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Estimating Values for Australia's Native Forests

Environmental Economics Research Paper No.4
This report was prepared by consultants
Francis Grey Consulting Economist At Large and Associates for the Department of the Environment, Sport and Territories.

Commonwealth of Australia, 1996
ISBN 0 642 24863 X

3.3. Identifying pricing/financial valuation practices.

As mentioned previously, pricing and financial valuation practices are critical to the correct appraisal of any commercial activity. These valuation techniques, unlike those for NFV's, are well known through many years of commercial activity. However, in calculating the total economic value (TEV) of each option, it is necessary to have realistic and accurate estimates of the primary financial value derived from the forests (forestry) and the value of alternative, substitute or complementary financial values such as recreation, water production, tourism etc.

Pricing and financial valuation are discussed simultaneously in our report, since the pricing of forest timber represents the ultimate expression of a series of financial calculations and estimates of financial value. The system by which an ultimate price for forest products is determined needs to be soundly based on commercial and economic criteria if it is to eventually give rise to an economically efficient price. Thus to examine forest pricing is to analyse the system by which forest products come to be priced, and, to some extent at least, the pricing systems of other forest products.

We formally examined the thirteen reports for their insights into the evaluation of the financial values of timber. Table 3 briefly reviews some key points from each report with respect to financial considerations.

Table 3

Report Name Comments on the Pricing/valuation of Forest Timber.
1. The National Forest . Policy Statement (NFPS, 1992) The NFPS adopts a 'compartmentalised' (see note below) approach to pricing. As a result the NFV's of harvested areas must be very small for harvesting to be profitable.

The NFPS (1992:21) specifies that plantation harvesting must be based on commercial criteria, whilst native forest harvesting should be based on the full cost of 'efficient management of wood production'. This implies that native timber and plantation timber are not on an equal basis, instead the native timber is being subsidised. This puts plantation timber at a commercial disadvantage, and represents an 'uneven playing field'. This reduces economic growth and job creation in plantations. It biases against NFV's because it artificially inflates the value of timber by cost subsidies.

The cost of capital would also appear to be subsidised since forest agencies are only required to earn a 'fair' (NFPS, 1992:20) rate of return on capital, when commercial enterprises, including plantations, must earn a market rate of return. This tilts the 'playing field' in favour of native timber harvesting and against conservation and plantations, resulting in sub-optimal economic performance (lower regional income and job growth).

2. The RAC Forest and Timber Inquiry (RAC, 1992) The RAC recommends a 'compartmentalised' approach to. pricing.

The RAC found it difficult to establish benchmark prices for native forest timber.

The RAC found that forest agencies accounting systems 'made it impossible' (RAC, 1992:429) to determine the costs of timber harvesting.

The RAC found that capital costs were equivalent to those expected from public investments only for plantations. Capital costs were being subsidised for native timber harvesting, beyond that which already exists, via lower discount rates, for public projects.

3. The Ecologically Sustainable Development Working Group on Forestry.

(ESD, 1991)

The ESD Working Group recommended ‘compartmentalised’ pricing.

The timber should be priced commercially to reflect the costs of its extraction. The identification of opportunity costs suggests that alternative financial activities, where they are of higher worth should be the preferred use; ie the resource should go to its highest valued use.

There should be no cross-subsidies.Timber pricing should be done on a marginal cost basis rather than the average cost basis which cross-subsidises the more expensive timber extraction work from the cheaper timber extraction work.

It recommended corporatisation of forest agencies within an ESD framework.

4. The NSW Parliamentary Public Accounts Committee Report on the Forestry Commission.

(PAC, 1990)

Whilst identifying the impact of NFV’s, pricing policy appeared to be based, by this committee, on a ‘compartmentalised’ basis as per recommendations 29 and 34 (PAC, 1990:xxiii). Pricing was valuable because it reduced demand. Discussion about costing NFV’s into prices was too short to clarify the PAC’s intentions, other than by examination of the Recommendations.

The possible impact of regulations protecting NFV’s was demonstrated by the result which showed that NZ softwood prices were lower than NSW due to lower environmental standards.

The PAC noted significant deficiencies in production control which imply that NFV’s were not being protected. The raised concerns about the sustainability of quotas for supply of timber and other forest values. (PAC, 1990:55, 56)

The PAC report identified the following subsidies to native timber harvesting:

  1. The lack of marginal cost pricing.
  2. The non-existence of an effective commercial accounting system.
  3. Long-distance transport subsidies.
  4. Non-payment of rental for use of public land.
  5. Low royalties; ie. low log prices for timber (see note below).
  6. Possible cross-subsidisation from community service obligations.
  7. The report recommended that a resource rental tax should be paid.
  8. The report recommended payment of a notional income tax (presumably meaning company tax).
  9. The report recommended that local government rates should be paid.
  10. The report recommended the removal of exemptions from sales tax on vehicles, plant and equipment.
  11. Non-payment of interest.
  12. Non-payment of dividends.
  13. Low user charges for cost recovery from long-distance transport

The serious effect of these exemptions on the prices is drawn out by this quote from another Commission Officer “If we were a private sector company we would toss in the towel.” (PAC, 1990:27). In a similar vein the non-payment of these imposts comprises the “principal economic advantage of old-growth and regenerated natural forest over plantations” (PAC, 1990:106).

The committee explicitly noted that if pricing did not include non-wood values then “pricing may not be above society’s costs. This argument has never succeeded in finding an objective footing since the costing of non-wood values is highly contentious. However the difficulty of estimating the magnitude of non-wood values does not diminish the importance of doing so.” (PAC, 1990:67).

5. The Joint Scientific Committee on the South East Forests. (JSC, 1990) The JSC was not centrally concerned with pricing.

It did note that different management regimes would induce different costs for logging operations.

6. The Report of the National Plantations Advisory Committee (NPAC, 1991) Distortions in the pricing of native timber will be have an impact on the price of substitutes such as plantation timber.. Market distortions that artificially raise the price of plantation timber will make native timber more attractive.

The NPAC report identifies the following specific measures that raise the price of native timber:

  1. Serious defects in the taxation system that increase the amount of tax paid relative to equivalent investments. These include: inability to index for inflation, inability to smooth income between tax years, inappropriate classification of tree stock, inability to index stock. These problems lead to higher than average tax loads for plantations.
  2. Natural imperfections in the pricing system for wood in Australia , due to small numbers of buyers and sellers, are serious impediments.
  3. The dominant supply role of the State forest service in each state and the price leadership that results;
  4. The government restrictions on sales of forest products that are often due to concerns about the public forest but are applied to plantations as well; and
  5. The rigid purchasing system in use by major forest industries that disadvantages small growers.

Other costs faced by plantation owners come from bans on woodchip exports of plantation timber, problems caused by long term supply contracts & the activities of local councils via landuse and rating systems.

The NPAC report highlighted to this economist another serious deficiency which is the non-payment by forest agencies of rental on public land.

7. The Industry Commission Inquiry into Value Added Processing in the Timber Industry.(IC, 1993) The IC raised the following issues which all have a bearing on the relative prices of plantation timber, native timber, alternative financial values and NFV's.
  1. Privatisation of state owned plantations,
  2. Corporatise remaining public plantations.
  3. Management of crown land for timber production to be corporatised.
  4. Corporatised wood management agencies to face the full gamut of commercial arrangements.
  5. Non-commercial functions to be separately funded.
  6. Income tax treatment of private plantations to be reviewed.
  7. Changes to the ownership basis of trees on private land.
  8. Discrimination against private plantations through local councils to be removed.
  9. Clear guidelines and more efficient administrative procedures to remove inefficiencies associated with existing project and environmental approval processes. (IC, 1993:15).

The IC raised the possibility of multiple wood supply agencies in each state.

8. The Australian Heritage Commission Annual Report, 1991-92. (AHC, 1992). The report did not consider pricing issues.
9. Draft Report on the National Estate Values in the Southern Forest Region of South-West Western Australia, 1992. (AHC-CALM, 1992). The report did not consider pricing issues.
10. The Victorian Auditor-General’s Report No 22, The Timber Industry Strategy. (AG, 1993). The Victorian AG’s report identifies a range of distortions that increase the relative financial value of native timber versus plantation timber, alternative financial values and NFV’s. They include:
  1. Low rates of return on capital; (AG 1993:5)
  2. Low licence fees for timber access; (AG, 1993:5)
  3. Financial losses indicate subsidisation from the taxpayer; (AG, 1993:15, 137)
  4. Price increases for State timber have been held below price increases charged by sawmillers. (AG, 1992:17)
  5. The price equalisation system leads to cross-subsidisation within the State. (AG, 1993:17)
  6. Present pricing makes hardwood timber cheaper than softwood timber despite higher production costs and greater environmental values. (AG, 1993:129)
  7. Preparation of financial statements appears to be inadequate. (AG, 1993:135)
  8. Community Service Obligations have not been categorised or quantified. (AG, 1993:136)
  9. Limited number of staff with appropriate expertise in accounting. (AG, 1993:136)
  10. Inadequacies in the accounting system prevent an accurate analysis of costs. (AG, 1993:138).
11.The Industry Commission Reports into Recycling (ICb, 1991), Paper Recycling (IC, 1990). Prices should reflect the full value to society.

The IC cited the Australian Bureau of Agricultural and Resource Economics when it suggested that prices for timber may be too low.

12. The Public Management of Forestry Projects, (OECD, 1986) No comments on pricing per se, except that there was a presumption that the market prices charged were efficient (ie.. reflected full social costs). Non-financial values were factored in by shadow prices or by decision rules which limited options. The World Bank report discussed later had similar views. (World Bank, 1992).
13.The New Zealand Resource Management Act, 1991. (NZ, 1991) No comments on pricing located.

See the section on pricing theory (Section 2) for an explanation of 'compartmentalised'.

They also felt that the market price was too low and that international prices were not as significant in pricing native forest timber as was considered by the Commission. (PAC, 1990:77) They felt that the native forest timber price should be raised to 'the point of indifference.' (PAC, 1990:77) and that the case for doing so was 'overwhelming' (PAC, 1990,79). This even more significant when it is considered that 'the Forestry Commission sets these prices...the Commission is clearly a price leader.' (PAC, 1990:97)

3.4. Identify the suggested assessment frameworks for evaluating policy options.

The previous section (3.2) identified valuation techniques for application to the values identified in section 3.1. This section seeks to identify how differing reports have integrated valuation methods into an assessment framework for estimating net social benefit.

In this report, it would be very useful to draw a distinction between assessment processes and assessment frameworks. The assessment process is a way of describing the means by which decisions are made, ie. the method used by a group of people in order to determine the decision. The assessment framework, conversely, describes the context within which decisions are considered, ie. the various institutions involved in the decisions and the relationships they bear to each other. Using this definition, assessment processes take place within assessment frameworks, and hence both are important in ensuring that decisions are optimal. A broader approach, however, would see assessment processes and assessment frameworks as being part of the same seamless decision making apparatus. In this report, we have not sought to distinguish between frame works and processes, although it is worth bearing the above definitions in mind, because they are both descriptions of a means to valuation.

The significance of this distinction is that the review conducted in this study revealed that recommendations did not deal only with the means of decision making, but also with whom and how that decision was arrived at. Thus it was important to have community involvement, for example. Institutions needed to have clearly identified functions that kept the regulated separate from the regulator.

It would seem to be difficult to create an assessment framework, in advance of identifying the relevant values and valuation techniques. It is of some interest, however, that most reports have explicitly or implicitly applied an assessment framework. It is our view that only the RAC and the OECD studies had done sufficient analysis to justify the term 'framework'.

Again, the RAC offered the most carefully structured arrangement for its assessment framework. The assessment framework was demonstrated by example rather than by explicit discussion, even though many suggestions were proposed. The OECD also put forward a structured assessment framework that involved user groups, community liaison, multiple project alternatives, etc. The OECD explicitly considered how data should be presented in the assessment framework. The decision makers were then left to absorb the information that had been put forward. The following Table No.4 provides a brief summary of the views of each report with respect to assessment frameworks.

Table 4. The results of our survey of assessment frameworks are summarised in this table.

Report Title. The Assessment Framework & Process in brief.
1. The National Forest Policy Statement The closest approximation to an assessment framework offered. by the NFPS is the implication that expert working groups will draw up guidelines under the auspices of ANZECC/AFC. The guidelines will seek an optimal balance between values. Information on how choices are to be made (ie the process of assessment), and values evaluated is absent.
2. The RAC Forest and Timber Inquiry See the separate summary of the RAC framework and process. in Section 3.5
3. The Ecologically Sustainable Development Forest Working Group. (ESD, 1991) The ESD working group pointed to the need for a nationally agreed framework, strong public participation, the use of balanced panels of experts to assess tradeoffs and the use of. integrated agencies. Institutionally, their proposals centred on variations on the theme of ministerial advisory bodies under an independent chair. The decisions would be made by Ministers based on information put forward. The AHC-CALM model from Western Australia was looked upon favourably.
4. The NSW Public Accounts Committee report on the NSW Forestry Commission. (PAC, 1990) The PAC recommended a committee of interested groups to assess values of the forests. Ultimately society should decide the trade off which was interpreted by this survey to mean parliament. Some suggestions consisted of: formal consultative processes, rights of appeal, & provision of information before finalisation. Tripartite agreements between conservation, forestry & government groups could provide a solution. Separation of functions within the managing institution, eg. regulatory functions should be separated from commercial activities.
5. The Joint Scientific Committee on South East Forests(JSC, 1990). This report dealt principally with the scientific values of the forests and hence can only be judged as a partial analysis of forest values. The report advocated codes of practice to protect forest values without detailing how these trade offs were to be calculated. No assessment framework or process was offered beyond the analysis of scientific values.
6. The Report of the National Plantations Advisory Committee 'Integrating Forestry and Farming'. (NPAC, 1991). This report did not provide an explicit framework for consideration of all values, either in the context of plantations, or native forests. The report did note that certain benefits were not included because 'of the difficulties associated with quantifying them in economic terms.'(NPAC, 1991:Appendix C1:9)
7. The Industry Commission Inquiry into Value-added Processing in the Timber Industry. (IC, 1993) The IC did not comment on an assessment framework except to recommend the separation of regulatory and administrative functions. Corporatisation was also recommended as a means of obtaining accurate valuations of financial values.
8. The Australian Heritage Commission Annual Report, 1991–92. (AHC, 1992) The AHC framework appears to represent a systematic effort to identify the attributes of places which are worthy of conservation. The analysis is conducted by comparing the physical characteristics of the object against a benchmark or threshold standard. It does not appear to deal with subjective values, and hence can be regarded as only providing a partial analysis.
9. Draft Report of the National Estate Values in the Southern Forest Region of South–West Western Australia. (AHC-CALM, 1992) This report applied the process described in 8. above. It deliberately excluded social values, but did appear to represent a negotiated solution. The focus on scientific values makes this also only a partial approach. Assessment of social values may require greater involvement of other parties.
10. The Victorian Auditor-General’s Report No 22, ‘The Timber Industry Strategy’. AG, 1993) The report identified the assessment framework in place in Victoria prior to December 1992. This was a cutting areas review committee that had representation from the department, industry and the Land Conservation Council. The management plans were intended to protect non-wood values, and logging only proceeded if the committee came to a consensus decision. Disputes were settled ultimately by the responsible Victorian Minister.
11. The Industry Commission Reports on Recycling (1991b), Interim Report on Paper Recycling (1991c). The IC did not provide a framework for assessing values, even though it strongly recommended such an approach. It did note the need to corporatise the relevant institutions, as well as provide incentives to them to maximise the value to society. It recommended that the worth of non-financial values be estimated. In the past “Environmental and other values have been vaguely specified, and commercial criteria neglected.” (IC, 1991b:108)
12. The Public Management of Forestry Projects. (OECD, 1986) See separate discussion.
13. The NZ Resource Management Act, 1991. (NZ, 1991) The NZ Act lays down principles by which regulators are to abide. A cost benefit analysis must be conducted of 'objectives, policies, methods or rules introduced under the Act. Decisions must be justified 'explicitly' & alternatives considered.

3.5. Best Practice in Assessment Frameworks

The RAC and OECD reports have provided the most comprehensive approach to assessment frameworks. Briefly, the RAC set out the following assessment framework with the following components:

  1. Definition of four goals (ie. taking account of unpriced social and ecological values; providing for community support and involvement in decisions; maintain the natural capital of forest eco-systems; and maintenance of options and use of the precautionary principle when dealing with irreversible actions) which determine the basic framework of forest decisions.
  2. Deciding on the spatial framework for forest decisions.
  3. Developing an effective management structure for the national forest estate.
  4. Dealing effectively with risk.
  5. Identify and create an assessment process.
  6. The assessment process contained:
    • the further development, implementation and enforcement of management plans and codes of practice for all uses of the forests;
    • the further development and application of economic techniques to permit a monetary estimate of non-market goods and services to be included when evaluating options;
    • ensuring that price paid for forest goods reflects the true costs of their production,
    • the development and application of integrative methods that accommodate a variety of measures of forest use and value in order to better identify and evaluate trade offs between alternative uses.
    • providing society with access to the information required to make informed judgements;
    • maintaining existing public participation processes and developing new ones to support public involvement in forest issues,
    • using instruments such as community attitudes surveys to identify the concerns and aspirations of society.
    • establishing and managing a representative conservation reserve system,
    • recognising the importance of conservation management strategies for forests outside the reserve system,
    • a better understanding of the ecological processes that maintain the biological diversity of forests and the uses that degrade those processes,
    • recognising the changing needs and values of society,
    • recognising the need for better information about forest ecosystems and human uses of them,
    • developing and adopting an adaptive management ethos; that is, an approach to forest use decision making and management that better incorporates society's changing needs and aspirations, that is flexible in the face of risk and uncertainty, and that is able to rapidly and effectively incorporate new information. (RAC, 1992:116)
  7. Practical application of the assessment process.

The RAC report attempted a practical application of the assessment process. It used cost benefit analysis supplemented by fixed constraints to protect certain objectives such as ecological sustainability. Non-financial values were estimated by a contingent valuation study utilising the concept of 'threshold analysis'. Multi-criteria analysis was used to assess trade offs.

The OECD study assumed that there was no simple 'black box' answer. Its approach sought to prepare multi dimensional scenarios that captured all important aspects of a project. The scenarios were designed to make assumptions, trade offs and options transparent. The OECD study recommended:

According to the OECD, the best way to incorporate non-financial values was to have social and environmental experts as part of the project appraisal team. The report featured measures to appraise non-financial values, including monetary techniques. The favourite technique however appeared to be ranking of alternatives, preferably with public input. These alternatives also included a 'without' alternative; ie. the scenario whereby the project does not go ahead. The OECD report also recommended the development of multiple alternative projects. The OECD put forward the following assessment matrix as a means of assessing project options.

The OECD developed relative indexes for each non-financial value. It recommended using rankings created by different social groups to evaluate the options. To deal with uncertainty, it suggested the use of sensitivity analysis around key variables. It also thought the project would need to iterate backwards and forwards until it emerged in an appropriate form ready for decision. This means that a project will need to progress through several stages and then return to earlier stages as new information becomes available. This circular process may go on for a while, until the sources of new information are exhausted.

Table 5. A proposed evaluation matrix from the OECD (1986).

Effects Definition of effect*

Without project

Project A

Project B

Project C

I Cost of establishing the project ($).

0

10

15

5

II Operating cost ($ per year)

0

2

3

1

III Timber production (cubic metres/hectare/yr)

0

3

1.5

1

IV Number of visits (1000/per year)

10

30

100

20

V Quality of landscape

4

3

4

5

VI No of species protected.

10

8

5

15

* OECD documentation of this column was wrong. The OECD publication labelled this column 'Project Alternatives'. (OECD, 1986:22).

In Table 4, the views of each report have been summarised. The reports seem to fit into one of three categories. The first category make general statements that things need to be done better, without specifying how this should be achieved. The second category of reports focused almost exclusively on evaluating the 'scientific' (characteristics valued as a result of their description by a specialised body of knowledge) worth of 'objective' characteristics of the native forest.

The third category of the report attempted, more or less successfully, to describe differing frameworks by which the full suite of values could be estimated. In this third category, for example, the OECD analysis seemed reasonably clear and practical, in the sense that 'there are no right answers' to this problem, only a range of possible solutions. The RAC process lacked emphasis on the presentation of data, but made up for this by seriously attempting to implement its own analytical framework. Amongst the third category of reports, there were strong themes emphasising the need for community participation in the decision making process, as well as estimating non-financial values, separation of functions, the importance of information and the importance of evaluating alternatives in a rigorous framework.

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