The economics of forestry and carbon farming

	Emission Trading, where are the Carbon Credits coming from?

	The Climate Change Bill before the Finance and Expenditure Select Committee sets out the framework for an Emissions Trading Scheme ("ETS"). For the ETS to work, carbon credits or NZUs as they are to be known, have to be available. (An NZU is one tonne of carbon dioxide CO₂or 1/3.67 tonnes of carbon.) There is a presumption that many of these NZUs will be generated from owners of post-1989 forestry opting to join the scheme. That seemed to be a fair assumption. However we have just undertaken an analysis of what a "carbon farming" business may look like. And its not a pretty sight!



	The underlying issue is that if you sell an NZU you either have to ensure that that 1 tonne of CO₂ is sequestered in perpetuity or you have to purchase an equivalent unit to replace it at the market price at the time of purchase, whatever that might be. Sequestration benefits only accrue for the first growing rotation. Under the current protocols, all that subsequent plantings do is replace the emissions generated by the harvesting. (It is hoped that from 1 January 2013 some recognition will be given to fact that building timbers etc offer a degree of permanent sequestration but this will probably not exceed 20% to 25%.)

	To get a better understanding of the process of generating a carbon credit, the best analogy is that of a currency issuing bank. If a bank prints new notes and issues them, it will receive the face value of the notes from the sale. Because in the future someone with a note may want it redeemed, the bank has a liability for that note as well. If the currency of the sale and the redemption liability are the same, there is no risk of the liability being greater than the sales proceeds however if there were different currencies, the liability could be greater than the historical proceeds received.

	With Carbon Credit, there are two exposures. First there is a carbon credit price itself that most experts agree is likely to increase over time. Then, because this is a global marketplace, there is the exchange rate exposure. If, as all our analyses suggest, NZ becomes less and less competitive because of the impact of the Climate Change legislative framework, the NZ currency is going to weaken over time resulting in further exposure for those having sold NZUs.
	Then we have the impact of taxation. This is the final nail in the coffin of the proposed ETS. Any proceeds from the sale of NZUs are taxable, however the liability is not tax deductible. (Deductibility will only occur when any carbon credits are purchased but the costs will be such that any tax benefit is likely to accrue over many years.) This means that for a 33% taxpayer, if you sell $100 worth of NZUs you bank a net $67 however the cost of delivering to the purchaser, assuming a constant NZU price, is $100.
	The analysis on the next page, Carbon Farming, demonstrates that a theoretical business model for carbon farming does not exist. To succeed, an investor would need to be able to sell when carbon credit prices are high and buy when they are low. You can try that without being a landowner and it would be a much safer business without the carbon delivery liability!

					The ValueAdd Company.

Carbon Farming, does it have a business case or not?
	The key to any business model that is seeking third party participation is to ensure it delivers financial benefits to its participants. One would have thought that Carbon Farming, [ie land owners growing trees either on their own account or in "partnership" with others as a commercially viable proposition, within the Emissions Trading Scheme ("ETS") in the Climate Change Bill] would have been tested as such by the Government before introducing the Bill.
	Our analysis, (for which the user-definable assumptions are shown below), demonstrates that the only scenario that has total revenue from carbon credit sales and the associated liability in balance is zero tax and zero increase in the carbon credit price. (Obviously reducing carbon credit prices could yield a positive result but we suggest that this is highly unlikely. IRD has already determined that receipts for carbon credit sales is taxable.)
	The analysis below looks at just carbon credits, not the economics of forestry because in the analysis, that is irrelevant. Forestry investment needs to stand alone as an investment option. In the model, there is a provision to include a carbon credit income to a forestry investor. There is no such provision with regards to liability for such an investor.

	First Carbon Credit sale, year			9		Results:

		CO₂ year 9			tonnes	Analysis land area		ha

			Year 28		tonnes	Cash from CC sales

		CO₂ start price $				Year 28 liability

	Share for forestry investor

Annual price growth (excl inflation)

		Taxation rate



	Years	CC price growth	CO₂sold (t)	Annual sales	Cumulative sales	CCredit Liability	Excess liability

The cost of Climate Change legislations for pre-1990 forest owners
	There is a considerable cost associated with the proposed Climate Change legislation and the full burden falls on the owners of pre-1990 forests. Owners who have entered into JV arrangements with corporates are particularly disadvantaged because the total deforestation liability lies with the landowner.

	The calculator below undertakes an analysis based on the stated, user definable assumptions. It has the ability to take into account the proposed allocation of carbon credits by the crown and assumes that they are retained to mitigate any future deforestation liability.


	Assumptions:
	Allocation of carbon credits						Sequestered CO₂ by yr 28		t

		CO₂ start price $				Growth (pa)		Harvest year

		Analysis year						Age

Forest establishment cost $							Annual cost (of initial)

	Capital value of land $				/ha		Capital charge (net)

	Cost of funds						Net stumpage value $		/m³

						(In place of pa growth)		Taxation rate

	Harvest yield (click here)					m³ / ha	Note: Under the current proposed tax rules, the deforestation cost is a capital transaction and not a deductible expense.

	RESULTS

	Revenue (per hectare)
		Stumpage (net of tax)



		Net Surplus from forest

		Revenue sacrifice @ $









	Growth	Year	CO₂ $ / tonne	Deemed CO₂ seqstd		Cumulative	CCredit Liability