As Australia’s first carbon fund nears its initial close. The Ecosystem Marketplace looks at the deal and asks: How does it work and where are its customers. In short, where is the upside?
As Australia’s first carbon fund nears its initial close, the Ecosystem Marketplace looks at the deal and asks: How does it work and where are its customers. In short, where is the upside? An innovative Australian fund -billed as the country’s “first carbon fund”- looks set to achieve its first closing, possibly as early as late October 2004. The fund, known as The Australian Sustainable Investments Fund (ASIF), was set up by Australian fund manager, the James Fielding Group, in February and seeks to invest in the carbon sequestration potential of Australian forests. Already the fund appears to be attracting the attention of institutional investment groups seeking hedges to offset their increasing climate change exposure. According to James Fielding Infrastructure Manager, Michael O’Sullivan, the fund is on track for its target capitalisation of $AUS300 million which will be achieved “in a number of phases”. The initial closing will come on the back of an impressive first acquisition of forest assets spanning three Australian states. These forestry assets are specifically managed to produce core income streams from forestry-related activities and will seek to add value through other activities such as the generation of CO2 emissions offsets. ASIF has engaged Hancock Natural Resource Group Australia as the asset manager. In an information release to the Australian Stock Exchange (ASX), the James Fielding Group notes that ASIF will seek to enhance the core income streams provided by traditional forestry resources “by implementing sustainable value-added strategies such as timber sales of plantation forests, carbon credit sales, renewable energy incomes (e.g. wind farm rentals) and biodiversity and salinity credits”. ASIF’s first acquisition, known as the “Timbercorp portfolio”, involved the purchase of 20,500 hectares of mainly freehold land in South Australia, Victoria and West Australia for $AUS46.6 million. The portfolio includes around 15,800 hectares of managed forestry operations. ASIF assumed title to the carbon rights (Australia recently became one of the first countries in the world to pass legislation that allowed carbon rights to be created and separated from rights to land, trees, etc.) of the predominately plantation timber, but Timbercorp, the seller, continues to operate the forestry business under a leaseback arrangement which gives an attractive core return to ASIF investors. “Its an impressive initial investment for the Fund,” says O’Sullivan. Hancock Natural Resource Group Australia’s New Forests Program Director, David Brand, calls it “a great first deal” and “all upside” thanks to the combination of traditional forestry income and speculative return from additional environmental products. And Brand should know. He is considered by many to be one of Australia’s most knowledgeable carbon credit specialists, having been involved in putting together the New South Wales power generation carbon offset scheme, and serving on many of the government committees that have established the ground rules for carbon estimation, valuation, and marketing. Brand further argues that ASIF is set to become a critically important part of the investment universe in Australia. “We have had SRI funds that try to pick companies that do less damage to the environment, but nothing where we try to make the environment the actual profit center. It’s very exciting. By using strategies where you have the underlying, relatively safe, cash flow from timber or leasing land and try to build environmental credit streams as upside, people are going to become comfortable enough to start dipping their toe in the water and start trying to understand this area.” From the investment manager’s point of view, Mr O’Sullivan is more measured. “My personal view is that we are well positioned,” he says, “but there are views out there that would challenge that. The major risk with the carbon is that we have gone out and bought an asset for which the market never develops.” However O’Sullivan points out that his company has “priced the asset on the underlying forestry returns so if the carbon market never develops, investors will still receive competitive returns over the life of the Fund. We also have a contingency in place whereby if a market does not develop in a certain period of time we will take steps to wind up the Fund.” Although O’Sullivan and Brand are understandably excited by the possibilities of this fund, there are others with different views on the desirability of timber alone as an investment. They note that Australian export woodchip prices have been trending down over the long term and that plantation timber often competes in this market with State Forestry operations, which sell off timber from native forests at what, they contend, are often extremely low prices. Forest economist Dr Judy Clark of the Australian National University (ANU) Centre for Resource and Environmental Studies told Ecosystem Marketplace that forest investments marketed on the basis of taxation advantages have obscured the relationship between investment and return. In private forestry therefore, volatility could come from the possibility of changes to tax laws, the uncertain effects of long-standing and growing political ferment over the exploitation of native forests, particularly those characterised as “old growth”, and the existence of large State-run plantation reserves that are currently under-utilised. ASIF, say its proponents, is precisely designed to maintain some distance from these uncertainties. “The intention is to diversify the Fund’s ability to derive revenue not just from timber or forestry related activities,” explains O’Sullivan. “The pricing of the environmental externalities if you like is what we are trying to extract some value from.” In other words, O’Sullivan and his colleagues believe it is the environmental products and services, such as the carbon credits, that give this deal its underlying interest. Hancock’s Brand concurs. He says that with ASIF, “you go beyond a straight timberland investment and start to develop a ‘Made in Australia’ model where you take account of the fact that you have this very tax efficient money that can grow trees through Managed Investment Schemes sold to retail investors. Australia is therefore a low cost place to grow carbon in an international context and you have opportunities around rehabilitation of land to reduce dryland salinity on a commercial basis. There are numerous opportunities to create a different forestry investment model as compared to the models that we have in the US.” He adds that, overall, forestry and forest-linked investments can also help in “beefing up the private equity space” of large portfolios. Dr Clark, meanwhile, says that, with “myths and misunderstandings” around both forestry investments and emissions trading -and given that more science is needed on both- it made some sense to split the timber and the environmental externalities markets. A key variable in the ASIF equation then is the development of a viable national market in carbon at a time when the current Australian Federal government has made it clear that it does not intend to ratify the Kyoto Protocol of the UN Framework Convention on Climate Change. (For more on this, see Brown story) Despite the fact that Australia -depending, to some extent, on the outcome of the October 9, 2004 election- may or may not ratify the Kyoto Protocol, most observers expect that the country will significantly add to its one existing carbon-trading scheme (in New South Wales) over the next few years. The most optimistic even argue that, as a result, there will one day be a viable national carbon market in Australia with at least some degree of international compatibility. And, even if the Federal government does not implement some national carbon-trading scheme, Australia’s most populous States are considering a joint scheme that could easily become national in all but name if some of the smaller States sign up. One option under consideration is to bypass Canberra completely, and enter into some sort of agreement with the European Union, set to launch a Union-wide emissions trading system (ETS) in January of 2005. Although Fielding’s O’Sullivan acknowledges that “Australia is potentially lagging internationally in the development of markets in externalities”, and carbon trading in particular, he adds that ASIF will appear a very compelling proposition as Australia catches up. “I think these markets are an inevitability -given the level of participation of the other nations around the world- but I am not so sure it is going to be soon” he said. “But we are comfortable with where the [Australian] States are going. Victoria has commissioned a study on a trading scheme being brought in and [is looking at] how it would be constructed. The likelihood is that this would interface with the existing scheme in New South Wales. I think other States will follow.” But given all this uncertainty, who are ASIF first big investors? O’Sullivan would not give names but said “they are all major superannuation (pension) funds and large institutions”. There is also international interest, but not, as yet from overseas industrial concerns seeking to offset their carbon emissions. On carbon sinks, O’Sullivan explains, “we have been really restricting ourselves to Australia at this stage” although discussions have been held with some international organizations who are interested in offsetting emissions in Australia. O’Sullivan did say that James Fielding has “been in discussion with some major overseas institutions and they are at various stages in considering this. They are a bit further away from it than the local investors, but there is considerable interest in this particular product.” In part, he says, it has to do with Australia’s current approach to the Kyoto Protocol. “I guess,” explains O’Sullivan, “it [the lack of interest] is purely because there is no certainty with what is happening with Kyoto; there is no certainty how the NGACS – the New South Wales certificates – would be treated in international markets. There is no interest from that perspective at this point in time but certainly from the investment side, there is significant interest.” On the international side O’Sullivan says that being “as specific as I can be”, the interest was – not surprisingly – coming from Europe and North America. “I can tell you however, that they are insurance institutions and they are looking at it from the perspective that they have a potential increased exposure to global warming and that they are looking for a means by which they can hedge their insurance exposure.” Brand predicts that this kind of interest in hedging is likely to become an increasingly important factor in markets for environmental externalities such as carbon. By way of example he notes that “If you invest in a coal fired power plant and you invest partly in something like ASIF, as the price of carbon goes up your return from the power station goes down and your return from ASIF goes up, so it acts as a hedge.” And how does he know this is a growing trend? In responding to that question, Brand simply states that “People for the first time are actually talking about that [hedging] and a few years ago, they weren’t, so there is a shift that is happening.” Phil Dickie, a regular contributor to The Ecosystem Marketplace, is a freelance journalist based in Brisbane, Australia. Phil can be contacted through www.melaleucamedia.com.au
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