Long-Term Financial Planning for Timber and Carbon

Owners who want to be responsible financial stewards of their forest need to be able to make informed decisions regarding different future outcomes.

Introduction

The costs and benefits associated with forests can vary significantly depending on the owner's values, management objectives, and type of forest. Owners who depend on their forest for some income should consider financial planning as part of their stewardship activities. In fact, a financial plan is just like the creamy center of an Oreo cookie (Figure 1), it helps bring together the owner's management activities and long-term goals. 

One way to approach a financial analysis is to determine at what point carbon payments to the owner can add value to the stand, but also exceed opportunity costs. Opportunity costs are the benefits forgone by taking a certain course of action. Once the value of managing carbon compared to other land uses is known to the forest owner, the owner can then keep an eye out for opportunities that offer preferred benefits.

Identify Harvest Rotations

A key consideration in financial planning is deciding on the harvest rotation interval or time of final harvest. A clearcut harvest is used for even-aged management strategies, and the rotation interval represents the lifetime of the stand before it is clearcut. Uneven-aged management strategies are more often used in natural forests and the rotation refers to the frequency that individual trees are selected and harvested over a period of time (i.e., cutting cycle). The example used in this article is an even-aged pine stand, but the lessons are still useful for understanding the long-term financial implications for either approach.

Establishing a rotation interval or cutting cycle is also useful for helping owners get better prepared for upcoming harvests (e.g., operations planning, hiring forestry and tax consultants). For example, hiring a forestry professional to make a harvesting plan can help ensure that the owner's intentions are carried out while also practicing sustainable forestry. Forestry professionals can also help owners avoid violating any local or state regulations related to zoning, transportation or environmental quality. Being aware of tax provisions before your income taxes are due can also help maximize financial returns.

Consider Management Costs

Forests that grow quickly can be harvested at shorter intervals compared to forests that are slower growing. Faster growing forests also have higher rates of carbon sequestration. How quickly a forest grows depends on factors such as type of tree species (e.g., evergreen confiner versus hardwood species), site conditions (e.g., soil quality, erosion, annual rainfall), and number of trees per unit area, which influences competition among trees (e.g., water, light, nutrients) (Figure 2).

Management activities also influence how quickly trees grow and can include site preparation activities. There is also site prep for naturally regenerated stands (e.g., seed tree and shelterwoods). Management costs may include herbicides to control competition between crop trees and undesirable plants, pesticides to help reduce disease and infestation, and fertilizers to help improve sites where nutrients are limiting. Accounting for differences in tree species, stand quality and associated management costs is part of smart financial planning.

The Value of Time

Owning forests is a long-term type of investment, which requires a special kind of accounting. For example, payments for timber only occurs after the harvesting occurs at some point in the future. Since money is more valuable today than in the future, it is necessary to use discounting to "bring back" those potential revenues from the future and compare them with other options today using the same baseline. Keep in mind that as trees age they also grow bigger and generally become more valuable, but that value declines when the payout is further in the future (Figure 3).

Scenario A: Financial Plans for Timber Production

This section describes the value of investing in tree planting for the purpose of timber production. Maximizing timber production, or often the maximization of financial returns, is often considered the "business-as-usual" scenario in carbon incentive programs. The best way to account for the value of time in timber production is to estimate the "present value" of future harvests based on rotation lengths. Using current timber market prices one acre of slash pine at age 25 is estimated to produce timber benefits of up to $8,314 per acre (Table 1).

Table 1. Forest product yield estimates, timber prices, and total timber benefits at age 25 years.

Yields of sawtimber, chip-and-saw, and pulpwood are provided by Pienaar et al. (1966). Timber prices were obtained from Timber Mart South (2021).

The problem is, the slash pine stand is only 1 year old today, so the timber benefits can only be captured 24 years in the future. In order to make useful comparisons with other management alternatives, all estimates need to be converted to the present value.

To determine the present value (PV) of the timber benefits, we use the following formula: 

PV timber benefits = Future value of timber benefits / (1 + r)^t

In this equation, r represents the discount rate (i.e., the opportunity cost of the capital invested in the forestry investment). In many forestry models, the discount rate is set at 3%.

PV timber benefits = $8,314 / (1 + 0.03)²⁵ = $3,970 per acre

Here we find that $8,314 per acre obtained at age 25 years in the future is the same as $3,970 per acre today. Forests grow more quickly when they have more space to grow. Thinnings and select harvests at designated times can help make more space in the forest and help generate small amounts of income in the near future. In this example, a thinning occurs at year 15 and provides an income of $350 /acre. The present value of all the timber benefits throughout the entire 25-year rotation are:

PV timber benefits = present value of thinnings + present value of final harvest
PV timber benefits = $350/(1 + 0.03)¹⁵ + $8,314 / (1 + 0.03)²⁵ = $4,195 per acre

Likewise, we need to determine the present value of management costs that occur over time. All costs in this example were obtained from Maggard (2021). For example, the present value of a fertilization cost ($87 per acre) at age 5 years can be calculated as follows: 

PV fertilization = $87 / (1 + 0.03)⁵ = $75 per acre

If there is a second and third fertilization at ages 12 and 16 years ($87 per acre each), the costs would be calculated like this:

PV costs = present value of fertilization 1 + present value of fertilization 2 + present value of fertilization 3

PV costs = $87 / (1 + 0.03)⁵ + $87 / (1 + (0.03)¹² + $87 / (1 + 0.03)¹⁵ = $190 per acre

Fertilization is a more common practice in pine plantations. In natural forests, this may be the costs associated with pesticide and herbicide applications to help protect forest health. There may also be some annual costs that are assumed to have the same value over time such as maintenance of property boundaries, legal fees, and property taxes. The formula to calculate the present value of a cost that occurs every year and of the same value is:

For example, if the annual management cost is $52 per acre, the present value of this amount over 25 years is

If you are planting a new forest, most of the planting costs occur in the first year, so these values do not need to be discounted. In this example the planting cost is $376 per acre (e.g., costs of seedlings, site preparation, physical planting of the seedlings).

The difference between the present value of cash from the timber harvest and the present value of management costs gives the net present value (NPV) of that particular management scenario at a 25-year rotation interval (Table 2). 

Table 2. Determination of the NPV.

Scenario B: Financial Plans for a Reforestation Carbon Sequestration Project

This section describes the value of investing in tree planting for the purpose of carbon sequestration services (i.e., reforestation). The baseline amount of carbon is zero because there are no trees yet. Any carbon sequestered in the woody biomass grown over the next 25 years can be considered additional carbon and receive payment. Keep in mind that reforestation carbon projects are sometimes intended to establish a permanent forest, depending on the type of project. Payments may also only occur for a limited number of years.

Growth and yield models predict that after 25 years one acre of slash pine could sequester a total of 110,000 pounds of carbon, or 50 metric tons of carbon. The amount of carbon sequestered each year increases as the trees grow in size. Carbon sequestration values are estimated for each year based on the amount of carbon sequestered between two periods of time. For example, if the amount of carbon stored during year 2 is 0.08 metric tons per acre, and the carbon price is $10 per metric ton, then the value of carbon sequestered in year 2 year is $0.80/acre. This value can only be realized at the end of year 2, so the present value of carbon benefits at year 2 are,

PV Carbon benefits between years 1 and 2 = $0.80 / (1 + 0.03)² = $0.76 per acre

Present values for carbon benefits are always calculated at the end of each year and should not include the values from previous years. Each year has to be discounted separately because the amount of carbon stored in a given year differs. At the end of the contract the present value of each year is summed to provide a total present value, as shown in the following equation.

PV carbon benefits = PV carbon benefits at age 1 + PV carbon benefits at age 2 + PV carbon benefits at age 3 + ... + PV carbon benefits at harvest age.

You can see how calculations are made for each year by following the payments schedule in Table 3. It shows the total net present value of carbon sequestration at year 25 is $320 per acre. 

Table 3. Total net present value (NPV) of carbon sequestration in metric tons.

The most notable finding here is that timber production is still the more profitable land use when carbon payments to owners is at $10 per metric ton of CO₂. The carbon payments would have to approach $23 per metric ton of CO₂ to start competing with timber production as a financial investment in this scenario. Also, the rate of carbon sequestration can be higher and thus more valuable within common economic rotation ages. Since the benefits of selling carbon in a reforestation project may not be realized for several decades, programs that lease the land from the owner for a reforestation project can help provide revenues to owners more quickly, because the payments are part of the lease and not the carbon sequestration service.

Scenario C: Financial Plans for a Delay-in-Harvest Scenario

The example in this section is when an owner decides to delay harvest to sequester more carbon. The owner was offered $10 per acre per year to delay harvest for 5 years in a 25-year-old stand. It had already been determined that the total amount of carbon in the 25-year-old stand was 110,000 pounds or 50 metric tons per acre, and this would serve as the baseline. Growth and yield models predict that the amount of carbon stored in the coming year would be 2.3 metric tons per acre. At $10 per metric ton of carbon, the first payment would be $23.00 per acre, but this value can only be realized at the end of year 1. So, at a discount rate of 3% the present value of carbon benefits at end of the year 1 delay are,

PV carbon benefits between years 0 and 1 = $23.00 / (1 + 0.03)¹ = $22.33 per acre

Just as before, the present value for each year is calculated separately and summed to calculate a total present value for this scenario. The total present value of carbon sequestration at year five of the delay is $114.22 per acre (Table 4).

Table 4. Total net present value (NPV) of carbon sequestration after five years in metric tons. 

To help determine when it is economically efficient to delay harvest it is important to compare rates of change in value over time. The rate at which the carbon payment increases the total value of the stand should be faster than the rate of losses due to a delay in timber revenues. In this example, carbon payments increase the value of the stand by $114.22 per acre. The value of the stand also increases by $287 per acre due to new forest growth, but that value today is worth only $236 per acre due to discounting. So, waiting five years to harvest increases the total value of the stand by $350 per acre. There are some important caveats to consider however:

• Eventually, the value of adding carbon payments may not exceed the cost of waiting to harvest. At some point, the rate of carbon sequestration will start to slow down, as trees mature. The value of the harvest may also decline if it is set far enough into the future. Important rates of change can vary across forest types, management strategies, and site quality.
• Timber markets may change in the future, which makes it difficult to predict future land values. An extreme event (i.e., storm, wildfire, diseases) may decrease the total value of the stand within the delay period. Owners who do not have access to insurance and/or are not covered for "acts of god" in the carbon contract may end up losing money on the investment.
• A discount rate of 4% is typically used in forestry projects, but this may not represent real costs of delay for all forest owners. If the owner is in debt at a higher interest rate, the cost of waiting for revenues could be expensive. It may make more sense to pay down the total debt with a harvest instead of using the carbon payments to pay off the interest. It is important to account for all types of costs in a financial plan.
• Similarly, some owners may not have enough of a financial buffer to wait until the end of a carbon contract to get paid, even if land values increase significantly by waiting. Financial assistance programs that support owners through fiscally challenging periods can help increase the likelihood their land will increase in value.
• Delaying harvest for a short period (e.g., 5 to 10 years) can also impact revenues for the next generation, because the next generation will have to wait just that much longer before the stand is at optimal age for harvest. However, this may not always be the case for uneven-aged stands and when select harvesting methods are used.

Cut or wait decisions are common among forest owners, even if carbon programs are not available. Owners who have a strong land ethic are generally interested in making decisions that help protect forests in the future, as part of their stewardship legacy. Involving forestry professionals in the planning process is important for including the unique characteristics of individual properties and addressing the financial goals of the forest owner.

Closing Thoughts

• The slash pine illustrations used here are based on densely planted, even-aged, fast-growing pine species and not typical of all forests. The estimated values are for illustration only and not intended to directly represent any individual property. Financial estimates can be dramatically different for every case depending on forest type, costs, and market prices. Learn more about the cut or wait decision in the links below.
• Not every financial plan needs to be economically efficient or justified. Some owners may be willing to forgo revenues because they care about being a climate steward or simply want to enjoy the forest aesthetics. It is important for owners to have a clear understanding of which management objectives are a priority so that personal values are also included in decision-making.
• The price of CO₂ on the voluntary market was generally around $5 per metric ton for forest projects in 2021. When making a financial plan, keep in mind that the price of carbon traded in a carbon market may not reflect how much a forest owner may be paid. Owners who consent to shorter commitments to delay harvest provide fewer climate change mitigation benefits and this may impact payment levels. Commission payments for project investors and managers are also represented in carbon market prices.

This article was produced by the Forest Owner Carbon and Climate Education (FOCCE) program. What do you think? Please take this short survey.

Related FOCCE Articles and Resources

• What Should I Think About before Signing a Forest Carbon Contract?
• How Much Should I be Paid to Manage Forest Carbon?
• Cut or Wait Decision-Making for Landowners. Mississippi State University Extension.

Article Information Sources

• Andres Susaeta and Chris Demers Determining the Net Present Value of Timber Investments and Comparing Investments of Different Rotations. University of Florida IFAS Extension (FOR 352).
• Pienaar, L.V., B. D. Shiver, and J. W. Rheney. 1996. Yield Prediction for Mechanically Site-Prepared Slash Pine Plantations in the Southeastern Coastal Plain. PMRC Technical Report 1996-3A, University of Georgia, Athens, GA.
• Norris Foundation. 2016. Timber Mart-South quarterly price data. University of Georgia, Athens. Data was retrieved March 25, 2022.