Farm Forestry New Zealand

What is the NZFFA’s role in facilitating well designed forestry cooperatives?

Hamish Levack and Howard Moore, New Zealand Tree Grower May 2010.

The UN Food and Agriculture Organisation estimated, before the collapse of the Soviet Union, that just over a third of the total world forested area was in private forests.The great majority of this area was in the possession of people owning less than 20 hectares each.

In developed European countries, North America and Japan, where there has been a long history of forest management, most of these owners have formed associations with other similarly-placed proprietors. It is widely recognised in these countries that co-operation provides better profits from economies of scale, including mutually beneficial agreements with the buyers of their wood, and the suppliers of necessary goods and services. Cooperatives can also make substantial gains for their members by planning a sustainable cut of timber and better use of capital equipment.

The history of forestry co-operatives

The NZFFA is itself a sort of low-level forestry cooperative. Members exchange useful technical information, mainly through the Tree Grower.

The Western Farm Co-operative Forestry Company Ltd takes cooperation up to the next level. It has been set up under the Co-operative Companies Act 1996, and is kept going mainly due to the enthusiasm of two Middle Districts stalwarts, Hew McKellar and Humphrey Rainey. What it has done is to offer its 60 members the option of a discount if they use the services of a particular harvesting and marketing manager.

In 2003 Wrightsons tried to get cooperation going at a higher level. They advocated the formation of single asset forestry companies or SAFCOs.

Wrightsons tried to get a number of geographically distinct forest owners, with trees of similar age class, to come together under one entity and have their trees harvested and marketed jointly. The idea was that they would exchange their cutting rights in return for shares in a SAFCO, the shares being proportional to the value of the contributors’ trees at the time of joining.The SAFCO’s managers would then harvest and market the combined forest to best commercial advantage.

At the NZFFA conference in Wellington that year, Don King provided convincing evidence that a woodlot owner’s pre-tax net income under such an arrangement would increase by between 15 per cent and 30 per cent. However no Wrightson SAFCOs have yet been established.

Rick Osborne and Kelly Coghlan also tried to put together a SAFCO in the lower North Island in the late 1990s. Kelly Coghlan says that many private woodlot owners were initially enthusiastic, but when it came to the crunch, these supporters would not sign up.

Why no well designed cooperatives?

Woodlot owners would certainly be a lot more comfortable about joining a SAFCO if there was evidence that one already existed in New Zealand and was working well. Some believe that there is a culture of stubborn independence among New Zealand rural land owners and that this will prevent forestry cooperatives from ever forming. However the existence of Fonterra, a very successful dairy co-operative, invalidates this myth.

Kelly Coghlan reckons that woodlot owners just do not understand how much more marketing strength they would have if only they acted collectively. Another factor is that the demands of the daily job take precedence over making decisions about marketing several years time.

Critical mass

Critical mass could well be a very significant factor. Woodlot owners will become more interested in forming forestry cooperatives as woodlots increase in number, in maturity and in total aggregate area. Such pressure is building up.

The total area of privately owned, non-large-company forest has risen from about 80,000 hectares in 1986 to about 900,000 hectares today. The peak in the new planting rates associated with this expansion occurred in the period 1992 to 1998. This means that we are on the cusp of a significant increase in the harvesting of small privately owned wood, this should trigger off a lot more interest in co-operatives.

Cost of bush tax

Forest owners labour under a unique tax disadvantage. They must hold the expense of buying standing trees in a ‘cost-of- bush account’. They cannot deduct this expense against other income at the time of purchase, but can deduct it from the proceeds of the sale of those trees when they are harvested.

For example, if someone buys a 15-year-old mid rotation forest and does not harvest it until it is 30 years old, the cost of purchase is only deductible against the revenue obtained from that forest in 15 years’ time. If inflation averages two per cent, then the buyer’s purchase price will decrease in real value by 26 per cent over the 15 years before it can be deducted.

Not having the benefit of early deductibility also means that the buyer has to pay more for raising the necessary fund. You have to pay interest for 15 years on money that would otherwise have been recovered from tax deductibility. In this example it is estimated that, at a three per cent real interest rate, the buyer suffers a 17% penalty arising from the time cost of money on the tax element. This is on top of the 26% loss of deductibility caused by inflation. More detail on these calculations can be found in the February 2010 issue of the NZ Journal of Forestry.

As a result, immature forests are worth much more to a seller than to a buyer, and it explains why mid-rotation forests have very seldom been sold. This is generally called ‘the cost-of-bush’ anomaly. Not only does this anomaly stop the consolidation of forests, but it also offsets many of the benefits of joining a SAFCO. The exchange of cutting rights in return for shares in a co-operative is deemed by the Inland Revenue to be a forest sale.

What needs to be done

The NZFFA executive needs to encourage the NZ Forest Owners Association and the NZ Institute of Foresters to support and lobby the government to get the cost-of-bush anomaly abolished. This should not be too hard because its abolition would increase the government’s revenue.

For example, imagine that the cost-of-bush anomaly has been removed and as a consequence, almost all the 800,000 hectares of small private forests.These could yield an extra profit of $3,000 a hectare when harvested, with an aggregate extra profit to growers between 2014 and 2035 of $2.4 billion. The extra income to the Inland Revenue would be $700 million, assuming an average tax rate of 30 cents.

Support needed

The government should also support forestry co-operatives as they will help to accelerate the education of individual owners about good forest practice. Among other things this would result in more owners planting the right species on the right sites, pruning and thinning being done on time, and better forest protection measures being implemented. All of this would eventually result in even higher profits and more tax revenue. Other flow-on benefits include co-operatives with the power to guarantee a sustainable supply of wood for investors in processing which will provide the scale needed for the effective certification of timber and greater efficiency in the sustainable management of stored carbon.

The NZFFA needs to build a register of all woodlot owners. It can be explain to them that it would be in everyone’s interest if information on forest crops − particularly maturity, species and area − is made available
to all participants, so that owners can and consider the benefits of organising continual work for logging gangs. The Executive should also look for funding, perhaps from MAF’s Sustainable Farming Fund and from volunteer contributions, to investigate and develop templates of all the legal documentation necessary to set up properly structured forestry co-operatives.

If cost-of-bush is not abolished

Some complicated and administratively inefficient structures to get around the cost-of-bush anomaly might work. One option is that we should be thinking about woodlot owners not selling their cutting rights to the SAFCO. Instead they could sell a proxy for the cutting rights which confers the same rights, and acts as though the cutting rights were sold.

Under such circumstances each forest owner would sell to a SAFCO, in return for shares, the right to time the harvest, and market the trees on harvest. The timing right would allow the SAFCO to arrange the sale to provide continuity of supply to mills and work for contractors. The marketing right would allow it to take a commission on the sale of wood. However each contributor would still own his trees and each would receive the income from selling the trees through the cooperative when the cooperative chose to harvest them. In this way no cost of bush would be incurred.

Equalisation account

The commission would be used as an equalisation account to pay co-operative members an adjustment related to the sale of the timing right. All members would receive their stumpage net of commission irrespective of log prices. However, those whose wood was cut at times when log prices were good would receive no further distribution. Those whose wood was cut at times when log prices were bad would receive an additional distribution from the commission equalisation account.

The level of commission and distribution would be designed to equalise, as far as possible, the payments by log grade to each member. It is understood that arrangements based on pledges with reference to the times when individual forests are to be harvested and a limited form of equalisation funding is currently under investigation by Forestry Enterprises Ltd.

Conclusion

The cost-of-bush anomaly should be abolished. The NZFFA needs to lobby hard to achieve this, but that should not be an excuse for delaying activity on other fronts. The NZFFA should be beginning basic work towards the building up of a register of woodlot owners, the provision of relevant information to woodlot owners and doing relevant research. (At the AGM in April a remit to the meeting approving the above action was passed)