Impact of Finnfund-financed forestry companies for the development of forest industry in East Africa

We need more forests!

It is universally accepted that the world needs more forests to mitigate climate change. Less attention has been paid to the role of forests in helping climate change adaptation and serving as critical renewable natural resources for green economic growth.

Finnfund is among the largest investors in forestry in emerging markets, especially in Africa. Finnfund requested Indufor to analyse the role of three Finnfund financed companies – Kilombero Valley Teak Company, New Forests Company and Green Resources – for the development of forestry industry in East Africa. The study found the companies to be important actors in climate change mitigation and in promoting socio-economic development in the areas where they operate. However, the impact on development of forestry industry or markets is more mixed, but the future looks promising. Forestry is becoming a viable source of livelihood in rural Africa.  

Climate imperative

The world’s forests cover 4 billion hectares, but this cover is shrinking by about 3 million hectares every year. Although deforestation has slowed down in the 2010s, it is still fast especially in Africa and Latin America. Between 2010 and 2015, the global forest area declined by 0.4 percent, but in Africa the forest cover shrank by 2.1 percent and in East Africa by 2.7 percent or by 7.6 million hectares.[1]

Deforestation causes 20 per cent of total annual global greenhouse gas emissions – more than all the world’s traffic. The main cause of deforestation is the clearing of land for agricultural use that accounts for almost 80 percent of world’s forest loss.[2] Ensuring food security and simultaneously increasing forest area is one of humanity’s greatest challenges.

Economic potential

93 percent of world’s forest is natural forest. Globally, planted forests cover 300 million hectares, but in Africa only 16 million hectares is planted. The estimates area of commercial forest plantations in Africa is 5 million hectares.

It is expected that over the next ten years, the demand for wood in Africa will double from the current level of about 100 million cubic metres. Existing plantation forests can only supply one-third of the increasing demand; the rest will come from felling natural forests or from imports[3]. Already now, Africa’s wood product trade balance is over €1 billion in deficit.[4]

The forest sector has great potential for contributing to inclusive green growth. It is labour intensive, it replaces imports and provides export opportunities and, when managed sustainably, it can help to mitigate climate change[5]. However, for transformation of forestry sector in East Africa to maximise its economic, social and environmental potential, supportive industrial policies and strategies would be needed.

Research on planted forests concludes that Africa has a major issue with continuing loss of natural forest area, increasing wood demand caused by urbanisation and rapid population growth, and a very low increase in planted forest area. Continuing competition for land requires forestry and farming practices to produce more with less resources. Well-managed planted forests have up to 10 times higher growth rates (10-30 m3/ha) compared to natural forests.[6]

Africa needs more productive and economically viable planted forest to stimulate green economic growth and to offset continuing deforestation.

One key challenge to increase and manage planted forests is around social expectations. Previously negative perceptions of planted forests are changing thanks to independent third-party audit certification schemes. Forest Stewardship Council (FSC) certification is found to be the best existing proxy for sustainable and responsible forestry investment through the breadth of issues the certification covers and the depth of quality control[7].

Finnfund’s response

Sustainable forestry is one of Finnfund’s priority sectors. At the end of 2018, our forestry investment portfolio stood at €126 million and included investments in 10 forestry companies and five forestry funds. The invested amount represented 18% of Finnfund’s total portfolio and makes Finnfund one of the largest forestry financiers in emerging markets.

Finnfund’s forestry investment rationale states that Finnfund wants to invest in forestry companies that:

1. Are/will become profitable;
2. Contribute positively to the development of forestry industries in the target countries;
3. Operate in socially and environmentally responsible and sustainable manner;
4. Yield significant socio-economic benefits at local and national level; and
5. Increase forest cover, reduce forest loss and help mitigate climate change through carbon sequestration and creation of carbon sinks.

Approximately 40% of Finnfund’s forestry portfolio is invested into three plantation forestry companies in Tanzania, Uganda and Rwanda: Kilombero Valley Teak Company (KVTC), New Forest Company (NFC) and Green Resources (GR). KVTC grows and produces teak mainly for export, while both NFC and GR grow and produce pine for sawnwood and eucalyptus for utility poles. At the moment, these three companies are the largest private forestry actors in East Africa. NFC and GR are certified by the Forest Stewardship Council (FSC). Finnfund requested Indufor to determine what has been the impact of the three companies in developing forestry industry in Tanzania, Uganda and Rwanda.

The data collection methods included analysis of relevant available background documentation and existing studies, field visits to Tanzania and Uganda which included interviews and requests for additional data from the companies. There were limitations to data availability at national, regional/local and company level that compromised the breadth and depth of the analysis. However, several significant and credible new findings were identified.

Increasing forest cover and carbon sequestration

A key rationale for Finnfund to invest in forestry is the desire to increase forest cover, reduce pressure for felling natural forest, reduction of forest loss, carbon removal and climate change mitigation.

Combined, the three companies have 94,000 hectares of forest under sustainable management. Of this, 53,000 hectares is plantation and the remaining is protected natural forest or buffer zones and hence contributing to biodiversity. The forest cover represents only 0.2 percent of the forest area in the three countries, but the planted area amounts to 13 percent of the total forest plantation area.

Based on Finnfund’s CO2 calculations, NFC and Green Resources sequester approximately 1.5 million tonnes CO2-equivalent annually. This equals to annual CO2 emissions of for example 150,000 Finns or 7,500,000 Tanzanians.[8]

All companies have their own nurseries for seedling propagation. In the past five years, the companies have distributed over 24 million seedlings to other companies, out-growers, communities and forestry development projects. Assuming that the number of seedlings planted per hectare is 1600, the number of sold seedlings converts to 15,000 hectares planted forest, which represents 20% of new plantation forest cover in East Africa.

Furthermore, the seedlings are produced from high quality seed material and contribute to better plantations, which have faster growth and produce higher quality end products and higher incomes for tree growers in the future. In addition to seedlings, all companies offer training to out-growers and small holders in tree planting and management.

It was beyond the scope of the study to assess in detail to what extent the companies have contributed to forest loss. There is, however, compelling evidence that the local small holders are increasingly planting and growing trees despite the fact that the earnings from trees will come only after several years. This philosophical change for making longer term investments for future income might be one of the biggest structural changes in rural East Africa.

Support to local economies

One important rationale for forestry investments is that they are highly beneficial for local economies. The companies operate in rural settings where livelihood and economic opportunities outside subsistence farming are limited.

The study found the three companies to be very important contributors to local economies. First, they provide formal jobs to almost 4,000 people in East Africa. Approximately 20 percent of the workers are women and women are usually in majority in the tree nurseries. In the absence of detailed labour statistics, it is difficult, though, to establish exactly how big a share the 4,000 formal jobs are of total formal jobs in the companies’ operating areas.

Secondly, the companies pay around €6 million in salaries to local staff. Depending on location, the average salaries are two to five times more than the average salaries in agriculture. In addition, all companies have extensive corporate social responsibility programmes into which they allocate €1.5 million every year. Thirdly, the companies pay local taxes a total of approximately €700,000 per year. In many locations, Finnfund financed company is responsible for over 10 percent of collected local revenues.

The biggest contribution to local economies comes, however, through local purchases of goods and services. KVTC, GR and NFC spend approximately €27 million in local purchases every year. That big amount of local purchases stems from the fact that the companies’ own plantations are still too young to produce utility poles or roundwood. Over the past five years, NFC alone has procured about 200,000 m3 of roundwood (eucalyptus) from local producers, creating significant source of income for local small-scale producers.

Though detailed study of the impact of these purchases was beyond the scope of the assignment, there is a good reason to believe that the forestry companies are important engines of local economies.

Contribution to the development of forestry industries

The primary goal for Finnfund’s forestry investments is, however, the creation, development and consolidation of forestry industries in the countries where the companies operate. The thinking behind market creation is that by increasing good quality domestic supply, the demand side will gradually pick up, and there would be a virtuous cycle whereby forestry industry would grow and contribute to overall economic growth, reduce poverty through more inclusive growth, improve balance of payments through increased exports and replacement of imports, and help mitigate and adapt to climate change.

In 2018, the three companies produced 42,000 m3 of sawn wood and 180,000 utility poles. Over the past five years, there have been some fluctuations in production numbers, especially in utility pole production that depends on the demand of public electrification agencies. But all in all, there has not been any significant growth in production.

The main indicator for efficiency is the recovery rate of the sawmills. The study found the recovery rate to be around 50%, which is at par with South African sawmills and much higher than that of small “ding dong” mills[9] and chain saws that most local saw mills use. Similarly, the study found the quality of the sawn products from the Finnfund funded companies to be superior compared to the average quality available at the timber yards in terms of accuracy of dimension, bark, sawn surface and deformation. Consequently, the price for sawn wood was generally higher than the national averages.

The utility poles are mostly produced for the national electrification agencies through competitive bidding processes. Though exact comparative information of prices and quality of poles is not available, the closely monitored procurement process is a good indication of standardised quality and competitive price. Consequently, the Finnfund financed companies are not expected to benefit or suffer in terms of pricing or quality.

The estimated combined sawnwood production in Tanzania, Uganda and Rwanda is 650,000 m3 per year. Therefore, the combined production of sawnwood in KVTC, NFC and GR of 42,000 m3 represents 7% of the total production. In utility pole production, NFC and GR produced approximately 180,000 poles in 2018, which represents approximately 1/3 of the total pole production in Tanzania, Uganda and Rwanda, and equals to 9,000 km of electricity grid.

Wood product exports in East Africa are marginal averaging a little over €50 million per year and representing less than 1 percent of the total exports. In Tanzania, KVTCs exports of €5 million represent approximately 15 percent of Tanzanian sawn wood exports. A further 15 percent is from sawmills supplied by KVTC with logs. In Rwanda NFC is the sole domestic pole producers and has replaced utility pole imports entirely.

Conclusions

Despite data limitations, there are many important conclusions that can be drawn from the study.

1) Forestry industry is still nascent in East Africa

The overall production of sawn wood and poles is very small in comparison to international benchmarks. The below table summarises the different scale of forestry industry in Tanzania, Rwanda and Uganda compared to Finland.

The numbers clearly show that from half of forest area, Finland produces nearly 20 times more sawn wood and exports 35 times more in value. Even though the point is not to say that Tanzania, Uganda and Rwanda should follow Finland’s path in forestry industrialisation, it is obvious that the three countries could benefit significantly more from better and more sustainable utilisation of their renewable natural resources. This would require more supportive forestry industry policies in the three countries.

2) Demand for quality timber needs to increase (and it will!)

The amount and share of the three companies of especially sawn wood was surprisingly low. This is explained by under-developed market that is dominated by informal sector operators who offer cheap, low-quality pine sawn wood. While there are regulated standards for sawn wood in Tanzania and Uganda, these standards are not followed and adherence to these standards is not enforced. Consequently, any cheap slat can be used for construction material.

There are some large construction companies and national housing agencies are starting to demand for better quality timber, but the number of operators and companies that demand, and are willing to pay, for better quality, certified timber is still limited. For transformative sector development, there is a need for increased investments into larger scale construction, furniture or other manufacturing factories that would use quality, domestic timber or fibre for production.    

3) The future smells sawdust

Despite the difficult current market situation, the future still looks promising for at least three reasons. Firstly, rapid urbanisation and steady economic growth will increase demand for wood products, also for the higher quality and more expensive ones. Secondly, Finnfund-financed companies’ own forests are largely still too young for harvest. In the coming years, the companies will have the capacity to significantly increase their production from own forests. Thirdly, and perhaps most importantly, there are clear indications that local people are increasingly planting trees, often with the help of Finnfund’s investee companies. Forestry, planting and growing trees has to become economically viable option for small-scale farmers in rural Africa. For this to materialise, they need: (credible) market for their product, good quality inputs, training and change in their life philosophy. The study found evidence of all requirements and that bodes well for future forestry in Africa.

[1] FAO (2016): World Forest Resource Assessment 2015.

[2] FAO (2018): The State of World’s Forests 2018 – Forest pathways to sustainable development.

[3] In 2012, African forest plantations produced only 26,200 thousand cubic meters of industrial roundwood, representing only 3.4% of global production. In comparison, Finland produced 55,000 thousand m3 in 2012, increased to 63,000 in 2017.

[4] https://wits.worldbank.org/

[5] Harnessing the potential of private sector. Engagement in Productive Forests for Green Growth. Policy brief. Climate Investment Funds, ProFor, World Bank Group. 2017

[6] Payn et al (2015): Changes in planted forests and future global implications. Forest ecology and management 352 (2015).

[7] Brotto, L et al (2016): Planted forests in emerging economies: Best practices for sustainable and responsible investments. Occasional Paper 151. Bogor, Indonesia. CIFOR.

[8] KVTC CO2 sequestration has not been calculated

[9] Rudimentary, low CAPEX sawmill equipment.

For more information, please contact:

Juho Uusihakala, Senior Development Impact Adviser, juho.uusihakala(a)finnfund.fi