Farm Forestry New Zealand

Risk and opportunity in forestry

Geraint Bermingham and Kevin Oldham, New Zealand Tree Grower August 2012.

Forestry as a risk business

If you are in business then you are in the business of taking risk in the hope of gaining a return. The forestry business is no different in that respect, so how can we account for and manage this heightened uncertainty when trying to gain from opportunity? When considering the opportunities associated in an investment in trees, how can we consider risk and how can we communicate opportunities to investors.

It can be argued that given the timeframes and variability, to be confident of making a profit out of growing trees you have to be particularly adept at managing long-term risk.

The time has passed when things were a sure bet and a canny eye could keep your investment safe. A professional approach to the management of risk is now a vital for a successful business. Luckily, the discipline of risk management has advanced enormously in the last 10 to15 years and there are now established ways to help us manage risk.

Much of the thinking and development work behind modern risk management techniques happened in New Zealand and Australia. The relatively small scale of industries and sectors created the conditions for a good ideas. As a result, risk and how it should be managed from the insurance sector, the process industries, finance and operations merged and resulted in new insights.

Threats and risks for woodlots

What have these developments given us? There are some obvious threats that the forestry sector or an owner faces which need to be considered. These can be whether you are making investment decisions, purchasing a stand, choosing when to harvest or actively managing the asset. A few examples illustrate how many factors influence the performance of a woodlot –

• The future market price of timber
• Changes to compliance requirements which affect the purchaser
• Future growth and economic activity in the target markets
• Changes in building technology
• Trade agreements and other factors which influence market dynamics
• Outbreaks of known diseases such as dothistroma.

In addition to these we also need to be aware of the threats that could cause shock or other problems. Examples could include –

• An outbreak of new or unrecognised tree disease
• Sudden international change
• Disruptive technological innovation.

On the other hand there are the imperceptible but potentially catastrophic changes which could be caused by the climate, as well as economic and market changes. These may also be the triggers for the so-called black swan events – the sudden change that no-one predicted.

Risk or opportunity?

The picture changes depending on how they are viewed. Each can be seen as either a risk or an opportunity, to out-think your competitors, move earlier or wait.

In addition, if these risks are seen as threats they may apply to the same or lesser extent to overseas competition. Therefore these external factors are as much a risk as an opportunity. Understanding the global risk picture and how it potentially affects others in the market may have as much value as understanding your own risk profile.

It was mentioned before how the contemporary approach to risk management was developed locally. This approach is built upon two main points. The first is that you must understand your context, the second is that risk is defined by your objectives.

In simple terms, understanding the context means understanding all aspects if the world in which you do business. What you do not control includes constraints, compliance requirements, resources and capability of all those that have some influence on the business, as well as other external factors such as climate and natural hazards. Then there is what you may have control of, or should have, such as debt ratio, when to harvest, the way the stands are managed and choice of contractors.

Defining risk in terms of objectives may at first seem somewhat odd, and yet it is vital. There is a range of objectives imposed upon us by legislation and regulations, as well as those we take for granted such as ensuring no-one gets hurt during harvesting. But there are also the business objectives regarding your cash flow, target markets, diversification, growth and exit plans. Risk relates only to these various objectives. Anything which creates uncertainty in meeting these goals, and the extent that they may be missed, is how risk is defined and measured.

Treating the risks

Having established the context and defined the risk, the process consists of identifying risks, understanding the causes and significance, deciding what if anything to do about them, and then treating the risks. The idea behind the use of the term treat is that risk is not inherently bad – the uncertainty of meeting an objective could equally mean you may exceed expectations. It is a fact that without risk there is no return, and in a perfect world the greater the risk the greater the potential returns. But in the real world it is more a case of the smarter you are at taking risks the better the chance of the expected or better the return.

Risk identification can be problematic and does take practice and skill. As Donald Rumsfeld famously said there are the ‘known knowns’, the ‘known unknowns’ and the ‘unknown unknowns’. You need to look past what you already know or have considered. One particular danger is or getting caught up in the moment.

Insurance as a default

Judging the level of risk involves considering how the potential outcome of a hazard, event or other cause of risk could affect your objectives. Once risks are understood, you are then in a position to consider what to do about them. Going through the process to understand and manage your risks is always valuable, but the earlier the process is undertaken, the greater the range of options and the cheaper and more effective the response.

The default is insurance. However, if you have a good risk story showing that you understand the risks and have mitigation strategies in place, good brokers should be able to put this to the market. However, underwriters will fill a lack of information with premium, the less they know the more it will cost.

Considerable savings should be available to those who know how to define, identify, understand, actively manage their risk, and then communicate this to a broker. This can be done at a stand of trees, in a portfolio or at an organisational level. There is also the added value of being able to give confidence to investors.

Geraint Bermingham and Kevin Oldham are directors of Navigatus Consulting, a risk management specialist business consultancy.