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.

According to Beef+Lamb there are approximately 920 of these farms, averaging around 830 hectares, and therefore totalling about 750,000 ha. The total area might be somewhat more, somewhere around 1,000,000 hectares, in part because Beef+Lamb work on effective hectares rather than total hectares.  On average, these farms have been making a profit after depreciation but before owners’ drawings’ of between $200 and $250 per effective hectare.  The owner-return on assets, before drawings, is of the order of 2%, recognising that this is the average.  Some farms will be more and some will be less.

The way I approached the analysis was to go first to the MPI forestry website. From there I was led to the website of the Parliamentary Counsel Office and the updated 2020 ‘Climate Change (Forestry) Regulations 2008’. Here I found the carbon ‘Look Up’ tables for post-1989 forests.

I chose the numbers for Hawkes Bay / Southern North Island but the numbers are close to identical for all of the North Island except Bay of Plenty where they are about ten percent lower.

Working on a 50-year time frame, the sequestered carbon for a permanent forest is 1345 tonnes of carbon-dioxide-equivalent (CO2e). At that point the trees are still sequestering around 26 tonnes per annum but that is as far as the tables currently go. Accordingly, the current assumption is that the forest remains as a permanent forest thereafter but earning no more carbon credits.

To compare this with production forests, regulations now coming into play mean that production forests can only claim the first 17 years of credits under the new averaging system.

To put that further into perspective, the amount of carbon credits claimable for a production forest will be 436 tonnes over a 17-year period, with that forest, typically harvested at about 28 years, to then be replaced by another forest but with no further credits. This compares to the 1345 tonnes over 50 years for a permanent forest.

The current price of carbon credits is around $48 per tonne. Ten years ago, it was about $2 as the scheme was destroyed by fraudulent Ukrainian credits purchased by the NZ Government. Two years ago, the credits were worth around $25. One year ago, they were worth around $37.

As to what those credits will be in another five or ten years, that is a big unknown. But this is a market controlled by Government policies and associated regulations. All of the main political parties are on board and so it seems unlikely that the carbon price will drop significantly. Indeed, it could go a lot higher!

So, what do the numbers say?

At present prices, the carbon forest will return around $65,000 over 50 years. I have assumed that local-body rates will continue at the present level of around $23 a hectare, but some will say they should be increased. I have played around with those numbers and even if rates doubled it has minimal impact on the forestry economics relative to other land-uses.

I have also assumed that it costs $3000 to plant each hectare. Some might say that is too high, but I have allowed for considerable land preparation, such as spraying for weeds at the start.   I have not made a specific allowance for subsequent weed and pest control, but once again I don’t think that alters the big picture a great deal.

I then looked at the current land and buildings value which Beef+Lamb lists as about $8100 per ha. I asked, what is the carbon return on this investment?

I answered this by calculating the ‘internal rate of return’ (IRR). This is a measure widely used in finance. I have used and taught IRR and associated financial techniques throughout my career.

I am always somewhat cautious when people ask me for an internal rate of return as to whether they understand what it means. However, in broad terms, and applied to this specific situation, the IRR calculates the return you would make on a purchase price of $8100 per hectare, recognising that after 50 years the land then has no sale value. In other words, the economic returns are exhausted over that 50-year period, and the loss of capital value has to be accounted for.

The answer is that the expected return is 9.7% per annum. It would be higher if credits beyond 50 years become available.

Note that this is what we call a ‘real return’ assuming constant-value dollars. If, for example, the carbon price increases with inflation, then the nominal return will be higher. If the carbon price increases faster than general inflation, then the real return will also be higher.

The next question is how does this return compare to sheep and farming on that land?

That question is reasonably easy to answer. Assuming current profitability of sheep and beef, with returns increasing at the rate of inflation but no more, then the internal rate of return, assuming in this case that the returns go on forever, or alternatively that the land can be sold at any time, is around 2%.

Now, let me make it clear that I am not advocating that any farmer should rush out and convert the farm to forestry just on what I say here. Any such decisions need to be specific to the specific farm. What I am doing is drawing a general picture.

The type of calculation that I have done here is something that big and small corporates are currently doing with their financial teams. They can work out for themselves how the numbers align. However, this sort of calculation is not within the skillset of most farmers. Nor is it necessarily in the skill set of their local accountant.

I also asked another question within the spreadsheet. How high could the price of land go and still return at least 6% IRR? The answer was $15,500 per hectare, based on the current carbon price.

I emphasise that in this article I am not arguing that New Zealand should necessarily put all of the hard-hill country into pines forests. That is another issue, and it is a big issue. I am simply suggesting to rural folk how the numbers lead towards serious discussions.

Also, I emphasise that in this article I have focused specifically on the North Island hard-hill country. The issues do extend well beyond that land-class, but that needs its own analyses.

Finally, a little less than two years ago I gave a guest lecture to the Diploma of Farm Management students at Lincoln at the end of their course. My key message to those thinking ‘sheep and beef’ was that they needed to keep abreast of carbon-farming issues. Two years later that message needs to be screamed out again, this time from the tree tops.

About Keith Woodford

Keith Woodford is an independent consultant, based in New Zealand, who works internationally on agri-food systems and rural development projects. He holds honorary positions as Professor of Agri-Food Systems at Lincoln University, New Zealand, and as Senior Research Fellow at the Contemporary China Research Centre at Victoria University, Wellington.
This entry was posted in carbon farming, forestry, sheep and beef farms, Uncategorized. Bookmark the permalink.

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

  1. Peter Baker says:

    Keith, What is likely to happen to the thousands of hectares of 50 year old pine forest once credits can’t be claimed?
    Could you give me an understanding of what drives the price of NZ Carbon Credits?
    Is the supply of credits fixed or expanding and are the credits available to all comers at a price?

    • Keith Woodford says:

      Peter,
      1) Under the current rules, it has to be left in forest. Or else the credits have to be repaid.
      2) All emitters will have to purchase credits. The demand for credits is likely to increase. For example, big companies like NZ Steel and the aluminium smelter currently get free credits but free credits are supposed to decrease over time. But it is a market that depends on regulations so anything can happpen.
      Keith

  2. robin gardyne says:

    Land used for forestry is depleted of nutrients, where as pasture land regularly fertilized and rotation ally  grazed is rich in nutrients and has better retention of moisture. Root growth promotes soil microbe health and generally is better for land than forestry. This buying up of large blocks to plant in trees is destroying not just land but also communities.  The Government obsession with this does not advance there wish to manage carbon as land under pasture with good management also conserves large amounts of carbon  Yours faithfully Robin Gardyne

  3. George Wilson says:

    Hi Keith,

    Would you be able to share you calculation spreadsheet of IRR?

    Regards

    George Wilson

    • Keith Woodford says:

      George,
      I put the spreadsheet together for myself and it is not documented for others to make sense of.
      But it is just a simple cash flow model
      As a starting point, the Beef+Lamb value of Land and buildings goes in at the start of year 1.
      Then there are $3000 of establishment expenses throughout year 1
      Production for the next 50 years thereafter is from the official look-up tables.
      Carbon is priced at $48 per tonne.
      Property rates are included but there is no disaster insurance.
      I then calculated the IRR.
      I then calculated the maximum purchase price of the land assuming a 6% real rate of return – calculated as the land price that drives the NPV (6%) down to zero.
      I have in mind another article that looks among other things at carbon plus production timber. So I will need to look at some more scenarios for that.
      Keith

      • Warren Begley says:

        Hi Keith
        Can you please comment / elaborate on the disaster insurance aspect. If the risk of loss to fire increases in a warming world won’t this be reflected in the cost to insure? I understand one model is to self insure by retaining units however would this significantly impact the IRR?
        Cheers for the incites.
        Warren

      • Keith Woodford says:

        Warren
        I have an article coming out in the next couple of days which covers some of this.
        Keith

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