Dodging the drought

Perhaps one of the greatest risks to an agribusiness project in the future will be the investors themselves.

To be exact, the risk will be from them and the rest of the human race adding to the climate change problems now occurring around the world.

Australia, a dry country at the best of times, is experiencing drought in the southern states, while in the north there is record rainfall.

As agribusiness managed investment schemes are dotted around the country, the impact on returns depends on where the crop is being grown.

Some schemes are finding it tough in the south due to water restrictions and drought, while in the north flooding is a greater problem than lack of water.

However, agribusiness managers throughout the country are now looking hard at how they handle the water component of managing the investment.

Adviser Edge Investment Research senior investment analyst Marc Soccio said as a research house it was looking at climate change and the broader implications for projects.

“It is too early to be making calls on climate change and rainfall problems,” he said.

“But we do need to be looking at the broader picture when looking at a project, and the risks need to be taken into account.”

Soccio said the importance of water management for projects was coming to the fore and critical for the long-term success of any scheme.

“We are looking at water irrigation against the water allocation for a scheme and, as we have seen with the Murray River, allocations have been cut back,’ he said.

“We have been looking at allocation figures for Victoria, New South Wales and South Australia.”

While Victoria has cut some water allocations in certain areas, New South Wales growers have been allocated water in excess of their entitlements and can carry over unused amounts into following years.

“There are issues of over-allocating reserves and underpricing,” Soccio said.

“The issue is if people don’t change their water use then the problems get worse.”

According to Rural FundsManagement (RFM) managing director David Bryant, the drought has forced the company to dramatically change its investment strategies.

“RFM’s approach therefore is to plan for the drought to end, but not before the rivers dry up and severe economic losses are sustained by those who are unprepared,” he said.

“While it is good to hope that we are wrong, it is prudent to plan for being right.”

Bryant said the current drought started in 2002 and as a result the fund manager decided not to expand its cotton investment because of its dependence on river water supplies, which were not guaranteed.

This has seen a switch to crops that need less water, such as almonds.

“We have moved to redirect highly reliable bore water from the production of cotton, using inefficient flood irrigation, to potentially high-yielding almond orchards using efficient drip irrigation,” he said.

The manager has also moved into agribusiness sectors that use more reliable water supplies other than rivers.

These sectors include chicken farms, vineyards and cut flowers operations.

“The reason is these types of businesses, while paying more per mega litre of water consumed, produce greater economic output from a continuity of supply,” Bryant said.

SAITeysMcMahon (SAI) head of capital transactions Stephen Lynch said it was impossible to drought-proof a property, but it was possible to implement policies for wiser water use.

“The difficulty at present is a lot of people are talking about drought-proofing when the answer is how we use the water we have.”

Lynch said the issue facing project managers is drought management, not drought-proofing.

“We have been managing our water allocations and we include a dam on every new development,” he said.

“That doesn’t change water use, but it does help the authorities to manage the river water resources better.”

Lynch said SAI had drawn up a list of good water use practice to make more efficient use of existing water supplies.

“We are looking at how we can manage the crops with low water supplies next year,” he said.

“We are looking at what projects to crop and which to just grow the trees to allow their long-term survival.”

SAI has almond and citrus orchards as well as vineyard and table grape properties, which are offered in the Primary Infrastructure Fund.

“It is about optimising production rather than just producing a crop,” Lynch said.

“Of course, this does affect the return to investors in the short-term, but agriculture is cyclic. It is a supply and demand story.”

Blaxland Vineyards director Ron Collins agreed, saying a drop in grape supply this year will avoid the wine lake that has developed in the past few years.

But the real problem in the future is making sure the vines survive with a lack of water.

“The good thing is vines are from the Mediterranean region originally, so they have some resistance to low rainfall,” Collins said.

“But we have to work on the problem that we may not get any water this winter and what will happen to the vines.”

Blaxland has planted a trial block of vines in South Australia and Langhorne Creek that are not being irrigated to see what happens.

“Our policy is to keep the vine intact to preserve the asset,” he said.

“We will take the knowledge we gain from the trial block to see what we have to do to keep the vines alive.”

The manager has built large dams on the vineyard projects and has imported a Canadian product that puts a film over the water to stop evaporation.

“We are expecting to see up to 40 per cent saving in water due to the lack of evaporation,” Collins said.

This will prove to be very useful in South Australia, where water allocations have been cut by 40 per cent this year, and he admitted that if there is no significant rainfall this could fall dramatically in future years.

For investors, this will mean falls in returns, but the lack of grapes in the marketplace will mean higher prices to compensate for the reduced crop.

“We have seen grape prices rise 20 per cent this year, but 2008 is looking to be a difficult year for the wine industry,” Collins said.

The lack of production from the project also has its upside. As recently seen with grapes, over-production forces prices down, but producing less has the reverse effect.

“These are opportunistic returns, but investors should be looking at agribusiness schemes on a long-term basis,” Lynch said.

“The investor needs to look 10 to 15 years, not just short-term this year.”

He said some of the work being done now on water management will deliver returns in future years.

Also, SAI has diversified the fund out of relying on pure horticultural crops, which inevitably have more demanding water use.

Lynch said the fund also invests in the infrastructure of the farms.

“This has provided off-farm, non-horticultural assets such as the infrastructure with water management,” he said.

A new player to the managed investment scheme market is Maccacorp, which is planning to grow macadamia nuts at Bundaberg in Queensland.

The macadamia tree is native to Australia and those grown in New South Wales do not need irrigation, according to Maccacorp managing director Don Ross.

“However, in Queensland we do irrigate them, although Bundaberg is not in a drought area,” he said.

“We do have water licences and because the trees are being grown on former sugar cane land, we have twice the water allocation that we actually need.”

Maccacorp also has the right to draw water from the local river, and Ross admitted the company is well aware of efficient water use despite the abundance on the property.

“We want to be a very efficient water user so we have a supply when the trees need it,” he said.

RFM has also joined the list of agribusiness managers that have diversified into the northern half of Australia by investing in sugar production.

The basis of this decision is the amount the manager earns from the product compared to the water used.

According to RFM, one bale of cotton generates $400 per megalitre of water used. The same amount of water produces $12,000 revenue from a grape investment, $46,000 from farming chickens and $600,000 from cut flower production.

Another high earning sector is cattle feedlots, which generate $53,000 per megalitre of water used, according to Mort & Co commercial manager James Maclean.

“One megalitre of water will support 133 cattle a year and each beast will generate 26,000 kilograms of beef,” he said.

“It is achieving effective water use when compared to some cropping projects.”

Mort is building a feedlot in south-east Queensland and while water is important, other factors also play a part in site selection, Maclean said.

“The proximity to grain and its price is very important, but as we rely on underground water on the property, surface water is not crucial,” he said.

“Rainfall is beneficial rather than essential for the cattle.”

The proximity to processing facilities for the cattle is another important factor and as many of the country’s abattoirs are in south-east Queensland, this was another reason for locating the Mort feedlot there.

The majority of agribusiness schemes are in tree projects, which come in a variety of species.

In simple terms, while some plantations in the southern half of the continent have suffered due to the drought, tropical forestry schemes in the north are awash with water.

The biggest problem these trees have is getting root rot because of the amount of water.

ITC general manager of managed investment schemes Eugene Quass said his company diversified the types of trees planted and the regions planted in to avoid suffering drought problems across all plantations.

“We have diversified the managed investment schemes offered across all regions of Australia — both north and south,” he said.

“It is the type of diversification the investment market expects when looking at mainstream assets classes.”

ITC acting general manager of forestry Carl Richardson said the diversification strategy was to 50 per cent of the schemes in gums and the rest into tropical trees such as sandalwood.

“We also undertake detailed weather modelling to look at the effects of climate change,” he said.

Apart from achieving consistent rainfall for the plantations in southern Australia, ITC is also ensuring the tropical timbers are on well-drained land to avoid flooding problems.

“We have done a lot of work during the last three years looking at sites and picking those with well-drained soil,” Richardson said.

“In the south, like at Esperance, we look at coastal regions that have consistent rainfall and tend to be less affected by drought.

“This means rainfall for us is not a problem, as we have done detailed site assessments before planting any trees.”

However, in a drought affected area such as the Green Triangle (Victoria/South Australian border has many gum and pine plantations), Quass said different soil conditions actually help trees survive the lack of rainfall.

“In the Green Triangle the soil is more clay, which stores the water to give growth during the summer,” he said.

The tree industry is also being welcomed in some areas, as it is helping overcome the problem of salinity in the soil.

“At Albany and Esperance we have gathered a lot of public support with planting trees to help deal with salinity problems in the area,” Richardson said.

“In the last five years in that part of Western Australia, plantations in the catchment areas have seen a marked improvement in the water quality.”

Again, this is another step in water management as no agribusiness operator can use water with salinity problems.

In some areas of the north, there are similar problems.

In the Ord River irrigation area at Kununurra the water table has been rising for a number of years because of intense horticultural use. Tree planting has lowered the water table again.

Quass said the expansion of the irrigation area has seen defined areas put aside for tree plantations to ensure longevity of the region for agricultural use.

While rainfall is not a problem for tree plantations in the north, cyclones are a threat.

In recent years while the number of cyclones has diminished, those that do hit landfall have often been devastating.

Richardson said ITC put its plantations at least 50 kilometres inland, where cyclones lose some intensity.

Great Southern managing director John Young said at the company’s recent annual general meeting that the company had not incurred any material extra costs because of the drought.

“The company has a very responsible approach to the environment, and this extends across everything we do, including water management,” Young told shareholders.

“In recent years, northern Australia has become a particular focus for the company as this is one part of our nation with consistently high annual rainfalls.”

Great Southern has looked north in recent years, with a tropical forest scheme on Tiwi Island and a cattle project in the Northern Territory.

The company is also launching a high-value timber project as part of the geographical diversification for projects.

“Not surprisingly, one of the recurring questions for the company over the past year has been in relation to the impact of the drought on our operations,” Young said.

“There are several elements to this issue and the first, and perhaps most important, is geographic diversification.

“Having operations located in numerous regions around Australia reduces the impact of the drought, as we tend to find that while one area is experiencing dry conditions another will be continuing to receive rainfall.”

Young said the second factor in combating drought conditions was land selection.

“Our highly-experienced land acquisition team targets properties in areas with historic patterns of good rainfall,” he said.

“Finding land particularly for our chip wood plantation projects is a challenge, but one our team is well equipped to deal with, and a big positive for the company is our extensive land bank.”

Young said the third factor was crop selection, which involved matching crops to the location, taking into account climatic considerations.

Macquarie retail agribusiness division also spends a lot of time on site selection as the first step to ensuring there is good water supply, according to executive director Anthony Abraham.

“We start looking at the things that influence site selection long before we purchase the land,” he said.

“We know areas have good years and bad years, and that includes rainfall.”

Abraham said the economic productivity of the property is crucial to a successful project. That includes looking at the factors affecting the productivity both above and below the ground.

The modelling for the productivity of a site is based on actual results and not projected figures, he said.

“The actual results received include looking at rainfall and the impact of recent climate conditions.

“We are looking at running a 10-year project, so we need to get the full picture of cycles, which includes good and bad years although recently there have been more bad years.”

Abraham said the type of timber plantations Macquarie is involved in are more at the industrial end of the scale, with the end product going to pulpwood.

“The types of trees we plant are best suited for pulpwood, which is more suitable for the areas we select for plantations,” he said.

Good use of the water that is available again comes down to work before trees are planted.

Abraham said work starts with ripping up the compacted soil to allow water to get down to the tree’s roots when planted.

“If we didn’t rip up the soil the roots wouldn’t get any moisture, which has a knock-on effect on the productivity of the plantation,” he said.

A spin-off benefit from tree plantations is dealing with salinity in some areas.

Abraham said Macquarie is working with Greening Australia to plant trees along washed out gullies to rehabilitate the area and reduce salinity in the soil.

This has a benefit for the plantation manager and nearby farming community.

“It is about re-establishing the natural balance in the soils, which benefits everybody,” he said.

There have been suggestions by politicians that all agriculture move north, but Lynch dismissed this as a simplistic approach that won’t work.

“You cannot move all agribusiness north as some crops will not grow in the tropics,” he said.

“Just look at Katherine in the Northern Territory. You can grow citrus there for some of the year, but you can’t grow table grapes or almonds.

“You can’t just say it doesn’t work in the south so let’s move it north.”

Moving schemes around the country chasing water is not a solution, but managers will need to pay close attention to their water management.

Water budgets in schemes would come under pressure as the situation worsens, but money spent on storing water when there are excesses should be well spent for the lean years.

“Nothing will fall over with schemes provided they have got the water allocation ahead of the project,” Soccio said.

“The projects that will have problems are those that are leasing water.”

He said this option may not guarantee the water supply is there when the plant needs it and it makes project managers vulnerable in their budgeting.

“It is all about managing risk and making sure the water is there when needed,” Soccio said.

“Project managers must assess that risk and be continually reviewing the situation for changes.”

Bryant said the current drought has transformed RFM’s investment strategy, moving it from being a large user of unreliable water supplies, to a smaller and more efficient user of more reliable water rights.

“As a consequence of these changes, the company is able to manage its businesses through this most severe drought and position itself to manage profitable investments despite the forecast long-term reductions that may result from climate change.”