Thursday, July 7, 2022

THE BRAIDED TRAIL; Carbon farming in the north

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 NZ there are approximately 920 of these farms, averaging around 830ha and totalling about 750,000ha. The total area might be somewhat more, somewhere around one million hectares, in part because B+LNZ works 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 Hawke’s 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 10% lower.

Working on a 50-year timeframe, 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 10 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 B+LNZ lists as about $8100 a hectare. 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.

When people ask me for an IRR, I am always somewhat cautious 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 a 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 based on what I say here. Any such decisions need to be specific to the 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 corporations 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 skillset 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/ha, based on the current carbon price.

I emphasise that in this article I am not arguing that NZ should necessarily put all of the hard hill country into pine 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 analysis.

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.

***

Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. He can be contacted at kbwoodford@gmail.com  Previous articles can be found at https://keithwoodford.wordpress.com

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