THE SHADOW PRICE OF ENVIRONMENTAL SERVICES FROM U.S. FORESTSOR

Valuing ecosystem services from productive forests in the U.S. (and elsewhere): A Supply-side Approach

Daowei ZhangAlumni and George W. Peake Jr. Professor

Auburn University, Alabamazhangd1@auburn.edu

OUTLINE Purpose/Motivations Methods

Assumptions/Arguments Linkage between timber market

and the market for environmental services: Supporting evidences

Computation/Calculations Results

Discussion

PURPOSE To quantify the marginal value

of environmental services from productive forests in the U.S. (arguably, from all U.S. forests) in a simplistic and economic fashion in aggregation In the long-run (although the marginal

value is an annual estimate)

for informed debatefor tradeoff (decision-making)

NOTES Environmental services

=Ecosystem servicesMy definition is slightly

different from UN 2004 Millennium Ecosystem Assessment

Forests produce timber and else (environmental services)

Productive forests=Timberland=forest land can produce >1.43 m3/ha/year, not being restricted from timber production (harvesting)

Forest33%

Nonforest 67%

Timberland 22%

Reserved forest 2%

Other forest 9%

Reserved forests=no timber production/ forests are too valuable for something else (i.e., ecosystem services)

Other forests= mostly are not recoverable economically for timber

MOTIVATIONS (1)

High (wild?) estimates of ecosystem service values Costanza, R., R. d’Arge, R. de Groot, S. Farber, M. Grasso,

B. Hannon, K. Limburg, S. Naeem, R.V. O’Neill, J. Paruelo, et.al. 1997. The value of the world’s ecosystem services and natural capital. Nature 387:253-260

The value of ecosystem services from 17 global ecosystems = 2 times of global GDP

Problems?

MOTIVATIONS (2) Costanza et al. (1997) raised

awareness But

Can we pay more than we make?God forbidden….Demand side only (but can not be

used to do tradeoff)Area under the whole demand

curve?Methods questioned (being called

“reckless”)

MOTIVATIONS (3) Economic methods

Contingent valuation Travel cost Hedonic pricing Replacement cost (cost avoided)

Most of them are demand-side/used for specific service (design/double counting?)

None can be used to estimate the aggregate value of all the environmental services from all forests in a country, not from the supply-side

MOTIVATIONS (4) What is the amount of

environmental values, in aggregation, that a country (the U.S.) sacrifices by harvesting the amount of timber it produces annually?

How is the tradeoff between timber production and environmental service is made, explicitly or perhaps more inexplicitly, in economic term?

MethodsAssumptions/

ArgumentsSupporting evidencesCalculationsResults

Two Primary Forest Goods TimberEnvironmental services

Water/air quality + climate mitigation

Biodiversity/habitatRecreationSpiritual/culturalNon-timber forest products (hunting, fruits, mushroom)

ARGUMENT 1: Timber & Environmental Service Are Competing Uses

Timer and environmental services are competing uses, at least in a large scale

Some of these environmental services are complementary to timber production, and therefore need not to be compensated (not to be “studied”?) in economic sense

In other cases, simply produce one of them (either…. or….)

Theory on multiple/combinations of Uses

• See pages 175-182 in Zhang and Pearse. 2011. Forest Economics. UBC Press

Complementary uses

T

 

R

 

Competing usesA

 

Cubic metres of timber

per year

Recreation days per year0

 

T

 

R

 

Mutually exclusive uses

B

 

0

 

T

 

R

 

Highly conflicting uses

C

 

0

 

T

 

R

 

Constantly substitutable

uses

D

 

0

 

T

 

R

 

Independent uses

E

 

0

 

T

 

R

 

0

 

F

 

Figure 6.4: Types of production possibilities for two products on a tract of land

Resource allocation (1)• For mutually exclusive, highly conflicting and,

in most case, constant substitutable uses (Figure 6.4B, 6.4C, 6.4F): Always produce one of these uses

• Some forests, because the environmental services they produce are so significant, need to be reserved/protected, and only used for producing these service

• For example, Yellowstone, Yosemite…

Resource allocation (2)

• For independent and complementary uses (Figure 6.4E, 6.4F): Always produce both

• Some environmental services produced by private landowners need not to be compensated (One can value them, but compensation is not necessary, not efficient, and not fair)

Resource allocation (3)• For competing use (timber and ecosystem services):

the allocation of resource depends on the relative value/price

• But most environmental services are not priced

• There is little incentive to supply them• Yet, a growing population and rising personal income

increase the demand for these services (environmental Kuznets curve?)

ARGUMENT 2: With One Exception, The Market For Environmental Services Largely Works

The imbalance of supply and demand suggests a need of government intervention

When this imbalance grow over time, government: Land set-aside (e.g., Yellowstone…) Regulations (forest practice law/cap and

trade): try to limit the negative externality Reduce land base for timber production/raise its price Tax adjustment/subsidy/contract/payment

A Political Market For Environmental ServicesSupplier---politiciansDemanders---the public Is the political market for environmental

services effective and efficient? Can it meets the demand of the public for

these services? Can it restrict the negative externality in a

efficient way? YES, NO, Maybe. What is the better

alternative other than this political market?

Summary for my first 2 arguments• Efficient allocation of competing uses is

based on the relative value/price• Even though most environmental services

are not priced, and their supply mostly depend political process, their demand/supply is affected by the development of timber side of the forest sector

• Human demand for environmental services influence the supply/price of timber

• Through market and mostly politics, society decides how much forests are used to produce timber and environmental services, either exclusively or jointly

ARGUMENT 3: There Is A Tradeoff

These environmental services be valued from the supply-side

Tradeoff is made at the margin

Thus, the focus of this paper is “marginal benefits”, not total benefit

OA OB

DTDES

P

P

QTimberland

PTPES

ARGUMENT 4: These Environmental Services Can Valued In Aggregation and At The Margin

Can these environmental services be valued in aggregation?

Yes/no/maybe, yes if we want to study about the tradeoff at the margin and from the supply side

All are produced from forests; vary with forest age + structure

Often not priced Demand: increase with income Supply:

A lot of public good in nature (non-exclusiveness + non-rivalry)

Some aspect of private good, which is taken care of in the market

There is nothing wrong to think them as one, theoretically

I Argue They Can Be Aggregated

IF SO, WE HAVE A JOINT PRODUCTION PROBLEM WITH 2 GOODS

Environmental Services

Timber

Price ratio

B A

X

Y

A - B is the shadow price of environmental services

Dynamics In The Forest Sector In The Long-run And Large Scale

Timber/Environmental services Joint production of timber and

environmental services from forests in a country

Estimating Shadow price of environmental services

Let us think about timber only at first

Faustmann Formula: Timber Only Price P(t) is a function of time land expectation value of a typical old-growth forest

long-term balance relationship

Adding an afforestation cost (or reforestation cost, C) will only modify the RHS term slightly

Timber Production In The U.S. European settlement:

timber was harvested for building materials and fuel wood land was cleared for pasture and agriculture

As timber inventory declines, timber becomes increasingly scarce and prices increase

Price rise is not limitless as shifts in extensive margin forest protection plantation forests Technology change in manufacturing Substitution

Now Adding Environmental Services Demand is increasing, but most are not priced

Likely (undersupply) in a market economy Government steps in periodically to reflect

society’s desire Governmental means

Public ownership –land set-aside; less timber harvesting

Regulations of private forestry – BMPs Subsidy – Conservation Reserve Program Tax --- lower tax for timber income/reforestation tax

credits Private means

Private demand (thus supply through private means) increases along with income

All government + private means change the price and volume…

FAMILY FOREST OWNERSHIP OBJECTIVESUNITED STATES, 2006

0% 10% 20% 30% 40% 50% 60% 70%

Land investment

Part of home or cabin

Nature protection

Privacy

Family legacy

Aesthetics

Percent of Family Forest Land

U.S. Forest Service, National Woodland Owner Survey

FAMILY FOREST OWNERSHIP OBJECTIVESUNITED STATES, 2006

0% 10% 20% 30% 40% 50% 60% 70%

Nontimber forest products

Firewood production

Timber production

Other recreation

Part of farm

Hunting or fishing

Percent of Family Forest Land

U.S. Forest Service, National Woodland Owner Survey

FAUSTMANN FORMULA: TIMBER+ ENVIRONMENTAL SERVICES

F(t) is the value of environmental services flowing from a standing forest at age t

land expectation value of a typical old-growth forest

long-term balance relationship

Adding an afforestation cost (or reforestation cost, C) will only modify the RHS term slightly

The Marginal Value Of Environmental Services

The above equation can be re-arranged as

Forests are capital goods This is a long-run relationship What about net imports? (U.S. net imports

of forest products=10-12% of its consumption)

U.S. Forest Service, National Woodland Owner Survey

Softwood And Hardwood Growing Stock Volume, Net Growth And Growth Rate, 1977 To 2002

Volume (million cf) Net growth (million cf) Growth rate

Softwood Hardwood Total Softwood Hardwood Total Softwood Hardwood Total

1977 466960 266096 733056 12501.3 9425 21926.3 2.68 3.54 2.991987 467575 314081 781656 12520 9562.4 22082.4 2.68 3.04 2.831992 449895 335722 785617 11973.9 9652.3 21626.2 2.66 2.88 2.751997 483855 351816 835671 13393.5 10155.7 23549.2 2.77 2.89 2.822002 491800 364257 856057 13666.5 10022.3 23688.8 2.78 2.75 2.77

Alabama Stumpage Prices For Sawtimber And Pulpwood

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

0.0050.00

100.00150.00200.00250.00300.00350.00400.00

So Pine Sawtimber Mixed Hardwood Sawtimber

$/mbf, D

oyle

$/cord

$/mbf,

Scribner

Average Stumpage Prices For Selected Sawtimber Species Sold From National Forests

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

0100200300400500600700

D-Fir S-Pines P-Pines W-Hemlock E-Hardwoods Oak

$/tb

f

Average Stumpage Prices For Selected Sawtimber Species Sold From Private Lands In Louisiana

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

050

100150200250300350400450

S-Pine Ash Gums Oaks

$/tb

f

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

0123456789

LA S-Pine LA-HardwoodsNH-Hemlock & Pine NH-Spruce & Fir

$/co

rdAverage Stumpage Prices For Pulpwood Of Louisiana

And Northern New Hampshire

0.88%

(in real terms)In The U.S. South

From 1956 to 2005

The Weighted Average Rate Of Annual Change in Stumpage Priceis

Prime and 10-year T-bill Interest Rates

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

02468

101214161820

Prime 10-Year T-Bill

The Average Annual (Real) Rate Of 10-year U.S. T-bill = 3.59%

The Real Rate Of Return in the Stock Market (S&P 500) = 7.39%

From 1956 to 2005

Growth rate = 2.8Price change 1956-2005= 0.88

Interest rate =11.48-4.09=7.39

Assuming average rotation age =40-50 year

The RHS of equation 4 is 7.39

SO, WE FOUND

Equation 4Left-hand-side=2.8%+0.88%=3.68%

Right-hand-side=7.39%7.39% - 4.68%=3.71%

This 3.71% represents the disparity (margin) between managing the forests for timber and environmental services, and managing the forests for timber alone

LONG TERM (IM)BALANCE

margin = 3.71% average stumpage price in Alabama in 2005

= $1.03/ft3

U.S. forest growing stock in 2005 = 856 billion ft3

$33.25 billon of environmental services(Forest Sector’s contribution to US GDP = 1.0%

or $121 billion in 2005)

SHADOW PRICE OF ENVIRONMENTAL SERVICES

Is this a valid method? Based on marginal analysis from the

supply-side Consistent with economic theory

(tradeoff) Using a stand-level model to the whole

forest sector in a country? Results does not fluctuate much in the

long-run, but it does not work in the short-run (r and P fluctuate too much) or a small region (Q fluctuate too much)

What interest rate to use? The MBES may become negative!

Cannot assume all timber growth is for the value of timber! There is an environmental service component in it

DISCUSSION (1)

Does society/political + economic markets behave efficiently? In the long-run, maybe

Can we aggregate all environmental services?

What about the total value of environmental services in other forests (not timberland)?

If the method is valid, I plan to ….

DISCUSSION (2)

SUMMARY Purpose/Motivations Methods

Assumptions: 1 good (timber) / 1 service ( all environmental services in aggregation)

The political market for environmental services influence the timber market /production and vise versa (there is a tradeoff)

Dynamic Faustmann formula Results

Discussion