Thursday, July 7, 2022

The Braided Trail: Post-1989 forest owners face complex decisions

This is a further article in a series I have been writing exploring the issues of carbon farming. The issues are important because we are on the cusp of massive land-use changes. These are driven by the current economics of carbon farming now being far superior to sheep and beef farming on most classes of land.

This is a further article in a series I have been writing exploring the issues of carbon farming. The issues are important because we are on the cusp of massive land-use changes. These are driven by the current economics of carbon farming now being far superior to sheep and beef farming on most classes of land.

Carbon farming is part of a virtual market, called the Emission Trading Scheme (ETS) in which there is no exchange of a physical product. As such, the ETS is controlled by Government rules and regulations, rather than by physical supply and demand factors.

The carbon farming component of this virtual market relates to post-1989 forests. These are forests on land that was not in forest on December 31, 1989, or in the immediately preceding years.

The current amount of post-1989 forest land is around 700,000 hectares and increasing. All of it is eligible for entry into the ETS, but perhaps surprisingly, less than half is currently registered. That means that less than half is earning the carbon credits that it could earn.

Why is this happening?

As with everything in relation to the ETS, the answers are complex. But in large part this non-registration in the ETS is because forest owners do not appreciate the extent to which the ‘rules of the game’ have changed.

People shy away because of the complexity, combined with the fact that it is a virtual market controlled by government regulations rather than physical supply and demand. These regulations can and do change, making foresters cautious. Nevertheless, my expectation is that within the next year most owners of post-1989 forests, including farm-foresters, will join the ETS.

The ETS forestry rules work in five-year cycles. The current five-year period runs to the end of 2022. As long as forests are registered before the end of 2022 it will be possible to obtain credits back to 2018.

The forestry elements of the ETS were designed to encourage people to plant new forests, with the international baseline set at December 31, 1989. Any land already in forest immediately prior to that does not earn credits. Also, there are strong financial disincentives applied to deforestation of pre-1990 forests.

Accordingly, if a pre-1990 forest is harvested, then almost always the forest is replanted. Some of these forests are now into their fourth cycle since original planting in the 1920s.

These pre-1990 forests are production forests, independent of carbon farming, and there are about 1.4 million hectares in this category. Sometimes they have been profitable and sometimes not.

Then came the 1990s, which was a time when timber prices were booming relative to agricultural prices. Conventional wisdom at that time, at least in relation to the harder hill country, was that production forestry based on a rotation length of around 28 years was the smart thing to get into.

In contrast, there was no consideration given at that time to carbon farming. Some of us were already talking back then about carbon farming as a possible future land use, but such thinking was a long way from mainstream thinking. The ETS that would make those earnings possible was still well over a decade away.

The big planting years for post-1989 forests, with new forests termed ‘afforestation’ to indicate the land was not previously forested, were from about 1993 through to around 1998. Plantings then declined rapidly and have only started to recover in the last two years. Accordingly, well over half of the 700,000 hectares of post-1989 forests are between 21 and 28 years of age.

Approximately 330,000 hectares of these post-1989 forests are currently registered in the ETS. Those forest owners, including farm foresters will have been receiving one NZU for each tonne of carbon dioxide sequestered, with each unit currently worth around $64.

Some foresters will have sold their NZUs when the prices were much lower than now and some will be holding them as registered assets.

Those who have sold their NZUs under old rules and old prices will now have good reason to be nervous about the carbon liabilities they will incur at harvest. The ETS has not worked out well for them.

I expect many of the foresters who have sold their NZUs will never harvest their forests. Rather, at the start of 2023 they will move across to the permanent forest category and keep acquiring carbon credits. Alternatively, some of them will decide to convert to the new ‘averaging system’ that commences in 2022 so as to minimise their liabilities.

For those who have sold their NZUs, it is not possible to say which option is best without looking at the specific situation of the individual forester. What can be said with confidence is that anyone in this situation needs to get specialist informed advice specific to their situation. There are some nasty fish hooks out there.

The situation for those who have registered in the ETS but have retained their NZUs is somewhat simpler. As of March 2021, there were 71 million NZUs worth over $4 billion held by foresters.

If these ETS foresters with retained units now harvest their forests, then they will need to surrender their NZUs. However, by signing up to the averaging scheme they could well be left with a significant number of units which they can sell, with these having a current value of around $64 each.

Alternatively, some of these foresters might also choose to join the permanent forest scheme, cash in all of the units they currently hold, and earn more credits in the coming years that they can sell for cash.

So what about the approximately 400,000 hectares of post-1989 land that is not in the ETS?

My assessment is that these foresters should be looking very seriously at joining the ETS. The clock is ticking and they need to do this prior to the end of 2022. At that date, the option to earn credits for the 2018-2022 period will be foregone.

These forest owners will typically be able to claim between 125 and 160 NZUs per hectare for this five-year period, with each unit currently valued at around $64. That approximates to between $7500 and $10,000 as credits available to be cashed, with further credits available in following years.

If these foresters also join the averaging scheme, they can earn between 300 and 400 units a hectare, depending on location, without incurring harvest liabilities as long as they replant. Alternatively, they may choose to join the permanent-forest scheme as from 2023.

I know of some foresters who have not joined the ETS but plan to do so when they plant the second rotation. This is on the assumption, which is correct, that they will be able to claim credits for that second rotation.

However, what many foresters taking this stance do not appreciate is a nasty little fish hook called ‘residual carbon’ from their first-rotation forest, which relates to both above and below ground carbon remaining after the first-rotation harvest. The consequence is that although they will be registered in the ETS, they will typically not be able to claim any credits for at least the first 10 years of their new forest.

If I was the owner of one of these forests, I would be starting the registration process right now, recognising also that there is currently a six-month processing delay within the system. But I would not cash in my credits until all the new regulations are locked in place.

The big message in all of this is that for any forester with existing post-1989 forests, and this includes many farmers as well as the corporate foresters, specialist advice is essential. The challenge is to separate informed from misinformed advice as there are very few experts, if any, on how the ETS will play out. Also, although the principles are all laid out in enacted legislation, the detailed regulations are yet to be gazetted.

When I started writing this article, I thought I would also write about some broader implications of the post-1989 forests on carbon prices within both the ETS and national carbon budgets. But alas, that will have to wait. Once again those are big complex issues. I suspect that the Government will encounter some unexpected consequences from non-alignment between the ETS and the national carbon budgets on which it reports to the UNFCCC.

***

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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