Red flags were raised before the Northland Regional Council handed over $750,000 to help set up a timber company that went bust after just three years.
The loan to Marsden Pt-based Resource Enterprises Ltd (REL), together with outstanding interest of $69,933, may have to be written off even though NRC is actively pursuing collection of the outstanding debt.
NRC councillors last month voted to record the almost $820,000 which is owed as an "impairment loss".
At the beginning of the sorry saga, REL proposed to buy between 71,000 cubic metres and 133,000 cu m of large industrial logs known as KI, make flitch or sawn cuts of soft inner wood and export them to Saudi Arabia and India.
In seeking capital, REL put its proposal to the NRC's economic development arm, Northland Inc. Of the $4 million REL needed to set up a sawmill, NRC provided $750,000 and the rest was secured through ASB.
Northland Inc had earlier engaged Forme Consulting Group, around August 2014, to review REL's proposal for funding.
Documents obtained by the Northern Advocate show chief among concerns Forme raised was what it called an "optimistically low" budgeted log price of $85 per cu m which the sawmill forecast would remain static for seven years.
At that price, Forme said gross margins were low, operating costs of the sawmill high, and the operation would only break even at $87 cu m.
"Hence losses, possibly substantial, are likely to occur within a 5-year period," the pre-loan report stated.
Log prices have risen about 40 per cent since 2014.
Forme said no firm log contracts were in place by REL when the report was written. Forme also highlighted the extremely limited ability of the proposed sawmill to produce alternative products should the proposed markets in Saudi Arabia and India fail.
The REL proposal targeted using 71,000 cu m of logs per year on one shift and rising to 133,000 cu m on two shifts, but Forme said the company would need to pay a competitive price for logs.
Forme said if the log price moved up it would affect profitability.
It said every NZ$1 change in log price over the seven-year modelling period would affect the net profit before tax by $877,000, or $133,000 a year once the sawmill double-shifted.
When the sawmill double-shifted in the second year of operation, Forme said the production efficiency gains would be realised and the gross margin for the Northland Inc/NRC money remain constant at $8 cu m from that year onwards.
"This gross margin is low and it raised questions about sustainability, particularly if log prices increase beyond $85 cu m as they are expected to do,'' the 2014 report said.
Following NRC members' vote last month to record the outstanding amount as an impairment loss, council chief executive Malcolm Nicolson said most of REL's woes were linked to the increase in log prices since 2014, when the sawmill opened.
The price hike drastically reduced REL's ability to secure logs at a price that allowed it to compete on the export market.
According to Northland Inc at the time REL opened, the mill was expected to employ about 20 people under full production and have an estimated economic impact of about $20m.
In response to Forme's report, REL said the $85 cu m log price was used at the time as it was close to the five-year average price of $83 for KI logs.
"REL has been structured as a low-risk infrastructure operator focused on timely acquisition of logs and the efficient processing of these logs into flitch,'' a statement said.
Northland Inc acting chief executive Vaughan Cooper said the Forme report was commissioned in the initial stages of talks with REL to highlight any key risks.
After receiving the report, Cooper said Northland Inc continued to work with REL to ensure they updated their business case and addressed key risks raised in the Forme report.
Cooper said Northland Inc made a recommendation for NRC to support the funding, based on the updated business case and actions taken.
For example, he said Forme identified a concern with the log price assumption.
"REL subsequently obtained a report from Woodbank, a log purchasing company, which indicated that the baseline price of industrial grade logs at $85 cu m was clearly achievable based on then current market conditions.
"REL was also required to undertake further actions, including securing a supply agreement for the sale of its product, changes to the sawmill operation itself, and improved health and safety approach."
Cooper said Northland Inc made a number of recommendations to NRC to ensure potential risks had been mitigated in order for NRC to consider investing.
"However, as with any start-up operation, there is potential risk that the business may not ultimately be successful."