GUNNS Ltd maintains its pulp mill preparations are progressing — despite speculation its plummeting share price would kill off the $2 billion project.

Cheered on by ‘supporters’ who took no risks, Gunns actions have turned out to be self-destructive with:
• non commercial business models that degrade and waste resources
• pulp mill plans that failed to disclose real risks
• legal anomalies that threaten its business partners and others
• optimistic valuations of itself and its future.

The following groups are at risk of being embarrassed or put at severe risk including…
• taxpayers
• plantation ‘investors’
• contractors
• brokers
• financiers.

Because many of the undisclosed risks were so high, the project has become a ‘black hole’.

The mill fantasy

Jaakko Poyry has spent 2 decades selling Australia on the idea of plantations and ‘industrial forestry’ in order to sell us pulp and paper mills that deliver billions to Poyry & partners.

Poyry convinced Gunns that if they ponied up for a mill they’d make considerable money …  but where would it come from?

Many people have queried how Tasmania could possibly compete with huge countries like Russia, China and Brazil in a high volume, low margin fibre commodities business.

The plan was to take perfectly good trees that took over a decade to grow and reduce them into chips for fibre (pulp). In the process they’d take clean water, worth real money in today’s climate, and turn it into industrial waste that would then pollute Bass Strait, or be poured into a vast landfill site to threaten groundwater supplies. The clean air of the Tamar valley was to be stunk out with sulfides, mercaptans and various micro fine particulates, while much of our farmland was to be converted into a ‘permanent plantation estate’ that took hundreds of gigalitres of water from our catchments.

For their plan to work, Gunns needed to borrow $2 billion which they would pay off with chips and pulp made from publicly owned trees.

Most people (except our political parties and Gunns) recognised that such business ideas were totally incompatible with the socio-economic situation in the Tamar valley (a), as well as hostile to our climate and environment, plus grossly wasteful of Tasmania’s increasingly precious resources.

Their IIS missed serious risks, including the risks of over-leveraging and sensitivity to critical variables like rainfall and political change, thus exposing Gunns to serious business problems.

It now seems that the concept was for mill profits to result from other people making losses by picking up much of Gunns costs and risks — a.k.a. cross subsidies which would give our forestry industry the appearance of being a real business, rather than a highly subsidised basket case.

In other words, the way that ‘industrial forestry’ is able to be ‘sustainable’ is with government approval to pass their costs and risks onto other people and businesses.

Taxpayers and investors

Andrew Bent has estimated the scale of subsidies provided to forestry by taxpayers (1) which amounts to over $200 million per annum currently and would jump to around $350 million per annum if Gunns pulp mill goes ahead, due to the extra resources required.

John Lawrence’s article (2) brought out the failure of tree MIS, which is a taxpayer subsidised program to convert land to tree plantations ‘in perpetuity’ — for ever.

‘Investors’ pay around $9,000 in total for a hectare of Gunns woodlot project (3). When the wood is harvested after (say) 13 years, a further 9% of the sale price is due as rental for the land & sales commission.

‘Investors’ claim their costs off their tax, so the taxpayer pays about $3,000 per hectare, or a total taxpayer cost for 260,000 ha of $780 million over 15 years — another huge bonus to forestry who don’t have to use their own money or take any risks themselves.

Given the payout risks, investors are rightly asking ‘is this a scheme or a scam?’

Is profit likely?

For simplicity I’ve focussed on pulpwood (E.nitens) and used an average growth rate of 15 tonnes/hectare/year (CSIRO) which, in 13 years, means 195 tonnes of timber. Gunns agrees to pay a minimum of $33.88/tonne for plantation timber which leads to a sale price of about $6,600 per hectare — a loss of $3,000 per ha. ‘Investors’ take all of the risk but may insure — at extra cost.

Gunns makes no commitment about tonnage per hectare so the final amount paid may will depend on Gunns unaudited declarations of yield.

N.B. The 15 tonnes per hectare growth figures that I’ve used come from CSIRO scientists and the typical growth rates reported (e.g. John Lawrence) and from a few plantation owners.

The $9,000 paid for the privilege of growing the trees, rated over 260,000 ha, is over $2.3 billion dollars that Gunns doesn’t need to spend.

With 260,000 hectares of plantation, Gunns will defend its monopsony position vigorously to retain control of the price paid.

What will it take to profit

If our plantation ‘investor’ has put up $9,000 per hectare, they’d need to get 265 tonnes in 13 years to break even at the ‘floor price’. Since Gunns woodlot project comprises thousands of hectares of plantation, that would mean an average growth rate of nearly 22 tonnes per year – an unlikely outcome.

Yields over time are threatened by water shortages, insects, fires and poor soils while any profitable payouts to ‘investors’ require Gunns to report honestly on actual yields.

Contractors

Logging contractors have been drawing the short straw for a long time (5). They are paid by tonnage, so their income has no direct relationship to their actual costs.

When fuel prices, maintenance etc. increase in price, it’s paid by the contractors. In other words the contractors pick up the risks associated with collection and transport of Gunns raw materials, and they also absorb many of the costs, e.g. fuel price increases and maintenance.

Most of the contractors are stuck with major debts incurred to buy their heavy forestry equipment.

They have to work for forestry and take what they can get — or go broke trying.

That’s why many of them report driving 16 hour days and not getting their trucks maintained.

Log truck drivers can spend over $150,000 per year on fuel alone, saving Gunns tens of millions across the whole contractor base.

But there’s more risks for Gunns mill contractors …

The Pulp Mill Assessment Act Section 11 prevents any person from seeking common law redress in anything “arising out of or relating to any assessment or approval of the (pulp mill) project.”

The boundaries of this section are entirely unclear and legal opinions vary widely. Any person who falls into dispute with Gunns could find Section 11 used against them. If so, subsequent court cases could be both expensive and extensive, placing all those who deal with the project at unknowable risk …  plus Gunns is infamous for its propensity to sue.

Those at risk could include their mill contractors, landowners whose land was used to hold the pipeline and others — basically no-one knows because the legal situation is unclear.  The uncertainty has been amplified by the State Government’s refusal to give reasons in court for Sec 11, instead threatening to strike out the case. (6)

Brokers

Brokers rely on reputation in order to be able to persuade their clients to acquire any given portfolio.

Just a few weeks ago, brokers at Macquarie, JP Morgan and Credit Suisse, persuaded investors to part with $1.50 per share in Gunns to help their capital raising. This was after Gunns shares had plunged to $1.67 from $2.30 in a few days and Gunns suspended trading.

At this writing, Gunns shares stand at $1.17 — a loss of 50c per share for those investors. Since the amount raised was $336 million or so, that means those ‘investors’ lost 30% — $100 million which Gunns probably used to pay off some of the debts that they’d incurred.

The reputations of the brokers who convinced investors to buy those shares may need considerable rehabilitation.

Financiers

Gunns worth is influenced by the value of their plantations, which can be understood in at least 2 ways.
• What the plantations and timber might be worth to Gunns
• What the plantations and timber might be worth to any financiers and others

Determining either of these requires a reasonable understanding of how much timber might be produced from the plantation estate, when it will be available commercially and what its commercial value might be.

Clearly the commercial value of pulpwood to Gunns will be related to whether they have a pulp mill or whether they have to sell the timber as wood chips or other feedstock (e.g. biofuels) because each delivers different profit lines.

Many would argue that wood is worth considerably more as timber, but that doesn’t match Gunns concept.

It is very much in Gunns interests to claim the highest value possible because it leads to a higher perceived value for their company, paints a rosy profit picture for plantation ‘investors’, and provides collateral for big loans.

On going harvests

There are sufficient failed or feeble plantations dotted around Tasmania to raise the question of the value of the land for regrowth of timber. Food growers understand the importance of crop rotation to replenish depleted soils, but tree plantations are in perpetuity so — no rotations — no replenishment.

This is important because the value of the plantation estate includes the value of the land. Notionally 260,000 ha of land would be worth around $3,000 hectare as farm land, giving a total value of $780 million for the land alone. But because the land can only be used for forestry, the value depends on whether or not successive generations of trees can be grown.

At the first harvest, there’ll be stumps aplenty. Replanting will require regeneration of soil nutrients to assure that the trees have the basics for growth; that’ll cost money. 2nd generation yield rates per hectare on Tasmania’s soils are unknown, but given the failure of first generation plantations there could be a high percentage failure.

If financiers choose to accept Gunns valuations then they’ll consider the company as good value. If they pause to think about what would happen if Gunns couldn’t meet its debts, and they had to sell plantations to meet those debts, then they’d need to revalue the plantations in that light.

Who would want the plantations and at what price? Will plantations be tolerated if they’re shown to be draining catchments of valuable water? What is land that is forestry ‘in perpetuity’ really worth to anyone else?

There may be some answers if Gunns manages to sell its 40,000 ha of plantation in South Australia.

In the meantime, wise financiers will stay well away because there are just too many unknowns and too many risks.

The role of governments

It appears that governments are happy to create, participate in, or promote, any scheme that shores up the growth of the timber industry. That view is reinforced by the federal Department of Forestry’s goal ‘to assist our forestry industry to grow, improve and capitalise on new opportunities’ (7).

You’d expect it to read something like ‘to assure that public forestry resources are deployed in the best interests of the community’ or some such, but the department is clearly an example of ‘regulatory capture’ (8).

Governments’ have also led Gunns deeper into difficulties with incomplete and inadequate assessment processes that helped to conceal real risks and paint an artificially rosy economic future.

Taxpayers could be forgiven for believing that the government is colluding with the industry to transfer wealth from taxpayers, contractors, investors and financiers into forestry pockets. They also appear to be quite happy to use taxpayers’ money to promote the schemes, easing the burden of ‘investor’ losses.

Keeping on

Whether Gunns can prevail in today’s financial climate and whether Kevin Rudd can, or will, act to protect taxpayers, contractors and investors from dubious federal schemes, remains to be seen.

At every step, pulp novices Gunns have been spurred on by knowledgeable consultants that convinced Gunns to bet the company on a project that was too big, too risky and too expensive.

Did they honestly report the risks to Gunns?

The IIS contained no economic risk assessments, no alerts about the many weaknesses in Monash economic modelling, understated dioxin hazards and so on. The RPDC process that would have alerted the company to such concerns was truncated, leaving Gunns’ whole company at risk.

Independent experts identified the risks when the IIS first appeared, but the project carried on regardless.

Perhaps Gunns will bring their advisors to account in a new legal action.

Watch this space.

Mike Bolan
http://www.abetteraustralia.com

Mike
is a complex systems consultant, change facilitator and executive/management coach.

References
    a.  http://tasmaniantimes.com/index.php?/weblog/article/dont-miss-follow-in-peter-cundalls-footsteps/
1. http://tasmaniantimes.com/index.php?/weblog/article/mill-doing-the-sums/
2. http://tasmaniantimes.com/index.php?/weblog/article/the-death-of-mis/
3. http://www.100percentinvesting.com.au/tax_effective/gunns/gunns_woodlot_project_2008.htm
4. http://tasmaniantimes.com/index.php?/weblog/article/a-tale-of-temma/
5. http://www.news.com.au/mercury/story/0,22884,24291746-3462,00.html
6. http://www.abc.net.au/news/stories/2008/09/10/2360325.htm
7. http://www.daff.gov.au/forestry
8. http://en.wikipedia.org/wiki/Regulatory_capture

Note. The author welcomes constructive criticism, corrections and new information that adds to our understanding of these matters.

Mike Bolan

  Whether Gunns can prevail in today’s financial climate and whether Kevin Rudd can, or will, act to protect taxpayers, contractors and investors from dubious federal schemes, remains to be seen. At every step, pulp novices Gunns have been spurred on by knowledgeable consultants that convinced Gunns to bet the company on a project that was too big, too risky and too expensive.  Did they honestly report the risks to Gunns?  The IIS contained no economic risk assessments, no alerts about the many weaknesses in Monash economic modelling, understated dioxin hazards and so on. The RPDC process that would have alerted the company to such concerns was truncated, leaving Gunns’ whole company at risk. Independent experts identified the risks when the IIS first appeared, but the project carried on regardless. Perhaps Gunns will bring their advisors to account in a new legal action.