Biological growth refers to the fact that under normal conditions the trees within forestry assets will grow increasing the volume of timber, the commodity for sale, held within the asset. Following the analogy of Harris et al. (2018, 192), then the underlying land within the forest constitutes the factory machinery, whilst the standing trees constitute the stock and work in progress.
Yao et al. (2014, 943) suggest that more than 50% of timberland returns can be attributable to biological growth, with the secondary driver being timber price change and finally land value appreciation. Also, Mei et al. (2013, 18) investi- gated timberland return drivers in southern United States and found that 61% of the return could be attributed to biological growth. They highlight that biological growth of timber constitutes two dynamic components; firstly the physical in- crease in the volume of timber within the trees, and secondly the incremental transference of timber volume proportion from lower value to higher value prod- ucts as the size of the tree increases.
Fu (2014, 97) describes this effect in Loblolly pine in the United States. He as- serts that during the point in the rotation when trees are converting pulpwood, worth $8 a ton, to chip and sawn at $16 a ton, over 5 years a tree would double its volume and increase in value by 300%. This is illustrated in figure 2.
Figure 2: Increasing tonnes of timber in loblolly pine showing product proportion evolution over a rotation (after Fu 2014).
Also, Danish TIMO the International Woodland Company, highlights biological growth as the greatest driver of returns in timberland investment, along with tim- ber price change and land value appreciation in their web material (IWC, 2019) The International Woodland Company illustrate the process of timber increment along with product evolution over time in figure 3.
Figure 3: Biological growth and product volume evolution over time, after the In- ternational Woodland Company.
A key feature of biological growth is that it occurs independent of business cycles and market movements (Mei et al. 2013; Hoyt 2015, 3). Thus, especially for in- vestors or funds diversifying into forestry, biological growth is not just a steady predictable element of investment return, it can actually improve the risk adjusted returns of the portfolio. For example, the impact on a fund of falls in the stock market will be dampened by the forestry constituent of the fund, since the quantity of the timber commodity produced by the forestry asset for future sale will con- tinue to increase irrespective of the market deterioration (Mei et al. 2013, 25). Another way to consider biological growth is as a product storage. Storage of growing products in trees gives forestry as a business a higher degree of man- agement flexibility in the timing of when its goods may be sold, relative to many other industries. For example, if a traditional factory makes product, and due to
ished products must either be sold at a loss, or stored for future sale. Storage could be expensive for large quantities of product and there is a risk of the product losing value over time depending on the nature of the industry.
Conversely, during times of negative timber price fluctuation, owners of forestry investments generally can retain standing timber on the stump without compul- sion to sell into poor market conditions. When forestry assets produce goods in the form of timber, in most cases, the forest can store the commodity if desired without significant cost (Mei and Clutter 2015, 329), or incurring loss of value of the timber. Indeed, as illustrated in figure 2 and 3, when trees are grown on longer into their rotation, there is the opportunity of transference from lower value to higher value products (Mei et al. 2013, 25; Fu 2014, 97).
If a significant proportion of forestry owners pursue this strategy, then when tim- ber prices drop the supply of timber reduces as forest owners retain their timber commodity on stump. Equally, during times when timber demand increases, for- est owners can bring more timber to market and increase the supply. The impact of forest owners’ prerogative on whether or not they decide to sell their commod- ity, timber, to market therefore may dampen systemic fluctuation in timber prices. However, management flexibility of timber harvest and product sale is not unlim- ited, and depending on the nature of the forestry asset, there are opportunity costs to consider. For example, by exerting flexibility of the harvest year diver- gence from any ’financially optimal’ harvest time would be required.
Financially optimal harvest time
Extensive research has been undertaken on calculation of the optimal financial length of rotation of a growing crops of trees. The initial solution of this problem was the formula from the highly cited Faustmann paper of 1849 (Kant 2013, 1) and the history of surrounding work on the formula to take account of various forestry situations is described by Harou, Zheng and Zhang (2013, 46). Faust- mann’s formula is in effect an LEV. LEV can be used to find what, in theory, is the optimal financial rotation length. The rotation length which generates the highest LEV is the optimal financially.
Divergence from optimal financial rotations, whilst sometimes desirable, will have an impact on long term financial performance of the asset, or delay opportunities to switch to more productive land uses (Abdallach and Lasserre 2016, 3). There- fore, the financially optimal harvest date should be considered in a context of managerial flexibility. Forestry investment managers may wish to consider the utility of accepting a harvest timing decision not at the moment of the optimal financial harvest due to timber price change.