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Sale of timber assets by the South Australian government

CHAIR —Welcome. Are you familiar with the rules around giving evidence or would you like them read to you? You are under privilege. If you give false or misleading evidence, it is considered a contempt of the Senate and you are protected from intimidation. You can go into camera if you so require. As long as you are comfortable with that—

Dr Leech —I am comfortable with that.

CHAIR —Can you tell us the capacity in which you appear, and if you want to make an opening statement go for your life.

Dr Leech —I am a consulting forester. I have a Diploma of Forestry and a Master of Science in forestry and a PhD in developing growth models for radiata pine, so fairly relevant to this. I am a registered professional forester. I am a fellow of the Institute of Foresters of Australia. I am a member of the Association of Consulting Foresters of Australia, a life member of the Commonwealth Forestry Association, a member of the Australian Computer Society and a member of the Surveying and Spatial Sciences Institute. I was formerly the principal scientist Forestry Systems in what is now ForestrySA and I am currently the senior technical editor of the Australian forest valuation standard. I believe I have some—

CHAIR —Reasonable qualifications.

Dr Leech —Some expertise in some of these areas. I believe that you should realise that ForestrySA is a going concern where the growth is currently equal to the cut, so it is an institution which is in balance. The real problem here is: how does one handle risk? Who is going to carry the risk, and the risks are obviously in fire? We had an Ash Wednesday fire where we burnt a third of the forest. Risk includes disease, such as a pathogen or insect attack—years ago we had the sirex woodwasp attack.

You have got quite reasonable risks attached with forestry. Who is going to handle the risk? This question was asked of Treasurer Snelling, and in his reply he left the risk word out of the questions. Risk needs to be accounted for in the books. If he does not understand risk, how can he account for it.

I said forestry is a mature industry but, in the last 30 years, the average growth rate in the south-east has changed from about 16 or 17 cubic metres a hectare to about 23 or 24, which is an increase of probably 40 to 50 per cent. If you have a well managed forestry enterprise like ForestrySA is, then an buyer has little room to move because they have contracts they have to deal with and they have not got any overcut that they can suddenly put on the open market. This is going to affect its value. The annual report value from ForestrySA says it is about $770 million, although you hear figures bandied about of $1.3 billion, if you include land and other things.

Consultants that I have been talking to will put the value somewhere probably at $600-650 to perhaps $700 million but it depends very much on the amount of room that people have got to move, which depends on the contract. As you know, no-one really knows the model they are going to use. Every time you put a constraint on the potential buyer, you are going to drop the value to that buyer.

The two things I have not heard mentioned today—although you are probably aware of them—are what the water values are. They are talking about imposing water restrictions on the forests, and forests would have to account for water used even though dryland agriculture would not. This does not make any logical sense at all but it needs to be built into this whole analysis. The other one that has to be built in is carbon. You have heard that the profit from the forestry is about $45 million a year, but there is $80.6 million or roughly $81 million that is the change in the value of what they call the biological asset, which is actually the value of the forest. Although they are gaining $45 million a year, their forest has been increasing in value by about $80 million.

They talk about rotation length—and I am sorry I am skipping from one subject to another but I am trying to fill in some of the gaps. The rotation length in ForestrySA was 38 and that was set as the objective rotation length. I believe it is now set just below 35. That is below the age at which you will get maximum volume production, which is about 35 to 37. How do I know that? My PhD was developing the growth model that they used to determine that. If you look at the maximum mean annual increment of volume for sawlogs it is probably over 40. If you build risk into the analysis—I have presented a paper on this and I could provide the PowerPoint presentation of it—then the rotational length becomes over 40. I know that some people do not accept that and do not like it, but the point is that dropping the rotational length below 35 is really, in my view, not a sensible option.

I would like to say that this is not just the first time governments in South Australia have tried to sell their pines. I can name at least two occasions when it has happened—one Labor, one Liberal—and they failed because the forests have basically been used to support the state’s AAA credit rating. You have heard about the AAA credit rating, but if they have got the forests in their books at, say, $1.3 billion including the land then they are in essence mortgaging the forests at $1.3 billion. So if you sell it for $500 million or $600 million, where are you going to find the other $700 million of assets to support the credit rating, even if you do use that $600 million to pay off the state debt? No-one has effectively explained that to me, and that concerns me.

You hear about the need for more investment in forestry. I believe it is obviously needed, as the volume required for a world-class sawmill is basically increasing by one to two per cent a year. I cannot name the company for obvious reasons but one international investment house has probably two to four per cent of its total assets invested in forestry around the world and it is the only group within that institution that has actually got out of the global financial crisis without showing a loss. In other words, forestry tends to be countercyclical in the economic sense: it might not make the massive profits that you can make in some of these other areas, but it can mitigate disasters. I suspect that it would be sensible for the South Australian government to suggest to Super SA or other superannuation funds that they should be investing perhaps one to four per cent of their total assets and total funds in forestry, because then they would have an ongoing income and it will still be virtually in state hands.

If you look at the South Australian government, and Senator Xenophon would be aware of this, superannuation in SuperSA were told by the government to buy the Moore’s Building, which is now the court building in Victoria Square. Years ago I was told that the value was set—that is, the price that the owners wanted to sell it for—and they would get, say, four per cent real per year plus inflation. That was a pretty solid investment for the superannuation fund. If you have something that is making perhaps four per cent a year plus inflation and we are talking about a return on an equity of 11.5 per cent in forestry, it does not make any sense to me to be selling ForestrySA.

CHAIR —Thank you very much.

Dr Leech —Have I confused you enough now?

CHAIR —No. I want to go to water interception. What annual rainfall are you talking about in forest interception?

Dr Leech —You need to understand it is a range of rainfalls, from probably 500 up to 750 to 800 millimetres per year but it goes into an aquifer. The aquifer starts at the north and comes south.

CHAIR —I am very familiar with interception. At 32 to 35 inches of rain, the forest interception is about 2½ megalitres per hectare per annum in the growth phase of the forest. I am very familiar with that. I just want to challenge you in terms of ‘what’s good for the goose is good for the gander’. At a 20-inch rainfall there is minimal run-off anyhow, so a pasture should not be brought into the equation at under 25 inches.

Senator O’BRIEN —You ought to declare an interest as a farmer here.

CHAIR —I have to declare an interest. I am a worn-out farmer.

Dr Leech —That is fine. I have an interest in this too. The point is not the water that is going into the ground under the forest. The point is that the water has gone into the aquifer north of the forest and is then moving south through the aquifer out to the sea. On the shallow country, a proportion of the forest is getting down into that aquifer and drawing water. The dryland pastures are too. As I understand the state water deal, it is going to be dryland farms that are irrigated and forests that are not being irrigated. So there is a water issue in there.

CHAIR —There definitely is. So is the proposition that you would have to buy a water licence to grow the forest?

Dr Leech —As I understand it—and please do not treat this as being absolutely correct—the forest is going to be issued a water licence. If you sell the forest then it will be in the interest of an investor, perhaps, to seriously think about clear-felling all the trees, selling the water licence and just letting the land revert to scrub. I am not saying it is not a possibility.

CHAIR —I will not continue with this, but it is about the interception of the run-off as against the interception of the aquifer. We know that in certain portions of the Lower Murray 40 per cent of the flow of the river is actually the aquifer. There is a bore at Wagga that supplies Wagga, Temora, West Wyalong et cetera with their town water supply. It is pumping 86 per cent of the water that is about to go to the river.

Dr Leech —I think water is an issue in this whole debate because we have not got anything out of the government defining what the water rules will be.

CHAIR —The root systems of annual pastures versus perennials are a lot different.

Dr Leech —Sure.

Senator COLBECK —I just want to go back to your discussion about the potential model that is being discussed at the moment. The question that comes to mind at this point in time is: is there a model or is the government basically going to the market to see what they are prepared to offer? The issues that you talk about are in relation to the rollover of some of the conditions in the charter that has been discussed this morning and what impositions might be made on the management of the forest, which will potentially impact on its value, depending on how bidders cost those risks or obligations. But if the government are looking to go for maximum value it may very well be that they are just going to the market to see what is available rather than going for a pure market option.

Dr Leech —Yes. Who knows what the model is? I remind you that Queensland sold their plantations for $600 million to the Hancock Group and it is in the Productivity Commission report that it was worth, according to them, $1.4 billion. So they sold it for roughly 50 per cent of another independent value.

CHAIR —There would have been some good consultancy fees there.

Dr Leech —I will pass on that. My point is that the government in Queensland wanted the money, or so it would seem. I do know of a company that were quite happy bidding about $700 or $800 million. Obviously I cannot name them. But they did not bid because there were so many constraints put on the sale that they just opted out of the bidding process.

Senator O’BRIEN —I just have one question. You said you did not put a submission in for some reason.

Dr Leech —That was me being lazy more than anything else.

Senator O’BRIEN —Did you want to put a submission in? Do you want to be more fulsome in what you put to us or are you happy with what you put to us?

Dr Leech —If you are happy with what I have put to you, fine. If you want some of that put into an email then that is fine too.

Senator O’BRIEN —It is your choice. We will take the evidence you have given us, but if you wanted to give us more I am sure we would be happy to take it in writing.

Senator COLBECK —Can I just follow up on that. I would be interested in more information around your rotation lengths and values and your maximum volume production—some of the rationale behind the 35 to 38 and the sawlog issue. I would like some background information around those particular issues—on notice, rather than now.

Dr Leech —Yes, I can provide that, but it has been 15 years since I was working in ForestrySA, although I have been heavily involved in forest management since and I still have some very good friends in ForestrySA. I know what was happening before that. I can give you some general stuff. What I cannot give you, obviously, is the current situation and what has driven the situation where they have dropped the rotation length from 38 down. I know they have because I have heard that mentioned in a public forum, but that does not mean—

Senator COLBECK —My interest was more in your opinion based on your professional qualifications and experience in the industry just around those particular issues.

Dr Leech —What I can do, if it would help, is provide the presentation that I made to a research group on rotational length and the management of risk. I can annotate that so that you can understand it. You will have the whole presentation, so you will know that was in the public domain. Then there is the paper I wrote on risk and rotational length back in the nineties.

Senator COLBECK —That would be handy.

CHAIR —With the knowledge that we have on the fire strategy of forward sale of the forest asset to someone, wouldn’t the argument over who is responsible to put the fire out if it is left to the volunteers who have nothing to do with the forest industry become a lawyer’s feast or a river of gold for the lawyers?

Dr Leech —I am sure that you could actually get the information from ForestrySA and from the Country Fire Service. The Country Fire Service should be able to provide it for you so that you could determine the number of units that ForestrySA has in operation at the moment. I think there are 10 to 15 units, compared to the number of units that are supplied by Gunns, Hancock, Green Forest, Global Forest Partners and all the other people in the region. That information should be readily available through CFS. I believe it will demonstrate that ForestrySA are holding a much larger investment in fire control than the other forest growers.

CHAIR —We might have a look at that.

Senator XENOPHON —Dr Leech, thank you for your evidence. I would appreciate further details from you in writing. That would be very useful, from my perspective. I want to touch on three areas. Firstly, ACIL Tasman has been given the job by the state government of preparing a regional impact statement. Have you had any input on that regional impact statement?

Dr Leech —No. I have been involved with the councils. They had a little forestry group attached to their strategy group. I have been involved in that. I have not had any contact with the consultants at all.

Senator XENOPHON —So indirectly, in a sense, you have been involved in the process?

Dr Leech —Very indirectly. Forestry, as I understand it, was not part of their terms of reference.

Senator XENOPHON —We do not know what the terms of reference are.

Dr Leech —Yes, I know, but I do not see any aspect in there where forestry is mentioned in their terms of reference.

Senator XENOPHON —From your contacts in ForestrySA, are you aware of whether they have been extensively consulted as part of this process?

Dr Leech —I have to be careful in what I say, but I believe ForestrySA were asked to provide some information to Treasury. From that point on, I am not certain how much contact there has been.

Senator XENOPHON —We do not know what contact there has been, but you would assume that the ACIL Tasman report would of necessity want to get information from ForestrySA.

Dr Leech —You would have to ask John Ross as Chairman of ForestrySA that question. I do not know.

Senator XENOPHON —I have two more issues. When I spoke to you during the coffee break you mentioned your understanding of the New Zealand market and what has happened there with exports. Given the difference between, say, New Zealand forestry and here, particularly with respect to the issue of exports, are you concerned that if there is a forward selling of assets there will be an incentive to simply export products without value adding here?

Dr Leech —Yes, the figures I have been given by a New Zealand consultant were that, for equivalent logs, they were getting, say, $75 a cubic metre in the sawmill and they had Chinese buyers on the wharf at Mount Maunganui offering $100. I have absolutely nothing to support that apart from hearsay evidence but if you can get $25 a cube more for your log by exporting it then it makes sense to export it if you are trying to make money.

Senator XENOPHON —Finally, I just wanted to touch on these figures. You have given us a global view; you have looked at not just the forestry rights, but the water rights and the potential carbon value. You have estimated it to be worth about 1.3 billion.

Dr Leech —I am saying they are figures that I have heard. I do not know how to value the water because we do not have a water model out of government that can be valued. I do not know quite how to value the carbon one, you know the problems with the carbon debate anyway. If you look at the New South Wales figures et cetera and look at what might be in and what might be out that is where I get this figure of between one billion and 1,400 million from. It is almost out of the air as a figure because it is very hard to put a figure on it when you do not have a model to use.

Senator XENOPHON —But you are saying that in order to consider the potential value of the forestry asset you need to look at the sale of the timber asset itself, the water rights and also the potential carbon value?

Dr Leech —I believe that under some circumstances depending on the models it could be that the value of the water rights and the carbon rights are actually greater than the value of the forest.

Senator XENOPHON —Which gets you to that figure of $1.3 billion?

Dr Leech —No, I have nothing to base this on, I think the 1.3 billion is based on the value of the forest, the biological asset, to use the International Accounting Standards Board term, which is very restrictive and is not the value of the forest asset as an ongoing forestry concern—let me say they are quite different but there is not that much difference in money perhaps 10 to 15 per cent—and the value of the land. I am not certain that they have not said, ‘The whole value of ForestrySA is the value of the land plus the forest and we will mortgage that value as the value of forestry as a going concern.’ That is what I think may well have happened with the ForestrySA valuation. What is the value of ForestrySA in terms of the state government and their investment in terms of building up their triple-A credit rating? Obviously I am not aware of that, but that is the only way I can see it would work. The previous two times the government in South Australia has tried to sell off the forest—the moment they have realised that they have basically been mortgaging the forest for more than they could get for it anyway, so it was not going to gain them anything to sell it—both parties pulled out.

Senator XENOPHON —We are running out of time. I just want to be specific on this. It is your view that in considering this proposed forward sale you need also—I am trying to put this as objectively as possible—to consider the value of the water rights and the value of the carbon which could be worth more than the timber asset itself.

Dr Leech —Could be.

Senator XENOPHON —Potentially, could be.

Dr Leech —You would need to value them.

Senator XENOPHON —Sure, but it would have a significant value in any event depending on the price of carbon and the water rights themselves?

Dr Leech —Yes.

Senator XENOPHON —In terms of back of envelope figures what you are saying is that if these assets are forward sold for $700 million that could potentially, in terms of the mortgage value if you like, be short-changing the full value of the asset, depending on what the values are, by hundreds of millions of dollars?

Dr Leech —Yes. If you consider almost an absurd, extreme strategy, a company could come in and buy the forest, let us say they might even decide to pay $750 million. If they could sell the water rights on that for, say, $400 million and clear-fell the whole of the forest and if the ForestrySA value is about $670 million, which is, if you like, an immediate liquidation value, then they could sell the whole of the forest for $700 million and say, ‘We’re not going to replant it and now we can sell the water rights on that.’ Therefore they would get $1.2 billion. These are the sorts of figures. I am not suggesting that is likely to happen but it would mean that you would decimate the forest industry and you would certainly not have the sawmill industry or a utilisation industry.

Senator XENOPHON —It is almost slash and burn in that scenario.

Dr Leech —It is a straight slash and burn. If the government starts putting constraints on the sale, whatever constraints they put on the sale are going to reduce the value that some companies are prepared to pay for the asset.

Senator BACK —I have two questions. You mentioned that there has been an increase in productivity from 16 to 24 cubic metres per hectare, I think.

Dr Leech —On average.

Senator BACK —Over what period of time?

Dr Leech —The real change started in the late 1970s so we are really talking about a 30-year period. That is not value; that is volume production.

Senator BACK —The taxi diver told me yesterday—I have a great faith in taxi drivers—that there has been a reduction of about one third in the rainfall over that period of time. So therefore I would assume that if there has been this increase of 16 to 24 or 25 it must be through genetics, weed control, fertiliser use et cetera, in the face of declining rainfall.

Dr Leech —It has been a combination of genetics, weedicide at early ages and fertiliser at early ages. Up until the last time that the government in South Australia wanted to increase the amount of wood that was cut, late-age fertiliser application had been funded on an annual basis. All of a sudden we said, ‘Well, if you want to increase the cut you’re going to have to fund late-age fertiliser application.’ So a million dollars or more on fertiliser goes there.

Senator BACK —From your background and expertise, to what extent do you think that figure of 24 or 25 cubic metres per hectare can be increased through further improvements?

Dr Leech —If you had asked me 35 years ago whether it could be increased by 25 per cent in the next years I would have said, ‘You’re in cloud-cuckoo land.’ In terms of tree breeding I think the answer is yes. In terms of better weedicide application and better fertiliser application I am certain there are gains to be made; what they are I would not like to guess.

Senator BACK —My final question, since time has run out, follows further from Senator Xenophon’s. You might take it on notice. If the government needs $500 million or $600 million in a relatively short period of time could you give me some indication as an alternative to the crop how much land would have to be sold—the mayor has told us there is 70,000 hectares of forest owned by FSA—to yield that $500,000 or $600,000? If you cannot give it to me now I would like to know it on notice.

Dr Leech —I do not think I can give you that figure, even on notice.

Senator BACK —You would not be able to make an estimate of it?

Dr Leech —At no stage in my whole forestry career have I ever been asked to value the land itself, apart from the land that has been bought, where we have valued it on the basis of what the forest would produce. I cannot value that land but remember that it is well over 100,000 hectares of land of which only 70,000 is in forest. There are 20,000 or 30,000 hectares which is actually in native forest reserves which are managed by ForestrySA. I believe they get an amount paid to them to manage it. That is fine; they are doing it far cheaper than National Parks or anyone else can, but would you want to sell those patches of forest?

Senator BACK —I am not suggesting you have to sell any. If this is their end game I am just asking what alternatives there might be to yield the same dollar value and still end up with an industry here in the south-east.

CHAIR —I would have a little guess that if you sold the lot you would not get lot; you would not get the $600 million because it would be $4,000 a hectare and a lot of it is—

Dr Leech —There are a couple of things. What value is the land? When you have forest growing on the land and you value it as a going forestry concern you cannot sell the land off from under the trees, although they have valued the trees on top of the land.

Senator BACK —That is right; you have to value the product in.

Dr Leech —You value it combined. The moment you use a long-term discounted cash-flow type of analysis and if you go for an infinite rotation and an infinite period net present value then the value of the forest actually includes the land value as well. So it is very difficult to extract the land value from the forest value.

CHAIR —Thank you very much for your evidence.

Proceedings suspended from 1.04 pm to 1.49 pm