A fundamental change is occurring in the economics of production versus permanent forests. The policy environment is getting left behind
During 2019, I wrote five articles discussing land-use transformation that would be driven by forthcoming forestry investments. One of the key themes of those articles was that New Zealand’s forestry policies are a mess. The rules are complex and confusing. Also, the alignment of those rules with the overall public good is at best debatable.
I wrote about how policy communication by Government has been driven by public relations spin about the so-called billion trees programme. It has been virtue signalling but little else.
I also wrote that the investor focus to date has largely been driven by production forestry with that focus shaped by proximity to ports rather than the most appropriate land-use. In that context, selling carbon units has been seen as a bonus.
In contrast, I suggested that the future would be dominated more by the price of carbon than the value of production forests. I also stated that I would much prefer New Zealand’s carbon-forestry investments to be funded by New Zealanders, with there being no need for overseas funds for any permanent forests.
It is now 13 months since I wrote the last article, so what has changed in the meantime?
The biggest change is that the price of carbon units (NZUs) has risen from around $25 to $37.50 per tonne of carbon dioxide. That in itself is not a total surprise. But there is always a difference in the decision-making weight to be placed on what might happen and what is happening. So, this price rise is a big reinforcement of the upward trend.
Conversely, in this last year the focus on climate change and the Paris Agreement has been dulled. This is because COVID19 has crowded out other issues. However, the Paris Agreement has not gone away. The focus will come back, and New Zealand has committed.
In this last year, I have also become increasingly cautious as to the long-term value of production pine forests. Right now, most of the trees go to China where they are used for formwork on big infrastructure projects. Then they get burned for energy.
By my reckoning, the Chinese infrastructure programme may well have another ten years to run with more roads and skyscrapers still to be built. By then, the Chinese population will be declining. There will still be more apartments to be built as old buildings are torn down, but the overall pace of infrastructure growth will by then be much slower. Hence, the demand for New Zealand timber will also be lower.
Not everyone will agree with that perspective on future log prices. Perhaps we will find new uses for logs at a scale that replaces formwork and paper. However, I see increasing caution from investors until those new uses become embedded in the economy.
More immediate, there is a flood of international capital looking for a home. This is a key reason why interest rates are so low. Look forward another year or two as COVID19 recedes, and international investors will be clamouring for business-class seats to come, ‘look see’, and invest in carbon-trading activities.
Pulling those factors together, the consequence is that the focus will soon shift fundamentally from production forests to permanent forests that will be planned on the basis of never being harvested. That means that investors can afford to look at the hinterland, without worrying too much about road access and proximity to ports.
The shift in thinking from production to permanent forests creates an associated shift in the financial assessment framework. In a physical sense, a permanent forest is there for ever. In a financial sense, the investment is like a mine with a limited life.
The value of land for permanent forests is the assessed present value of a carbon annuity that extends for around 50 years, perhaps a little more, and then stops. That is because the forest is no longer producing new carbon.
The notion that a permanent forest is a short-term investment seems incongruous, but in a financial context it is true. It is a direct consequence of carbon trading being a market for carbon sequestration, not maintenance of existing carbon.
As to where these permanent forests might be located, as a starting point I went to Beef and Lamb’s ‘Sheep and Beef Survey’, focusing initially on Class 3 North Island hard hill country. There are about 920 of these farms averaging 670 hectares (6.7 square kilometres) per farm and totalling about 600,000 hectares. These farms have land and buildings valued at about $8300 per hectare. This gives a gross value of about $5 billion across 600,000 hectares, something that international investors could snaffle up in a few bites.
Some quick calculations suggest this hard hill-country land, at current carbon prices of $37.50 per one-tonne unit, could earn at least $750 per hectare per annum over a 50-year time horizon after allowing $25 per hectare for rates but with minimal other expenditure needed. As a comparison, these sheep and beef farms net around $330 per hectare on a similar basis.
Of course, this comparison is not quite the full story. If planted in permanent trees, then the land has minimal further market value after 50 years. But this is not a big deal for international investors who have long recouped their investment and made nice profits along the way. That is the nature of any mining investment.
This comparison also does not allow for sheep and beef farms providing ongoing employment, whereas carbon farming provides minimal employment once the trees are planted. Nor does it account for the fact that each hectare of these sheep and beef farms earns more than $1000 per annum of export income once the products have been processed. In contrast, the carbon farm is providing carbon units to balance New Zealand’s internal carbon emitting economy, with the proceeds becoming a foreign exchange outflow if owned by international investors.
These numbers illustrate that the issues go much deeper than simple cash flows. Also, when it comes to fixed assets like land, international investors may beat to a drum that does not necessarily align with the greater public good back here in New Zealand. Although my focus here has been on the hard-hill country, that is really only a start.
Another part of the needed debate relates to natives versus exotics. The problem with natives is that they are much slower growing than exotics, be that pine or eucalypts. Natives are also expensive to plant. No investor is going to favour natives.
I often walk through a small exotic forest near my home that has an understorey of natives. It has convinced me that exotics can indeed be a transition phase. However, in my local forest the transition has been helped by man doing some plantings. Also, birds have been assisting with transfer of seed. That will not happen in a big forest.
The big message of this article is not that there is a clear path ahead. Rather, exactly the opposite. That is why there is a need for an informed and wide-ranging debate as we search for the path that will lead to the right trees in the right place, planted and owned by the right people.