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1 Submission to Senate Economics References Committee Inquiry into forestry managed investment schemes Dr Judith Ajani Australian National University Fenner School of Environment and Society 2 September 2014 1.

In this submission, I address Terms of Reference no: b) the role of governments in administering and regulating forestry MIS, and g) the options for reforming forestry MIS to protect investors and rural communities.

2.
2.

The Commonwealth Government is responsible for the legislative environment for forestry MIS and tax law implementation.

3.

There appears to be an anomaly in the ATO treatment of forestry MIS.

Investors in forestry MIS are able to deduct their costs against income earned elsewhere.

This is only possible because they have received a dispensation from the ATO deeming their business activity to be commercially viable.
In granting this dispensation, the ATO must have judged that forestry MIS are inherently commercial.

4.

In fact, my research (and that of others) some years ago found that, far from being an attractive investment proposition, forestry MIS are high cost to both the government and investors and I presented evidence that many investors may recoup just 25 per cent of their funds.

Forestry MIS were never a commercially viable arrangement from the perspective of the so called ‘investor’.

5.
5.

These issues are discussed in detail in the attached paper Ajani 2010, Climate change policy distortions in the food and paper market presented at the Australian Agricultural and Resource Economics Society National Conference Adelaide.

Forestry managed investment schemesSubmission 26 2 6.
The key question is: How did Treasury establish the view that forestry MIS were commercially viable: a requirement it appears as part of the dispensation from Division 35 rules for commerciality (see page 6 of Ajani 2010).

7.

In principle Government agencies should not be required to make assessments of private sector commercial viability.

The tension arises because Australian tax law allows for the deduction of costs in one enterprise/activity against income earned elsewhere.
If this tax policy framework remains unchanged, then the challenge for reforming forestry MIS (TOR g) in the first instance is one of addressing the administrative arrangements in the ATO for activities that receive dispensation from Division 35 rules for commerciality.

8.

In the interim, if Government wishes to avoid a future forestry MIS mark II disaster, it should implement arrangements to effectively close them down.
Papers attached Ajani 2011, Submission to House of Representatives Standing Committee of Agriculture, Resources, Fisheries and Forestry.

Ajani 2010, Climate change policy distortions in the food and paper market, paper presented to the Australian Agricultural and Resource Economics Society National Conference Adelaide.

Ajani 2009, Submission to the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into Agribusiness Managed Investment Schemes.
Ajani 2009, Submission to Senate Select Committee on Climate Policy.

Forestry managed investment schemesSubmission 26 Submission to House of Representatives Standing Committee on Agriculture, Resources, Fisheries and Forestry 3 Australia’s forestry industry Dr Judith Ajani Fenner School of Environment and Society The Australian National University February 2011 Australia’s native forests and wood-based industries are at a crossroad.

Which path they travel is entirely dependent on government policy.
The House of Representative Standing Committee’s inquiry is timely and opens the opportunity for Australia to turn a new page for native forests and the plantation based industry.

In this submission, I draw on four of my recent papers.

A. Ajani J.

(2011), Australia’s Wood and Wood Products Industry – Situation and Outlook Analysis, Working Paper, The Fenner School of Environment and Society, The Australian National University.
The aim of this working paper is to present key background information and analysis to those engaged in policy areas that interact with Australia’s wood and wood products industry.

This includes climate change, native forest biodiversity conservation and carbon stores, the carbon farming initiative, plantation managed investment schemes, tax based subsidies for carbon forest sinks, wood and wood products industry policy and bioenergy and other biomass feedstocks.

B. Ajani J.
B. Ajani J.

(2011), The global wood market, wood resource productivity and price trends: an examination with special attention to China, Environmental Conservation, doi:10.1017/S0376892910000895 Forestry managed investment schemesSubmission 26 4 In this paper, global wood consumption trends are reviewed in the context of framing a coherent forest policy in the era of climate change.

Over the period 1980 to 2007, global wood consumption has been essentially stagnant, increasing by only 0.4% per year.
In contrast, over the same period, global consumption of wood products increased steadily, paper by an average 3.2% per annum and solid wood products (sawn timber and wood panels) by 0.8% per annum.

Wood saving (eg paper recycling, high yielding pulp mills, wood-based panels substituting for sawn timber) explains these significantly different growth trajectories in unprocessed wood and processed wood products.
(Historically, Australia’s forestry policy has focussed on the slow-growing market – wood growing – rather than processing).

China’s rapidly growing wood products industry has lifted wood saving to a new high.
China has so far avoided triggering a global wood shortage and associated wood price increases through a progression of strategies: successful pre-emptive price negotiations, increased use of recycled paper, adoption of high-yielding pulp technologies, substitution of reconstituted wood panels for sawn timber and tree planting substituting for natural forest supply.

C. Ajani J.
C. Ajani J.

(2010) Climate change policy distortions in the wood and food market, contributed paper to the Australian Agricultural and Resource Economics Society National Conference 2010, Adelaide Convention Centre, February 8 - 12.

There is an apparent anomaly in the Australian Taxation Office (ATO) treatment of plantation managed investments.

Investors in plantation managed investment schemes (MIS) are able to deduct their costs against income earned elsewhere.
This is only possible because they have received a dispensation from the ATO deeming their business activity to be commercially viable.

In granting this dispensation, the ATO must have judged that plantation managed investments are inherently commercial.

In fact, my research suggests that, far from being an attractive investment proposition, plantation MIS are high cost to both the government and investors and I present evidence that many investors may recoup just 25 per cent of their funds.
This is not commercially viable.
Hence my first recommendation: that Treasury review the ATO information and process that deemed plantation managed investments to be commercially viable D. Ajani J (2010), Submission to the Department of Climate Change and Energy Efficiency on the Carbon Farming Initiative Forestry managed investment schemesSubmission 26 5 The natural and inevitable decline in the plantation MIS sector, with its inherent flaws, is in danger of reversal as MIS companies and intermediaries making money from the schemes will use the CFI to resurrect it as an even more attractive tax minimising venture.
Although most plantation MIS companies have collapsed, some remain and tax minimising investors still subscribed $74 million into plantation MIS in FY2010.

The Australian Government retains the enabling legislation.
The details for CFI rules and integrity standards are not finalised, but it is virtually unimaginable (in the absence of substantial political engagement) that plantation MIS will not enter in the CFI carbon credit market with plantation MIS companies becoming CFI project proponents, promoting and managing ‘carbon sink forests’ as another income stream.
Plantation MIS requires productive agricultural land to generate (at least on paper) the wood yields and therefore income to cover these high-cost tax minimisation products.

The tax arrangements underpinning the schemes work as a subsidy distorting agricultural land and water use away from food production to plantations.

The CFI is likely to intensify resource misallocation in Australian agriculture.

The contents of the four papers are relevant to the Committee’s Terms of Reference as follows: 1.
Opportunities for and constraints upon production  Australia’s ‘forestry’ industry is now heavily plantation dependent with the processing sector more economically robust as a result.

Australia’s plantation wood resource presents immediate and substantial processing opportunities, particularly in the wood panels and pulp/paper sectors (Paper A).
 Industry concentration in the printing and writing paper sector is a major inhibitor to what would otherwise be highly attractive commercial opportunities in pulp/paper based on import replacement (Paper A).

 Productive plantations help build competitive processing industries.

The policy attention to plantation expansion (high cost) works against focussing on economically sensible plantation productivity improvement on land already planted with trees.
The average productivity of Australia’s plantation estate is mediocre: the rewards from enhanced plantation productivity are high (Paper A).

 Largely due to a long-term absence of sophisticated Parliamentary political engagement, the native forest conflict has spread into the plantation sector.

No industry engulfed in conflict prospers over the long term.
Forestry managed investment schemesSubmission 26 6  If ‘production’ in the ToR means meeting plantation area targets devoid of market analysis or commercial viability, then Australia is playing the mugs game – at the bottom of commodity production.

Policy dominated by plantation area expansion keeps industry and resources focussed to the slowest growing sector of the global wood and wood products industry, namely wood production (Paper B).

2.
2.

Opportunities for diversification, value adding and product innovation  For too long (half a century), the Australian Government has held the ‘forestry’ industry’s hand and the industry is less robust as a result.

The public purse is also poorer.

Wood and wood products investment opportunities should be a matter for the private sector.

Business assesses opportunities, makes decisions, takes risks and enjoys the benefits.

3.
3.

Environmental impacts of forestry  In ‘forestry’, so called win-win outcomes require rethinking ‘balance’.

We should abandon the ‘multiple use’ approach to native forests (more recently rebranded ‘ecologically sustainable forest management’) and replace it with a policy frame of allocating land to the job it does best.
Native forests do biodiversity conservation/carbon storage like no other biological land use and plantations generate high quality wood for scale economy processing better than native forests.

There in lies the ‘win-win’ (Papers A & B).

 Removing the plantation MIS tax based distortions in agricultural land and water use (and not replacing them with another distortionary subsidy) will also see agricultural resources put to their most efficient use.

There in lies a ‘win-win-win’ (Papers A, B, C and D).
4.

Creating a better business environment for forest industries  Removing wood and wood products industry subsidies and props (eg low native forest wood prices, tax based subsidies for wood growing) will help build economic robustness into the industry and reduce distortions in agricultural land and water use (Papers C & D).

Such actions will reduce the conflict with environmentalists and food producing farmers now engulfing the industry.
This is necessary for a better long-term business environment for the wood and wood products industry.

 Commercially viable plantation processing should be the dominant objective for the wood and wood products industry.
Wood and wood products industry policy should sit within the generic industry policy frame and include research and development programs, worker and management skill development and transport strategies with a focus around regional hubs with a critical plantation mass for scale economy processing (Paper A).

 An incorrect interpretation of market failure has been used in calls for government funding to do the job the private sector apparently is not interested in – investing in long lead-time plantations.
Long lead times are not in themselves a market failure.

Rather, investors in long rotation plantations require higher returns to compensate for the increased risk.

However, hardwood sawmillers (in particular) appear unwilling to pay the higher wood prices to attract the plantation investment and expect the public Forestry managed investment schemesSubmission 26 7 to keep subsidising their wood costs.
The well-established trend decline in Australia’s consumption of hardwood solid wood products, comprising mainly sawn timber, turns-off private investors but does nothing to temper the calls for government subsidies to plant trees for a market in decline (Paper A).

The argument is essentially the same for softwood sawlogs.

5.
5.

Social and economic benefits of forestry production  Wood and wood industry economic wealth benefits are maximised when plantations, not native forests, dominate the market (as they do) and most plantation wood is processed domestically in commercially viable facilities (which is becoming less so, notably for the hardwood plantation resource) (Paper A).

 If ‘social benefits’ means maximum long term stable jobs, then plantation processing should be top priority.
If ‘social benefits’ means reduced levels of conflict, then allocating native forest land to biodiversity conservation/carbon storage and ending distortions in agricultural land and water use through the termination of plantation MIS is relevant (Papers C & D).

6.

Potential energy production from the forestry sector  Using native forests for energy has a high climate change opportunity cost, namely carbon stock deterioration.
 Planting trees for energy production needs rigorous appraisal from an energy efficiency perspective.

Building incentives for such plantings will undermine the commercial viability of more efficient energy products/systems.

7.

Land use competition between the forestry and agriculture sectors  Efficient use of agricultural land and water requires the removal of subsidies that, after decades of work to reduce agricultural subsidies, favour wood growing over food production.
Building new schemes to promote plantations will exacerbate resource use inefficiency and escalate conflict in rural Australia (Papers D & C).
Forestry managed investment schemesSubmission 26 8 Climate change policy distortions in the wood and food market Judith Ajani The Australian National University Fenner School of Environment and Society judith.ajani@anu.edu.au Contributed paper to the Australian Agricultural and Resource Economics Society National Conference 2010 Adelaide Convention Centre, February 8 - 12.
Forestry managed investment schemesSubmission 26 Abstract 9 The widespread shift of Australia’s wood products industry away from native forests to an agricultural regime–wood plantations–has enhanced forestry industry competitiveness.

Wood now competes against food for agricultural land, water and other resources (including government support).
New plantings have increased substantially since the mid 1990s via plantation managed investment schemes (MIS), arousing protest in the traditional agricultural sector and claims of unfair government policy treatment.

This claim is investigated in an analysis that integrates the taxation treatment of plantation MIS with economics and forestry industry knowledge.

Three methods are developed, and applied, to estimate the plantation MIS tax-based subsidy.
Preliminary estimates indicate a tax-based subsidy to forestry through plantation MIS of between $0.9-1.2 billion over the five years ending 2008.

The estimated subsidy is then incorporated in the Productivity Commission’s calculations of the effective rate of assistance (ERA) to industry groups from tariff, budget outlay and tax-based government policy.
The ERA to Forestry & logging in 2008 was estimated to be 41.8 per cent: government assistance is equivalent to 42 per cent of Forestry & logging’s unassisted value added.

The estimated plantation MIS tax based subsidy accounted for 77 per cent of the assistance.
Assistance to Forestry & logging exceeds substantially the assistance (including drought related payments) to food growers: 7.2 per cent to Grain, sheep & beef and 17.3 per cent to Dairy cattle farming (a significant proportion was assistance that ceased in April 2008).

A detailed examination of Australia’s proposed climate change policy concerning the land use sector indicates that agricultural resource use distortions created through plantation MIS arrangements are lightly to intensify.

1.
1.

Introduction The debate over agricultural managed investment schemes (MIS) and plantation MIS in particular has attracted high media coverage, four parliamentary inquiries and a Treasury review.

While the Government worked to close non-plantation agricultural MIS, plantation MIS remain immune.

The debate about whether plantation MIS distort resource use, particularly in agricultural land and water markets, is bogged in tax law and its implementation.
Advancing the debate requires integrating tax aspects with economics and forestry industry knowledge to clarify the nature of the subsidy and develop methodologies to estimate the size of the subsidy.

In a paper presented on Australian Taxation Office (ATO) web pages, the former plantation MIS lobby group, Treefarm Investment Managers Australia (TIMA), argued that plantation MIS do not receive special tax incentives.
They operate under the same basic tax regime as other agricultural enterprises (Cummine 2004).

The paper concludes that, because plantation MIS investors do not receive special tax incentives, there are no tax-based subsidies.

Forestry managed investment schemesSubmission 26 10 This conclusion is understandable if we leave to one side the detail of tax law implementation and economic efficiency as distinct from tax interests.
Amendments to the Income Tax Assessment Act (ITAA) to address potential tax evasion through plantation MIS investment have generated today’s situation where the outstanding issue, from a tax perspective, is the potential for plantation MIS investors to minimise their tax (not an illegal act) by deferring tax liabilities until income is received (for forestry, a decade or more into the future) which may be when the investor’s income falls into a lower tax bracket.
If this aspect of tax minimisation is significant in the decision to invest in plantation MIS, the matter should be placed in a wider taxation context.

Progressive tax systems have the potential to impose a higher average rate of tax for a taxpayer whose income fluctuates significantly between years as compared to a taxpayer with the same average income received at a constant rate per annum, such as some agricultural producers and artists (Lacey and Watson 2004).
Agricultural producers and artists have special tax treatments to address this situation (e.g.

tax averaging and income equalisation deposits).

Lacey and Watson (2004) argue that the Government take a wider view of the role for ‘taxation products’ to enable taxpayers to smooth taxable income, thereby increasing competition with MIS in the market for tax deferral.

Plantation MIS could be viewed as a complicated, high cost and inefficient de facto ‘taxation product’ to address period inequity.
We now bring economic efficiency interests into the debate.

The plantation MIS ‘taxation product’ flows into the economy as a potential distortion in agricultural land and water use.
The Parliamentary Joint Committee on Corporations and Financial Services Inquiry into Aspects of Agribusiness Managed Investment Schemes explained how: ‘…, there is currently potential for MIS to use unprofitable high cost structures to provide greater tax deductibility to investors, while directing a proportion of this tax-related investment to related entities charging above commercial rates for project services.
While investor focus is on minimising tax, rather than investing in the most profitable venture, this directs capital away from profitable uses and disadvantages traditional farming enterprises by increasing natural resource costs and encouraging oversupply.’ (Parliamentary Joint Committee on Corporations and Financial Services 2009 pp.

45-6).
45-6).

The aim of this paper is to integrate tax issues with economics and forestry industry knowledge to establish whether plantation MIS embody a tax-based subsidy and to clarify the effect of plantation MIS tax arrangements on resource allocation (mainly agricultural land and water) between food and wood growing.

Three methods of estimating the plantation MIS subsidy to wood growing are presented and tested empirically.
The estimates are then integrated with the Productivity Commission’s effective rate of assistance (ERA) measures to gauge the potential for plantation MIS tax arrangements to distort agricultural land and water use, away from food to wood growing.
The discussion applies this analysis to examine the potential for amplified inefficiency in agricultural Forestry managed investment schemesSubmission 26 resource use with the government’s proposed emissions trading system and related climate change policy measures for forestry.

Recommendations conclude the paper.

11 2.


Plantation MIS 2.1 Background Investors (growers) in plantation MIS pay fees to a plantation MIS Responsible Entity to have trees planted and receive a share of the harvest revenue after specified costs have been deducted.

Investors do not purchase capital items, notably land, thus enabling their expenditure to be fully tax deductible.
(The Responsible Entity acquires land–through freehold purchase or leasing through a third party–which is sub-leased to investors.)

Investors can offset their expenditure against taxable income received from other activities.

Borrowing money (the interest being a tax deductible cost) to purchase the MIS investment enables investors to claim a tax deduction greater than the amount they invest personally.
Plantation MIS are focussed heavily to growing hardwoods for the woodchip market with Responsible Entities offering varying cost-structured products.

Table 1 presents an indication of the spread.


Table 1 Eucalypt chip log plantation MIS costs Forestry managed investment schemesSubmission 26 12 WA Blue Gum Project 2009 (Product Ruling 2009/35) Great Southern Plantations 2007 Project (Product Ruling 2007/27) Gunns Plantation Woodlot Project 2009 - Option 1 (Product Ruling 2208/66) Establishment fee ($/ha) 5 500 10 000 7 480 On-going costs ($/ha/yr) 600 for tending & land rent, indexed Other costs  15% fee when chip sales revenue exceeds $17 050 indexed.
 Unforseen expenses for fertiliser or insect control.

 Fire insurance.

 Fee on credit card payments of fees.

Rotation length Clearfell at approx.

10 years Assumed wood yield (m3/ha) 340 Assumed woodchip price ($fob/bdt) not reported  Management fee of 3.3% of net proceeds from chip sales (revenue less costs of logging, cartage shipping & sales costs).

 Rent/lease fee of 2.75% of net proceeds from chip sales.

 Insurance premiums.

Clearfell at approx.


10 years  Management fee 8.8% of net wood sale proceeds.

 Rent - 5.5% of net wood sale proceeds.

 Sales commission - 2.2% of net wood sale proceeds.

Clearfell at year 13 & thinning at year 9 250 $181 322 $207.40 Source: ATO 2009b, c and d; GPL 2009; Great Southern Plantations 2007; WA Blue Gum Ltd. 2009.
In 2009, the Australian Securities and Investment Commission (ASIC) reported 198 registered plantation MIS, accounting for slightly over half of all agribusiness MIS (ASIC 2009 p. 47).

The accountancy/financial services sector established most of the early plantation MIS companies, not companies engaged directly in wood growing.
It is incorrect, however, to consider that the plantation MIS tax arrangement is assistance to just the specific plantation MIS companies and associated investors and not the wood growing industry.
With the Government retaining the plantation MIS tax arrangements, despite the persistent public debate and numerous Parliamentary inquiries that it could have used to end the arrangements, wood growing companies (in a traditional industry sense) started establishing subsidiary plantation MIS companies and wood processing companies became potential wood buyers linked to specific MIS.
The strength of forestry industry support for plantation MIS is clear in the united and forcefully argued calls to retain the tax arrangements by all the national forestry lobby groups in their submissions to the Parliamentary inquiries.

Plantation MIS accounted for 34 per cent of Australia’s plantation estate in 2008 (Gavran and Parsons 2009).
Forestry managed investment schemesSubmission 26 13 Of the three projects presented in Table 1, the Great Southern Plantations 2007 Project is the best suited for examining whether plantation MIS are unprofitable high cost structures providing greater tax deductibility to investors and distorting agricultural resource use.
The Great Southern Plantations product required most of the investor’s money paid as a pre-determined establishment fee, meaning relatively less is paid at harvest time in fees on net woodchip sale proceeds, the amount of which is heavily dependent on two unknown variables–the actual wood yield and the woodchip price.
Using Great Southern Plantations’ assumed wood yields, costs, prices and various conversion rates presented in their 2007 and 2008 Product Disclosure Statement and assuming all costs and prices remain unchanged in real terms over the 10 year investment, reveals that investors would receive a 1.9% per annum nominal return on their investment: a loss in real terms (taking the average in Great Southern Plantation’s expected inflation rate) of -0.6% per annum.
At least for products with high front-end loading of costs, the concern that plantation MIS may direct capital away from profitable uses is valid.

Products with lower establishment fees but with the Responsible Entity sharing a greater proportion of the net sales proceeds are more difficult to evaluate because of the uncertainty about future wood yields and woodchip prices.

Many analysts have claimed the projections are overly optimistic for both variables (for a history of the debate see Ajani 2007 pp.
254-258), but the proof is in the pudding.

Plantation MIS Product Disclosure Statements typically do not include any direct statement or information about forecast project returns (ASIC 2009).

Rather, relevant information is presented in an independent (forestry consultant) expert’s report included in the Product Disclosure Statement, but limited to forecast wood yields and prices.
This arrangement, which meets ASIC’s requirement that Responsible Entities have reasonable grounds for any forecast statement (otherwise remain silent), means that investors have to calculate the return on investment or seek financial advice.

The plantation MIS subsidy issue revolves around establishing whether investment in plantation MIS is inherently profitable.
It is time to move into tax law and the ATO treatment of plantation MIS to examine how the ATO has deemed plantation MIS a commercial activity, thereby enabling investors to deduct costs against income earned elsewhere.

These arrangements are crucial for plantation MIS viability.

2.2 Taxation aspects–plantation MIS commerciality Following its loss in the courts over Budplan MIS, the ATO introduced Product Rulings in June 1998.
Product Rulings allowed MIS Responsible Entities to provide relevant information for the ATO to rule on deductibility of scheme payments for investors.

As long as the MIS was implemented according to the information on which the ATO made its decision, investors could be certain about the deductibility status of their claims.
Obtaining a Product Ruling requires the Responsible Entity to Forestry managed investment schemesSubmission 26 14 supply the ATO with, amongst other things, an extensive amount of information supporting the profitability of the project–cash flow forecasts, budgeted profit and loss statements and expert reports on these forecasts (ASIC 2009).

Much of this information is not presented in the publicly available Product Ruling documentation.
Plantation MIS Product Rulings (see for example ITC 2008) list clear factual information about the project, like establishment costs, fixed fees, location, species, plantation area etc., but not forecast returns, wood yields or prices.

When it comes to scheme commercial viability, the ATO distances itself and advises investors to ‘form their own view’ and emphasises that Product Rulings do not guarantee commercial success: ‘[T]he Commissioner does not (ATO emphasis) sanction or guarantee this product.
Further, the Commissioner gives no assurance that the product is commercially viable, that charges are reasonable, appropriate or represent industry norms, or that projected returns will be achieved or are reasonably based.’ In 2000, the Government responded to the Ralph Review of Business Taxation with, amongst other things, Division 35 amendments to the ITAA.
The amendments aimed to remove the practice of presenting consumption expenses for non-commercial activities (for example, hobby farms) as business expenses.

After first passing the business (as distinct from hobby) test, individuals or partnerships seeking to claim deductions for investments in new businesses against income earned elsewhere had to pass Division 35 rules for commerciality.
The tests being that the business passes one of the following: 1. has an assessable income from the activity of at least $20 000, or 2. has produced a profit in three out of the past five years, or 3. uses real property or an interest in real property worth at least $500 000 on a continuing basis, or 4. uses other assets worth at least $100 000 on a continuing basis.
Leaving aside very important arguments about the commerciality tests’ arbitrary and inequitable nature and scope for improvement (Lacey and Watson 2004), a review of matured (ex post) hardwood plantation MIS investments would probably find that most failed the first test and probably no plantation MIS investor would pass the other three tests (Test 2 is inappropriate for most hardwood plantation MIS with income received in the final year of a ten year investment).
Plantation MIS investors have received dispensation from Division 35 with the ATO Commissioner exercising discretionary powers in specified areas.

One being to give dispensation where the business has a lead time between the commencement of the activity and the production of assessable income and because of this is yet to pass one of the four tests but there is an expectation that it will do so.
The example given by the ATO is an activity involving the planting of hardwood trees for harvest where many years would pass before the activity could reasonably be expected to Forestry managed investment schemesSubmission 26 produce income (ATO 2009a).

To make the connection: the commercial loss provisions, which are specifically addressed in product rulings, require the ATO to consider the commercial viability of plantation MIS.
In using his discretionary powers to give plantation MIS investors the right to deduct investment costs against income earned from other activity, the Commissioner must have judged that plantation MIS investments are inherently commercial by some criteria.

15 Lacey and Watson (2004) report that there is no publicly available data on the ATO’s operation of Division 35.
Within the ATO’s system are tax returns from thousands of plantation MIS investors containing the key ex post information on deductions claimed and income declared for plantation MIS investments.

A survey would clarify the return on their investment–the single most important piece of information in establishing the commercial viability of plantation MIS.
It is also apt for the ATO to periodically (say five yearly) review the process and information used to rule on plantation MIS dispensation from Division 35 commerciality tests.

2.3 Market evidence of plantation MIS profitability Doubts about the profitability of plantation MIS investments surfaced in the mid 2000s, with early plantings coming on stream.
Great Southern Plantations purchased all the wood from its 1994 project for $6.4 million, thereby meeting the investors’ expected returns, and sold the wood into the chip market for $2.1 million (Anon.

2006).

The collapse and subsequent sale of Timbercorp’s plantation assets to an international forestry investment fund provides further market valuation of plantation MIS investments.

The sale included a $198 million payment to investors and the termination of MIS arrangements (KordaMentha 2009).
With Timbercorp’s 90 000 hectares of plantations (including large areas approaching maturity), this equates to an average $2 200/hectare, significantly less than the establishment costs of any plantation MIS product currently on offer.
In late December 2009, Gunns received Great Southern Plantation MIS investor approval to become Responsible Entity for approximately 122 000 hectares of their predominantly hardwood plantations established through the now collapsed Great Southern Plantations (excluding Tiwi Islands plantations).
At the time of writing, Gunns’ costs exclude any freehold land owned by Great Southern Plantations but include approximately $8.7 million for property, plant and equipment, water licences, insurance payment receivables and inventory and additional sums for managing the plantations over their first rotation.

These costs are not expected to exceed approximately $20 million in any given year (Gunns 2009).
Gunns also established flexibility over the age when plantations will be harvested (and therefore when investors will receive income) to allow for drought and market conditions.

Investors in Great Southern Plantation 1998 to 2005 schemes will receive net harvest proceeds of an (area weighted) average of 63.4 per cent (Gunns 2009).

Investors in Great Southern Plantation schemes expected to receive 94.5 per cent of net harvest proceeds.
In addition to the reduction in their share of net harvest sales revenue, Forestry managed investment schemesSubmission 26 investors are likely to have revised downwards their expectations of total harvest revenue to more realistic levels.

16 The above mentioned 2009 Parliamentary Joint Committee on Corporations and Financial Services inquiry into agribusiness MIS drew submissions relevant to the potential inflated cost problem.
A corporate lawyer with 15 years experience in MIS advised of his 1995 plantation costing $1 200/hectare to establish on his farm through a forestry contractor.

At the time, Great Southern was selling product at $9 000/hectare (Smart 2009).

Smart’s establishment costs align with those reported by Adrian de Bruin, former managing director Auspine Ltd. and a plantation forester (Ajani 2007, p. 254).
de Bruin also considered that as little as 25 per cent of the money raised through plantation MIS would be returned to the investor (Anon 2001).

In contrast to this public evidence of substantial losses to plantation MIS investors, there appears to have been no public counter examples of profitability presented by Responsible Entities, TIMA or investors.

Perhaps there is a valid explanation.


Alternatively, perhaps investors have remained silent about any losses, fearing that declared losses may invalidate their earlier deductions (for expenditures on a business the Tax Commissioner judged to be commercial) against income earned from other activities.
And a related point: investors may also be comforted knowing the tax office generally requires records to be kept for audit purposes for only five years–less than the time between plantation costs being declared and income received.
2.4 Estimating subsidies for plantation MIS The Productivity Commission advises that their estimated effective rates of assistance to industry exclude subsidies through the plantation MIS arrangements, with the exception of an estimate for a now removed taxation provision, originally called the 13-month rule (Productivity Commission 2009).

Quantifying the assistance measures is complicated by the complexity of the financial and taxation arrangements of the schemes and severe data limitations.
An ATO investigation of ex post plantation MIS investment performance, as discussed earlier, would fill a substantial information gap: as could ASIC in its work to make Australia’s financial markets fair and transparent so that investors and consumers make informed decisions.

ASIC’s information transparency role is discussed in more detail below.
The approach taken in this paper to estimate the subsidy to forestry through plantation MIS is to first simplify the task by limiting the investigation to the major product–MIS investment in hardwood chip plantations.

This will underestimate the subsidy by excluding the relatively small investments in softwood and hardwood saw and veneer log plantation MIS.
Three approaches, as detailed below, Forestry managed investment schemesSubmission 26 were developed and the subsidy for each estimated using the following information and assumptions: 17  New MIS hardwood plantings over the five years 2004 to 2008 inclusive are estimated to cover 290 000 hectares (calculated using ABARE (2009) for total hardwood plantation area and Gavran and Parsons (2008) for ownership mix based on 2007 data).
It is assumed that 90 per cent of the area is for chip production managed over rotations of around ten years– 260 000 hectares.

    $3.7 billion invested in hardwood and softwood plantation MIS over the past five years (ASIC 2009 p. 49).
From the above, and deducting investment in longer rotation saw or veneer plantations with an arbitrary adjustment (because there is no publicly available data), the average hardwood plantation MIS investment over this five year period is assumed to be $10 000/hectare.

The actual cost of planting a hectare of trees and managing them over the approximate 10 year rotation was estimated at $2 000/hectare (Ajani 2007 p. 255).

All investors are in the top marginal tax rate.


Approach 1: Tax deduction for true costs only If deductions on income were limited to the true cost of plantation establishment and management over the rotation1, the difference between this amount deducted and that under the plantation MIS arrangements represents the investor’s assessment of the tax benefits of the higher cost MIS arrangements.
This approach generates an estimated tax-based subsidy of $0.9 billion over the five years to 2008, $187 million per annum.

Approach 2: Investor informed of return reality 1 This should be read as hypothetical.

How much a taxpayer ought to spend in obtaining income is the taxpayer’s commercial decision and not for the ATO to say (ATO 2009).
Forestry managed investment schemesSubmission 26 The tax benefit to the MIS investor is the tax deferral, but only if the MIS investment generates a positive return at the investor’s opportunity cost of capital.

If not, the MIS investor would have been better off paying the tax rather than investing in the scheme.

18 At this point, the complexity surrounding the investment return is revealed: as is the importance of the ATO/ASIC making available ex post return on investment data.
Conceptually, plantation MIS have three returns to investors:    the prospectus forecast return (which the investor must determine from the information in the Product Disclosure Statement which is heavily dependent on wood yield and chip price assumptions), the actual return (which may or may not have a Responsible Entity cross subsidised component as practiced, for example, by Great Southern Plantations for its 1994 plantings), and the ‘true’ return (not known, but may be possible to estimate through linking an ATO survey of tax returns with Responsible Entity financial accounts).
While the actual and ‘true’ return should align eventually, the potential for tax-based subsidy in the intermediate term may be substantial following the Timbercorp and Great Southern Plantations collapses.

Just as Great Southern Plantations had a commercial incentive to subsidise the returns to its 1994 investors (therefore maintaining confidence in plantation MIS to attract new high fee-paying investors), the same motivation applies to other Responsible Entities.
If another Responsible Entity acquires a collapsed scheme at significantly below cost, this will enhance the Responsible Entity’s capacity to engage in this internal to the company cross-subsidy strategy.

Information asymmetry through moral hazard and principle-agent relationships are a feature of plantation MIS.
Investors face the moral hazard reality that Responsible Entities, who act on their behalf, have more information and are also more insulated from the risk of their decisions: Responsible Entities may behave differently if they were exposed to the risk equally.

It is likely that no investment in hardwood chip plantation MIS would have occurred if investors expected a 1.9% per annum return (nominal), as calculated earlier in this paper for Great Southern Plantations.
Investors, most with their opportunity cost of capital many times higher than 1.9%, would be better off paying the tax rather than investing in the plantation MIS.

Forestry managed investment schemesSubmission 26 In this case, all the tax deduction on plantation MIS would be a direct subsidy to the forestry industry.

Extending across all hardwood plantation MIS, the tax based subsidy to forestry over the five years to 2008 is estimated at $1.2 billion, $234 million per annum.
19 Approach 3: Opportunity cost The difference between the MIS investor’s expected return and the yield on risk-free 10 year Treasury bonds gives a highly conservative estimate of the investor’s valuation of the tax benefits of plantation MIS.
On the basis that investors did their own calculations on a plantation MIS and estimated a return of 1.9% per annum (using the earlier Great Southern Plantations example) and proceeded with the investment, we can take the difference between the 1.9% and 5.35% (current 10 year Treasury bond yield) as the investor’s valuation of the tax benefit of plantation MIS.

This is a highly conservative estimate because most investors have a higher opportunity cost of capital than risk-free Treasury bonds.
The tax based subsidy to forestry through plantation MIS investments over the five years to 2008 is estimated at $1.0 billion.

2.5 Summary The estimates of the subsidy to forestry through the plantation MIS using the three approaches range narrowly between $0.9 to $1.2 billion over the five year period ending 2008.

Obtaining actual return to investor data is the single most important piece of information for enhancing the quality of the subsidy estimate.
In addition, such information would improve substantially on that currently available to investors and go some way to addressing the asymmetric information problem.

3.

Effective rate of assistance to growers of wood and food 3.1 Introduction Forestry managed investment schemesSubmission 26 20 Governments of fossil fuel powered societies, confronted with the catch up effects of the resultant green house gas pollution, seek politically attractive approaches to the climate change problem.
Offsetting fossil fuel emissions using land-based sequestration, through tree planting in particular, appears to be gaining traction in countries with relatively large agricultural land assets, such as Australia.

A potential risk lies in the diversion of resources away from food production to carbon uptake.

Because human survival requires climate security, food security and water security, prudence is required in formulating climate change policy to avoid such unintended consequences as food shortages.
The Productivity Commission’s effective rate of assistance (ERA) measure is apt for evaluating and monitoring government climate change policy effects on agricultural land and water use.

The Productivity Commission (2009 p. 18) advises that the ERA measure for the industry sector ‘Forestry & logging’ is a significant underestimate because it excludes under-priced native forest wood and tax based assistance through plantation MIS.
The plantation MIS subsidy estimates presented in the previous section of this paper fill one gap, leaving outstanding the assistance to Forestry & logging through state government native forest wood pricing policies.

As argued in the next section, it is important to fill the gap concerning subsidised native forest wood even though most plantations are now established on cleared agricultural land.
Although beyond the scope of this paper, it should be noted that unpriced access to water by plantations is another form of assistance with trees using water from a much deeper soil profile than annual crops, which impacts on groundwater flows into rivers and streams.

3.2 Wood stumpage price subsidies Historically, a range of statutory marketing arrangements, regulations and price support schemes made up the bulk of the measured assistance to agriculture.
Most have now ceased in food growing (Productivity Commission 2009 p. 14), but native forest wood remains subsidised through state government stumpage (log price less logging and haulage costs) policy.

This assistance escapes measurement because state and territory government assistance to industry, other than designated agricultural marketing arrangements and rural support programs, is not covered in the Productivity Commission’s assistance estimates (Productivity Commission 2009 p. 4).
Based on ABARE sawmill survey data (Burns et al.

2009 p. 9), approximately 80 per cent of native forest wood sold in Australia was sourced from public land in 2006/07.

Although plantation products continue to displace native forest wood products in all major markets (Ajani 2009), it is incorrect to conclude that the distortion created by subsidised native forest wood will eventually resolve itself.

Rather, new native forest wood opportunities, most notably bioenergy, are being sought.
If realised, the resource use distortion from subsidised native forest wood will broaden into the energy sector.

This issue is discussed later in the paper.

Forestry managed investment schemesSubmission 26 21 Native forest wood underpricing may have also influenced the heavy concentration of plantation managed investment schemes to the hardwood chip market.

Due largely to low wood stumpages, native forest chip exporters appear to have enjoyed many decades of extraordinary profits (Ajani 2007).
These profits are rarely reported: the information integrated with other business activities, like sawmilling and pulp production.

The Eden based South East Fibre Exports (SEFE) is the exception with its business, until recently, virtually entirely concentrated on native forest chip exporting.

SEFE’s after tax profit on equity averaged 34 per cent over the three decades to 2005 (Ajani 2007 p. 245).
An easing in this long period of very high profits emerged from the late 1990s with SEFE’s after tax profits on equity tracking slightly above 20 per cent (Financial statements lodged with the Australian Securities and Investment Commission).

Implicit in the 1990s structuring of the plantation managed investment schemes is the assumption that the historical profit sharing arrangement built up between the (Japanese) chip buyers and the Australian native forest chip exporters (Ajani 2007 pp.
110-113) would remain.

In other words, all hardwood plantation chip buyers would behave like the post WWII resource security-conscious Japanese paper industry and not use their buying power to forcefully drive real chip prices down.

On paper, the architects of plantation MIS switched the high profits saturating Australian native forest chip exporters to the plantation MIS investors.
The reality of this implicit assumption about market power is questionable, especially if Responsible Entities expect China to become a major buyer of Australian hardwood chips.

Evidence of state government subsidised native forest wood and its extent has been researched periodically (see for example Byron and Douglas 1981, Dragun 1995).
The research, however, is constrained by substantial information gaps in forestry agency financial reporting and the complexities in valuing ‘multiple-use’ public native forests for the purpose of determining returns on net assets (Forests Advisory Committee to the Minister for Economic Development 1983).
In the near three decades since the Victorian Forest Advisory Committee’s report, there has been no advance in overcoming these information gaps in Australia’s main native forest wood supply states, with the exception of Victoria.
Table 2 lists the basic information required to investigate native forest stumpage price subsidies and checks this off against the information provided in the latest financial accounts of the forestry agencies of Tasmania, Victoria and New South Wales–together accounting for 89 per cent of Australia’s native forest wood production in 2007/08 (ABARE 2009).
Only Victoria gets to first base–presenting separate native forest financial accounts–the unintended consequence of privatising its plantation business in 1998.

Forestry Tasmania, Australia largest native forest wood supply business, does not report its profit (loss) for native forest business activities separate from its plantation activities; the same for Forests NSW.

For these two states, not even native forest stumpage revenue is reported.
Theoretically, plantation parity pricing offers a way through these financial reporting gaps.

Applying plantation parity pricing, however, runs into problems.

In excess of 80 per cent of the log cut in Australia’s major native forest logging regions is geared to woodchip production (Ajani 2007) and most of the substitutable hardwood plantation chip production is linked to MIS.
Therefore, using plantation MIS log stumpage price assumptions is likely to generate a significant over-estimate of Forestry managed investment schemesSubmission 26 the native forest stumpage price subsidy.

An alternative approach is to answer the question: what native forest stumpage price would Vicforests (the only state reporting on the profit performance of its native forest wood production business, see Table 2) need to cover its costs?
The answer sets a lower limit to the estimated subsidy because there is no allowance for any dividend to the state of Victoria for its native forest business activities.
22 Forestry managed investment schemesSubmission 26 23 Table 2 Transparency in stumpage prices and financial reporting for public native forest wood production in Victoria, Tasmania and NSW VicForests (2008/09) Forestry Tasmania (2008/09) Forests NSW (2007/08) Average native forest stumpage price $16.50/m3 not reported5 not reported7 Net profit (loss) on native forest operations ($ million)1 ($5.0 million) not reported6 not reported8 Native forest log production.
(million m3 2) 1.9 million m3 2.4 million m3 1.1 million m3 % pulplogs3 66%4 77% 41% Area of public native forest available for wood production (million hectares) 3.2 million ha 1.0 million ha 2.0 million ha Source: VicForests 2009; Forests NSW 2009; Forestry Tasmania 2009; Audit Office NSW 2009; ABARE 2009.

1.

Profit (loss) after market adjustments, asset revaluations and tax.

2.

Quantities reported in tonnes converted to m3 using 1.1t = 1m3.

3.
3.

Unquantified proportion of sawlogs are used in pulplog based products.

4.

2007/08 estimate calculated by deduction using ABARE reported sawn timber production and sawn timber recovery factors.

5.

Annual stumpage price data is collected and used in forest asset valuations but reporting is limited to annual changes in stumpage.

6.

Forestry Tasmania reported a $32 million profit, which includes profit (loss) on plantation activities.
2008/09 profit is a marked turn around from previous year loss of $38 million despite an 11% volume decline in log sales from 2007/08 to 2008/09.

7.

Stumpage revenue is reported for all log sales–68% was from the plantation estate.

8.

Audit Office NSW (2009) reported a loss of $14.4 million.

Eliminating Vicforest’s $5 million loss in 2008/09 requires a 16 per cent increase ($2.60/m3) in its native forest stumpage price.
Extending this $2.60/m3 increment to Tasmania and NSW generates an increased annual stumpage revenue across the three states of $14 million.

This is considered a conservative estimate of the subsidy on wood from public native forests.

3.3 Effective rates of tariff and budget assistance to food and wood growers The shifting of wood production to plantations has brought new competition to certain food growers for agricultural land and water.
This competition aligns approximately to the Productivity Commission’s industry classifications ‘Dairy cattle farming’ and ‘Grain, sheep & beef’, which includes Forestry managed investment schemesSubmission 26 wool and omits fisheries, horticulture and fruit growing and other crop and livestock farming.

From here on, these activities are referred to as food growing.

24 The Productivity Commission’s estimated assistance to food growing, including drought related payments, is presented in Table 3.
Also presented is the estimated assistance to Forestry & logging totalling $272.5 million in 2007/08.
This comprises the Productivity Commission calculated net tariff assistance of $12.9 million (Productivity Commission 2009 p. 17), estimated state government native forest wood pricing assistance (calculated in Section 3.2), Productivity Commission estimated Commonwealth Government outlay assistance of $35.6 million (Productivity Commission 2009 p. 17) and the estimated assistance through plantation MIS taxation arrangements of $210 million (calculated using the average of the first two approaches in Section 2.4).
Table 3 Effective rate of tariff and budgetary assistance for wood and food growing 2007/08 (%) Net tariff assistance ($ million) Budget based assistance ($ million) Tax based assistance ($ million) Net combined assistance ($ million) Unassisted value added ($ million) Effective rate of combined assistance (%) 12.9 49.6 210.0 272.5 652.6 41.8 -15.9 937.7 107.2 1 028.9 14 290.3 7.2 -3.6 300.3 21.8 438.7a 2 535.8 17.3a Forestry & logging Grain, sheep & beef Dairy cattle farming a.
Combined assistance includes $120.1 million for agricultural pricing and regulatory assistance that ceased in April 2008.

Source: Productivity Commission 2009 with gaps in Forestry & Logging filled using the analysis presented in Sections 2.4 and 3.2 of this paper.

The estimated effective rate of combined assistance to Forestry & logging is 41.8 per cent: government assistance is equivalent to 42 per cent of Forestry & logging’s unassisted value added.
This exceeds substantially the assistance (including drought related payments) to food growers (Table 3).

At such significant differentials, government assistance works to redirect agricultural land, water and other resources away from food growing to wood growing relative to an unfettered market outcome.

Forestry managed investment schemesSubmission 26 4.

Policy discussion 4.1 Who bears the risk?


25 Australia’s Constitution, which saw the states retain responsibility for Crown land, has influenced greatly the nature of government assistance to the wood and wood products industry.

State public servant foresters managed public native forests to supply wood to private industry.
This arrangement continues today with subsidised wood contributing to the losses of government native forest wood production businesses (Table 2 including note 8) to the advantage of native forest wood processors.

Because competing forest land uses (largely native forest conservation) operate outside the market, land use contests play out in the democratic competition for votes.

Effective rates of assistance measures cannot easily bridge the two markets: the market for votes and the market for profits.
Long-entrenched subsidised native forest wood has slipped under the radar in industry policy.

Australian forestry changed fundamentally with the introduction of agriculture for wood production–plantations.

It brought new players and technology into the industry’s manufacturing arm and raised productivity and competition.
The associated substantial Commonwealth Government assistance for tree planting over the 1970s and 1980s–mainly softwoods for sawlog production (Ajani 2007)–did not however generate new competition for agricultural land because most of the land for planting was obtained through clearing native forests.

In this situation also, effective rates of assistance measures are marginalised.
Clearing native forests for plantations, however, triggered waves of protest (Plumwood and Silvan 1973) and now all states have policies restricting, to varying degrees, clearing native vegetation for plantations.

Australia’s adoption of the Kyoto protocol carbon accounting system is likely to further reduce planting on native forested land because, under Kyoto accounting, the land is considered to remain ‘forested’: therefore, tree planting can not be recorded as CO2 removal to earn credits.
Plantation wood growing in Australia is now focussed largely to agricultural land and the importance of generating realistic ERA measures for forestry shifts from being of marginal value to highly valuable in quantifying the distributional effect of government polices on agricultural land, water and other resource use.
Over Australia’s 130-year plantation wood growing history, many arguments have buttressed the case for government assistance for plantation establishment: self-sufficiency and by implication the trade deficit, addressing land degradation, as countervailing assistance to low native forest log stumpages, regional development, to address market failures associated with long rotation times, rural jobs and more recently CO2 removals.
Leaving to one side CO2 removal that is discussed below, the argument that retains traction concerns the linkage of long plantation rotations to capital Forestry managed investment schemesSubmission 26 market failure (see for example Parliamentary Joint Committee on Corporations and Financial Services 2009 p. 46).

There appears, however, to be no evidence of capital market failure resulting in plantation investors not being able to access finance.
Higher interest rates may accompany finance for planting, but this is normal for any long-term and therefore more risky investment.

26 Government engagement in native forest wood production originally linked the public sector to the risk associated with long lead-time forestry.

Wood buyers–the manufacturing arm of the industry– have become accustomed to this arrangement for well over a century.
When state governments started investing in plantations, the risk-sharing arrangements generated oversupplied wood markets, again highly attractive to cost-conscious commodity wood buyers (Ajani 2007).

When state governments began scaling down their plantation investments from the early 1990s, new plantation investment flattened for a decade before the revival by plantation MIS.
Under plantation MIS, the market risk remained deflected from wood buyers with tax minimising investors joining the public purse to bear most of the risk.

Decades of successful risk avoidance explains forestry’s high effective rate of assistance measure as presented in Table 3.

The challenge for governments seeking to bring forestry’s effective rate of assistance into line with that of competing agricultural land and water users is to encourage the wood and wood products industry to grow up economically.
This means, in particular, an industry whose managers and boards are able to manage risk and governments who prevent industry deflecting risk onto the public purse.

If the ERA differential between forestry and food growing remains significant, agricultural land and water will be allocated inefficiently to wood and away from food.

Some in the forestry industry may see this as correcting for past land clearing for agriculture: ignoring that plantations are agriculture not native forests.
Whilst the tension between forestry and traditional agriculture has dissipated since the days when forest agencies were branches within land departments that facilitated extensive land clearing, it would be wrong to conclude that growers of food and wood are partners in the Australian agricultural enterprise with resources, especially land, allocated through unfettered market price signals.
Today, government forestry policy (notably at the national level) is integrated within the agriculture portfolio but the forestry industry lobbyists continue their historical practice of remaining outside the agriculture club.

This brief historical policy background, combined with the ERA analysis, establishes the context for examining the role the Australian Government is now creating for plantations in climate change policy.
4.2 Plantations and the proposed emissions trading system, renewable energy targets and tax arrangements for carbon forest sinks Tree planting (‘reforestation’ or ‘afforestation’ using Kyoto protocol terminology) is the only land use CO2 removal activity able to participate in Australia’s proposed emissions trading system (ETS).2 2 Using land based CO2 removals to offset fossil fuel emissions is double-dipping, made possible in the setting Forestry managed investment schemesSubmission 26 Opting-in ‘reforestation’ participants would be required to establish a Kyoto ‘forest’ for 100 years, this being a 0.2 hectare or greater area of trees that have the potential to reach two metres in height with a 20 per cent or more canopy (Australian Government 2008).
Opting-in participants face two ‘reforestation’ options: 27  not for harvest projects–trees grown for carbon storage and not harvested over the 100 years, or  wood and biofuel production projects–with logged areas replanted to maintain the land as Kyoto compliant ‘forest’ for 100 years.

It is unlikely that productive food producing land will be used in the ‘not for harvest option’ given its opportunity cost of a century of income from food growing.
(The efficiency of planting and maintaining an area of trees for 100 years relative to other carbon storage options like not clearing native vegetation, restoring degraded native forests or establishing criteria to ensure the planted ‘forests’ are multi-species and have self-regenerating capacity is a very important issue but out of the scope of this paper.)
The second option–establishing new areas of Kyoto ‘forests’ for wood, biofuels and other products– will bring increased competition for agricultural land and water and highlights the importance of comprehensive ERA measures for wood and food growing.

Under this option, the Government proposes to issue permits (CO2 credits) for tree planting on an average crediting basis (Australian Government 2008).

Permits would be issued for net greenhouse gas removals up to a limit.
For a 25 year rotation plantation, for example, opting in growers would receive permits over the first half (approximately) of the first of the four rotations.

By limiting permits to the average of the carbon stored in the ‘forest’, growers will not be required to buy permits for the emissions on logging or for any emissions through fire so long as the ‘forest’ is replanted after these events.
This arrangement means that, once the ‘forest’ is established, the CO2 price signal to growers is blocked for the next 100 years.

It effectively ensures that the ‘forest’ will be harvested for wood (or biofuels) despite movements in CO2 prices relative to wood.
In addition, it is unclear to what extent the public will bear the risk if a plantation is destroyed or otherwise fails to store carbon for the required period and it appears the public bears the emissions cost if the plantations are not re-established after the 100-year expiry date.

of the base year for carbon accounting.

Most of the carbon emissions from earlier land clearing, in Australia and globally, remain as a stock in the atmosphere.
Replanting trees will draw down that stock, but Australia’s proposed ETS has tagged the drawdown as an offset against fossil fuel emissions (Brendan Mackey pers.comm.).

Globally and from a science perspective, the base should be set pre the industrial revolution because emissions since the industrial revolution remain in the atmosphere as a stock.
Combining this base with rigorous carbon accounting (incorporating carbon stocks and all major flows from the land sector measured in gross terms (Blakers 2009) as is done for financial accounts), would establish scientific rigor to the treatment of land-based offsets.

The funding of efficient and effective land based climate change mitigation activities can still be linked to carbon trading/tax revenue but not via offset credits against fossil fuel emissions.
Forestry managed investment schemesSubmission 26 28 In unfettered markets however, plantation owners are likely to forgo wood production and preference carbon production at relatively low CO2 prices.

This is because only half the plantation biomass is suitable for wood production but all the plantation biomass is suitable for selling into a carbon market (Wood and Ajani 2008).
The average crediting approach ensures that a CO2 price signal works to stimulate plantation investment, but once the plantation is established, average crediting eliminates the CO2 price signal and therefore the risk to wood buyers of growers preferencing the carbon market and keeping plantations unlogged.

In August 2009, Australia adopted a 20 per cent renewable energy target.

Renewable sources would account for 20 per cent of grid-based electricity production by 2020.
Wood from both native forests and plantations was classified as a renewable energy source.

The Government considers that provided the land remains forested, logging for wood and/or biofuels is carbon neutral and therefore should be CO2 cost free.

Leaving aside the issue of the ecological soundness or otherwise of using native forests for electricity, the carbon neutrality ruling ignores the temporal dimension of carbon flows in a plantation wood growing regime.
The CO2 emissions from biofuels made from say 20-year-old plantations will be CO2 cost free for the 20 years of regrowing required to drawdown the emissions (In reality the removals are offsets to earlier land clearing, see footnote 2).

These arrangements work against efficient resource use in the energy sector by disadvantaging renewable energy systems that have no temporal risk for climate change mitigation.
So far, there are a limited number of plantation MIS that include biofuels in the product mix (see for example ATO Product Ruling 2007/45).

Completing this description of the regulatory framework for plantations in Australia’s climate change policy requires mention of the still contested interpretation of subsection 40-1010(3) of the ITAA.
Senator Milne, on the basis of legal advice that capital expenditure ‘in relation to’ the establishment of trees in carbon sink forests means that land purchase costs and other associated capital costs are fully deductible upfront from 1 July 2007 to 30 June 2012, moved to disallow the guidelines relating this part of the ITAA (Senate Hansard 1 December 2008 p. 7716).
The motion generated a long debate, which on reading appears not to clarify the taxation treatment of capital expenditure for carbon sink forests.

Perhaps the legislation could have been drafted more clearly, but Milne’s legal advice warns that the near unimaginable may be a legal reality: that capital expenditure ‘in relation to’ the establishment of trees for carbon sink forests may be fully deductible.
If correct, the amended legislation would be a fundamental change from the ordinary taxation treatment of capital expenditure.

Research into the effect of the ETS on agricultural land use change has ignored the plantation MIS tax-based subsidy, although the MIS arrangement is likely to be the implementation mechanism.

Lawson et al.
Lawson et al.

(2008) estimate that at a CO2 commencement price of $20.88/t in 2010 increasing by an average 4 per cent per annum to 2050, around 5.8 million hectares of agricultural land may shift Forestry managed investment schemesSubmission 26 29 into ‘forested’ land: around 3 million hectares as commercial plantations and 2.7 as environmental plantings.

At a commencement CO2 price of $29.10/t, Lawson et al.
(2008) estimate a 26 million hectare ‘forestry’ land use change between 2007 and 2050 comprising slightly over 4 million hectares of additional commercial plantations with the remainder being environmental plantings.

The CSIRO, based on work they describe as “prospecting’ for opportunities”, reports that 17 million hectares of agricultural land may be suitable for carbon ‘forestry’ through a combination of biodiverse carbon sink plantings and commercial plantations (CSIRO 2009 p. 12 & 112).
Like Lawson et al.

(2008), the research ignores the plantation MIS arrangement and complementary measures to classify wood as a carbon neutral renewable energy source.

The omissions reinforce the importance of incorporating plantation MIS arrangements into the Productivity Commission’s ERA measures.

5.
5.

Recommendations The preliminary ERA estimates presented in this paper incorporating government assistance to Forestry & logging through the plantation MIS suggest substantial distortion in resource use in Australia’s agricultural industries, away from food to wood.
The plantation MIS, combined with emerging climate change policy for the land use sector which privileges tree planting as the sole land-based offset in the proposed ETS and assumes away temporal issues in classifying wood as a carbon neutral renewable energy, is likely to exacerbate the distortion.

To create the information for policy debate and policy making, evaluation and monitoring, it is recommended that: 1.
Treasury and the ATO conduct five-yearly reviews (with the first to be undertaken immediately) of the process and information used to rule on plantation MIS dispensation from Division 35 commerciality tests.

2.

The ATO, ASIC, Treasury and Productivity Commission establish a publicly accessible plantation MIS reporting and monitoring system where, at a minimum, the key variables– return on investment, wood yield and woodchip prices–are tracked over time for each project.

3.
3.

The Productivity Commission’s ERA estimates be expanded immediately to include assistance through plantation MIS using, in the first instance, Approach 1–tax deduction for true costs only.

4.
4.

Failing State Government engagement in Tasmania and New South Wales in particular, the Australian Government intervenes to ensure greater transparency in state native forest Forestry managed investment schemesSubmission 26 wood production businesses, including separate financial reporting of native forest wood production profits (losses), stumpage revenues and log sales for major product groups (saw/veneer log, chip log and bioenergy).
To assist in policy development aimed at food and climate security, it is recommended that: 30 5.

The Australian Government initiate a major investigation into the land use sector’s potential contribution to climate change mitigation, setting as the first task the compilation of a coherent system of land use sector carbon accounts that includes carbon stock measures together with separately reported emissions and removals.
Acknowledgements I thank Ross Lambie and Geoff Bennett for discussions on plantation MIS subsidy estimate methods; Gordon McCauley, Margaret Blakers and Neil Bryon for comments on an earlier draft and the Productivity Commission for assistance in interpreting ERA data, and remind readers that the views expressed in this paper are not necessarily theirs.

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Available from URL: http://www.forestrytas.com.au/uploads/File/pdf/pdf2009/Appendix1_Financial- Statements.pdf [accessed 17 December 2009].

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Annual Report 2007/09.

Available from URL: http://www.dpi.nsw.gov.au/aboutus/resources/corporate-publications/forests-nsw-annual- report-2008-09 [accessed 17 December 2009].
Gavran M. and Parsons M. (2009).

Australia’s Plantations 2009 Inventory Update, Bureau of Rural Sciences, Canberra.

Available from URL: http://adl.brs.gov.au/mapserv/plant/NPI2009Update.pdf [accessed 2 January 2010].

Gavran M. and Parsons M. (2008).

Australia’s Plantations 2008 Inventory Update, Bureau of Rural Sciences, Canberra.

Available from URL: http://adl.brs.gov.au/brsShop/data/npi2008update.pdf [accessed 2 January 2010].

GPL (2009).
GPL (2009).

Woodlot Project 09 Product Disclosure Statement, Gunns Plantations Ltd., Tasmania.

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Product Disclosure Statement 2007 & 2008 Project.

Available from URL: http://www.great-southern.com.au/Plantations_Project.aspx [Accessed 17 December 2009].

Gunns (2009).

Gunns proposes to manage Great Southern Plantations for investors, company announcement to Australian Securities Exchange 20 November 2009.
Available from URL: http://www.gunns.com.au/Content/uploads/documents/ASX%20Releases%202009/2009%20 11%2020%20ASX%20Release%20- %20Gunns%20Proposes%20to%20Manage%20Great%20Southern%20Plantations%20for%20I nvestors.pdf [accessed 30 December 2009].

Industry Commission 1993, Adding Further Value to Australia’s Forest Products, AGPS, Canberra.

ITC (2008).

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Available at URL: http://law.ato.gov.au/atolaw/view.htm?docid=PRR/PR200829/NAT/ATO/00001[Accessed 17 December 2009].
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Ltd. acquires Timbercorp forestry assets, Media release 30 September 2009.

Available at URL: http://gfplp.com/pdf/TIM9.2009PressRelease.pdf [accessed 17 December 2009].

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(2004).


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Forestry managed investment schemesSubmission 26 33 Lawson K., Burns K., Low K., Heyhoe E. and Ahammad H. (2008), Analysing the economic potential of forestry for carbon sequestration under alternative carbon price paths, ABARE.

Available at URL: http://www.treasury.gov.au/lowpollutionfuture/consultants_report/downloads/Economic_Po tential_of_Forestry.pdf [accessed 17 December 2009].

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Inquiry into Aspects of Agribusiness Managed Investment Schemes.

Available from URL: http://aph.gov.au/senate/committee/corporations_ctte/MIS/report/index.htm [accessed 17 December 2009].

Plumwood V. and Silvan R. (1973).

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Available from URL: http://www.pc.gov.au/annualreports/trade-assistance/tar0708 [accessed 17 December 2009].

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Available from URL: https://senate.aph.gov.au/submissions/comittees/viewdocument.aspx?id=bb994582- b92c-4cf7-82e0-4817b6d63744 [accessed 16 December 2009].

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Vic Forests Annual Report 2009.

Available at URL: http://www.vicforests.com.au/assets/docs/publications/vicforests_annual%20report%2009% 20final.pdf [accessed 17 December 2009].

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Available at URL: http://www.wabluegum.com.au/assets/PDS.pdf [accessed 29 January 1010].

Wood P.J.

and Ajani J.

(2008).

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Available at URL: http://www.climatechange.gov.au/en/submissions/cprs-green- paper/~/media/submissions/greenpaper/0133-wood-ajani.ashx[accessed 2 January 2009].
Forestry managed investment schemesSubmission 26 35 Submission to Senate Select Committee on Climate Policy Dr Judith Ajani Fenner School of Environment and Society The Australian National University 8 April 2009 Key points a) Plantations should be withdrawn as a covered sector in the CPRS.

b) Australia is poised for another round of zealous plantation establishment that has a potentially serious climate change downside and is disconnected from wood market realities.
c) The CPRS accounting rules for plantations are designed to stimulate plantation investment and to isolate the resulting projects from future changes in the carbon price.

It is inconceivable that governments around the world engaged in developing a global carbon market wish to create outcomes where projects/businesses, once issued with units, become immune from CO2 price signals for the next 130 years.
d) Separate to the CPRS, Australia should bring the land use sector into a wider climate policy, with food security, water and ecological sustainability prime considerations and with special attention to the boundary issues with the CPRS, most particularly bioenergy and biomass feedstocks.

e) The Government should guarantee its interpretation of Subdivision 40-J of the Income Tax Assessment Act 1997 that capital expenditure for carbon sink forests is not fully deductible upfront.
Introduction Forestry managed investment schemesSubmission 26 36 1.

The Government presents the Carbon Pollution Reduction Scheme (CPRS) as the centre-piece of its climate change policy.

‘Reforestation’ (mainly tree plantations for wood and/or carbon) is the only land use activity covered by the Government’s proposed CPRS.3 There is mounting evidence-based scientific research alerting us to ecologically superior land use activities for climate change mitigation.
In November 2008, the Ad Hoc Technical Expert Group on Biodiversity and Climate Change (established to provide biodiversity related information to the United Nations Framework Convention on Climate Change) listed the following key principles in considering this issue: a.

In their natural state, ecosystems are generally more carbon dense and biologically more diverse.
Well functioning ecosystems have greater resilience to climate change that will aid in their natural adaptation and ongoing climate change mitigation function.

b.

Primary forests are generally more carbon dense, harbour the highest biodiversity and have higher resilience than other forest ecosystems (notably plantations).
c. Land use activities that involve clearing and logging reduce the standing stock of living biomass carbon, cause collateral damage to soil and dead biomass carbon, reduce biodiversity and thus ecosystem resilience.

This creates a carbon debt that takes decades or centuries to recover.4 2.

From these principles come the following ecologically-based priorities for climate change mitigation and adaptation for the forest ‘land use’ sector, starting with the highest priority: a.
Avoid emissions from deforestation and forest degradation by protecting existing carbon stocks in primary forests and woodlands,5 i.e.

do not clear or log these ecosystems.

b.

Maintain, or where necessary, re-establish the restorative capacity of deforested and degraded natural ecosystems to ensure maximum carbon sequestration as they return to their full carbon carrying capacity.
c. For natural forests and woodlands devoid of restorative capacity, reforest using mixed native species to enhance resilience and therefore long-term carbon storage capacity.

Reforestation should make use of remnant natural forests and woodlands.

3 Even if agriculture is included from 2015, CO2 fluxes associated with land use will not be included.

Agriculture, as a sector in emissions trading would include only non-CO2 emissions, mainly arising from animal husbandry.
Soil carbon will not be included under the Kyoto Protocol.

4 Ad Hoc Technical Expert Group on Biodiversity and Climate Change (2008), Draft findings of the first meeting of the second Ad Hoc Technical Expert Group on Biodiversity and Climate Change, London 17-21 November 2008.

5 For estimates of the carbon stocks in South eastern Australian eucalypt forests see Mackey B.G., Keith H., Berry S. and Lindenmayer D.B.
(2008), Green Carbon: The Role of Natural Forests in Carbon Storage, The Australian National University, E PRESS < http://epress.anu.edu.au/green_carbon_citation.html> Forestry managed investment schemesSubmission 26 37 3.

‘Reforestation’ through plantations of single and/or exotic species–the mainstay of the ‘reforestation’ component of the proposed CPRS–will not create resilient self-regenerating ecosystems.
Whilst plantations sequester carbon, they store considerably less carbon per hectare than natural forests because the stands are usually harvested at a relatively young age and young trees store less carbon than old trees.

Plantations of single and/or exotic species established for carbon sinks (i.e.
not for wood production and therefore not regenerated through replanting after harvest) are more vulnerable to collapse through pests and disease than natural forests and, having no intrinsic regenerative capacity, will eventually die and release large quantities of CO2.

4.

The government’s climate policy has promoted the least ecologically sound forest land-use activity–‘reforestation’ through plantations for wood and/or carbon–over ecologically superior options.

This is wrong.
This is wrong.

Australia’s contribution to tackling climate change will be stunted and will cost more than need be.

The role for plantations 5.

Australia’s ‘forestry’ industry is now plantation based and, as a consequence, more productive and competitive in all major wood products sectors–pulp and paper, wood panels and sawn timber.
In 2006/07, plantations made up nearly 70% of Australia’s wood supply; plantation processors made 82% of Australia’s sawn timber and wood panels; and plantations accounted for 77% of the wood used in Australian paper manufacturing.6 According to the Bureau of Rural Sciences’ projections, Australia faces an immediate surge in plantation wood supply following more than a decade of strong, steady growth in plantation wood supply (Figure 1).

6.
6.

Australia’s softwood and hardwood plantations can meet virtually all our wood needs for paper, wood panels and sawn timber without having to call on native forest wood or imports.

Figure 1 Australia has moved beyond wood self-sufficiency, using plantations alone.

6 Ajani J.

(2008) ‘Australian production of wood and wood products in 2006/07 disaggregated by wood source’, unpublished paper, Fenner School of Environment and Society, The Australian National University.
Forestry managed investment schemesSubmission 26 38 Projected plantation wood supply Wood consumption - wood used to make the wood products we consume (paper, wood panels and sawn timber) whether made domestically or imported.

Growing at an average of 0.7% p.a.
Actual plantation wood production ) m u n n a r e p 3 m n o i l l i m ( d o o W 35 30 25 20 15 10 Source: ABARE Australian Commodity Statistics & Australian Forest and Wood Products Statistics; BRS Australia's Plantation Log Supply 2005-2049.

7.
7.

With plantations dominating domestic processing, woodchip production (mostly for export) now dominates Australia’s major native forest logging regions: 84% of Tasmanian production is chipped, 80% Central Victoria, 81% East Gippsland, 40-50% North East NSW and 90% Eden region NSW.7 However, MIS hardwood plantations are now bearing merchantable wood and starting to displace native forest woodchips (Figure 2).
The substitution is taking place primarily in the Japanese woodchip market where 85% of Australia’s hardwood chip exports are sold.

Japan’s woodchip market has been stagnant since the early 1990s.

Figure 2 Hardwood chiplog production - Australia 7 Ajani J.

(2007), The Forest Wars, p. 278.


Forestry managed investment schemesSubmission 26 39 Native forest chiplogs Hardwood plantation chiplogs 10 9 8 7 6 5 4 3 2 1 0 ) a p 3 m n o i l l i m ( n o i t c u d o r p g o p h c d o o w d r a H l i 2001 2002 2003 2004 2005 2006 2007 Source: ABARE Australian Forest and Wood Products Statistics.

8.

The Bureau of Rural Sciences projects 14 million m3 per annum of hardwood plantation chiplogs coming on stream from 2010.
This is double the volume of Australian native forest woodchips exported annually.

The native forest displacement is already in train.

The Australian Government can choose to accelerate the substitution and work to remove the economically damaging low- priced native forest woodchip competition from the three south eastern state governments.

9.

The role for plantations is very much more than a high quality raw material enhancing the competitiveness of Australian wood processing.
Plantations liberate large areas of Australia’s native forests to do the job they do better than other ecosystems–substantial carbon storage in biologically diverse, resilient natural ecosystems.

The global wood market 10.

Although absent in half a century of Australian forestry policy, rigorous market analysis should precede consideration of another plantation investment surge.
Because Australia is past wood self-sufficiency (Figure 1), additional substantial planting for wood production requires exporting: probably as unprocessed wood given Australia’s historical policy settings.

Wood used to make paper, sawn timber and wood panels is no longer a high-growth global industry.

Over the quarter century post the 1970s oil-shock period (1980 to 2007), global wood consumption increased by an average of only 0.4% per annum (Figure 3).
Stagnating wood products consumption in high-income countries and resource saving strategies across the wood products industry explains the low growth in global wood use.

Figure 3 Growth in global wood consumption Forestry managed investment schemesSubmission 26 40 Global wood consumption growing by only 0.4% per annum 1980 to 2007. )
r y / 3 m n o i l l i b ( n o i t p m u s n o c d o o W 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0. Source: FAOSTAT.

11.

The persistent predictions of global wood deficits remain an illusion.

Real prices for globally traded wood have not deviated from their long-term downward trend.
Many of Australia’s first round MIS hardwood plantation prospectus documents assumed real price increases for hardwood chips.

Real hardwood chip export prices continue to trend down (Figure 4) and large areas are coming on stream at a time when the main outlet–the Japanese market–has moved from flat to contracting.

12.

China’s strong growth in wood products consumption is not delivering the wood growers’ market dream.
Whilst its wood imports (mostly softwood) surged in volume terms by an average 19% per annum over the decade ending 2006, real import prices have declined by an average 6.8 per cent per annum over the same period: in other words, halved.8 China’s heavy use of recycled paper in paper making is dampening the demand for wood, as is its investment in higher pulp- yielding pulp mills.
Through its State Forestry Administration, the Chinese Government has set a target of establishing 13.3 million hectares of wood producing plantations over the period 2001 to 2015, with the aim of reducing its dependence on imports of wood and wood pulp for paper making.

8 Ajani J.
8 Ajani J.

(2008) ‘Australia’s Transition from Native Forests to Plantations: The Implications for Woodchips, Pulpmills, Tax Breaks and Climate Change’ Agenda: A Journal of Policy Analysis and Reform’, 15(3), 2008 <http://epress.anu.edu.au/titles/agenda.html> Forestry managed investment schemesSubmission 26 Figure 4 Real prices for hardwood chip exports trend down 41 Real hardwood chip export price - Australia Declining at an average 2% p.a.
* ) e n n o t y r d e n o b $ b o f ( / e c i i r p t r o p x e p h c d o o w d r a h l a e R 300 250 200 150 100 50 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 * Deflated by Aust.

CPI 1989/90 = 100 Source: ABARE Australian Commodity Statistics 2008.

New markets for plantation wood–bioenergy 13.


Plantation wood has been tagged a renewable fuel source (leaving aside wood growing issues concerning biodiversity, water catchments, soils and chemicals).

Plantation advocates make comparisons with fossil fuel emissions when policy should consider the greenhouse impact using annual accounting and comparisons with the full range of energy supply options, including the various renewable energy systems.

14.
14.

Logging plantations, including for bioenergy, causes emissions from collateral damage to living and dead biomass and soil carbon.

This creates a carbon debt that takes decades to recover.9 In a Kyoto accounting construction, the emissions come from sequestered carbon resulting from planting land cleared before 1990.

This suggests carbon neutrality if the time period of the analysis is constrained to one or a few rotations.
However, from the more fundamental earth system perspective, the ‘reforestation’ is a return of land to its former forested state (albeit less biodiverse).

This is the proper base from which the carbon neutrality scale should be set to zero.

Using this scientific base, logging Kyoto compliant plantations is carbon negative.
For the time being, Kyoto accounting is the convention, but if climate change reaches danger level for humans, debates about the base and carbon neutrality will dissipate and our efforts to reduce emissions from all sources, including logging plantations will intensify.

Zealous ‘reforestation’ through plantations has a serious climate change downside.
9 Ad Hoc Technical Expert Group on Biodiversity and Climate Change (2008), Draft findings of the first meeting of the second Ad Hoc Technical Expert Group on Biodiversity and Climate Change, London 17-21 November 2008.
Forestry managed investment schemesSubmission 26 Submission to the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into Agribusiness Managed Investment Schemes 42 Dr Judith Ajani Fenner School of Environment and Society The Australian National University 24 June 2009 Key points and recommendations 1.

Plantation managed investment schemes have quadrupled the cost of growing wood in Australia and are an unnecessary drain on the public purse.

2.
2.

Plantation managed investment schemes are boom bust by nature because investment in wood is driven by the demand for tax minimisation, not wood market realities.

3.

The combination of investment driven by the demand for tax minimisation and highly profitable plantation MIS companies receiving their income up-front has generated a hardwood chip glut.

4.
4.

An investigation of late 1990s hardwood plantation prospectus documents reveals a wide chasm between chip and paper market expectations and actual market realities.

With prospectus company profits not pinned primarily to revenue from wood sales, there is little commercial motivation for them to invest in rigorous market research or to respond to wood market realities.

5.
5.

If the Commonwealth Government decides to engage in tackling the woodchip glut (acknowledging its substantial hand in creating the arrangements that generated the glut), it will need to attend to the entrenched alliance between the bureaucracy and the forestry lobby groups.

In particular, it must rise above a handful of lobbyists who pedal perceptions of wood shortages (including on the domestic front through misrepresenting the wood and wood products trade deficit) despite the hardwood chip glut.
Forestry managed investment schemesSubmission 26 It is recommended that: 43 1.

The Commonwealth Government terminate immediately the arrangements enabling plantation managed investment schemes.

2.

The Commonwealth Government terminates the policy goal of tripling Australia’s plantation estate by 2020, as was the first recommendation of the 2004 Senate Committee report Australia’s Forest Plantations – A Review of Plantations for Australia: The 2020 Vision.

3.
3.

The Commonwealth Government engages in tackling the woodchip glut by facilitating the clearing of competing native forest supplies from the market.

4.

Plantation managed investment schemes be investigated more deeply than is possible for the parliamentary committee given its time and resource constraints.

5.

The carbon forest sink legislation (Subdivision 40-J of the Income Tax Assessment Act 1997) be revisited in the light of the plantation MIS corporate and system failure.

1.
1.

Introduction While the global financial crisis and economic recession may have triggered the downfall of Timbercorp and Great Southern Plantations, all hardwood plantation MIS investments face a very difficult next few years.

The schemes have driven a hardwood chip glut in a no growth market: securing sales means displacing heavily subsidised native forest supplies from Tasmania, Victoria and New South Wales.
The complexity underpinning the likely on-going failings of the schemes may be unprecedented in Australia’s corporate and government history.

There are many questions.

How did a free-market-believing government get to sign an industry dream target of tripling the output of an agricultural commodity?

Where did all the money go?

Why didn’t the ratings agencies sound the alarm?

What was the role of forestry lobbyists, including the one created specifically for the plantation MIS companies, in the debacle?
Why didn’t either major party in government terminate the schemes?

In this submission I focus on two elements.

First, an investigation of the late 1990s hardwood plantation prospectus documents aligning their portrayal of the future market for woodchips and paper with what actually happened.
Secondly, a mapping of the job movements of five key Forestry managed investment schemesSubmission 26 forestry/plantation lobbyists as key background information for understanding why, despite their instrumental role in creating a woodchip glut, they appear never to have called for competing low cost native forest supplies to be withdrawn from the market.

44 This submission addresses the Committee’s Terms of Reference numbers 1, 5, 6, 7, 8, 9, 10 and 12.

2.
2.

Eucalypt plantation managed investment scheme - fundamentals By focussing on four key variables (presented in Table 1) we can rise above the tax, financial and corporate complexities of plantation managed investment schemes (MIS) and understand their fundamental flaws, inevitable bust and how wood growing in Australia has become a very high cost business draining the public purse.
MIS eucalypt pulpwood growers invest 4.5 times more than non-MIS growers to do the same job of planting and managing trees over the rotation (Table 1).

Yet MIS growers–informed by the projections presented in prospectus documents–expect rates of return ranging between 6.5% to 11.0% (Lonsec Agribusiness Research 2001).

On paper, the cost chasm between MIS operations and actual industry standards has been reconciled using highly optimistic assumptions on wood yields and stumpage prices.
In the case of wood yields: in the vicinity of 60% higher than industry actuals.

In the case of stumpage prices: in the vicinity of between 93% to 820% higher than industry actuals (Table 1).

Most plantation MIS are structured to focus virtually all the market and wood yield risk onto the grower (not the MIS company) when the trees mature ten to twelve years after the initial investment.
As time passes, it is clear MIS growers in doing the job of growing hardwood for woodchips have not soared above current industry actuals and the projected returns for many investors are unlikely.

Great Southern Plantations’ 2005 annual report sounded the alarm.

The company reported buying all the wood for its 1994 project for $6.4 million and claimed an after tax expense of $3 million.
Financial advisors estimate that Great Southern Plantations then sold the wood for around $2.1 million, less than a third it paid for it (Intelligent Investor 2006).

Great Southern Plantations argued the failure was in the past and rectified.

Ratings agency Australian Agribusiness Group, whilst noting the failure, gave Great Southern Plantations 4 ½ stars (out of 5) for Corporate Governance and 3 ¾ stars for Track Record in their rating of the company’s 2007 project.
Alan Cummine, executive director Treefarm Investment Managers Australia (established in 2000 as the lobbyist for plantation MIS companies) worked to contain the damage spreading sector-wide by arguing that past performance did not accurately reflect future wood yields from better managed plantations and planting stock.

Funds continued flowing into plantation MIS companies.
Forestry managed investment schemesSubmission 26 45 Summary    Irrespective of grower-investor knowledge of wood growing and market realities, they have used their pumped-up investment cost for immediate tax relief.

Through tax and financial engineering, the demand for tax minimisation has displaced wood market signals as the driver for investment in plantations.

(Wood market realities are discussed later in this submission and Appendix A.)
The public purse pays for this concocted high-cost wood growing system destined, inevitably, for economic bust.

Forestry managed investment schemesSubmission 26 46 Table 1 Eucalypt plantation MIS–costs and key assumptions for plantations established mid-term in the life of Australia’s MIS plantation program.

MIS Industry actual Source/comments Cost per hectare (including management over rotation) $9 300 $2 000 Source for MIS costs – Lonsec Agribusiness Research 2001 using eight prospectus documents.
Source for industry actual as reported by Auspine, then a major private plantation grower, reproduced in Ajani 2007 p. 255.

Land cost Lease costs included above $2 500 For most schemes, growers do not own the land.

Source for MIS costs – Lonsec Agribusiness Research 2001.
Industry actual is the average of the yields used by the Bureau of Rural Sciences for their wood supply projections for eucalypt pulpwood plantations in Western Australia, Green Triangle, Murray Valley and Central Victoria (Parsons et al.

2007 p.

46.)

Source for MIS stumpage prices – Lonsec Agribusiness Research 2001.

Nominal stumpage prices reported at end of rotation (average 11 years) converted to nominal prices at start of rotation using average assumed annual real price increase of 0.2%.
Source for industry actual – softwood plantation is ForestrySA list price; native forest is actual stumpage prices for Tasmania and Victoria (Ajani 2007 p. 265) plus a 12% quality adjustment factor.

Actual stumpage prices for hardwood plantations have transparency problems– see discussion about Great Southern Plantation payments on page 3.

Wood yield (m3/hectare/year) 27.3 17.00 Stumpage price ($ per m3) $36.72 $17 - $19 softwood plantation $4 - $15 native forest 3.
Hardwood chip supply Forestry managed investment schemesSubmission 26 47 Contemporary plantation MIS were created in the first half of the 1990s.

Most offered investments in hardwood plantations geared for woodchip production because these require relatively short rotations that generate earlier returns.

In addition, the hardwood chip market held a special attraction for MIS companies.
Exporting native forest woodchips was highly profitable10 due largely to state government willingness to sell public native forest chiplogs at low prices (meaning the three main native forest woodchip states– Tasmania, Victoria and New South Wales–have been willing to operate their forest agencies as loss making or barely break even operations).
Embedded in the hardwood plantation prospectus financials is an assumption that the extraordinary profits enjoyed by the native forest woodchip exporters (principally Gunns, Midway and South East Fibre Exports) would be transferred in full to the plantation growers.

Such an assumption defies the long historical reality of profit margin differentials along the agricultural commodity production and marketing chain.
Largely through MIS investments, Australia’s hardwood plantation estate increased from 146 000 hectares in 1993 to 950 000 hectares in 2008 (ABARE 1993 p. 57; ABARE 2009 p. 10).

The resources from the mid 1990s plantings are now on stream, supplying 40% of Australia’s hardwood chips in 2007/08 (Table 2).

The Bureau of Rural Sciences projects plantation chip supply will soar by around 2010 (five months away!
): tripling plantation supplies in the immediate future and doubling native forest production (Table 2).

Table 2 Hardwood chip production and projected supply – Australia (million m3 roundwood per annum) Plantation Native forest Source/comments Production 2007/08 4.4 6.1 Calculated using ABARE 2009; Ajani 2009.

Includes relatively small volumes (around 10%) processed domestically into pulp.
10 The Eden based South East Fibre Exports, drawing on native forest wood in New South Wales and Victoria, has recorded an average 34% after-tax profit on equity over the past 30 years (Ajani 2007, p. 245).

I see no fundamental reason for other native forest chip exporters not enjoying similar results.

Forestry managed investment schemesSubmission 26 48 Projected supply 2010 to 2014 Projected supply 2015 to 19 13.8 12.8 Bureau of Rural Sciences projections prepared by Parsons et al.

2006.
2006.

Bureau of Rural Sciences projections prepared by Parsons et al.

2007.

Most (around 90%) of Australia’s hardwood plantation and native forest chips are exported unprocessed.

Japan buys 85% of Australian exports and China 12% (ABARE 2009, p. 79).

Australia accounts for a third of Japan’s hardwood chip imports.
Summary The key features of Australia’s hardwood chip supply reality today are:   dominated by heavily subsidised public native forest resources with state governments entrenched in loss making native forest wood supply; on the brink of a massive surge in plantation supply; and  markets heavily concentrated to Japan whose pulp and paper industry dominates the global hardwood chip trade.

Forestry managed investment schemesSubmission 26 4.
Hardwood chip consumption The future demand for hardwood chips is crucial information for potential investors.

Appendix A, aligns statements on market expectations presented in various hardwood plantation MIS prospectus’ on offer by the late 1990s against what actually happened in the market.
49 Overwhelmingly, the hardwood plantation prospectus market analyses have been feeble: often referring to the total global wood market outlook (not mentioning that hardwood chiplogs account for only 14% of global industrial wood production); failing outstandingly in projecting fundamental market trends, downplaying the growing significance of paper recycling; misrepresenting Australia’s wood products trade deficit; and never moving past vague generalities.
The reality of the markets for which the MIS wood was destined is:      global growth in wood consumption of just 0.4% per annum from 1980 to 2007; average annual growth in Japanese consumption of paper and paperboard of 0.1% from 1997 to 2007; Japanese hardwood chip imports stagnant from 1997 to 2007; Japanese use of recycled paper and paperboard growing by 1.9% per annum since 1999; China working to achieve resource security for its paper industry through an awesome increase in recycled paper input, investing in high-yielding pulp technologies (requiring less wood to make a unit of pulp) and substantial investment in short rotation plantations for pulp production; and  a long-term trend decline in real prices for globally traded hardwood chips.
The much quoted trade deficit in wood products is in reality a manufacturing industry problem, caused largely by imports of printing and writing paper.

Australia’s monopoly paper producer also substantially controls merchanting of both domestic and imported paper and is in a position to block or enable new domestic paper manufacturing.

Forestry managed investment schemesSubmission 26 50 5.
Government support On 2 October 1997, John Anderson, Minister for Primary Industries and Energy launched Plantations for Australia-the 2020 Vision.

Its overarching goal was to triple Australia’s plantation estate by 2020: a goal developed jointly by government and industry including the National Association of Forest Industries, Australian Forest Growers and Plantations Australia.

It was endorsed by the Commonwealth and State Governments in July 1996.
The market analysis backing the goal– conducted by the Centre for Economic Analysis and attached as a Reference Document to The 2020 Vision–was shoddy (Ajani 2007, pp.

249-52).

Launching The 2020 Vision, the minister referred to the event as a ‘ceremony’ and ‘a good news story for rural and regional Australia – indeed for all Australians’.
Jobs, partnerships with farmers, large scale land care benefits, greenhouse gas sequestration and creating a wood and wood products trade surplus were The 2020 Vision’s offerings.

Managed investment schemes were never mentioned as the vehicle for implementation, although they were then effectively fully fledged.
In concluding his speech the minister listed the rewards to flow from The 2020 Vision: ‘The result will be a vibrant, sustainable, internationally focussed and competitive plantation sector that will deliver substantial rewards to all those involved in the industry; to rural and regional Australia; and to the economy at large.’ Minister for Primary Industries and Energy launching The 2020 Vision, Canberra 2 October 1997.
The outcome has largely been the opposite: an unsustainable boom-bust high cost activity benefitting a few at great expense to the many (including in rural areas) via the public purse.

Government-endorsed production targets are rare.

They are marketing gold.

Wood plantations have this privilege through The 2020 Vision, despite there being no evidence of market failure in plantation wood growing.

Plantation MIS prospectuses regularly highlight The 2020 Vision.
Australian Plantation Timber included it as a dot point ‘highlight’: ‘An initiative by State, Territory and Commonwealth Governments and the forestry industry called the “2020 Vision” seeks to treble the area of Australia’s plantations between 1997 and 2020.

This will have significant benefits for the future of Australia’s forestry industries.’ Australian Plantation Timber 2000 Prospectus p. 5.
Forestry managed investment schemesSubmission 26 Integrated Tree Cropping included the target as one of ‘a number of reasons tree farming in Australia is a sensible investment’ and emphasised the Australian Government connection: 51 ‘The Australian Government supports the development of an expanded plantation industry and has the aim of tripling the country’s tree farms by 2020.
It is working with state and local governments to ensure impediments are minimised and every incentive is given to tree farming.’ Integrated Tree Cropping Eucalypts 1999 Green Triangle Project p. 8.

In October 1998 Wilson Tuckey, as newly appointed Minister for Forests and Conservation with jurisdiction over plantations, became the plantation MIS companies’ champion.
Minister Tuckey forcefully defended public attacks on the schemes (see for example the minister’s response to Alan Kohler’s article ‘Tax bill to ringbark tree schemes’ in letters to the Australian Financial Review 23 June 2000 p. 87) and worked to ensure investments remained 100 per cent tax deductible in the year of expenditure.
In spite of the government’s unwavering support, by 2002, mounting disquiet about plantations and government plantation policy saw The 2020 Vision and the taxation treatment of plantations engulfed in inquiries:    A Senate Committee inquiry into Australia’s Forest Plantations - A Review of Plantations for Australia: The 2020 Vision which reported in 2004.

A Senate Committee inquiry into Australian Plantation Forestry which reported in 2004.
A Treasury review of The Taxation Treatment of Plantation Forestry.

But Australia’s plantation policy remained intact with Senate Committee recommendations (for example, to scrap the target to triple Australia’s plantation estate) effectively ignored.

6.

Native forest competition and blockages to economically coherent forest policy Investing in plantations through MIS companies required the perception of wood shortages and therefore expectations of steadily rising real prices for wood.
Australia’s misrepresented wood and wood products trade deficit has been commandeered to this end.

In the global market, wood price trends continue to contradict predictions of a global shortage (Figure 1, Clark 2001).

Price trends also Forestry managed investment schemesSubmission 26 52 continue to contradict predictions of a shortage of hardwood chips.
This misrepresentation of market reality works to promote investment and at the same time mask opportunities to substitute native forest wood with plantation wood.

The arrangement has operated without government correction for 15 years and has generated a hardwood chip glut (Figure A7 combined with market trends in Japan and China as presented in this submission).
Clearing the market of the low-priced native forest woodchip competition is economically coherent, but never has the hardwood plantation sector, or its lobbyists, called publicly for this.

Intensifying competition between native forests and plantations in the hardwood chip market was inevitable.

But the MIS companies do not bear the risk because their corporate and financial arrangements passed this onto the grower- investors.
Forestry managed investment schemesSubmission 26 Figure 1 Real price for exports of globally trade industrial wood ) 3 / m b o f S U $ ( * s e u a v l t i n u t r o p x e l a e R 120 100 80 60 40 20 0 53 120 100 80 60 40 20 * Deflated using US CPI.

Source: FAOSTAT.
Source: FAOSTAT.

As increasing volumes of plantation wood came onto the market–first softwood and now hardwood–new plantation industry groups were created.

NAFI, the historically dominant ‘forestry’ industry voice, primarily representing native forest logging, scrambled to maintain control.

Five people effectively managed the new hardwood dynamic within the forestry industry (Table 3).
All started their careers in the government sector and moved into forestry lobbying, most rotating around the lobby groups, including those they created (Figure 2).

Their careers were firmly tied to plantation expansion but they appear to have an ideological fix against retiring native forests from wood production.
Summary Australia’s forest policy remains economically and ecologically incoherent: it has produced a hardwood chip glut with loss-making state forest agencies competing against failing private plantation investments promoted by government at public expense.

And in this mess, on-going, unnecessary native forest logging is drawing down carbon stocks and biodiversity.
Forestry managed investment schemesSubmission 26 54 Table 3 From government to forestry lobbying Government Forestry lobbies Academia Alan Cummine  DPIE  Adviser to environment  Australian Forest Growers (AFG)  Treefarm Investment Managers minister Ros Kelly Australia (TIMA) Allan Hansard  ABARE  DAFF (Plantation Tax Review) Miles Prosser  State Forests NSW Richard Stanton  DAFF  State Forests NSW (National Co-ordinator 2020 Plantation Vision)  Australian Plantation Products and Paper Industry Council (A3P)  National Association of Forest Industries (NAFI)  Tree Plantations Australia  FORTECH*  NAFI  Plantations Australia  Boral  A3P  Aluminium Council  NAFI  Australian Paper Industry Council  A3P Phil Townsend  DAFF  NAFI  Tree Plantations Australia  ANU A brief history of the forestry lobby groups listed in Table 3: Industry organisations * FORTECH (Forestry Technical Services Pty Ltd)–a forestry consultancy (not lobbyist)–part of the Dames and Moore Group now URS.
Prosser’s work included provision of independent forester’s reports to plantation MIS companies.

Plantation organisations Australian Plantation Products and Paper Industry Council (A3P) – formed to represent the interests of the plantation sector.

Includes the merged Plantations Australia and Australian Paper Industry Council.
Forestry managed investment schemesSubmission 26 Treefarm Investment Managers Australia (TIMA) – formed in July 2000 as a special branch of Australian Forest Growers to represent the interests of the plantation MIS companies.

Recently absorbed into Australian Plantation Products and Paper Industry Council (A3P).

55 Tree Plantations Australia – within the NAFI group.

Organisations representing ‘forest’ industries (both native forests and plantations) Australian Forest Growers (AFG).
National Association of Forest Industries (NAFI) Figure 2 The jobs network for Australia’s five key plantation forestry lobbyists Government Forestry consultants Forestry industry Academia NAFI Australian Forest Growers Plantation sector lobbyists* Outside this network Direction of appointment Jointly held positions * Comprises TIMA - Treefarm Investment Managers Australia (a special branch of Australian Forest Growers recently merged into A3P); A3P - Australian Plantation Products and Paper Industry Council; Tree plantations Australia (within the NAFI Group); Plantations Australia (merged into A3P); Australian Paper Industry Council (merged into A3P).
Forestry managed investment schemesSubmission 26 56 7.

Conclusions Plantation managed investment schemes are boom and bust by nature because the investment is driven by the more intense demand for tax minimisation, not wood market realities.
Combined with highly profitable corporate arrangements where plantation MIS companies earn most of their income up-front from selling high priced products to grower-investors, and relatively little if any from wood sales, Australia’s plantation MISs have generated a hardwood chip glut.

While the global financial crisis and economic recession may have triggered the downfall of Timbercorp and Great Southern Plantations, all hardwood plantation MIS investments face a very difficult next few years.
Surviving MIS companies may use Timbercorp’s and Great Southern Plantation’s demise to help realign downwards grower expectations of returns on investment but will not escape the consequence of the wood glut without action to reduce native forest wood supplies.

An investigation of late 1990s hardwood plantation prospectus documents reveals a wide chasm between market outlook and actual market realities (Appendix A).
Uncertainty is always present in projecting markets ten years out, but the failure to pick-up on fundamental structural changes in the hardwood chip and paper market should be of concern to grower-investors.

Maybe the prospectus documents are protected in legal polish.
But the reality is that with prospectus company profits not pinned primarily to revenue from wood sales, there is little commercial motivation for them to invest in rigorous market research or to respond to wood market realities a decade into the future.

Before the MIS approach to growing wood, it cost around $2 000 to plant and manage a hectare of trees over a ten year rotation.

Managed investment schemes more than quadrupled that cost.
Neither wood prices nor plantation yields have increased anywhere near sufficient to offset this cost increase.

The public purse is the biggest loser in this arrangement.

To contain the problem, plantation managed investment schemes should be wound up immediately.

To prevent it recurring, schemes with similar characteristics such as the carbon sink plantation tax deductions (Subdivision 40-J of the Income Tax Assessment Act 1997) should be withdrawn pending full analysis.
On the woodchip glut, the Commonwealth Government faces two choices.

It can ignore its substantial hand in creating the arrangements that generated the glut and leave it to the market to sort out.

The market includes supplies from heavily subsidised State Government business enterprises using public native forests in Tasmania, Victoria and New South Wales.

In this situation, we can expect a drawn-out battle between private plantation growers and native forest based chip exporters.
[Australia experienced such a play when large areas of government funded softwood plantations came on stream over the 1980s and 1990s.

The battle for the sawn timber market–won Forestry managed investment schemesSubmission 26 ultimately and inevitably by the plantation sector that now produces 80% of Australia’s sawn timber–was unnecessarily protracted and hugely damaging to plantation sawmilling profitability.]
57 The alternative is for the Commonwealth Government to engage and find the wherewithal to clear the woodchip market of native forest supplies.

[As an added plus: substantial carbon storage and biodiversity benefits would be realised.]

If this is the chosen path, the Commonwealth Government will need to attend to the seriously entrenched alliance between the bureaucracy and the forestry lobby groups.
An engaged government–at the ministerial level–would find it unacceptable that a handful of lobbyists continue to pedal perceptions of wood shortages (including on the domestic front through misrepresenting the wood and wood products trade deficit) with a hardwood chip glut building momentum.

Forestry managed investment schemesSubmission 26 Appendix A.
58 Aligning market expectations presented in various hardwood plantation MIS prospectus’ on offer by the late 1990s with what actually happened in the market.

[Note: in the analysis below, all growth rates for non MIS prospectus statements were calculated using ordinary least squares logarithmic regression incorporating all annual data over the period specified.]

‘Worldwide wood production has increased at a rate of 1.3% per year since the early 1960s….
demand for wood is increasing worldwide …Current projections indicate that demand will increase within the range 1.5% to 4.9% per year.’ Forestry Tasmania 1999 Trees Trust Offer Document p. 16.

Reality   Structural changes in the global wood and wood products industry (notably stagnant developed country consumption of solid wood products and wood saving strategies, most significantly through increased paper recycling) have slowed wood consumption.
Developing countries have not offset these wood demand dampeners such that global wood consumption since the 1980s replicates the high growth in the 1960s and 1970s (Figure A1).

1999 Forestry Tasmania Tree Trust investors in hardwood chip plantations will not experience a global wood market growing at an average 1.5% per annum over the life of their investment–even before factoring in the current global economic recession.

The 4.9% per annum growth projection is bizarre.
Figure A1 Global industrial wood consumption Forestry managed investment schemesSubmission 26 59 Gloabal wood consumption grew by an average 0.4% per annum 1980 to 2007 Global wood consumption grew by an average 1.7% per annum 1961 to 1989 ) 3 m n o i l l i b ( n o i t p m u s n o c d o o w l a i r t s u d n I 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0. Source: FAOSTAT.
‘Japan, the second largest producer and consumer of paper and paperboard in the world, is estimated to show an annual increase in demand of 2.2% per annum by the year 2010.’ Timbercorp Eucalypts Project 1998 p. 8.

Reality   Since 1998, Japan’s consumption of paper and paperboard has stagnated (Figure A2).

It is quite possible that Japan’s consumption of paper and paperboard over the period 1998 to 2010 contracts.
Figure A2 Japan’s consumption of paper and paperboard Forestry managed investment schemesSubmission 26 60 Japan's consumption of paper & paperboard: * 1961 to 1990 - expoential growth * 1990 to 1997 - average annual growth of 1.6% * 1997 to 2007 - average annual growth of 0.1% Plantation MIS schemes enter growth phase in early 1990s 2020 Plantation Vision launched by Commonwealth Minister for Agriculture 2 October 1997. )
s e n n o t n o i l l i m ( n o i t p m u s n o c d r a o b r e p a p & r e p a P 40 35 30 25 20 15 10 Source: FAOSTAT amended using Japan Paper Association statistics for 2004 to 2007 that report higher production of printing & communication paper in those years.
‘Japan currently dominates the Asian market for internationally traded woodchips, and in 1996 imported approximately 26.3 million tonnes.

The Japanese Ministry for International Trade and Industry predicts an increase of 2.2% per annum in paper use in Japan between 1996 and 2010.

The use of recycled waste paper in the manufacture of new paper is approaching the maximum technical level and Japan’s domestic supply of hardwood chips is declining.
As a result Japanese woodchip imports are predicted to increase by 50% to around 40 million tonnes by 2015 to satisfy demand.’ Integrated Tree Cropping 1999 prospectus p. 10.

Reality    Yes, Japan dominates the Asian market for internationally traded woodchips.

This exposes Australian hardwood chip exporters to greater market risk.

Japan’s paper consumption has not grown by 2.2% per annum since 1996.

It has remained stagnant (Figure A2).


[How is it in the wood importing Japanese paper industry’s interest to not present optimistic forecasts?]

Rather than hitting a technological limit to paper recycling, the Japanese paper industry’s use of recycled paper has increased by around 2% per annum since 1999 (Figure A3).

Forestry managed investment schemesSubmission 26 61  Japan’s substitution of domestic hardwood chips with imports ended in the mid 1990s.
Since then hardwood chip imports have stagnated, in line with Japan’s no growth paper and paperboard production (Figure A4).

Predictions of a 50% increase in woodchip imports by 2015 are fantasy.
Figure A3 Japan’s use of recycled paper in paper and paperboard production ) s e n n o t n o i l l i m ( n o i t c u d o r p d r a o b r e p a p & r e p a P 40 35 30 25 20 15 10 5 0 Paper & paperboard production - contracting by 0.1% a year Use of recycled paper in paper & paperboard production growing by 1.9% a year 100 90 80 70 60 50 40 30 20 10 0 ) % ( n o i t c u d o r p d r a o b r e p a p & r e p a p n i r e p a p d e c y c e r l f o e s U 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: FAOSTAT amended using Japan Paper Association statistics for 2004 to 2007 that report higher production of printing & communication paper in those years.
Forestry managed investment schemesSubmission 26 Figure A4 Japan’s hardwood chip imports ) s e n n o t n o i l l i m ( n o i t c u d o r p d r a o b r e p a p & r e p a P 40 35 30 25 20 15 10 5 0 Paper & paperboard production Mid 1990s fundamental change: * Substitution of imported hardwood chips for other fibre sources ends * Hardwood chip import trends align with trend growth in paper production - ie stagnant over decade ending 2007.
Hardwood chip imports 62 ) s e n n o t y r d e n o b n o i l l i m ( s t r o p m i i p h c d o o w d r a H 16 14 12 10 Source: FAOSTAT (amended using Japan Paper Association statistics for 2004 to 2007 that report higher production of printing & communication paper in those years); Japan Paper Association and Japan Tariff Association statistics (I thank Ian Penna for assistance in data collection).
‘The market for woodchips in Asia is expected to grow to satisfy rising demand for paper products … As an example, in the period 1980 to 1996, the use of paper in China increased from 6 kg per head to 25 kg … If the existing rate of increase continues, by 2015 Chinese consumption with reach 279 million tonnes of paper, which is an amount equivalent to the current total world consumption.’ Integrated Tree Cropping Eucalypts 1999 Green Triangle Project p. 10.
Reality   Converting Integrated Tree Cropping’s quoted projections of China’s paper consumption into market opportunities relevant to Australian hardwood plantation growers requires netting out recycled paper use–currently feeding around 70% of China’s paper production; non- wood fibres like bagasse–currently feeding 17% of China’s paper production (Figure A5); softwood pulp (accounting for the majority of wood pulp production); and factoring in China’s uptake of higher yielding pulp technologies and domestic tree planting program for pulp production.
China well understands its capacity to shock the global wood market and drive wood prices up.
For its own interests, China is working to avoid such an outcome through a combination of pre-emptive price negotiations driving real prices for its wood imports down, an awesome increase on recycled paper use, uptake of high-yielding pulping technologies (requiring less wood to make a unit of pulp) and a substantial short rotation plantation program geared for Forestry managed investment schemesSubmission 26 pulp production.
Projecting China’s wood imports over two decades assuming linear relationships is naive.
63 Figure A5 China’s fibre sources for paper and paperboard production Non wood pulp Recovered paper Wood pulp (predominantly softwood based) Wood pulp as a % of paper production ) r y / s e n n o t n o i l l i m ( t u p n i e r b F i 90 80 70 60 50 40 30 20 10 0 100 90 80 70 60 50 40 30 20 10 0 ) n o i t c u d o r p r e p a p % l ( ‘Your Woodlots will be planted with E. globulus, a fast growing species of native Australian eucalypt.
E. globulus is considered one of the best species for high quality paper providing bulk and opacity to printing and writing papers while its short fibres fit closely together to provide the smooth writing surface needed for printing and writing papers.’ And the page earlier ‘Strong demand [for paper and paperboard] from China and the ASEAN countries is also expected…’ Timbercorp Eucalypts Project 1998 pp.

8-9.
8-9.

Reality  Many prospectus documents advise on the suitability of eucalypts for printing and writing papers and the growing market opportunities for wood especially China.

To my knowledge, none have presented information on the types of paper and paperboard China actually consumes and their relative trends.
Since 1998, wrapping, packaging and board papers (made using mainly recycled paper and softwood pulp) have accounted for 63% of China’s growth in paper and paperboard consumption; printing and writing papers for 23% and newsprint and household and sanitary papers for 14% (Figure A6).
Forestry managed investment schemesSubmission 26 Figure A6 China’s paper consumption 65 ) s e n n o t n o i l l i m ( n o i t p m u s n o C 50 45 40 35 30 25 20 15 10 5 0 Wrapping, packaging and board papers Printing & writing papers Household & sanitary papers Newsprint 50 45 40 35 30 25 20 15 10 Source.
FAOSTAT.

‘Australia currently has an estimated $1.5 billion deficit in wood and wood products.

As part of the process of addressing this imbalance the Federal Government has issued the 2020 Vision policy to encourage ongoing investment in the timber plantation industry.

The primary target of this policy is to encourage private investment in plantations in order to treble the area under plantation in Australia by the year 2020.’ Great Southern Plantations 1999 share offer prospectus p. 6.
Reality  For those apparently concerned about Australia’s wood products trade deficit (but not our computer or coffee trade deficit), the problem is not a shortage of wood.

Australia has enough wood in plantations alone to meet virtually all our wood needs (Figure A7): meaning that an insufficiency of wood cannot explain the deficit.

The so called wood and wood products trade deficit problem is a manufacturing industry problem.
It lies substantially in Australia’s printing and writing paper sector with its monopoly producer which also has a substantial controlling interest in merchanting, including of imported papers.

Imports of printing and writing papers account for 70% of Australia’s wood and wood products trade deficit.

(See Ajani 2007 pp.

299-303 for a full explanation of how the structure of Australia’s printing and writing industry (one company) frustrates the building of a new plantation based hardwood pulpmill.)
Forestry managed investment schemesSubmission 26 66   Leaving aside the above crucial issue of domestic market access for a new plantation-based pulp and paper operator, such potential investments face a wood pricing problem.

It appears that plantation MIS companies have been unwilling to enter into supply contracts with more realistic stumpage prices, possibly because of the negative signals to potential new MIS investors from whom the plantation MIS companies generate their profits.
The plantation prospectus companies have exploited entrenched misunderstanding about Australia’s wood and wood products trade deficit.

The trade deficit helps market their investment products with their high stumpage price assumptions which make unviable any new hardwood plantation pulp and paper mill in Australia, the essence of the so called wood and wood products trade deficit problem.
Figure A7 Australia’s wood consumption and projected plantation wood supply ) 3 m n o i l l i m ( d o o W 35 30 25 20 15 10 5 0 Wood consumption (actual) Plantation wood production (actual) Native forest wood production (actual) Plantation wood supply (projected) 35 30 25 20 15 10 Source: ABARE Australian Forest and Wood Products Statistics ; Parsons et al.
2007 (Bureau of Rural Sciences plantation wood supply projections) ‘The price for internationally traded pulpwood, and in particular hardwood woodchips, has been stable for the last 25 years…’ Integrated Tree Cropping Eucalypts 1999 Green Triangle Project p. 11.

‘The export price is negotiated annually by the Australian plantation industry with Japanese purchasers.
In February 2008, this price increased to $207.40 per bone dry tonne, a 9.5% increase on the 2007 price….The 2008 price is relevant for investors in Great Southern’s 1997 and 1998 projects, whose plantations are currently being harvested.’ Great Southern Plantations Projects ‘Plantation communication to all advisors’ 8 May 2008.
Forestry managed investment schemesSubmission 26 [Since this communication, Great Southern Plantations, Integrated Tree Cropping and Timbercorp have negotiated no change to the nominal chip price ($207/BDT) for 2009 for sales to Japan.]
67 Forestry managed investment schemesSubmission 26 68 Reality  ABARE’s latest published data set for woodchip export prices (native forest and plantations combined) commences from 1989 – the source data from the ABS for earlier years apparently have inconsistencies in the unit of measurement.

For the duration of reliable price data, real prices for hardwood chips have trended down by an average 2% per annum (Figure A8).

This is a familiar trend for commodity production over the long term.
The more recent easing in the price decline for hardwood chip exports partly reflects quality changes as plantation resources account for an increasing share of the trade.

 Higher prices for plantation chips reflect a tangible quality premium.

What Great Southern Plantations does not communicate to advisers is how their negotiated woodchip prices for 2008 compare with the prices assumed in their 1997 prospectus financials–the relevant prospectus for growers selling into the 2008 market.
Great Southern Plantations assumed that plantation woodchips would command a 10% to 20% price premium over native forests and that the woodchip nominal price would increase by 2% to 3% a year.

Taking the average of these two sets of assumptions: o 1997 growers selling into the 2008 market would have expected hardwood plantation woodchip prices (nominal) to reach $244.40/BDT.

This is 18% higher than the price Great Southern Plantations negotiated.
o 1998 growers selling into the 2009 market would have expected hardwood plantation woodchip prices (nominal) to reach $250.50/BDT.

This is 21% higher than the price Great Southern Plantations negotiated.
Figure A8 Real prices for Australian hardwood chip exports * ) T D B $ A / ( s e c i r p l i a e r p h c d o o w d r a h B O F 160 140 120 100 80 60 40 20 0 Hardwood plantation chip export prices negotiated by Great Southern Plantations, Integrated Tree Cropping and Timbercorp Total hardwood chip export prices (for a shifting mix of native forest and plantations) 160 140 120 100 80 60 40 20 * Prices adjusted for inflation using Australian CPI 1989/90 = 100.
2008/09 CPI calculated using data for three quarters and assuming no growth in June qtr 2009.

Source: ABARE Australian Commodity Statistics 2008; Great Southern Plantations 2008; Great Southern Plantations Stock Exchange announcement 27/3/2009.

Forestry managed investment schemesSubmission 26 69 References ABARE 1993, Quarterly Forest Products Statistics March Quarter 1995.

ABARE 2009, Australian Forest and Wood Products Statistics September and December Quarters 2008.

Ajani J.
Ajani J.

2009, ‘Australian production of wood and wood products in 2007/08 disaggregated by wood source’, unpublished paper Fenner School of Environment and Society, the Australian National University.

Ajani J.

2007, The Forest Wars, Melbourne University Press.

Clark J.

(now Ajani) 2001, ‘The global wood market, prices and plantation investment: an examination drawing on the Australian experience’, Environmental Conservation 28 (1) 53-64.
Great Southern Plantations 2008, ‘1774 Plantations communication to all advisors’ 8 May 2008.

FAOSTAT, United Nations Food and Agricultural Organisation forestry data <http://faostat.fao.org/site/626/default.aspx#ancor> Intelligent Investor 2006, ‘Act of generosity’, Issue 203, 5 July 2006, p. 2.

Lonsec Agribusiness Research 2001, ‘Comparison of similar eucalyptus pulpwood projects’, Lonsdale Securities Ltd. Parsons M., Frankes I.
& Gavran M. 2007, Australia’s Plantation Log Supply 2005-2049, Bureau of Rural Sciences.

Forestry managed investment schemesSubmission 26 Accounting for plantations in the CPRS 71 15.

The draft CPRS bill stipulates that the number of units to be issued for ‘reforestation’ projects be the ‘net total number of tonnes of greenhouse gases removed’.

This means that carbon accounting for ‘reforestation’ will use average crediting; not annual accounting of uptake and emissions separately.
The White Paper (section 6.13.4) presented the case for average crediting: that drought or fire could ‘unexpectedly’ reduce the number of permits in any one year and that annual accounting has high compliance costs.

16.
16.

Under average accounting, opting-in wood-producing ‘reforestation’ investors will receive units as the ‘forests’ grow, up to a limit determined by the Authority–the net total number of tonnes of greenhouse gases removed by ‘reforestation’–and must maintain the land as ‘forested’ land after each logging event for 130 years.11 By averaging, investors receive fewer units up-front but they avoid surrendering units at harvest time.

17.
17.

In a world where carbon prices are expected to increase, average accounting isolates wood- producing ‘reforestation’ investors from a rising carbon price.

Investors receive units early (when carbon prices are expected to be low) but do not surrender units at harvest when carbon prices are likely to be higher.
If carbon prices soar globally in response to a political and public dawning reality of our perilous situation, wood-producing ‘reforestation’ investors who have opted-into emissions trading under the CPRS will receive no price signal to avoid adding to emissions by not logging their ‘forests’.
By including wood-producing plantations in the CPRS, the Government will allow the demand for carbon uptake to stimulate plantation investment but, through the accounting rules, will isolate the resulting projects from changes in the carbon price.

18.

The first two objects of the proposed Act are to give effect to Australia’s climate change obligations and to contribute to the development of a global carbon market through the CPRS.
It is inconceivable that governments around the world engaged in developing a global carbon market wish to create outcomes where projects/businesses, once issued with units, become immune from CO2-e price signals for the next 130 years.

19.

There is also pressure to expand the Kyoto accounts to include carbon stored in wood products.
If wood growers are able to discount their emissions at harvest time, by the amount presumed to be stored in wood products, a substantial additional distortion will be introduced.

Carbon Sink Forests 20.

Expenditure in relation to establishing trees in carbon sink ‘forests’ now enjoys taxation benefits through Subdivision 40-J of the Income Tax Assessment Act 1997.
In the last 2008 sitting of parliament, the Greens (with tax barrister advice) and the Nationals argued that the legislation, 11 The draft CPRS bill does not rule out the possibility for opting in plantation investors to opt out by surrendering units equal to what they have been issued.

The Government proposes to deal with this matter in the regulations.
Forestry managed investment schemesSubmission 26 72 as written, means that land purchase costs and other associated capital costs are fully deductible upfront from 1 July 2007 to 30 June 2012.

Such provisions are not available to food producers.

The Government argued in the Senate that this interpretation was wrong.

Perhaps the matter will only be settled through the court.
If the opposition parties’ interpretation of Subdivision 44-J proves correct and if ‘reforestation’ is included as the only land use activity in the emissions trading scheme, we can expect a fundamental change in agricultural land use, away from food production and to carbon sink ‘forests’.

If the objective is climate, water and food security, this policy frame is incoherent.

21.
21.

The draft CPRS bill’s proposal to account for carbon using averaging to avoid surrendering units at harvest time is not an issue for opting in carbon sink ‘forest’ investors, because harvesting is not part of the management plan (although the legislation does not prevent investors from changing their minds at a future date).

However, carbon sink ‘forests’ generate another problem for the long-term integrity of a global carbon market aimed at tackling climate change.
Without harvesting and replanting, the trees in most carbon sink ‘forests’ will eventually die and release CO2 emissions because most of the plantings will not be self regenerating native vegetation.

With taxation based subsidies for carbon sink ‘forests’ and the CPRS, Australia may build a vast ‘reforestation’ estate that becomes a serious future emissions liability.

Recommendations 1.

That the Government exclude ‘reforestation’ as a covered sector in the CPRS.

2.
2.

That the Government, separate to the CPRS, bring the land use sector into Australia’s climate policy frame, with food security, water and ecological sustainability prime considerations and with special attention to the boundary issues most particularly bioenergy and biomass feedstocks.

3.

That, if the Government retains ‘reforestation’ in the CPRS, the legislation stipulate that the issue and surrender of units for ‘reforestation’ be accounted for annually.

4.
4.

That the Government guarantee its interpretation that Subdivision 40-J of the Income Tax Assessment Act 1997 does not provide for land purchase costs and other associated capital costs in relation to establishing trees in carbon sink ‘forests’ to be fully deductible upfront from 1 July 2007 to 30 June 2012.

Forestry managed investment schemesSubmission 26