It seems a bit surprising that KPC would give up such a cushy deal, especially since the contract was not due to run out until 2004. LP officials explained that the mill had been losing money for several years. But, practically in the same breath, they admitted that they had considered asking the Forest Service for a fifteen-year extension on the contract.
Some light is shed on the question by looking at the history of the KPC contract. This history comes in three phases: 1955 to 1975; 1975 to 1990; and 1990 to present.
However, the Forest Service formula for estimating fair market value is notorious for underestimating timber prices. In the presence of competition, bids are often twice as great as the Forest Service's estimate. But the KPC contract guaranteed KPC the timber without any competition, which eventually saved KPC millions of dollars.
The Forest Service calculates fair market value by estimating the value of the end product and subtracting all of the costs. The amount that is left, or the "residual value," is presumed to be what a purchaser of average efficiency can pay for the timber. Of course, many purchasers are more efficient than others. Many of the Forest Service's numbers are based on crude estimates. And the agency includes in the deductions a substantial premium for "profit."
The residual value is not allowed to go below zero, of course, and in fact usually has a higher floor such as $1 or $2 per thousand board feet. In the case of the KPC timber, the floor was apparently slightly less than $2 per thousand, since that is what KPC actually paid for nearly all of the timber it cut between 1957 and 1969. Of this amount, the Forest Service routinely kept 25 cents for reforestation under the Knutson-Vandenberg (KV) Act, and the rest went to the U.S. Treasury.
The market for pulp apparently boomed in 1970 and 1971, as KPC paid around $6 per thousand in those two year. Then it fell back to slightly under $2 per thousand for the rest of the early 1970s.
During most of this period, the average cost to taxpayers of putting timber up for sale was about $10 to $15 per thousand board feet. So the $1.66 per thousand that the KPC sale was returning to the Treasury only covered about 10 to 15 percent of costs. But the subsidies were only beginning.
By the end of 1975, APC and KPC together had cut 4.2 billion board feet of timber from the Tongass under their fifty-year contracts. They had paid a total of $8.7 million for this timber, an average of slightly more than $2 per thousand. But by a quirk in Forest Service contract interpretation, they would get most of this money back after 1975.
To understand the contract change we have to go back to 1964, when Congress passed the National Forest Roads and Trails Act. Under one provision of this law, national forest managers could require timber purchasers to build roads and then deduct the estimated cost of the road from the price the purchasers paid for the timber.
In the vast majority of cases, this was nothing more than an accounting change. Prior to 1964, purchasers were frequently required to build roads. The road costs were simply counted as one of the costs deducted from the end-product price to get the residual value. After 1964, the road costs were no longer deducted but were counted as "in-kind" payments. Since the purchaser had to pay a minimum amount in cash in either case, it made no difference to the purchaser whether the costs were deducted or counted as an in-kind payment.
Sometimes the Forest Service would sell a timber sale in which the estimated road construction costs were greater than the estimated value of the timber. Since the purchaser had to pay a minimum amount in cash plus build the road to agency standards, it ended up paying far more than the agency thought that the timber was worth. The Forest Service called excess purchaser credits "ineffective" credits because they could not be credited against the price paid for timber.
The Forest Service labelled such sales "deficit sales" because they would result in a deficit for the purchaser. (The Forest Service never had a name for sales that would result in a deficit for the taxpayer.) The fact that the agency sold so many deficit sales was just one more demonstration that it undersestimated fair market value.
There were two exceptions to the rule that the 1964 purchaser credits law was little more than an accounting change. Those exceptions were the KPC contract and the similar Alaska Pulp Company fifty-year contract which was forfeited a few years ago.
Under Forest Service rules, the minimum cash payment that a purchaser had to make was 50 cents per thousand to the Treasury plus K-V reforestation costs. In the case of KPC, this totalled to 75 cents per thousand. Since KPC had paid a minimum of $1.92 per thousand board feet for most of the contract period, it had built up a huge "surplus" of payments above the minimum cash payment.
In 1975, during routine contract renegotiations, the Forest Service agreed to build purchaser credits into both the APC and KPC contracts. This was an invitation to the companies to reclaim much of the money they had already willingly paid for timber cut in the previous two decades.
The way they worked the system was simple. When timber values were low, estimated road costs were routinely greater than net residual values. Instead of paying 50 cents plus KV costs for the timber the mills were cutting now, they asserted that that 50 cents plus KV should come out of the "surplus" that they had paid in previous years. The Forest Service called this "converting purchaser credits to cash."
This concept can be confusing, and readers who don't understand it now will get really confused later in this paper. So let's go over it again. By the end of 1975, KPC had paid $6.8 million in cash for 3.1 billion board feet of timber. But under the terms of the 1975 contract revision, the "minimum" cash payment was only 50 cents per thousand plus KV, or about $2.3 million. This meant that the remaining $4.3 million was available for refund or credit as KPC built roads that were more expensive than the timber was worth.
1955-1975 1976-1992 Volume cut (mbf) 3,058,811 2,734,212 Cash paid $6,771,557 $18,554,182 Cash to KV 217,490 18,625,921 Net to Treasury 6,554,067 -71,739 Purchaser Credits 0 64,319,764 "Surplus" (approx.) 4,300,000 8,300,000Table one shows the 1955-1975 and 1976-1992 volumes, cash, purchaser credits, and the "surplus" cash remaining in 1975 and 1992. This table is based on the Institute's 1993 report, "The $64 Million Question: How Taxpayers Pay Pulpmills to Clearcut the Tongass National Forest." Getting data since 1992 would require visits to Alaska forest offices.
When timber values were high, the mills would have to pay cash as before. But in later years they could depend on values to fall and then they would get most of that cash back as they built expensive roads.
No other timber purchaser could credit ineffective credits against the amount they had paid for timber years before because no other purchasers had long-term timber sales. But under the revised APC and KPC contracts, no purchaser credits were ineffective so long as the purchasers had ever paid a single penny above the minimum cash payment of 50 cents per thousand plus KV (which in the case of the KPC contract was 25 cents per thousand before 1975).
APC, which had renegotiated its contract slightly before KPC, was the first to take advantage of this. After calmly paying $50,000 to $100,000 per year for its timber, it suddenly claimed $3.2 million worth of purchaser credits in 1975. This allowed it to get back several hundred thousand dollars for timber that it cut in 1975, all dollars that it had paid in previous years with no expectation of ever getting a refund. In 1976, KPC got a similar refund of about $100,000.
The Forest Service wasn't going to let this new contract provision jeopardize its KV fund. In fact, it quickly decided to join in the fun, jumping up its KV costs from 25 cents per thousand before 1975 to $1.60 or more per thousand after 1975. The agency was encouraged to do so by a 1976 law that allowed it to spend KV funds on wildlife, recreation, and other forest resources as well as on reforestation.
The loser, of course, was the taxpayer. The Forest Service freely transferred funds from the federal treasury, both to pay APC and KPC for cutting federal timber and to increase its KV fund.
The real damage came in the early 1980s, when a recession caused timber prices to go through the floor. In 1981 and 1982, the Treasury transferred close to $1.5 million to APC's account, which was its entire "surplus" up to that time. For the next seven years, all of APC's roads would be ineffective.
KPC did even better, getting $5.3 million transferred to its account in 1981 and another $6.9 million in 1984. In between, in 1982 and 1983, it actually paid real money for timber, but it got much of that money back in 1984 or later.
Incorporating a factor for competitive bidding led to substantially higher prices, particularly in KPC's case, because its contract covered higher quality timber than the APC contract. But the Forest Service refused to alter the purchaser credit formula. When the GAO criticize the agency for failing to do it, the Forest Service merely insisted that it treated purchaser credits the same in all sales and the fact that the APC and KPC contracts were for fifty years instead of the more typical three shouldn't make a difference.
A slight recession in 1992 was enough to send even the revised prices below the cost of roads. This proved to be a bonanza for both APC and KPC. APC converted a total of $2.5 million to cash. Some of this was used to pay for timber, some paid directly to APC. Since APC wasn't paying any money for the timber it was cutting, the Forest Service also helped itself to more than $500,000 of taxpayer money for its KV fund.
KPC did even better, converting nearly $10 million worth of purchaser credits to cash. The Forest Service ended up giving KPC a check for $5.7 million in January and another check for $3.1 million in September. The agency also grabbed another $1 million from the Treasury for its KV fund.
After all of these deductions, the gross returns to the Treasury from Tongass Forest timber was minus $14.3 million in 1992. That is before counting any costs to the Treasury such as the costs of arranging timber sales or designing the roads which purchasers would build at taxpayers' expense.
In all, APC and KPC had cut 4.6 billion board feet of timber between 1975, when purchaser credits were added to their contracts, and 1992. Their cash payments for this timber totalled minus $900,000. In other words, taxpayers paid them nearly $1 million to cut billions of board feet of timber.
At the end of 1992, APC's surplus--the amount it had paid in cash above minimum cash payments--was again exhausted, but KPC still had more than $8 million that it could claim in the future. Although I don't have the details, it evidently got some of this back in 1993, when the gross return to the Treasury from timber sold by the Ketchikan unit of the Tongass was minus $2.3 million.
Despite getting paid $8.8 million in cash for the 160 million board feet that it cut in 1992, KPC complained bitterly about the Forest Service's contract revision that raised timber prices to competitive rates. It sued, arguing that such a unilateral change was a violation of the company's contract.
The Ketchikan Pulp Mill fifty-year contract thus ends up as the most expensive timber sale in Forest Service history. Not only did the Treasury gross only about $5 million for well over 6 billion board feet of timber that cost the Treasury well over $100 to put up for sale, but the Treasury ends up paying the company $140 million at the end of the contract. The net loss from this one sale was close to a quarter billion dollars.
What are the lessons to be learned from this experience? The easy lesson is to avoid long-term contracts because if the contract is poorly designed the taxpayers will lose. Ironically, the forestry programs of almost every timber-producing country in the world are based on similar long-term contracts, and taxpayers in those countries are similarly ripped off.
A more important lesson is that we can't trust bureaucrats to automatically safeguard the taxpayers' interests. If any employee in the Tongass National Forest ever worried about the effects of the long-term contracts on taxpayers, they quickly suppressed their worries or they didn't last long within the agency.
Nor can we trust elected officials to safeguard taxpayers' interests. Members of Congress generally defer to local delegations to handle local problems, and while environmentalists provided some counterbalance on the Tongass they were less interested in costs to the taxpayer than in on-the-ground environmental damage.
Even if environmentalists were interested in safeguarding taxpayers' interests, they had few handles in this case. As Andy Stahl notes, "private individuals defrauding the government are not half the problem of government officials defrauding the government, and there is no remedy under the law when that happens." No one would have had standing to sue the Forest Service either for the initial fifty-year contract or for the 1975 revisions that opened the door for KPC to get the money it had already paid back.
So who can we trust? One possibility is to trust public resources to officials who are rewarded only when they work they do benefits taxpayers and who are penalized when their decisions harm taxpayers. Anything less will prove a sellout of both the environment and of taxpayers.