Is it time for joint ventures?
Howard Moore, New Zealand Tree Grower February 2018.
We accumulate stuff. We die. Often this is just a simple correlation. However, the fact is at some point we have to pass stuff on, and when that time comes it is useful to sort it into different heaps. The relative size of each heap depends on the discrimination of the hoarder and the understanding of the sorter. Even if the hoarder knew their stuff, few sorters would recognise a box of unlabelled papers as anything but fire starters.
Wives call reducing stuff ‘de-cluttering’ but it can feel like amputation. Bleeding from such a trauma I recently found a box-file full of papers on small forest investment. Pleased, I realised that with the election of the new government these might be saved. Instead of Class E stuff they were now in fact Class A stuff, fully entitled to shelf space.
The papers are important because the new government wants us to plant and replant another million hectares of trees. This requires both land and money, and frequently people have one, but not the other. If there is going to be a massive change of land use without a massive change of land ownership, we might need to revisit the ideas in these papers.
For convenience I have listed at the end of this article several of the papers you might recognise. Are they still relevant, now that we have the internet? Well, yes, since they relate specifically to New Zealand where land owners and investors have the same concerns as before, laws have the same purposes as before and legal agreements have the same strength as before. The biggest change in recent time has been the introduction of the Emissions Trading Scheme.
The ETS has made it possible to earn money and recover the costs of establishing and tending a forest early in its life. It gives you a higher internal rate of return or alternatively, once you have your money back you can run the forest for cash flow without worrying about internal rate of return. There is a catch of course. Any carbon credits you sell become a carried liability on the land which is never forgiven, and rises with the price of carbon. The exception, at the time of writing, is if you sell a forestry right. Then any carbon liability passes to the buyer of the right.
A repayable loan
In essence, the ETS provides you with a contingently repayable loan. The government issues you with carbon credits, equivalent to lending you money, which are repayable in the event you cease to store the carbon. Just like borrowing real money, you have to report on progress and so you incur compliance costs. Unlike borrowing real money, the loan carries an unknown interest rate – you have to repay the ‘borrowed’ credits irrespective of their dollar market value.
If you receive carbon credits and sell them at $20, but then have to surrender them at $50 ten years later because your forest has been destroyed, it might hurt.
For the time being you can insure against loss of carbon from fire and storms, but make no mistake, carbon credits are not a gift. They come with risks.
That said, you can plant an ETS forest with outside investment if you accommodate carbon credit benefits and liabilities in the agreement. The basics remain the same.
Ruling out borrowing, which has been used in the past, there are three mechanisms available to land owners for sourcing outside investment for forestry − joint ventures, leases and grants.
My favourite paper on joint ventures Guidelines for Participants in Joint Venture Forestry defines a joint venture forestry agreement as −
‘A contractual arrangement between a land owner and an investor, where the land owner gives the investor the right to establish, manage and harvest a forest on his land. …As both land owner and investor contribute resources essential to the growing of trees, both are entitled to a beneficial interest in the trees and hence a share of harvest value. It follows that both parties also share the risks.’
It goes on to discuss 50 different things which should be addressed in an agreement, offering draft clauses in many cases that you can cut and paste into an agreement of your own. However, the underlying structure is simple. Stripped to its bones, a joint venture forestry agreement under the Forestry Rights Registration Act will −
- Name the parties
- State the purpose
- Define the land by title, map or aerial photograph
- Grant access
- Set the term
- Define the inputs or contributions and how they are shared
- Define the outputs or benefits and how they are shared
- Define the responsibilities of the landowner, the investor, and of both parties together
- Set out a procedure for handling disputes and changes of circumstances.
There are lots of examples, some good and some poor and you should get advice to work out which is which.
A lease is a more arm’s length arrangement than a joint venture. Although leases and joint ventures have much in common, the biggest differences are that in leases you have to commit complete titles, tenants have full rights of occupation, there is no sharing inputs or outputs and there are usually provisions for rent reviews. Other than that, the bones of the agreements can look similar.
Forestry leases were popular in the 1960s and 1970s but no longer so. They can provide for rent to be paid in cash, perhaps as carbon credits, or as a share of harvest. Cash rental leases were used when the land owner needed the income. Rent payments were sometimes indexed to the Consumer or Producer Price Index or land values, and reviewed at regular intervals. Disputes arose periodically because in general, investors and land owners had little in common. A whole generation of land owners’ children could be born and raised within the term of the lease, with little understanding of why their parents had alienated their land.
‘Share of harvest’ leases overcame this by creating strong common interests, and were used by the NZ Forest Service in particular. Examples of these leases are the Lake Taupo and Rotoaira forest leases with Ngati Tuwharetoa and the Mamaku lease with NZ Forest Products, negotiated between 1968 and 1973.
Much like a joint venture share of harvest leases offered land owners an equity stake in the forest, which appealed if the land owner did not require a regular income from ground rent. Of course, disputes arose but with some qualifications these leases proved successful. Leases are not popular today probably because joint ventures under the Forestry Rights Registration Act are simpler to document, offer the landowner more options and are cheaper to arrange for small forests.
The government, via MPI, provides two cash grants to landowners for afforestation − the Afforestation Grant Scheme and the Erosion Control Funding Programme. The first is ‘designed to help establish 15,000 hectares of new forest in New Zealand between 2015 and 2020,’ the second ‘to help reduce wide-scale erosion problems in the Gisborne district.’ These cash grants offset the costs of land preparation and planting, but at the moment neither is funded to make any impact on the government’s planting target. Of course, this could change but no-one I know thinks it is likely any time soon, given other demands on State income.
Thought has been given to privatising the Afforestation Grant Scheme to allow it to run on a grander scale. You might encourage investors to fund landowners by, in effect, forward-buying the carbon credits earned by newly planted forests over their first 10 years. But there are obvious catches.
First, it is unlikely investors would be interested in dealing with large numbers of small forest owners and second, without help, investors would have no way of ensuring the forests they paid for would grow and produce the necessary carbon credits. The government would probably have to do three things to reassure investors and make it work – introduce a price floor for carbon credits, manage land owner compliance and take the credit or default risk. Unfortunately, this risk would appear as a liability on the Crown accounts just as if it the money had come from MPI. Under the National government, that was unacceptable and today it still looks unlikely.
Little will happen
Where does that leave us? Well, I will keep the papers, but unless something changes radically I doubt they will be in demand for a year or two for the following reasons.
Despite the good news signals from the government, it seems to me that −
- Any new forests will have to be planted on grassland, and there is no appetite to grow much of it on the Crown estate.
- Because farm prices are high and farmers do not want to change land use, any land they plant or offer to investors is likely to be steep, unproductive, remote, relatively inaccessible or all of the above. As a result, no-one will rush to buy farm land for commercial forestry.
Little is likely to happen until −
- The rising costs of environmental compliance force down farm land prices;
- The rising price of carbon drives up investor willingness to either buy farm land for long-term commercial forestry using carbon income to help offset the land price, or enter into joint ventures to plant commercial forests on farm land using carbon income to help offset establishment costs
- The public starts asking for forested rather than tussock landscapes.
Even with these changes no-one will want to plant steep, unproductive, remote or relatively inaccessible farm land unless carbon prices are high, stable and offer returns into the future irrespective of possible harvest.
The key to a successful joint venture is a profitable forest. Right now, and for the foreseeable future, the profitability of new forests is determined by the price of land and the price of carbon, and those stars do not align. Until conditions improve I will keep my papers in the box-fle.
There are some useful joint venture publications.
- Joint Venture Forestry on Farmland, J G Groome & Associates, 1983
- Forestry Joint Ventures, NZ Forest Service, 1984
- Guidelines for Participants in Joint Venture Forestry, NZ Forestry Council, 1985.
- Report of the Forestry Joint Venture Working Group, Ministry of Forestry, 1991
- Forestry Joint Ventures Ministry of Forestry, June 1994
- Forestry (law and legal precedents), Ministry of Forestry, 1994
Howard Moore has made and documented commercial loans to forest owners, introduced a forestry right as a security instrument for commercial lending and researched and helped re-negotiate cash and ‘share of harvest’ forest leases. He is a member of the NZFFA and NZIF.