Approximately 80% of NZ forestry grown for commercial use is managed by large scale commercial operations. The remainder is managed by an estimated ten to fourteen thousand individual growers. Individual growers are some of the more exposed parties in forestry, as they lack some of the information that can help them to mitigate their risks and avoid the common pitfalls associated with forestry investments.
This week, we take a warts-and-all look at investing in forestry assets in NZ.
We speak with Howard Moore, member of the Institute of Forestry and the New Zealand Farm Forestry Association, about his views when considering a long term investment in planting trees.
Location, location, location
If you want to make money from a production forest, i.e. planting, harvesting and replanting trees, it is important to remember that you are dealing with large tonnages of relatively low value products that have to be cut and hauled with heavy machinery. The costs associated with harvesting and freight play a big role in determining your profitability per hectare. Location is important, because the shorter the distance to market the better, says Howard. Easy access to roads and ports can be the difference between a profit and a loss when harvesting time comes.
Topography / steepness
Along with location, the steepness of the land is very important when considering the logistics and costs associated with harvesting. In steep country it’s much more expensive to build access roads within the forest; you need specialist harvesting machinery; the risks of erosion are higher and it’s harder to protect waterways. In addition to transport and machinery costs, gravity works against you. You generally need to haul trees up to the ridgelines, rather than down to the creeks. That takes much more time, energy and cost than if you were harvesting a forest on easier land. Not only is gentle land safer and less expensive to work, there is less chance of unexpected costs that will eat into the profitability of the operation.
Ports
Different ports have different levels of infrastructural challenges associated with loading large quantities of logs. Some ports have traffic issues, and are short of flat areas where you can store and assemble log cargoes. The top four ports for forest growers are, in order Tauranga (6 million tonnes pa), Whangarei, Gisborne and Napier (1 million tonnes pa). The next three are Wellington, Nelson and Dunedin. Congestion and double handling at a port will add to costs, resulting in a lower profit per hectare.
Log prices
With a given forest location, topography and access to infrastructure, your profitability will depend on log prices. These are driven by export demand, exchange rates and shipping costs, all of which change through the year. Log price is also related to log ‘quality’, in the sense of size, straightness and, to some extent, appearance. Quality is managed by tending the forest as it grows: it’s common practice to thin out poorly growing trees to give better ones more room; and you might prune the trees as they grow to produce clean, straight trunks. Tending not only keeps the forest healthy and productive, it improves the quality of the logs for processing, and hence gives you better log prices. Achieving quality will require a higher level of investment in the maintenance of the trees, and also administrative costs for record keeping, but the higher log prices make it worthwhile.
Economies of scale
As mentioned above, there are maintenance costs with forestry during growth; not only for tending but also for rates, fire protection, pest control, access and fencing. Per hectare, these costs are generally more affordable if the forest is larger, rather than smaller. Howard estimates that the costs of managing a plot of say 20 hectares, from bare land to harvest (i.e. including planting) in present dollars is around $3,500-$4,000 per hectare. Since forestry investments do not generally create cashflow until harvest, the money to meet these costs will have to come from the investor’s pocket.
With smaller plantations, where the forest management costs will likely be higher per hectare, it is possible for the owners to do some of the work and reduce the cash drain. However, advice from a qualified forestry consultant will reduce the risks and help improve the final result.
Economies of scale are particularly important in harvesting. Because contractors use heavy machinery, it’s really useful if one forest owner can combine his harvesting with a neighbour, or with a small group of other forest owners close by. The bigger the area the longer the contract, the lower the per tonne costs to the contractor, and the less he will charge (per tonne). It might be difficult to organise, but this ‘harvest aggregation’ can improve returns by up to $3,000 per hectare.
Resource consents
With many district councils a landowner does not require a Resource Consent to plant a forest. However one might need a Resource Consent to harvest a forest, because harvesting will create impacts on other people (for instance, logging trucks might cause road damage, dust and traffic issues). Since the rules might differ from place to place it is worth checking out the local requirements before commencing any planting, and contacting the council or a local professional if you are unsure. Naturally, you should keep in mind that council regulations can change over the life of a forest and that these changes might affect your outcome.
Emissions Trading Scheme
The Government would like new forests to be planted under the Emissions Trading Scheme (ETS). As trees grow they capture carbon, which under the ETS will earn you carbon credits (if you meet all of the stringent compliance requirements). These credits can be sold to businesses who have to account for their annual greenhouse gas emissions to the Government. Over 30 years a radiata pine forest might earn 800 credits per hectare, and today these sell at around $18 each; so a forest under the ETS could earn the grower a lot of money on its way to maturity. However, it’s not all that simple.
The ETS carries its own risks in terms of future liabilities, and they’re not well understood even by people closely involved with the industry. Although trees act as a ‘carbon sink’ during their lifetime, the harvesting of trees results in the release of carbon dioxide back into the atmosphere. When this happens, the ETS credits given for carbon storage have to be returned. Similarly, the ETS requires that carbon credits be returned if the trees are cut and the land ceases to be forest. This means that there is an encumbrance on your land: anyone wanting to clear the ETS forest and farm the land must clear its full ‘carbon liability.’ Since that liability runs with the land, selling the land doesn’t remove it. These carried liabilities can create problems for growers who choose to sell their carbon credits as they earn them. At present the cost of buying additional credits to meet any shortfall under harvest or land conversion obligations can be as high as $25 each. Since there is no guarantee that price will apply in the future, there is uncertainty with regards to future liabilities under the ETS.
If the best land use is forestry, then there is a safe level of carbon credits one can earn and sell under the ETS, and this can generate a welcome cashflow. If you want the freedom to change land use again in the future however, think carefully before registering your forest in the ETS.
Technology disruption
Technology disruption, particularly relating to overseas research into forests and genetic engineering, can affect your potential for return. With a forestry investment you are committed for 25-30 years, and you trust that demand, prices and costs will be favourable when you come to harvest. In most countries, forest rotations are longer than this. Because short rotations reduce risk, cut investment times and allow you to respond more quickly to changing demand, research institutions all around the world are looking at how they can grow forests faster. If some of these initiatives are successful, they could result in new products entering the market that disrupt log prices, change demand for the sort of timber and fibre New Zealand produces, and add risk to your investment.
Genome research and genetic modification technologies are gathering pace, and being applied more and more widely. At present most of the focus is on food production and disease control, where conservative arguments against research can be countered with liberal arguments for public good. How these complex arguments will work out for forestry, and how long that will take in a world trying to adapt to climate change, is unknown. But technology disruption is a very real risk that could literally change the landscape over time.
Natural hazards – fire, flood, wind, pests and diseases
As climate patterns change and storm events become more severe, the risk of fire, flood and wind damage to forests increases. Statistically, annual forest losses in New Zealand are still small but they can be devastating for the owners concerned. Informed forest owners are aware of the need for fire protection (access tracks, security, water points), and good forest management to prevent or reduce loss.
Droughts that stress trees can increase their susceptibility to insect and fungal attacks. Trees like radiata pine succeed in New Zealand because they are exotics, with few local pests and diseases. Over time however there is inevitably biological leakage from one country to another, and sooner or later the productivity of exotic species start to fall as more and more home predators become established. MPI is constantly on the watch for unwelcome pests and diseases turning up in New Zealand. In forestry alone we already have opossums, goats, hares, pigs and deer; and Dutch Elm disease, eucalypt leaf skeletoniser, poplar rust and cypress canker. Research is ongoing to find resistant variants that can fight off these challenges, and humane ways to rid forests of browsing animals, to restore exotic productivity.
Liquidity Risk
Forests are popular as investments because when they are growing they increase in value through biological growth, independent of share prices and interest rates; and large forests that are being continuously harvested and replanted can be cash cows, earning much more each year than they cost to run. The real challenge is in establishing and growing a forest long enough to reach that happy state. A new forest is a money sink with the liquidity risk of a 25-30 year commitment; and while immature forests can be bought and sold, it is a thin market and there are tax implications that are not widely understood. Anyone can run a discounted cash flow analysis to work out their possible return on investment, but the uncertainties that cannot be quantified mean the resulting IRR might be far from the truth.
Conclusion
Before making an investment in forestry you have to be comfortable with the idea that you will be spending money for years to come; that you won’t see it again before harvest; and when that time comes, that there will be strong demand for your trees with moderate harvesting costs. You can control some of these factors so it’s not entirely an act of faith, but it’s close.
As time goes on the whole investment landscape changes; technology, regulations and biological risks change. For all of the above reasons, investing in forestry is a complex operation best undertaken with expert advice. Roughly 20% of New Zealand’s exotic forests are owned by investors who have little or infrequent access to this advice. For new investors, a great place to start is the New Zealand Farm Forestry Association, who take it upon themselves to inform members of the general public about the risk and return associated with forestry investments. The benefit of good advice is competitive advantage in forest health, cost control and profitability. This is good not simply for you as an investor, but also for the industry and in the wider context, for New Zealand’s land management. For more information refer to the websites below:
http://www.mpi.govt.nz/growing-and-producing/forestry/
