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Sale of timber assets by the South Australian government

CHAIR —I welcome Mr Robert Eastment. I invited you to make an opening statement, after which we will go to questions.

Mr Eastment —I am the Director of Industry Edge, a company that supply market reports and general industry analysis across the forestry, pulp and paper sector across Australia and New Zealand. We have done so for 25-odd years. We have a client base that contains corporations and government agencies, as well as individuals, both in Australia and overseas. Essentially, I work for a wide client base. My reputation has been built on impartiality. I am certainly not here to take sides with anybody; I am not here to push a point. My understanding is that I am here purely to clarify any issues that the committee may have and to assist in their understanding of some points.

Senator O’BRIEN —Mr Eastment, you and your company have had involvement in or knowledge of other states forward selling timber resource assets. I understand that there may be limitations in what you can say, but I am interested in anything that you can tell us that would assist the committee to perhaps form recommendations about what this sort of process should involve to protect the interests of the citizens of a particular state.

Mr Eastment —I have been involved in a lot of sales. I have signed some confidentiality agreements, so I will not disclose today financials. That is not, I believe, what this is about. What I can talk about is the efficiency of those processes and, in my view, what has gone wrong. Essentially, the timber resources around the country have been developed by state governments, particularly post World War II and initially as employment for returned soldiers. The timber resources are or were essentially in government hands. That has meant that the costing of the development of those resources has never really been taken into account. But having said that the sales of these resources have been of interest to various governments. They can separate the trees from the land. That has happened. A classic example of that would be something like Great Southern Plantations. They sold the trees to one responsible entity and sold the land to another responsible entity. So you can separate these things. It makes for a legal nightmare, but it can be done.

One of the biggest issues is that they will take the gain today; they will take the profit up front; they will take the money rather than looking at the full period of time. When the Victorian government sold off their softwood sector they initially put it into a state business entity, Victoria Plantations. Then they moved it across into Hancock Victoria Plantations. The issue is that, if they sell a softwood or hardwood resource, they are looking for income today. If you do that, you are probably looking at a financial return of maybe eight per cent or nine per cent on a per annum basis. But the people who buy often do not put in the care or pay the upfront costs necessary to develop future resources—even a second rotation or a third rotation. In the other states, the gains have been clear. They have been short term. They have achieved what they were looking for in their returns.

So you have to be careful. You may have a good set of trees that the government has run for a long time with some fairly low costs associated with it. But they have grown good wood and they have proved it. But if the commercial company that is buying it have to produce an eight per cent return instead of a four per cent return, such as a TIMO or some other form of international investment company, they will therefore cut costs and some of the costs will be the work that is required to produce better timber resources for future rotations. You can argue that that has possibly happened in Victoria, Queensland and in my home state of Tasmania.

Senator O’BRIEN —What is the solution?

Mr Eastment —The solution is to separate the off take of the timber to the development of the resources. You can get into a contract with someone who will buy it or agree to take it. But you can require a payback over a period of time to ensure that the state or whoever the responsible entity is continues to develop that resource to ensure that future rotations meet quality and productivity standards. You can still grow trees, but will those trees be adequate for a local sawmill or whatever? They have tried various processes in places like Canada under which they have sold off some of the state resources into private hands. The problem of separating the taking of the wood from the future management of the forests is that people do not want to pay as much for the wood, because if they have to pay the government money to manage the forest it lessens the return for them. You must understand that when people come to look at the resource that we are examining here, which is forest in South Australia, there is an immediate profit for the government if they sell it off but the buyer gets a great resource that they can get a high return on now. And they know that in 30 years time they may not necessarily get that same rate of return, because the work that they put in between now and then will not be the same that was put in over the last 10 or 15 years. There is a risk. But I am pointing out the reality of what happens; this is the way that it is; that is human nature.

Senator O’BRIEN —If a government wished to ensure that however many rotations—if it was only selling timber rotations—it ended up with an equivalent resource it would have to give a discount in terms of the price that it was prepared to accept for the resource.

Mr Eastment —Yes, that is correct. I have not seen a resource that has been sold that has improved in quality.

Senator O’BRIEN —Are you talking about the private and public sectors?

Mr Eastment —In the private sector it is different. You would need to look at the value of the land and the quality. But I am just talking about the quality of the timber and what you can do with it.

Senator O’BRIEN —In terms of the numbers of rotations that are sold, are there any examples that we should look at in terms of different states?

Mr Eastment —It is difficult, because the Victorian sale did not really start until the end of the 1990s, New South Wales tried to sell but that fell about and Queensland sold the resource underpriced. Having said that, it is all very well to say, ‘It was worth this amount but it was sold for less,’ but are the people who bought that resource going to be able to sell the wood at a higher price? The answer is probably no, because if you have a dysfunctional or fairly small timber processing community they are not going to pay as high a price for that. Unfortunately, and with respect, a lot of these sawmillers have got very used to cheap wood. They want to continue to receive cheap wood. They are not prepared to re-engineer.  So the people who buy into the resource are not necessarily able to sell it at a price which would suit the sawmillers. Often the best price that they can get is from just putting it on a ship and sending it elsewhere.

I would like to extend that answer to a point which I am about to clarify a bit. There was talk that the market here is dead for sawn wood, that it is really not big. But there is a strong market in Australia for sawn wood. We import about $1 million worth of sawn wood a day. There is no doubt about that at all. That is clearly in the statistics. But that wood is increasingly coming from Europe, from Stora Enso. The reason that Stora Enso is able to send it here so cheaply is that the primary product its sawmills are producing in Europe is woodchips, because Europeans have a subsidy for bioenergy and they have commitments to meet certain renewable energy targets, so the logs are going into the Stora Enso sawmills, and a by-product of the sawmills is sawn wood. Therefore, as long as the Europeans are subsidising their energy, Australia will be flooded with cheap wood. That is the reason why the guys here cannot sell it. It is because we have got this influx of cheap wood coming in. That is the straightforward dynamics of it. Yes, we have continued demand for softwood here. The only way we can stop the imports coming in is by reducing our processing costs—taking costs out of our production to be able to meet the import costs, to get import parity.

Senator O’BRIEN —What is the rough difference in value? Is there an equation you can give us which would explain it to us?

Mr Eastment —Yes, certainly. Four years ago, just before the financial crisis hit, we knew that Baltic pine was being landed in Melbourne by Stora Enso for $3 a tonne less than it could be cut at the big Carter Holt Harvey mill in Victoria, at Myrtleford. They could land it in Melbourne, with all the costs associated, for $3 a tonne less than we could get it from Myrtleford. Now that the Australian dollar is running above parity, that gap might have gone out to $4 or $5 a tonne. And Baltic pine is a better-performing timber than radiata.

Senator O’BRIEN —Would the resource from the Iron Triangle automatically find its way overseas as a consequence of the sale of the asset?

Mr Eastment —With the sale of Forestry South Australia timber—because the land is not for sale; it is just the timber that is going to be sold—I assume that it would be bought by a TIMO or something, an international investor, and today they would be wanting to put it on a boat, because the demand in China is high. But you really would not want to lose your fallback position or plan B, which could well be selling it into the local market. So you would certainly want to keep enough of the local industry alive to ensure that, if your export markets collapsed or the dollar moved significantly against you and went up to US$1.50, you could have that domestic pool you could sell it into. So you would want to hedge your bets both ways. There could well be some collateral damage in the local domestic processing, because you may not have enough to keep everybody alive. Kerry Packer wanted to keep all his printers going, for the competition and pricing and everything else. It was never in his interests to see people go. For him it was always a plan B. He just needed that pull there. So it is now with the timber sector. So you want to look at both, but certainly there would be some damage to the local industry.

Senator O’BRIEN —So you would suggest that as a consequence of any sale the likelihood is that there will be some damage and there will be some remaining local industry for spreading-the-risk purposes, if I can put it that way.

Mr Eastment —I would put it as more than a likelihood; I would say there would be some certainty. But we were just talking now about import parity and pricing. Therefore, if you want to compete against imports, that is not impossible. We look at the Hyne mill at Tumbarumba. That used to be a 300,000-tonne mill. They have increased that now to just under a million tonnes. It is now a 960,000-tonne-a-year mill. To increase it threefold, they have actually cut the staff by two-thirds. So that mill has three times the throughput on a third of the staff. That mill is a world-scale mill and it is competitive. It can compete against imports. What we cannot do is have very high labour costs, energy costs and probably inefficient processing—manually done—in the local industry. There is no doubt that, if we were to keep the timber here and process it, we would have to be looking at a million-tonne-a-year mill. Otherwise, imports are gradually going to take it away. You cannot have you cake and eat it. If you are going to keep your wood here, you have got to be able to process it sufficiently efficiently to compete. To do that, you are going to have to reduce your labour costs. But the labour that you keep will have to be of a much higher calibre. There will be far more professionals involved—technical people. A lot of it will be computer driven, made to order. Mills will be running in darkness because all the people will be sitting at consoles operating it—that type of stuff.

Senator O’BRIEN —So that is what is happening at Tumbarumba?

Mr Eastment —Yes. And at Myrtleford they are stopping sawn wood and they are putting through plywood there now. But they are reducing the staff considerably and they are making an engineered wood product, which is far more complicated, with fewer people. In my opinion, I do not see that the resource would be able to stay here without significantly restructuring the industry to compete on a world scale. If you want a million tonnes, you have got two players here—Carter Holt Harvey and Gunns, or Auspine. Is either of them capable of doing it? Yes. Have they both got the wood supply? Yes. Would either of them do it? I do not know.

Senator O’BRIEN —You mentioned Gunns. You told me in the break something about a pulp mill getting FSC certification in Tasmania.

Mr Eastment —Yes. There is a view that they do not want to build a pulp mill in Tasmania. There already is a pulp mill in Tasmania. It is called the Norske Skog Boyer mill. I have just heard that today that has received FSC certification for its wood supply and management. So can a pulp mill in Tasmania get FSC certification? The answer, briefly, is yes. It has; it is done.

Senator O’BRIEN —Thank you.

Senator BACK —I have a couple of brief questions, Mr Eastment. In your experience, when it comes to the outsourcing of the product, where do the skills lie in being able to audit these long-term productivity standards that you have referred to?

Mr Eastment —That is an excellent question, because that has always been difficult. Who does it? The trouble with forestry is that it is very emotional and therefore it is very biased. But, when you look at the skills, you need to have somebody who is very, very independent. I will use an example that has occurred overseas. Some company audits were done on a particular mill. In the plantation process, the area of land that was claimed to have been planted was probably about four times what had actually been achieved. Also, the trees that had been planted had simply never grown. This was on the peak grounds in Indonesia, which rainforest had been removed from. But the audit said that they had to plant trees as they were harvesting the native forest and had to ensure that the trees were there, so, as they had failure of the trees that they were planting, they could put trees back in.

So my experience is that the audits are only as good as the initial contracts of sale or requirements stated. Also, you would certainly need an independent and third-party audit process. I am not saying that companies are misleading, but on that particular occasion it blatantly was the case. You do not need an audit at the end; you need the RFA process whereby you need maybe a minor audit every five years to make sure that the state and Commonwealth are abiding by the RFA, and then you would have a major audit every 10 years. The RFA system worked, and I think the Commonwealth should take a lot of credit for getting that through. The audit process is fine, and it is reported to a very clear set of principles. Nothing less than that, I think, should be acceptable, especially over a public asset, for instance.

Senator BACK —So you would need some highly proficient and reliable base measurement against which to eventually compare performance, would you not? At the time that that transfer or changeover took place, you would need objectively measured and agreed data so that there was complete clarity as to what the asset was in its various forms at the time it was handed over, because we are talking in this instance, aren’t we, of up to a hundred years. Not even the Chairman is going to be around in that time! Does that expertise reside to be able to lay those baseline measurements?

Mr Eastment —I would say yes, providing you cut out what-ifs such as carbon, water and other things like that. Just say, ‘Look, we’re talking about trees, the growth of trees and what the volume of a tree is.’ You make it clear what you are talking about and you do not get fogged with other things that potentially may come into place: ‘That is what the issue is; that is what you are measuring; and we want reports every five or 10 years on that.’

Senator BACK —You mentioned payback clauses, and I am thoroughly familiar with those. They are the sorts of things that a proponent is going to discount in its proposal to a government; isn’t it? It is going to take a worst-case scenario of the burden on it financially and its eventual price will be reflected in the number of and the complexity of those payback clauses. Would you agree with that?

Mr Eastment —I do not think I would agree that they would necessarily take the worst case. I think, with respect, that they would weight the risk on those clauses and then they would discount their value from there. Every financial transaction has risk involved. Certainly, on a deal like this, you want to make sure you do not get disease, earthquake, wind or whatever it would be to kill the trees—or the industry goes out of business and you cannot sell your wood—and everything else. There is a lot of risk involved in it, so you would need to weight the probability of that and then set yourself what you think is a commercial price there.

The other thing is, too, that you need two or three people in this process. I have seen that sometimes it makes the sale so hard that they only have one person who is in the ring at the end, and then the government or the seller invariably becomes a price taker because all the power stays within that company. That is not good. You really want to have two or three people bidding against each other to get a—

—To keep them honest.

Mr Eastment —Yes.

Senator BACK —You also mentioned the quality of the contract. Is it your experience that the expertise does exist to put down into a contract the sorts of terms and conditions that can be later relied upon, given the fact that it may well be that all the participants have long gone by the time disagreement, litigation et cetera comes to the fore?

Mr Eastment —In brief, I think the answer is yes. But, again, it has to be practical and you have to be absolutely unemotional. You have to leave emotion right out of it.

Senator BACK —In contractual terms or any others, how do you protect the eventual owner of the asset, which in this case presumably is the people of South Australia? How do you protect against a scenario in which a rogue buyer, or perhaps someone who starts out with the best will in the world but eventually finds that they have made a mistake, takes the maximum and either liquidates and walks away or tries to on-sell to a third party who has even less interest in meeting the contractual obligations than they did? How do you protect a community with a publicly owned asset against those sorts of possibilities?

Mr Eastment —The only protection you can give is that you do not go into the sale to begin with, because, once you have entered the sale and the purchaser does the wrong thing, the vendor is seriously at a disadvantage, and the deed is done. I am not going to say that you can solve that. The only way is not to do the sale, really, because we see it time and time again. Whether it is a power station, a mine, a forest or whatever it is, they have done the sale and then the person who has bought it—it simply has not worked.

Senator BACK —And the ultimate cost of getting it back to the condition that it was in at the time of the original sale might well and truly exceed any benefit that may have accrued in the meantime.

Mr Eastment —Forestry is a very slow process. It is generational. The trees can take 15, 20, 25 or 30 years sometimes. We need to be very careful about doing that because it is not like a mine, manufacturing or a power station, where you put money into it to get it fixed. With forestry it could take a long time to do. I will just give you an example. It is the MIS sector. Do I have to say more? It appeared a really good idea at the time and lots of people put money in. The companies failed. What do you do? There is a lot of cheap land now coming up. Some of those companies were buying land for $5,000 a hectare and some of it is now back on the market for $1½ thousand or something like that. That is a classic example, I think, of how, in the forestry side of things, with all good intent, it can go seriously wrong.

Senator BACK —This is my final question. We have, I presume, in the case of South Australia, foresters who are currently managing this resource. One would think that you would look to them to be the parties to oversee a private sector operator undertaking this role—in other words, they then become the auditors. Do you have any experience on the success with which those sorts of people transfer their skills from being the one doing it to being the one overseeing somebody else doing it? Or is it your view that you bring in totally independent skilled third parties? If that is the case, where do those people develop their skills?

Mr Eastment —Firstly, regarding ForestrySA, I do not have any experience—

Senator BACK —I am just using that as an illustration.

Mr Eastment —Generally, there are companies which have been managers of forests in the past which have stepped back in the process. The failure that has occurred—I am thinking of one particular case, and I have to be a little bit careful of this because there are some legal issues tied around it—is that they need to get all the available data to be able to assess whether that is occurring; the management and everything else. Certainly, someone like ForestrySA would have the ability, providing they have 100 per cent access to everything—the forest, the data, the economics and everything else. It would be very hard to be in that role and then have one hand tied behind your back.

Senator BACK —Thank you for that.

Senator COLBECK —We were talking earlier about local and global markets for timber pricing at raw log state. You have alluded to it to a certain extent in your discussions about what people are used to paying at a local level for the timber at the moment. I want to get a sense of the current trends in relation to—it might pay to qualify that with the drivers, given some of the evidence you have already give—the prices for timber or for logs into local store milling versus the whole log export market.

Mr Eastment —The whole log export market is very much a spot market so it is sale by the sale. Take Japan, for instance. Japan is going to need it to be rebuilt in about a year’s time. There is a lot of construction going on so we can expect an increase in the price of exports there. A lot of the local markets are for long-term supplies and they do run out. Export markets are spot markets, therefore the price does fluctuate. That is why, if you become say a person who has large resources you want to keep both your exports and your domestic going as well. At the minute export markets a pretty high because there are a number of drivers out there and it is reasonably competitive. I was looking at the prices into China the other day and I did not believe what they were. I thought there had to be some manipulation on those prices. There are other times when that market can really collapse. It is not the timber business or the owners who have much control over the pricing fluctuation on those markets; it is the foreign exchange. If our dollar stays high, technically the logs going offshore should be at a lower price but they are not because demand is strong. If our dollar fell back to 60c, why would you want to sell anything to a local sawmill? Put the log on a boat and get rid of it. You make more money. We are an open economy. If the dollar goes up to a $1.50 and people simply cannot afford to do that then they will be more inclined to put it on a ship.

Senator COLBECK —So it is a market of opportunities as much as anything else?

Mr Eastment —Yes and it is very hard to say what is a gap. At the moment, with some of the logs being put onto boats there is $20 or more a tonne difference. A classic example would be what happened in Tasmania when Auspine had was still owned by Auspine, De Bruin and everything else, and they had the Scottsdale Mills. They were buying the timber there from GMO from Rayonier and they had a 10-year contract. Those 10-years contract ran out. Those contracts were put in place by the government. Rayonier said, ‘If you want that wood, you are going to have to pay at least export parity now,’ because Rayonier was under a dictate to maximise revenue from the resources they were managing for GMO and Forestry Tasmania. Auspine said, ‘No, we can’t afford that’ and FEA came alone and said, for their Bell Bay mill, ‘We will give you export parity.’ Auspine lost the resource, the mill, and the rest is history. If you are running a resource and there is an opportunity to put the wood on a boat and essentially the local boys cannot afford it—because they are inefficient, they are not well scaled, they do not have a million-tonne mill and they need low-price logs to survive—the forest owner will simply say, ‘I’m sorry, they’re on a boat and that’s it.’

Senator COLBECK —So it comes back, in effect to the market in that circumstance?

Mr Eastment —And things like foreign exchange over which no-one really has much control.

Senator COLBECK —Which is the market. Foreign exchange is an element of the market, what the spot price might be and, if there is strong demand, that is a viable threat to the local supply.

—Yes and if you can get a long-term contract—’I will build you a big mill, after all this processing through I need this volume and I will have a supplier for that many and I will give you a committed price for a long period of time’—there is an interest for both parties. At the minute the structure of the industry in this region is such that you have the opportunity to do both and make more money by putting it all on boats. Portland is very convenient.

Senator COLBECK —I think we heard evidence that about 20,000 tonnes a month is going out through Portland at the moment.

Mr Eastment —Yes—easy. Japan is getting critically short of timber at the moment. The irony is that we are sending our wood, unprocessed logs, out there, and yet bringing all this stuff in from Europe—at probably $5 a tonne less than what we could process our own wood for, if we were in the business.

Senator COLBECK —You bring me to my next point with a nice segue. That subsidy that is effectively being applied to the imported timber out of Europe, the biomass, also demonstrates the need to have a strong market for all the outflows from the round log—all the different product classifications, from sawn timber right down to waste, whether it be for biomass or something similar. That really demonstrates the importance of having all those things in place for a viable industry.

Mr Eastment —It does. Some of the solid-wood processors in this region were able to sell some of their chips into various areas, but we must remember that Tantanoola Mill at Millicent is shutting by the end of this year. That was Kimberly-Clark—about 300,000 to 400,000 tonnes went into that mill. Woodchips from sawmillers would have been able to go in there, but that has gone now. That mill is shutting.

Senator O’BRIEN —Definitely?

Mr Eastment —Definitely? No. Likely? Yes. It is a bisulphite mill. It has a capacity of 70,000 tonnes of pulp but they can dry only about 30,000 tonnes; the rest has to go wet into the machines. Kimberly-Clark do not want to make those drying machines. To keep that mill running, you would have to put in about another 40,000 tonnes of drying capacity. That would be like coagulating electricity; it would use a huge amount of power, and they do not have that power in this region. You cannot put a line across the Latrobe Valley or something like that. You could increase the drying capacity of that mill to be able to take the pulp and put it on the boat, but you do not have the power to do that.

Senator COLBECK —That has the nasty sound of Burnie and Wesley Vale to it.

Mr Eastment —If they sell that mill they will most likely take it apart and put it on a boat.

Senator XENOPHON —Which would be bad news for some of the people I know who work in that mill who are hoping for sale. So you are saying that at this stage the chances for that mill are grim?

Mr Eastment —I really hope it stays here.

Senator XENOPHON —So do I.

Mr Eastment —I seriously hope it stays here. But it is a bisulphite, not bisulphate, mill; therefore, the market for it is—

Senator XENOPHON —Sure. I will be very brief. My colleagues have comprehensively covered the issues I was concerned with. I thank you for your evidence. I want to go to the issue of the process that the state government has used. I ask this in the context of your general experience in these matters. The complaint has been that ACIL Tasman, who has been commissioned by the state government, will not reveal the assumptions made or the parameters of the study; they have just provided a generic regional impact statement. Would you be concerned about such a process, where there is that dearth of information in the context of what is being planned?

Mr Eastment —Yes, emphatically. It is inappropriate. I do not know what else I can add.

Senator XENOPHON —I do not think that there is much more to add. Depending on what is being proposed, the impacts could be quite severe. If it is about getting a cash flow or getting the money in to maximise the sale of the asset, that is not necessarily a good thing for the long-term viability of the timber industry here.

Mr Eastment —Forestry is not about a five-year window; forestry is about 30, 40 or 50 years. That is the way life is. It is not a mine, it is not manufacturing; it is forestry. Therefore, your sale process has to be about not a five-year gain but 30-, 40- or 50-year security.

Senator XENOPHON —I that that is the key to this.

CHAIR —Thank you very much for your evidence today, Mr Eastment.

Senator O’BRIEN —Thanks for bringing yourself here.

Proceedings suspended from 2.30 pm to 2.44 pm