Risk & Economy » Climate change » Focusing on natural capital balance sheets

England’s public forests are seriously undervalued, according to a report published by Forestry England. Net assets for the organisation, which manages the quarter of a million hectares – the approximate size of Derbyshire – are declared at £2.5 billion in its 2018-2019 annual report. But the accompanying natural capital account suggests asset value is far greater, standing at £26.1 billion.

Why the difference? The natural capital balance sheet integrates values ignored by Forest Enterprise England’s conventional balance sheet. True, most real estate balance sheets include value that recognises land use such as forestry. “If you can plant trees on land, just like if you get planning permission, it’s generally worth more”, says Emily Norton, head of rural research at property agency Savills.

But the natural capital value incorporates a broader definition of value in terms of ecological benefits from the land, such as sequestered carbon, plants and seeds, recreation and public access – all monetised using emerging financial techniques.

By contrast, the annual report and accounts only acknowledges such biological assets through the market value of the timber, plants or seeds held on the estate. This is added to conventional assets such as property, plant and equipment, and financial assets. The natural capital account thus aims to reveal a wider and deeper picture.

“We want to provide a clear sign of the value the organisation delivers that the financial accounts don’t show, such as the environmental benefit and public good. Our natural capital accounts reveal that value,” explains Pat Snowdon, chief economist.

Detailing the value

Among the benefits provided by the management of the land, but not reflected in the estate’s market price, are health prevention for local people enjoying visits: flood alleviation; water quality and carbon storage. As Snowdon explains, the land’s status as a public asset motivated the organisation’s investigation into its natural capital value.

“Why attract a public subsidy that varies each year if the public doesn’t know what they are getting for their money? It’s a way of showing that while demonstrating the value of maintenance”, he points out. In the natural capital balance sheet, the maintenance costs are deducted from the asset value, alongside government payments for ecosystem services.

These incentives, offered to farmers and landowners in the UK since 2013 (but pioneered in the US), encourage them to manage the land to provide an ecological service such as climate change mitigation, watershed (natural drainage) services and biodiversity conservation. They are a key factor underlying the trend towards natural capital valuation.

Similarities do exist between the two types of balance sheet where they both take a long-term view of assets. While a conventional balance sheet depreciates assets over time, natural asset depreciation is only accounted for if assets are spoiled by pollution, for example. Meanwhile, tree value in the natural capital account is discounted over 50 years in accordance with government guidance issued through the HM Treasury Green Book, which shows how to appraise a range of policies, programmes and projects (not all of which are environmental).

Overlooked considerations

According to environmental economists developing such balance sheets, most annual reports exclude significant considerations. For example, the value of land in most construction company annual reports still does not reflect the carbon storage achievable through tree plantation – now a widespread activity essential to climate stability and long term resource availability. Instead, these only feature as a comparatively low-profile environmental benefit.

“Carbon sequestration would only appear in financial accounts if the company sells carbon credits. Otherwise, it won’t appear in financial accounts. But the tonnes of carbon sequestered could appear in the corporate social responsibility report”, notes Ece Ozdemiroglu, founder of consultancy Economics for the Environment (eftec).

The company facilitates the integration of natural capital into financial assessments by corporations, as well as the use of natural capital balance sheets alongside conventional balance sheets. Companies with large estates are an obvious starting point.

Recreation and public access would appear in financial accounts if a company generates revenues from entry fees or car parking income, says Ece Ozdemiroglu. However, health or other benefits provided do not usually enter company financial accounts. Assessment techniques already devised by health and tourism practitioners could help companies more effectively account for these benefits.

Government payments for ecosystem services appear in the Forest Enterprise England financial accounts as part of turnover. This is included as a benefit to the organisation in the natural capital account but this social benefit is not visible in the conventional accounts.

As it is a considered a transfer payment, the gain to the organisation is viewed as a loss to the public purse. Meanwhile, maintenance costs in the conventional statements are found in the profit and loss account for the year. Where planned in advance, these may appear in the liability section of the financial balance sheet too.

Proceed with caution

Despite these additional insights, financial managers would be right to treat such conservationist approaches with caution because some of the ecological assumptions underlying the figures are still under investigation. Natural capital measurements are not easy to standardise because individual sites show unique characteristics, while ecosystems are under pressures that have no precedent. This, of course, is bound to affect comparability between reporting organisations.

Nevertheless, real estate consultants have over the last couple of years observed change in existing business practice. Some estate sales have always integrated particular benefits arising from biodiversity on land historically used for leisure purposes such as hunting and fishing.

“In countries [with large rural properties] such as Scotland, the quality and variety of wildlife, which affects the shooting capacity, does already affect the value of the estate”, says Emily Norton. “Including this in valuations is not new.”

However, she suggests the wider concept of natural capital is also gradually filtering into the price discovery process as people negotiate land sales. “What is new is a consideration of what else the land can provide. We have to understand how the land managers use the land to make the economic case for different forms of investment.”

One example of this growing perception is the detrimental effect of particular land management on flooding. “If you lose income from agriculture that would have allowed you to borrow to purchase the estate, you can gain from management that deals with the flooding agenda. There might be no net increase to the value, though”, she says.

However, she sees more people making arguments for compensation for helping avoid flooding downstream. Their case is driven in the UK by new policies due to go through parliament such as the Agriculture Bill 2017-2019. This gives the government new powers to provide financial assistance to those managing the land and delivering public benefits such as air and water quality, public access and productivity.

Despite these innovations, property negotiations continue to fall short of, at the very least, systematically acknowledging the value of carbon sequestration when pricing woodlands. A set of new UK and EU regulations requiring carbon or climate related disclosure from large corporations and investors, including those owning and leasing real estate, could help drive new practice over the next few years.

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