An inspirational address delivered to the Timber Queensland symposium by keynote speaker David Brand, Chair of New Forests, captured the nature-based investment manager’s global outlook for forests.
Key themes focused on the steady shift of wood supply from harvesting extensive natural forests to intensive timber plantations, the rise of Asian timber and wood fibre demand, new opportunities for the forestry sector in a circular bio-economy transition, the rise of sustainability and climate mitigation opportunities and the rising importance of investment capital in the evolution of forestry and land use.
Dr. Brand’s views on key trends were outlined in the latest Forestry Investment Outlook report (2023-2028) published on the New Forests website.
Wood Central has republished extracts from the report.
Geopolitical shocks are driving rapid changes to forest stocks
There have been significant shifts in geopolitics, supply chains, the Covid-19 pandemic, a Russian invasion of Ukraine, and the intensification of global efforts to address the twin challenges of climate change and biodiversity loss.
These issues translate into both an acceleration of previous trends and new opportunities and risks for investors in sustainable forestry and broader land use.
Markets for forest products are complex, and there is a myriad of supply chains for roundwood, wood fibre, wood products, and energy products.
Both supply and demand are dispersed around the world. Markets have various cycles driven by economic conditions, housing demand, technological changes, and public policy settings.
The capture of profit margins is also in continuous flux among feedstock suppliers, logistics providers, and manufacturers. Unprocessed wood can be shifted between markets depending on relative prices.
Developing economic models to predict market prices
Due to these multiple variables, it can be difficult to develop an overall econometric model that can accurately predict forest product market prices.
Investors are well-advised to create diversified portfolios of forestry and land assets to reduce excessive volatility in their returns.
Since the global financial crisis of 2008-2009, forestry supply chains have been globalising to accommodate rising demand from Asia.
This has particularly benefitted Australian, New Zealand, Russian, European, and Latin American suppliers of raw logs, woodchips, market pulp, and sawn timber.
In North America, the slow but steady recovery in housing starts has been tightening the supply and demand balance until the recent rise of inflation above target levels.
With timber harvest in Canada declining and the US West timber supply fully allocated, growth in wood processing has been centred on the US South to balance demand.
The Covid-19 pandemic disrupted supply chains
As the world entered the Covid-19 pandemic, market conditions were tight in many regions.
The pandemic disrupted supply chains, causing spikes in lumber prices in the US, log prices in China, and pulp and woodchip prices in the Asia-Pacific.
The impacts of the Russian invasion of Ukraine have tripled the price of wood pellets for energy and disrupted trade between Russia, Europe, and China.
This shows supply chains adjust slowly, repositioning wood from areas of oversupply to areas of higher demand and wood processing investments to areas of higher wood supply availability.
It is interesting to note that in the US South, where there has been a long-term build up in standing timber, this did not translate into substantial log price increases, and most of the profits went to manufacturers.
In the case of New Zealand log exports to China, the profit margins were captured by the shipping industry, which benefitted from logistical challenges and port congestion.
Australian plantation owners have seen record stumpage prices for exported product
With the peak market conditions for wood fibre in the Asia-Pacific, Australian eucalyptus plantation owners are seeing record stumpage prices, up 15% year-on-year.
In this case, the availability of underlying wood supply is the limiting factor. Investors conducting due diligence should seek to understand these dynamics.
In some cases, investments that integrate forestry with logistics, infrastructure and / or timber processing facilities can perform much better than the segregated ownership of the forest alone.
… if the profits are largely secured in these other parts of the supply chain.
Forestry markets are less volatile when there is free trade, well-established and flexible supply chains, and reasonably steady or at least slowly evolving conditions in the sources of supply and demand.
The next five years could be defined by increased price volatility
It would be hard to argue that the next five years will see these kinds of relatively benign conditions. It now appears that international trade peaked in 2018, and many countries are actively pursuing policies to localise supply of critical raw materials.
The geopolitical situation between China and the West has been increasingly tense in recent years, and the Russian invasion of Ukraine was a surprise disruption to markets for energy, food, and other natural resources.
Timber prices will likely remain volatile in the coming years.
Again, diversification in market exposures, both geographically and by end-product, will be the best way to manage volatility, as forestry markets are not well correlated.
For the investor, it is not enough to understand the timber markets, but also to consider the supply of well-priced assets.
The 2000s was the decade of US forestry rationalisation, and the 2010s was the decade of Australia and New Zealand rationalisation. What will the 2020s bring?
What will the 2020’s bring investors?
It seems like there will be a rollover of assets initially acquired in the 2000s occurring in the USA.
Australia and New Zealand have a high carbon price which is spurring greenfield forestry along with some continuing asset turnover.
A few managers have established businesses investing in European forestry assets, and there are also small funds seeking to identify emerging market opportunities in Latin America, Asia, and Africa.
Alongside this has been a proliferation of nature-based carbon project platforms, developers, and financiers.
Most traditional forestry investment managers have launched some form of climate or carbon-focused investment strategy to harness the role of sustainable forestry as a climate solution.
Decarbonisation could change the economics of forestry and land use dramatically
If the world moves towards decarbonisation, the economics of forestry and land use are likely to change dramatically, as has already been seen in New Zealand where the US$50 per tonne carbon value exceeds the timber stumpage value in many areas.
Since the Paris Agreement of 2015, there has been a concerted effort to transition the global economy away from fossil fuels and towards the goal of keeping global warming well below 2 deg. C, and preferably to 1.5 deg. C.
Sustainable forestry is a solution to climate change both in terms of the potential of forestry assets to absorb and store carbon dioxide from the atmosphere and also to provide low embodied energy and low emission substitutes for higher emitting materials.
Government’s have acknowledged forestry’s role in achieving zero emissions
The recognition of the role of forestry and land use in reaching net zero emissions has increased since the Paris Agreement. Some researchers suggest that up to one-quarter of the decarbonisation process will come from forest conservation, reforestation and restoration of degraded ecosystems, and sustainable forestry and agriculture.
That represents 10 billion tonnes of emission reductions and carbon removals per year.
To encourage land-based carbon sequestration and storage, multiple government-regulated and voluntary carbon markets have been implemented over the past decade.
These markets allow forest owners who protect forests, increase carbon storage in managed forests or reforest new areas to create tradable emission reduction certificates or units.
Carbon offset markets can impact on economic returns for forestry investments
Where these carbon offsets or credits are low-priced, say less than US$10 a tonne of carbon dioxide, it causes little implication for forestry investment returns.
But where prices reach US$20-50 a tonne, as they have in the government-regulated forestry offset markets of California, Australia, and New Zealand, it can have significant implications for the economics of land use.
Given that the rules are different across these regulatory regimes, the outcomes vary. In California, as the carbon price rises, more and more stands are shifting to longer timber rotations or from timber production to conservation.
Rules in Australia and New Zealand can be inhibitive to productive forestry
In Australia and New Zealand, rules promote the reforestation of marginal grazing land, and switch from short-rotation eucalyptus plantations to longer-rotation pine plantations.
In New Zealand particularly, where the carbon offset price is reaching US$50 a tonne, some investors are planting marginal agricultural land with pine plantations that they have no intention of ever harvesting.
As these carbon price signals expand and increase in value it will have implications for forestry asset valuation and asset management strategy.
For example, landowners in New Zealand who have the option to reforest their land and participate in the country’s emissions trading regime have seen underlying land values for grazing land rise from NZ$ 4000 per hectare to almost NZ$ 20,000 per hectare as the carbon option value is capitalised into land value.
This suggests investors should be looking for countries or types of forest or land use where a carbon price is yet to be established or low and buy land or forestry assets with potential upside exposure to carbon price signals in advance of those markets being realised.
The role of climate change in forestry
Climate change is both an opportunity for the forestry sector and a risk.
Forestry assets are being exposed to increased physical risk factors.
In the last couple of years, there have been major hurricane impacts on USA forestry plantations in the southeast, increased prevalence of forest fires in western USA and Canada which has burned hundreds of thousands of hectares, and high-intensity rainfall events impacting softwood plantations in New Zealand.
Australia has gone from extreme drought and extensive wildfire where millions of hectares of forests were burned, to record rainfall and floods over the past two years.
Investment management systems will not only need to increase fire detection and initial attack capability, but also explore innovations like captive insurance vehicles to consolidate and transfer these increased risks.
The role of the circular bio-economy
Another trend linked to the decarbonisation of the global economy is the need to transition to a circular bio-economy.
Circularity refers to the imperative to move away from the linear process of using natural resources in various products and then disposing of them as waste.
A circular economy re-uses, recycles, and re-purposes materials like paper recycling, reuse of glass bottles, or taking wood waste from demolition sites and uses it as feedstock in producing wood panels.
The bio-economy uses renewable biomass from forestry and agriculture as the basis for a spectrum of materials in society.
Wood, wood fibre, woody biomass and biochemicals can substitute for much of the materials used in society, from concrete and steel in the built environment, polyester fabrics, plastic packaging, fillings, coatings, food additives, and even metals and batteries.
This is a tremendous opportunity for the forestry sector, and rapid innovation occurs across a spectrum of goods and materials.
Demand for wood and carbon price signaling will drive investment in plantation
The combined factors of rising demand for wood, an increasingly persistent and pervasive carbon price signal, and the efficiency of plantation production systems will inexorably lead to a transition in wood supply.
The economics will increasingly push natural and semi-natural forests into conservation and low-intensity harvesting.
At the same time, carbon prices reward the expansion of plantation forestry systems onto degraded or marginal agricultural land, especially in the southern hemisphere and tropics.
The rise of China could be succeeded by India, and then Africa
The demographics of the 21st century suggest that the recent rise of China as a source of timber demand will be succeeded by the rise of India over the next 10-15 years and then ultimately by the rise of populations in Africa after the mid-century.
For investors, the long game is gaining exposure to high-quality forestry plantations serving the rising demand for a circular bio-economy and urbanisation of the Indo-Pacific region.
While there has been criticism of monoculture plantations, there is also a recognition that a world of 10 billion people with a gross world product potentially reaching US$300 trillion per annum by late this century will only work with the significant intensification of production on a proportion of the land base.
The end game must be balanced, stable landscapes incorporating substantial biodiversity conservation and sustainable intensive agriculture and forestry systems.
The landscape context is also important for adaptation, allowing migration of species, gene flow, and broader regulation of physical and climatic factors such as floods, droughts, wildfires, windstorms, and the recharge of groundwater tables.
Investments to create these sustainable landscapes will increasingly integrate real asset investments such as land, forestry, and agriculture, as well as conservation finance, climate finance, and social impact investment.
Competition for uses will intensify
As the world transitions to sustainability, competition among various land uses will intensify. Timber, agricultural commodities, carbon and biodiversity credits, water rights, wind farms, solar farms, and urban development will all need to be accommodated optimally.
Sophisticated geospatial and temporal optimisation modeling will be used to examine land allocation at an ever more granular scale.
In some ways, the future of investing in rural land is becoming analogous to investing in infrastructure like airports, where multiple forms of option value like parking lots and shopping malls were used to increase asset value and income.
In land use, however, these forms of option value are more challenging to optimise because they often compete in the landscape and have dynamic, uncorrelated market price signals.
There will also be a regulatory overlay and strong investor demand to ensure that key values like biodiversity, water quality, and soil conservation are prioritised.
Using modeling to identify farmland that are candidates for reforestation
New Forests has explored ways to create heat maps that show, for example, areas of farms with lower net primary productivity, which might be candidates for reforestation or heat maps of unrealised climate mitigation potential in certain forests.
Overlaying multiple data layers for water yield, groundwater recharge and seepage sites, crop productivity, proximity to ports, wind profile, and biodiversity value can help assess what values to apportion where and where to allocate capital investment.
As these values are dynamic, shifts in land use may also occur over time.
These new modeling tools will not only promote sustainability but should also increase returns and unlock unrealised option value over time.
Designed well, these investment strategies should also create more rural economic benefits, improved quality of life and stable rural communities.
The African Forestry Impact Platform
As an open-ended fund, it can help create and perpetuate sustainable landscapes that deliver production, conservation, and community benefits.
The investment vehicle is dubbed a platform because it can house a core forestry investment fund, an impact investment vehicle, and could act as an implementation partner for third parties seeking conservation, restoration, or climate mitigation investments.
These examples point the way to a future where the forestry asset class expands and morphs into a much more analytics-driven and solutions-driven investment strategy.
New Forests believes this will benefit both investors and the planet.
