Treasure in the Trees

Reid Carter has a simple suggestion for Canada’s provincial governments that, if adopted, could put tens of billions of dollars into their coffers…

… attract hundreds of millions of dollars of new investment to one of the nation’s largest and most beleaguered industries, shore up Canada’s public pension plans, and maybe even end our most chronic bilateral trade dispute.

If that sounds like an irresistible pitch, think again. Mr. Carter, a managing partner with Brookfield Asset Management Inc. in Vancouver, has spent four years crossing Canada, talking up bureaucrats and cabinet ministers about a proposal that sounds too good to be true, but isn’t.

Privately, many tell him it’s a great idea. Publicly, nobody will touch it with a hundred-foot tree trunk.

“How come we haven’t tried this?” he says.

Why not? Because it would involve doing what many Canadians would consider unthinkable: privatizing the forests. Fully 93% of Canada’s 402-million hectares of forest is owned by government — mostly the provinces — and Brookfield owns a portion of the rest, in British Columbia and the Maritimes.

If Mr.Carter had his wish, Brookfield would own a lot more. He’s not alone. “There’s a significant institutional interest among investors in Canada and globally” in Canadian timberland, he says. In B.C. alone, it is estimated the province’s roughly 22 million hectares of timber harvest area would be worth an average of US$1,000 per acre — US$22-billion in total — if sold, enough to reduce the provincial debt by 60% and save $1.44-billion in annual interest costs. That is more than its annual revenue from forestry fees and taxes.

Such compelling calculations don’t change the fact that in most legislatures, the idea of selling the forests is considered as politically astute as advising peasants to eat cake on the eve of the French Revolution.

Privatization “is certainly not on my radar screen,” says Rich Coleman, B.C.’s Forestry Minister, whose Liberal government backed down in 2004 under public pressure from a proposal to overhaul forestry management practices, which could have led to privatized Crown land. “There’s always some discussion whether we should put the forests up for sale. It just hasn’t been something we decided we wanted to do.”

Bill Thornton, assistant deputy minister of the Ontario Ministry of Natural Resources’ forestry unit, adds: “I don’t see any political appetite in Canada for a dramatic shift to outright selling of public land to private interests. It’s a very tightly held Canadian idealism that Canadian-owned timber and water belong to us as Canadians and simply shouldn’t be auctioned off. It conjures up, rightly or wrongly, a lost asset” for citizens.

That’s too bad, because it doesn’t have to be that way. Privatization, done right, could be one of the best things to happen to the Canadian forestry business. It would improve the yields of Canada’s timberlands, making them more competitive with nations where private ownership is common, such as the United States, most of Europe, New Zealand, and Australia. It would simplify the thicket of regulation that has mired Canada’s forestry industry in a prolonged crisis. Best of all, it would open the gates to a surge of deep-pocketed investors, not just Brookfield but also large pension funds, university endowments and timberland management specialists — such as Manulife Financial’s Hancock Timber Resource Group [HTRG] — that are keen to invest more in forests.

“There are literally billions of dollars available for investment in forest land,” says Clark Binkley, a former dean of the University of British Columbia’s forestry faculty who ran HTRG, the world’s largest private timberlands investor, from 1998 to 2005. Timberlands have exploded as an asset class of late because they are the perfect investment for long-term investors: they constitute renewable assets that serve as a hedge against inflation. When timber prices are low, owners can choose not to cut. After all, the inventory will keep growing.

“You have these Canadian institutions that want to put capital into growing trees,” Mr. Binkley says. “Provincial policy says ‘We don’t need your capital.’ To me, it’s an absolutely stunning situation.”

Done right, privatization could even satisfy conservationists concerned about the fate of wildlife habitat, ecology and recreational areas. “If we put in place a system to maintain the recreational and biodiversity aspects of the forests, we’d have room to free up timber values and privatize them,” says Marty Luckert, a professor of forest economics and policy with UBC. “Put the regulations and policy constraints where they’re supposed to be. But now, they are in exactly the wrong place.”

To understand why change would be good, consider that much of forestry policy in Canada is 50 years old and hearkens back to a time when markets weren’t global, environmental standards were non-existent, and governments were keen to create jobs. Firms are entitled to cut trees on given sections of Crown land for fixed periods, pay fees when they cut, and have to ship the timber to specified mills. Under these licenses — ranging from five to 20 years — firms are granted an “annual allowable cut,” and have to plant replacement saplings.

The system is now dated and toxic to industry. As Peter Pearse, a leading forestry academic and special advisor to then-B.C. forestry minister Michael de Jong, noted in a 2001 report on the B.C. coastal forest industry, the system — similar to other provinces — was a mess. Lumber production costs on the coast were the highest in the world. Profits were down, mills closed and jobs vanished.

That was before the Canadian dollar began to rise. The allowable cut was rigidly enforced, so companies couldn’t log according to market demand. Standards for log sizes were based on set measurements with no regard for market interest; cutting fees were likewise unrelated to the market. The requirement to feed lumber to set mills — rather than where they were most in demand — led to rampant inefficiency and weak investment.

Fortunately, the practice of linking logging to a specific facility has disappeared in B.C. and “is the emerging area of public policy debate in Canada,” Mr. Thornton says.

That’s a start, but much more could be achieved. That’s where the issue of privatizing timberlands comes in.

The problem with the current system is that cutting licenses are too short, and property rights too weak, for forestry companies to be effective stewards of the tree supply. The length of most licenses in Canada doesn’t cover a full “rotation,” or life of most trees, so loggers have no incentive to foster the replacement saplings they plant.

That would change if there were stronger property rights for those who log the land. Prolonging their claim to the land, and their freedom to manage and harvest it as best suits them, would add to the care and tending that goes into a property: it’s the difference between owning and renting. “If you own the thing, your objective is to generate as much long term revenue as you can.”says Leo de Bever, a former top executive with Ontario Teachers Pension Plan and Manulife, where he oversaw their timber investments.

That could be achieved by an outright sale of the land, but there are less controversial ways to privatize. The state of Victoria in Australia, for example, sold the rights to log its timberlands, but not the land or non-timber rights. In New Zealand, the government sold leases on its timberlands that were long enough to give the buyers a vested interest in tending to two to three generations of trees.

And what happens when private owners take over timberlands? They aim to grow trees more densely and quickly than before. They prepare the land, haul away detritus on the forest floor, use genetically modified saplings, fertilize the land and grow the trees as they would a field of corn. That means more investment, better yields, and more valuable land, studies have found.

But are Canadians ready for a carpet of monocultural tree farms on formerly public lands, full of genetically improved saplings that are now banned from public property? Actually, there is a new school of thought that suggests intense forest management could in fact improve the lot of tender ecosystems.

Under this “triad” concept a commercial forest would be divided into an intensely managed plantation, a conservation area and an area for mixed use.

Could that work in Canada? Craig Nitschke, a UBC post-doctoral fellow in conservation biology has put that theory to the test. His research group asked B.C.’s Tolko Industries to hypothetically split up a 145,000-hectare area in the Okanagan into three such zones. Tolko set aside 12% for conservation and 31% for plantations. Mr. Nitschke’s team then took a detailed look at the terrain and determined what it would take to protect tender ecosystems and wildlife. Their conclusions: more area — 17% — should be protected. But also more area — 34% — could be used for plantations.

“We found there were areas that could be intensified and the rest of the landscape would provide for other values,” he says. The U.S. National Wildlife Federation concurred in a 2006 report: “There is room for intensive plantation forestry, provided that landscape biodiversity needs are met by adjoining land.

These sorts of findings are key, because they help lay the groundwork for the future of Canada’s forestry industry, a future few policy makers have dared to consider. They may soon have to. “The provinces will face the same kinds of budget pressures others are experiencing now,” Mr. de Bever says. “At that point it would make sense to say, ‘Gee, should we really have so much on our balance sheet tied up in forests?'”