IAS 41, IFRS 13 disclosures biological assets, risks, forestry

Stora Enso Oyj – Annual report – 31 December 2019

Industry: agriculture

Note 2 Critical accounting estimates and judgements
Biological assets
The Group has biological assets in subsidiaries, joint operations and equity accounted investment companies. Biological assets, in the form of standing trees, are accounted for under IAS 41, which requires that the assets are measured at fair value less the costs to sell. Fair value is determined using discounted cash flows from continuous operations based on sustainable forest management plans taking into account the growth potential of one cycle. These discounted cash flows require estimates of growth, harvest, sales price and costs, discount rate, and changes in these premises are included in the consolidated income statement, for directly owned interests and for joint operations, on the line for Change in Net Value of Biological assets. For those assets shown in the Consolidated statement of financial position of equity accounted investments, changes are included on the line for Share of results of equity accounted investments. In determining the value of biological assets the management of subsidiaries, joint operation companies and equity accounted investments need to make appropriate estimates of future price levels and trends for sales and costs, and to undertake regular surveys of the forest to establish the volumes of wood available for cutting and their current growth rates. See Note 12 Biological assets for more detailed information.

Note 12 Biological assets
Accounting principles
The biological assets of Stora Enso consist of standing trees to be used as raw material in pulp and mechanical wood production and as biofuels.

IAS 41 Agriculture standard requires that biological assets are shown in the Consolidated Statement of financial position at fair value. Group forests are thus accounted for at level 3 of fair value less the estimated point-of-sale costs at harvest, there being a presumption that fair values can be measured for these assets.

The valuation of forest assets is based on discounted cash flow models whereby the fair value of the biological assets is calculated using cash flows from continuous operations, that is, based on sustainable forest management plans taking into account growth potential. The yearly harvest from the forecasted tree growth is multiplied by wood prices and the cost of silviculture and harvesting is then deducted. The fair value of the biological assets are measured as the present value of the harvest from one growth cycle based on the productive forestland, taking into consideration environmental restrictions and other reservations. Young standing timber less than two years old (less than three years in Montes del Plata) is considered to be an immature asset and is accounted at cost. At harvesting, biological assets are transferred to the inventory.

Fair value is deemed to approximate the cost when little biological transformation has taken place or the impact of the transformation on the price is not expected to be material, which varies according to the location and species of the assets.

Stora Enso also ensures that the Group’s share of the valuation of forest holdings in equity accounted investments and joint operations are consistent with Group accounting policies.

The Group has biological assets in its own subsidiaries in Sweden, China and Laos, as well as in joint operations in Brazil and Uruguay and in equity accounted investments in Finland and Brazil.

The value of biological assets disclosed in the group Consolidated statement of financial position from subsidiary companies and from joint operations amounts to EUR 3 627 (EUR 457) million as shown below. The Group’s indirect share of biological assets held by equity accounted investments amounts to EUR 753 (EUR 2 871) million.

Biological assets

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1 Items are recorded in the profit and loss lines.
2 The impact in 2019 was mainly due to fair valuation increase of Swedish forests, which was mostly driven by lower discount rates.
3 Assets mainly acquired through Bergvik Skog AB restructuring in 2019.

Valuation and standing stock of forest assets in main subsidiaries, joint operations and equity accounted investment

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1 forest cubic metres
2 solid under bark cubic metres
3 Swedish forests harvesting volume is annualised based on June-December outcome. Estimated Growth is a full year estimate.
4 Total figures exclude minor forest ownerships in Laos and equity accounted investment Arauco Florestal Arapoti S.A. in Brazil
5 Biological asset fair value, excluding land values. The corresponding forest land value was EUR 548 million at end 2019.
6 Non-productive natural forest area is not included to Veracel’s total area standing stock

Subsidiaries and joint operations:
On 31 May 2019, Bergvik Väst AB, a subsidiary of Bergvik Skog AB, was distributed as dividend to the shareholders of Bergvik Skog AB. On the same date, the Group acquired an additional 20% of shares in Bergvik Väst AB from other shareholders, resulting in a total holding in Bergvik Väst AB of 69.8%. Simultaneously, Bergvik Väst AB was demerged and Stora Enso became the 100% owner of a new subsidiary holding around 69.8% of the former Bergvik Väst AB assets and liabilities. The acquisition date of the new Swedish forest was 31 May 2019. As a result of the transaction Stora Enso’s direct forest holdings in Sweden are 1 408 thousand hectares, of which 1 140 thousand hectares is productive forest land. Details on the Bergvik Skog AB restructuring are shown in Note 4 Acquisitions and disposals.

At 31 December 2019 biological assets were located by value, in Sweden 86% (0%), China 5% (36%), Brazil 2% (16%), Uruguay 6% (44%) and other areas less than 1% (4%). The land area comes to 1 732 (325) thousand hectares of which 7% (37%) is leased and under 1% (2%) is restricted. From Stora Enso’s total forest holdings 1 344 thousand hectares is productive forest land. The harvested wood amounted to 7 (4) million m3. These changes are mainly driven by the acquisition of Swedish forests. The Montes del Plata and Veracel amounts are taken into account in the ownership share and number of hectares.

At the end of 2019, the fair value of the biological assets in Swedish forests amounted to EUR 3 133 (EUR 0) million. The discount rate of 4.2% used in the discounted cash flows (DCF) is determined using the weighted average cost of capital method. The productive land in Swedish forests, totals 1 140 thousand hectares with a standing stock of 120.3 million m3 solid under bark (sub). The annual harvesting is on average 3.4 million m3 sub.

At the end of 2019, the fair value of the biological assets in Guangxi, China, amounted to EUR 181 (EUR 166) million. The biological assets included young standing timber with a value of EUR 34 (EUR 29) million. This increase is driven by higher sales prices and volumes. The discount rate of 8.9% (8.7%) used in the discounted cash flows (DCF) is determined using the weighted average cost of capital method increased slightly. The productive land in Guangxi, China, totals 76 (77) thousand hectares with a standing stock of 3.1 (6.4) million m3 solid under bark (sub). The annual harvesting is on average 1.0 (1.1) million m3 sub.

Veracel Celulose S.A. (Veracel), a 50% joint operation company in Brazil, had biological assets fair valued at EUR 172 (EUR 150) million, of which Stora Enso’s share was EUR 86 (EUR 75) million. This increase is driven by higher sales prices and volumes. The biological assets included young standing timber with a value of EUR 33 (EUR 33) million. The discount rate of 9.0% (8.3%) used in the DCF is determined using the weighted average cost of capital method. Stora Enso’s share (50%) of the land area is 112 (113) thousand hectares.

Stora Enso’s 50% share of the productive land in Veracel, Brazil totals 50 (44) thousand hectares with a share of standing stock of 3.1 (2.9) million m3 sub. The ownership share of annual harvesting is on average 0.9 (1.7) million m3 sub.

Montes del Plata (MdP), a 50% joint operation company in Uruguay, had biological assets with a fair value of EUR 445 (EUR 398) million, of which Stora Enso’s share was EUR 222 (EUR 199) million. The biological assets included young standing timber with a value of EUR 55 (EUR 55) million. The discount rate of 8.0% (8.0%) used in the DCF is determined using the weighted average cost of capital method. Stora Enso’s share (50%) of the land area is 131 (126) thousand hectares.

Stora Enso’s 50% share of the productive land in Montes del Plata, Uruguay totals 86 (81) thousand hectares with a share of standing stock of 8.2 (8.1) million m3 sub. The ownership share of annual harvesting is on average 1.4 (1.4) million m3 sub.

Equity accounted investments:
The Group has two equity accounted investments holding biological assets:
• Tornator Oyj (Tornator), a 41% owned Finnish associated company, had biological assets with a fair value of EUR 1 805 (EUR 1 451) million, of which Stora Enso’s share was EUR 740 (EUR 595) million. The increase in fair value is mainly due to increased harvesting volume and long term sales prices. Growing costs had a slight reducing impact on the fair value. Stora Enso’s 41% share of the productive forest land in Tornator totals 262 (223) thousand hectares with a share of standing stock of 25.1 (24.6) million m3 sub. The ownership share of annual harvesting is on average 1.0 (1.2) million m3 sub.
• Arauco Florestal Arapoti S.A., the 20% owned Southern Brazilian associated company, had biological assets with a fair value of EUR 67 (EUR 73) million, of which Stora Enso’s share was EUR 14 (EUR 14) million.
• The Group owns 49.79% of shares in Bergvik Skog AB which continue to be reported as an equity accounted investment, but there are no biological assets to be reported anymore at the end of 2019.

Sensitivities of significant assumptions of a +/- 10% movement

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Risks and risk management (extracts)
Compliance risks (extract)
Forest and land use
Wood is our most important raw material. Failure to meet stakeholder expectations or to ensure the chain of custody and economically, socially and environmentally sustainable forest and land management practices throughout our wood procurement and plantation operations could also result in significant reputational and financial loss to Stora Enso. Furthermore, global challenges such as population growth, global warming, increasing demand for agricultural land and bioenergy, and the widening gap between the supply and demand for wood, all require us to use natural resources even more efficiently. See also Global warming – physical impacts, Regulatory changes and Community relations and social responsibility.

Policy principles and mitigation measures
Our Policy for Wood and Fiber Sourcing, and Land Management, robust traceability systems and our active promotion of forest certification all help to ensure that no wood or fibre from unacceptable sources enters our supply chain. In addition, when sourcing logging residues and other forest biomass for energy use, we follow the specific guidelines developed for the harvesting of forest energy, which include strict environmental considerations.

Related opportunities
As trees absorb carbon dioxide (CO2) from the atmosphere and – together with wood-based products – act as carbon sinks, wood from sustainably managed forests represents a carbon neutral, renewable alternative to many non-renewable materials. If forests and plantations are managed sustainably, new generations of trees will replace those that are logged, sequestering more CO2 from the atmosphere. Well-managed forests can make entire ecosystems more resilient to negative impacts, and benefit from positive ones.

Strategic risks (extract)
Global warming – physical impacts
Physical risks related to climate change are assessed based on stress scenario on long- term (25-30 years) basis. Changes in precipitation patterns, periods of drought, typhoons and severe frost periods in the subtropics could cause damage to operations and tree plantations. Increases in average temperatures could lead to changes in the tree species composition of forests. Drought periods together with high temperatures increase the risk of forest fires and insect outbreaks, potentially affecting forests and regional wood prices. Milder winters will impact harvesting and transport of wood in northern regions and the related costs. The increase in risk level vs 2018 is driven by higher ownership of forest assets in Sweden, as well as by increased understanding of risks due to the availability of recent scientific analysis. See also Competition and market demand and Sourcing.

Policy principles and mitigation measures
Physical risks are to great extent subject to risk transfer and thereby within the cover of our property and business interruption insurance programs. With regards to forest and plantation assets, making roughly 25% of the Group’s balance sheet, Stora Enso benefits from strong strategic resilience through geographical diversification within the asset portfolio. Moreover, risks related to insect damages such as bark beetle infestation in Nordic forest assets is limited by better inherent endurance of Nordic forest compared e.g to Central-European forests. Diligent plantation planning is ensured to avoid frost sensitive areas and non-controversial tree breeding and R&D programmes are applied to increase tolerance of extreme temperatures. Stora Enso maintains a diversity of forest types and structures and enforces diversification in wood sourcing. Wood harvesting in soft soils involves the implementation of best practices guidelines.

Related opportunities
• Nordic forests in Finland and Sweden benefit from increased heat summation and longer growing seasons, leading to acceleration in forest growth with direct positive impact on the value of own forest asset and indirect impact related to market wood availability and cost.

Compliance risks (extract)
Regulatory changes
The Group’s businesses may be affected by political or regulatory developments in any of the countries and jurisdictions in which the Group operates, including changes to fiscal, tax, environmental or other regulatory regimes. Potential impacts include higher costs and capital expenditure to meet new environmental requirements, expropriation of assets, imposition of royalties or other taxes targeted at our industry, and requirements for local ownership or beneficiation. In particular, the EU energy and carbon policies may impact the availability and price of wood fibre. Concerning the EU Emissions Trading Scheme (ETS) 4th trading period, carbon leakage will remain, but the allocation of free allowances is expected to decline. A stress scenario over the next ten years and with a carbon allowance price at 50 EUR/t, assuming the current proposal for the 4th ETS trading period, implies an annual financial impact below Group materiality threshold, even when factoring in increased costs from purchased electricity.

Increased demand for carbon neutral primary and secondary biomass fuels may increase energy costs. General opinion and political consensus to limit wood harvesting, arising from the view to further increase forests’ function as carbon sinks while ignoring the net-positive climate impact of forest products, could limit the availability of wood, increase costs and reduce investment opportunities. Additionally, political instability may result in civil unrest, nullification of existing agreements, harvesting permits or land leases. Unpredicted changes in forest certification schemes could limit the availability of certified raw materials.

Regulation as part of the EU’s Action Plan on sustainable finance brings new climate related obligations on both investors and corporates, in particular through the EU Taxonomy on sustainable activities and integration of ESG risks in investment processes. There is uncertainty as to how Stora Enso’s share will be classified as an investment object in light of this emerging regulation, but good management of financial climate and other sustainability related risks and opportunities, as well as disclosure thereof, will improve the likelihood of a favourable perception by the capital markets and thus the cost of capital.

Policy principles and mitigation measures
• Active monitoring of regulatory and political developments in the countries where the Group operates
• Participation in policy development mainly through industry associations and other partnership programmes

Related opportunities
• Regulatory changes involve market growth potential for sustainable products. Resource efficiency, the low-carbon circular economy and renewability are increasingly important sources of competitive advantage.

Operational risks (extract)
Community relations and social responsibility
Social risks may harm existing operations and the execution of investments, especially in growth markets. Failure to successfully manage relationships with local communities and non-governmental organisations (NGOs) could disrupt our operations and adversely affect the Group’s reputation. The Group operates in certain countries, where land and resource ownership rights remain unclear and where related disputes may arise.

Potential impacts include reputational impacts and negative media coverage, harm to communities and rights holders, disruption of operations, and loss of the licence to operate.

Policy principles and mitigation measures
Stora Enso strives to identify and minimise risks related to social issues in good time, in order to guide decision-making in its investment processes as well as in its ongoing operations. Tools such as sustainability risk assessment, human rights due diligence and Environmental and Social Impact Assessments (ESIA) help ensure that no unsustainable projects are initiated, and all related risks and opportunities are fully understood in all operations. These tools also enable project plans and operating practices to be adapted to suit local circumstances. Furthermore, dialogue with NGOs is a part of the Group’s stakeholder engagement. More information on community engagement is presented in Stora Enso’s Sustainability Report.

Related opportunities
• Ensuring that the communities around our operations thrive economically, socially, and environmentally is crucial for the success and sustainability of Stora Enso.
• Clear business benefits to Stora Enso through a strong focus on social responsibility, as customers, business partners, investors and potential employees become more and more attracted to socially responsible companies.