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
|
|
|
