Financial analysis for sustainable management of private forests. Example of Aleppo pine.

1 Title, abstract and keywords

TITLE: Financial analysis for sustainable management of private forests. Example of Aleppo pine.

This paper presents a methodology for a financial and sustainable valuation of business forest management that also allows to improve the incentives to enhance public policies for prevention and conservation, with application to the Catalan case study of the Aleppo pine forests. Every summer and more recently due to the long drought, the situation of Catalan forests is not good, with criticism for the results of public policies and for the abandonment or low intensity of forest management because there is a low proportion that are planned or certified for both environmental and economic sustainability, despite its economic and political importance. A paradigmatic case could be the Aleppo pine forests, one of the most representative of Catalonia, both for being a Mediterranean variety and for its extension, since it spreads easily through the open areas and its pyrophilic characteristic makes the fire also facilitates its "colonization". It is a type of forest that tends to be unmanaged and unexploited, despite its representativeness (almost 30% of the Catalan private forest area), although there are studies to help the sustainable management of these forests [1] and detected its potential benefit [2, 3]. However, the economic conclusions of these studies and the private maximization of public subsidies have led to a preference for non-exploitation, with perverse effects on fire prevention policies and protection and conservation of mature forests. However, with a broader view, especially from a financial analysis perspective [4, 5], it is possible to show both the economic viability of its business management, not only in contexts of very favorable prices, as well as the improvement of the effectiveness of public policies with stimuli is feasible if it is not based on the concept of immediate economic utility and other elements linked to sustainable finance are considered [6]. However, the results could be more ambitious in the recommendations of public instruments if there were a greater detail of the type of private forest owners in Catalonia as in other European cases [7].

KEYWORDS: Sustainable finance, Forest management, Degenerate financial operation, Financial Analysis

2 The main text

1. INTRODUCTION

Every summer and more recently due to the long drought, the situation of Catalan forests is not good, with criticism for the results of public policies and the abandonment or low intensity of forest management because there is a low proportion of the Catalan forest area (63% of Catalonia, of which 47% is wooded [8]) that are planned or certified for both environmental and economic sustainability [9], despite its economic and political importance. These problems are shared, mainly, with the whole of Mediterranean Europe, as show the European monitoring [10, 11]. Public policies about forest management in the European Union are integrated in the EU forest strategy for 2030 (from 2021), what sets a vision and concrete actions to improve the quantity and quality of EU forests and strengthen their protection, restoration and resilience [12]. The new EU forest strategy will support the socio-economic functions of forests for thriving rural areas and boosting forest-based bioeconomy within sustainability boundaries, providing financial incentives for forest owners and managers for improving the quantity and quality of EU forests and focusing on strategic forest monitoring, reporting and data collection, among other actions. A paradigmatic case could be the Aleppo pine forests, one of the most representative of Catalonia, both for being a Mediterranean variety and for its extension, since it spreads easily through the open areas and its pyrophilic characteristic makes the fire also facilitates its "colonization". It is a type of forest that tends to be unmanaged and unexploited, despite its representativeness (almost 30% of the Catalan private forest area), although there are studies to help the sustainable management of these forests [1] and detected its potential benefit [2, 3]. In [4, 5] we present an alternative model to analyze the financial returns of the forest management, applied to the case of Aleppo pine, that allows to detect a more effective public policy in the subsidies for sustainable and prevention forest exploitation based on avoiding both the less frequent investment pattern of initial expenses and long-term earnings and the immediate economic utility (cash) as only one valuation criterium. The economic conclusions of most of the economic studies about forest management and the private maximization of public subsidies have led to a preference for non-exploitation, with perverse effects on fire prevention policies and protection and conservation of mature forests. Although there are a growing number of publications about forest benefits and diversity of economic valuation methods [13, 14, 15]. Moreover, there is an open debate about the utility or use of the Net Present Value (NPV) as general criterium of financial valuation [16], after an intensive use between 2000-2015. From 2015, with the approval of SDG it is observable an increment of forest valuation methods with additional criteria of NPV [17]. The forest policy and its financial incentives are complex [18], and it is not free from conflicts and trade-offs between sustainable goals and policy instruments [19]. Also, it is observable there is not a link within financial incentives and regulations with valuation methods of forest. With a broader view, especially from a financial analysis perspective [4], it is possible to show both the economic viability of its business management, not only in contexts of very favorable prices, as well as the improvement of the effectiveness of public policies with stimuli is feasible if it is not based on the concept of immediate economic utility and other elements linked to sustainable finance are considered [6]. With this proposal, the paper is structured in five parts. The vision of Forest management is presented in the first part, followed by Rodriguez’s financial model [20] in the next section (Financial vision). The Aleppo pine case is presented in the third part to finish with the Results and Final remarks. All these parts develop the thesis of this paper for good forest management: The need both order economic use of the forest and financial reserves to guarantee reinversion to the profitability rate.

2. FOREST MANAGEMENT

Forest management involves the systematic exclusion of the maturation and senescence phases (from Stem exclusion phase to regeneration or gap phase), precisely those that are most important for the conservation of endangered species [21], but it reinforces the economic use and the prevention state of the forests through the silviculture, recreation activities and eco-system services. Additionally, in [3] it is constated most of forest owners manage privately their forest "like a piggy bank that is being filled free of charge (by natural forces) and they can take advantage of from time to time." This implies passive management of the forest and the dependence of the owners on economic incentives and public regulations. These characteristics are the basis of the first hypothesis of this paper for a good forest management: The need an order of economic use of the forest, in the sense of a planned and circular exploitation which follow the Martínez-Alier criterium [22] about renewable use or exploitation, avoiding its potential depletion. The economic order of forest exploitation in phases of use or service must be provided by public or competent units in order to get scientific and reliable data, as a public valuation of the economic capacity of the forest, additional to biomass and ecological services. These reference values allow a fair valuation of the economic cycle of forest management and the inclusion of administrative, financial and reputational incentives in the valuation model.

3. FINANCIAL MODEL

The financial analysis is based on a valuation equilibrium to the interest rate (financing operation) or to the profitability rate (investment operation). This financial equilibrium implies mathematically at the interest or profitability rate every financial capital or monetary quantity can be reinvested or discounted to this rate during the whole term of the operation. The stereotyped financial operations suppose a temporal structure of first net expenses and long-term net earnings and a valuation by default with the financing rates. However, the economic cycle of forest is not as stereotyped financial operation because, although the net losses can be concentrated in initial phases of the cycle (clearing and regeneration), the moment of beginning of the investment can be usually in an intermediate phase of the cycle of the forest (treatment, maturation…) because they are the longest The Rodriguez Model [20] is a general analysis what allows a robust alternative financial-mathematical model and the incorporation of “degenerated financial operations” (investment operation receives before net earnings than net losses), atypical in finance but not in forest management, where the application of the classical financing and relative rates, as the IRR, it is not useful because either it is not significant or it is not real solution. These characteristics are the basis of the second hypothesis of this paper for a good forest management: the need financial reserves to guarantee at every moment of the economic cycle of the forest, the financial reinversion of payoffs to the profitability rate. This means the economic return of the forest management cannot be considered as a taxable yield, but rather a fund must be remunerated to profitability rate to guarantee the relative yield of the investment. Profitability can be taxable at the end of the forest cycle to guarantee the financial results. The Faustmann’s formula is a very useful tool to evaluate activities where their cycle is endogenous to make a decision in order to maximization of profits, which is the final evolution of principles and valuation issues in forest and renewable natural resource economics [23] with the introduction of series of regeneration costs and discounted them. But, in general, according to Faustmann’s formula, in a complex model of the evolution of forest and prices, it is always better to wait until the end of the cycle to the final felling [4]. However, Faustmann’s formula has applications [24] and it is in the basis of the standard valuation through models based on NPV, as [25]. But, in the discussion of this paper, Rodriguez’s model offers us a wider and better analysis because it allows us to compare the different cycles of the forest, according to the moment of the cycle the investment starts.

4. ALEPPO PINE

The study of expansion in Catalonia of forest of Aleppo pines is well-known [26] from the agricultural land abandonment and decrease in traditional land use activities. Also, there are available different studies about forest description and economic values of Aleppo pine forest in Catalonia [1, 3, 4, 9, 26]. The Aleppo pine forests are the biggest forest area of Catalonia with an important percentage of private owner, who search a forest management as “piggy bank” in the sense of passive management. This vision supposes the optimal strategy is not to exploit economically this kind of forest because it spreads easily through the open areas and its pyrophilic characteristic, with the negative impact in the policies of fire prevention, biodiversity conservation and promotion of bioeconomy.

5. RESULTS

An economic case of forest management for Aleppo pine is presented in [5] with an ordered cycle of 70 years and 5 phases of exploitation, with a positive financial profitability:

Figure 1. Source Ceballos, D; Perramon, J. 2021. “THE PRIVATE FOREST: FINANCIAL TIME AND FOREST TIME. Review of the methodology of economic and financial analysis of logging and its implications in forestry policy”. IX Conference of the Spanish-Portuguese Association of Resources and Environmental Economics. Lleida 2021.

In this example, it is easy to see the different results of the financial analysis according to the phase of the cycle of the forest. The least profitable cycle is which starts with plantation or regeneration because the 10 initial years produce low income. Then, in this case the subsidies are effective because the absolute net losses are compensated. But, if the forest is in an intermediate phase, in which it is generated an initial positive income, the positive net profitability is “real”, in the sense of absolute earnings at the end of the cycle, if the positive accumulated net annual income can be remunerated at the rate of annual FPR, and without penalization by taxes in order to guarantee the total reinversion in the natural and ordered cycle of exploitation of the forest. This economic restriction supposes the need a financial fund or reserves to remunerate the annual net income to the rate of FPR of the forest cycle, which is a kind of public policy different to an absolute subsidy. Moreover, at the end of the cycle, taxes can be activated for all the benefits of the cycle, with the return of the financial reserves or funds to remunerate the net income. This approach is also a simple way to structure the complex financial incentives for forest policy [18], which simplify the economic strategies of private owner int the management of their properties.

6. CONCLUSIONS AND FINAL REMARKS

The principal contribution of this paper is the application of two hypotheses for a good forest management: 1) The need an order of economic use of the forest, in the sense of a planned and circular exploitation which follow the Martínez-Alier criterium [22] about renewable use or exploitation, avoiding its potential depletion. 2) The need financial reserves to guarantee at every moment of the economic cycle of the forest, the financial reinversion of payoffs to the profitability rate according to a more fitting financial model to forest cycle as Rodriguez model [20]. The application of these two hypotheses or visions to the analysis of economic management of the forest allows the detection of a public policy more effective in the determination of the form and quantity of public and financial incentives for the exploitation and preservation of forest. In this context, the maximization of immediate utility is not the optimal strategy because the guarantee of a remunerated FPR is more attractive for investors. Moreover, the ecological and bioeconomic principles, inherent in the two hypotheses, suppose also a positive contribution or the consideration of the utility of future generations. Then, there is a compatibility between preservation and exploitation of the forest, between the ecological and the financial dimensions in the valuation of the forest management. Finally, it is necessary to mark the existence of a model risk because all model (in forest and in financial analysis) is a simplification of reality and it is necessary an estimation of parameters with an error for a fix moment and context (T: moment and its relevant information). This means the determination of forest cycle and the estimation of FPR are not trusted value for every king of forest and financial conditions.

3 Bibliography

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