Long-Term Timber Contracts in the Southeastern United States: Updating the Primer Valuation Framework

Abstract

AbstractTimberland ownership has drastically changed in the United States since the 1980s, driven by the divestitures of vertically integrated forest products companies. Having sold their timberland, forest products companies have exposed themselves more to the risk of raw material supply. To hedge against this risk, forest products companies usually use long-term timber contracts (LTTC). The objective of this article is to update the valuation framework for LTTCs proposed by Shaffer (1984) by including alternative option price models and refining the estimates of some key economic variables. In particular, conditional volatility from the generalized autoregressive conditional heteroscedasticity model and quasi-conditional volatility from rolling estimation windows, in addition to simple standard deviation, are used for the volatility estimates in the option pricing models. Contrary to the previous result by Shaffer (1984), our analysis suggests that LTTCs that were once profitable for forest products companies in the 1980s are no longer so under current market conditions. This is primarily because both timber price volatility and the risk-free interest rates have declined significantly. Thus, to be better off, forest products companies need to either lower the administration and management costs of those LTTCs or rely more on the open market for timber procurement.Study Implications: Forest products companies have traditionally relied on long-term timber contracts (LTTC) negotiated with forest landowners to mitigate the risk of raw material supply. The value of these LTTCs highly depends on the economic context. This research provides some insights into the valuation of LTTCs in the southeastern United States. Forest products companies can use this updated framework to aid their decisionmaking in timber procurement.