Meeting of the Hawke's Bay Regional Council

 

Previously Public Excluded

Late Items

 

Made public in accordance with the 19 December 2018 Regional Council’s confirmed meeting minutes where it is noted that Ngati Kahungunu and Kahutia Limited Partnership have given their agreement to making the 28 November 2018 Public Excluded Agenda and minutes available to the Public.

 

 

Date:                 Wednesday 28 November 2018

Time:                1.00pm

Venue:

Council Chamber

Hawke's Bay Regional Council

159 Dalton Street

NAPIER

 

Agenda

 

Item       Subject                                                                                                                  Page

 

Decision Items

16.       Kahutia – Ngati Kahungunu Iwi Incorporated Carbon Credit Proposal                        3

Previously Public Excluded 28 November 2018 Meeting Minutes                         39

 

 


HAWKE’S BAY REGIONAL COUNCIL

Wednesday 28 November 2018

Subject: Kahutia – Ngati Kahungunu Iwi Incorporated Carbon Credit Proposal

 

Purpose of Report

1.      This paper reports back to Council on the proposed agreement with Kahutia Limited Partnership (Kahutia LP) for a ten year loan of up to 100,000 of the Council’s carbon units (NZUs) and seeks a Council decision to proceed with a loan with conditions.

Staff Recommendations

2.      It is recommended that Council considers and discusses the options for the Council’s safe carbon portfolio and provide staff with direction on whether it would like to proceed with a loan to Kahutia LP of 100,000 NZUs or a lesser amount, or to undertake an RFP process for loans of some or all of the Council’s safe carbon portfolio, or a combination of both.

3.      It is not recommended that the Council either do nothing, as this will not assist with the Council’s strategic objective for accelerating afforestation within the region, nor sell its safe carbon portfolio at this time as the future value of the NZUs is likely to appreciate at a rate greater than equivalent funds invested in the Council’s managed funds portfolio.

Background

4.      On 3 October 2018 the Corporate and Strategic Committee resolved:

4.1.      endorses the Chief Executive negotiating a lease of New Zealand Units to Kahutia Limited consistent with the proposal as detailed

4.2.      requests that the Chief Executive provides a draft contract and appropriate legal and financial advice to Council on 24 October 2018 to enable consideration of a decision, as being recommended following, to approve a lease agreement with Kahutia Limited

4.3.      recommends that Council approves a lease of up to 100,000 New Zealand Units of the Council’s safe carbon portfolio to Kahutia Limited.

5.      The strategic context for this initiative is that the Council has identified. In its 2017-2021 Strategic Plan the Council stated it would “Incentivise afforestation of erosion-prone land” and set the following targets:

5.1       By 2030, all farms in critical source areas have phosphorus management plans being implemented, with at least 50% of highly erodible land treated with soil conservation plantings.

5.2       By 2050, all highly erodible land is under tree cover.

6.      On 25 July 2018 the Council resolved to sign a memorandum of understanding with Ngati Kahungunu Iwi Incorporated (NKII) for the Kahutia Accord with a stated intention of the Council and NKII to co-invest, both jointly and in aligned investment, in a programme of regional afforestation.

7.      This proposal to loan NZUs to Kahutia LP is consistent with the Council’s current strategic direction and is complementary to the Council’s current works with the Erosion Control Scheme and the Right Tree Right Place study underway. The proposal is also consistent with the stated intention of the Council in its MoU with NKII under the Kahutia Accord.

8.      The principal benefit of the proposal is that it utilises a current asset of Council to support further afforestation, while generating a modest return for Council, and does not require the permanent alienation of an asset which has an expected longer term valuation uplift.  As long as the contract contains appropriate safeguards, the risks to the Council are low and considered to be outweighed by the benefits.

9.      The Council’s current NZU portfolio consists of 105,640 ‘post-89’ NZUs and 14,907 ‘pre-1990’ NZUs. By 2033 the total gross NZUs accrued by the Council’s forests will peak at 275,094 NZUs, of which an estimated ~110,000 units is deemed to be ‘safe’ in that they do not have to retained or surrendered for future harvest liabilities. The exact quantum of future harvest liabilities will depend upon the timing of future harvests and future field-based carbon measurements. The looming harvest liabilities arising from the harvest of the Council’s forest at Tutira can be accommodated within the current and expected Council holdings of NZUs at the end of the 2023 Emissions Trading Scheme reporting period, even with 100,000 NZUs on loan to a third party or parties.

Proposed Loan Agreement

10.    Following the October meeting of the Corporate and Strategic Committee, Kahutia LP provided a revised contract, which is attached and while it requires finalising, the key elements are contained within.  This newer version differs substantially in two particular respects.  The original contract had been expressed as a lease but is now expressed as a loan.  This better reflects the fact that the NZUs to be returned to the Council are not the same NZUs as that initially provided but have equivalent surrender value.  This works in the same way a monetary loan will be repaid with equivalent cash but it may well be money acquired from another source.

11.    The second significant change to the terms of the loan is that interest is now repayable from the end of year one and it is no longer proposed that this be capitalised for the first four years.

12.    There has also been the introduction of an interest penalty to apply to non-performance by the borrower.  It is recommended that this be set at 5% per annum, not 2% expressed in the draft contract, and apply to both interest and principal payment due at the end of each year that is not repaid on time.  It is proposed that this interest be calculated on a daily basis pro rata to the total annual sum due.

13.    As previously advised the Council has been invited by the directors of Kahutia LP to co-invest in the company up to, and including, as a 50% joint venture shareholder. If the Council was to take up this option at a 50% shareholding the company would be deemed to be a Council Controlled Organisation and a decision to invest would require a special consultation under the Local Government Act. Any decision to invest substantial capital into the company may also trigger the significance policy and necessitate special consultation as well. It is proposed that the question of whether to invest in Kahutia LP be considered in 2019 once the ‘Right Tree Right Place’ forestry investment case has been completed.

Legal Advice

14.    The draft loan contract has been reviewed by Sainsbury Logan and Williams (SLW) on the Council’s behalf.  This legal advice is attached.

15.    SLW note that while the contract expresses an intent that Kahungunu Asset Holding Company (KAHC) provide security for the loan, we do not have a confirmation of this directly from KAHC at this time.  Representatives from NKII attending the Council meeting may be able to confirm that this security has been formally agreed by the board of KAHC.  It is recommended that any agreement to loan NZUs to Kahutia LP be done so on the condition that KAHC become a party to the loan agreement and expressly guarantee the necessary security to the satisfaction of the Council’s solicitor.

16.    SLW recommended that Council seek comfort from Kahutia LP on the afforestation plans to ensure the level of carbon intended to be sequestered will be sufficient to meet the obligations under the loan agreement.  Discussions with Kahutia LP have indicated that the company has expressions of interest and a desire to afforest 1600 hectares of land within the region.  Representatives from NKII attending the Council meeting will give a presentation to Council on the land that is intended for afforestation and the mix of intended species and area to be planted.  It is recommended that the contract require Kahutia LP to report annually to Council on its achievements in terms of forest area and species planted, forest establishment success and volumes of carbon sequestered.

Financial Advice

17.    The primary cost to the Council from this proposal is the administration and oversight of the contract with Kahutia LP.  The cost of transferring NZUs between the Council and Kahutia LP on the NZTES Registry is minor.  The principal costs related to NZU registration arise from registering new land for NZUs and the costs in this situation have already been borne by the Council with respect to its own forests and the cost of registering units against land planted by Kahutia LP will be funded by the borrower.

18.    The value of the NZUs in question presently reside on the Council’s balance sheet as assets and this will remain the case as the loan to Kahutia LP will also be an asset, albeit a non-current one until the loan is repaid.

19.    The loan agreement proposes that a 2% per annum interest rate applies to the loan balance.  A repayment schedule has not been finally negotiated with Kahutia but if this is set at interest only for the first four years and then 16% per annum repayment of the principal thereafter then interest income to the Council would be 2000 NZUs at a current market value of approximately $50,000 at the end of year one.  In year ten, the interest payable would be 400 NZUs with a value of $5000. Over the life of the loan, under this repayment schedule, the total NZUs payable as interest would be 14,982 with a current market value of approximately $375,000. Given the forward price path for NZUs it can be expected that expected returns will actually be higher.

20.    The Council presently holds insurance cover on its forestry estate but this cover does not extend to the NZUs attributed to them.  In the event of material fire, wind or pest damage the Council is liable for surrendering NZUs to the extent of the damage. As the Council’s forests are geographically spread and have a mix of species the portfolio provides a natural hedge against this risk and enables the Council to self-insure.  If the Council is loan its NZUs to Kahutia LP or any other party staff recommend insurance is obtained to ensure any liabilities arising from material damage to the Council’s forests can be covered while the NZUs are effectively on loan to other parties.

21.    Staff have obtained a quotation for cover from its current insurer for the Council’s full NZU portfolio, which has a current market value of approximately $3m, with an annual premium payable of $3,753 ex GST.  The Council’s Chief Executive has determined that this cover should be obtained - regardless of the whether NZUs are leased or not - as the value of NZUs is now at a level that the Council’s overall portfolio is a valuable asset and warrants protection, and represents a liability to the Council in the event of material damage.

Options

22.    As alternatives to the proposal from Kahutia LP, the Council could proceed with any of the following instead.

23.    Do nothing – this would involve the Council retaining all of its NZUs at this time.  The Council would continue to benefit from the expected increased value of these assets (although this is not guaranteed) but would receive no income from them until such time as the Council decides to sell.  This option would not result in any additional trees being established as a result of the Council’s NZU portfolio.

24.    Sell the safe carbon NZUs – the Council could sell all or some of its current safe carbon portfolio for up to $2.6-2.8m and direct these funds toward Council operations, such as supplementary funding for the Erosion Control Scheme, or set aside the funds for future commercial forestry investment, or add the funds to the Council’s managed funds portfolio for financial returns.  Under this option the Council could ensure additional tree planting occurs within the region but this is unlikely to be practicable for the 2019 planting year and would not leverage the work already undertaken with landowners by Kahutia LP.  If the Council was to use the realised funds for the Erosion Control Scheme they would cease to be a balance sheet asset for the Council as this is a grant-based scheme.

25.    Call for a Request for Proposals (RFP) – the Council could undertake an RFP process to determine whether there are other parties who wish to borrow some or all of the Council’s safe carbon portfolio.  In the same way that Kahutia LP have approached this opportunity other parties may wish to borrow NZUs from the Council in order to fund afforestation activity and use their future carbon allocations to repay the loan and any interest.  Council could run a competitive process and seek to maximize the level of afforestation achieved for the allocation or seek higher interest/returns on the loan. Kahutia LP could submit their proposal into this process.  The benefit of this approach is that the Council may achieve a better rate of return or greater levels of afforestation than proposed by Kahutia LP.  However, to date the Council has not received any expressions of interest from other parties for the use of its carbon portfolio.  Furthermore, in signing the Kahutia Accord the Council has expressed an intention to work collaboratively with Ngati Kahungnunu Iwi Incorporated, as the regional iwi authority, to undertake afforestation activities and choosing other parties over Kahutia LP may be seen as a breach of the good faith provisions the Council sought for inclusion with the Kahutia Accord.

26.    Undertake a combined RFP and loan to Kahutia LP – the Council could run a RFP for part of the safe carbon portfolio (for example 50% or 50,000 NZUs) and loan the remainder to Kahutia LP under the current proposed terms or similar. Kahutia LP could also compete within the RFP process for the other half of the portfolio.  This approach may balance the risks and benefits of the approach outlined above.

Implications for Tangata Whenua

27.    A loan of this nature to Kahutia Limited Partnership is an avenue for the Council to exercise partnership with regional iwi and assist in the development of afforestation on erosion prone Maori land. The Kahutia LP is owned by Ngati Kahungunu Iwi Incorporated, which has 31,241 members, and so working in partnership with Kahutia LP gives the Council the maximum indirect partnership with regional tangata whenua. However, it should be noted that Treaty Settlement Entities within the region may also wish to enter into similar arrangements with the Council and maybe critical if the loan is made exclusively with Ngati Kahungunu Iwi Incorporated via Kahutia LP and an RFP process is not followed.

Decision Making Process

28.    Staff have assessed the requirements of the Local Government Act 2002 in relation to this item and have concluded that the decisions sought in this paper are not significant in terms of the Council’s Significance and Engagement Policy.  This assessment is based on the fact that the level of community interest and the impact on individuals or groups is likely to considered low.  The proposal does not impact upon levels of service, rates or debts in the current Long Term Plan, and the costs and financial implications for ratepayers are minor. The Council’s carbon portfolio is not a strategic asset.

Recommendation

That Hawke’s Bay Regional Council:

1.      Receives and notes the “Kahutia – Ngati Kahungunu Iwi Incorporated Carbon Credit Proposal” staff report.

2.      Authorises the Chief Executive to finalise the terms of a loan to Kahutia Limited Partnership for a ten year loan of XXX,000 NZUs consistent with the other terms in the attached draft contract and within this paper, and including an appropriate repayment schedule.

3.      Agrees that the loan only be authorised subject to Kahungunu Asset Holding Company becoming a party to the loan agreement and providing security for the loan to the satisfaction of the Council’s solicitor.

And/or

4.      Directs staff to undertake a Request for Proposals for loans of NZUs from the Council’s carbon portfolio for XXX,000 NZUs.

 

Authored & Approved by:

James Palmer

Chief Executive

 

 

Attachment/s

1

HBRC and Kahutia LP Carbon Loan Agreement

 

 

2

Memo from Jonathan Norman re Kahutia

 

 

3

List of Titles owned by Kahungunu Asset Holding Co

 

 

4

Previously Public Excluded 28 November 2018 Meeting Minutes

 

 

  


HBRC and Kahutia LP Carbon Loan Agreement

Attachment 1

 























Memo from Jonathan Norman re Kahutia

Attachment 2

 






List of Titles owned by Kahungunu Asset Holding Co

Attachment 3

 


Previously Public Excluded 28 November 2018 Meeting Minutes

Attachment 4