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Management Side
Australian Plantations - Profit at any Cost
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The Roman Statesman Cicero is credited with the expression "as you have sown so shall you reap," and there are biblical variants in the Old and New Testaments. The expression has a powerful literal and figurative relevance to the Australian forestry industry.

In the just-released 2015 Forest & Wood Annual Strategic Review, the IndustryEdge Market Intelligence Company has summarized the inevitable consequences from significant supply and demand functions in the Australian forestry industry over the past few years. In 2014 the estimated total harvest was 22.9 million m3, marginally higher than in 2013 but well below the peak of over 28 million m3 in 2008.

The marginal improvement in 2014 can be attributed to demand from a red-hot housing market in Australia and an optimistic outlook for export woodchips driven by a depreciating dollar. Plantation utilization has been improved also, through significant rationalization of plantation ownership. It seems, however, that the outlook for hardwood plantations is rather less favorable than for softwoods.

Underlying the overall trend is the continuing rapid decline in native hardwood harvesting and the inevitability that native forests will effectively disappear as a resource in the years to come.

It should come as no surprise that demand for hardwood has taken a battering, or more correctly, its implied future demand has, with the failure of the Gunns pulp mill to go ahead. The voracious potential of that mill, partly spurred the frenzy to develop hardwood plantations, aided and abetted by various other speculative pulp mill developments that did not stand the test of financial scrutiny or the courage of would be investors.

The fact that thousands of investors suffered huge financial losses through their investments in managed investment schemes (MIS) for plantation development has also left its indelible mark. This catastrophe continues to unfold and was the subject of a previous column in 2010. Because these schemes were largely promoted for their tax-advantaged status, most investors significantly leveraged their investments through loans, which are still outstanding. The investments are now worthless, but the debt is compounding.

Despite the tax-minimization opportunity, it transpires that many investors were in fact not the very wealthy who stood to gain the best tax outcomes, but mom-and-pop investors who were encouraged into these investments by greedy financial advisers, who it seems pocketed commissions of at least 10%. But the reality was worse than that, as findings unfold from a Senate inquiry into the industry. In late 2014, Fairfax Media (one of two national media groups in Australia) published an in-depth analysis of the murky road to failure of Timbercorp, one of the biggest of the MIS companies and the first to implode in 2009 as the global financial crisis was at its peak. Revelations about the financial creativity employed puts these investments right up there with the Collateralized Debt Obligations (CDO's) that precipitated the crisis.

The Timbercorp story provides a salutatory case study. Established by two accountants in 1987, Timbercorp was floated in 1996. Over its first 17 years 18,500 investors sank more than $2 billion into 32 schemes, primarily blue gum (eucalyptus) plantations, but also olives, almonds, grapes, mangoes and tomatoes. At least two-thirds of this investment was financed through a subsidiary company, Timbercorp Finance, which securitized the loans and sold them to banks and other institutions. A total of 2,871 investors now owe Timbercorp Finance $490 million. The Timbercorp liquidators have been aggressively pursuing investors to repay the loans, which have mostly been inflated by interest and penalty charges. Many investors joined an unsuccessful class action during which time they stopped repaying their loans and now find themselves financially ruined.

The Senate inquiry seems to be having difficulty digesting all the evidence. Findings were due in October 2014, but the report has been delayed through several extensions and is currently due in September. Included in the terms of reference were compensation schemes for small investors, but in this regard it may be too little too late for many of them.

The financial tragedies associated with Timbercorp apparently also apply to Great Southern Group, which was the largest MIS Company, and Willmott Forests. The spotlight has fallen on the banks, who also directly bankrolled investors and their aggressive policies regarding repayment of outstanding debts. One bank has suspended interest and penalty charges but Australia's largest bank (and most prominent in bankrolling MIS offerings) remains intransigent with debts escalating to as much as four times the original loans according to newspaper reports (The Australian, October 17, 2014).

The personal toll has been significant and, unsurprisingly, private investment in plantation forestry to expand the forest estate has tanked, as has more traditional institutional investment. There has been significant on-selling of established plantations to global plantation managers. These include Campbell Global (94,000 hectares) and Global Forest Partners (140,000 hectares) from the USA and New Forests Asset Management, a multi-national investor (500,000 hectares). These companies join Hancock from the USA (240,000 hectares), which has been significant in Australian plantation ownership for many years. According to the Australian Bureau of Agricultural and Research Economics and Sciences, the annual rate of new plantation establishment has declined from a peak of 137,000 hectares in 1999-2000 to a net loss in 2013-14, mostly hardwood plantations managed to produce logs. The plantation estate has fallen below 2 million hectares for the first time since 2008.

During the growth phase and beyond, markets had to be identified for surplus wood production. Demand and supply of plantation softwood has been relatively steady for the last 15 years and managed almost entirely for saw log production. Softwood comprises about 57% of the total yield generated from both native and plantation forests. Increased softwood demand from Visy Industries for their Tumut Kraft pulp mill has offset a declining demand for wood panel manufacturing, resulting in a stable supply/demand balance for softwoods. On average, about one million m3 annually of softwood chips have also been exported over the last decade.

Chip exports have been the key driver of demand for hardwood plantations. For quality reasons as well as environmental pressures, woodchips supplied from native forests have declined significantly from a high of about 5.6 million m3 in 2004 to less than 1.5 million m3 on average for the past few years. Plantation hardwood chips have more than offset the decline - from about 1.4 to 6.4 million m3 over the same cycle.

At its peak about 10 years ago Australia was the leading global exporter of hardwood woodchips, a status ceded to Vietnam in recent years. Australia is now roaring back, assisted by a depreciating dollar and the increasing volumes of maturing wood. Japan has been Australia's original and largest market for many years, but China is progressively becoming a significant customer. Vietnam remains the largest (and still growing) supplier to China, but Australian supply has escalated significantly to more than 2.1 million m3, about half the Vietnamese amount.

At current exchange rates Australia should consolidate its return to a leading (probably the leading) hardwood chip producer - and it will need to do so. As IndustryEdge points out, assuming that existing hardwood plantations are replanted after harvest, annual hardwood pulpwood production will explode and almost double for the next 10 years settling back to a more modest 50% surplus thereafter. Buyers must be eagerly anticipating lower woodchip prices!

For the naïve investors in managed investment schemes the cash flow from these rivers of wood will be of no consolation, as none of it will come to them. The Senate inquiry may find a way to soften the financial burden, but not eliminate it. The legacy, however, is a magnificent resource; the challenge is to make the most of it.

 

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