Executive summary

	The focus of our audit
	Timber is an important resource. It is a popular building material used in the construction of homes, furniture, and floorboards. The timber industry directly supports over 7,000 jobs in regional towns across NSW.
	Timber is a renewable resource, meaning if managed properly, forests will regrow. There are laws and regulations in place to help ensure our native forests are maintained.
	Forests NSW is a public trading enterprise within the NSW Department of Primary Industries. Its key role is to sustainably manage state forests and maintain timber supply.
	The timber industry has undergone many changes. Since 1997 around a third of state forest area in NSW has been converted to national parks or reserves. From 1999 onwards the Government also entered into wood supply agreements with industry for up to 20 years to provide certainty of supply and encourage long term investment.
	This reduction in capacity to supply timber and the long-term obligations to supply have led to concerns about whether there is enough timber to meet contractual commitments. In the Auditor-General’s report to Parliament (1999 volume two) we stated the period of greatest financial and operational risk was within the first eight years of the wood supply agreements. The agreements at that time had a clause allowing a reassessment of timber yield after eight years and a reduction in volume with no compensation being payable to sawmills.
	This audit aimed to assess whether Forests NSW manages the supply of hardwood to meet wood supply commitments and sustain our native forests. Specifically we wanted to find out whether Forests NSW: § knows how much native forest and plantation hardwood is available for harvesting, presently and in the future § has promised to sell more native forest and plantation hardwood than it can sustainably supply.
	This audit included all hardwood species and cypress pine. We also examined all hardwood timber products including sawlog and pulpwood. The audit did not review softwood plantations and associated supply obligations.
	Audit opinion
	We found that Forests NSW has adequate estimates of how much timber is available from native forests, now and into the future. It uses an industry accepted process to develop estimates, but more could be done to improve reliability. For instance, yield estimates for the South coast, Eden and Tumut are well overdue for review.
	We also found that Forests NSW should have sufficient timber to meet its wood supply commitments which are fixed for periods up to 2023 using both native and plantation hardwood. However, the cost and difficulty of harvesting and hauling this timber is likely to increase over time. This presents a significant challenge for Forests NSW to manage.
	Sawlog production over the last five years indicates that contractual commitments for sawlog products in some regions have not been met. This gap cannot be readily explained by information collected by Forests NSW. It argues that part of the gap is due to downturns in demand, and we have evidence to support this.
	Forests NSW have also advised that there have been some supply issues with lags in production. And in some cases, substitutions have been made with mill owners receiving smaller logs rather than the premium large sawlogs which is allowable under a number of the contracts.
	These issues indicate that Forests NSW faces difficulties managing supply especially for large, high quality sawlogs.
	This is due in part to the actions of Government in negotiating a new wood supply agreement for the north coast in 2003 and the loss of forest estate.
	In this new agreement, the Government waived its rights to reduce commitments without compensating industry for any loss. This removed Forests NSW’s ability to better manage supply risks by adjusting commitments. In addition, timber volumes were more or less maintained despite the loss of forest estate to national park and reserves.
	To meet wood supply commitments, the native forest managed by Forests NSW on the north coast is being cut faster than it is growing back. This is especially the case for the blackbutt species. This does not mean that the forest will not regrow but there will be a reduction in yield in the future.
	After the current agreements cease, Forests NSW plans to fill the shortfall on the north coast with plantation hardwood. However, we found it is currently sourcing significantly more from plantations than anticipated to meet its commitments, which may place this strategy at risk.
	Forests NSW continue to look for new sources of hardwood timber to meet existing commitments including private property and leasehold land. As timber haulage distances increase and yields decrease, the overall cost of production will rise. These additional costs will have to be borne by both Forest NSW and the industry.
	Given that native forest operations ran at loss of $14.4 million in 2007‑08, this raises concerns about how much worse this financial burden may get.
	Key audit findings
Chapter 1 What is the role of Forests NSW?	Forests NSW is a public trading enterprise within the NSW Department of Primary Industries. It manages 2.2 million hectares of native forest and 48,140 hectares of hardwood plantations. There are legally binding rules in place to help ensure harvesting practices protect wildlife habitat and sensitive flora, and limit erosion.
	Forests NSW’s key role is to sustainably manage state forests and maintain timber supply. In 2007-08 Forests NSW produced 872,000m^3 of sawlog and 612,000 tonnes of pulpwood from native forest and hardwood plantations.
	The National Forestry Policy 1992 established a framework for sustainable timber production. Between 1999 and 2001, three Regional Forest Agreements (RFAs) were signed between the Commonwealth and NSW Government for the coastal regions of NSW. These agreements outline the management of the State’s native forests for 20 years and require five-yearly reviews of yield estimates.
	Key changes in the industry over the last 10 years include : ▪ conversions of large areas of forest estate to national parks ▪ 20 year wood supply agreements with industry ▪ industry assistance packages to help customers develop their businesses or exit the industry ▪ increasing focus on value add products from lower quality timber and smaller logs.
Chapter 2 How much timber is available?	We found that Forests NSW has adequate estimates of how much timber is available from native forests. It uses an industry accepted process to develop estimates, but more could be done to improve reliability.
	Forests NSW has developed and implemented inventory procedures to estimate yield of high quality large sawlogs from native forests. It has produced yield estimates for three of its four regions, with estimates for western region still to be finalised. Forests NSW advises that it also has yield estimates for high quality small sawlogs, low quality sawlogs and pulpwood however it has not made these estimates public for all regions and products.
	In addition, reviews of yield estimates for the southern region, due in 2004 for Eden and 2006 for Tumut and the south coast, have not been completed. Yield estimates for hardwood plantations on the north coast also need to be reviewed to improve their reliability.
	Forests NSW appears to use an adequate number of sample plots to estimate the number, species and size of trees in the forest. Recent internal audits indicate that plot measurements are reasonable. However it needs to do more to ensure all plots are regularly remeasured to capture changes in the forest. It also needs to review the parameters it uses to adjust harvest areas for unknowns such as threatened species.
	Forests NSW does not routinely compare harvesting results to its yield estimates. It advises that this is because these cannot be used at an operational level given yield variability across harvest areas. However we consider these reviews necessary to test the validity of its estimates.
Chapter 3 Can commitments be met?	We found that Forests NSW should have sufficient timber to meet its wood supply commitments which are fixed for periods up to 2023 using both native and plantation hardwood. However, the cost and difficulty of harvesting and hauling this timber is likely to increase over time. This presents a significant challenge for Forests NSW to manage.
	Forests NSW has comprehensive information on its wood supply commitments, and it regularly monitors performance against allocations.
	Over the last five years, not all contractual commitments for sawlogs have been met, although the results vary by product and region. Forests NSW advise that the gap exists due to production lags and downturns in the industry, rather than insufficient timber resources. In some cases, demand has been met through the substitution of smaller logs instead of the premium large sawlogs which is allowable under a number of contracts.
	Forests NSW identifies risks which may affect its ability to supply hardwood, both at a corporate and regional level.
	It has strategies in place to address its key supply risks, but has had mixed success. It manages bushfires and salvages timber after major fires. However, it has not met its targets for sourcing timber from private properties.

	Recommendations
	To improve its knowledge of timber availability, we recommend that Forests NSW:
Recommendation 1	▪ by December 2010, upgrade its forestry management system for native forests to capture all harvesting results and other events which impact on yield (page 19)
Recommendation 2	▪ by September 2009, finalise its net area and strike rate modifier studies to improve the accuracy of its estimates (page 20)
Recommendation 3	▪ by June 2010, undertake and publicly report the results of: ▫ a review of yield estimates for native forests in Southern Region including Eden, South Coast and Tumut ▫ a review of yield estimates for hardwood plantations (page 24)
Recommendation 4	▪ by June 2010, publicly report the results of yield estimates for high quality large sawlogs, high quality small sawlogs, low quality logs and pulpwood for each region (page 24)
Recommendation 5	▪ compare harvest results against its yield estimates over five year periods as a means of testing the accuracy of estimates ▪ report the results annually starting June 2010 (page 25).
	To address business risks, we recommend that Forests NSW:
Recommendation 6	▪ investigate the reasons for not meeting its private property targets for hardwood timber and develop better ways of addressing these (page 42)
Recommendation 7	▪ investigate the potential for developing commercial markets for forest waste (page 44)
Recommendation 8	▪ simplify and improve timber pricing by introducing a new pricing system by December 2009 that: ▫ ensures log production costs are recovered ▫ is transparent (page 43).
Recommendation 9	We recommend that the Minister responsible for native forest operations include yield review requirements that allow for non-compensable reduction in allocation, in all future wood supply agreements (page 38).

Response from Forests NSW

I appreciate the opportunity to respond to your Performance Audit Report “Sustaining Native Forest Operations”.

I support your recommendations in principle and I believe their adoption will assist Forests NSW to continue to meet the NSW Government’s timber supply commitments, monitor performance against those commitments and to better manage its future commitments to the timber industry.

As you acknowledge, Forests NSW is a Government Trading Enterprise with a commercial focus that requires it to make a profit. Forests NSW is also a part of the Department of Primary Industries and is bound by Government policies. It has particular responsibilities and accountabilities to the NSW Government and the community, being the steward of a highly prized and sustainable natural resource and public asset. The Government and the community rightly demand that the highest environmental standards are applied in native forest harvesting. Forests NSW must also provide for a range of non-commercial activities like fire hazard reduction, maintenance of access roads and trails, threatened species protection, pest animal and weed control and recreational use.

From a public finance perspective, one of the advantages of a commercial forest is that ongoing land management costs including the non commercial activities mentioned above are largely met from timber revenue, not public funds. In fact, without revenue from timber sales, managing our 2 million hectares of State forests would cost the NSW taxpayers many tens of millions of dollars.

Your Report notes the cash loss attributed to Native Forest Operations Branch (NFOB) in 2007/08. While I acknowledge that NFOB has run at a loss it should be noted that the 2007/08 financial year was affected by reduced demand for timber products supplied to the housing sector across Australia but more particularly in New South Wales. It should also be noted that Forests NSW is managed as a consolidated business, ie Plantation Forest Operations Branch (PFOB) results are consolidated with NFOB and the entity as a whole has been profitable. Accordingly, Forests NSW has the ability to fund its operations into the future.

However, I accept that Forests NSW must also be seen to be working as efficiently as possible. Accordingly my management team and I have been working over the last year to develop a program that aims to achieve a cash-neutral or better financial outcome for NFOB within three years. It would then be the intention to move to a cash positive position in subsequent years. The program will address the issues of operational efficiency, overhead cost reduction and timber pricing that better reflects its market value.

I would also acknowledge your observation that the changing availability of preferred species will present challenges for Forests NSW and its customers to manage in terms of cost relative to demand and price for finished products.

I note your suggestions for further refinement of standing timber and yield estimates and wood flow projections. The actual volume and mix of timber harvested is governed by factors that cannot be fully anticipated in the long term modelling. However, we have put in place systems to improve yield estimates at the regional level for the coastal regions and can now focus on improving sampling and yield reconciliation at the operational scale. I am committed to achieving a satisfactory level of accuracy for public reporting purposes in this regard.

I note also your observation that over recent years the volume of logs to be supplied under Wood Supply Agreements in aggregate has either not been delivered or ordered. This is not unusual and is also a feature of Forests NSW PFOB business. There are various factors contributing to this variance such as contractor capacity and availability, weather conditions, customer and market demand and species preferences. Your suggestion that Forests NSW more systematically monitor the contribution of these various factors will be more closely examined and I believe such a system could be a valuable addition to our information base.

As to the future, I believe that the timber supply requirements of industry for the term of the present agreements and beyond will be able to be met for the following reasons:

- Projections on which the current wood supply agreements are based, as reflected in Forests NSW Ecologically Sustainable Forest Management (ESFM) plans, are holding up and yields continue to be at sustainable levels.

- Current harvesting levels of hardwood plantations are consistent with long term projections of yield and availability, despite annual harvesting rates varying up or down from the estimated levels shown in the ESFM Plans.

- Subject to favourable business case analyses, Forests NSW will aim to replant and regrow its plantations harvested during the current supply commitment period to meet future commitments.

- There has been a significant expansion of hardwood plantations on the north coast funded by private investment in recent years. These plantations are being grown for future sawlog production and will increasingly become available to supplement supplies from both public and private natural forests. These plantations were not envisaged at the time current commitments to industry were framed but will assist in making for a healthy and diverse timber industry into the future.

- In the last five years, using timber supplementation funds, Forests NSW has sourced almost 54,000 m³ of sawlogs through Timber Purchase Agreements with private landholders. Forests NSW has recently commenced a transformation of the current Private Property Timber Unit into a separate Business Unit which will have as its focus acquiring 30,000 m³ of sawlogs pa (as per the ESFM Plans) on a commercially viable basis.

I note that your recommendations will need to be considered by Government and implementation will require a degree of Government support. Subject to that consideration and the resolution of some prerequisite actions partly outside Forests NSW control, I believe the timelines you have suggested for the implementation of the recommendations are achievable.

Thank you and your staff for making a positive contribution to improving the sustainability of native forest operations in NSW.

(signed)

Sean Hooper

Acting Chief Executive

for Nick Roberts

Chief Executive

Dated: 17 April 2009