Forestry investments – Current returns and future prospects
Peter Gresham, New Zealand Tree Grower November 2015.
The first part of this article, about forestry investments and the returns from harvest, was first published in Tree Grower in early 2004. Now, over 11 years later, it seemed to be a good idea to follow up what the author considers about forestry investments in the intervening years. Those avid readers with excellent memories can skip the first couple of pages but if you want to be reminded what was said in 2004, read on...
There has been a good deal of publicity recently  regarding difficulties facing the forestry industry and most commentators have put a very negative twist on this most important facet of the New Zealand economy. Concerned that this may be depressing for you, I am motivated to set out the realities of our own tree growing and harvesting operation and to put in perspective what I observe of the processing and exporting industry.
While I can give facts in respect to our own experiences to date, my observations regarding processing and exporting or future prospects for the industry are not put forward as expert opinions.You can give them whatever weight you deem appropriate.
Joint venture harvesting
Along with Geoff Redington, I have been involved in marketing logs from plantations we have had an interest in since 1993. Initially these came from small joint venture plantations with local farmers, but since 2000 we have been harvesting plantations which are part of our group – firstly Waitotara, and then our current operation at Brunswick Forestry Company in Wanganui.
The Waitotara block harvested over 2000/2001 produced an average of 572 tonnes a hectare at an average price nett of all harvesting and marketing costs of $54.74 a tonne – a return of $31,311 a hectare for the 101.8 hectares cut, and a return to investors of $25,049 per hectare after deducting the 20 per cent due to the land owners.
There had been intermediate returns from thinnings as well as very low establishment costs, so the return to the investors on their investment was a very presentable 20 per cent a year over the 26 year life of the plantation.
The Brunswick harvest started in December 2001 and is projected to finish in mid 2004. To date it has produced 510 tonnes a hectare with the net price averaging $45.17 a tonne. Harvesting at Brunswick costs $14.25 a tonne more than Waitotara because of the steeper terrain and roading costs are $3.42 a tonne more. The mill or wharf gate price of logs before deduction of costs of harvesting, cartage, roading or marketing for Brunswick has averaged $99.79 a tonne which is 14 per cent above the figure of $87.50 a tonne realised for Waitotara.
Factors affecting the market
Whilst all of this seems very good from our perspective, the serious tremors throughout the industry have been caused by the deterioration in log and timber markets since around April 2003.
The factors affecting the market over the past few months have been −
- The steady fall in the value of the US dollar, the currency most overseas timber trades are denominated in, which whittles away the returns from export logs as well as timber sales
- Increasing competition in the US mouldings market mainly from South American producers who enjoy some freight advantage and are well organised
- Increasing supply of clear fibre to the US market from New Zealand and South American producers some of whom are able to compete at lower values
- Reduction in US prices for our quality timber mainly as a result of above two factors
- Surges in log supplies to the Asian markets mainly from Russian sources which have affected prices
- Reduction in processing capacity in China due to the SARS outbreak
- Increases in sea freight costs due to oil prices and pressure on shipping from the consequences of the Iraq war which affects all log and timber exports
- Buoyant domestic construction markets in New Zealand and Australia which has encouraged many New Zealand mills to switch to saw log rather than pruned logs.
Log price changes
Overall, these factors have combined to bring about a serious fall in profitability for New Zealand processors involved in exporting, and a consequent mark down in log prices, particularly for pruned logs. Any profits we were making in exporting logs disappeared and, as far as possible, these grades were marketed to New Zealand mills.
Examples of log price changes over this time are −
- Pruned logs went from $165 a tonne in June 2003 to $145 per tonne in October
- Sawlogs were $90 a tonne in June and $87.50 a tonne in October
- KI grade export gave a net return in April of $4 a tonne and a net loss in October of $8.88 a tonne
- For pulp logs the net loss of $11.98 a tonne in June stayed the same for October.
The above changes give a broad picture, as there are many grades of logs and a wide variety in prices from processors. The net effect of all this on the Brunswick returns has been to reduce our average stumpage from $50 a tonne in June to $44.50 a tonne in October. I emphasise that this fall would have been much greater if our marketers had not quickly switched all possible export logs to the local market and also found some niche markets for various grades.
Agrifax log prices
A comparison worth making at this point is the published Agrifax average log prices for New Zealand with our own results. The Agrifax price is based on a mill/wharf gate basis which is the price from which harvesting, cartage and selling costs have to be paid before profit is made. This figure for October 2003 was $68 a tonne which compares with our own result of $99.79.
To put it another way, a plantation owner producing average quality logs with the same harvesting and cartage costs as Brunswick would be pocketing only $22 a tonne before paying for roading or replanting. This may put in context the comments made by some growers that there is no money in trees and the reason for a number of growers suspending their harvesting.
The best option
When it was apparent that these price falls were coming, the Brunswick partners met to make a decision regarding continuing harvesting. After careful consideration they decided that the best option was to keep going. This was motivated by a variety of reasons, amongst them being the thought that there was no reason to think that higher prices would return in the short to medium term.
In fact there has been some brighter news since that meeting with some small price lifts in the US and a marked rise in prices offered for logs in Korea.
On the other hand the US dollar continues to slide and sea freight rates climb ever upwards, so there is no significant improvement in our nett returns.
Observations on market factors
The big question is how log prices will move in the future? I cannot give a certain answer to this but I make the following observations relating to the market factors mentioned earlier:
- The US dollar may strengthen but there is no certainty to this and we will possibly be having to cope with a relativity of 60 cents or more for some time
- Competition in the US or any market will not diminish, but I see signs that our exporters will market better and to a wider range of markets. Our own stable fiscal climate may give New Zealand an important edge when competing with South America or Russia.
- Export markets for logs may well come back into profitability and the approval of radiata as a building product in China is welcome
- More shipping may become available if international tensions ease and freight rates will drop if oil prices go down.
- Construction markets in Australia and New Zealand my well stay strong but history tells us that good times do not last forever.
All of the above is something of a gamble, but what is quite clear is that at the present time New Zealand processors are struggling to make a profit. They will resist any log price increases until their margins improve substantially.
The return on investment
Overall, I have estimated the return on investment in two of our ventures. For Brunswick, which we are harvesting now, total returns nett of harvesting, roading, cartage, selling and administration which were projected to be $6,500,000 at commencement of harvest will now come in at around $5,500,000. The average partner who has invested $27,183 will receive $292,261 and the internal rate of return on the investment will have dropped from the projected 16.3 per cent to 15.1 per cent. There is no credit given in this for the value of the land which will be realised by those withdrawing after harvest and retained by those continuing.
The next plantation to be harvested is called TEFCo. If current log prices continue for the seven years or so it will take to complete this block the net returns should amount to $18,025,000 which will see an investor with a 2.5 per cent interest receive $450,625 for their investment of $50,666. I calculate this as an internal rate of return of 12 per cent. Again this is without any credit for the value of the land. It should also be noted that many TEFCo investors had handsome tax gains through the early 1980s when the top tax rate was 66 cents and we gained a tax refund without spending any cash.
I could extrapolate further for later harvests but there is little point in trying to guess them all that far out. I have applied today’s prices to another plantation due to be harvested in 2013 to 2015. Allowing for the likely costs between now and the harvest period, my figures show an internal rate of return of 11 per cent with an average investor putting in $49,763 for a return of $364,440.
I hope you find the above comments of value. As you can see I have used facts wherever possible and avoided any optimism. I would like to think that these figures give growers and investors reassurance that your investment in growing trees has not been unwise, even allowing for some pruning of profit expectations.
I would add the following proviso. Rates of return quoted must be considered in the context of the management of our plantations which is based on tight control and low overheads. They should not be taken as the norm for the industry.
This article on forestry investment is something of an update on the one I contributed to Tree Grower in 2004. It is a salutary exercise, in effect a review of forestry returns over the last decade which have been rather disappointing. A point which occurs to me is that 2004 was the year we experienced the first major wind storm some months after my article was written and we have had several more of these destructive events in the years since.
There have been many other influences on the economics of forestry in this period and I recognise such factors as the growth of the export market for logs to China which tends to now dominate our industry. In addition is the wane and wax of the United States market and their currency in particular, which has such a bearing on our profitability.
The historical data I gave in my previous article is correct but the rates of return achieved in years before 2004 outshine the returns from the past decade and I reflect on the reasons for this while looking ahead to expectations for the future years. It is a matter of fact, for the forests which I am involved in, that nett returns over the past decade have dropped sharply. This is due to influences such as increasing costs of harvesting and transport, fluctuating log prices both domestic and export and until recently, the steady deterioration in the value of the United States dollar.
In the case of our own forests these returns have also been adversely affected by the series of wind storms we have encountered and the poor grades we have produced from plantations which had dubious tree stock quality. Returns to investors have fallen sharply from previous highs to levels which see them drop to three times the cost of the original investments and in worst cases, towards a factor of two. The only consolation which occurs to me as the promoter of these investments is that, during the past decade, we have seen the collapse of many finance companies which has resulted in many investors losing their capital altogether.
The effect of carbon credits
A new factor was introduced during the past decade and this was the implication of the Emissions Trading Scheme and its consequent New Zealand Units or carbon credits. The government ruled that all plantations with trees planted before 1990 were ineligible for entry to the Emissions Trading Scheme but also had to be maintained as forests in perpetuity if heavy penalties were to be avoided. This was effectively an annexation by the government of the carbon credits produced by all pre 1990 forests.
In recognition of this annexation and its effect on land values, the government allocated 60 New Zealand Units a hectare to the owners affected. These units are tradeable on a carbon market and can be considered to be worth, at any point, their current bid. This is around seven dollars at the moment and while this is a big increase from their low point of less than two dollars, it is well short of what most growers have seen as appropriate to compensate them for the aforesaid annexation. It would appear that most forest owners are holding their units until the price is at or around $20 which gives a figure more in line with the drop in value of the land affected.
For some years now the export market for log grades A, U, K and KI and more latterly P have been a major factor in harvest returns.This market has been dominated by China whose construction industry has had the capacity to absorb seemingly vast quantities of logs. However, the growing reliance on a single market has its problems as recent price swings have shown, fuelled by an increase in the China inventory.
The fluctuating fortunes of the dairy industry have resonance and we should note how the international auction prices have been boosted recently by the decision of Fonterra to withhold some of their products. While it is clear to those in the log export trade that what is needed to induce price rises in China is a reduction in our supplies to them, we are not in a position, as is Fonterra, to carry this out other than with a consensus among exporters which would be difficult to achieve.
The importance of the export market, particularly to China, cannot be over-stated in respect to the performance of our industry over the past decade and for the foreseeable future. Returns from this area have been cyclical but have seen good profits being achieved from harvesting relatively low grade plantations provided they are located near a port.
The local processing industry has continued its consolidation over the past decade with a number of less profitable mills closing or selling out to competitors. While this has resulted in additional transport charges in some cases, the combination of increased efficiency and competition from export prices, together with a buoyant local market has led to price lifts to levels not seen for many years.
Spectacular to moderate
The current situation where export prices are depressed stresses the importance of the local market. With log supplies likely to increase soon because of the 1990s planting boom, access to local mills will become increasingly important and probably competitive between plantation owners.
All of our harvested areas have been replanted which, as far as the investors are concerned, is a decision induced by ETS and regional council requirements rather than any faith in the future profitability of the resulting tree crop. However, having stated this I am of the personal opinion that forests planted at this time will come to harvest at a time when the wall of wood from plantings in the 1990s will have been consumed and there could well be a timber shortage.
The final comment I would like to make is from my perspective as a tree grower for nearly 50 years and a person of senior years. A number of points emerge from this situation but, in relation to investment in forestry, I highlight two. First, the return from my forestry investments over this time have varied between spectacular and distinctly moderate but have always been positive. The second point I make is that your need for the security of cash resources increases as you age, and with our life expectancies extending into the 80s and 90s the wisdom of making investments, such as in forestry, is pertinent to a much later aged group than is generally thought.
Finally I thank Tree Grower for giving me this opportunity to follow up my previous article. I hope that the publication and the author are in a position to follow up this one in a further 10 years’ time.
When Peter Gresham wrote the first article in 2004 he was chairman of a number of forestry partnerships and companies. He had also been active in promoting and managing forestry enterprises, in partnership with Geoff Redington, since the late 1970s.