Is your forest sunk by carbon?
Matt Hanna, New Zealand Tree Grower August 2012.
Valuing a forest for sale before the ETS was introduced was a two-part story of land and trees. Now post-1990 forest owners have to consider what value carbon in their forest has, or whether it has any additional value over and above the other two core components of land and trees.
The obligation to surrender New Zealand units for forests which have become part of a carbon accounting area is a contingent liability, and will have an effect on the future value. For buyers it is impossible to predict what that liability will be. This makes the offer process difficult when buying a forest where the owner does not surrender the required units on settlement.
Let us look at the issue from the perspective of buying a forest which is not in the ETS. It is far from certain from a valuation basis as to whether carbon which has not been entered into a carbon accounting record has any additional value. There has been considerable debate already among forest owners and financiers as to the value of carbon in relation to forest valuations.
Reaching a sound and optimistic conclusion about the reliable future value of carbon in a forest was dealt a body blow very early on. Within a very short time of forest owners really getting into the swing of the possibilities that the ETS had to offer in terms of a cash flow, the landscape had become quite bleak.
With the price of New Zealand units now hovering around six dollars, unit holders thinking of selling must be seriously considering their long-term risk and the effect that a revived international economy might have on the price. Selling units today, which might be worth $20 in five years, could result in a serious dent the value of the forest and the land. If anything, a risk taker might buy units toady or convert pre-1990 land and pay out the liability.
Effect of the rural estate market
Of course, it is not only the price of carbon which affects the value of a forest. The value of potential and actual forest land is affected by the overall real estate market and the performance of competing land uses. The rekindling of the rural real estate market has seen the number of rural sales climb in the past 12 months. REINZ data shows that in the 12 month period to May 2012, the number of rural sales increased in New Zealand as a whole by 50 per cent.
This increase in sales volumes is a healthy sign for owners and banks alike, demonstrating confidence in the rural sector. Rural real estate prices appear stable with sufficient listings on the market to meet current demand.
For foresters, the cooling of the real estate market in 2007 has seen more subdued forest land prices so that there is more reality in buying land to plant. However, finding suitable land at traditionally viable land prices of between $3,000 and $5,000 a hectare in a suitable location is still a challenge.
Benefits of pause in the market
One of the benefits of a pause in the market, and an early reality check with the ETS, is that forest owners can now really understand the risks and benefits. The ETS was introduced at a furious pace, with a significant run toward the start line. Forest owners of pre-1990 forest had to make their application for the forest allocation plan by November last year. Many post-1989 forest owners were focused on classification and detailing of their forest land rather than understanding the operation of the complex system of the ETS.
Buying and selling forests and farms with forests on them has become more complicated with the introduction of the ETS. Previously the focus was on the underlying land title issues, forest value and tax. Now when buying forest land it is a critical first step that both sides understand how the forest is classified. Is it part or all pre-1990 forest, or post-1989 forest. How does the forest relate to the ETS?
As the ultimate obligation under the ETS falls on the landowner, any buyer needs to establish what, if any, the liabilities might be. The agreement for sale and purchase must enable the buyer to clearly identify from maps, plans and photographs the age classes of the trees and areas. Full inventories for carbon accounting areas and the record in the ETS must also be available, along with disclosure of the vendor New Zealand unit holding account.
If historical information for forests on the ETS time barrier of 1989 to 1990 is not available, then other evidence such as invoices from nurseries and contractors can be used. As a last resort, counting the tree rings is an option, but not on every tree.
Getting the classification right is obviously important, not just because pre-1990 forest land is worth significantly less than post-1989 land. It is because it comes with the contingent liability of reafforestation or obligation of surrender of units if not replanted within four years of harvest. Often vendors are prepared to give warranties. However with such a long term-crop, suing the vendor 15 years later for a misrepresentation is probably unlikely, especially as most civil actions are time limited.
Negotiating the appropriate price
For forests which have been entered into the ETS by the participant forest owner, lessee or forestry right holder, there will need to be a negotiation which understands what units have been transferred to the vendor and the status of the carbon accounting record in respect of the forest to be transferred.
There are two possible ways to resolve the problem and negotiate the appropriate price.
The first option is that the vendor can sell the forest without surrendering any units. The purchaser becomes the participant and accepts the liability for surrendering units in the future to bring the carbon accounting record account for the forest to a nil balance.
Alternatively, the purchaser can insist that the vendor surrenders to the New Zealand Emissions Units Registry, at the time of the settlement of the transaction, sufficient units to balance out the carbon accounting record, or transfer to the purchaser’s holding account the number of units agreed. This may or may not be the number required to settle the carbon accounting record. The agreement needs to provide a mechanism to achieve this. Leases and forestry rights, which grant the lessee or forestry right holder the right to become the participant, need to be regulated in a way which protects the land owner at the expiry of the term, or if the lessee or the forestry right holder become insolvent.
In both of these examples, unsatisfied obligations to surrender units will fall to the landowner. That, in turn, will definitely have a negative effect on the underlying value of the land and the landowner’s cash flow if the obligation to surrender units is mitigated by replanting.
All these problems really lead to both buyer and seller needing to have a clear understanding of what the issues and risks are. They need to make sure that they end up with the result that they expected, and only taking risks they can manage. Most farm foresters either harvest or sell their forest once. The lessons of old of ‘not selling in haste and repenting at your leisure’ still apply.
This article is provided by Matt Hanna, a commercial lawyer with 20 years’ experience in the forestry sector.