It’ll be interesting to see if the Government’s recently announced substantial increase in forestry premia will reverse the trend of decline in plantings.
Climate change has meant that every farmer is conscious of the critical importance of forestry as a source of sequestration.
A continuation of the decline in planting will place more pressure on the land use sector to secure its demanding reduction targets.
In this article, I’m looking at the economics of afforestation and I want to first declare that I’m a small forest owner. The critical difference between a decision to plant trees versus an annual crop or to produce livestock is that the returns to afforestation arise over a very long period.
So, apart from factors such as expected output and input prices and productivity, the planting of trees incurs significant risks.
Moreover, the cost of waiting for future revenues (interest rates) implies that future income from the trees will be discounted to the current value of money.
Future earnings from afforestation are driven by the revenues from periodic thinning, the felling at the end of the rotation and, of course, the premia provided by Government for the first 20 (up from 15) years of the rotation.
An important factor in the planting of trees is the opportunity cost of the decision, ie what income the land might yield if used for other purposes.
Rationally, a farmer shouldn’t consider planting trees unless the profit is at least as good as the next best alternative (NBA) option.
Because of the long time period for the realisation of the financial benefits, any advantage over alternatives would need to be substantial.
An economic consideration, however, that hasn’t received any assessment is the so-called options’ cost of afforestation. The way that the grants system is structured, the decision to plant trees is effectively a decision to do so in perpetuity. Within two years of felling, forest owners are obliged to replant, at their own expense.
Moreover, no premia are available for the initial or subsequent replantings.
The options’ cost of planting trees, therefore, is the opportunity cost that arises in perpetuity following the first harvest.
The decision to plant trees today will not only impact the farmer’s own lifetime earnings but the earnings of the future generation of landowners.
Based on long-term average timber prices, a final harvest in year 35 would generate a revenue of about €23,000/ha
Let’s first look at the decision to plant a new forest. I’m going to assume it’s a mixed species spruce and birch forest and is yield class 24 and that the farmer follows best practice concerning their thinning strategy so as to maximise the productivity of the final fell.
Account is taken of the future costs that will arise over the rotation. Enhanced premia income is assumed to yield €746/ha from years one to 20. Revenues from thinning are assumed to arise in years 18, 22 and 27.
Based on long-term average timber prices, a final harvest in year 35 would generate a revenue of about €23,000/ha.
Putting all assumed costs, including the replanting cost (currently about €3,600/ha) no later than two years after the fell, and revenues together, over the next 37 years and assuming a discount rate of 5%, yields a net present value (NPV) of €11,500/ha.
A 5% rate is a fairly standard assumption in analyses of this kind but it’s conceivable that individual farmers would use a much higher discount rate. To enable the estimated returns to be compared with shorter-cycle agricultural products, it’s important to translate the NPV into what’s called the annual equivalent value (AEV).
Assuming that the opportunity cost is the family farm income from suckler cattle production, which according to Teagasc, has averaged about €300/ha for the last six years, the decision to afforest over the next 37 years implies an indicative AEV per hectare of €700 or about 2.4 times the NBA.
This is undoubtedly an attractive return but it doesn’t fully capture the potential financial benefits of forestry.
Income is tax-free and there’s little or no labour input required.
The main difference compared to a new plantation is that they will not receive any premia payments
Forest owners are also likely to be eligible for BISS and CRISS. And there’s the possibility that, in the future, forests may become a source of carbon farming and wider ecosystem service income.
But now consider a forest owner who has just felled their first forest today and is looking ahead to their future income from the next rotation.
The main difference compared to a new plantation is that they will not receive any premia payments.
In these circumstances, the likely AEV per hectare could be around €200, which is substantially short of the NBA. This situation will be repeated for the third and all subsequent rotations.
If many farmers contemplating a potential forestry investment decision look at the issue the way that I’m suggesting, there may be a need for a further consideration of the public supports for afforestation.