The ETS is both a goldmine and a minefield

The Government never foresaw the land-use forces they were unleashing with the ETS

In recent weeks I have written multiple articles on the Emission Trading Scheme (ETS) with a particular focus on forestry. This week I also had an extended interview with Kathryn Ryan on RNZ ‘Nine to Noon’.  However, there is still lots more that needs to be said.

The bottom line is that carbon forestry is now far more profitable than sheep and beef farming on nearly all classes of land. We are indeed on the cusp of the greatest rural land-use changes that New Zealand has seen in the last 100 years.

For many sheep and beef farmers, carbon farming can now be a gold mine. The key requirement is pastoral land that will grow an exotic forest that will not be destroyed by storm, fire or disease.  

It will take a while for the pine trees to march further across the sheep and beef landscape, with seedlings and planting labour the immediate constraints. But let there be no doubt, right now whenever sheep and beef farms come onto the market, then both the purchaser and the underbidder are typically ‘thinking forestry’. They can easily outbid those who have a sheep and beef perspective.

Sheep and beef farmer options
Sheep and beef farmers now have four options.

Option 1 is to progressively plant at least part of the farm in trees. The major constraint is the cost of establishing the forest. Many farmers need all of their current cash flow for property maintenance and living. There is nothing left over to establish the forest which is likely to cost between $2000 and $3000 per hectare.

Option 2 is to lease-out the land or alternatively to take on a joint-venture partner. Anyone going down the lease path needs to be very sure they have got things worked out as to who owns both the assets and any carbon liabilities at the end of the lease.

Option 3 is to sell to a new owner who will plant a forest. Land prices are rising and the selling option is increasingly attractive.

Option 4 is to ‘hang in’. This is fine for those who love their sheep and cattle and are ‘making a go of it’ financially. It may even be the best option, at least in the interim, if land prices are going to continue rising. But eventually, managing the process of generational succession requires moving with the times to the most profitable option.

So there lie the options linked to the goldmine. In short, based on the current economics and assuming the carbon price is sustainable, then it has to be carbon farming, either as a permanent forest or in association with lumber.

In coming to that conclusion, the key assumption is whether or not carbon prices will be maintained. There lies the first potential landmine. I now turn to that issue.

Carbon pricing
The current rules of the game are complex but the big-picture message is clear, at least when it comes to forests versus sheep and beef, on land that is currently used for pastoral purposes. On that class of land, the ETS is the driver and carbon is the new gold.

The emission trading scheme was first introduced back in 2008. However, until recently the ETS has largely been a background issue, with the price of carbon too low to dominate investment decisions.  To the extent that the ETS has been relevant, the key forestry focus from a Government perspective has been in association with production forests.

 It is only in the last two to three years that some people have started to realise that, with the carbon price rising rapidly, carbon farming without harvesting might actually be the option that provides the best financial return.  Associated with this, no-one in Government seems to have realised the potential for sheep and beef to be blown away by the march of the pines.

Increasingly, there is now recognition even among forestry professionals that carbon farming has the potential to not only push sheep and beef farming aside, but to also profoundly affect the lumber industry, with considerable timber production also being pushed aside.  

The spreadsheets that I run for my own analyses, confirm that non-harvested permanent forests not only look better than sheep and beef, but are also looking better than the combination of carbon plus production forests.  This is certainly the case on the hard country and increasingly on the better country.

A key feature of importance within the current ETS is that the carbon price required to make urban folk change their lifestyle behaviours is much more than the price that will lead to pine trees marching across the landscape. There lies the conundrum.

For example, If the carbon price were to reach $100 per tonne, the petrol emission charge would only be 24 cents per litre. At the same carbon price of $100, then non-harvested forestry is not only looking more profitable than sheep and beef, but also looking the best financial option on a considerable proportion of current dairy land.

When I first started writing about these incongruities in mid-2019, the articles were read by some influential people on both sides of the political spectrum. But the dominant paradigm at that time was that we must plant more trees, and that carbon trading through the ETS was the way to achieve this. So there the matter lay.

The key point for the discussion here is that if the ETS is going to have a meaningful effect on emissions in the broader economy, and both sides of Parliament have already committed to that policy, then the price of carbon certainly has to be well above $50 and in all likelihood a lot higher. This means that unless the Government fundamentally changes its perspective, and hence changes the rules of the game set out in the ETS, then carbon farming looks a safe bet. 

Political options
It is important to note that no-one of major influence across the political spectrum has said that they want to blow away our existing land-based industries, although some have said they wish to see a decline in these industries.  Of relevance here is that, according to the Ministry of Primary Industry’s recent State of Primary Industries document, 83% of New Zealand’s physical exports are from primary industries. We live in an export-led economy with primary industries doing the leading.  

Carbon farming, as currently set up, does not earn foreign exchange. In the long run, that could change, but that prospect is a long way off.  

Climate Change Minister James Shaw has been stating recently that higher prices for carbon are desirable and indeed needed to change emitter behaviour. Similarly, the Climate Change Commission has advocated with success for the upper limits on the carbon price to be raised to $110.15 by 2026.

There seems to have been a failure by both the Minister and the Commission to recognise what high prices do to land-based activities. In contrast, the supposed price limit for 2021 was only $50, but that number was itself blown away by the market. As I write this article, the current price is $64.50 and the futures price for 2026 is above $73.

There would seem to be an inevitable conclusion that the ETS as currently structured may not be fit for purpose. That is a conclusion that will not sit at all well with Government.

Put another way, within an ETS there is no price of carbon that will substantially change emitter behaviour without being sufficiently high to blow away sheep and beef.

Changing the rules of the game will be messy.  Almost certainly, there will be lots of defensive attitudes within Government and lots of upset people outside Government. That will include many sheep and beef farmers, together with the new breed of investors, if the new goldmine is subsequently taken away by any countermanding set of regulations.

The position of industry organisation Beef+Lamb seems to be that regulatory limits are needed.  But one should not assume that this is what many sheep and beef farmers themselves necessarily think. They might prefer the goldmine.

I said at the start of this article that there was a lot more that needs to be said.  That remains the situation.  I have only scratched the surface.

Carbon farming will determine the future of sheep, beef and production forestry

The carbon price is now high enough to change land-use sufficiently to blow away sheep and beef, but too low to significantly influence emission behaviours elsewhere

The concept of ‘carbon farming’ has been around for a long time. I recall carbon farming discussions with my colleagues at University of Queensland back in the early 1990s, but the industry has taken a long time to finally arrive.  Well, it is now here. And it has the potential to overwhelm not only the sheep and beef industries, but also have big impacts on the timber industry.

It is only six weeks since I wrote an article setting out that carbon farming is now considerably more attractive than sheep and beef on the hard North Island hill country. Then two weeks later I extended that analysis to the easier hill country. In a more recent article focusing on the Emission Trading Scheme (ETS), I mentioned that the same conclusion could be drawn for considerable parts of the South Island. All of those can be found archived at my own site https://keithwoodford.wordpress.com in the forestry category.

I undertook those analyses using a carbon price of $48 which was then the market price. As I now write this article on 8 September, the price is $62 and has been moving up each day.

Futures contracts for 2026 are now available above $71.  That means that anyone who knows they will have carbon NZUs available to sell at that time can right now lock in a price above $71.

There is talk that, given current settings within the ETS, the price could soon rise to more than $100.  The Government’s current advice is that a price as high as $110.15 would be acceptable in 2026, with the Government’s cost-containment reserve only being activated at that point.

Given that this year’s cost-containment reserve is already exhausted, there is considerable speculation as to what will happen as soon as the next auction on 1 December. The Government will need to find some more firepower if it wants to put a lid on current prices. At last week’s auction, they were totally outgunned by the commercial investors, who sucked up all of the 2021 reserve and still the Government could not hold the supposed maximum price to $50.

I have just rerun some forestry calculations using $60 as the carbon price. At that price, and if financial returns are to be the key criteria, I can confirm that carbon farming is clearly the highest and best use across most of the existing sheep and beef land. However, note the caveat about financial returns being the criteria for that finding.

There is also no doubt that if financial returns are the criteria, then it has to be exotic forests. Natives grow much more slowly and are more challenging to establish.

In contrast, if amenity values and perhaps biological diversity are the criteria, then native forests can indeed be the solution in some specific situations. But if the criterion is either dollars or carbon sequestration, then it has to be exotics.

Those exotics don’t necessarily have to be the Pinus radiata that we refer to as ‘pine trees’. It might be eucalypts, or it might be redwood, or in some cases Douglas Fir. But let there be no doubt, it won’t be native forests if dollar returns and carbon sequestration are what counts.

Until recently, the timber industry has been rather keen on carbon farming as an adjunct to production forests. Once the carbon averaging system is introduced next year, the risk associated with claiming carbon credits for first-rotation forests will have been greatly reduced.

As long as carbon credits were valued at $20, $30 or even $40, then for first-rotation forests it looked like a nice little income earner alongside the main business of timber production. However, foresters are now realising that carbon farming has the potential to totally outrun production forests in relation to these first-rotation forests.

From a land-owner perspective, in many situations it is now looking better to collect credits for the carbon, not just for the first 16 or so years under the new averaging system for production forests, but to let those credits run on, initially to 50 years, but then beyond for another 30 or so years to full maturity at perhaps 80 years. Forget about the harvest!

Note that this situation pertains to new forests on land that has most recently been in pasture. Carbon credits are not available for any land that was in forest immediately preceding 1990. There are also major limits in regard to those first-rotation forests planted after 1989 that are now reaching maturity. In general, but with exceptions, those forests will remain as production forests.

One of the major exceptions will be post-1989 forests where the owners registered their forests in the ETS and collected the associated carbon credits. The key issue is whether or not these credits were cashed-in or are still held as NZUs. If the NZUs were cashed in, then at least some of those NZUs will need to be repaid at the now much higher carbon price.

Hence, there are some nasty situations coming up for some landowners, with the only escape being to now convert these forests to permanent-forest status. But the details are too complex to get into right now. It must wait for another article.

James Shaw in his role as Minister of Climate Change has been explicit that the ETS is operating much along the lines he had hoped, and he is not at all upset that the carbon price is now rising rapidly. His perspective has been that the carbon price needed to be at least $50 per tonne before emitters would start significantly changing their behaviours. Similarly, he has indicated that he can see the price of carbon rising considerably higher and he is comfortable with that occurring.

So, let’s look at what would happen if the price of carbon, with ‘carbon’ being the shorthand for ‘carbon dioxide’, reached $100.   It would mean that the carbon tax on petrol would be about 24 cents per litre, given that a litre of petrol releases approximately 2.4 kg of carbon dioxide. This change would undoubtedly be an issue of annoyance to many motorists, but it would not greatly change petrol-buying behaviours.

In contrast, a carbon price of $100 per tonne would mean that carbon farming would blow away all significant agricultural land-uses apart from dairy and horticulture.

One of the problems with carbon farming becoming dominant is that carbon returns are received in New Zealand dollars. As currently structured within the ETS, they are transfer payments within the New Zealand economy. In contrast, the agricultural industries earn export dollars, and it is export dollars that underpin the New Zealand economy.

According to Ministry of Primary Industries in their most recent ‘State of the Primary Industries’ document, New Zealand’s primary industries earned 83% of New Zealand’s export income in the most recent year. They also state that this percentage has been increasing for the last ten years.  Sheep and beef currently earn about $10 billion of foreign exchange each year.

Another issue is that land converted to carbon forestry is locked up permanently. Give the associated carbon liabilities attached to the land, there is unlikely to ever be a pathway for future generations back to agriculture.

I have been writing regularly about forestry for more than two years.  There are now fifteen articles focusing on forestry archived at my own website https://keithwoodford.wordpress.com amongst the more than 60 articles on many topics that I have written during that period.

Back in June 2019, I wrote that the “equilibrium price of carbon needed to ensure that emitters change their behaviour is much bigger than the price required to make carbon forestry profitable”.  That insight remains the reason that carbon farming now has the potential to blow away the sheep and beef industries.

When I first made that statement, it was heard in Wellington. Someone with considerable influence rang me and we talked about it for well over an hour. But we were not on the same wavelength.  I was politely told that New Zealand’s focus had to be on planting a lot more trees given our international obligations. The implication was that collateral damage to sheep and beef was just the way things were.

As for solutions, that gets real tricky. Unscrambling the egg is not easy and I will have more to say on that. But the first step is to get acceptance that we have already headed into dangerous territory.

Institutional investors outgun Government at carbon auction

On Wednesday September 1, The Government lost control of the ETS to speculators. This has big implications and challenges for the path ahead.

The September 1 2021 auction of carbon credits within the Government’s Emission Trading System (ETS) has brought considerable embarrassment to the Government. Quite simply, the Government was outgunned by institutional investors and could not cap the price to the supposedly guaranteed maximum of $50 per NZU.

The ETS is a Government construct, within which the Government supposedly holds all the cards. The Government makes the rules and it also plays the game.

At this latest quarterly auction, there were supposed to be 4.75 million NZUs up for sale, with these available for purchase by companies needing to meet their carbon liabilities. However, there was also nothing to stop other companies that had no carbon liabilities from purchasing the units as a financial hedge.

Food-derived opioids are a medical frontier

In late 2020, I was invited to write a paper on food derived-opioids for the International Journal of Environmental Research and Public Health, with a focus including effects on microbiota.  Eight months later and the paper has been written, then refereed by three scientists chosen by the journal, then modified in response to the referees’ critiques and now published. The paper draws on and integrates evidence from 125 prior-published papers. It is available online via a link at the end of this post.

The key messages are that food-derived opioids from A1 beta-casein and also from gluten are a medical frontier, with clear evidence that they affect the microbiota in our digestive system, but also linking within a complex system to the brain and multiple internal organs.

Fundamental to this system is the widespread presence of opioid receptors to which the food-derived opioids attach. These opioid receptors are present in the brain, intestines, pancreas, lungs, heart, kidneys, liver, adrenal glands and many other places.

The natural role of opioid receptors is as part of the internal messaging system between the gut, brain, internal organs and peripheral tissues. But when external opioids are consumed, either in the form of drugs or within food, then the internal messaging is disrupted. The body then reacts to this in multiple ways, including inflammation and autoimmune responses.

Carbon farmers need to understand the ETS

The price of carbon is determined by Government. There lies the risk for carbon farming. 

Two recent articles of mine have explored the economics of carbon farming on land that is currently farmed for sheep and beef.  Those articles showed that, if financial returns are what matters, then at current carbon prices the development of permanent forests for carbon credits provides significantly higher returns than sheep and beef.

My focus there was on the close to three million hectares of North Island farmed hill country, but a similar situation exists in considerable parts of the South Island. One big exception is the Canterbury Plains, where history shows that shallow soils plus norwest wind storms wreak periodic havoc to forestry operations.

Those findings on the apparent economics of forestry lead to a series of other questions. First, how reliable is this carbon market? Second, what are all the other important things apart from simple economics that need to be considered?

Carbon-farming economics are also attractive on easier country

Given current carbon prices, the march of the pine trees across the landscape has only just begun. The implications are massive

My previous article on carbon farming focused on the North Island hard-hill country. If financial returns are to be the key driver of land-use, and based on a carbon price of $48 per tonne, then the numbers suggested that carbon farming on that class of country is a winner.

By my calculations, sheep and beef farms on this hard-hill country provide an internal rate of return (IRR) of around 2%, whereas my recent estimate for carbon farming was 9.7%.

Here I extend the analysis, still using a price of $48 per tonne, by looking at the easier hill country that Beef+Lamb (B&L) categorise as ‘Class 4 North Island Hill Country’. This fits between their ‘Class 3 North Island hard-hill country’ and the ‘Class 5 North Island intensive finishing farms’.

Carbon farming steps forward on the North Island hard-hill country

In recent months I have been analysing New Zealand sheep and beef farming to try and understand the changing scene. Here, I shift the focus to carbon farming on the North Island hard-hill country where sheep and beef currently predominate.

In this article I am not looking at lumber because much of the hard-hill country has lumber problems arising from logging costs and associated infrastructure. Rather, I am focusing on permanent pine forests and asking whether the economics now stack up.

In telling this story I am going to be challenged by some people who hate pine trees and also by others who love them but have a focus on lumber. Here, I am not taking sides on either of those issues. My approach is simply to report what the carbon numbers are saying.

The big picture with sheep

The sheep-farming retreat will continue despite excellent meat prices, with carbon farming the mega-force.

In recent months, I have written four articles focusing on the sheep and beef industries across New Zealand. My main focus has been to identify the current situation and to document how the situation varies for different classes of land across the country. Here I return to the overall big question: what is the future of the sheep industry?

There are two parts to that question. The first is the market opportunities. The second is about competing land-uses.

Sheep remain dominant on South Island hill and high country

In previous articles, I first described the North Island’s 4000 commercial hill-country farms (Beef+Lamb Classes 3 and 4). Subsequently, I wrote about the approximately 4400 intensive sheep and beef farms that are spread across both North and South Islands (Beef+Lamb Classes 5, 6, 7 and 8). That left the story of 620 South Island hill-country farms and 200 high-country farms to be told here. It is a contrasting story.

The combined number of South Island hill and high-country farms is modest, comprising less than ten percent of the 9200 commercial sheep and beef farms in New Zealand. However, these farms comprise more than one third of New Zealand’s total sheep and beef grazing area.

These are big farms both by area and livestock numbers, despite much lower stocking rates than all other farm types.  However, the differences between the hill and high-country farms are sufficient that first I will consider them separately before, drawing out some common themes.

Intensive sheep and beef provide cash but wealth depends on capital gain

Intensive sheep farms have been squeezed by dairy and are now drifting to beef with wool right out of the money

 This is the third article in a series investigating New Zealand’s pastoral sheep and beef farms. The first one was an overview of New Zealand’s 9200 commercial sheep and beef farms, and how the pastoral-farming area has declined over the last 30 years.  The second article focused on the North Island hill and hard-hill country, now comprising approximately 4000 of these 9200 commercial farms. On those hill farms, key issues are land-use competition between pastoralism and production forestry, combined with retirement of the tougher country for carbon farming.

This time my focus is on the 4400 intensive farms spanning both North and South Islands.