Integrating forest ecosystem services into the farming landscape: A stochastic economic assessment

• Considers case of dairy farmers under volatile markets and environmental limits.
• Risk aversion concept and stochastic efficiency were used to rank optimal land uses.
• Certainty equivalent was used to identify optimal stochastic portfolio of land uses.
• Payments for forest ecosystem services help achieve a resilient landscape.
• Environmental payments for afforestation should be lower with risk averse farmers.

The objective of this study was to assess how payments for ecosystem services could assist plantation forestry's integration into pastoral dairy farming in order to improve environmental outcomes and increase business resilience to both price uncertainty and production limits imposed by environmental policies. Stochastic Dominance (SD) criteria and portfolio analysis, accounting for farmers' risk aversion levels, were used to rank different land-use alternatives and landscapes with different levels of plantation forestry integration. The study was focused on a modal 200-ha dairy farm in the Lake Rotorua Catchment of the Central North Island region of New Zealand, where national environmental policies are being implemented to improve water quality and reduce greenhouse gas emissions. Nitrogen and carbon payments would help farmers improve early cash flows for forestry, provide financial leverage to undertake afforestation projects and contribute to improved environmental outcomes for the catchment. The SD criteria demonstrated that although dairy farming generates the highest returns, plantation forestry with nitrogen and carbon payments would be a preferred alternative for landowners with relatively low risk aversion levels who consider return volatility and environmental limits within their land-use change criteria. Using the confidence premium concept, environmental payments to encourage plantation forestry into the landscape were shown to be lower when the majority of landowners are risk averse. The certainty equivalence approach helped to identify the optimal dairy-forestry portfolio arrangements for landowners of different levels of risk aversion, intensities of dairy farming (status quo and intensified) and nitrogen prices. At low nitrogen prices, risk neutral farmers would choose to afforest less than half of the farm and operate at the maximum nitrogen allowance, because dairy farming at both intensities provides the highest return among the different land uses available. However, at relatively low risk aversion levels, farmers would operate at levels below the maximum nitrogen allowance by including plantation forestry to a greater extent, compared to risk neutral farmers, due to its more certain returns. At a high nitrogen price of $400/kg, plantation forestry would completely subsume dairying, across risk aversion and intensity levels. These results confirm that plantation forestry as well as being an environmentally sound land-use alternative, also reduces uncertainty for landowners that are exposed to volatile international markets for dairy commodities.