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Linking forest valuation and financing

S. Kengen

Sebastião Kengen has a Ph.D. in forestry economics and works with the Brazilian Institute for Environment and Renewable Natural Resources (IBAMA) in Brasilia, Brazil. He is a former FAO André Mayer fellow.

Exploring the link between forest valuation and the financing of forestry projects and programmes.

Most funders or financing agents require a firm indication of a net positive economic contribution (value) from the investment project or programme being considered. In fact, this requirement is becoming increasingly important to many public financing agents, including national governments and multilateral agencies. Positive economic impacts are sought and are expected to be paralleled by positive environmental impacts.

To the extent that we can generate quantitative measures of economic values for forestry projects - and particularly value measures that are credible and defensible in the perspective of the financing agent we can improve the attractiveness of returns from forest investment.

This article first reviews briefly the state of the art in forest valuation and explores some of the issues in forest valuation, including the key issue of the extent to which valuations related to forest-based non-market goods and services are used in actual investment decisions. Second, the article considers in more detail the links between valuation and forestry financing and, finally, it suggests possibilities for improving forest valuation in the context of creating stronger links between valuation and financing.

Progress and issues in forest valuation

The valuation of forest resources has been a concern in forestry for quite a long time. For example, German foresters such as Martin Faustmann and Max R. Pressler already focused on the topic last century. However, most valuation efforts until the 1950s were limited almost entirely to the timber component of the forest (e.g. Chapman and Meyer, 1947; Hiley, 1956).

One of the early references advocating the need to value the broad range of forest goods and services occurred at the Fifth World Forestry Congress, held in the United States in 1960. It was stated that it was "not only through the production of wood but by means of all other 'forest values' that forests could contribute to national prosperity" (World Forestry Congress, 1960). That congress called for "systematic studies to develop methods for evaluating intangible forest values in quantitative terms". Although timber continued to be the major concern in forest valuations during the following decades, valuations of recreation, water, wildlife and other non-timber goods and services from forests were given increasing attention, particularly in the United States, Canada and some European countries.

However, until recently, relatively little attention was focused on developing comprehensive valuations of all the different goods and services supplied by a forest, including such environmental services as carbon sequestration, biological diversity and watershed protection. At the United Nations Conference on Environment and Development (UNCED), held in Rio de Janeiro in 1992, Chapter 11 (Combating deforestation) of the conference document Agenda 21 emphasized that one of the major reasons for the widespread failure to practice sustainable forest management, and for deforestation and the transfer of forests to other land uses, was the inadequate recognition and the underestimation of the values of the total package of goods and services provided by forests at the local, regional, national and global level.

Unfortunately, when comparing the forest sector with other land-use options, there is little evidence that a more comprehensive valuation of forests means that they will be better managed. To attribute deforestation to a lack of knowledge of forest values seems to be a narrow view of the problem. The issue is not so much one of valuation, but rather one of capturing the values that are known and agreed on.

This short article cannot provide a complete review of all the forest valuation principles, methods and information developed and utilized to date in estimating forest values (cf. FAO, 1995). Attention may be drawn, however, to some of the key principles and issues that have arisen in attempts to make more complete and relevant valuations of forests.

Economic values

Value is the worth of a product or service to an individual or a like-minded group in a given context, often involving a complex set of relationships (Brown, 1984). Values are of concern not just in the field of economics; for example, they are dealt with by philosophers in their treatment of ethics. Classifications of value are varied and complex. Here the focus is on economic values. All economic values are anthropocentric by nature; that is, they are human-oriented and human-assigned. Values are specific to a given context and situation.

The reference to "a given context" in the definition of value is of fundamental importance since, even in the "same" situation, it is likely that people with different values will behave quite differently. This suggests that forest valuation always should be situation-specific and results should be attributed back only to the group studied and to the actual context and situation studied (FAO, 1995).

Types of forest values

Economic value associated with forests can be classified into four categories: i) direct use values (including consumptive and non-consumptive use values); ii) indirect use values; iii) option values; and iv) existence and bequest values. The Box provides examples of each type of forest value. The "total economic value" is an attempt to add together all these values.

The total economic value

The purpose of valuation is to make the value of each forest use explicit, and not necessarily to put a total value on nature (Michael, 1995). As one can note in the literature, there has been much interest in estimating the total economic value (TEV) of forests (Ayres and Dixon, 1995; Kumari, 1995; Adger et al., 1995). The TEV is an aggregate of i) total use value plus ii) total non-use value. The total use value, in its turn, can be divided into the direct use value, indirect use value and option value. Total non-use value includes existence value and bequest value (see the Box). Different values are estimated in a particular situation by applying specific techniques. The TEV is expected to be the sum of the various values.

Classification of forest values

Direct use values associated with:

· Consumptive uses

- Commercial and industrial market goods (fuelwood, timber, pulpwood, poles, fruits, animals, fodder, medicines, commercial non-wood products such as rattan)

- Domestic non-market goods and services (fuelwood, non-commercial non-wood products, animals, skins, poles, fruits, medicinal plants)

· Non-consumptive uses

- Recreation (jungle cruises, wildlife photography, trekking)
- Science and education (forest studies)

Indirect use values are associated with:

- Environmental protection

- Watershed protection, nutrient recycling and soil fertility, agricultural productivity enhancement

- gas (e.g. carbon dioxide/oxygen) exchanges, contribution to climate stabilization and carbon storage

- habitat and protection of biological diversity

- aesthetic, cultural and spiritual values

Option values

· People may value the option to use a forest in the future. Although such values are difficult to measure in economic terms, they should be recognized in valuing the contributions of forests to human welfare. This concern can contribute to the conservation and preservation of forests.

Existence and bequest values

· People may value a forest or resource complex purely for its existence, without any intention of using it directly in the future. This includes intrinsic value.

· People may value a forest as a bequest to their children.

Source: Adapted from FAO (1995).

However, this simple expression for total value oversimplifies the problem. One cannot just look at a forest and compute all these values separately as though they were independent of each other. That is rarely the case. Many goods and services from forests affect each other. The various uses of those goods and services interact both in space and over time. For example, the removal of trees by timber harvesting may degrade (or improve) the habitat for specific birds and animals; the amount of watershed protection may be strongly related to the amount and kind of vegetation disturbance by domestic uses, such as grazing and fuelwood gathering, or by wildfires; ecotours may disrupt wildlife behavior patterns and thus alter an area's use for scientific studies; the setting aside of a nature preserve may preclude the use of the area for the extraction of commercial (or home use) products. Such potential interrelationships among various forest uses and forest goods and services must be carefully defined and described before total forest values can be correctly determined. The problem of aggregating differing values of forests with multiple uses deserves further research, particularly when we consider the different value perspectives of different stakeholders.

Measures of value

There are three main types of measure that can be used for the forest values indicated in the Box: direct market prices; indirect market prices or values; and non-market estimates (hypothetical) of value. It is important to note that the first two measures are based on an estimate of exchange values where buyers and sellers exchange goods or services for money or for other goods or services. In the case of indirect market prices, we have to make assumptions regarding proxy market conditions and how buyers and sellers will behave under different circumstances (Dixon et al., 1994).

In contrast, non-market values typically estimate the willingness of "buyers" to purchase or pay for specific goods or services under defined hypothetical conditions, but do not attempt to establish the exchange value that might be established between buyers and "sellers". Thus, non-market value estimates (values to users) are not directly comparable with market-based (exchange) values.

Valuation techniques

Various techniques have been developed over the years to derive the various measures of value that are appropriate for particular forest valuation situations. There are several comprehensive reviews and appraisals of these techniques that outline how they can be applied as well as their advantages and disadvantages (cf. IIED, 1994; Winpenny, 1991). Table 1 outlines the key measures of value described previously, suggests appropriate techniques for estimating those values and gives examples of how they can be used.

Clearly, it is important that the valuation techniques selected produce the kind of information needed to meet the valuation objectives, within the budget and time available. On the other hand, some complex valuation techniques can produce more information that can be usefully applied to the decision at hand. This is why it is necessary that the information needed by the policy-maker or decision-maker be clearly spelled out early in designing a valuation approach. It must be kept in mind at forest valuation is not an end in itself but is a tool to be used in the decision making context of forest-based projects and programmes.

Linking forest values to decision-making

Having discussed types of forest values, measures of relevance and techniques used to derive values, the question remains as to how widely the methods are actually used in practice, i.e. the extent to which derived, quantitative value measures enter into decisions on forest-based projects and programmes.

Most commercial forest investment decisions are based on a comparison of estimates of costs and returns involved in the investment being considered. Public project decisions also generally include some consideration of direct or market costs and direct benefits involved. In fact, identifying forestry project decisions that have not considered market values is difficult, at least on the cost side of the investment. At the same time, it is also difficult to find forestry project decisions that have considered quantitative estimates of the non-market environmental services associated with forests - biological diversity protection, watershed protection, carbon sequestration and so forth. While academics have spent a lot of time developing value measures and measurement techniques, there is little evidence that such measures have been used widely in decision-making of forestry development policy or forestry management (Winpenny, 1991; Bishop and Eaton, 1996).

Commercial forestry projects and programmes

Conventional financial measures of forest values are widely used in the case of investment in and financing decisions regarding commercial forestry projects (including timber, various types of commercial ecotourism projects, and so forth). To a lesser extent such values are used in making decisions on commercial aspects of social forestry projects (marketed fuelwood values, values of non-timber forest products, etc.).

Valuation approaches in relation to type of forest goods and services

Measures

Valuation techniques

Example

Direct market prices

· Market surveys, use of statistics
· Direct observation
· Experimental markets

· Used to value all market goods and services from the forest unless there are market distortions. The most common cases of distortion is when there are imposed minimum prices or ceilings on goods and services (in such cases, indirect market price techniques are used)

Indirect market prices1



Residual values

· Use of market prices for final goods and intermediate inputs plus some measure of profit to arrive at residual value

· Stumpage value of timber is derived by looking at market prices for finished lumber and subtracting costs from harvesting through processing to lumber sale

Value of production increases as minimum measure of an input

· Use of market prices of production increases to provide proxy measure of the value of one or a set of inputs

· Increased market value of crop production with a windbreak over what it would have been without a windbreak provides a proxy minimum gross value for the windbreak. Associated costs of the windbreak are then subtracted to arrive at net value

Surrogate prices and replacement or avoided costs

· Use of market prices for close substitute as a proxy measure of value for the unpriced good or service being valued. Both are converted to a common denominator (e.g. heating or protection value)

· The maximum value of fuelwood in a new market is estimated on the basis of the value of alternative fuels, e.g. kerosene, after adjusting for the calorific value of the two fuels
· The maximum value of a watershed management programme focused only on containing sediment in a downstream reservoir is equalled to the alternative market cost of dredging the reservoir of the additional sediment that would occur without the programme

Opportunity cost

· Use of market prices for the best alternative foregone provides a measure of the minimum value for a good or service. This is essentially a cost measure used to provide minimum value for a benefit

· The minimum value of a wilderness park is estimated on the basis of market priced value of the goods and/or services forgone (e.g. timber, mineral, grazing)

Differences in travel costs as the measure of value of an area, facility or activity

· Per caput measures of participation from different distance zones are used to derive estimates of the value of an area, facility or activity

· Differences in market-priced costs of trips by different users to a reserve are used to value nature-based tourism on the basis of differences in use rates in relation to differences in trip costs

Non-market value estimates

· Contingent valuation or surveys of stakeholders' willingness to pay for a given event, area, facility, activity (this is a measure of value in use)

· Value of a certain wildlife population is inferred from a survey of environmentalists' willingness to pay to save the population

1 Value inferred from other market paces. Used for both non-market priced and market priced outputs and inputs.
Source: Adapted from Gregersen, 1996 (Table 9.2).

In the private sector, the comparison tends to he between the financial returns that the investor can achieve from the investment and the financial costs involved. The analysis generally considers only market priced values. This particular form of forest valuation is a critical input for such private or commercial forest financing decisions.

Public forestry projects related to non-market goods and services

In the public sector, the decision on whether to finance a forestry project is often based on political, ethical or subjective values in addition to financial or economic values of the forest benefits being achieved. At the same time, some public sector agencies do base financing decisions on a comparison of economic costs and benefits (the so-called "benefit-cost" analysis). This certainly is the case with international financing institutions, such as multilateral investment banks and many bilateral donor agencies, most of which have their own financial and economic assessment requirements.

To a lesser extent, measures of economic value are used in environmental forestry projects. Pearce (1994), Winpenny (1991) and IIED (1994) provide overviews of actual practice in this area. Most authors are careful to point out the difference, in these cases, between developing measures of value and actually capturing those values through investment and financing schemes.

Private projects with public financial support

An interesting intermediate situation is one where decisions are made primarily on the basis of private or corporate financial values, but where such decisions can be influenced by economic values associated with public benefits from the project, e.g. watershed benefits, biological diversity preservation and carbon sequestration benefits.

Such values are translated into financing mechanisms through the provision of incentives or payment for environmental services, when positive environmental impacts are valued; or through taxing entities that cause social and environmental costs. This is the case, for example, when we consider the value of negative downstream impacts of forest harvesting projects: or when we consider the value of positive watershed protection benefits from a commercial forestry project.

A new area that provides some interesting links between valuation and financing is that of carbon sequestration in forests. Work over the past ten years or so has indicated that there are some significant economic values associated with the carbon sequestration function of forests (i.e. by storing carbon taken in from the atmosphere) (Pearce, 1994; Sedjo et al., 1995). This particular forest service is a good example of the gap between being able to value a forest service and reaching agreement on how to finance and capture such forest values.

In these types of situation - where there are both clear financial values and socio economic values associated with a forest activity - there are significant opportunities to link valuation more positively to financing decisions and to decisions on how best to capture the values in a financing context.

Improving the links between forest valuation and financing

Foresters and others promoting forestry investment activities - including both commercial and non-commercial ones would like to see more investment and more financing flow into the forestry sector. The point was made above that valuation has a role to play in guiding and promoting investment into the sector (but also keeping funds out of the sector when low or negative net values are indicated by the assessments).

There has been progress in developing valuation approaches that can deal with non-timber values and with non-market values associated with various forest environmental services. However, so far most of this progress has been on the conceptual side. One cannot find much application of the new thinking in actual investment or financing situations. However, opportunities exist to improve application and to strengthen the links between valuation and innovative financing of forestry projects (FAO. 1995). Some of the most obvious opportunities include the following:

· Improve understanding among decision-makers of how forest valuation can contribute to improved financing decisions for forestry investment projects. Education for analysts, financial officers, and decision-makers is needed. Such information programmes should put less emphasis on the methods and techniques of valuation and more on the opportunities and difficulties in applying forest valuation techniques to produce information useful in policy and decision-making. Too much emphasis has been placed on the tools of valuation and too little on how to apply those tools successfully and incorporate their results in actual investment decisions.

· Expand current efforts to incorporate environmental values into national income accounts. Such accounts are essential when considering the longer term role of forests in sustainable development. Past decisions have generally been made on the basis of extraction values without consideration of the changes that occur in the "capital" values of the forests involved.

· Carry out a systematic survey of how forestry decision-makers actually have used economic value measures in their decisions, i.e. the positive and negative experience from practice. Based on this information, directions for future research and development in this area can be identified.

· Spend the resources and effort now to build up better baseline information on forestry and the different potential outputs that can be incorporated into estimates of aggregate forest values. At present, many of the problems in forest valuation relate to the lack of biophysical production function information (information on the relationships between biophysical inputs and associated outputs) rather than to the lack of economic unit value estimates. Without production function information, it becomes difficult to value the changes that take place in the forest (the latter depend directly on the former).

· Focus more effort on issues related to appropriate mechanisms for capturing known values.

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