SSGF Exploring New Approach to Term CE Compensation
SSGF Exploring New Approach to Term CE Compensation
Dr. Jared Carlberg, Professor of Agribusiness and Agricultural Economics at the University of Manitoba, has carried out a research report for the Saskatchewan Stock Growers’ Association and Saskatchewan Stock Growers Foundation (SSGF), designed to investigate the differences in returns between cow-calf systems and annual cropping systems based for producers in southwestern Saskatchewan. The overall objective of the report was to determine long-term returns for both sectors, but was carried out in part to contribute to the ongoing public discussion of appropriate levels of compensation for landowners who sign Conservation Easements (CEs).
Carlberg looked at per-acre returns in both the cow-calf industry and annual cropping systems for periods of 10, 25, 50 and 100 years. He used a discount rate of 5% in his research but this discount rate can be easily varied using the simulation tool designed by Carlberg. The discount rate accounts for inflation, risk and time preference in order to translate (or “discount”) expected future cash flows into today’s dollars. This is important when considering financial implications of conservation easements due to the landowner agreeing to impose restrictions that prevent them from converting that land from grasslands for cow-calf production to annual crop production for a term length or indefinitely. Furthermore, as grain commodities increase in price, the land value of a parcel under easement would (in theory) remain the same because of those restrictions against converting the land use to something potentially more profitable. Using a 5% discount rate and average yields with a three-year crop rotation system (durum-lentils-canola), the discounted return on investment for the annual cropping system at the 25-year mark was $341/acre higher than the cow-calf production system. Over 50 years the discounted net cash flow increases more to $508/acre more if the land is used for annual cropping vs cow-calf production.
Carlberg’s findings are consistent with recent trends that have seen annual crop production enjoy higher profitability compared to cow-calf production. Using data provided by cost-of-production network members through Canfax Research Services, a representative cow-calf operation in the southwest corner of Saskatchewan has barely broken even in the most recent five-year period of information collection. Accordingly, given the current differences in commodity prices and cattle prices, converting native grasslands into annual cropping can be more attractive to producers in order to get the most monetary value out of their land. While understandable from a farm management standpoint, this trend can be worrying when considering the continuing decline of native grassland ecosystems. It may be necessary to provide additional incentives in order to continue to keep grasslands intact, and some of those incentives may need to be provided through conservation easements or agreements. In order for those programs to increase participation among landowners, it is necessary to determine, appropriate compensation for landowners.
Conservation Easements in perpetuity have landowners legally agree to never convert land use from the natural state into something such as annual crop production. The value of this type of CE have historically been assigned by determining the fair market value of the parcel of land, then paying the landowner between one-quarter and one-third of that value. Since the SSGF has created Term Conservation Easements, the compensation for that program is still currently under investigation. Regardless of whether a landowner is signing an easement for a term or perpetuity, the level of compensation they receive must be sufficient to offset the potential future loss of revenue from alternative uses, such as crop production, while also acknowledging the value of the ecological goods the grasslands provide.
Carlberg noted in his report that using fair market value to determine appropriate compensation for a CE may not be the best approach as this approach poses a number of challenges that may not reflect the actual value of the land. “My concern with the use of ‘fair market value’’ Carlberg observed, “is that as an economist, my perspective is that the ‘market value’ of something is not necessarily fair. What someone else is willing to sell their land for does not necessarily reflect my valuation of my own land.” Carlberg also outlines that the practice of using fair market values can be flawed due to agricultural markets already being notoriously thin and an asset’s true value is difficult to determine in the absence of an adequate number of buyers. Agricultural markets are often characterized by having a small pool of buyers that can exert undue influence over prices compared to competitive markets.
With respect to conservation easements, it can also be quite challenging to calculate the expected future cash flow of a parcel of land with much certainty, which further complicates the process of determining fair compensation. Determining the fair market value takes into account the value of land surrounding the parcel of concern and if wetlands or other native prairie is present, the land value may be discounted. Conservation Easements exist to protect these lands that are currently being discounted by the market, but it is critical to recognize the significant value they do contribute to the overall landscape.
A potential further downside to using the notion of fair market value in the assessment of values for CE’s is that prices can also be negatively impacted if the land is geographically further from already owned land because bidders may offer less due to proximity. This does not necessarily mean the land is worth less, but may cause adjoining parcels of land to be priced lower than what they are actually worth, Carlberg noted, and this adds even more uncertainty to how land can be valued for easements. Native grasslands on marginal land or even wetlands have been classified as ‘wastelands’ according to financial institutions which can also push landowners to cultivate or drain these landscapes to increase their overall equity. It is necessary to recognize the benefits the natural landscapes can offer as they are and this is incredibly important when it comes to carbon storage and sequestration, water quality, reduction of erosion, habitat for species at risk and numerous other ecological values.
When asked if he believes there is a place for a payment system that rewards not only the landowner who places the easement on the land but also future landowners, perhaps through a mechanism such as the idea of yearly payments, Carlberg mused, “I actually believe a system of yearly payments and flexibility to move in-and-out of CEs would be the best possible solution. There is a discontinuity issue associated with the current structure of CEs – because future landowners are bound by the terms of CEs, and because the benefits of the CE are all paid out front, we create conditions under which the market for the parcel of land attached to the CE cannot function effectively in the future.” The way that easements are currently paid out only benefit the current landowner and not the future landowners who have to incur the costs of not being able to change how that land is utilized, yet are required to maintain it to provide a set of ecological benefits. The creation of Term Conservation Easements creates a flexibility for landowners to commit to an easement for a set period of time with an option to renew once done. This could make it possible for multiple landowners to benefit from easements payments when the term comes up for renewal.
A considerable number of steps need to be taken to ensure landowners can receive appropriate compensation when signing a CE. The SSGF introduction of Term Conservation Easements brought our own investigation into how we can properly compensate landowners for the services and goods their grasslands provide, without the temptation of cultivating the land for annual crops. Using the information brought forward by Carlberg, the SSGF is exploring an income-based approach to conservation easement valuations to better compensate for the possible lost opportunities/income when placing an easement on land. Our temperate grasslands are one of the most endangered ecosystems, and easements are one of the ways we can protect them. Carlberg’s report highlights the potential need for change in how we value Conservation Easements, and the revenue gap between cattle production and cropping systems. Changes to these payment systems takes time, but we are hopeful that one day grasslands under protection by conservation easements will be a more enticing option for landowners when better compensation is available.