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New Zealand Forestry Today

Some Observations and Management Implications[1]

Political relevance

Commercial forestry in New Zealand, has, for the first time in decades, become politically relevant. Unlike most other sectors, its relevance is not a result of its lobbying power or size of its voting constituency. It comes from the importance to NZ politicians and our economy of being seen to be part of the international fight against global warming.

Politicians and academics understand very well that if New Zealand is to get anywhere near its stated target of 10%-20% below 1990 emission levels by 2020, we need more forests planted.

It is a great tragedy that the previous government wasted the last 5 years, and the current government the last 1 year, debating forestry policies that have essentially sought to reduce deforestation, rather than to create the right environment to encourage afforestation. So we have some catch-up work to do.

The National / Maori Party revised ETS, if passed into law will provide certainty for forestry investors.

Pre-1990 compensation units

Other than those that apply for a <50ha exemption, pre-1990 forest land is entered into the ETS compulsorily. Deforestation of this land will attract a tax.

In partial compensation for this destruction of land value the government is allocating NZUs to pre-1990 plantation forest landowners. Once the new Allocation Plan is published by MAF we can expect a limited time to define pre-1990 forest land, get it mapped and measured according to MAF's mapping conventions and make application for these credits.

Forestry servicing firms such as ours can expect to be inundated with landowners seeking help to assess the 1990 land cover and make application for these units. I anticipate that those who leave their request for help to the last minute may be disappointed.

Pre-1990 forest land values

While there has been virtually no transactions to support it, on an economic use basis the value of pre-1990 forest land on hill country is now virtually nil, other than the value of compensation units that attach to that land. Pre-1990 forest land cannot be converted back to pasture without paying a massive deforestation tax; somewhere in the order of $14,000 - $20,000/ha depending on the forest growth, maturity and value of NZUs. Clearly that land must be replanted in trees or left to regenerate as unproductive land.

But a forestry investor needs 6% - 8% after tax real rate of return to part with capital for planting. On today's stumpage returns, after discounting future cashflows at 6% - 8% without any carbon credit revenue, there is nothing left to pay for the land. The investor would be better off paying current market value or leasing $3,000 - $3,500/ha for pasture land and participating in the ETS, or taking up the Afforestation Grant Scheme.

Once some pre-1990 land transactions do take place at low prices land valuers will pick up on this economic reality and of course rates income from such land will largely evaporate.

Anticipate therefore aggressive moves by local authorities to implement differential rating for forest land.

Existing post-1989 forests

A market for NZUs at $25/unit fundamentally changes the financial viability of new forestry investment, but opportunities for existing post-1989 forests planted on pasture are less obvious. All credits earned on each Carbon Accounting Area will need to be surrendered at harvest. Entry into the Scheme is voluntary but at relatively low cost in terms of the application and annual upkeep.

Due to the lack of planting over the last decade, only few post-1989 forest owners are well-placed to sell credits now and cover harvest liabilities with carbon from younger stands.

We expect some will sell some or all credits, take a risk on price and use harvest revenue to buy back units to cover harvest liabilities. If there is a mismatch at the time of harvest, there is always the option to delay harvest, except under a fixed term lease or Forestry Right. However there is very little knowledge of what will happen to carbon stocks in pine forests on steeper hills once the pines get over about 40 years old.

Opportunities for existing "Kyoto" forest owners to sell their credits at a discount to credible entities that will undertake to give units back to cover harvest liabilities are likely to emerge.

New forests

Money will be made from the planting of new forests on pasture. Our modelling suggests that those with access to land valued at around $2,500 - $3,000/ha and the ability to plant over several years stand to earn over 10% real on a carbon plus timber investment. At today's pastoral land values the underlying timber investment without carbon is just 2% - 3%. This of course explains why we have seen no new planting of forests in recent times.

Will there be upwards pressure on pastoral land values? In the short-term the answer is no. In our view a ROI of at least 10% real will be needed given the risks associated with carbon. The ROI from carbon/timber tree farming is very sensitive to land value.

Those best placed to make money from carbon/timber forestry are existing drystock farmers. Using the economic opportunity cost of drystock production currently returning 1% - 2%, land is worth much less than $3,000/ha. In that case the ROI on carbon / timber investment rises well above 10% real.

Demand / supply balance

Our calculations suggest that NZ emitter needs will not be met from existing forests, even if 100% of post-1989 forest owners entered into the scheme (which is not likely). We conclude that there are strong drivers to commence new planting now. We do not yet know the rules for CP2, but regardless of the outcome from Copenhagen, it seems inconceivable to me that a carbon market of some form is now a reality for many years to come.

When estimating the market for forestry credits we need to understand not only the NZ emissions, but what options emitters have to meet statutory returns. NZ forestry credits and CERs are the most obvious units. The delivery rate on CERs has slowed down as the low-hanging fruit dries up, so there is likely to be upwards price pressure. So far the only provision for emitters to import AAUs is for the purpose of trading. They cannot be used to surrender against emissions under the NZ ETS unless permitted by regulations. So far those regulations do not exist. Expect that the next lobby focus for emitters will be to get those regulations drawn up in a way that gives them access to the millions of tonnes of Hot Air Russian/Ukranian surplus AAUs. But even these are not likely to be obtained at low cost.

The chart below from Euan Mason shows the planting that would be needed to meet NZ emitter demand assuming:

  1. No import of AAUs.
  2. Exports of 24 million forestry AAUs in CP1 and 30 million in CP2 and CP3.
  3. 50% of pre-1990 credits appeared on the market (40% in current CP and 10% in CP after issue).
  4. 25%, 50% or 75% of post-1989 forest owners enter the ETS and sell all credits generated.
  5. Each hectare of forest supplies 30 NZUs/annum to the market (i.e. they had excellent inventories) and that our national emissions profile stayed constant at 75.5 Mt/annum, which were estimated 2007 emissions).

Note that any import of AAU (if allowed) will not alter the net picture as such imports enable the equivalent amount of additional exports.

Chart Showing Planting Required to Meet Emitter Demand. Source: Euan Mason

It appears to me that a strong case for planting new forests does exist.

Bio energy

Wood-based bio energy is an interesting opportunity for the future. The big question is how far in the future? It is already a big business in Europe but is subsidised there by the taxpayer. With oil at US$70/barrel and coal at US$100/tonne those investing in bio energy cannot compete without subsidy if the wood is more than about 80 km away from the processor or end user. How should the forest manager be reacting to this opportunity?

Due to the energy conversion efficiency, the first target for wood energy should be for direct heat. Only when all the coal boilers are converted to wood should liquid fuels be considered.

While I support the good work of the Energy Efficiency Conservation Authority (EECA) in promoting the demand side through subsidised replacement of coal boilers with pellet or chip burners, I have yet to see any material subsidy that will give security of wood supply to such users - and nor am I suggesting there should be. A sufficient pollution tax on industrial emissions would be a more effective tool to increase use of wood in place of coal.

As a forest manager I'm finding it a bit of a struggle to get up in the morning and ask "How can I grow and supply more free wood for a bio energy company?"

But I will not be surprised if in 5 - 10 years time forest managers are fielding a call every week seeking access to wood fibre for energy at prices that displace all but our most valuable pruned and structural logs.

We have run out of cheap oil. Every additional barrel that comes from deeper offshore wells, tar sands, shale etc requires more energy to extract. Renewables even more so. The Energy Return on Energy Invested equation is turning adverse. But it gets worse. Clean domestic water has traditionally been nearly free. With increasing urban populations and agricultural demand we have to get water from deeper aquifers and further away - and this depends on cheap hydrocarbons.

India alone uses 20 million water pumps and Beijing gets over two thirds of its water from aquifers and has now started pumping from >1 km down. It takes 9,800 joules to lift 1 tonne by 1m.

Energy shortages will also impact on food production as both water and fertiliser applications are energy intensive.

As an indicator of the scale of this energy shortage issue and the dilemma facing mankind, it is instructive that despite its advice against locking the world into a high carbon infrastructure, the World Bank is currently financing coal power plants in India, South Africa, Botswana and other developing countries. Last year the Asian Development Bank approved US$850m in loans to finance a coal-fired plant in western India. The Environmental Defence Fund, a United States lobby group, said that the plant, the first of 9 planned for India, would be one of the biggest new sources of greenhouse gases on Earth, emitting 26.7 million tonnes of CO2 a year for the next 50 years.

What does this mean for forest managers in New Zealand?

  1. There are no significant technical barriers to increased use of forests for bio energy, especially heat. Wood-based bio energy will have a future in NZ commercial forestry when the cost of using hydrocarbons gets sufficiently high.
  2. Focus on growth, volume and dry matter production when choosing species, site, genetics and silviculture.
  3. Don't ignore the energy balance when selecting where to grow forests. Liquid fuels will become a larger part of the total production cost. It is no use to have lots of bio energy growing on steep hills with no road access and a long way from where the wood can be used.

Diversified species

While I'm a big fan of alternative species to radiata pine, I am not expecting widespread planting of alternatives. At present, other than Douglas fir in the colder South Island sites we would have to classify all alternative commercial tree species in the same camp that NZ drystock farmers might classify Llamas - cute but would you really want to base your livelihood on these beasts?

The fundamental problem is dry matter production early in the rotation, and the NPV impact of that.

While radiata is not the best species for all sites, it is for 90%+ of the available land that does not have high food production value.

Expect foresters to continue to experiment at the margins (it's in the nature of foresters to do so) and researchers to continue to learn more about the best provenances for growth, stem form and wood properties. Such R&D must be encouraged. But do not expect a wholesale shift away from radiata pine.

Tree breeding

Radiata pine remains one of the most researched and readily improved tree species in the world. We have only just started the genetics journey despite 50 years of tree improvement effort.

DNA markers should enable much earlier identification of positive growth and wood property genes to speed up the selection and propagation process.

Clonal propagation is looking very promising as a technique to increase wood yields, wood density and CO2 sequestration rates.

Genetic engineering must still be on the radar in the "not excluded but proceed with caution" camp. FSC really does need to be challenged on the reasons they cite for their blanket ban on GE for plantation tree species. Most do not align with scientific evidence.

Source: Forest Genetics Ltd

R&D & innovation

Research, technology and innovation and its rapid deployment is a source of increased human productivity, safety and competitive advantage. In fact this applies whether we are talking NZ Inc., the forest industry or one particular firm. R&D and innovation is the ONLY long-term strategy that will sustain us into the future. Eventually, without continuously re-inventing, experimenting and finding new and better ways to meet customer needs, our competitors will always catch up or overtake us.

Overall however the funding for research in the NZ forestry and timber processing industries has lagged behind other NZ primary sectors and timber industries in some competing countries. The start-up of Solid Wood Innovation is a positive step and hugely important for both forest owners and processors as we grapple with turning a highly variable and expanding pine resource into products more valuable and easier to ship to market than logs.

The questions to ask when considering funding for R&D is not whether the specific projects being put up have a likely payback, but:

  • What are the structures in place to enable our R&D effort to be well-directed, and flexible to changing demands and early findings?
  • Are the mechanisms in place to enable R&D findings to be disseminated and quickly picked up by industry?
  • Where will I be relative to my competitors in 10 years time if I do not innovate based on new knowledge?

Forest Management Trends

General

Some general trends of the last decade that are unlikely to go away:

  1. Outsourcing ahead of expanding staff hired directly by the forest owner.
  2. Increasing prominence and demands of community stakeholders represented by local and Regional Councils and ENGOs.
  3. Increasing technology to more precisely map, model and analyse forest yields and values.
  4. Increased uptake of FSC certification.
  5. More forestry practitioner specialisation.
  6. Increasing TIMO ownership of forests.
  7. Increasing ownership of forest land by Maori. This will eventually lead to increased tree ownership as well, and potentially more integration with processing and market distribution.
  8. Large integrated corporates are on the endangered species list. These used to carry a major burden of R&D, industry advocacy and leadership that is now spread across a wider base of forest owners and managers. Service providers tend to be smaller but are the natural "owners" of forest management tools, skills, research IP and innovation. Some service providers are now taking a more active part in pan-industry R&D and initiatives to improve the operating environment.
  9. Organisation of R&D administration and delivery of results to industry has changed. Those that want to participate in R&D are finding they need to provide part of the funding. Freeloaders are now being shut out of access to knowledge.

Risk management

Emerging issues are:

  • Insurance for carbon loss in addition to tree crop loss.
  • Covering harvest liabilities if entering the ETS:
    • hold back units from sale
    • plant new forests
    • defer harvest (what happens to radiata on the longer term?)
    • sell or commit credits to a "pooling" entity.
  • Climate change:
    • increased windthrow from tropical cyclones
    • more intense rainstorms
    • increased fire on east coast of NZ
    • new pathogens
  • Fumigation - continued use of methyl bromide?
  • Statutory
    • reducing tolerance of stream sedimentation
    • reducing tolerance to workplace accidents
  • Roads - log volumes rising, larger rigs and more competing traffic
  • Ports - storage at most ports already constrained

Strategy

Perhaps the single biggest risk we face as a forest industry sector is on-going erosion of the profitability of growing forests. Carbon may have given new forest owners a shot in the arm. Preference for low-energy and low-emissions building materials should favour forest products.

We need to focus on fundamentals. Excellence in site selection, site preparation, genetics, weed control and silviculture is critical. But without investment in R&D, new products, harvesting and transport productivity, marketing and distribution channels, we will still lose market share and profits will decline over time.

Reliance on log export is a highly risky strategy. We are simply too far from markets to compete. While log exports are strong right now, that will not always be so. Unless we can create a manufacturing environment that enables investment in processing logs in NZ, our industry future is at risk.

I'll finish with a direct quote from the Prime Minister's Chief Science Advisor, Professor Sir Peter Gluckman:

"Few New Zealand businesses look beyond the short-term, and even our largest businesses such as the farmers' collectives do not - look at what has happened to the wool levy".

" - any transformational strategy will depend on knowledge, and science is in the end simply the only way we have to gain new knowledge."

So the question I ask you all to consider is: "What role can I and should I play in:

  • support for R&D,
  • the early adoption of new technologies; and advancing the creation of a forest owner and wood processor friendly New Zealand?"

[1] As presented at the ForestTECH technology showcase event in Rotorua, 11-12 November 2009.