Log Pricing in Victoria

Part 1: The Evolution of Pricing Systems
David Williams (bio)
Introduction

Log pricing systems in Victoria have developed considerably over more than 150 years, from a rudimentary licensing system providing unrestricted access to forest timbers for very little payment, to current market pricing involving competitive processes and mill door sales. A major development was the Royalty Equation System (RES) based on ‘equalisation’ principles to provide equity between sawmillers. It was introduced in 1950, and was resilient and long lasting being re-confirmed by the Government’s Timber Industry Strategy (TIS) in 1986. This Report on log pricing is presented in two parts. This Part 1 covers the evolution of the pricing systems, and Part 2 describes the complicated RES.

The Evolution of Pricing Systems

Initially the pricing of timber cut and removed from Crown forests was managed by a licensing system. Systems evolved over time to the stage where current systems involve market pricing including competitive processes and mill door sales (sales of delivered logs which including costs of harvesting and haulage). The evolution of pricing systems can be represented in four phases:

  1. Licence system – this entirely inadequate system applied from the mid-1800’s until 1892 in the case of red gum and applied to all logs by the early 1900’s.
  2. Royalty payments – royalty charges based on amount of timber cut and removed replaced the licensing system. Initially royalty was charged on the quantity of sawn timber and later it was based on log volume.
  3. Royalty Equation System – the RES was developed and implemented by the FCV and the Industry in 1950 to ‘equalise’ royalty payments by adjusting for differences in timber quality and the costs of putting timber on the market. This provided equity between sawmillers by removing the cost disadvantages associated with logs supplied from poorer quality and/or more distant forests.
  4. Market pricing - market pricing was a commitment by the Government in the Timber Industry Strategy in 1986 (TIS, 1986).

Licence System

A licence system was used to authorise the cutting and removal of timber from Crown forests from the mid-1800’s until it was replaced by a royalty system in 1892, in the case of red gum, and by the early 1900’s for all hardwood species. A licence to cut and remove timber was obtained by payment of the minimal fee to the local receiver of revenues. The licence was unrestricted and did not limit the amount of timber cut and removed.

The system had been applied in every British dependency but shortcomings were quickly apparent and it was replaced by more effective systems in other jurisdictions. Other jurisdictions, including other Australian States, replaced the licence system many years before action in Victoria established a regulated system for timber cutting and charging royalty for the actual quantity of timber cut and removed from the forest. The obvious shortcomings of the licence system included lack of control over the quantity of timber cut, excessive wastage with sometimes large quantities cut and left on the forest floor, a very poor financial return to the Crown, and a high level of illegal operations.

Various forestry inquiries and reviews identified the inappropriateness of the licence system and recommended replacement with more effective systems. One important review of Victoria’s State Forests was carried out by Mr B Ribbentrop, Conservator of Forests in India (Ribbentrop, 1896). Ribbentrop reported on the poor state of Victoria’s forests and observed the …

‘The present licence system, which permits a scramble for the forest produce so long as it can be found anywhere, is at the bottom of much of the disorder which exists.’

He also noted that ….
’The income from the forests is ridiculously small’.

Ribbentrop recommended replacing the licence system with an effective system for controlling timber harvesting and ensuring reasonable financial returns for the Crown.

The Government established a Royal Commission into State Forests and Timber Reserves in 1897, and it ran for four years. The Commission reported findings on forest royalties and royalty system in 1900 (Royal Commission, 1900). It noted the unsatisfactory licence system which it observed had resulted in gross over exploitation of forests, excessive timber wastage, high levels of illegal operations and produced very low revenue. It recommended application of royalty for timber removed and improved regulation of quantity of timber to be harvested.

Under the circumstances, one wonders why a widely recognised unsatisfactory system applied for such a long period in Victoria, when other jurisdictions had moved to more effective system many years previously. At the time Victoria experienced huge increase in population as immigrants came in search of their fortune with the gold rush. Mining was a booming enterprise and forest clearing to establish mines, and obtain timber for mining, placed great pressure on forests. Following the rush there was an urgent need to open the land for farming to provide for the increased population and many ex-miners were keen to try their hands at farming by investing earnings from successful mining. Reserving forests, or regulating the quantity of timber harvested, was a low priority. Forests were generally regarded as ‘forest wastelands of the Crown’ by the public and elected Parliamentarians in the second half of the nineteenth century. It was only after excessive exploitation resulting in extremely degraded forests that the need for improved conservancy and management of Crown forests was considered more seriously. There was the realisation that the costs of rehabilitating degraded forests would become a substantial liability for the Government. Along with this realisation was recognition that the totally unsatisfactory licence system was a contributor to the forest problem. However, replacing the licence system was also challenging as there was considerable opposition from licensees.

Royalty Payments

Payment of royalty based on the quantity of timber was unsuccessfully proposed to replace the licence system prior to the 1890’s. The merits of the proposal were apparent with an example of logs from the Barmah Forest. A miller from Echuca paid £31 for 1,600 logs under the licence system which would have attracted a royalty of £700 if cut just over the border in New South Wales (Royal Commission, 1900). This resulted in a royalty system replacing the licence system for red gum logs in 1892. Royalty was extended subsequently to some mining timbers and bridge, wharf and jetty timbers. A Royalty system finally replaced the licence system for all timbers in the early 1900’s. This resulted in increased revenue and improved regulation of the amount of timber cut and removed. Fig.1 shows the increase in royalty received from 1910-50. There was a substantial increase in royalty particularly from 1930 until 1950 when royalty increased 12 fold from £50,845 to £645,793.

royalties.jpg

Royalty on milling timber was initially charged on sawn timber as reported by millers. The approach, whilst an improvement on the licence system, still exhibited shortcomings. There was still wastage with trees cut and left in the forest and the volume of sawn timber, and therefore the amount of royalty paid, was nominated by the miller. The State Forest Department preferred a system based on charging royalty on log volume as measured in the forest or as logs were received at the mill. The Department unsuccessfully sought to introduce royalty based on log volume in 1917-18 (State Forests Department, 1918). There was considerable opposition from millers against the change as self-reporting the amount of royalty was favourable to the millers. Charging royalty on log volume was finally fully implemented by the FCV in late 1930’s.

A higher proportion of removals were for products other than milling timbers in the earlier period. Such other timbers included fine-grained timber for cabinet and joinery work; mining timbers; fencing timber; timbers for bridge, wharf and jetty use; sleepers; telegraph poles and fuel wood.

The Royalty Equation System

The Royalty Equation System (RES) was introduced in 1950 and remained in use for more than four decades. The aim of RES was to ‘equalise’ the cost of sawn timber to key nominated markets to ensure royalties were equitable to sawmillers. The total of the royalty and transport costs of selling base grade sawn timber on defined key markets was to be the same for operations accessible to that market. The RES was not a full residual stumpage price (log price at the stump). It did not appraise stumpage as a residual after all production costs had been subtracted.

The RES was designed for the circumstances of the time. The housing boom following World War II saw a huge increase in the demand for sawn timber, especially structural timber. This was also on the heels of the destruction of forests close to Melbourne by the 1939 bushfires. There was then an urgent need to open up more distant forests to meet the increased demand. The RES removed the cost disadvantages of establishing mills to be supplied from more distant forests by ‘equalising’ for differences in value of timber produced from different types of logs and costs of transporting logs from the forests to the mill and then getting the sawn timber to market. This facilitated the opening-up of forests in North East Victoria and Central and East Gippsland.

Originally the RES applied to hardwood logs (other than red gum) from forests that supplied the Melbourne timber market. It was subsequently extended to apply to hardwood logs from native forests in North East Victoria and Central and East Gippsland, red gum and softwood logs other than those from plantations in South West Victoria. In the latter case, royalties applying to softwood logs in South East South Australia applied.

The system remained unchanged for more than three decades with the exception of its extension to red gum and softwood sawlogs. Over time public policy expectations changed and economic rationality and environmental considerations became more important. This led to reviews and changes in 1984 (Forest Advisory Committee, 1983) and 1991 (DCFL, 1990; DCE, 1991a; DCE, 1991b). The 1984 changes involved updating the RES factors and did not change its’ structure. The latter review was an outflow the Government’s Timber Industry Strategy (TIS, 1986) which confirmed that RES would continue to be used with changes to ensure that market prices operated as much as possible and that inefficient sawmilling operations were not subsidised.

Under the RES pricing sawlogs involved two processes:

  • Setting the total sawlog royalty revenue from year to year, and
  • Setting the individual royalty rates using the RES.

The operation of the RES is separately described in Part 2 of the report on log pricing (Williams, 2020)
Market Pricing

Market pricing was committed to by the Government in the TIS in 1986 (TIS, 1986). Whilst TIS confirmed the continuation of the RES, it also committed a commercial approach to managing timber harvesting operations for plantation softwood and native hardwood. Initiatives included market pricing for logs, at least four per cent return on invested funds and introduction of commercial accounts for this publicly-owned resource.

The concept of market pricing and regarding forest produce as a commercial product was raised by the FCV in 1920 but was not introduced at that time. The FCV was keen that timber supply be regarded as a commercial operation. It regarded the term royalty as unfortunate as it considered this created a tendency for the charges for forest produce to be regarded as a tax. Many decades later the FCV’s early expression was initially partly implemented through changes announced in the TIS (TIS, 1986) and finally fully implemented with the establishment of Victorian Plantations (VPC) in 1993 and VicForests as State Owned Enterprises (SOE) in 2004.

RES ceased to be used for softwood logs with the establishment of the VPC in 1993. VPC introduced full market pricing through individual negotiations for established supply agreements and competitive market processes for new log supplies. Mill door sales were also introduced.

RES ceased for hardwood logs in favour of full market pricing with the establishment of VicForests in 2004 and its’ responsibility for the sale and supply of timber resources from public native forests. Full market pricing was applied for existing supply agreements and an auction system was introduced for sale on uncommitted resources. VicForests also introduced mill door sales.

Conclusion

There has been considerable evolution of the log pricing systems applied in Victoria over more than 150 years. The licence system was initially used for a lengthy period in the second half of the nineteenth century. It continued to be used despite recognition of shortcomings and adoption of improved systems in other jurisdictions. Introducing royalty for the quantity of timber cut and removed was successfully opposed by millers who benefitted from the licence system for some considerable time. However, the increasing awareness of the degraded forests resulting from unsustainable exploitation and wastage under the licence system eventually provided the impetus to introduce a more effective royalty system in the late 1890’s-early 1900’s.

Initially royalty was charged on sawn timber volume as reported by millers and hence there was under payment and wastage in the forest. Again introducing royalty based on log volume was a hard fought move as it was successfully opposed by millers for some time.

The RES was a significant step that was developed by FCV and the industry. It introduced equity between sawmillers by providing allowances for differences in quality of logs, costs of transporting logs to the mill and costs of getting sawn timber to market. It met the needs of the time by supporting the opening up of more distant forests to provide the sharply increased timber demand for the post-World War II housing boom. It was a resilient and long lasting system, being applied for more than four decades.

The initial step to market pricing was introduced under the Timber Industry Strategy in 1986 and was fully implemented for plantation softwood and native forest hardwood respectively with the establishment of VPC in 1993 and VicForests in 2004 as SOE’s. Both organisations also moved to mill door sales.

References

Royalty Equation System Review. Discussion Paper. Department of Conservation Forest and Lands, January 1990
The Royalty System for Pricing Sawlogs from Victorian State Forests, Department of Conservation and Environment, 1991a
Review of the Softwood Royalty Equation System. Description of the New System. Department of Conservation and Environment, 1991b
A Review of Royalty Systems to Price Wood from Victorian State Forests. Report to the Minister for Economic Development, Government of Victoria.Forests Advisory Committee, 1983
Report on the State Forests of Victoria. Ribbentrop, B 1896
Forest Royalties and the Royalty System. Royal Commission on State Forests and Timber Reserves. The Tenth Progress Report 1900
Report of State Forests Department for year ended 30th June 1918.
Timber Industry Strategy, 1986
Log Pricing in Victoria Part 2: The Royalty Equation System. Williams, David 2020