Market-based method

1. Market-based method Residual Method

2. Theoretical foundations of Economic Values[cont] • Valuation is the process of measuring the change in welfare arising from the resource use. • The above change in welfare can be categorized between : (i) Consumers • Welfare (WTP) change to consumers is measured by consumers surplus. (ii) Producers • Producer’s welfare change is measured by producers surplus [Area OP1B] • Producer’s surplus measures the economic rent accruing to resource owners Who are consumers ? =>recreation visitors and the local community relying on the water supply from the forest. Who are producers ? =>resource owners, recreational site operators

4. Five basic EV approaches • Market price-based; • Surrogate market-based; • Hypothetical market-based; • Cost-based; and • Benefits transfer

5. 2.1 Market Price-Based Valuation Methods • When adopted? • When the environmental goods and services are transacted in formal markets. • Where commonly used? • To estimate the economic rent of extractable resources such as timber, minerals and edible species. • Policy implications? • Unsustainable rent seeking behaviour of firms and • Rent capture failure of resource owners

6. Market-based: Residual method to obtaining economic rent • Economic rent = • Revenue – [direct production cost + profits for entrepreneurial skill and risk] • Data Requirements • market prices, production costs and the profitability of the enterprise collected from a market and/or household survey. • When to use the method • To assess reservation price prior to tendering out concessions to firms such as timber or mining companies. • To assess compensation that owners could seek if damage is done to their resources by other parties. • To explore the extent of rent capture from the exploitation of their resources. • Strengths • Easy to use if the information on the cost structure of the industry is available. • Limitations • Prices may not reflect true economic scarcity • => shadow or surrogate prices have to be used. • Prices underestimate the true willingness to pay (WTP) • => underestimation of rent

7. Application to assessing standing trees • Standing tree value is the difference between the selling price of the nearest end-product and the stump-to-market processing costs. • The nearest product made from standing timber that has a market price is saw logs and veneer logs. Thus, the stumpage value of the standing timber equals the difference between the price a buyer will pay for the logs and the total costs of harvesting (inclusive of a fair or equitable profit margin for the contractor) and transporting the timber from the forest to the buyer. Only a portion of the total profit margin is imputed and allocated to the contractor • SP= LP - (ALC + APM) (1) • where • SP is the price per cubic metre of a standing tree, • LP is the price per cubic metre of logs purchased by a buyer, • ALC is the average direct logging cost (not inclusive of contractor’s profit margin) • which is constant for a given concession as the logging crew are paid piece meal, APM is the equitable profit margin allocated to the logging contractors for the risks • taken up. • SP is the rent to be allocated to the resource owner or State Governments.

8. Use of residual method • Estimated tree stand value can be used to measure worth of logging compartments. • Can also be used to determine the ability of State Governments to capture compartment’s worth • Tree stand value can be compared to the total value of forest taxes (summation of premium, royalty and silvicultural cess) from the allocation of compartments to successful licensees.

9. COMPUTATION PROCEDURE AS APPLIED TO FORESTRY Data Requirements • Residual method requires four basic sets of information net standing timber volume, market prices, production costs and the profitability of the enterprise • To compute net standing timber volumes requires information on timber volumes and rate of harvesting damage that can be obtained from pre-felling forest inventory. • Log prices are obtainable from the Malaysian Timber Industry Board’s MASKAYU monthly bulletin • Information on logging cost and profit margin for the industry can be obtained from a market survey.

10. COMPUTATION PROCEDURE AS APPLIED TO FORESTRY • The formula for calculating stumpage value for a logging concession is given below: • n k • SV =  d Vij { (LPij) - (ALC + APMij ) } • i = 1 j = 1 • where • LPij which is the log price of species group i and diameter class j, = rf LPi • APMij which is the equitable profit margin allocated to the logging contractors for harvesting logs of species group i and diameter class j, = (LPij) / (1 + ) (3) • SV is the stumpage value per hectare • Vij is the volume of timber in species group i and diameter class j • d is the logging damage factor • rf is the price reduction factor • ALC is the average direct logging cost (not inclusive of contractor’s equitable profit margin) and •  is the average Malaysian industrial profit margin but adjusted to reflect the risk undertaken by the logging contractor.

11. IMPLICATIONS OF RESIDUAL METHOD FORMULA • Variation in stumpage values within a compartment will result mainly from differences in standing timber characteristics and log prices across species, and diameter classes. • The standing timber value has to be distinguished between below and above the cutting limits as prescribed by the Selective Management System (SMS). • The value below the cutting limits constitutes the residual tree stocks to be left in the forest to grow into the next cutting cycle's harvest. • The value above the cutting limits is the value of standing trees that should be harvested and forms the commercial value that can be extracted from the forest. if contractors adhere to prescribed cutting limits.

12. Illustration of Standing Timber Value in Kedah Standing timber value above the cutting limit in Muda Rorest Reserves: • above the cutting limits (RM22,000 – RM26,000/ha) that accounted >93% of the total value. • Residual trees left for the next cutting accounted 7% only • Tender system for premium payment led to Government capturing a large portion of the economic rent ranging from 91.74% to 103.80%. • Above rent capture computed by: [tender + other taxes] / [standing timber value above CL]

13. Residual Method Applications Can you suggests how you can apply this method in non-forestry resources? Can apply the method to measure economic rent for other resources such as sand, mineral, fishery, fruits etc to be used when • selling harvesting rights or • seeking compensation if destroyed