Applying financial risk approaches to the challenge of assessing natural disturbance risks to forests

Abstract

The commercial forest sector manages a significant proportion of the global forest resource, just under a third being classified as ‘production forest’. This sector faces a number of threats, including those from natural disturbances, such as wind, fire, pest and disease, and drought. Climate change adds further complexity and uncertainty, as it is likely to lead to an increase in losses from these disturbances. Risk management can help reduce the likelihood and impact of natural disturbances and increase resilience, but needs adequate information to quantify risk and inform decisions.

The premise of this PhD is therefore to investigate whether approaches from the finance sector for dealing with risk can be adapted to the forest sector and the risk of natural disturbances. Key financial concepts are introduced in Chapter One, and the results are presented in the three following core chapters.

In the introduction, I briefly introduce how uncertainty is intrinsic to the finance sector. Risk management has always been present in the finance sector, but it rose in importance after a series of high-profile losses from the end of the 20th century. Hard lessons learned from this, led to revision and innovation of both external regulatory and internal processes to address risk. I focus on adapting and applying a capital adequacy approach (which quantifies the amount of capital to set aside against losses), and a Risk Adjusted Performance Management (RAPM) approach (which evaluates return against risk) to the forest sector.

To better understand the commercial forest stakeholders and their information needs, Chapter Two presents a global survey of these stakeholders to understand their current level of awareness and usage of information on natural disturbance risks. Previous surveys being location-specific and focusing on private forest owners, this global sectoral examination addressed a significant gap in the underpinning knowledge base. It revealed that the main natural disturbances perceived to be threatening global forests and causing the most losses on commercial forest projects to date were fire, pests and diseases, wind, and drought (in descending order of impact). Other disturbances were of less significance. The sector also reported an upward trend in impacts from these and an expectation for a continued increase in such losses. The survey revealed a perceived absence of global information on disturbance losses other than for fire and wind. Likewise, no standardised global information is available on losses experienced purely by the commercial sector. The survey also identified that approaches to assess risk from pests and diseases and drought were either non-existent or ill-suited to the current needs of the sector. This explains why insurance products are more widely available for fire and wind relative to those for pest and diseases and drought. Suitable methods to assess risk and underpin risk management are therefore required.

Building on the review presented in Chapter One, approaches from the finance sector are therefore translated to address commercial forest sector needs. Chapter Three presents the application of capital adequacy approaches to pests and diseases. Pests and diseases pose a growing threat to woodlands from both endemic sources, and increasingly, from interregional transmission. Analyses of this risk should include estimates of potential worst-case loss from relevant pest and disease threats to key tree species. Existing approaches tend to focus on single pest or disease assessments or overall trends. I present a capital adequacy based approach for the systematic, risk-based assessment of the future threat to a given woodland where all known individual pests and diseases to constituent individual tree species are considered. The Woodland Carbon Code (WCC) serves as a case study but the approach is adaptable to any woodland resource worldwide. Its novelty lies in the simplification of complex threats, from numerous pests and diseases, to measures that can be used by a range of forest stakeholders.

Chapter Four presents the application of a risk versus reward (RAPM) approach to drought risk. Climate change will alter precipitation patterns across the world increasing drought risk to forests in some areas. Choosing tree species resilient to drought would support continued timber supply. The chapter presents a locationspecific risk versus return analysis for twenty commercial timber species in Scotland. The impact of drought risk on potential return, modelled as change in volume of timber production (yield in m3 ha-1) under a high emission climate change scenario, is quantified. The results show that drought tolerant species offer good alternatives to Sitka spruce, which accounts for 58% of the stocked area in Scotland. Whilst Sitka still dominates, these alternatives would deliver only relatively minor volume penalties in areas of the highest drought risk. Diversification is a key strategy to increase forest resilience against multiple risks. This analysis provides strategic regionally coherent information on suitable alternatives to Sitka spruce.

I conclude the thesis by presenting views on the next stage of development for these approaches, and offer my perspectives on additional areas of research needed to enhance risk management approaches adapted from the finance sector at a later stage.