In the mid-1990s an ambitious strategy was developed to effectively triple Australia’s plantation resource (then about 1 million hectares) by 2020. This national objective was officially launched in October 1997 as a strategic partnership between the Commonwealth, State, and Territory governments and the plantation timber growing and processing industry as the Plantations 2020 program.
To achieve the goals of this initiative, a new approach was developed to supersede the previous practice by which state governments had responsibility for establishing new plantation resources using federal government funding.
The object of the new program was to encourage the private sector to take the lead in funding plantation development. Pulpwood plantations can take 10-12 years and sawlog plantations in excess of 20 years to realize a return and these long investment horizons have always been a major obstacle to investment in forestry. To offset these disadvantages, special financial arrangements known as retail forestry investments were established to encourage the private sector to underwrite the plantation strategy. These schemes have structurally complex operational requirements but the attraction for many investors was a tax incentive whereby investors could take a 100% tax deduction up front on all future projected costs.
These investments were facilitated by arrangements known as “managed investment schemes” (MIS). Depending on the reference dictionary consulted a scheme is defined as a systematic plan of action, or program carried out by a government or business but an alternative definition is as a secret and cunning plan, especially one designed to cause harm.
There are about 100,000 Australian investors who will have no doubt that the second definition applies to these schemes, which have seen investors bear massive financial loss.
The Plantations 2020 strategy approach spawned a number of MIS companies that grew to be significant in size but with the onset of the global financial crisis in late 2007, one by one, these companies buckled under their debt burden, exposing clear shortcomings in their operational model.
With the recent demise of Willmott Forest Company (which grew their MIS activities from their vertically integrated lumber operations) the MIS experiment can be now truly seen as an unmitigated failure. Willmott follows Timbercorp, Great Southern, Environvest, and Forest Enterprises of Australia (FAE) into liquidation with total combined debts of over AUD 2.5 billion.
There are a number of involved organizations that need to provide answers, including the Australian Tax Office, but more of that later. With what was ironic but overdue timing, the Australian Securities and Investment Commission (ASIC) has subsequently released new requirements for MIS companies to hold greater capital and to restrict deals with related companies. None of this is likely to be of much comfort for investors who have lost money on these deals. Unsurprisingly, a number of class actions have been initiated on behalf of investors in an attempt to get some of their money back.
So what went wrong with the managed investment strategy? Well, significantly, the investments were driven by tax minimization objectives rather than by the merits of the underlying investment. Positive characteristics associated with forestry investment include the counter-cyclicality of returns relative to alternative investments and the flexibility to manage harvest to reflect market conditions while the wood volume continues to grow.
Although highly taxed individuals could receive accelerated tax deductions, successive governments “fiddled” with the rules relating to deductibility, which unsurprisingly slowed down the money for investment. To address this situation, the MIS companies increased the usage of third-party brokers to market these schemes for which very large commissions were payable.
Perhaps it was an inevitable outcome but MIS companies also identified opportunities to use the MIS funding model for a range of agricultural products that were not envisaged by the Plantations 2020 strategy. Apart from exotic wood species, such as sandalwood, the repertoire of investments expanded to include olive groves, avocado, and almond farms, and even beef cattle production.
With unfortunate timing for investors, in 2007 the Australian Tax Office abolished deductibility for all future agricultural MIS, with the exclusion of those involved in forestry, as originally intended.
Opponents of MIS schemes used data from some agricultural economists to claim that the schemes were operating off an unsustainable cost base in that the effective cost to investors in many MIS investments was 2-3 times the going rate for a commercial plantation, based on the true cost of growing and managing the trees, and the anticipated revenue from sale of the harvested wood.
The MIS experiment at the national level did in fact encourage plantation development and currently the national plantation estate is estimated to be around 2 million hectares, so half of the goal has been achieved. At its peak, MIS forestry was responsible for 80%-90% of the plantation expansion over the past decade -- an average expansion of 70,000 hectares per year, although for reasons now obvious plantation establishment rates have fallen significantly over the last few years.
According to data from the Australian Agribusiness Group (AAG) in the 2005-2006 fiscal year some AUD 1.14 billion flowed into MIS, (includes forestry, horticulture and other products). By the 2008 fiscal year investment had peaked and investment declined slightly to AUD 1.079 billion but plummeted rapidly to AUD 250 million in FY09 and in the 2010 fiscal year was only AUD 103 million.
In the face of tougher tax regulations a dividend flow was necessary to encourage investors and the MIS effectively became a Ponzi scheme because until the trees matured, new investors were the only source of cash to provide a return to previous investors. For example, it was revealed that Willmott had sold just AUD 20 million in MIS in 2009-2010 (and only AUD 1.5 million was actual sales to investors, the rest was borrowed). That was down from AUD 65 million in 2008-2009 and AUD 95 million the year before.
When combined with the reality that promoters of managed investment schemes do the vast bulk of their business in the last weeks of the financial year, when people want tax deductions, at best cash flow was very lumpy.
It also transpired that all of the large MIS companies had major exposure to Australia’s largest bank, which progressively called in the liquidators as they looked to tighten their balance sheets as a consequence of the global financial crisis. Recent revelations that at Timbercorp, the first MIS company to fail, the company had paid undisclosed commissions and had undisclosed plantations on their books suggesting that the bank had real reasons for concern, at least with that company.
With an effective end to logging of native forests in Australia, demands from plantations will continue to grow but the MIS model does not now seem to be the way of the future. Larger and more integrated companies will need to drive resource development with less reliance on retail investors.
Obviously, if there is a clear and continuing market demand for wood resources based on an ongoing processing requirement there will be a lower investment risk and this will be an investment more suited to a genuine private investor.
To put the demand into context it is helpful to understand the total picture for wood consumption in Australia. In 2007-2008, Australian forests produced more than 28 million cubic meters of wood, of which 68% was sourced from plantations and the balance from native forests. This wood was processed to generate some 5.3 million cubic meters of lumber, 1.8 million cubic meters of panels, the pulp component of 3.2 million metric tons of paper and paperboard product, and 5.2 million bone-dry metric tons of export wood chips. The importance of value adding will be seen by the small return that exported woodchips, although the largest sector by volume, make in the overall picture. Paper and paper products contribute 45% by value, wood panels and laminates 34%, and sawn and dressed timber 17%. Wood chips contribute a paltry 4% of the total.
At the present time there is marginally more softwood estate than hardwood reflecting established processing for lumber and panel board products. There is a continuing opportunity for softwood resources. The Housing Industry Association predicts a national deficit of 466,000 dwellings by 2020, which would require an additional 66,000 hectares of trees to meet the accumulated deficit. But the 20- to 25-year time horizon for sawlog projects is not attractive to investors.
Gunns has a large MIS resource and has assumed responsibility for some of the failed MIS assets. It has a current market for export wood chips but this is subject to the vagaries of international trade and currency fluctuations. Confirmation that their proposed hardwood bleached kraft pulp mill was to proceed would provide the incentive needed for the resumption of private forestry investment. Under this scenario hardwood plantation development would continue to dominate and be more attractive to investors because of the perceived lower risk attached to a shorter rotation and investment time frame for pulpwood.
Beyond the rhetoric of government support of the concept of significantly increasing the national forest estate there needs to be a national recognition of the need for sawlog production as an investment in infrastructure. Right now there appears to be no shortage of large institutional investors ready to buy previously established plantations which have become available at distressed prices but little interest from them to establish new plantations for wood.
Governments will need to rethink how they can encourage bruised and battered private investors back to investing in forest resources and kick-start reinvestment. Perhaps MIS programs will still occupy a place in the future fabric of investment options but other strategies for direct incentives such as land grants, low cost loans or free seedlings may be introduced to encourage plantation investment.
Finally, to conclude with some follow up from my previous column on carbon credits for those who would like to know more, the New Zealand Greenhouse Policy Coalition has prepared a comprehensive fact sheet on the subject, which could be described as a “Carbon Credits for Dummies.” The fact sheet can be accessed at www.greenhousepolicy.org.nz/Site/News_Releases/ETS_fact_sheet.aspx.