Farm Forestry New Zealand

The Emissions Trading Scheme – Opportunities closing

Forest 360, New Zealand Tree Grower February 2021.

Legislative changes and carbon models

At the forefront of the recent changes is the introduction of the ‘averaging’ accounting model. This is based on the average volume of carbon that would be stored in a forest over multiple rotations and avoids surrender liabilities associated with harvesting, assuming the forest is replanted. It is more in line with how New Zealand reports under the international climate change Paris Agreement. The regulatory settings of averaging are not quite set-in-stone, but an example of how this model is likely to work is as follows −

• A first rotation forest is planted in Hawke’s Bay and registered into the Emissions Trading Scheme
• The forest owner earns carbon credits for the period up to 16 to 18 years, which would be 398 to 473 New Zealand Units a hectare
• From year 19 to harvest, at between 25 and 30 years, the forest owner does not earn any carbon credits
• The forest is harvested, and a second rotation forest replanted. No carbon credits are required to be surrendered. However, no further carbon allocation would be received for growing over the same rotation length, unless the stand is grown to an older age than the first rotation, more than 25 to 30 years.

Advantages and disadvantages

Averaging aims to incentivise new planting as forest owners will know that they can keep the carbon allocated from the first rotation. However, older and second rotation forests will be significantly disadvantaged under this model as they will already have passed the average age of 16 to 18 years, or the forest will have already entered its second rotation and is unlikely to receive any further carbon allocation.

In contrast, under the current sawtooth accounting model, the forest earns credits as it grows, but must surrender credits if carbon stock decreases from harvesting, before beginning the cycle again in the second and subsequent rotations. The table below aims to summarise some of the advantages and disadvantages of all carbon models.

Owners of small forests could miss out on a number of opportunities if their forest planted after 1989 is not registered and application approved before the end of 2022. This is when the option to register under the sawtooth model comes to an end, other than for what is classed as permanent forestry.

Asking some questions

We have seen land owners miss out with the Emissions Trading Scheme previously. For example, the pre-1990 forest allocation plan which aimed to compensate land owners for the potential costs of deforestation or reduction in land value through an allocation of credits. Those who submitted applications before the deadline and were approved they benefited, but those who failed to do so missed out. In 10 years’ time, the same may be said about this situation.

Every owner and forest are different. The questions to ask when considering the carbon models are −

• What is the age class distribution of the forest estate? Example − A forest planted in the 1990s which has passed the ‘average’ amount of carbon.
• When is the forest planned to be harvested? Example – A forest planted in the 1990s which will be harvested over the next five years and not currently registered in the Emissions Trading Scheme.
• What is the long-term strategy for the forest or business? Example − Syndicated 1990s forest due to harvest, replant and sell in the next five years.
• What is the risk appetite of the forest owner and what means are available to manage risk? Example – You do not like the risk of trading carbon credits yourself but could be interested in leasing them to someone else.

Model type	Advantages	Disadvantages
Sawtooth	Full allocation of carbon credits	Surrender of credits liable at harvest
Averaging	No harvest surrender required	Limited volume of carbon credits allocated
Permanent	Full allocation of carbon credits	Restricted harvesting activity

Older or second rotation planted forests

There is a common misconception that for older or second rotation forests the Emissions Trading Scheme is not worthwhile because a significant amount of the carbon units or credits, if not all of them, will need to be surrendered at harvest. This is true and there are risks to be considered, but they are manageable and the potential benefits and opportunities can, in a lot of circumstances, outweigh the costs.

Historically forestry investments for those involved in small-scale forestry have involved outlaying a significant amount of capital in the first 10 years, for a financial return in around 30 years. However, a variable log market with low prices at harvest can lead to mixed results in terms of return on investment. The harvest nett returns can range from negative to upwards of $50,000 a hectare.

The Emissions Trading Scheme changes the structure of a forestry investment with the ability to achieve income throughout the rotation by trading or selling carbon credits. With two products being available − carbon credits and timber − a forest can be a resilient investment.

The carbon price

A typical forest in the Manawatu region could earn around 587 units a hectare between 10 and 28 years in the second rotation. These will need to be surrendered at harvest, but they could be leased or used to fund other investments in the interim. They would otherwise be foregone under the averaging accounting model. At current prices this represents $20,500 a hectare and is equivalent to a reasonable return from harvesting.

There is uncertainty in predicting carbon prices for 2050, although the current thinking suggests there will be higher prices in the near future. A further price increase could tip the scales in favour of carbon. Whether or not this is a good thing is up for debate.

This raises the question. What is right for you as the owner of one or more small forests? We suggest that the expense of registering and participating in the Emissions Trading Scheme is low when compared to the potential opportunities and returns. These include −

• Better marketability and value to a prospective purchaser who may want the option of trading or selling carbon
• The ability to respond to a market opportunity
• The use of carbon units to fund forest management or the growth of more credits
• Retaining the units as a hedge for cashflow shortages, or lease the units

A brief recap of the four opportunities covered in the November Tree Grower are summarised below:

Better marketability

Thinking of selling your forest soon? Forest land which can earn carbon credits has seen significant increases in value. For example, in the Wairarapa, current land values for cut-over harvested land from a forest planted after 1989 which is, or can be, registered in the Emissions Trading Scheme averages around $5,500 a hectare. Cut-over land with no carbon opportunity, in other words land which was planted in trees before 1990, averages around $3,000 a hectare.

However, not all forest land is made equal. If you own a forest planted after 1989, by registering for the Emissions Trading Scheme under the sawtooth model, you provide more options to prospective buyers, potentially increasing your marketability and value, if you do decide to sell.

Respond to a market opportunity

Whilst no-one has a crystal ball, you can give your asset more resilience by having more than one market it can access − logs and carbon. Your carbon units in the future could be worth more than the harvest return or vice versa.

Many banks and investors use the discounted cashflow analysis valuation method, which heavily penalises forestry as an investment. However, using carbon credits to offset early expenditure could significantly improve the investment case.

Carbon accrued by an older forest registered under the sawtooth model could be sold and used to offset costs of a new forestry investment. As long as the new forest is registered in the Emissions Trading Scheme, it could then earn credits to repay the first forest if needed at harvest or carbon units could be purchased to meet the surrender obligation. In this scenario, credits are actively managed as a resource to even-out cashflow over a long timeframe.

Retain credits or lease units for cashflow

If you feel uncomfortable selling units and having to purchase them back at an unknown price at harvest, you could accumulate these units and hold them in an account and not sell. This will enable you to see what happens with the carbon and log price and take any opportunities which may arise.

Another mechanism in which cashflow could be aided with lower risk is to lease carbon units. A carbon lease offers forest owners an annual payment for the rights to all carbon sequestered by the forest, with a guarantee of all unit surrender obligations being met at harvest.

Summary

There are thousands of hectares of unregistered forest land planted after 1989, many of which have been planted in the 1990s. If these forests are not registered and the application approved by the end of 2022, they will miss out on the additional benefits the Emissions Trading Scheme currently offers over and above those of a conventional forest.

Understanding the Emissions Trading Scheme, your options, opportunities and obligations does take time. In addition, if you do make a decision to register forest land you need to be aware that it can take more than six months for a decision to be made on applications. With a probable surge in applications as we approach 2022 these delays may increase. Bearing this in mind, with the carbon price at just over $37 a unit at the time of writing, it may be time to take a closer look at entering the Emissions Trading Scheme, particularly if you own one or more small forests planted in the 1990s and want to have all options available to you.

The Forest360 Land Use and Emissions Trading Scheme team are based in Masterton but operate nationwide. Our harvesting and operations team span the North Island. We advise all forest owners considering entering the Emissions Trading Scheme to seek independent advice.