Last week incoming Minister of Forestry Peeni Henare announced a $57 million fund to invest in wood processing capacity. Officials probably told him this is what the industry wants. It is not.
Unwritten in the Beehive press release and media articles was the fact that the local fund is just Debt.
Well technically ‘equity investment’ is an option, but who in their right mind wants the hassle of a government minority shareholder. So, for all intents and purposes, $45 million of the fund is just debt.
MPI developed the fund on the erroneous pretext that wood processors lack access to capital. They do not. Debt from banks, the Provincial Growth Fund and MPI’s SFFF fund have all been plentiful during the last decade. Very few took up the option.
Now that the market is moving from boom to bust, why would a wood processor suddenly think this is the time to put their head in the debt noose?
No, we don’t need debt. Capital will flow easily to projects with ‘internationally cost-competitive margin and feasibility across the economic cycle’.
Remember that phrase, because it is the test against which all ITP initiatives should be assessed.
MPI officials knew funding was not the issue in 2019, with their advice to Ministers noting: “Scion research indicates that access to capital is not necessarily the main barrier to investment in higher value processing, rather it is investor nervousness around the profitability of producing new products and entering new markets.”
So if debt is not the answer, the question the government should be asking industry is; “What levers can government pull to level the playing field for wood processors so they can achieve this long term feasibility?”
A very unlevel playing field
Enter the Australian announcement to support wood processing investment that happened to come out on the same day last week. Their government has given grant funding of up to $5 million each to wood processors, with the total fund exceeding $112 million.
It is important to understand what these grants mean in practice in the marketplace for New Zealand companies competing to supply Australia and competing with supply from Australia.
Firstly, I’ll lay out what is already a very unlevel playing field. New Zealand wood processors must compete using the highest cost logs in the world. Next, we have an expensive Tasman Sea crossing to fund, not helped by an overvalued NZ-AU exchange rate and onerous timber grading standards meaning we get less higher value timber per log than Australians. All this results in a higher cost structure than our Australian competitors.
Next, having got past all that, we need to compete with Australian mills and engineered wood product factories that are heavily grant funded.
Take for example the Australian Hyne sawmill - Xlam CLT supply chain, owned by the Hyne family, which has benefitted from $16m of grants over recent years. The grants means the group does not need to factor this re-payment and interest cost into its product pricing in the marketplace. Effectively they can reduce CLT pricing by $4 million per year and be no worse off.
This equates to a 10% price drop on their A/NZ volume, or 20% should they focus their funding windfall on just their New Zealand volume. This is what actually happened in their CLT supply into New Zealand and explains why it is dangerous to invest in New Zealand by comparison.
Is it any wonder wood processing in New Zealand has flat-lined for the last three decades?
Carbon value of ‘Harvested Wood Products’ the answer
Okay, so what can New Zealand do about it? What levers can we pull?
We can pull the lever that Climate Change minister Shaw and then Forestry minister Jones instructed MPI and MfE to develop nearly four years ago in June 2019.
That instruction was to develop a scheme to distribute the carbon value of Harvested Wood Products to processors that have been and will invest to create more long life wood products that store carbon.
Now I won’t go into the detail of this as it is complex, but in short, the UN and therefore New Zealand recognises carbon sequestered in the ‘tree growing’ stage of forests (deemed to release to the atmosphere upon harvest), and then separately, for the ‘long-term storage’ stage in wood products. The latter is known as ‘Harvested Wood Products’, or HWP.
$180 million annual carbon value
A report by Scion that MPI commissioned in 2019 established that the value of HWP carbon to New Zealand is $180 million annually, using current carbon pricing.
That amount has the potential to make a lot of feasibility models suddenly work.
New Zealand incorporates that HWP carbon value into our Nationally Determined Contributions when we report to the UN against our Paris Accord commitments. So, it is a legitimate and internationally recognised carbon storage mechanism.
However, unlike forest growers, who receive the value of their stored carbon in the form of NZUs that they can sell on the Emissions Trading Scheme, wood processors do not yet get the value of their carbon storage in long life products.
As a result, the forest growing industry has boomed in recent years due to this dual log/carbon income stream.
Conversely, the wood processing sector has flatlined for three decades.
Undisputedly, the way to transform the wood processing sector is through developing the dual income stream of wood products plus this HWP carbon value.
Instead of subsidies and grants, this will provide the ‘internationally cost-competitive margin and feasibility across the economic cycle’ the industry so desperately seeks.
The MPI officials have had all the foregoing explained to them many times yet have pushed on with a debt fund anyway.
Fund set to breach Budget 22 rationale for allocation
The other aspect of this fund that concerns the industry is that its announcement talks of it being used to fund ‘structural timber’ investment. The Budget allocation for this fund noted: “These initiatives will directly increase recorded carbon storage and contribute to the first three emission budgets by more than 27 million tonnes over 2022-2035, reducing the Crown’s liability by up to $1.8 billion.”
The fund will not achieve that and won’t improve carbon storage at all if used for ‘structural timber’ investment. That market is oversupplied already. Funding more would simply be more capacity into a finite domestic market. It’s a zero-sum game.
Export framing markets must be targeted and once again, that requires levelling of the playing field – not debt.
Further, competing in the domestic market for structural timber will be risky, as the two largest mills in the Southern Hemisphere slug it out in a dropping market.
If the industry and government work strategically this decade and target large-format commercial and apartment buildings, as well as exports, wood’s market share in that segment could increase to 50 percent.
Calculations show that this would create demand for 2 million cubic meters of additional timber, create 3,600 more jobs, trigger over $1 billion of investment, and sequester an additional 1.5 million tonnes of CO2 per year.
Just as importantly it will require processing of an additional 3.5 million tonnes of logs. This is important as 48 percent of our logs are currently sold to one country, China. With conflict over Taiwan looking increasingly likely, this is a precarious position for our forest growers. US sanctions on those dealing with China are likely, and with many of our forests owned by US institutions, the industry would have to comply. There is nowhere else to sell them. A strong domestic market is therefore crucial.
The key to levelling the playing field and unlocking all this potential is getting the carbon value of wood products into producers’ feasibility models. This is what the industry has been telling MPI it wants, not another debt fund.
Few with the new Minister’s ear really understand this stuff. Certainly, his officials do not. His success, and that of the industry, will depend on his ability to engage those with their fingers hovering over the investment trigger.
About: Marty Verry is group CEO of the Red Stag group of companies, with asset including the Southern Hemisphere’s largest sawmill, NZ’s only Cross Laminated Timber (CLT) factory, NZ’s most experienced Engineered Wood Products Company, and 3,500 ha of plantation forestry.