Forest Sector Participation in NZ ETS: Alternative Policy Submission

1. Summary of recommendations

1.1 Permitted Deforestation Regime

Replace the allocation of 21 million NZU’s to Pre-1990 landowners with a “Permitted Deforestation Regime” of 21 million NZU’s during CP1.

1.2 Proportional allocation of Post-1989 Kyoto Units across sector

Kyoto units earned by the Government from Post-1989 forest carbon removals during CP1 should be allocated proportionally (during CP1) to all forest owners (Pre-1990 and Post-1989, exotic and indigenous) based on the carbon removed by the forest owner concerned.

1.3 Complementary Measures

1.3.1 Forestry Taxation Amendment

Allow full deductibility of land development expenses, roading infrastructure and all costs associated with afforestation and replanting.

1.3.2 Government Afforestation Group

Establish an Afforestation Group within LINZ to:

a) Identify Crown land, Crown leasehold, and private land suitable for afforestation;

b) Satisfy and clear all regulatory restrictions preventing afforestation;

c) Prepare landscape, biodiversity, and species plans for afforestation;

d) Secure rights and tender long-term forestry rights over such land to forest investors;

Edwin Jansen
Ngäi Tahu Property Limited
03 377 8268
3 Dec 2008

2. Summary of proposed forestry design features

a) Source of Emissions and Removals

i) “Change in carbon stocks held in “Forests” (plantation and indigenous, Pre and Post 1990, all forests and participants treated equally);

b) Scope of Activities

i) Carbon removal and emission activities; (emission liabilities should be limited to the amount of previously earned credits)

  • Carbon removal activities include: afforestation, reforestation, re-establishment of trees, forest protection and the passage of time to allow growth.
  • Carbon emission activities include: harvesting and/or the killing of trees and vegetation. (These activities initiate irreversibly the emission of previously stored carbon).

ii) Deforestation (under a permitted deforestation regime);

c) Participants

Commercial entities undertaking activities:

i) Forest Owners, CFL Holders, Forestry Right Holders (in respect of forest activities); and

ii) Landowners (in respect of deforestation activities).

d) Proportional Allocation

Kyoto units earned by the Government from Post-1989 forest carbon removals (during CP1) will be allocated proportionally to all forest owners (Pre-1990 and Post-1989, exotic and indigenous) based on the carbon removed by the forest owner concerned.

e) Permitted Deforestation Regime

i) The NZ Government / NZ Taxpayer will underwrite 5% deforestation during CP1;

ii) 21m NZU’s will be retained by the Government to offset permitted deforestation activities during CP1;

iii) Landowners of Pre-1990 forests (exotic and indigenous) wishing to deforest during CP1 will be required to submit an application (in a prescribed format) and if approved, to undertake the conversion during CP1;

iv) Landowners who have not been granted sufficient deforestation permits under this scheme may supplement deforestation by surrendering NZU’s or AAU’s.

f) Complementary Measures

i) Forestry Taxation Amendment

Allow full deductibility of land development expenses, roading infrastructure and all costs associated with afforestation and replanting.

ii) Government Afforestation Group

Establish an Afforestation Group within LINZ to 1) Identify Crown land, Crown leasehold, and private land suitable for afforestation; 2) Satisfy and clear all regulatory restrictions preventing afforestation; 3) Prepare landscape, biodiversity, and species plans for afforestation; and 4) Secure rights and tender long-term forestry rights over such land to forest investors;

3. Deforestation regime - Allocation to pre-1990 landowners

3.1 Summary

Replace the allocation of 21 million NZU’s to Pre-1990 landowners with a “Permitted Deforestation Regime” of 21 million NZU’s during CP1

New Zealand should avoid “free allocations” on a pro-rata basis that bear little correlation with the actual loss incurred by the affected party concerned. This is not the purpose of allocations and results in windfall gains to some participants at the expense of others and importantly the New Zealand taxpayer. Such “hot air” allocations undermine Government objectives, reduce the integrity of both NZU’s and climate change policy and come at a significant indirect cost to the New Zealand economy.

Assuming that no other changes are made to forest sector polices, it is recommended the proposed allocation to Pre-1990 landowners be replaced by a contestable “Permitted Deforestation Regime” of up to 21m NZU’s (~35,000 hectares) during CP1. This is consistent with the Government’s prior advice that it would underwrite up to 5% deforestation during CP1.

3.2 Government Objectives

We understand the objective of the Government is to:

a) Manage deforestation;

b) Limit Crown liability under the Kyoto Protocol;

c) Provide compensation for imposing liabilities on Pre-1990 deforestation activites;

d) Introduce and pass legislation as soon as possible;

e) Not upset the voting public; and lastly

f) Achieve positive environmental and carbon emission outcomes while minimising the cost to the economy.

A “Permitted Deforestation Regime” during CP1 will give effect to these objectives.

3.3 Proposed Forest Sector Policy and Allocation

The Government’s proposed domestic policy for the Forest Sector is closely aligned with Kyoto Protocol rules for CP1.

There is significant work being undertaken in the negotiation of Kyoto Protocol rules for LULUCF in CP2. Depending on the outcome, the Government’s proposed domestic polices for CP1 may not be appropriate for CP2, CP3 and beyond.

Landowners of Pre-1990 forests will be looking for compensation packages for losses incurred during CP1, CP2 and CP3 (and so on) based on the domestic rules applying for those periods.

While the forest industry would prefer long-term certainty in domestic policy, the industry will continue to seek amendments to inappropriate domestic policy beyond CP1.

Recommendation: The Government should be very specific in stating that the forest sector polices (and unit allocation) apply only to CP1 and not beyond.

3.4 Financial loss incurred by Pre-1990 landowners due to Deforestation liabilities

Under the proposed polices, landowners of Pre-1990 forests face financial losses from a number of sources:

a) For forested land where the highest and best use is not forestry, landowners may incur:

i) A margin loss associated with undertaking a landuse change during CP1;

ii) A loss associated with delaying landuse change during CP1 in the hope of more favourable policies in CP2;

iii) An opportunity cost associated with reinvesting in forestry during CP1; and

iv) A loss in the overall market value of land due to policy uncertainty in respect of CP2 and beyond;

b) For forested land where the highest and best use is forestry landowners incur:

i) A loss in the overall market value of land relative to Post-1989 land as the Post-1989 land is capable of receiving a higher return due to being eligible for emission reduction units;

The Government is proposing to allocate 21 million units to Pre-1990 landowners to offset financial losses associated with deforestation liabilities incurred during CP1. This allocation attempts to address financial losses associated with a(i), b(ii) and c(iii) above.

There are alternative policies however, that the Government could adopt to minimise the financial losses associated with a(i) to a(iv) above and therefore reduce the need for ongoing compensation.

3.5 Allocation Deficiencies

The proposed allocation of 21m NZU’s during CP1 to Pre-1990 landowners is based on the Government’s commitment to underwrite 5% deforestation during CP1.

The 21m NZU’s have a direct cost to the NZ taxpayer of $315m (@$15/NZU).

The proposed pro-rata area based allocation:

a) Does not provide compensation relative to the loss incurred by landowners; and

b) Provides a windfall gain to landowners having no ability or intention to deforest during CP1.

This windfall gain is likely to be inflationary to the NZ economy or likely to be appropriated offshore in the case of foreign investors. The windfall is unlikely to be re-invested in carbon sink activities or used to offset deforestation activities.

c) Will delay deforestation and the conversion of land to a higher and better use and thus depress the growth in the NZ economy and weaken NZ’s ability to finance climate change initiatives.

Deforestation will therefore continue to be an issue requiring compensation in subsequent periods.

3.6 Opportunity Cost

The NZ Government has a responsibility to ensure that the expenditure of taxpayers’ money ($315m) creates value for taxpayers and does not come at a significant indirect cost to the economy.

The allocation of 21m NZU’s could alternatively be targeted specifically at commencing the inevitable process of allowing the conversion of land use to the highest and best use.

During CP1, 21m NZU’s would permit the conversion of around 35,000 hectares. The economic benefit of allowing this conversion to proceed is compelling.

The Net Present Value of converting cutover land to a producing dairy farm is in the order of $14,000 per hectare @ 8%. The farmer would invest around $35,800 per hectare in the provision of water, conversion, farm development and operating capital (stock, machinery and Fonterra shares). The resulting operating revenue (assuming inflation and the achievement of full production in Year 7) would approach $9,100/ha/yr generating a net economic farm surplus of $3,500/ha/yr.

Extrapolated over 35,000 hectares the direct economic benefits to the economy would be as follows:

Increase in Market Value of land $437m
Development expenditure $1,253m
Annual Operating Revenue $318m/yr
Annual Economic Farm Surplus $122m/yr
Increase in Income Tax take $37m/yr

In addition to this direct opportunity cost, there is an indirect regional and national economic benefit. The direct benefits need to be multiplied by a economic multiplier (2-3) to quantify the total opportunity cost.

In short, the Government’s proposed pro-rata allocation and deforestation restrictions come at a significant opportunity cost to New Zealand taxpayers and the economy.

3.7 Alternative Allocation - Contestable Permitted Deforestation Regime for CP1

3.7.1 Recommendation:

It is recommended that:

a) The NZ Government / NZ Taxpayers underwrite 5% deforestation during CP1;

b) The 21m NZU’s be retained by the Government to offset permitted deforestation activities;

c) Landowners of Pre-1990 forests (exotic and indigenous) wishing to deforest during CP1 should be required to submit an application (in a prescribed format) and if approved, to undertake the conversion during CP1;

(We note that the Sustainable Farming Fund has an effective administration and criteria for allocating funds to worthy ventures and managing compliance)

d) Landowners who have not been granted sufficient deforestation permits under this scheme may supplement deforestation by surrendering NZU’s or AAU’s.

3.7.2 Outcome achieved:

This alternative deforestation regime will:

a) Target assistance to those parties who are adversely affected by climate change policies;

b) Ensure flexibility in landuse change (albeit regulated);

c) Ensure the NZ economy and Taxpayer obtains a benefit from its $315m investment;

d) Give effect to the Government’s intention to underwrite 5% deforestation;

e) Begin the process of shifting the NZ plantation estate onto appropriate land use classes;

f) Minimise the financial loss incurred by Pre-1990 landowners due to the deforestation restriction; and

g) Avoid creating the expectation of repeated windfall gains in CP2 and beyond.

4. Proportional allocation of post-1989 Kyoto units

4.1 Summary

Kyoto units earned by the Government from Post-1989 forest carbon removals (during CP1) should be allocated proportionally to all forest owners (Pre-1990 and Post-1989, exotic and indigenous) based on the carbon removed by the forest owner concerned

The New Zealand Government must ensure that its proposed policy to devolve 100% of NZ’s Post-1989 Kyoto credits to Post-1989 forest owners provides an appropriate return to the NZ Taxpayer.

The amount in question is estimated at $1.17 Billion (@ $15/unit). (78 million Kyoto Units during CP1).

This alternative proposal to introduce “proportional allocation” of the 78 million NZU’s ($NZ1.17b) across the entire forest sector better serves the interests of the NZ Taxpayer, the NZ forest sector, climate change abatement and Government objectives.

4.2 Government Objectives

We understand the objective of the Government is to:

a) Promote economic investment in renewable resources that are carbon neutral or which create carbon removals (such as forestry);

b) Promote afforestation of bare land and re-establishment of existing forests within NZ;

c) Promote policies that are equitable and which have highly predictable outcomes;

d) Remove erroneous economic distortions and create a level playing field for investment in the New Zealand forest sector;

e) Create and brand a NZ carbon unit (NZU) that has environmental integrity;

f) Introduce domestic policies and a NZ ETS that will help shape future markets;

i) Promote the adoption of effective and rational policies on LULUCF (for CP2) that will find greater long-term global acceptance (from Annex 1 & 2, non-Annex and non-ratified countries); and

ii) Promote equitable Kyoto policies (for CP2) that can be adopted uniformly in the domestic policies of participating countries and which can also be applied at a business level (to assist participation by countries and international businesses);

g) Not upset the voting public; and lastly

h) Achieve positive environmental and carbon emission outcomes (that satisfy NZ’s Kyoto obligations) while minimising the cost to the economy.

The removal of the distinction between Pre-1990 and Post-1989 in the application of domestic policy together with “proportional allocation” will give effect to these objectives.

4.3 Proposed Forest Sector Policy

The Government is presently proposing to “devolve” 100% of the Kyoto units earned by New Zealand’s Post-1989 forests (during CP1) to Post-1989 “forest and land owners”.

No “allocation” is proposed in respect of the carbon removed by New Zealand’s Pre-1990 forests to their respective owners.

Adherence to the Kyoto Protocol framework on LULUCF is constraining the development of rational, effective and equitable domestic policy.

The Government’s proposed domestic policy does not satisfy Government objectives and has a number of very negative consequences.

4.4 Activities and Individual Responsibility

A commercial entity (such as a landowner or a forest owner) should have individual and independent accountability for the change in carbon stocks resulting from their activities.

4.4.1 Activities

New Zealand should adopt best practice in the definition of “activities” that result in the carbon emissions or carbon removals.

In respect of the forestry sector:

a) Carbon removal activities include: afforestation, reforestation, re-establishment of trees, forest protection and the passage of time to allow growth.

b) Carbon emission activities include: harvesting and/or the killing of trees and vegetation. (These activities initiate irreversibly the emission of previously stored carbon).

Note: The release of carbon associated with catastrophic events such as fire, windthrow or disease are not human induced “activities”. Such events should not incur an immediate financial liability for the participant concerned but should be carried forward and written off progressively against future growth in carbon.

4.4.2 Deforestation

“Deforestation” is defined under the Kyoto Protocol as “the direct human-induced conversion of forested land to non-forested land”.

The Government proposes to introduce domestic policy that will make the person converting a previously harvested cutover site to pasture responsible for the total carbon emissions associated with the prior harvesting activity.

The application of “deforestation” as a single “activity” in domestic policy is problematic as it involves two independent activities that may be undertaken by two different participants (the forest owner and the land owner).

The two activities are:

a) The killing and/or harvesting of trees and vegetation to produce a cleared or cutover site (First Activity); and

b) The establishment of a non-forest landuse on the cleared or cutover site (Second Activity).

The first activity (involving the killing of plant matter) is under the control of the owner of the forest or vegetation.

The activity of killing plant material irreversibly initiates the emission of 100% of the previously stored carbon associated with that plant material. The timeframe for this carbon release may take five or more years and longer in the event that wood fibre is contained in semi permanent wood products. The point is however that the activity of killing the plant material irreversibly initiates the emission of previously stored carbon.

The second activity (involving the conversion of a cutover site to a non-forest landuse) may be under the control of either the forest owner or the landowner.

The second activity does not initiate (or add to) the emission of carbon associated with the former forestry landuse (as this emission has already been initiated). The second activity is not a forest activity as such. This second activity should be subject to the rules of the sector concerned (usually the agricultural sector).

4.4.3 Participants

If New Zealand is to adopt “activity based” policies, than participants should be held accountable for the change in carbon resulting from their own activities and not the activities of others.

New Zealand forest sector polices must fully distinguish between the activities of forest owners as opposed to landowners.

4.5 Inequity

There are a number of inequitable consequences and perverse outcomes that will arise from the Government’s proposed 100% devolution of credits to Post-1989 forest owners (subject to landowner agreement). Theses include:

a) Pre-1990 landholders will suffer an immediate reduction in market rents and land values (due to reduced demand by forestry companies to replant this land);

b) Landowners that have no interest in investing in forestry but own land subject to Pre-1990 Forestry Rights and Crown Forestry Licences will find it difficult to lease their land to forestry investors. (They will also be unable to convert the land to another use);

c) Landowners of Pre-1990 forests that commence forestry investment on their land holdings for the first time (i.e. Maori in respect of former CFL land) will not be credited with having made any contribution to arresting climate change or being carbon neutral.

d) Bare land suitable for the establishment of Post-1989 forests will increase in value while Pre-1990 land will become valueless;

e) Forest owners of Post-1989 forests will not be able to participate in the NZ ETS unless they have the agreement of the Landowner. There is no independence;

The Government acknowledges that its proposed domestic polices creates winners and losers. Such acknowledgement does not justify the result.

4.6 Opportunity Cost

The New Zealand Government has a responsibility to ensure that the devolution of 100% of credits to Post-1989 forest owners (estimated to be 78 million Kyoto Units during CP1 and valued at $1.17 Billion (@ $15/unit) provides an appropriate return to the NZ Taxpayer.

4.7 Alternative Allocation

4.7.1 Recommendation

Kyoto units earned by the Government from Post-1989 forest carbon removals (during CP1) should be allocated proportionally to all forest owners (Pre-1990 and Post-1989, exotic and indigenous) based on the carbon removed by the forest owner concerned.

This proportional allocation would work as follows:

a) All forest owners (Pre and Post-1989, exotic and indigenous) would be required to register and account for changes in carbon;

b) NZU’s should be issued to participants (during and at the end of CP1) based on the following formula (illustrated for CP1):

i) Kyoto compliant carbon removals = ~78 million Units;

ii) 78 million Units / Total removals for all Forests = Factor;

iii) Individual Participants carbon removal x Factor = Individual NZU entitlement;

(A new Factor will be calculated at the end of each compliance period)

4.7.2 Outcome Achieved

a) Consistent and equitable domestic policy across the forestry sector;

b) Uniform incentives for afforestation, reforestation and re-establishment;

c) Achievement of Government objectives at least cost;

d) No losers;

5. Complementary measures

5.1 Forestry Taxation Amendment

Taxation amendment to encourage afforestation and re-establishment:

Allow full deductibility of land development expenses, roading infrastructure and all costs associated with afforestation and replanting.

5.2 Government Afforestation Group

5.2.1 Summary

Establish an Afforestation Group within LINZ to:

a) Identify Crown land, Crown leasehold, and private land suitable for afforestation;

b) Satisfy and clear all regulatory restrictions preventing afforestation;

c) Prepare landscape, biodiversity, and species plans for afforestation;

d) Secure rights and tender long-term forestry rights over such land to forest investors;

5.2.2 Rationale

a) New Zealand is already principally deforested.

b) The availability of land is a principal constraint to afforestation.

c) Environmental education is required on the limited merits of New Zealand’s barren landscapes.

d) New Zealand must encourage the “re”-afforestation of barren landscapes.

e) Such afforestation needs to be sensitive to landscape and biodiversity objectives.