Ratifying the Kyoto Protocol could be costly for wood processors, reports BRIAN FALLOW.
Ratification of the Kyoto Protocol on climate change would be costly for the owners of most of New Zealand's plantation forests, and for wood processing industries, says an Institute of Economic Research report.
The institute did a model for the Wood Processing Strategy Group, a combined industry and Government body.
At first glance, forestry would be a winner under the Kyoto Protocol.
It creates a new property right, "sink"credits for the carbon dioxide mopped up from the atmosphere by the growing trees in Kyoto forests - forests planted since 1990 on land not already forested.
The idea is that these credits can be sold to those who need to hold permits to cover the increase since 1990 in their emissions of the greenhouse gases blamed for global warming.
About a third of New Zealand's 1.7 million hectares of plantation forests qualify.
The institute's modelling puts the benefit to the owners of Kyoto forests at anything from $400 million to $2 billion.
But the loss of earnings for the owners of non-Kyoto forests range from $100 million to $2 billion.
The wood processing industry would suffer a loss of anything from $700 million to $3.4 billion.
The model is designed to show the outcome for whatever combination of log prices and carbon prices is selected.
The institute's report considers two possible carbon prices, $48 a tonne and $120, which it says are at the low end of the ranges used in New Zealand and international studies.
For log prices, the best-case scenario assumes they would fall 1 per cent, compared with business as usual, before 2008 when the Kyoto Protocol's first commitment period starts. It reasons that the owners of non-Kyoto forests would have an incentive to harvest early and avoid the need to hold permits for, or pay a carbon tax on, the trees felled.
Under this scenario, log prices would be 4 per cent higher from 2008, because less timber from non-Kyoto forests would be coming on to the market.
The worst case considered has log prices 5 per cent lower during the pre-2008 rush to harvest, but outpacing business-as-usual by only 1 per cent thereafter.
The impact also depends on whether the owners choose to replant once they harvest the trees. If they do not replant, they become emitters and would have to hold credits for the carbon in the trees.
Although the model decides that the owners of Kyoto forests would come out ahead, the institute says that it does not take account of offsetting factors.
"In particular, some of the gains could be offset by the greater risk faced by forest owners, in that the wood processing capacity to underpin the value of their forests may not eventuate."
This means that higher returns go with higher risk.
The owners of non-Kyoto (pre-1990) forests are likely to be worse off, says the institute.
The loss of earnings stems from a mixture of falls in log prices before 2008, lower log yields from trees harvested early and the carbon tax liability incurred if owners quit forestry.
The loss ranges from $100 million to $1.1 billion, if forest owners continue replanting.
But if the carbon price is high and the owners want to get out of forestry, the losses would be in the $1 billion to $2 billion range.
These losses would come on top of the fact that rates of return on forestry were already well below the cost of capital, said institute director Alex Sundakov.
The owners of non-Kyoto forests would be locked into an unprofitable activity. The result would be that asset (in this case land) prices would fall until rates of return were normalised.
The Ministry of Agriculture and Forestry commissioned Dr Geoff Bertram of Simon Terry Associates to review the institute's model.
He criticised the model for comparing a world in which New Zealand ratifies the Kyoto Protocol with the business-as-usual case where no one ratifies.
It does not consider the case where other developed countries ratify Kyoto but New Zealand does not. That would have been a better way of isolating the costs of New Zealand ratifying, Dr Bertram said.
But Mr Sundakov said it made no difference in practice.
New Zealand's main competitors in the log trade were Chile - with no Kyoto commitments - and Russia.
Russia is a Kyoto country but it will be awash with credits arising from the implosion of its industrial base since 1990, Kyoto's year zero, so that ratification will impose no extra costs on its forestry industry.
For the wood processing industry, and its ability to attract investment and add value to logs before they leave New Zealand, the crucial thing about the Kyoto Protocol is that it will increase energy and transport costs here but not in competitor countries.
The institute says at a carbon price of $48 a tonne, diesel costs would rise 4.7 per cent and electricity costs 4.3 per cent. At $120, the increases would be 11.7 per cent and 10.7 per cent respectively.
With the same best-case and worst-case scenarios for log prices as used for the logging sector, and the same high and low carbon prices, the impacts range from a loss of $700 million to a loss of $3.4 billion.
That is the loss of profitability to New Zealand's existing investment in wood processing.
The losses are concentrated in the mechanical pulp industry, which produces newsprint and tissue paper.
Kyoto would also introduce uncertainty about the supply of fibre, increasing the hurdle rate of return required of investment in processing.
It is not just that pre-2008 logging to avoid the carbon liability on non-Kyoto forests might reduce the availability of wood after 2008.
Relatively small changes in the assumptions about future log prices, future carbon prices, climate change policy and forest management regimes could trigger a crossover from growing trees to harvest to permanent forestry, where the trees are kept growing indefinitely for their carbon credits.
"It's a boundary that is well within the plausible range of both carbon and log prices," Mr Sundakov said.
Dr Bertram criticised the preoccupation with Chile as the competitive benchmark.
"Chile may well be regarded as New Zealand's chief competitor at present but since both countries are at the low-cost end of the world industry both are liable to remain viable investment prospects.
"In so far as forest industry investors can be expected to switch from New Zealand to Chile in response to relative cost changes, they can equally be expected to switch to New Zealand from Scandinavia, the United States, Europe and Canada," Dr Bertram said.
But Mr Sundakov said that overlooked the fact that the higher cost Northern Hemisphere producers were protected by tariff barriers.
If the World Trade Organisation's new round of trade talks succeeded in lowering forestry tariffs, that would benefit New Zealand and mitigate the impacts of Kyoto on forestry here. But it would be unwise to bank on it.
Another of the "other things held equal" by the institute model is the exchange rate.
Dr Bertram said: "Exchange rates regularly change by amounts sufficient to offset the direct domestic cost impacts that drive NZIER's results.
"And since exchange rate changes would be an integral part of the economy's adjustment to climate change policies, little weight attaches to estimate of the change in competitiveness at fixed exchange rates."
Mr Sundakov said: "If we take on extra costs and the exchange rate declines, to compensate, we are poorer as a consequence."
Intergovernmental Panel on Climate Change (IPCC)
United Nations Environment Program
World Meteorological Organisation
Framework Convention on Climate Change
Executive summary: Climate change impacts on NZ
IPCC Summary: Climate Change 2001