Timber harvest scheduling with price uncertainty using Markowitz portfolio optimization

Abstract

Harvest scheduling models need to account for uncertain revenue predictions when minimizing risk of financial loss is an important management objective. In this paper, we present methods for estimating the means and covariances of stumpage prices and incorporating them in harvest scheduling models. We approached the estimation problem by fitting time-series models to loblolly pine sawtimber and pulpwood stumpage prices in Georgia, USA, and deriving formulas for means and covariances of price predictions. Statistical evidence supported integrated autoregressive models, which caused covariances of price predictions to increase with time. The means and covariances of price predictions were combined with timber yield and land value predictions to give exact formulas for the revenue means and covariances of timber management activities. Sawtimber regimes dominated pulpwood regimes by providing higher mean revenues across a wide range of revenue variances. Harvest scheduling results for a hypothetical forest of pine plantations showed that the forest plan that maximized mean income without concern for risk (expressed as the standard deviation of income) involved sawtimber production with a 35-year rotation age. Risk was reduced 30% with little effect on mean income by using shorter-rotation sawtimber regimes. Risk was reduced 80% by using a mix of short-rotation sawtimber and pulpwood regimes because pulpwood price was only weakly correlated with sawtimber price. The latter risk-reduction came at the expense of mean income, which was reduced by as much as 50%. The risks and compositions of optimal forest plans were extremely sensitive to assumptions about the range of future prices that were inherent in different prediction models. This sensitivity emphasizes the importance of carefully determining the decision maker’s beliefs about stumpage price behavior.