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.