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’.
The Class 4 hill country totals around 1.8 million effective farming hectares according to a B&L 2020 Fact Sheet. These farms average 434 farming hectares, with the land and buildings worth about $12,400 per hectare. The average return on total capital invested, which includes livestock and machinery, is around 2.5%, but this still has to pay the owner’s drawings.
In general, trees don’t mind too much whether they are on medium or steep hills. It is all about moisture and light interception. Accordingly, the official ‘Look-up’ tables setting the allocation of carbon credits do not discriminate by slope or aspect.
Land area is always measured as the equivalent flat area, as if all the land was bulldozed to a flat condition. Accordingly, a steep slope will have more sloping surface area than a flat area, but the light interception per square metre of that sloping surface area will be less.
In assessing the economics of carbon farming on this land and using the official Schedule 6 Look-up tables, there is only one important change needed to the figures I recently used for the hard-hill country. That change is that land and buildings for this more moderate land are valued by B&L at $12,400 per hectare rather than the $8100 for the hard-hill country. I also increased the land rates from $23 per hectare to $32 per hectare but the overall effect of that is trivial.
So here is the comparison for B&L Class 4 hill country. Under carbon forestry, the estimated IRR is 7.0%, compared to about 2.5% under sheep and beef.
In response to my last article, I received numerous emails both from foresters, farmers and others. Some of the points they were making apply to both hard and more moderate hill country, and I will respond to key points here.
The risk of disaster
The calculations I have reported so far do not include allowance for disaster by fire, pests or disease. What happens to the carbon credits in that situation?
The disaster regulations are not necessarily set in concrete quite yet, but my understanding is that if disaster occurs, then carbon credits take a ‘holiday’. The forest owner does not have to repay anything, but there are no more credits until the forest recovers to its previous stage, with this including replanting if necessary.
As an example, I analysed a scenario whereby disaster strikes after eight years, and that it then takes another ten years to recover to the previous state. On the hard-hill country, that reduced the IRR from 9.7% down to 6.9%. On the moderate hill country, it dropped the IRR from 7.0% % down to 4.9%. In both cases, it extended the claimable credits out further into the future, with the 50 years of credits still claimable but now over a longer period.
Delaying the disaster until the forest is 20 years of age has a lesser effect. For example, on the easier hill country and assuming the same recovery period of 10 years, the IRR now becomes 5.9% rather than 4.9%. This smaller effect may seem surprising, but it is caused by the carbon credits having already substantially exceeded the initial investment by the time of the disaster. Accordingly, for carbon forestry and in marked contrast to production forests, a late-stage disaster is a lesser disaster from a purely financial perspective.
Extending the benefits beyond 50 years
In my previous article, I stated that the benefits were only valued out to 50 years because that is as far as the ‘Look-up’ tables extend. However, an MPI specialist confirmed in a recent webinar to members of the NZ Institute of Primary industry Management, which I attended, that these tables will be extended once more data become available.
Based on discussions with foresters, I have assumed as one scenario that the forests will continue to earn credits for another 30 years through to 80 years at 20 tonnes per annum per hectare. That is sufficiently far off that those additional years have only a minor effect on the IRR, raising it by only around 0.1%. This is trivial in terms of the overall financial returns.
The benefits of scale
The advice I have received from foresters has emphasised that the Look-up tables are conservative. However, for forests of less than 100 hectares, I am told these are the numbers that must be used.
In contrast, for forests larger than 100 hectares, the numbers to be used must come from surveys by professionally accredited forest surveyors. This obviously comes with a cost, but the additional benefits on well managed and favourable sites can be considerable.
One forester advises me that he recommends a permanent forest should be planted at 1600 trees per hectare, instead of the normal 1000. Also, there is no need to thin or prune such a forest, and this gives a further advantage over the Schedule 6 Look-up numbers. The upside from doing things this way is considerable. It is a big advantage for the big boys!
What happens of the carbon price crashes?
I don’t expect that to happen. But if it did – let’s say that it dropped to $2 which is where it was for several years earlier this century. The financially optimal investment strategy would then be to cut down the forest and repay the credits at that miniscule price of $2, and then change the land-use back to whatever had become more profitable. This is exactly what happened some ten years ago with big areas in the Central North Island, and also to a lesser extent elsewhere, with the most profitable alternative land-use being dairy.
Pulling it all together
If financial returns were all that mattered, then it is clear that current carbon prices are sufficient to justify turning much of the North Island sheep and beef land into carbon forests. However, financial returns are not everything.
To explain that a little more, the commercial world operates on the basis of maximising profits within a regulatory environment. It is up to the regulatory environment to take other things into account. Those issues include the need for export earnings, with carbon trading being essentially an internal market. There are also big issues as to whether locking up land in this way is actually the right moral thing to do.
Those issues are too big to address here. However, I am likely to have more to say about those issues in the near future.
The big message right now is that carbon farming is becoming a game changer in New Zealand rural land-use. It is where the money lies. We need to think carefully about the full implications thereof.
***
Posts from Keith Woodford 
An interesting article, Keith, as ever. What about the economics of planting native forest versus the bland monoculture of pine forest?
Mike,
I have not as yet run the numbers on native forests but they won’t be flash. Expensive to establish compared to pine, and growth rates a little over one third that of pine. So cannot be justified on simple economics. There have to be other motives if it is to stack up.
Keith
Thanks for your article Keith. For me, the key point is that allowing carbon offsets just lets emitters get away with emitting and not changing bad practices. CO2 emissions must be virtually eliminated, full stop!
Great, Keith, that you’ve opened discussion, as it shows the folly of political ways to try to solve what is a very serious problem; Climate Change.
Are using Carbon Credits really going to cause a different ecological disaster by covering NZ in non indigenous pine forests & upsetting our ecology even more than when we chopped down the native Bush in the 1800s?
Replanting or regeneration of native Bush may be slower, more difficult & expensive, but that would result in re-establishing NZ’s ecology.
Sterile pine forests? Don’t we care about the world ecology any more than plastic pollution & what we’ve already done to the world?
Well said. Carbon Credits appear to be a huge political fudge.
Hi Keith, Really pleased youve done some projections on this damned Carbon Forestry thing ,I have thought for a while now that it could well be a tool for the anhialation of our industry by unfriendly politicians. I wont forget the leftwing attitude in the 80’s and90’s and painting of sheepfarming as”hill country lice”. That very small mindedness and invictiveness doesnt suddenly disappear altogether, and given the slightest bit of oxygen ,can suddenly reappear again .
So for me its “all hands to the guns “, as my Dad used to say.
Keith, I was wondering if you had extended your Cost /Benefit analysis out much further than the 17yr cut -off of C payments in the first rotation, and taken into account the non-payment for C in any subsequent rotations ?
The IRR rates for Forest C , you show, are particularly high , and for a permanant forest cover ,with no income outside the 17yr cut-off , and no wood income,into perpetuity, it does look pretty rosy.
I just hope that there’s not a few politicians on the inner circle sitting back with a smile on their faces and saying –“Bring it on!”
Alan Stuart
Every blade of green grass is sequestering carbon. To harvest trees it takes heavy machinery using diesel and oil but sheep and cattle harvest grass with less emissions it should be acknowledged as carbon neutral. But climate is not changed by emissions but by air pressure- anti cyclones fine settled weather or cyclones cool wet unsettled or stormy weather. Read Patrick Moore, he is a scientist who has a better understanding and says it better than I.
Keith is there some capital component in your calculations? My understanding is there is a limit to how much Carbon can be sequested in an area of land. As the area approaches that limit it will reduce in value unless the price of carbon drops to the point where the land can be cleared
Tim,
Yes, the IRR calculations factor in the initial value of land as a capital cost, and allow that this capital value will decline to zero eventually because the land is locked up in permanent forests and therefore no longer has a market value. The commercial folk think of it in the same way as a mine, in that they not only want a return on their capital but they also have to recoup their initial capital, and this capital recoupment is factored in to the IRR calculation
Keith
So if the total income is spread over eternity then the return will approach zero? A mine if it is open cast will probably have a restoration clause in any consents which limits the time frame.
Tim
Tim,
If the same total income were spread across eternity then the return per year would be minimal and so would the IRR.
Once the pine trees stop sequestering carbon, then you can cut the IRR analysis at that point or add in a series of zeroes through to eternity. Both approaches will give exactly the same IRR.
IRR places a lot of weight on early returns whereas distant returns are heavily discounted. It is the standard method that all the finance corporates use, and also groups such as Treasury. A key part of the logic is that money earned early can be reinvested to earn even more money.
IRR is a good way of comparing investments but it is not the right tool for people who place a high weighting on the long term future. It works well as long as the economy is growing but the logic can get shaky from a societal perspective once global growth peters out.
To give an example of IRR:
Assume an investment of $1000 gives an annual return of $100 per annum through to eternity. The IRR will be 10%
Now assume the same investment only gives a return for 20 years and the initial investment has no further value to you or anyone else. The IRR will reduce to approximately 7.7% because some of the returns are needed to repay the capital which has depreciated in value to zero.
Now assume the returns only last for 10 years. In this case the IRR is zero because all of the returns are needed to repay the capital and there is nothing left over.
These calculations are best done on a computer. The principles are taught in finance courses.
Keith