Financial analysis of adopting the ‘biodiversity-friendly’ certification criteria

the workshop, a biodiversity-friendly coffee plan- tation must meet the following basic requirements: a the shade, in the part of the farm devoted to coffee production, must cover a minimum of 40 of the land with even distribution; at altitudes above 1200 m, average shade of 40 over the entire property is acceptable; b the shade of the coffee plantation must include as a minimum ten species of native trees, with a minimum density of 1.4 individuals of each species per hectare; c prescribed conservationist practices for managing forest, soil, and bodies of water must be adopted; d hunting and removal of flora and fauna for commercial purposes are prohibited; e solely authorized low-toxicity pesticides must be used following national and international standards for the application of agrochemicals; and f workers must be trained in the use, storage and application of agrochemicals.

4. Financial analysis of adopting the ‘biodiversity-friendly’ certification criteria

A benefit-cost analysis to evaluate the financial viability of investing in the conversion of an estab- lished coffee plantation to ‘biodiversity-friendly’ BF was conducted. Models were developed fol- lowing Brown 1979 and Gittinger 1982 for five hypothetical, but representative, coffee planta- tions under different production systems in west- ern El Salvador. The five coffee plantations were defined as follows: 1 plantation with TP; 2 plantation with CP; 3 plantation with TS at less than 1200 m; 4 plantation with TS at more than 1200 m; and 5 plantation with SUN at more than 1200 m. For each one of the models, the following steps were carried out: 1 estimated parameters of pro- duction and sale for the ‘typical’ farm according to each coffee production system; 2 computed investments to certify the farm as BF, and esti- mate the production costs and sales of the farm once certified; 3 created cash flow over a 20-year period; 4 using a Monte Carlo approach, incor- porated risk for the production and price vari- ables; and 5 estimated expected net present values NPV considering the situation certified as BF with the project versus the situation non-cer- tified without the project in order to obtain the incremental net benefits due to adopting the BF certification criteria. The final result for the Monte Carlo simulations were sets of 3000 NPVs for each model. Results are presented as frequency distri- butions of a possible range of incremental NPVs. The basic numbers for production costs, pro- duction per hectare, replanting costs, investment costs, and sale prices were derived from data provided by the Salvadorian Coffee Research Foundation PROCAFE. The data correspond to a total of 45 coffee farms located in western El Salvador, identified according to production sys- tem, that were surveyed by PROCAFE during 1997. All data are pertinent to the coffee farming year 19961997. Data were used to create farm budgets, which were later utilized as a base for developing the models. All prices production costs and sales are farm-gate prices, presented on a 1-ha basis. Prices are expressed in US dollars 1 and without adjustments for inflation. Operating funds are derived from sales of coffee and production loans. In addition to coffee, other products from the coffee plantation may be sold. 2 1 US 1.00 = 8.75 Salvadorenian colones 1297. 2 Other products from the coffee plantation include: medici- nal and ornamental plants, wildlife meat, timber, fruits, and firewood. Sales of medicinal and ornamental plants, and use of wildlife are common in farms with TP, although under the certification criteria sales of these products is allowed under restricted circumstances. Fruits are produced in farms with CP. A combination frequently employed in El Salvador con- sists of bananas and citrus Galloway and Beer, 1997. In addition, timber trees are components of the shade strata in farms under both systems. Common timber species in northern Latin America include laurel Cordia alliadora, cedrum Ce- drela odorata, balsam Myroxylon balsamun, conacaste En- terolobium cyclocarpum, and mahogany Swietenia humilis Galloway and Beer, 1997. Farmers often recruit timber trees from natural regeneration in crop fields rather than planting them, in which case no harvest plans are followed Somarriba, 1992. Usually timber species are harvested at small scale and at irregular intervals to fulfil unpredictable needs in the farm, such as demands for building materials. Furthermore, coffee plantations under all systems except SUN are important sources of firewood Current and Jua´rez, 1992. Firewood is produced as a result of pruning shade and windbreak trees to increase sunlight for the coffee plants. Firewood is usually used in the farm for cooking and the excess is sold at the market. Revenues from these additional products was not quantified or included in the analysis because: 1 there was no information about the magnitude or value of the sales sales of medicinal and orna- mental plants, and uses of wildlife; 2 sales are erratic and unplanned, making revenue calcula- tions unwieldy timber; 3 precise yields are not reliable since reported sales include sources other than coffee plantations firewood; or 4 there is no inherent difference in the situation ‘with’ ver- sus ‘without’ the project in the value of the sales fruits. Coffee plants have a ‘cyclic production’ so that a year of high production may be followed by a decrease up to 50 the next year due to depletion of the plant resources. To reflect this circum- stance, yields from the last 3 years were averaged. In this way, production values represent the farm’s mean yields taking into account years of high as well as low yields. In general, more than half of the coffee plants in El Salvador are older than 20 years. Given that older coffee plants produce lower yields, farmers are re- placing those plants. The models assumed that the farmers replant 5 of the coffee plantation every year. The representative coffee price paid by the beneficios processing plants to the coffee farmer for the harvest 19961997 was 103 per quintal oro qq, common weight unit used for coffee equiva- lent to 46 kg; Consejo Salvadoren˜o del Cafe´, 1997. This price was adjusted into the future by the historical rate of price increase for cocoa, coffee and tea, which is 0.63 per year Radetzki, 1990. As with other certified environmentally-friendly products e.g. organic products UNCTAD, 1996, it is expected that a BF coffee will obtain a premium 3 over the market price for being cer- tified as such. Since no coffee is currently mar- keted as BF, it is assumed that the premium for BF will have a similar behavior to that for or- ganic coffee. Premiums for organic coffee vary inversely with the relative price of the coffee market Boyce et al., 1994. This means that when the commodity market is low, premiums are high and vice versa. In the models, the expected premi- ums for BF vary along with the price in an inverse relationship. The premiums are also set up with declines in premium size over time, as more pro- ducers enter the market. The premium is obtained during the second year for the farm with tradi- tional polyculture, after investments have been undertaken in the coffee plantation to be certified BF. In the rest of the farms, the premium is obtained at the sixth year of the project, when the shade trees provide a minimum cover of 40 and all the certification criteria are met Appendix A. Farmers borrow money to finance their annual production. In the models, the credits were as- sumed to be annual production loans covering 75 of the production costs. In the scenario of the farm certified as BF, certification costs are included as part of production costs. The real interest rate after inflation is removed for the short-term coffee production loan was estimated as 10, and the loan is fully paid back each year after the coffee was sold. Coffee production costs result from inputs and materials, harvest and cultivation labor, sales costs, administration, and repairs and mainte- nance. While expenditure categories are common to all production systems, magnitudes vary across systems Table 1. Most of the production costs were defined as fixed, i.e. a fixed amount per hectare of coffee in cultivation Table 1. The only production cost that was defined as variable is the labor cost for harvesting, which was stated in 5 man-days per quintal. Average harvesting labor wage was esti- mated at 3.00day. The labor costs of cultivation include clearing, replanting, weeding, pruning, and applying fertilizers. Costs related to compliance with the BF certifi- cation criteria include: a the implementation of a permanent training program for the workers in the use, storage and application of agrochemicals; b maintaining a minimum density and composi- tion in the shade trees; and c the expenses of the 3 Premiums are a percentage of the regular commodity price that act as market recognition for the merits of using sustain- able production practices, like organic farming or sustainable harvest schemes, among others. certifying team Table 2. The costs of implement- ing a training program on managing agrochemi- cals was estimated to be about 92.00 per year. For satisfying the second criteria, a certain mini- mum number of native shade trees, which varies according to production system and altitude of the farm, should be planted per hectare see below. It is assumed that each shade tree covers approximately 25 m 2 Mario Salazar, 1997, personal communication, and that shade trees planted in the first year of the project will provide such cover in the sixth year of the project. Costs associated with planting and maintaining shade trees are incurred during the first 3 years; afterwards, shade trees do not require further care other than pruning. The cost of certifying the farm as BF includes the travel expenses and the salary costs of visiting inspectors. This cost is fixed per farm regardless of production system, location, or size of the farm. The figure estimated for the cost of certifica- tion is 700.00 per year. The certification cost is incurred beginning in the first year in the coffee plantation under TP, while it is incurred begin- ning in the sixth year in the rest of the planta- tions. Table 1 Coffee production costs according to production systems for farms in western El Salvador in US Coffee plantations a TSB1200 m CP SUN\1200 m TP TS\1200 m Variable per qq. 15.00 Production labor-harvest 15.00 15.00 15.00 15.00 Fixed per ha 426.01 406.64 387.29 Production labor-cultivation 314.37 287.25 266.05 Inputs and materials 286.26 388.46 407.88 466.15 20.59 31.70 Repair and maintenance 32.90 33.04 55.72 60.09 95.77 54.47 85.83 Sales and administration 82.47 a TP, traditional polyculture; CP, commercial polyculture; TSB1200 m, technified shade at less than 1200 m above sea level; TS\1200 m, technified shade at more than 1200 m above sea level.; SUN \ 1200 m, unshaded monoculture at more than 1200 m above sea level. Table 2 Initial investments and incremental production costs associated with adopting the biodiversity-friendly certification criteria in coffee plantations under different production systems in USha, western El Salvador Coffee plantations a TP CP TSB1200 m TS\1200 m SUN\1200 m 28.00 Planting shade trees 1.00tree b 104.00 124.00 160.00 99.20 83.20 22.40 Maintaining shade trees 0.80tree c 128.00 62.00 80.00 14.00 Pruning shade trees 0.50tree d 52.00 140.00 46.67 Certification team d 20.00 10.00 10.00 6.13 18.40 1.31 Training workers in the use of agrochemicals e 1.31 26.28 a TP, traditional polyculture; CP, commercial polyculture; TSB1200 m, technified shade at less than 1200 m above sea level; TS\1200 m, technified shade at more than 1200 m above sea level.; SUN \ 1200 m, unshaded monoculture at more than 1200 m above sea level. b Incurred only during the first year. c Incurred during the second and third years. d Incurred beginning in the sixth year. e Incurred in the farm under TP beginning in the second year, in the rest of the farms beginning in the sixth year. Table 3 Financial analysis of adopting the biodiversity-friendly certification criteria in coffee plantations with different production systems in western El Salvador: simulation results Net present value Coffee plantations a Mean expected value USha b S.D. USha Percentage over 0 Farm under TP 100.0 369 96 55.0 Farm under CP 15 163 142 70.2 285 Farm under TSB1200 m 81.8 Farm under TS\1200 m 340 377 526 445 Farm under SUN\1200 m 87.8 a TP, traditional polyculture; CP, commercial polyculture; TSB1200 m, technified shade at less than 1200 m above sea level; TS\1200 m, technified shade at more than 1200 m above sea level.; SUN \ 1200 m, unshaded monoculture at more than 1200 m above sea level. b These values represent the incremental gains over the non-certified production of the coffee farm. Using the Monte Carlo simulation, the uncer- tainty of variations in coffee prices and coffee yields was incorporated into the models. World coffee prices show short-term fluctuations driven by factors such as weather patterns, size of stocks in producing and consuming countries, and eco- nomic conditions, among others UNCTAD, 1995. El Salvador possesses an open market sys- tem Pelupessy, 1993, that makes internal coffee prices paid to farmers move roughly parallel to the world market following its short-term fluctua- tions. It is estimated that the internal coffee price may deviate 9 20 from the projected future price based on an historical range of 30.60 – 172.71 per quintal. A lognormal probability distri- bution curve was used to model the price changes. For farmers with coffee plantations under pro- duction systems other than TP, an important concern regarding the investment in a BF produc- tion system may be that incorporating more shade trees may reduce coffee production yields. To reflect this concern, the models assumed that de- creases in the yields up to 15 in farms under CP, TS, and SUN may occur as shade trees grow and the canopy begins to close. A triangular probabil- ity distribution minimum, most likely, maximum was used to express decreases in production yields with the following values in percent: year 4 − 5, − 2, 0; year 5 − 10, − 5, 0; years 6 – 20 − 15, − 10, 0. A real discount rate of 10 was used, which was derived from the interest rate applied by the banks for coffee production loans minus the infla- tion rate. The life of the project for the investment analysis was 20 years. This period corresponds to the average optimal life of a coffee plant. 4 . 1 . Farm with traditional polyculture The farm has a surface of 5 ha and is located at low altitude 700 m above sea level. The coffee plantation has a density of 1700 plants of coffee per hectare with an average yield of 11.5 qqha. There are 200 shade treesha providing a 50 shade cover of the coffee plantation. The result of the simulations models are presented in Table 3 and Fig. 2. 4 . 2 . Farm with commercial polyculture The farm covers a surface of 15 ha and is located at low altitude 700 m above sea level. The coffee plantation has a density of 2200 plants of coffee per hectare with an average yield of 17.9 qqha. The shade cover includes musaceous plants bananas and citrus trees. The coffee plantation has a shade cover of 33 provided by 71 citric trees and 143 musaceous plants per hectare. To satisfy the requirements of minimum shade cover and diversity in the composition of the shade, 28 trees of ten native species are planted per hectare. The costs of planting and maintaining these addi- tional shade trees are summarized in Table 2. The results for adopting the BF certification criteria are presented in Table 3 and Fig. 2. Fig. 2. Probability distributions for incremental net present values NPV of adopting the ‘biodiversity-friendly’ certification criteria in: a farm with traditional polyculture; b farm with commercial polyculture; c farm with technified shade at less than 1200 m; d farm with technified shade at more than 1200 m; and e farm with unshaded monoculture at more than 1200 m. 4 . 3 . Farm with technified shade at medium altitude The farm has a surface of 35 ha and is located at medium altitude 1000 m above sea level. The entire farm is devoted to coffee plantation with a density of 3500 plantsha, producing an average yield of 32.6 qqha. There are 70 treesha of Inga spp., which provide 15 shade cover. To fulfil the certification criteria on the density and composi- tion of the shade cover, 104 trees of at least ten native species are planted per hectare. The costs of planting and maintaining these additional shade trees are summarized in Table 2. The simu- lation results are summarized in Table 3 and Fig. 2. 4 . 4 . Farm with technified shade at high altitude The farm has a size of 70 ha and is located at high altitude 1400 m above sea level. The coffee plantation contains a density of 4600 plantsha producing an average yield of 42 qqha. The coffee plantation possesses a 10 shade cover provided by 47 treesha of Inga spp. To provide a 40 shade cover of the coffee plantation, 124 shade trees of at least ten native species are planted per hectare. The costs of incorporating and maintaining the additional shade trees are described in Table 2. The simulation results are summarized in Table 3 and Fig. 2. 4 . 5 . Farm with unshaded monoculture The farm comprises a surface of 70 ha and is located at high altitude 1400 m above sea level. The coffee plantation contains a density of 5500 plantsha producing an average yield of 50.4 qq ha. To fulfil the certification criteria about shade cover, 160 trees of at least ten native species are planted per hectare. The costs of planting and maintaining the required extra shade trees are reported in Table 2. The results of the simulations for a SUN coffee plantation adopting the BF certification criteria are presented in Table 3 and Fig. 2. 4 . 6 . Sensiti6ity analysis The sensitivity of the investment to declines in coffee production due to shade effects and to declines in premium levels was assessed. Except for the farm with CP, the net present value of the BF coffee plantations is more sensitive to declines in coffee yields than to decreases in the forecasted premium levels Table 4. This is mainly due to the direct relation between coffee yields and net income.

5. Discussion