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Pre-1990 Forests and the ETS - A Solution?

Peter D. Clark
[CEO, PF Olsen Ltd. Paper compiled to provide information and views to the Climate Change Leadership Forum. Compiled with input from others in the forestry sector but time available prohibits full consideration and endorsement of this position by all forestry sector participants.]

Version 3, 23rd January 2008

Context

The issue

The treatment of pre-1990 forests in the proposed NZ ETS:

Is based on the current text of the Kyoto Protocol, not on the impact of these forests on the atmosphere or climate change, and not on likely changes to international climate change rules for CP2
Is not aligned to the environmental outcomes of planting and harvesting plantation forests, nor the environmental outcomes of using the wood generated from those forests
Is focussed on maintaining New Zealand s existing forest cover rather than aggressively encouraging the planting of lands which are currently not forested, but for which forestry would be the best land use, currently estimated at between 600,000 and 800,000 ha
Creates a significant long-term reduction of land value for some forest owners, including many Maori forest landowners, and smaller land value losses for others.
Permanently limits land use flexibility, even if full REAL environmental costs are fully accounted for.
Creates distortions between the economics of pre-1990 and post- 1989 forestry that can be expected to lead to some perverse management decisions which are not in New Zealand s best interests. The idea that we have good and bad forests is wrong.
Is retrospective. Pre-1990 forest landowners have been caught out by rule changes midway through their investment that make a big difference to the investment, and can potentially wreck some people s retirement plans.

Why are we doing this?

It appears the primary driver of the ETS proposals for pre-1990 forest is to meet New Zealand s CP1 Kyoto obligations at least cost to the taxpayer. The Forum has been told as much. This least cost objective is achieved by mirroring closely the Kyoto forestry policies in our own domestic policies.

But it is widely acknowledged that the Kyoto artificial cut-off date of 1990 in respect of forests is flawed in respect of the environmental contribution of New Zealand s plantation forests. The 1990 fix was introduced at the eleventh hour in an attempt to address concerns related to northern hemisphere forests. It was agreed to by NZ negotiators against the recommendations of the NZ forest industry. So why would we lock in place a long-term domestic policy that mirrors a flawed five year international policy at the very time New Zealand is seeking changes to the international rules?

New Zealand is likely to become the only country in the world with a land-use change carbon liability imposed on forestry at a time when international consideration is being given to providing payment to developing countries to avoid deforestation. New Zealand should lead the world in introducing climate change policy which will reduce emissions and increase carbon sinks rather than slavishly implementing flawed elements of the old international rules which, at this very time, are being changed to become more effective.

What can NZ contribute to global climate change?

As discussed, as a tiny emitter of greenhouse gases New Zealand s greatest contribution will be leadership in rational domestic policy instruments and fighting hard for those types of instruments to be adopted internationally.

The present CP1 Land Use Land Use Change and Forestry rules (LULUCF) only hold for the first commitment period and there is a good possibility that New Zealand can help bring about positive changes from 2012 through working with like-minded countries.

New Zealand has already shown leadership by being the first Kyoto country to include agriculture and forestry in our domestic climate change policies.

If these policies are to form the basis of our LULUCF negotiations and leadership role post 2012, then our CP1 policies must be rational from an environmental perspective and acceptable to private landowners.

Only if these criteria are met can we expect similar policies to be adopted in Australia, Canada, US or in South America or Asia that in turn could facilitate the next set of international agreements to cover these key sectors.

To be acceptable to the private sector, any government should be seeking to create a positive environment for:

(a) Retention of existing forest rather than penalties for removal of that forest, and

(b) Dramatically increasing total forest cover.

This concept is consistent with the trend towards rewarding avoided deforestation in developing countries that we also want to see included post-2012.

Our forests are carbon neutral at worst

NZ plantation forests were first established to provide timber needs without further destruction of our indigenous forests. Unlike many countries, this outcome has been achieved with stunning success.

Most of our early forests were established on the scrubby CNI volcanic plateau (because at that time that land was unable to be used for pastoral farming), sand dune coastal strips and cleared but reverting farmland, or cleared but eroding hill country on the East Coast. In the 1990s a further 600,000 ha was established mostly on low-producing hill country pasture land throughout New Zealand.

When a forest is harvested it simply releases CO₂ that has quite recently been captured from the atmosphere. Even if it is not replanted some of that carbon is stored in long-life applications like buildings, fences and furniture. Even under unrealistic Kyoto assumptions our forests are, at worst, carbon neutral. To the extent that we plant new forests, extend the rotation age or increase the rate of tree growth per hectare we create additional carbon sinks that can buy time for the world to adjust to a lower greenhouse gas emission economy.

Plantation forests also provide one of the greatest opportunities we have as an international community to produce low cost biofuels feedstock (via conversion of ligno-cellulose to ethanol ) to substitute for fossil fuels without impacting on global food supply, and to provide construction materials that replace more energy intensive building materials.

Deforestation drivers

While announcements of a deforestation tax have played a part in bringing forward some deforestation, the fundamental driver is changes to the relative economics of pastoral farming (especially dairy) versus forestry. These economic drivers have become particularly evident in the last 2 or 3 years.

A forward-looking scenario suggests up to 200,000 ha of pre-1990 forest could usefully support higher and better land use, mainly dairy. It is probable however, that the rate of deforestation that has occurred over the last 3-4 years will be significantly less going forward. Moreover, it is likely that at least 200,000 hectares of land which is currently not in forestry would deliver a higher economic return if turned to forestry.

It is future opportunities that should be the basis of stranded asset compensation, not some historical level of deforestation that was based on very different economic fundamentals.

Proposal

Key principles

Key principles of our proposal are:

Pre-1990 plantation forest deforestation provisions came as part of the Kyoto package negotiated by Government, but do not properly reflect actual greenhouse gas impacts of those forests. Changes to private sector land values arising from this provision (both for those that wish to deforest and those that do not) should be borne by the general taxpayer.
Acceptance that land use change is in the best longer-term interest of NZ Inc., but that current Kyoto accounting means that the emissions from gross deforestation must be capped, or fully paid for in excess of the cap, in CP1.
Accept that up to 200,000 ha of deforestation over 40 - 50 years (or some other quantum as determined by a new survey of deforestation intentions that includes offsetting costs but in any event, capped), under a Business As Usual scenario should be allowed for; but
That the government should be exposed to no more than 21 million NZUs plus the costs to the NZ government of a deforestation liability of say 15,000 ha of pre-1990 forest in CP1 (or some other quantum but capped as determined by the new survey).
Accept that all owners of pre-1990 forest land suffer some loss of land value and should be compensated for this loss, regardless of their intention to deforest.
That the focus of policy should be to eliminate net deforestation by encouraging conversion of appropriate land to forestry and dramatically increase New Zealand s total forest cover and contribution to reducing net carbon emissions

Objectives

This proposal is a pragmatic one designed to meet the following objectives:

Capping the government s CP1 Kyoto liability for deforestation emissions in CP1, and beyond if the rules are not changed.
Targeting compensation for stranded assets (loss of land value) towards those most impacted during the transition to full carbon accounting for all forests.
Providing some compensation to all pre-1990 forest land owners in recognition of loss of land values associated with land use restrictions (regardless of the intent to deforest).
Imposing a cost on deforestation activity to limit deforestation to land that has significantly higher and better use.
Retention of investor confidence in NZ as a place to undertake forestry activity in order to dramatically increase New Zealand’s total forest cover over time.
Provide a total compensation package that reflects reasonable unrestricted deforestation intentions for all pre-1990 forest land over the next 50 years to retain full compensation for landowners (mainly Maori) who will not have the opportunity to change land use until land is returned and the existing crop has matured and been harvested.
Consistency with how NZ may wish to negotiate its CP2 position and promote this with other countries with significant pre-1990 plantation forests.
Ensuring the principle of highest and best land use is preserved, which will have a positive economic effect and which can be expected to increase New Zealand s total forest cover over time.

Proposed offsetting

An amendment to the Bill to allow for domestic offset planting within New Zealand for any deforestation of pre-1990 forests on a hectare for hectare of equivalent carbon absorption capacity would:

(a) Preserve flexibility in land use, which is integral to a sustainable and prosperous primary sector;

(b) Slow the pre-2008 deforestation rate by requiring landowners to absorb the additional cost of offset planting; and

(c) Ensure that taxpayer expenditure on credits delivers long-term environmental benefits in the form of zero net loss of forest carbon volume;

(d) Be consistent with an environmentally defensible position for all plantation forests internationally that NZ may wish to promote in its CP2 negotiations.

Under this option taxpayers will carry a Kyoto obligation for the period 2008-2012.

However, this is a timing issue, because:

(a) The Government will receive additional Kyoto credits as the new trees begin to sequester carbon;

(b) The Government will receive additional tax revenue associated with the net economic benefits; and

(c) A favourable outcome of the current negotiations over the post- Kyoto agreement would remove the problem relating to pre-1990 forests after 2012, hence limiting the cost of the solution to the first five years.

Importantly, there are net economic, social and environment benefits (with associated net revenue benefits for the Government). CRA International undertook a comprehensive economic assessment of the conversion of forestry to pastoral land in June 2007 and found that for conversions such as those currently being done in the Central North Island, the net benefits to society of dairy farming exceed those from forestry by $767 per hectare per annum. In addition:

There will be more planting of new forests on land marginal for farming (often erosion-prone) under this proposal than under the Government s proposed solutions and this is most likely to result in net environmental benefits (the impact would be at least carbon neutral).

Landowners as the point of obligation will still face significant new costs for the establishment and management of an equivalent area of planting and compliance so there will not be conversion of marginal land except where there is a genuine and substantial economic benefit.

The taxpayers will receive better value for their money as the amendment will result in net economic benefits through best economic use of high value land.

There is no or minimal inequity between sectors as a result of offset planting.

Compliance and measurement of this approach could be readily undertaken within the terms of the proposed compliance and measurement regimes.

Land use flexibility will be enhanced delivering economic and environmental benefits to New Zealand

Transition proposal for pre- 1990 forests

Our proposal for pre-1990 forests, as a transition towards full carbon accounting for all NZ plantation forests and the removal of the distinction between pre-1990 and post-1989 forests, is:

Pre-1990 forest landowners would be entered into the ETS by default, but would not have to account for harvest emissions (nor would they receive sequestration credits).
Pre-1990 forest landowners who were prepared to establish new forest on non-forest land (subject to any exemptions around this pre-requisite) would be eligible to participate in bidding for an annual allocation of deforestation permits.
Pre-1990 forest landowners that wish to deforest, and could meet the offset forest condition above would bid annually in advance (on-line book build auction?) for a pool of NZ Deforestation Units (NZDUs) set at a level sufficient to cover deforestation intentions as revealed by a new survey of pre-1990 forest landowners.2
Importantly, NZDUs should be issued as non-tradable land owner specific deforestation units.
The annual auction of NZDUs should continue while a deforestation liability applies. Government would need to signal its intention to honour this commitment for up to 50 years (subject always to a known annual cap).
The annual auction process will ensure there is no need to bank these units unless:
a) The number of NZDUs on offer each year was clearly less than demand; or
b) Landowners did not trust that the annual allocation of NZDUs was a durable policy across many election cycles.
Any NZDUs not taken up at annual auction, plus the net cash proceeds from the sale of auctioned NZDUs would be retained by government.

Offsetting exemption

Some landowners (including Maori) are presently locked into lease or Forestry Rights arrangements with forest owners and have not been able to take advantage of early deforestation prior to 2008, and will not get access to their lands until current lease arrangements expire. CFL Maori land claimants are in a similar position, depending on the basis of their claim settlement and the land value impact on the quantum of land included in any settlement. There is a case that such landowners should be permitted to deforest their lands after hand-back, without the financial imposition of offsetting costs, as this would reduce the cash proportion of the settlement.

Why a specific unit?

If the cost of land use change is to be kept low or nil (true compensation), then a specific NZ Deforestation Unit will need to be created because:

The total available pool of deforestation units in any one period must equal the demand under a realistic BAU scenario; and
The deforestation units cannot have value outside of being surrendered for deforestation emissions.

Why an auction?

An annual on-line auction introduces a cost of carbon to the business as usual activities of landowners. The fact that the NZDU has no value other than for deforestation will discourage speculators entering into the auction process.

In theory the price bid for NZDUs should be low, given that supply and demand are expected to be matched.

Deforestation in excess of available NZDUs

The government s liability is capped at the level of NZDUs released to the market in any one period. While more deforestation may take place, this would need to be covered fully by the entities responsible through surrender of NZUs.

Deforestation less than NZDU auctioned

It is anticipated that 100% of the auctioned NZDUs would be taken up at auction. But some may be banked for future periods. Under this proposal the existing 21 million CP1 allocation would be maintained (see Current Expectations, page 11) and any NZDUs not taken up would be retained by the government, along with the proceeds from the sale of NZDUs.

Post 2012

Another important feature of the scheme, to give confidence to the forestry sector, will be a government commitment to fully covering (through annual allocation of NZDUs) deforestation of 200,000 ha over a 40 - 50 year period.

The net cost to government after 2012 will of course depend on what is negotiated internationally with respect to Land Use Change and Forestry. Carbon accounting for forests should be over much longer time periods (>25 years) reflecting that carbon stock changes in forests relate to rotational cycles over multiple decades.

Quantum of Compensation Package

Basis of compensation

It is broadly acknowledged that the compensation on offer for pre-1990 forest landowners is in respect of loss of land value (a stranded asset).

Within existing pre-1990 forest landowners there are two distinct groups:

Those who suffer loss of land value regardless of any clear alternative better land use. These owners should be compensated at a low level on a pro-rata land area basis.
Those who suffer larger losses associated with the loss of the economic opportunity associated with land use change. These owners should have the opportunity to deforest at the lowest cost consistent with the environmental impacts of land use change. At present this implies meeting the cost of planting an equivalent area of forest on alternative non-forest land.

Policies that enable land use change to continue to take place at reasonable cost will mitigate land value losses and reduce the case for land value loss compensation.

Expectations

The government has signalled 21 million NZUs would be made available in CP1 on a simple land area basis to all pre-1990 forest owners. That is now the expectation of many pre-1990 forest owners, regardless of deforestation intentions. Our suggestion is that in terms of maintaining the good faith and confidence of those forest landowners, and in terms of supply of domestically available units to help cover emissions in other sectors from 2010, this 21 million CP1 NZU package be maintained, but that 25% of those units be specifically targeted towards land capable of high agricultural production as indicated by its Land Use Capability classification.

Deforestation intentions - BAU

We recommend a new survey of CP1 deforestation intentions be carried out urgently, based on the offsetting pre-requisite condition to bidding for deforestation permits (NZDUs). The results of such survey would then form the basis of an additional allocation of NZDUs as per this proposal. The survey should also capture likely deforestation in future commitment periods up to 50 years from now. This would form the basis of a capped schedule of annual auction of NZDUs beyond 2012 should current Kyoto rules persist.

Proposal is a Whole Package

Not to be disaggregated

This proposal contains a number of separate elements that individually may have attraction to government but together do not. This proposal is presented with the intent that it be retained (no doubt with sensible improvements) as a total package. If component parts of the suggested policy is disaggregated then PF Olsen Ltd disclaims any individual element being attributable to its suggestion.

Benefits of Proposal

Sets course for post-2012

This proposal does not remove the differences in treatment between pre- 1990 and post-1989 forests. But it does acknowledge, in our domestic policy, that change in land use is both desirable and important to our national economy. This is a good starting point for post-2012 negotiations. It effectively creates a one-off transitional arrangement for pre-1990 forests for CP1. The eventual removal of that distortion is likely to be important for the adoption of forestry into the domestic climate changes policies of our major trading partners and competitors. It will also restore investment confidence in the NZ forest sector. The widespread international adoption of climate change policies that are similar to New Zealand is very important for our international competitiveness.

Land use flexibility retained

The proposal would ensure that land use flexibility was retained. In particular the ability to relocate forests without a net penalty could occur which would restore confidence and encourage new investment into the industry.

Land use flexibility has been a cornerstone of New Zealand s wealth creation since the first European settlements. This will remain the case as new technologies and Agricultural and Horticultural economic drivers change over time.

Who should pay?

Kyoto Protocol deforestation liabilities should be met 100% by the NZ taxpayer, given that:

Forests don t emit CO₂ at all, and even when deforested have only emitted the very same amount of CO₂ recently absorbed from the atmosphere (less any held in long-term solid wood products or in soils and undergrowth).
The liability on deforestation only arises because the government (despite forestry sector warnings) ratified the Kyoto Protocol that includes flawed rules for our plantation forests.
The signing and ratification of the KP has been deemed by the government to be in the best overall interests of the nation (general taxpayer).
The taxing of pre-1990 forests on deforestation represents a retrospective tax that is not even based on principles of polluter pays or matching of credits and liabilities.

Supporting Policies

New planting

The devolvement of post-1989 carbon credits and liabilities under the ETS will encourage new planting. That this policy is effective is critical to generate domestically produced credits to offset forecast growth in transport (including aviation), stationery energy and agriculture emissions over the next 50 years. New planting is very capital intensive. The major constraint to new planting during CP1 will be land availability at reasonable cost. Pastoral land values will remain high as long as:

Rules around the agricultural sector s participation in the ETS remain unclear. In particular the point of obligation for sheep and beef hill country farms needs to be at the farm level.
The MFE led Water Plan of Action and Environment Waikato seek to protect the existing right to pollute enjoyed by the farming sector in particular nitrification of waterways and lakes.

The contribution of the forestry sector to mitigate climate change will be enhanced by:

early decisions on agriculture participation in the ETS and modelling and disclosure of the financial impacts of participation at the individual farm level.
Imposition of a financial cost of water pollution, particularly nitrification, at the farm level. This will free up land that becomes uneconomic to farm for afforestation.

Other initiatives

Supplementary policies around biofuels, transport weights and dimensions, port infrastructure, labour and skills, domestic wood use etc were aggressively pursued.

A Note on Legislative Process under Way

Time to evaluate and reach consensus

Delays and abandonment of previous climate change policies in NZ means that we have now reached January 2008 without any clear policies (let alone legislation) with respect to pre-1990 forests other than a very blunt instrument that has effectively halted deforestation activity. The flow-on economic impacts of this blunt instrument to both affected private landowners and to the NZ economy are not well researched or understood.

There is differing views within the forest sector as to what is best for their own interests and for NZ Inc. This paper has been developed without the benefit of input from many forest landowners, and has not been subject economic evaluation nor peer review.

The proposed legislative changes, in whatever form, will have a profound effect on the New Zealand economy. There will be winners and losers, and we cannot afford to get it wrong.

One sensible option may be to take a cuppa. In effect the current policy announcements (and therefore no deforestation) would apply while a better researched and more inclusive process involving affected parties was entered into over 9 -12 months in advance of legislation being passed in respect of pre-1990 forest lands. This would also enable NZ to get a better understanding of the likely post-2012 international position.

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