  Reserve,  there  would  be  a  H&M costs. This would require larger  but (i) those  dollars would  be  paid back to  the company at the twenty five year maturity, resulting in a profit of the real  H&M cost  between  the  stumpage  payments on its entire harvest would be nil.  Another consideration that  forests  minimized  that  the  quoted  insects  management  forest  cost,  autonomous  from fire,  conscientious  essential  the  respecting  require protection through  therefore  and  company  strong  2  and  (ii)  if  H&M =  and  have  CP,  5  corporate forest disease.  and  difference  early  an  management  Protection  hazard  interest  costs  detection.  in  are  It  protection,  is  is  either  through a share in costs or through a loss of its Ceiling or Window if that share of the timber growth is damaged.  might and  There  are some  argue  that  therefore  point would  out  reflect  it favours  their  that  structural problems  H&M costs  corporate this  large  fact.  companies  might  managers  Also,  method.  method  If the  of  Fund  be  eat  bidding system.  in that  quoted  lunch  at  distribution would  bidding is effective,  however,  a lower  together,  sites which  the  level.  readers efficient  Others  might  and  the  general  would  be  losers as well  might receive  be  Some  their mills are more  'bidding' suggests there  winners. This implies that some forest geographic  with this  left  treatment  untreated  neglected  bid  by  level as  under a  the  bidding  sites should mostly  be  those of low natural productive potential.  Appraisal of Bids  A  tool  was  silvicultural treatments,  sought expected  which to  would  facilitate  the  comparison  produce either greater volumes  of  varied  or improved log  quality, on a common basis. The current relative values of a representative  range of  If H&M = CP the government would be able to draw the total investor return from the H&M Reserve. 2  5  log classes which might be produced are contained in  this  writing  Appendix  F, could  schedule, ternate  that  a  more  form  the  detailed basis  product  for  a  in Appendix F. It was felt early comparison,  'Schedule  of  along  Product  the  lines  of  Equivalents'. This  periodically updated by the Clearing House, would be used to appraise alsilvicultural  regimes.  This  method  would  however  be  administratively  complicated.  Instead,  the  indicator of value.  market  price  of  the  Wood  Relative prices of different  Unit  itself  may  be  used  as  quality Wood Units would reflect  current cash prices and the market perception  an both  regarding future prices, all rolled into  one price.  This thesis defines the 'Bud' of a Wood Unit as the difference  between the  issue price of the Wood Unit and the initial contribution to the H&M Reserve. This 'Bud' represents the net contribution to forest land management one  Mbf  comparing  of  a  varied  specified  quality  of  forest  silvicultural regimes  on  an  products. area  of  A land  from the pledge of  Benefit/Cost may  be  relating the Bud value, and the expected volume increment, to the the regime required to produce the particular quality of product B/C =  (B/C)  constructed  ratio by  cost of initiating  represented.  (Cr in m ) X (Bud per 4 m ) / Silvi Cost 3  3  Examples of the calculation of this B/C ratio are contained  in Appendix G.  Appraisal: The Distribution Template  The pected  from  comparing also  B/C ratio facilitates comparison silvicultural  stumpage-bearing  sought,  computed  alternate  in  order  volumes  that  by government.  projects  the  of  the  total  on  a  given  represented  net  returns  returns which forest  by competing from  This may be accomplished  candidate  site.  A  may be  ex-  method  of  corporate  bids  was  projects  might  be  pictorially through an adaption  of the P/L Diagram, as illustrated previously in Figure 4 (p.33).  The  establishment  costs from the investment rays,  to  of a Harvest and Mill  consideration  scheme. point  A  of the  This serves to on  the  Reserve eliminates  distribution of raise  point  P/L Diagram. The  future  future products  B, with  its  amended  set  created  of  diagram  processing by the  radiating growth is  here  called  a  'Distribution Template', illustrated in Figure 5.  In project this  use,  the  would  sketch  be  25 year growth increment anticipated for a candidate sketched  would  would  directly onto vary with  under consideration. The expected rather  than  being  a  precise  the  a  Distribution Template.  productivity  increment  prediction.  would  This  of  the  The location  particular forest  likely cover  range  investment  might  of site  a probability range  be  portrayed  by  a  cumulative probability distribution, as illustated in Figure 6.  The  corporate  Contract for the Distribution  Ceiling  or  Window  candidate project would then  Template.  Such  completed  competing projects on different forest magnitude 'Bud'  of  bid  the  stumpage-bearing  associated  be  the  Management  drawn directly onto  the prepared  Templates  submitted  timber volume  segment,  bid  of 9 m  3  companies  for  government,  valued  at the  current  silviculture will produce. A completed  Distribution Template is pictured in Figure 7, showing increment to investors,  by  sites might be compared on the basis of the  value for the quality of fibre which the  pected  with  the apportionment of the  and the forest  ex-  company under a Ceiling  on a medium Coastal site.  This completes the present discussion of TFL bidding.  Volume Based Licences: FL's  In  public  Timber  Supply  Areas  (TSA's)  outside  TFL's,  dollars  from  the  Silviculture Fund would be distributed directly to the land by the government under lowest bid silvicultural contracts. The volume  based licences prevalent in these areas  do not permit the structuring of an incentive particular sites.  Licensees  are presently  based on the  awarded volume  realized productivity of  incentives  (in  the  form of  FIGURE _5_ Distribution Template A tool for appraising forest company bids.  Cr=50  Cr=4  CP=H&M  CP ($)  - the growth rays radiate from the point where CP = H&M. - the slope of each ray is (Gr/4 - 1) - if CP <  H&M, harvest would not occur.  - the shaded quadrant represents the Harvest and Mill Reserve.  the investor return being provided from  FIGURE  ±  Growth Probability Distribution  Illustrating a probability distribution of growth expectations from a specific treatment.  Cr=50  CP  Percentages indicate the  probability of achieving that growth  ($)  level.  FIGURE 7  Completed Distribution Template  Illustrating the distribution of growth expectations between investors,  government,  and the forest company.  CP ($)  Distribution: I : Stumpage-free  timber  II : Stumpage-bearing timber III  : Pledged to  investors  immediate volume  increases  to  of timber to  actual stand response  Companies  their  be  AAC) for  undertaking  cut under the  incentives  well  as  on  silviculture,  is specified  but  by formula,  the  not by  to the treatment undertaken.  may presently  earn the  right to  52(a) of the Forest Act, but are expected as  intensive  timber harvested  increased harvests  to pay stumpage  under their 'quota'  of  under Section  on this incentive timber  natural growth. Companies  may have a stronger incentive to invest their own funds in intensive  management if  the  harvest  rated  volume  stumpage-free  If  increment  which  results  is  available  for  future  on  a  basis.  Forest  Licence  return for management  based  companies  expenditures,  were  granted  stumpage-free  volumes  in  three types of future timber volume would be  harvested from Timber Supply Areas:  (a)  The  residual  of  'nature's  under the existing quota system are expected  (b)  bounty',  at negotiated  unmanaged stumpage  natural  growth  harvested  rates. Volumes of this type  to reduce steadily over time.  Growth  response  due  to  investments  from  the  Silviculture  Fund.  This  timber would be sold competitively to the highest bidders.  (c) Growth response  due to investments  would be assigned to the respective  It  may  volume response the  volume  response with  the  Residual  of  be  expected  that  to be expected stumpage-free  companies on a stumpage-free  companies  to  timber they  Silviculture  timber available (the  actual AAC of  the  TSA, as  would  exaggerate  of their silvicultural activities, are assigned.  per dollar (or per unit of work) of response  by individual companies. This timber  Fund  difference  basis.  the  estimates  in order to maximize  Within  a TSA, the  corporate activity would  investment, between  indicated by surveys  measured  these two and sample  'natural growth', distributed under the existing quota system.  of  on  a  types  of  plots)  be  growth equated  similar basis. cut would  and  the  be  the  This type  of growth distribution presents  several options  to current operators  in a TSA:  Option J _ of  the  Companies do no spending; all forest management  Silviculture Fund.  This would  result  over  time  in more  is paid out  and more  of  the  generously;  no  TSA's timber supply being sold under competitive bidding.  Option  Companies  2  rush  into  silviculture,  spending  investment would be needed from the Silviculture Fund. Over time this would result in most of the TSA cut being harvested stumpage-free,  and the TSA would  become  a self sustaining forest production unit.  Option Silviculture  _3_  Fund  accumulating  A  and  rights  balance  spending  to  may  by  future  develop  some  companies.  stumpage-free  anticipate purchasing future supplies  between  on the  timber  investment  These while  competitive  from  companies  other  the  would  companies  be  would  market. The philosophy and  price projections of individual companies would determine which stance they take.  This Forest Licence discussion is made sites  of  timber. 'quality'. This is because  where  incentives,  is based on timber 'volume' only, no mention  forest  based  enhancement  is  incentives  undertaken.  It  are not tied to  is  worth  noting  the  specific  that  current  on volume only, tend to favour high-volume, low-quality silvicultural  activities.  Many into  area  granting  Forest  based  Tree  companies  silvicultural activities Farm  status  by  Licence holders Farm  are presently applying to  Licences.  site-specific  This  harvesting  on those sites.  might and  be  gradually  management  A company would then  undertaking management,  plus  convert their  it would  accomplished  rights be  then  in  return  able to  be  licences by for  earn Tree  rewarded  by  the  to  be  volume and quality responses to its activities.  To  provide  for  physical  risks,  Standing  Green  Reserves  would  located on a TSA basis, balanced at the Regional level. These reserves  need  would be a  Crown asset, and are discussed  in the chapter 'Government'.  Corporate Shareholders  In order for a corporation to justify management and shareholders,  the  resultant  This quantification would and  considering  the  be  corporate  by performing periodic forest  stumpage-free  light of the  prevailing stumpage  accumulating  growth,  rates.  to its directors  benefits should be quantifiable on its balance sheet.  accomplished  decrease  expenditures  share  rate. This balance with  physical  of  actual  growth  sheet entry would  losses,  and  fluctuate  It would be a real corporate asset whose value would be  inventories  increment  in  increase with  with  stumpage  recognized  in the  market price of the shares of that corporation.  Corporate attempts to maximize this productive silvicultural management,  balance  sheet entry should  and (ii) an incentive  prices. Activity (ii) would be especially  prevelant if the  to  inflate  result in (i)  current stumpage  majority of the  future timber supply was anticipated to be harvested on a stumpage-free  corporation's basis.  Transfer of H&M Contracts  It is possible even conservative  that the growth response  expectations.  Contract would wish to the  Harvest and Mill  and  stick  approach. The stick  processing maintenance  contract; duty,  the and  In such a case the  walk away from  Reserve.  to silvicultural activities may not meet  This  its  obligation,  eventuality  would  be  carrot would corresponding  company holding a Management  might  a loss of  be  the  ceasing  be  maintainence  provided for  stumpage-free  possibility  government  its  of  processing  of  by a carrot  timber and  the  transferring the H&M contract,  to  another  forest products company.  The difficulty with such a transference  is that the raw material would remain  located on the tenured lands of the selling company. If the sale were accompanied by  an  tenure  assignment  of  the  area, transportation  right to inefficiency  harvest would  a volume be  of  created  timber and  from  existing  the tenure  seller's rights  would  be  violated.  An alternative  would  be  for  the  purchasing  company  to  be  granted rights to cut timber near its own mill, if that timber was available, while a stumpage  A  differential was charged to the next timber cut by the selling company.  different  possibility would  be  for  an individual shareholder  company to be  awarded an increased equity position  undertaking  responsibility  would  the  likely wish  the  of  maintaining  H&M costs  to  be  the  stated as  discussion  above  assumes that  the  initial over-estimation, than  catastrophic  and the  In the  losses,  loss,  case of  provincial  these  insurance  causes would  be  This  of  shareholder  prevailing rates,  of that particular company.  Ceiling  due to  to  might  the  be  or Window is  (i) mismanagement,  principly due  a loss carried by that be  all four losses the  government  that companies  forest  (ii)  (iii) catastrophic losses, or (iv) poor protection practices. Other  inadequacy would  catastrophic  an average  stumpage-free  inadequately filled with timber growth. This may be  the  company in return for  H&M obligation.  rather than continuing to be quoted by management  The  in the  of  provided by the  to  corporation. In the federal  level  Standing Green Reserve would  extent of  its  investor  corporate  obligation,  of  error,  case of  government.  compensate  lt is therefore  the clear  bidding for Management Contracts would incorporate a large 'buffer  zone' in their Window or Ceiling bid.  Some  companies  selves, in order to  may  also  to  allow mills to specialize  quality mill should be interested the- mill's  wish  utilization  capability  transfer  efficient  among  them-  in certain quality Wood Units. A HIGH  in purchasing the is  H&M Contracts  by  H&M rights to a distant stand if  a factor  greater  than  log  transport  costs.  Company Buys a Wood Unit  Companies  holding  Tree  Farm  Licences  may  wish  activity at their own expense. This would be accomodated to  earn Wood Units by registering  to  undertake silvicultural  by permitting a company  its silvicultural activity with the  Clearing  House.  The activity would the  going  cash  Wood  value)  receive  be  appraised for extent and intended  Unit  would  cost  of  parallel  a government  performing that  the  ordinary  quaranteed pledge  products  activity.  A contractual  H&M deposit, of 4 m  and  the  stumpage-free  3  and divided by deposit  company  (no  would  timber, of the indi-  cated quality, per Wood Unit valuation.  Alternatively, purchasing  a  government.  a  Wood  company Unit  It would  with that Wood  the  receive  Unit,  asset of the company.  in  in  and the 2  might  nullify  market  and  an  turning  return a refund 4 m  3  existing  of  represented  it  the  H&M obligation in  for  cancellation  H&M deposit  would  become  a  by to  associated  stumpage-free  6  Utility Aspect of Company Operations  This to forest  a  proposal,  if implemented,  company operations. Through the  company's for  finance  manufacturing capacity would  future  period,  permitting  would  booked  (assigned guaranteed  coincidental  long  term  supplies and processing facilities to be made. Through the process specify right  its own H&M costs the to  benefit  company is assured of adequate  from extra value  of  stability  Management Contract, a portion of  be  accurate,  provide a measure  (unneeded  residues,  higher  the  utilization)  plans  for  timber  of being able to compensation. The  utilization,  or  higher  product quality than required) might be an added attraction to the contract.  A therefore capacity with  company be  engaging  providing  its  future  utilization. This would  water  and  electrical  Management with  a  Contracts  on  profitable,  predictable  add a 'utility'  utility  companies  component  which  also  an  to make  annual  basis  stream  operations, long  of  would future  comparable  term  plans  to  supply a steady stream of product at 'cost plus profit'.  There is a conflict between this provision and the provision for government to use the H&M funds for market purchases of Wood Units if CP< H&M (ie. if stumpage is zero or negative) or if the company defaults on its Management Contract. Under such purchases the stumpage value of the 4 m would become a government asset. 2  6  3  The  company  would  also  be  acting  as  the  spending  arm  of  a  large  silvicultural enterprise, undertaking a steady stream of forestry activity which might be profitably once  managed.  the  activity  performance  from  conservative  by  Growth, is  undertaken.  year  the  partially  to  year.  investment  a  company  These  factors  The  company  community,  asset,  would would  with  a  would tend  begin  to  thus  stabilize  be  resultant  accumulating corporate  viewed  effect  as  on  more  debenture  yields and stock prices.  Individuals and Contractors  Individual  silvicultural contractors  through an equity participation in the Ceiling). This type of incentive contracts,  stimulating  careful  might  be  offered  a  performance  stands they treat (perhaps  a small  incentive percentage  may be particularity effective for spacing and pruning  selection  of  trees  left  living  and  careful  removal  of  might  be  after  the  trees which are harvested.  The simplified activity  by  was  site-specific wait the  record  keeping  apportioning undertaken,  involved equity  be  horrendous,  according  to  a single  audit  possibility  being  years  warrant. If the warrants were transferable, contractors would not need  to  realize  a benefit  equity  ten  It  a  years to  interim  however.  by  ten  the  would  from excellent work.  contractors who perform well would develop warrants for premium prices.  represented  It should  a reputation and be  evolve that  able to sell their  CHAPTER SIX  DISCUSSION  Much interviews  of  with  the  primary research for this  people  government. This section  in  the  forest  paper was  industry,  the  in the  form  investment  of personal  business,  and  in  presents some of their concerns and observations, many of  which have been incorporated in the body of the thesis.  Recent Policy Changes  Several  people  provincial forest  have  asked  how  the  recent  (Parker,  1987)  changes  policy would effect this proposal. Three aspects of the  in  new policy  are relevant.  (1) own the  expense, forest targets  timber and  Forest companies will in future rejuvenate  of  stands  early  cost suitable  growth  land which has  been  minimization and for  profitable  experience  of  harvested. This is of  legislated subsequent  forest  to a satisfactory  stands  stocking  will  management. largely  level, at their  some concern, as  not The  determine  tend  to  initiate  species mixture their  subsequent  productivity.  (2)  Stumpage  and royalty rates  makes the offer of stumpage-free  (3) Tree  Forest  Licensees  will  have  tripled. This  is  a fine  development;  it  timber much more attractive.  be  offered  a means  to  convert  their tenures  to  Farm status. These conversions will not necessarily proceed, as the new policy  altered many tenure characteristics for TFL's, all in a negative direction.  The  Tree Farm Licence is the preferred tenure type under this proposal. Area  based, it permits stand specific These incentives practices.  are needed  incentives to be awarded to the managing company.  to stimulate quality log production and good protection  Political Feasibility  Several development  (1)  points  rose  in discussion  with the  Ministry  of  Forests  early in the  of this concept:  The government  made  it very clear that  it does  not  wish  to  become  involved in product manufacturing.  (2) The government  recognized that the  Forest Act contains no provision al-  lowing it to make the undertaking that would be required to back the Wood  Unit  securities.  (3) The government from intensive The  worried that  any incremental timber which might result  silviculture may be required to offset anticipated wood supply deficits.  incremental wood  may be  required to  maintain the  allowable  cuts  of  existing  licensees.  A resolution of each of these points would be necessary proposal  is implementable.  try and government.  Each point requires agreement  The implementation  of  this  before this finance  between the forest  proposal therefore  hinges  induson  the  small 'p' politics between those two parties.  The  two  senior  levels  of  government  have  been  brought  on forestry matters by the FRDA program and the softwood case.  Since  receipts) pected  many  of  the  that  implementing  the  benefits  financing scheme  that the  of  level  of  scheme.  (reduced  government  This  might  be  to the  recently  lumber countervail duty  UIC payments,  would flow  together  increased  federal level,  income  tax  it may be  ex-  assistance  to  would  provide  financial  in the  area of  silvicultural research,  or  funding for the computer facilities which would be required to maintain records and process favourable  growth rulings  and  yield  regarding  contributions to the program.  data. the  The tax  federal treatment  government of  investor  might  also  and  forest  contribute company  Price Risk  Recent  correspondence  that this proposed  method  from  of  the  Minister  of  Finance expressed  financing silviculture is too  particular, government worries about the 'open-ended  the  opinion  risky for government,  ln  liability' of pledging the future  value of forest products, without knowledge of what future prices will be.  This would the  expressed  create.  concern  If future  prices  ignores  the  growth  are high, representing  corresponding inventory asset should also  people  in finance  investment  would  will  need  serve  to  minimal  direct cost to  actually  lower  under  to  be  increase  government, this  response  the  investment  a large liability, the  value of  high. To implement this proposal  convinced that trees grow, that the silvicultural production from and that the  proposal  government expenditure for forest  be  which  than  the  existing  risk/return  under  the  land asset  ratio to  present  at a  government  method  is  of  direct  in  British  of  the Wood  Unit's  Since this  Reserve is  estab-  management.  Contractual Risk  At  several  meetings  Columbia are very low. value would come  questioners  If this  from the  have  is the  case  noted  that  stumpage  at maturity, most  Harvest and Mill  Reserve.  lished with only a quarter of the funds from Wood  Unit issuance,  rates  these  questioners  often express a desire to invest in the Reserve rather than the Units.  The  large  contributions from would  forfeit  its  (1)  loss  apparent forest  return  companies.  Management  to  the  H&M Reserve  If these payments  Contract. To  the  is  are not  company,  due  to  interim  made the company  contract  default  would  increment  would  mean:  become  a  of  stumpage-free  timber  (the  whole  timber  stumpage-bearing), and (2) a loss of the processing  be held by government).  contract (it would be sold to another party or  If the net value to the company of (1) plus (2) above is less than the cost of  maintaining the  H&M Reserve, the  company may at any time default.  Since  the  company originally entered the Management Contract of its own volition, the default would  be  due  prices,  which  to  environmental  make  operations  change,  principally either:  un-economic,  or  (ii)  poor  (i)  low  growth  forest  response  product of  the  invested stand.  (i) Low Prices  In the case of low and expected the  annual deposit  would be  most  continued  difficult to  low forest  product prices, when  make and default  likely, the market  price of the Wood Unit would also be low. The maximum cost to the  defaulted  contract  would  price and the existing deposit difference,  the  government  be  the  difference  level in the  may cancel  between  the  Harvest and Mill  both  contracts.  government of  Wood  Reserve.  Unit  market  By paying this  In doing so  it  re-purchases  the full stumpage value of the stands under consideration.  If prices  are low,  say $200 per Mbf, and expected  to  show no real gains  in the future, the Wood Unit price would be: $200 compounded at 5% = $677 discounted at 9% = A  Management  Contract defaulted  therefore  cost  government  stumpage  value  of  Management Reserve  $104  Contract is  would  be  $79  worth not  growing,  $677 $79  in this example -  of  $29  =  recent  in default, reducing the  immediately after  $50,  and  investment.  the  deposit  gap  recapture Over  level  between  time,  in the  issuance the as  full long  would future as  the  Harvest and Mill  bankruptcy price levels and  the insurance level per Wood Unit.  (ii) Poor Growth  In the case of default due be drawn when  needed  to  poor growth  response,  timber supplies would  from the Standing Green Reserves. The cost to  government  of the H&M  company's default would be the difference Reserve  low-price  and  default,  the  the  cost  gap  of  processing  between  the  between the deposit level in the  replacement  H&M deposit  timber.  level  and  Or,  as  the  in  the  Wood  Unit  price might be paid, cancelling both contracts and leaving the S. G. Reserve intact.  At  any  time  exist a deposit cash  price  the  silvicultural investment  has  been  made  there  would  in the Harvest and Mill Reserve, a growing timber increment, and a  for  determine the  after  products.  The  limit to the  relative  magnitudes  government's  of  these  three  variables  financial risk, and determine  the  would  most ap-  propriate choice of action in case of forest company default.  Yield to Maturity  The  data in Appendix A illustrates that  investors  would purchase the  Wood  Units at a discount of approximately 50% from cash prices. The paper from which that conclusion is drawn was distributed to five different forest economists the  U.S.).  A few  criticized fine  points  of the  analysis,  but all agreed  (three in  that the re-  sults are valid and believable. That paper also formed the basis of three seminars ~ one  at  UBC, one  Economists  before  meeting.  Each  government, seminar  and  resulted  one  in  at  the  positive  1987  feedback  Western and  Forest  enthusiastic  queries as to how the findings might be beneficially employed.  To  check  concept was $3  billion of  will  produce  agreed  that  whether  discussed assets.  this  yield  would  with a pension  Wood  Unit should be  Letters for  from  two  pension  attractive  expressed  the  marketplace,  believes that and enjoys  his  price  the  administers  personal skill volatility.  He  at a real return of approximately of potential investments  arises  meetings.  Americans, who  funds,  year,  diversifying aspect  two or three times per week in board  in  fund manager in Vancouver who  an optimal return in any given the  accepted  He is a hands-on trader who  3%. He also pointed out that the  syndicates  be  each positive  manage feelings  large  timberland  regarding the  investment Wood  Unit  certificate.  In particular they noted  that the Wood  Unit represents  an investment in  wood only, not in land. They expect the price of wood to appreciate more rapidly than the price of land, and therefore market at a lower  rate of  expect the  certificate to  be  return than a timberland investment  attractive to the  opportunity would  be.  Marketability  There are a number of considerations, beyond simply the 'rate of return', to marketing  the  knowledge  and understanding of timber investments,  of  Wood  Unit.  The  their performance. It has  lack of  knowledge  prime  been  consideration  pointed  out  is  the  and the  by several  public's  lack  of  lack of a track record correspondents  may result in a hard sell. With reference  that  this  to this subject several  specific comments have arisen:  (1) The analysis in Appendix A would not sell the certificate. description of what asset is represented,  Instead, a clear  and why it would be attractive, should be  packaged to fit in the first three or four paragraphs of an offering prospectus.  (2)  A prospective  purchaser would want  an estimate  of  the  expected  value  of his asset in 10, 15, or 20 years both in real and nominal dollars, under various growth  and price assumptions.  rate', with  These  the  projections  an estimation  of  Investors  require a guaranteed  might be  probabilities of  compared to  reaching or exceeding  a 'hurdle that hurdle  rate.  (3) cash  limit  certificates  to will  their  may  possible  losses.  require a premium to  Also be  price  they  paid  floor  may  if the  for their  want  investment,  assurance  government  that  a the  wishes to retract  (buy-back) in the first five years after issuance.  (4)  Stock  Exchange  prices  of  real  asset  proxies  frequently  diverge  from  underlying values; most closed end investment funds sell at a discount to book value.  The  original  issue  price  must  offer  the  first  owner  compensation  for  this  secondary market risk.  (5)  Stock  makers, hedgers market makers  Exchange liquidity is and speculators.  may be  created  through  the  participation of  market  One respondent pointed out that the attraction of  expensive  for government.  being offered a call on a block of stock,  Market  makers are attracted  or by receiving a commission.  (6) The pension fund manager described earlier thought that the Wood would  be  quite  volatile  once  it was  by  listed  for trading, and relished  the  Unit  thought.  This volatility would attract speculators, creating liquidity.  (7) There is a niche in the capital market for an inflation-indexed bond, but none exist. The Wood Unit might fill that niche.  (8)  In planning issuance,  the  investment  public would need  to the point where a threshold minimum of investment mum would be in excess of $100  to  be  educated  could be raised. This mini-  million.  Silvicultural Yield  All interviews with people return to ment, to  investors  treatments  British  come  from  the  increment  created  by intensive  not from the entire growth of the forest. The subsequent  measure  data  would  in the forest industry required clarification that the  the  increment (volume  always  spurred skeptical  regarding growth Columbia.  response  Data would  vs.  value)  comment.  to  a  need  to  range be  and how  to  discussion of how  apportion it to various  There is very little of  species,  adapted  from  manage-  sites,  publically available and  European  treatments  in  and U.S. trials,  and contributed by private industry. Under the FRDA program a wide range of data collection is being initiated, but complete  results from these trials will not be availa-  ble for many years.  The  pessimistic  attitude  of  most  quite disheartening. Instead of pointing to  correspondents  regarding  this  aspect  individual threads which might be  was  woven  into a simple framework, however sketchy, their opinion was that here the proposal faced  an  specific,  insurmountable experimentally  unavailable, foresters  it  is  would  wall. The attitude  verified  felt  that  produce  growth  an a  of  responses  aggregation  very  this  of  reasonable  the  writer is  for  all  government  confidence  that  growth  framework  response  species  experience  scheme could be implemented. This framework needs to the  quite  and  of  with  different. While treatments  British Columbia's  which  the  financing  be strong enough  will be  is  adequate  to  to give  provide the  investor return. The plan can then be implemented, with more accurate and specific data being collected  along the way.  Most respondents of  growth  response  on  government/company to  the  company  potential  of  felt that private forest companies lands  within  liason should  to  different  either  share  levels of  their tenure  exploit its  have reasonable estimates  jurisdictions. The  this knowledge,  actual  data  or to  silvicultural investment.  design  of  the  by providing an incentive indicate  the  gross  The bidding process  growth outlined  in the chapter 'Forest Companies' is one way this incentive may be created.  Experimental Controls  Several experimental  foresters controls  have  worried  (untreated  about  areas)  for  the every  logistics  of  establishing  silvicultural treatment  rigorous  undertaken.  Such a network would not be required.  Control blocks may be established part of the by  a  of  silvicultural unit; their expected  proportionate  determine future  treatment  for research purposes. These would remain  reduction  in  unit  production shortfall might be  silvicultural value.  the growth increment due to treatment, timber  would  be  is undertaken, of the  form of control in itself).  based  on  expected  a  however,  written  growth  The  controls  would  not  instead, the distribution  description,  of the  recognized  made  when  the  untreated stand. (This is a  Inventory Structure  Several  correspondents  have  opportunities  in British Columbia  harvest  within  age  therefore  means  that  are respecting  five  years.  a majority of  young  Revenues  of  partially diffusing  the  to  the silvicultural  stands which will not reach  repay  impediment  imbalanced inventory structure may be  provision be  out  current  investors  would  need to be drawn from existing mature, untreated timber stands.  A present  twenty  pointed  at the  replaced  end of  a Unit  to  Unit issue,  issuance  tentatively  Rotation, whereby  with a fresh Wood  to  created  the  provide for a roll-over  maturing portfolio  representing  by  holdings may  a subsequent  twenty five  year period. Several Unit Rotations would be required for British Columbia's existing forest  to be balanced. Once this occurs, the number of Wood Units retired in any  given year should correspond to the harvest rate in that year.  Stumpage-Free Timber  People  in • the  forest  industry  find  the  offer  of  stumpage-free  timber  an  attractive proposition. They worry however about the tax treatment of such an asset. In particular, they worry about  the  book value of accumulated volumes  taxation  of  valuation write-ups  recorded  as  the  are periodically adjusted to match rising product  prices.  Some  forest  companies  presently hold rights to stumpage-free  Timber Licences (Old Temporary Tenures). Timber harvested charged royalty at fixed being charged stumpage.  rates specified The value  resolution  of  pledge  of stumpage-free  would  however  arrangements,  need  to  the  licences is  Forest Act instead of  of such timber rights is not presently included  accounting  and  tax  explicitly addressed,  in share prices.  considerations  timber is beyond the expertise be  under these  in Schedule A of the  on corporate balance sheets, although it may be reflected  A  timber through  associated  with  a  of this writer. These matters  and described  in firm  before forest companies would participate in the investment  contractual scheme.  Tenure Security  The  discussion  in this thesis assumes that  contracts, as described in Sections  existing  forest  tenures  are  9 to 4 4 of the Forest Act. Many correspondents  from industry expressed  a contrary opinion, often  the recent establishment  of a park on South Moresby Island as examples.  bitter  the  and  helpless  in  face  secure  of  citing unresolved Indian Claims or  increasing  pressures  to  use  Many feel  forest  land  for  conflicts,  by  purposes other than commercial timber production.  The acting  as  Wood  Unit  a tool  may aid in the  which  quantifies  the  resolution  value  of  the  forest sites. The productivity of a site, expressed Wood from  of  some  land use  productive capacity of  specific  in terms of the market-determined  Unit price, might be quoted as the true opportunity cost of removing land commercial production. This technique  would  especially  serve  to  protect  rich,  fertile sites.  Perceived tenure to  the  would three  investment be  scheme.  affected  thirds  of  security will influence  a company's willingness  The company may ask whether  incremental  growth  would  be  contribute  its stumpage-free  by a reduction in its AAC, and in what  the  to  order of  processed.  'Trust  rights  priority and  the  security'  would be provided by enforceable contracts which address these points.  Legal Aspects  (a) Forest Management: Present tenure arrangements in British Columbia grant forest  companies  Licence) or the  the  exclusive  right to  right  cut a specific  (Forest Licence). Many correspondents does the  not wood  necessarily until  the  to  imply ownership. logs have  been  cut  over  an  area  of  land  (Tree  Farm  annual harvest within a timber supply area  needed  to be reminded that the right to cut  The forest scaled  company does  and the  assessed  not  actually  stumpage  own  paid. This  distinction is important, since it gives the government, which owns all growing stock on  Crown  land,  the  ability to  dispose  of some of that stock's  value to  investors,  and  the  ability to  firmly  negotiate  future  charges,  returns, and  benefits  with  each  forest company.  (b)  Stock  Vancouver  Stock  Commission,  Exchange:  Communication with  Exchange,  and  with  the  the  Manager of  Chairman  has indicated support for the scheme  of  commodity and equity options.  quired in order to list the Wood  B.C.  at  the  Securities  if the other participants favor it.  The Vancouver Stock Exchange presently only trades shares, and certain established  the  Listings  limited partnership units,  New legislation would be re-  Unit.  Applicability to Private Land  A number of that this scheme  correspondents  from  industry and government  be adapted and sold to  raise investment  ment of private forest  land. One forestry consultant  pointed  could  be  made  private  the  could  be  registered  with  against  landowners,  the  and that  land title.  suggested  capital for the  manage-  out that firm  contracts  obligations  He contrasted  have  this with  they the  undertook impossibility  of registering a lien against Crown land, and his general perception of a poor track record of government in keeping contracts made with industry.  The  investigation  has  not  been  diverted  to  consider  financing  forestry  on  private land for a number of reasons.  (1) The object of this investigation was to facilitate forest enhancement large scale.  (2)  on a  Crown land comprises 95% of British Columbia's forest land base.  Investors  on  private  land would  purchase  a different  type  of  contract  than the Wood  Unit. They would likely be offered the opportunity to participate in  actual  by  growth,  therefore forest  be  means  site specific,  management.  of and  a  share  involve  in the  stumpage investor  value.  in the  The fire  contract  and  pest  would risks of  (3) private  The  land,  investor  for  two  would  reasons.  desire One  a  higher  would  return  be  to  from  cover  his  his  participation  higher  risk  participation in physical losses. The other reason is that private obligations sidered by the market to be somewhat  A with  study  the  less secure than government  by Sterling Wood (1983) investigated  objective  of  attracting  pension  funds  report was favorable, the proposed investment  Private however. might  forest  landowners  might  be  to  due  on to  are con-  obligations.  private timberland  Vancouver Island.  investment,  Although  the  project has not been initiated.  able  to  benefit  from  this  proposal,  A provincial program offering standing timber insurance at reasonable prices  be  developed,  hedging  private  risks  against  the  proposed  Standing Green  Reserves.  Comparison with Mining  In discussing that  the  mining ventures  debentures  issued  sale of  timber equity,  sometimes  offer  a  several  mineral  to raise capital for facilities  correspondents  (silver,  gold,  or  pointed  oil)  backing  out to  construction. The backing is generally  stated as a weight or volume of mineral sufficient  at current market prices to offset  the dollar obligation of the debenture. The contract often  allows for the quantity of  mineral represented to be adjusted if mineral prices change.  The method of financing described in this paper is quite different. The miner pledges a fraction of his proven, fixed ore body in return for the  capital required  to access the  body. By contrast, trees grow. The forester is dealing with a rate of  increase  time  over  rather than  through Wood Unit issuance  with  a finite,  would be used  existing  resource.  to establish  The  dollars raised  or direct a procession of  time. Rather than pledging an existing asset, the forester would be pledging a share in the benefits of employing his soil, moisture, and climatic resource. The debenture holder's confidence  would therefore  in a physically existing commodity.  be  placed  in management  expertise  rather than  Limit to Issuance  Only two  correspondents  raised a point which  has  caused  this writer much  trepidation. The point is that there is no market-determined limit to the quantity of Wood  Units which might be sold. Theoretically, an upper limit would be the  entire  enhanced growth potential of British Columbia.  One  limit might be  imposed  by the  Each block of Wood Unit issuance  should  prorated  S.G.  Reserve  a  inventory  was  placed  area. in  issuer might however  investment  Reserves,  be  significant  Wood  Unit  limit might  accumulates,  be  reached  included  in the  by the  establishment  of  available  portion issuance  through  high yield sites suitable  initial stages of over-issuance  partially encompassed  Reserves.  the  might  slow.  of a mature  An ambitious  percentage  of Standing  per Wood Unit issued.  and the Window or Ceiling bid would become In the  matched  Standing Green  avoid this limitation by decreasing the  Green Reserve needed  Another  Once  availability of  the  Ceiling,  the  company  bidding  process.  for treatment would become  As  scarce,  an ever-larger share of total growth.  this would result in bids being accepted which  'natural growth', later the and finally the  Standing  entire  natural growth would  Green Reserves  themselves  be  might  be intentionally sold, with a twenty five year lead time, by an irresponsible issuer.  An  alternative  to  these  natural  limits  legislative  limit, perhaps stated as a percentage  with  are twofold:  this  the forest,  The  (i)  the  and (ii) legislated  limit to  issuance  proposal is implemented.  irresponsible  to  issuance  would  be  to  place  a  of the provincial AAC. The problems  issuer  would  likely also  be  overcutting  limits may be easily, gradually modified.  should  be  fully,  publicly debated  before  this  finance  CHAPTER SEVEN CONCLUSION This thesis  has  Unit Rotation (25  implications to  P/L  Diagram.  Reserves The  government  was  noted  thesis described by  using  how  a  of  the  such  that  should be established  activities  how  sale  of  year) basis might raise forest  The  It  illustrated  management  and  Mill  Benefit/Cost  might  ratio  on  and  alternative  the  on a  government.  through use  of  Standing  risks under the  appraise  based  investors  capital for  Reserves  cover government  government  Units to  a sale were analyzed  Harvest  to  Wood  the  Green  financing plan.  forest  management  market  price  of  the  provided  for  forest  Wood  Unit.  A  Management  Contract was  supervision of silvicultural activities  described  which  and maintenance  of the  Harvest and Mill  It was proposed that in return for the contract companies funding for their tenured A  bidding  process  company  would  receive silvicultural  lands, plus a Ceiling or Window of stumpage-free  based  on  this  exchange  was  described,  as  Reserve.  was  a  timber.  means  of  comparing bids through the use of a Distribution Template.  Implications Today, the  value  an issue of  of  ($133/Mbf,  20  million  commodity  5 million Wood Units, representing cubic  quality  meters product  premium quality product represented). the  Harvest and Mill  from $500 million to  of  the  intensive  25  A deposit  $800 million. These  required to  years,  represented)  $1.1  raise  the  $665  billion  deliver million  ($220/Mbf,  quarter of this capital into  contribution to forest  figures  fully manage  should to  of one  Reserve would leave a net  of  funding level  in  a pledge to  management  bracket Walters (1984) estimate Crown's best forest  land on an  basis.  The 30% of the  pledge of 20 million cubic meters represents current annual harvest  from Crown  a volume slightly less than  land. Readers  should  recall that in  order to facilitate this proposal it would be necessary to grant stumpage-free  timber  rights to of  the  forest  management  companies.  current harvest volume,  plus  Those  rights might  cover a portion of  represent  increased  another 20%  rates  of  harvest  due to future forest productivity being greater than it is presently.  Together,  these  figures  represent  50%  of  the  current  volume  of  stumpage-bearing timber harvested from Crown land. Distribution of this equity share in future $800  timber,  million  by the  annually  means for  outlined  silvicultural  in this  proposal, would  activity,  plus  provide  provide $500 for  to  conscientious  supervision of the forest management undertaken. British  Columbia's land  base  is  project envisioned. A minimum Wood necessary be  to  for  the  Harvest and Mill  Reserve and $150  At $1000 per hectare,  scale  of  the  investment  Unit issue of $100 to $200 million would be  ensure market liquidity. If $200 million were  placed in the  management.  adequate  this  raised, $50  million would  million would go  capital would treat  150,000  into  forest  hectares. The  current non-productive backlog of good and medium forest sites in British Columbia is  2.9  million hectares.  Treating  150,000  hectares  per year, this  backlog would re-  quire twenty years to address. Meanwhile, there are many currently productive forest sites where growth might be enhanced, and logging activity releases more land each year. Viability Some will  be  comment  implemented.  should  be  made  There are reasons  regarding the to  believe  likelihood that  it may go  this proposal  no farther than this  thesis. (1)  The government  has  indicated that  it views equity financing for forestry  as too risky a proposition. This view has been formed from a cursory inspection of the  concept,  however,  and  may  be  modified  once  this  document  has  been  circulated and analyzed. (2)  Forest companies  may resist the  proposal, hoping that once  government  tires of its recent wave of forestry spending it will consider tenure security, through land privatization, as a viable alternative. Private land would allow companies to reap  the  benefits  of  natural  growth  in  addition  to  the  growth  due  to  expertise.  Investment would however still be required in this case. (3) The  existing  forest  resource  in  British  Columbia  largely  inventory of mature timber, plus areas of recently regenerated land.  There  is  relatively  little  land  carrying stock  suitable  consists  of  an  or unproductive forest  for  silvicultural treatment  which would be ready for harvest in twenty five years, when the returns from current Wood Unit issuance would be due. (4) The transaction costs of issuing the Wood Unit securities  been  they would be approximately 3 % to  explicitly addressed in this thesis; it is assumed SWo of the revenue  have not  raised. These costs might turn out to be much higher, creating  an economic impediment to implementation. There are, however, sidered.  The forest  presently British  Columbia  been  would  The  sold result  new  to in  of  of to  It would  silvicultural  future  well  to  has been  been to  neglected  the  the  every  to  seriously  for years  investment.  investment.  exposed  but  between  (neither  of  detailed  treatment  bother  generations  struck  con-  and is  The people  No  of  individual with  its entirety,  and none  yet  individual, to varying degrees,  to  to  forest  operational  productive and cost-effective manner.  the  records to  The  industry,  be  expense  to  be written, and  an  to  be  nor a bond)  regarding  foresters,  knowledge  laws to  and  future  knowledge  responses.  use  government  a commodity  require precise  and  the  has  proposal may be  this proposal would require new be  accumulation  and  this  that they wished or hoped it would work.  the  accumulation,  respond  financial instrument  investors.  potentials  ability  contracts  Columbia  it is workable,  the sentiment  of  believe  respond well  discussed  that  to  British  also  implementation  types  entirely  was  convinced  has expressed  new  land of  in a state which would  whom this concept have  reasons  kept, site  of  should manage  and  this  be  and should  knowledge  offset  the  species  by  forest  the in  a  BIBLIOGRAPHY  Bank  of  Canada.  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Management," "Liquidity  1958,  "A  1985,  Natural  Public  Corporation  Resources Journal, 25,  Preference  as  Behavoir  Model  for  Federal  pp.373-387.  Towards  Risk,"  Review  of  Economic Studies, (February), pp.65-86. Thompson,Terri.  February U.S.  1985,  11,  Department and  WaltersJ.  36th  Price  1984,  Pension  Managers  into  the  Woods,"  Business  Week,  pp.89-92. of  Agriculture.  Statistics,  "Towards  Annual  Vancouver.  "Luring  1985,  U.S.  Timber  Production,  Trade,  Consumption,  Washington.  a  Meeting  Silvicultural  of  the  and  Political  Association  of  Strategy,"  B.C.  presented  Professional  to  the  Foresters,  White,Kenneth  J. 1978,  "A General  SHAZAM," Econometrica, Whiteside,I.D.  1982,  Evaluation Wood,R.O.  Clear  1984,  Exotic  Program for  Econometric  Methods  -  (January), pp.239-240. Grades  of Grading  Computer  Rules,  of  Radiata  Pine  Timber  -  Development  and  New Zealand Forest Service, FR! Bulletin No.1.  Plantations  in  British  Columbia,  1956  -  1983,  Victoria:  Canadian Forestry Service. Working,Holbrook. 1948,  Theory  of the Price of Storage,  Journal of Farm Economics,  30, pp.1-28. Young,William.  1981,  Timber  Supply  Management  in  British  Columbia,  Burgess  Lecture, University of British Columbia, Vancouver.  .  Legislation: Commodity Contract Act, RS B.C., Chap.56. Forest Act, RS B.C., Chap.140. Pension  Benefits Standards Regulations,  Securities Act, RS B.C., Chap.380.  CRC 1978,  c.1252, (as  amended).  Lane  82  APPENDICES  A  83  APPENDIX A Portfolio Analysis Theory  1  Fig A.1 (1) security  Investors inspect two  when  they want the  a high  return  tradeoff  to in  relating  be  stable,  return  a two the  its  purchase:  return, and  between  expressed A.1)  considering  aspects of (2) risk  dimensional  expected  risky.  The  may  Expected Return  be  diagram (Fig  return  (E) to  the  E  weighted  average  individual  securities,  portfolio tween  depends  the  of  the  portfolio  of  the but  B  c;  Standard Deviation of Return  When securities are combined  portfolios,  •  B: Conservative C: Inferior to A and B  the  standard deviation of return (a).  (2)  A: Speculative  A*  (1)  they want  not  and  a  into  is  the  returns  to  the  o  of  the  (p)  be-  the  on  the  correlation  returns to  the  individual securities.  (7  Fig A.2  Securities with low or negative correlation (Fig A.2) may produce a portfolio  with a lower  a  than each individual security.  Fig A;3 (3) market  When all securities available are  combinations, ed  on  the  combined the  upper left  E-a diagram  possible portfolio  in  all  in the possible  boundary indicat-  represents  combinations  the  best  available in the  market, as illustrated in Fig A.3. This boundary may be  determined  with mathematical  1  2  for a given  set  of assets  algorithms .  For a full exposition  2  of portfolio theory the reader is referred to Sharpe,  For a published example  see  Levy and Sarnat (1984).  1970.  Fig KA (4) (ff)  If  the  concept of  a risk-free  rate  of borrowing or lending is combined with  the  possibility  of  investing  in  a  particular  security (A in Fig A.4), the investor may position  himself  from the  anywhere  on  a  ray  extending  point E = 7r, a = 0 through the locus  of that security on the  E,a diagram by either  lending some of his investable funds at it or by borrowing at it to purchase more A.  (5) When  the  risk-free  rate  from  a  Fig  A.4 is combined with the portfolio possibilities curve (M)  shown  in  Fig A.3, one  optimal  is indicated on that curve (see  All  other  points  are  dominated  by  point  Fig A.5). M  com-  bined with lending or borrowing possibilities.  a For  empirical  analysis, M  Index (S&P) and ir is the in  Fig  A.5  from  it  is generally  taken  to  be  the  return to long term government  through  M  is  called  the  Capital  represents the best possible opportunities available in the  Standard  bonds. The ray shown  Market  Line  market.  Fig AJ>  (6) to  the  When a new security is introduced  market  existing  it will  holdings  if  it  attract offers  investment the  from  opportunity  to create  a portfolio which locates above (or  lifts)  CML  the  in  E-o  space by  an  amount  greater than the transaction costs of switching assets to the new security. 'Lift' is pictured in Fig A.6.  and Poor (CML)  and  Empirical Analysis  In order to prices of logs,  inspect  Annual  attractiveness  lumber, pulp, newsprint,  bonds were collected dollars.  the  for the  returns were  the  of  the  as  to  investors,  S&P index, and long term  25 year period 1959 calculated  Wood Unit  the  to  1984.  percentage  the  government  All prices are in U.S.  price gain from year  to  year, with dividends added to the S&P return. The resulting data was analyzed using the  SHA2AM  econometrics  computer program (White, 1978), and the results  plotted  on an E-a diagram (Fig A.7).  Fig A;7 Average Returns and Standard Deviation of Returns 1960  - 1984:  U.S. Dollars  Plotted on an E-a Diagram  o  LOGS BOND  c  o HI W3 W2  O  NEWS  o  LUM  o  PULP  Standard Deviation  On erage its  Fig A.7, the  return during the  return  (horizontal  location of each security is comprised of the security's avperiod studied (vertical axis) plotted against  axis).  For example,  log  more volatile than lumber prices during the basis  of  average  annual  price;  the  securities on a monthly or daily basis.  prices  rose  more  the volatility of  rapidly and were  period. Returns were calculated on  standard  deviations  would  be  larger  for  the all  A  86 A number of hypothetical Wood Units were created as follows:  and  W1  =  25% LOGS +  25% LUM +  W2  =  50% LUM +  50% PULP  W3  =  50% LUM +  35% PULP +  computed  curves is due  and to  plotted  on  the negative  the  25% NEWS  15% NEWS  the locii of the portfolio possibilities  were  25% PULP +  combining each Wood  Unit with the S&P  E-a diagram. The convexity  correlation between fluctuations  of  the  in wood  prices and  fluctuations in stock market prices.  fig A^S The  portfolio  possibilities  illustrated as open-dotted A. 9,  and  A. 10.  It  combining  the  Wood  did  'lift'  the  not  investors  would  Units  they  if  analysis was  was  observed  Units  with  purchase offered  therefore  are  W1,  W1 +  2%  in Figs A.8, that  the S&P  CML, implying  not  were  lines  curves  the  for  that Wood  sale.  The  re-run with a 2% or  2.5% dividend attached to the Wood Units, ln  this  case  investors  would  combine  Wood Units with their existing holdings.  resulting  the  Standard Deviation  Beta The  systematic risk relative to the  be characterized with the  market of holding a particular security may  beta coefficient  (0)  produced by regressing  returns to  the  particular security against returns to the market portfolio. Rj = where: Rj = R An tions  fluctuations shift,  m  return to the S&P.  by  risk-free  any  individual  considered  j3 = 1;an  asset  with  attractive  at less than  risky. beta the  return does  by the  Correlated fluctuations,  are  0(R )  asset whose variabiliy of  is considered  stability.  +  return to security i, and =  m  a  holder  of  security  are  which  would  A  risk-free  less  than  risk-free  rate.  correlate  a diversified  compensated allow  asset zero  not  has is  the  with  portfolio, for  by  whole  ^ = 0,  market fluctua-  the  overall  portfolio  portfolio market  counterbalancing,  Ordinary least squares  since random  and  return  portfolio  to has  is  therefore  regression  produced  the data below:  a and <3: 1960 to  1984  0  SEp  2.39  -.16  .17  6.99  2.18  -.15  .15  W3  6.37  1.96  -.08  .14  BOND  7.09  .79  .02  .05  a  SE  WI  7.63  W2  If  the  betas  for  spot  prices,  a  calculated  on  an  average  annual  basis,  are  indicative of betas for Wood Units, the Wood Units should attract capital at a rate of  return less than or equal to the  - 1984  risk-free market rate. The betas from the  study are negative, and not statistically different from zero.  Forest Products 1960 to  Intercorrelations 1984  LOGS  1.0  LUM  .56  1.0  PULP  .33  -.24  1.0  NEWS  .18  -.08  .80  1.0  LOGS  LUM  PULP  NEWS  1960  Portfolio Analysis: Data Summary 1960 j _ 1984  Corr. with  Mean Return  Symbol  St. Dev.  S&P  S&P  8.9  %  11.4  1.00  BOND  7.3  %  3.0  -.07  LUM  5.9  %  12.1  .33  PULP  5.4  %  15.3  -.48  NEWS  5.4  %  6.2  -.33  LOGS  8.1  %  20.2  -.09  WI  6.2  %  9.3  -.20  W2  5.6  %  8.5  -.20  W3  5.7  %  7.6  -.10  Data Summary: 1910  -  1984  Return  St. Dev.  Dow Jones Industrial Average:  6.26  23.1  Douglas-fir Log Prices:  5.91  16.1  Data: Inflation Year 1960. 1961 . 1962 . 1963 . 1964 . 1965. 1966 . 1967 . 1968 . 1969. 1970. 1971 . 1972. 1973 . 1974 . 1975 . 1976 . 1977 . 1978. 1979. 1980. 1981 . 1982 . 1983 . 1984 .  Rate and Annual Returns: 1960  Inflation Logs Lumber Pulp 1. 8 0 . .9 1.. 9 1..4 1..5 2 ..3 3.. 2 3 .0 . 4 ,.3 5 . 2 5 ,. 4 4 ..9 4 .2 , 5..8 8 ..8 9. .3 5 .2 5 .9 7 .4 8 .6 9 .2 9 .6 6 .0 3 .8 3 .8  1 .2 -1 .,5 -o. , 2 1 .9 1 ,7 . 5. 9 3. 2 6 ..0 19. ,0 2 0 . .4 -9.. 5 1 ,0 . 5.,4 81 ., 2 4 .8 . - 6 . .5 2 0 , .3 1 1 .3. 10, .8 52, .7 - 0 , .6 - 12, .7 - 6 .8 - 10 .2 4.1  -6.. 1 - 5 , .4 2,. 3 2..2 1 . ,1 0 , .0 5,.4 2,.0 21 ,.0 1 1 .6, -16, . 3 2 5 . .7 18, .3 2 7 . .4 -1 ,. 4 - 4 . .7 23, .4 19 .8 16, .5 9 .8 - 9 .2 - 0 .6 -6 . 1 14 . 9 -4 . 3  -0. 6 - 7 .. 1 -1 ..4 -2. 8 5. 0 2..7 -1 . 3 1 .4 . -3.. 3 0 . .0 13 . 8 -6., 1 1 .3 . 27 .,4 5 5 . ,0 2 0 . .0 0 . .0 - 6 . .2 - 1 1 . .8 26, .0 21 ,.4 3,.0 - 7 , .6 -1 1 .8 18 .2  -  Correlation  -.12  1984  News  W1  W2  W3  0 . .0 0 . .0 0. o 0 . .0 o..0 0 .0 2..2 2 .9 0..7 3 .5 3..4 3..9 4 .4 8 .5 21 .8 17, .9 8 .2 7 .9 4 .0 12 .8 12 .5 1 1.9 1 .6 - 2 .4 10 . 5  -1 .,4 - 3 . ,5 0 . .2 0 . ,3 2..0 2..2 2..4 3.. 1 9. .3 8 .9 -2.. 2 6. . 1 7 .4 . 36. . 1 20 .0 6. .7 13. .0 8 .2 4,.9 25 . 3 6 .0 0 .4 - 4 .7 - 2 .4 7.1  - 3 . .3 - 6 .2 o..4 - 0 . .3 3.. 1 1 .4 2..0 1 .7 8 .8 5 .8 - 1. 3 9 .8 9 .8 27 .4 26 .8 7 .6 1 1.7 6 .8 2 .4 17 .9 6.1 1 .2 - 6 .9 1 .5 7 .0  -3. 3 -5. 2 o. ,7 0 ., 1 2..3 1 .0 . 2..6 1 .9 , 9. .4 6 .3 - 2 ..8 1 1 ,3. 10, .3 24. .5 21 ..8 7..3 12, .9 8 .9 4 .7 , 15 .9 4 .8 , 2 .5 - 5 .5 2 .9 5 .8  S&P 2. 1 18. 7 -1 . 5 14. 7 20. 5 10. 9 - 0 . ,5 9. 7 13. ,4 2. 8 -12. . 7 22. 9 16. , 1 -0. 6 - 1 9 . ,0 6. 8 24 .. 1 4 ..3 • 3.,4 12. ,4 20 .4 10. .4 3..6 31 ..3 7,. 1  Bond 4.0 3.9 3.9 4.0 4. 1 4.2 4.7 4.9 5.3 6. 1 6.6 5.7 6.0 7. 1 8. 1 8.2 7.9 7.7 8.5 9.3 11.4 13.7 12.9 11.3 12.0  APPENDIX B.1  Real Lumber Price Gains The chart below, on price  trend  averaging  price  gains  for  steadily Skeptics,  1.7%  softwood  increasing  logarthmic per  year.  lumber  demand  and  The  of  2%  relatively  however, point out that the  supply restrictions  scale, shows a consistent rising real lumber U.S. to fixed  Forest  2.5%  Service  until  supplies  expects  the  year  (Haynes  and  real annual  2030,  due  to  Adams, 1985).  demand for lumber is elastic, and expect that  will cause substitution  rather than continued  rapid price escalation.  These skeptics estimate future price rises in the order of 1% or less per annum.  Based expectation  on of  the  1.3%  1960  - 1984  annual  real  study,  price  this thesis assumes a base case investor  gains,  with  a range  of  from  .5% for  low  grade lumber to 1.9% for premium quality product. Relative Producer Price Index for Lumber  1  r  Relative Index derived by dividing the Actual Price Index by the All Commodities Price Index (1967 = 100). U.S. Department of Agriculture (1985). 1  B 90  APPENDIX B.2  Real Returns, Canada, Nominal, bonds  were  1914 -  inflation,  computed  1986  and  on  real  an  returns  annual  to  basis,  Government  and  are  of  Canada  presented  below  long as  term  averages  per decade.  Real Rate  Rate of  of Return  Inflation  Nominal Rate of Return  1  1914  -  1920  -3.04  11.21  8.17  1921  -  1930  7.03  -2.38  4.65  1931  -  1940  5.18  -1.28  3.90  1941  -  1950  -1.66  3.97  2.31  1951  -  1960  1.52  2.36  3.88  1961  -  1970  3.21  2.71  5.92  1971  -  1980  0.88  8.03  8.91  1981  -  1986  5.24  7.18  12.42  1914  -  1986  2>35  3.50  5.85  This supported  thesis by  employs  numerous  a  base-case  authors  3  and  real  interest  the  interest  is  rate rate  of  4%.  employed  This  rate  by the  is  U.S.  Forest Service in appraising forestry projects. The would  rate  of  4%  is  used  to  arrive  pay per Wood Unit. The implications  at of  an  approximation  of  what  investors  changes in this rate are  discussed  in Appendix C.  Average annual increase 1987. 1  in the Canadian Consumer Price Index, Statistics Canada,  Average annual yield on Government of Canada long-term bonds, Canada, 1987. 2  3  Manning, 1977;  Foster, 1979;  Row et aj, 1981; Fitzsimons,  1986.  Bank of  2  APPENDIX C Hedgers Interest rate, long  term  differently depend  inflation,  investors than  on  bond  whether  in  and  product  Wood  prices the  to  Unit  price  trading.  hedgers The  may be  Wood  Unit  expected to price  changes in interest rates. The type of  inflation  or  real  component  of  the  nominal  will  join react  reaction will interest  rate  changes, as illustrated below. Example The 4% real)  base case in this thesis assumes that interest rates are 9% (5% inflation,  and that wood  prices  are expected to  appreciate  excess of the inflation rate. If the spot price of wood Unit  would  with  a  $9  be  priced  coupon  changes to the  at  $133.  would  be  Meanwhile, priced  at  five  Consider  inflation and real components of the  (3%)  Bond price = (ii) Inflation  +  real (4%)  $123  =  nominal  (7%))  Wood Unit price =  $132  increases by 2%  (inflation  (7%)  Bond price =  +  real (4%)  $83  =  nominal (11%))  Wood Unit price  =  $135  (iii) Real rate drops by 2% (inflation  (5%)  Bond price =  +  real (2%)  $123  =  nominal  (7%))  Wood Unit price =  $212  (iv) Real rate increases by 2% (inflation  (5%)  Bond price =  +  real (6%)  $83  =  nominal (11%))  Wood Unit price =  year  the  government  individual  nominal interest rate:  (i) Inflation drops by 2% (inflation  per annum in  is $250 per Mbf, the Wood  a twenty  $100.  at 1.3%  $85  bond  effects  of  If inflation rates change the  change  in the  change  in  the  change,  however,  expected  purchasing the  the Wood  Unit price will  future value of power  of  the  inflated  price of the Wood  be  barely affected,  security nearly exactly  future  dollars.  If  real  since  offsets  interest  Unit will be more responsive  the rates  than bond  prices.  The other factor influencing the Wood the  wood  mix  represented.  If interest  rates  Unit price will be the remain unchanged,  spot price of  Wood  Unit  prices  should move in a dampened fashion in proportion to spot prices.  These factors suggest several strategies for hedgers:  (1) An investor worried about inflation but satisfied rates  and  confident  in  wood  price  projections  might  with current real interest purchase  Wood  Units  to  counter some of the inflation exposure of his other holdings.  (2) An investor anticipating changes or  short  position  in Wood  Units, long  and short if rates are expected  in real interest  if interest  rates  rates  might take a long  are expected  to  decrease  to increase.  (3) The investor in (2) might hedge his position by taking an opposite position  in short  relative  to  the  term  lumber futures.  volume  of  The  hedge  lumber futures,  ratio,  would  be  responsiveness  of  or volume determined  of  Wood  by the  Units  individual  investor.  Term to Maturity  For the to  changes  above  investor,  in real interest  maturity. When  the Wood  the  rates Unit  is mostly  the  a function of  is first issued  it will  price of the the  fluctuate  Wood  Unit  remaining period to widely with  rates; as it approaches maturity the fluctuations will become limited.  interest  Example  This  example  maturity. Assume the  illustrates  numerically  the  effect  of  the  remaining  term  to  cash price of the product mix is $250 per Mbf and that two  Wood Unit series exist.  If the holder would  WUa: 24 years to maturity =  $137  WUb: 8 years to maturity =  $204 at 4%; $220 at 3%  real interest rate  opportunity,  from 4% to  3%,  the  at 3%  profit  to  a Wood Unit  be:  WUa: profit  An  falls  at 4%; $171  interest  rate  =  25%  hedger would  WUb: profit  be  attracted  to  WUa in this example. Such hedgers should  liquid trading in, newly issued Wood Units.  the  =  8%  more  highly  leveraged  provide a demand for, and  APPENDIX D.1 Silviculture: Techniques The  techniques  used  as silviculture (from the  to  enhance  (i.e.  to  garden)  the  forest  are referred  Latin sylvan: the woods). Silvicultural techniques  to  employed in  British Columbia include the following:  Site Preparation In 1986 the major treatment was burning (60%). 20,000 hectares were mechanically treated by windrowing, scarifying, or mounding. These latter treatments expose the mineral soil below the duff, much like ploughing a farm. Planting This is a labour intensive process which presently absorbs 80% of the Ministry of Forests and Lands' silviculture budget. Work is performed by lowest contractor bid and is quality checked by MoF&L personnel. Brushing and Weeding J_ Conifer Release As young trees grow after planting they are sometimes outpaced by wild shrubs and decidious trees. Weeding is the process of freeing the conifers. This process may be undertaken manually or with herbicides. Spacing In this process workers are sent through the woods with power saws to thin the forest, removing some of the trees (usually the weaker ones) to allow those remaining more air, light, and room to grow. The cut wood is generally left on the ground but may be removed if one is careful not to damage the remaining timber. Fertilization The  addition  improve growth  of  rates of  nutrients  (especially  certain species on  nitrogen)  has  low-fertility  been  shown  to  greatly  sites. The fertilizer may  be  spread by hand, from light planes, or by helicopter. Pruning The  lower  branches  of  selected  crop  trees  may  'lifts'. This provides for the production of clear wood tree stem.  The benefits of pruning are maximized if the  grow for a long time subsequent to  treatment.  be  removed  in successive  on the pruned portion of the crop tree is permitted  to  APPENDIX D.2  Silviculture: Productivity and Costs  Treatment Productivity  Average Cost  1  Labour and Support  1985/86, $/ha  Planting  $267  .7 - 2 hectares per person day  Brush and Weed  $375  .5 - 1.5  Conifer Release  $435  Spacing  $575  40 - 75 trees per person day  Pruning  n/a  30 - 75 hectares per person day  Surveys  $6  400  - 1500  .3-1  seedlings per person day  hectares per person day hectare  per person day  Machines and Operators .5-2 15-30  hectares per hour hectares per hour  Site Preparation  $196  Fertilization (Aerial)  $169  Source: personal communication with contractors. diversity of forest sites in British Columbia. 1  The wide ranges reflect  2  Source: Ministry of Forests Annual Report, 1985/86  3  Excludes cost of seedlings  the  3  APPENDIX D.3  Silviculture Yield The three examples below are taken from the Ministry of Forests and Lands' Policy Manual,  TIM 002  Annex 'A'. They  show  sample  calculations  for productivity  gains due to treatment of representative good sites on Vancouver Island (F1Z B). (1)  Backlog Reforestation:  state: yield =  Plant site  and  brush and weed  to  free  4  growing  4.2 m^/ha/year.  (2) Rehabilitation: Salvage existing scrub and burn site, prepare site and plant: yield  =  5.8 m /ha/year. 3  (3)  Conifer Release:  On an NSR site, remove the  in spots with planting: yield =  Preliminary  data  (12  3.7 m /ha/year. 3  years)  Service (Barclay and Brix, 1985) at  Shawnigan  224  Lake  show  that  overtopping alder and fill  from  an  experiment  by  the  Canadian  Forestry  on a low site (D-fir site index 21 m at 50 years) a moderate  level  of  spacing  and  fertilization  (30%,  kg N/ha) increased net volume increment by 3.5 m /ha/year over control stands. 3  This  growth  was  added  to  fewer  stems  of  larger  size,  increasing  merchantable  volume growth by 4.7 m /ha/year. 3  Pruning does not increase volume production; it may in fact reduce the rate of  growth if live branches are removed. The benefit  the value of  subsequent  of pruning is that it increases  growth of the tree. The reader is referred to Appendix F  for a discussion of the relative merit of clear vs. knotty wood production.  5  These sample yields are offered under Section 52 (a) of the Forest Act as incentive increases to licensees' annual cuts in return for reforestation activities. They may be considered conservative as only two licensees have earned increases in the eight years that this section has been in force. ft  5  Smith, 1987,  gives a good review of pruning in B.C.  The  illustration  growth  above is taken  response.  Trends  in  from the  cover  ring width  and  of  Barclay and Brix,  bark thicknesses  are  1985, both  12  year  worthy  of  note.  Natural Growth The trees 12.5  table below presents 'close utilization less decay' volumes per hectare of cm and greater dbh in unmanaged stands on medium sites.  6  Volume (m /ha) / Mean Annual Increment (m-Vha/yr) 3  100 yrs  25 yrs  50 yrs  75 yrs  33 /  294 /  5.9  624 /  8.3  892 / 8.9  113 /  2.3  248 /  3.3  371 / 3.7  Coast (Douglas-fir,  FIZ C 7  1.1  Bruce SI 45.8)  Interior (Lodgepole  Pine, FIZ H  Goudie SI  7  12 / .4  19.8)  Source: Ministry of Forests, FIZ: Forest Inventory Zone.  Planning and Inventory Branch,  1986.  E 98 APPENDIX E  Table of Conversion Factors Units Logs : m  (cubic meters)  3  Lumber : Mbf (thousand board feet) Chips : BDU (bone dry unit) Pulp : tonne (metric ton)  Conversion m  =  3  BDU  36 cu ft (solid wood) =  5000 lb  tonne =  2200 lb  bd ft =  12" X 12" X 1"  m  3  (log)  =  BDU (chips)  225  =  bd  ft  (lumber)  +  .1  1 tonne (B.K. Pulp)  +  BDU  (chips)  lignin slurry  Species specific gravity, air dry_ weight, lb/cu  ftj  Spruce Cottonwood Aspen, Alder  Abies 20  Light  22  24  26  28  30  32  34  36  38  40  Pine W. Larch  D-fir W.R. Cedar  4 m  3  =  144  cu ft  =  4000 lbs SPF or 5000 lbs D-fir.  Logging truck: highway = 3/4  50 m  ton pickup truck, heavy load  Railway car =  130  Hemlock Y. Cedar  3  ± ; woods = =  90 m  3  ±.  one Mbf.  Mbf of lumber or 80 tonnes of pulp.  Source: Mullins and McKnight, 1981.  Heavy  APPENDIX F.1  Wood Quality Different  silvicultural regimes would  be  expected  to  produce  quite  log-sets. The value of a log may be measured by the highest quality set products  which  may be  economically  appendix  is  illustrate  a system whereby  to  produced the  from that log. production  of  different of lumber  The object pulpwood  of  this  or utility  grade sawlogs may be compared with high quality saw or veneer logs. Prices  per  Mbf  for  ranging from utility to noted  that the  a  clears,  set  of  Douglas-fir  were collected  price lines never  cross;  lumber  grades  and are plotted  an inferior grade  in  below.  U.S.  It should  - 1986  (U.S. Dollars)  /Mbf  UT 1972  1974  CL  =  ME  =  1976  1980  1978  Timbers: 6 X 12 & WDR, #1  Merch, 15% #2  LF =  Light Framing: 2 X 4 ,  UT =  1986  Clear, 15% #3  Structural L F: 2 X 4, #1  =  1984  Clears: 2 1/2 X 6 & Wdr, #2  SF = SD  1982  Studs: 2 X 4 - 8 ' Utility: 2 X 4 ,  & Btr, Random 10/20'  Std & Btr, Random 8/20'  PET, Stud Grade  Random 8/20'  Source: Random Lengths Yearbook,  1986.  be  is always worth less than  or equal to a superior lumber grade.  Lumber Prices: 1972  dollars,  Four types of defined might  as be  growth  weighted  of  stands.  New  representative  combinations  representative of  timber  adaption  logs,  At the  Zealand  of  material figures  different  specified  form  other  of  grades  unmanaged  extreme,  (Park,  intensities of  the  1985)  of  silviculture, were  lumber.  The  LOW mix  or minimally managed PRUNED  which  mix  suggest  is  45%  a  clear  from their pruned stands.  Prices of Lumber Mixes: 1972 (U.S.  -  1986  Dollars)  593.83 581.66 569.49 557.33 545. 14 532.9? 520.80 908.63 496.45 484.28 472. 1 1 459.93 447.7S 435.59 423.42 411.34 399.07 366.90 374.73 363.55 350.38 338.21 326.04 313.86 301.69 289.52 277.34 265. 17 253.00 240.83 328.65 316.48 204.31 192.14 179.96 167.79 155.62 143.45 131.27 118. 10  Pruned  Medium / 1972  1974  1976  197B  I960  1982  ^ — L o w 1984  1986  (Dim  =. Average of light framing, structural framing, and stud.)  LOW  =  30% Utility +  MEDIUM  =  HIGH  45% Dim +  =  PRUNED =  70% Dim  10% Utility +  60% Dim +  40% Merch +  35% Dim +  30% Merch  25% Merch  15% Clear +  35% Clear  +  5% Clear  second  conservative recovery  To inspect relative price movements, Medium  grade-set  by  dividing  the  prices  prices were expressed of  other  mixes  for  year's price of the Medium mix. The price of each grade-set  as a ratio to the each  year  by that  forms a distinct belt  relative to the Medium grade mix for the 15 year period portrayed.  Relative Price Levels of Lumber Mixes  1972 - 1986  Pruned/Med  1.9138 1.8820 t.8502 t.8184 1.7889 1.7548 I.7230 1.69 13 I.6595 1.6277 1.5959 1.564 1 1.5323 1 .5005 1.4687 1.4370 1.4052 1.3734 1.34 16 1.3096 1.2780 1.2462 1.2144 1.1827 1. 1509 1.1191 1.0873 1.0555 1.0237 0.99194 0.96015 0.92836 I). 69658 0.86479 0.83300 0.80121 11.76943 •.73764 ' 0.7058S •.67407  High/Med  Med/Med  y  r  ^<  Low/Med  N» 1972  1974  It is interesting to  1976  note the  1978  1980  divergence  1982  1984  1986  of the trendlines. The price of the Pruned  set  has appreciated 1.9% per annum faster than the price of the Medium set over  the  past  15 years. The chart below  presents  best-fit  regression  dotted lines two standard deviations either side of the trendline. Pruned/Med  High/Med  Med/Med ~_-^Low/Med ~ .7 »73  1174  1176  1171  1H0  19S>  l»»t  !<•(  lines  bracketed by  APPENDIX Pulp and Paper Prices For  the  reader's  reference,  the  chart  below  presents  range of pulp and paper products in U.S. dollars. Some they represent as is the of  different  products  rather than  different  prices  for a  of the lines cross because  grades  of  the  same product,  case with lumber. A lumber grade rule is based on a sequential ordering  quality classes. A Paper Grade Rule, if one  scriptive  historic  rather  than  ordered,  with  each  were to  paper  be created,  selected  being  be  de-  representative  would  of  different fibre requirements. It is interesting acterized  by  a  very  therefore  fluctuates  to note the direct  stability of tissue (BATH) prices. Tissue is char-  contact  between  minimally in response  mills  retail  customers.  to business cycles.  Pulp and Paper Prices: 1973 (U.S.  and  1986  Dollars)  984.50 959.36 934.01 906.77 883-53 858.28 833.04 807.79 762.55 757.31 733.06 706.82 681.56 656.33 631 .09 60S.85 580.60 555.36 530.12 504.87 479.63 454.38 429.14 403.90 378.65 353.41 328.17 302.92 277.68 2S2.44 227. 19 201.95 176.71 151.46 126.22 100.97 75.731 50.487 25.244 -0. 112276-  B O O K  BATH  ^ -  NEWS  «* * « » BKP  **--%.....-* iiit  iT7«>  mt  nao  i*aa  lie*  * CHIP iiefc  CHIP: West Coast D-fir, export to Japan, $US/tonne. *H.*.XKIC xx BKP: Northern Bleached Softwood NEWS: 30 lb newsprint,  Kraft Pulp, $US/tonne.  $US/tonne.  BATH: Sanitary Papers, $US/20 cases, 1000  case lots.  BOOK: Book Paper, No.3 offset, 45 lb (sheets). Source: Miller Freeman, 1986.  Its  price  APPENDIX Wood  Unit Guiding Silviculture This  price The  £  of  Appendix contains  the  Wood  two  examples  Units would  guide  which  choices  together  between  illustrate  alternate  how  the  market  silvicultural regimes.  first example illustrates the theory of comparison; the second example  illustrates the  application of the theory to a practical situation. It is necessary to speak about the net dollar value per Wood go  directly into  Wood  Unit,  management.  This dollar value is here termed the  and is calculated as the  Unit and the mix  forest  initial  contribution to  Unit which would  difference  the  between  H&M Reserve  the  'Bud' of  issue price of  required to  the  the  Wood  process  the product  HIGH  product mix  specified. Bud  =  WU - H & M  G  where: Bud  =  net contribution to land management,  WU  =  revenue from sale of one Wood  H&M  0  =  Unit, and  cost of initial deposit to the H&M Reserve.  EXAMPLE 2L Derivation Data exceeds  in Appendix F.1  that  recently the  of  a  HIGH  illustrates  LOW product price has  been  mix  that by  today  the  price of  a ratio  of  1.3  to  a .7.  It  rising 1% per annum relative to  also  shows  that  LOW. If investors  expect  the price divergence to continue, and current product prices are used, the  Wood  Unit might sell in the market for $182 while the LOW Wood Unit sold at $77:  HIGH:  Cash price =  $325;  product prices =  +  1.5% p.a.;  LOW:  Cash price =  $175;  product prices =  +  .5% p.a.;  where:  $325/$175 =  1.3/.7  WU = WU =  $182 $77  HIGH  The H&M(high) the  cost of processing would likely be different =  $300 and H&M(low)  required initial deposits to  $44 and H&M (low) 0  =  =  the  $160,  and the  for HIGH and LOW products. If  H&M Reserve is earning 8%, then  Harvest and Mill  Reserve would be  H&M (high)  =  0  $23, and the Bud's are: WU  -  H&M  =  Q  Bud  HIGH  $182  -  $44  =  $138  LOW  $77  -  $23  =  $54  In this example  LOW management  should produce 138/54 times as much timber  volume increment per dollar spent on silviculture.  EXAMPLE 2i Application The  forest  under different Option _0j  manager  is  considering  a 20  The  unmanaged  stand  year old timber stand  for  management  regimes.  Do  nothing.  is  expected  to  average  growth  of  4  m /ha/yr of LOW quality wood. 3  Option J j  Treat  the  stand  with  a  heavy  dose  of  fertilizer  ($400).  pulpwood in 15 years. Expected increment due to treatment  =  Plan  to  harvest  3 m^/ha/yr (higher  at first, lower later, 3 is average). Option =  2: Space ($575), fertilize ($200), prune 300 $1375.  unmanaged is  5  Harvest in 40 years. stand,  m^/ha/yr of  product.  quality  ($600): total cost  Expected yield is only 1 m^/ha/yr greater than an  but all growth HIGH  stems per hectare  is of better product  less  quality. The increment the  value  of  4  in this  case  m^/ha/yr of LOW  c 105  A Benefit/Cost with  Ratio (B/C) may be formed to compare the options.  management  benefit value  is  the  expense  of  is  the  growth  which will be  for  the  quality  of  product  initiating  the  particular silvicultural  produced, valued  expected,  (eg:  The cost associated  at  B/C  present  =  (25  regime.  by the  years  The  current Bud  X mean  annual  increment) X (Bud per 4 m ) / Silvi Cost) 3  B/C =  (Cr X Bud/4) / Silvi Cost  where: Cr =  expected volume at 25 years, and  Bud =  Wood Unit price less H&M deposit.  Benefit: Option 0: (25X4) X ($54/4) =  $1350  Benefit: Option 1: (25X3) X ($54/4) =  $1013  Benefit: Option 2: [(25X5) X ($138/4)] - [(25X4) X ($54/4)] = Costs: Option 0 =  $0, Option 1 =  $400, Option 2 =  $4313 - $1350 =  $2963  $1375  Benefit/Cost Ratios:  Option  B/C Option 1 =  $1013/$400 =  B/C Option 2 =  $2963/$1375 =  0 represents  example  the  an asset already owned  current value of the  2.53 2.16  and accounted  'natural growth',  for by government.  realizable through the  In this  sale of Wood  Units, is $1350. The  B/C ratio  government economic  discounters  B/C ratio  Option  The  is  Option  2  different  rely on chosen  B/C ratio  prices.  prefer  that  1  however,  would since  be it  preferred  involves  to  three  Option times  2.  as  The much  activity per hectare of land.  This  The  may  indicates  formed  only  in  from  that  produced  by  discount  rate  analysis.  The  interest rates and future values to form a benefit/cost ratio. this  example  estimation  required  principal realm of the forest  manager.  is  is  constructed  that  of  forest  with  current  growth,  market  which  lies  determined within  the  A p p e n d i x h[  Harvest a n d M i l l  The  Harvest  conversion  of  It would be the  Reserve  and  Mill  is  established  to  growth increment into products specified a cash deposit  end of  Reserve  one  Unit  account,  intended  Rotation. It has  lished with a portion of the  been  proceeds  of  to  provide  in the  equal the  suggested  Wood  Unit  for  the  future  issued Wood Units.  cost of processing  at  that the  Reserve be estab-  issuance,  and be  thereafter  maintained to maturity by the forest company holding a Management Contract.  At rate' for  any  (%I), the  was  time  calculated as  Reserve the  remaining term to  actually earned  Reserve would would  the  be  by  exactly  required.  may  be  rate at which the maturity to  Reserve  equal  assets,  not,  the  with  existing  the  and the  provide for future If  characterized  needs,  contribution  an  deposit  'indicated level  interest  should  grow  current H&M quote.  If this  rate  H&M quote  inflate,  the  and no by  a  did not  maintainance  forest  company  contributions holding  a  Management Contract, in any given year, would be:  Co  contribution =  level in Reserve (%l +  %AH&M +  mkt rate)  where: %l H&M  =  deposit  indicated  interest  rate,  computed  level should grow for the  as  the  rate  at which  remaining period to  the  existing  maturity to equal  the  current H&M quote. %AH&M  =  percentage  change  in the  H&M quote  as  compared with  the  quote of the previous year. mkt  rate  =  rate of  return actually earned  by the  Reserve  assets over  the  preceeding year. For example, if a conservative  %I of 8% were chosen,  and the  H&M quote  was $200 per Mbf, the indicated deposit to the Harvest and Mill Reserve would be $29.20.  If over  the  following  year the  Reserve  earned  the  market rate (9%)  and  processing the  year would  interest =  costs rose be  with general $31.83  and  inflation (5%), the  the  H&M quote  deposit  would  level  be  at the  $210.  end of  The indicated  rate (%l) would then be 8.17% ($31.83 compounded at 8.17% for 24 years  $210). A deposit  by the forest  company of  $1.29,  raising the  deposit  level  to  $33.12, would drop %l back to 8%.  %I is annual  an indicator of  liability to  the  the  safety  company, to  of  the  a  particular Reserve.  extent  It represents  that it exceeds  the  difference  the be-  tween realized Reserve earnings and the rate of processing cost inflation.  A 'zero' level for %l would be the rate at which market rates are expected to  exceed  processing  cost  inflation.  At  % l , the 0  zero  level,  expected  annual  deposits would be nil. ie: % l or: % l  0  0  +  %AH&M - mkt rate =  =  mkt rate - %AH&M  0  ln the example, where market rates are 9% and %AH&M =  4%.  deposit  An indicated level of $75  rate ($75  should  of  4%  on  an  H&M quote  is 5%, % l of  compounded at 4% for 25 years  expectations,  $75  be  Management  Contract might  deposited choose  in  to  anticipating a series of annual deposits.  the  add  $46  Reserve. to  the  =  9% - 5%  $200 would  suggest a  =  The $29  Given these expectations,  0  $200). Under these company deposit  holding a instead  of  $46 is the present  value of undertaking the H&M obligation.  The forest cover processing  company would be cost inflation, to  the  contributing to the finance plan a pledge extent  borrowing capital at an interest  of  to  %l less market returns. It would  be  in effect  rate of  [(%AH&M - mkt rate)  to  make this contribution. This borrowing rate would be  +  %l]  reduced by (i) controlling  cost inflation, (ii) ensuring that H&M Reserve assets are productively employed, and (iii) periodic extra contributions to the Reserve. A Reserve with a large deposit level (low %l) would be less expensive  to maintain.  APPENDIX J< Glossary B/C Ratio a benefit/cost  ratio relating the  current value of growth expectations  to  the current cost of silvicutural activities, page: 49, 105 Bidding: the process which directs dispersals from the Silviculture Fund to TFL's. page: 45 to 53 Bud:  the  share  of  investor funds which are actually spent  calculated as the difference between Wood  on forest  management,  Unit revenue and the correspond-  ing deposit to the H&M Reserve, page: 49,  103  Ceiling: the level above which all growth is a stumpage-free return to the company, page: 44, 48, 50, 57 Clearing  House:  the  agency  which  coordinates  silvicultural  investment  with  Wood  Unit issuance, page: 38, 57 Distribution  Template:  a  pictorial  representation  of  the  distribution  of  expected  growth between investors, government, and forest management companies, page: 49 to 53 Growth: (i) nature's bounty: existing timber inventory past juvenile age. (ii)  total  growth:  the  twenty  five  year  growth  expectation  of  any  specific  stand. (iii) natural growth: that future growth which would occur on the site if left in an unmanaged state. (iv) investor pledge: four cubic meters per Wood Unit of investment. (v) expertise share: total growth less natural growth and the investor pledge, page: 36, 44, 63, 66, 96 H&M Contract: a sub-contract of the Management Contract, page: 46, 56, 106 H&M Reserve: a cash deposit account established to provide for the future processing of the products pledged to investors, page: 32, 45, 47, 50, 56, 62,  106  Management  Contract:  integrated  a  companies  comprehensive with area-based  agreement tenures  between  government  and  regarding silvicultural activity and  future processing responsibility, page: 45, 62, 57,  106  P/L Diagram: a graphical representation of government stumpage range of future price and growth response  eventualities  under a  possibilities,  page: 27 to 32 Silviculture sales,  Fund: a government from  account,  which disbursements  created  by the  for site-specific  revenue  from  Wood  Unit  silvicultural activity would  be  made. page: 39, 54 Standing Green Reserve: mature or near-mature timber volume reserved from current harvesting to be held as insurance against catastrophic loss of invested stands, page: 33, 55, 63 Stumpage: defined as the difference between the price of maturing Wood Units and the corresponding deposit level in the H&M Reserve, page: 16, 28, 40, 47, 54 Stumpage-free Timber: an incentive to forest company participation, page: 44, 50, 58, 68 Unit Rotation: a period of twenty five years, page: 14, 47, 68 Window: a specified  part of future harvest which would be  a stumpage-free  return  to the forest company, page: 44, 48, 50, 57 Wood  Unit: the in  twenty  contract sold by government to five  years  time  of  the  products. page: 16, 20, 26, 49, 57, 69, 85  cash  investors,  value  of  a  representing the delivery specified  mix  of  forest  

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