UK: Agricultural Bulletin - August 2006

Last Updated: 1 September 2006

Featured in this issue are developments in the bioenergy industry that could change the outlook for the arable sector. Another article discusses the best way to structure farming companies, especially if land has significant development value.

Biofuels Drive Confidence

With the harvest season upon us, there appears to be growing optimism in the arable sector. The main reason is the increasing interest in bioenergy and the effect this is having on crop values.

The high price of oil and Government incentives has stimulated a rash of new projects to exploit the opportunities available in the arable sector. This, together with other developments, could fundamentally change the dynamics of the UK combinable crop sector. However, this growing enthusiasm needs to be tempered with a dose of realism, as we shall see later.

The bioenergy market can be roughly divided into two categories. The first is where biomass (plant material/energy crops) is combusted to produce electricity or combined heat and power (CHP). There have been some problems with getting this sector up and running, as highlighted by the failure of the ARBRE plant at Selby back in 2002. However, progress is now being made. The Renewables Obligation Order 2006 has led electricity generation companies towards co-firing coal power stations with a proportion of energy crops, such as short-rotation coppice or miscanthus. In time, more biomass power stations are likely to be developed.

There is also interest in small-scale generators, perhaps even at farm or estate level, to reduce energy costs and to save/avoid having to transport the bulky biomass over long distances. However, many growers remain wary of these energy crops because they are unfamiliar, have a limited number of buyers, and require a longterm commitment of land. This is perhaps why biofuels, the second category of bioenergy, has tended to be the focus of farmer interest to date.

Biofuels are produced from biomass and used as liquid fuel replacements for diesel and petrol in vehicles. The Government has targeted this sector with the introduction of the Renewable Transport Fuel Obligation (ReTFO). This requires that by 2010, 5% of all forecourt road transport fuel must come from renewable sources. There are two main types of biofuel that can act as replacements for petrol and diesel: biodiesel, which comes from vegetable oils such as oilseed rape (OSR), and bioethanol, which comes from starch-based products such as wheat or sugarbeet.

The ReTFO has spurred a flurry of activity in setting up production facilities for biofuels, with the following being some of the largest developments planned or already underway.

Biodiesel projects

Biofuels Corporation
A plant at Seal Sands on Teesside began production in February this year. Output is in the process of being increased to the intended full capacity of 250,000 tonnes of fuel produced per year.

Greenergy
A 100,000 tonne plant at Immingham on Humberside is under construction and due to begin production at the end of the year. Phase 2 of the construction is planned to start soon thereafter to bring capacity up to 200,000 tonnes. Greenergy also has plans to build another similar-sized plant on Merseyside next to Cargill’s rape crusher. (Cargill is a shareholder in Greenergy).

INEOS Enterprises
There are plans to build a UK plant that will be in production by 2008. The favoured site is in Grangemouth, Scotland, with preliminary discussions said to be underway about a biodiesel plant at Rosyth.

The INEOS plant may also include an oilseed crushing facility. This would be very beneficial, especially to Scottish OSR growers, as currently the crop has to be transported to Liverpool or Hull for crushing, or exported.

Crushing capacity is a major constraint on the development of the industry and Tees Valley Biofuels is also planning a new 500,000 tonne crushing plant on Teesside. To produce one tonne of biodiesel (equivalent to 1,140 litres of fuel) takes around 2.4-2.6 tonnes of rapeseed (depending on oil content and crush efficiency). Adding to biodiesel production are various plants around the country that convert waste vegetable oil used in catering into fuel.

Bioethanol projects

British Sugar
British Sugar is constructing a bioethanol plant next to its beet factory at Wissington in west Norfolk. Although ethanol production from beet is not the most efficient method, British Sugar needs an outlet for the beet produced outside of quota, which can no longer be exported in the same way that ‘C’ beet used to be. In fact, a recent announcement has seen British Sugar link up with DuPont and BP in this new venture. It has been suggested that DuPont’s technology will result in the Wissington product being biobutanol rather than bioethanol. The advantage of biobutanol is that it more closely resembles petrol as it has similar energy content, can be blended at higher percentages and can be mixed and transported in the existing petrol pipeline infrastructure.

The consortium has announced that, subject to the performance of this first plant, it will be looking to build further facilities using cereals as the main feedstock.

Wessex Grain
Wessex Grain has planning permission to build a plant at Henstridge on the Somerset/Wiltshire borders. Production should reach 100,000 tonnes of fuel and is expected to commence in early 2008. The principal feedstock will be feed wheat, requiring approximately 330,000 tonnes per year.

Green Spirit Fuels (a spin-off from Wessex Grain) has plans for further plants. The first is to be on Humberside and will be twice the size of the Hentsridge facility, taking 650,000 tonnes of grain a year from early 2009. Others may follow, probably in East Anglia initially.

Bioethanol Limited
A plant near Immingham with an annual production cap of 100,000 tonnes of fuel is planned. Centaur Grain has been contracted to provide the 325,000 tonnes of wheat needed when the plant commences operations some time in 2008. Centaur is offering contracts through to 2012, with the base price rising to £89.25 per tonne by the 2012 harvest and excluding energy aid, starch premiums and late-season payments.

Roquette
This French-owned food group based in Corby, Northamptonshire is looking at installing a 190,000 tonne bioethanol plant.

Many worry that, for example, with climate change and population growth biofuels will take up valuable land that could, and should, be used for growing food. There are also questions about the energy balance of these crops once the fuel used in, for example, cultivations and fertiliser is included in the equation.

Perhaps these current projects are best seen as a way of crops gaining entry to a market that has hitherto been dominated by fossil fuels. The hope is that further down the line, secondgeneration biofuels will answer some of these criticisms. These involve techniques that use enzymes to convert starch materials directly into liquid fuels. Therefore, any starch-based material, including that currently regarded as waste, such as straw or even household rubbish, could be a potential feedstock.

Although all of these developments are welcome, it is worth sounding a note of caution.

  • These investments are being made due to a combination of high oil price and Government support through legislation, neither of which is guaranteed in the long term.
  • The companies investing are commercial operations and not simply there to help farmers. Farmers growing crops for any of these markets are, in effect, still producing commodities. It is essential that UK producers are efficient enough to compete, otherwise the feedstocks for this emerging industry can just as easily be imported from overseas. (It is noteworthy that many plants are being sited at deep-water ports.)

Despite this, all this new demand has to be good news. Combined with the new ‘Cerestar’ starch manufacturing facility opening in Manchester, domestic demand looks set to grow by 1,000s of tonnes. This opens up the possibility that the UK market could move from a situation where prices are set by export parity to one where prices are at import parity. This, in itself, could be worth up to £6-7 per tonne before any, more general commodity price rises are factored in.

Livestock producers may feel that this will work against them – higher grain prices making feed more expensive. But many of these plants will be generating by-products that will be looking for an outlet.

Single Payment Scheme Round-up

Payment target missed

David Miliband, the new Head of DEFRA, has admitted that the Rural Payments Agency (RPA) has missed its payment target for 2005. Under EU rules, 96% of payments needed to be made by the end of June. It was calculated that around 94.9% were issued by the deadline. This represents £1.438bn out of an estimated total figure of £1.515bn for England. By the payment deadline there were still 8,500 claimants out of a total of 116,474 who had yet to receive anything (admittedly, the vast majority of these had very small claims). In addition, 16,000 had received a partial payment but were still awaiting their top up. In order to achieve the 96% threshold, DEFRA is looking at submitting combined UK figures. Thus, Wales, Scotland, and Northern Ireland, where the payments process went much smoother, may help DEFRA avoid being fined further by the EU for late payment.

Interest

The RPA will pay interest where full payment had not been received by the end of the payment window (30 June). This will be at 1% over the London Interbank rate, which tends to be slightly higher than the base rate (currently 4.5%). It will only be applicable where the delay in payment is due to the RPA, i.e. not where the RPA is waiting for more information from the applicant. It will also be subject to a minimum payment level of £50. More details will be available shortly.

Late submission of 2006 forms

Due to a derogation granted by the EU Commission, the latest date for submission of SP5 forms without penalty was put back to 15 June. So those applicants who filed their returns after the original (extended) deadline of 31 May will not be penalised unless the forms went in after 15 June. Apparently, this covers some 4,000 farmers.

Interim 2006 payments

David Miliband has stated that the 2006 scheme year "will be very challenging" with "no quick fix". In response to the industry’s calls for an interim payment in December 2006, he was non-committal. However, he has asked the RPA to work on the necessary systems to make such payments. A further statement will be made in the autumn once the RPA has undertaken initial validation of the 2006 applications.

Sugar compensation

In order to simplify the operation of the 2006 Single Payment Scheme (SPS) in England, it has been announced that compensation from the Sugar Reform will be ring-fenced for sugar producers. This means that the money available will no longer be split 85% to 15% with the 15% going into the Regional Average Payment pot. According to our calculations, this means that producers will get around £6.80 per contract tonne in 2006 instead of £5.80 (gross before deductions). Remember that this aid is all still decoupled (i.e. no need to grow beet) and is likely to be based on contract tonnage in the 2005 year.

More Support Changes on the Way?

The industry is still struggling with the fallout from previous reforms of the CAP, but attention is now switching to what might come next.

As part of the 2003 Fischler Reforms, it was written into the legislation that a review of the system should take place in 2007-08.

The EU Commission is being careful not to call this a mid-term review, mindful that the last review with that name turned into the most radical overhaul of the CAP in its history. Instead the assessment is being dubbed the CAP ‘Health-Check’. At present, there does not seem to be a huge appetite for another wholesale reform of the CAP – especially as there is a major review of the whole EU budget (including the CAP) scheduled for 2007-08.

Despite all this, some reforms are likely to be on the agenda for the Health-Check.

  • Cuts in cereal intervention prices to deal with the large surpluses building up in central Europe. However, the problems are such that action may need to be taken before the proposed Health-Check. As a consequence (and also to sweeten the pill), any changes in intervention prices or standards could also see the set-aside requirement being removed.
  • Additional cuts in dairy support prices could be on the cards, while an end-date for milk quotas might also be announced.
  • It’s possible that the EU will look at the level of compulsory EU modulation. By 2007, this will stand at 5% and is scheduled to remain at that level. Ministers might agree to increase this percentage to direct more funding at European Rural Development.
  • There is also the possibility that the EU Commission will try to persuade member states to move away from historic SPS systems towards a regional basis, as adopted in England and Germany.
  • One further issue that may be included in the Health-Check is capping. Capping limits the amount of aid that any single business can receive from the CAP. The idea has appeared in previous reforms, with a limit of €300,000 being proposed (just over £200,000). In the past, capping has always been removed from any agreement due to the UK and Germany rejecting the proposal as they have large farm sizes. However, capping is an idea whose time has perhaps come.
  • Any money raised through capping can be recycled into rural development spending in the country concerned and, politically, it may be expedient for governments to be seen to be clamping down on large subsidy recipients. As it is likely that capping will only apply after modulation and financial discipline deductions, the result may well be that in the UK, only a few hundred farm businesses will be affected – not a very big lobbying block.

Use of Farming Companies

Historically, many farming companies were set up to take advantage of the large disparity between the rates of corporation tax that companies paid on profits and the income tax an individual pays. These advantages have slowly been eroded by rate increases over the years.

This, coupled with the fact that profits are taxed within the company and then again in the shareholder’s hands when the money is extracted, means that the creation of new farming companies is likely to be unattractive in most cases.

There are still some circumstances, however, where the use of a corporate structure may be advantageous. Usually when assets are transferred to a company there is a disposal for capital gains tax purposes and so a charge to tax may arise. There is, however, a relief available on the incorporation of a new company if the taxpayer transfers the whole of his/her existing business (this does not have to include cash balances) in exchange for shares. If such a transfer takes place the taxpayer can claim incorporation relief, which allows for no gain to arise immediately on the transfer. The downside is that the gain does not disappear, it is purely deferred by a reduction in the base cost of the shares in the company. If the shares are sold in the future then the gain will effectively crystallise.

This relief could be of use though where an existing farming business has identified an area of land with a significant development value. If planning permission is obtained and the land sold, an immediate charge to capital gains tax would arise. If, however, the business is transferred to a company, incorporation relief is claimed and the land is subsequently sold, no tax would be payable initially. This is due to the fact that the company takes on the land at its market value. The money could then be reinvested in the farming business.

The value of the shares in the farming company would be reduced by the amount of gain that would have arisen. This may not be a concern if the company is to be passed to the next generation, as on death, there would be a tax-free uplift of the shares to market value. As long as certain other criteria regarding the company are fulfilled, there would also be the possibility of claiming reliefs to reduce the potential inheritance tax liability on the shareholding.

Any potential planning regarding transfers of land has to be looked at with regard to stamp duty and, indeed, stamp duty land tax, and so these costs will have to be taken into account when calculating the benefits. It is also important to note that if the profit from the sale of the land is to be distributed to the shareholders immediately, rather than reinvested in the business, there will be a personal tax liability on the shareholders on extracting the funds from the company.

Milk Production in Decline

It seems that the 2005-06 milk year will see a record shortfall of wholesale UK production against quota.

The RPA has not yet confirmed the figures, but the final position could see production levels at more than 300m litres below quota.

This is the fifth time in the last six years that the UK has been below quota. The trend of production is clearly on a downwards slope: capacity is decreasing as many farmers leave the industry and those that remain are not taking up the slack by expanding fast enough. Production in the first few months of the 2006-07 milk year has also begun slowly, raising the possibility that this year’s production will again fail to reach quota. Indeed, the industry may be moving towards a situation where quota is no longer the major determinant of output.

However, there is still a long way to go before it is possible to talk about a milk shortage. In fact, some commentators believe that production would need to decrease by around 3-4bn litres before we reached the situation where only core high-value markets were left. But the industry may have reached tipping point over the past few weeks. As a result of the price war initiated by ASDA, the supermarket’s main supplier, Arla, subsequently reduced its milk price for June. This prompted the usual round of tit-for-tat reductions by other buyers. Many producers had hoped that prices had reached a period of stability, but this has not happened. For many, especially in light of cost increases, these reductions may be the final straw.

Hill Farm Allowance

It has been announced that Hill Farm Allowance (HFA) will continue in its present form for one more year, i.e. 2007 payments.

Therefore the information that producers entered on their 2006 SPS forms will be used to calculate the payment levels. Rates are unknown at present – they tend to be set once all the claims have been processed.

Looking forward, it seems highly likely that any replacement for the HFA for 2008 onwards will be a more environmental scheme.

The Government has stated that it wants to move towards rewarding upland farmers for the environmental benefits they provide. DEFRA will outline its plans for an HFA replacement later in the year.

We are grateful to Andersons, the farm business consultants, for their contribution to this bulletin. We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Limited 2006.

Smith & Williamson Limited Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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