Getting to the roots of Kyoto problems

The hole in the Government's accounts - caused by its obligations under the Kyoto climate change treaty - is prompting calls for incentives to plant new forests.

The Kyoto Forestry Association has backed away from its initial claim that the forest industry could "rescue the Government from its predicament by doubling the size of the Kyoto forest estate by 2012".

Because of the time it takes to acquire suitable land, grow seedlings and grow trees, it is too late to get us out of the hole for the climate change treaty's "first commitment period", 2008 to 2012.

But the Kyoto foresters still say a lack of new planting of commercial forests is one of the main reasons New Zealand is now likely to fall short of meeting its Kyoto target.

They object to the Government retaining forest "sink credits" - credits doled out under the Kyoto Protocol's rules for the fact that trees absorb carbon dioxide, functioning as "carbon sinks".

They say the credits should belong to those who risk their capital to plant trees - and say a fairer deal for forestry investors has to be part of the solution.

Kyoto forests are those planted since 1990 on land not previously forested.

When New Zealand ratified the protocol in 2002 the projections were that they would earn 100 million tonnes worth of carbon credits.

That would be more than enough to cover the projected increase in emissions of greenhouse gases from other sources, principally the exhaust pipes of vehicles, power station chimneys and the throats of cattle and sheep.

As the credits are internationally tradeable, Climate Change Minister Pete Hodgson argued that not to ratify the Kyoto agreement would be not only environmentally irresponsible, but setting fire to a very big cheque.

The cheque has bounced.

Revised projections for the net emissions released last month show we are likely to exceed our Kyoto target.

The commitment is to add no more greenhouse gas to the atmosphere on average between 2008 and 2012 than we did in 1990.

It now looks like we will exceed that by 36 million tonnes - which will have to be covered by buying credits from countries with a surplus - instead of being in credit to the tune of 33 million tonnes.

At an indicative price of $15 a tonne (the value used to set the carbon tax due to come into force in 2007) that is a switch from a gain of nearly $500 million to a cost of more than $500 million.

It may be much more: if the current carbon price on Europe's internal carbon market is used, the taxpayer would have to find around $1.5 billion.

The biggest change from last year's estimates is a 38 million tonne increase in expected emissions, but the next biggest reason for the turnaround in our net position is that the benefit from forest sink credits has been revised down by 24 million tonnes or 25 per cent.

Most of that, 15 million tonnes, is because officials now believe much more than they previously thought of the 670,000ha of post-1990 forest was planted on landed previously in scrub rather than pasture, and therefore not classified as new forest under Kyoto's rules.

But it also reflects a dramatic reduction in the rate at which the area under commercial forestry is growing.

New planting has dwindled from a near-100,000ha peak in 1993-94 to an estimated 10,000ha last year.

Roger Dickie, for the Kyoto Forestry Association, representing more than 30,000 individual investors, says the decline in planting reflects not only weak log prices but also the strong sense of grievance forest owners have had since the Government opted to retain ownership of the "sink credits".

"During the 1990s we averaged 65,000ha per annum. It would be very easy to get back to that. If the credits were fully devolved it would go above that," he said.

Forestry returns have dropped because of two main factors, he said.

One is the lower current value of trees at harvest - about two-thirds of what they were two or three years ago.

The other is the higher cost of land, reflecting good prices for meat and dairy products.

The result is the real internal rate of return on forestry is about 6 per cent.

"We have an independent report from three consultancy firms which shows that the internal rate of return rises from 6 per cent to 14 per cent if the credits are devolved," Dickie said.

The rise reflects that Kyoto forest owners would get income flow in the form of credits through the life of the trees, combined with the time value of money.

To get a similar rise in returns from stumpage (the market value of the trees at harvest) alone, it would have to be 10 times current levels, Dickie said.

It is akin to the effect of compound interest on a steady stream of savings.

But there is no free lunch. The credits allocated to the trees' owner year by year as they grow would have to be repaid all at once when they are harvested. If the forest is replanted the gradual flow of credits would begin again.

If Kyoto is to work, the market price of carbon credits will have to have climbed during the 28-year life of the tree.

Dickie said that to manage the cashflows Kyoto forest owners would have to organise into a group or groups.

"It would be impossible for the owners of a single stand of trees to do this unless they wanted to take the silly risk of having to go and buy credits back when they cut the trees down. It's a pooling thing - which is exactly what the Government plans to do. Private enterprise is equally capable of doing that."

The Government offers subsidies, payable in carbon credits, for projects such as wind farms which will reduce emissions. Legislation before the House would set up a similar scheme for people who establish new permanent, non-commercial forests, which is often done for other environmental reasons such as soil and water conservation.

But Hodgson said the Government was not going to reverse its decision to retain the credits arising from forests already planted since 1990.

If there were to be any incentive for new planting of commercial forests it would most likely be for communally owned, mainly Maori land, where it is difficult to raise the capital needed to develop a forest. Cabinet has considered but so far rejected the idea.

The Government has limited its options by two key decisions it made in drawing up its climate change policy in 2002.

One was to exempt from any charge on greenhouse gas emissions agriculture, which in New Zealand's case accounts for nearly half of them.

The other was to assume (up to a point) the liabilities arising under Kyoto's rules whenever a forest is felled but not replanted. Otherwise it would be a barrier to switching land from forestry to another more profitable use, Hodgson said.

The potential cost to the taxpayer of those two concessions is mitigated by the decision to retain the credits from Kyoto forests.

Hodgson insists that that is coincidental and that the decision to retain the forest sink credits was at least in part a response to farm foresters' concerns about the transaction costs that would arise in a devolved system.

But for Dickie it is a cross-subsidy at the Kyoto foresters' expense and a departure from Kyoto's underlying principle that polluters should pay and those who plant new forest should be rewarded.

If the policy were to be reversed the question would arise whether to devolve credits for the new forests established since 1990 or just for those planted in the future - on the grounds that you cannot offer incentive for what has already happened - or for some date in between such as 1979 when the Kyoto Protocol itself was drawn up.

The Kyoto Forestry Association wants retrospectivity to 1990, saying anything less would be unfair and inefficient too, since most of the people likely to invest in new planting are already aggrieved Kyoto foresters.

"They have been turned off totally by the Government expropriating those credits. If it had not done that, even at today's internal rate of return I bet there would still be forests being planted," Dickie said.

But even if Government policy were reversed now, and the association's claims about investors' reaction are right, it would take time for new planting to revive, he said.

"People have to buy land and the seed is planted in August. So unless the signal comes out now, there will be no seedlings for next year anyway."