Assessment Review Board
Commission de révision de l’évaluation foncière
Region Number: 30
Municipality: Town of Espanola
Roll Number: 5226-000-001-05000-0000
Hearing Number: 532466
Appeal Numbers: See Schedule “A”
In the matter of Sections 40 of the Assessment Act, R.S.O. 1990, c. A.31, as amended, and in the matter of appeals with respect to taxation years 2009, 2010, 2011 and 2012 on premises known municipally as Pulp Avenue, Espanola.
BETWEEN: Domtar Inc.
Assessed Person/
Appellant
- and -
The Municipal Property Assessment Corporation, Region No. 30 and the Town of Espanola
Respondents
APPEARING: P. Milligan - Representative for the Assessed Person/ K. West Appellant
J. Jamieson - Counsel for the Municipal Property Assessment Corporation
C. Townsend - for the Municipality
F. Courtemanche
INTERIM DECISION OF THE ASSESSMENT REVIEW BOARD delivered by:
J. M. Wyger
1These appeals came before the Assessment Review Board (“Board”) on August 20, 2012 in the Town of Espanola and continued on October 25, 2012 in the City of Toronto. During the lead-up to the hearing of this matter, counsel for the parties expressed their preference that the same panel hear the appeals of both of Domtar’s mills in Espanola and Dryden because the issues were very similar, and they craved some logical consistency in the resulting reasons, which they requested be released contemporaneously. The evidence and submissions in each appeal were considered separately, even though there is the occasional reference to one mill’s appeal in the other mill’s written reason.
INTRODUCTION
2Overlooking the Town of Espanola in Northern Ontario is an industrial complex of 1.2 million square feet situated on 67.92 acres of land. It was constructed as an integrated pulp and paper mill. The owner of the property, Domtar Inc. (“Domtar”) asserts that the aged mill has undergone so many alterations and changes over the decades that the disjointed, non-optimal layout results in substantial functional obsolescence (“F/O”). Further, that the excessive operating costs compared to other locations, and the bleak outlook for the paper industry in general contributes to substantial external or economic obsolescence (“E/O”).
3The property also has a hydroelectric facility which is valued and classified as Exempt and is not subject to dispute.
4Cynthia Townsend, the clerk-treasurer-administrator for the Town of Espanola made a statement at the outset of the hearing, explaining the importance of the Domtar assessment to Town finances. She requested that the Board consider the impact on the Town and provide some stability to its assessment base.
5Domtar’s position is that a willing buyer would pay no more than the cost to build a new mill dedicated to producing pulp and paper efficiently. They put forward a model approach, the purpose of which is to isolate all of the F/O in the existing mill. This approach results in an indicated value for the disputed large industrial portion (“LT”) of $7.124 million. The difference between this value and the Automated Cost Approach (“ACS”) value for the existing mill is said to represent all forms of depreciation, and both functional and external obsolescence. Sales of other mills across the country were put forward to support the indicated value.
6The Municipal Property Assessment Corporation (“MPAC”) costed the existing mill in the standard “rationalization” approach on a building by building basis using ACS, applying varying F/O amounts to each component based on their view of current usage and requirements. The final revised assessment places the current value of the LT portion at $ 24.957 million.
7The expert valuation witnesses are over $17.8 million apart in their estimates of the current value for the same real estate. The task for this panel is to determine at what amount a willing buyer and seller would transact this pulp and paper mill in or around January of 2008 and to explain why. This estimated value hinges largely on answering three questions:
Which cost approach method provides a better reflection of replacement cost for the purposes of the principle of substitution, and therefore best identifies or isolates the F/O in the Espanola mill, the model or the rationalization approach?
How much physical depreciation, if any, should be allowed?
What is a justifiable allowance for external obsolescence?
INTERIM DECISION
8This is an interim decision because there are numerous tanks on the property the value of which is included in the 2012 taxation year, but not in the earlier years. There is a dispute for all four years with respect to whether some or all of these tanks are exempt from taxation pursuant to s. 3 of the Assessment Act (“Act”), and that determination may affect the current value found in this decision. This Board has no jurisdiction to rule on that issue, so must await either a resolution between the parties or a determination by the Court. In addition the parties have reached some agreement on the Commercial (“CT”) component and they propose to provide an agreed apportionment. I have not dealt with this issue, so any reference to the LT portion is on the understanding that this value will be altered by a very small CT apportionment. For these reasons, this is an interim decision for all four taxation years, until there is some resolution on these outstanding issues. Upon that occurrence or for any other matter that counsel deem advisable, this hearing may be re-convened so the Board may be spoken to, and/or adjust the numbers as necessary.
9I find that the current value of the Espanola mill is as follows:
| 2009 | 2010 | 2011 | 2012 | |
|---|---|---|---|---|
| Large Industrial | $9,937,000 | $9,937,000 | $9,937,000 | $9,937,000 |
| Exempt | $15,738,000 | $15,738,000 | $15,510,960 | $17,725,960 |
REASONS FOR INTERIM DECISION
Facts
10The subject property is a 67.92 acre parcel, on which is built a 1.2 million square foot mill, originally built in 1905, that produces over 300 grades of technical and specialty papers, as well as Northern Bleached Softwood Kraft (“NBSK”), which is a variety of pulp sold to other end users. The property has a hydro electric facility which is valued and classified as Exempt and is not subject to dispute. The parties also agreed on a small CT apportionment, leaving only the LT portion in dispute.
11Counsel for MPAC, Jack Jamieson and, Peter Milligan and Ken West representing Domtar, provided the Board with an Agreed Statement of Facts which stipulates:
The highest and best use of the property is its current use as a pulp and paper mill.
The current value is the value in exchange i.e. the price that the property would most likely command in the open market between a willing buyer and willing seller.
The returned assessment of the LT portion for taxation years 2009, 2010, 2011 and 2012 was $26,465,000, $26,465,000, $19,000,000 and $32,014,040 respectively.
MPAC issued an omitted assessment in 2009 in the amount of $5,492,000 apportioned to the LT class for the tanks in issue. This value was included within the 2012 LT value of $32,014,040.
The land value is $136,927 for all years.
The Legislation
12Section 19.(1) of the Act states:
19.(1) Assessment based on current value. - The assessment of land shall be based on its current value.
13Section 1 of the Act defines “current value” as:
“current value” means, in relation to land, the amount of money the fee simple, if unencumbered, would realize if sold at arm’s length by a willing seller to a willing buyer.
14Section 19.2(1)2 states:
19.2(1) Valuation days. – Subject to subsection (5)1, the day as of which land is valued for a taxation year is determined as follows:
- For the period consisting of the four taxation years from 2009 to 2012, land is valued as of January 1, 2008.
15Section 44.(3) states:
44.(3) Same, 2009 and subsequent years. – For 2009 and subsequent taxation years, in determining the value at which any land shall be assessed, the Board shall,
(a) determine the current value of the land; and
(b) have reference to the value at which similar lands in the vicinity are assessed and adjust the assessment of the land to make it equitable with that of similar lands in the vicinity if such an adjustment would result in a reduction of the assessment of the land.
The Relevant Evidence
Scott Mosher
16Mr. Mosher, the general manager at Domtar’s Espanola mill, was called by the Appellant’s counsel to describe the pulp and paper-making process and show the Board which parts of the plant are not required for that purpose, and the function and use of the various component parts of the mill. Mr. Mosher conducted the Board and the parties on a tour of the Espanola mill. He explained the problems with the inefficient layout, asbestos issues, and poor physical condition. He also gave us a fascinating glimpse into the mill's history as a World War II prisoner of war camp by showing our group the "map room", where officers of the Luftwaffe had painted a large and very accurate-looking map of the world from memory. Also discovered were tunnels, at least one of which was evidently pointed straight towards a local tavern by the thirsty airmen.
17Mr. Mosher described the bleak state of the pulp and paper industry in Ontario, in comparison to other parts of the world, and specifically in comparison to Domtar's operation in Marlboro, South Carolina. He contrasted the optimal layout and lower operating costs, suggesting that those advantages were shifting more and more of Domtar's production to the United States (“U.S.”)
Ms. Jody Podlatis
18Ms. Podlatis is the controller for the Espanola mill, and gave evidence about the financial performance of the mill and the fibre industry in general. She detailed a downturn in the mill’s financial performance, largely due to competition from abroad, the dollar exchange rate, declining demand, fibre supply issues, low capital expenditures and the high cost of wood, transportation, energy and maintenance. She contended that head office decisions on allocating resources are often based on comparisons of costs to other "benchmark" mills in Domtar's fleet. She contrasted the cost of producing a tonne of pulp of at Espanola ($489/tonne) with the cost to produce a tonne in their Marlboro plant ($364/tonne).
Mr. Joseph Tsoi
19Mr. Tsoi, a senior consultant with AEC Valuations Inc., was called by Mr. Milligan to provide the Appellant’s review of the ACS tallies on a building by building basis. He testified regarding the purpose, function and utility of the various components. He detailed the uses to which the various components of the mill are put, and the areas that were closed or not in use for their intended purposes. Mr. Tsoi indicated that he worked with Charles Johnstone, the Appellant’s valuation expert, on the types and amounts of F/O to be allowed.
20Mr. Tsoi has been working with the Espanola facility since 1983 and has costed what he refers to as the reproduction cost using ACS. His resulting cost value of $90,217,215 differs only marginally from MPAC's Replacement Cost New (“RCN”) of $89,857,576.
Mr. Richard Lo
21Mr. Lo, the Director, Fixed Asset Valuation for AEC, was tasked with costing the model based on the Marlboro mill, in order to quantify the F/O in the Espanola plant. He had experience with creating hypothetical green field models from scratch in other provinces. Working with Marlboro was his first time working from as-built plans. He considered this an advantage and was quite excited about the assignment because Marlboro is a model that you could actually see and feel.
22Mr. Lo used the ACS to value the as-built facility and four additional hypothetical buildings comprising 204,000 square feet to enclose certain items due to the differing climate, in effect a winterized Marlboro. His Net Building Value came to $46,652,104. Mr. Lo conceded that certain conveyors probably should have also been enclosed for an additional cost of $1.2 million.
Mr. Stewart Marcoux
23Mr. Marcoux, the Vice-President of Asset Redeployment for Domtar Inc., joined the hearing by video conference from Vancouver. He gave evidence on Domtar’s perspective and criteria for the purchase and sale of fibre properties, the history of the troubled fibre industry and on the future of the Espanola plant in their business model.
24Mr. Marcoux catalogued a tale of woe for the Ontario fibre industry in recent years due to the softwood lumber dispute, the dollar exchange rate, reduced demand for paper, and steadily increasing costs, with no improvement in sight. He explained why Ontario wood costs were so high compared to highly efficient monster mills in Brazil and Indonesia that are continuing to be built in direct competition, and producing over six times as many tonnes per day as Espanola.
25Mr. Marcoux explained that a buyer of a pulp and paper mill would make sure it is in a competitive situation with a sustainable supply of low cost fibre, energy and labour. He also contended that the Marlboro mill is just such a situation and is a good choice for what you would build to replace the existing Espanola mill, if you could.
Mr. Charles Johnstone
26Mr. Milligan called as his valuation witness, Mr. Johnstone, the Director of Property Tax and Appraisal Services for AEC International Inc. Mr. Johnstone was qualified to give opinion evidence as an expert in the valuation and assessment of large industrial properties, including fibre mills.
27Mr. Johnstone explained the appraisal problem as being on two levels. On the micro level is an old, disjointed plant constructed piecemeal with numerous add-ons that resulted in poor flow of production and parts that have no use. The functional issues arise from a product flow that is broken up by two processes competing for space. A buyer would discount the cost value by an amount that removes that F/O.
28On the macro level is an economic situation that is not favourable to old, inefficient Canadian fibre mills the economic issues stem from the reality that a buyer will discount the price to be paid for a mill that suffers from external problems over which the owner has no control, such as escalating costs, a punishing exchange rate, and a stagnant market that has resulted in permanent mill closures across the country. This discount is reflected in an allowance for external obsolescence or E/O.
29Mr. Johnstone employed the cost approach which is generally used for special purpose large industrial properties. This requires analyzing the cost of replacing the improvements with improvements of similar functionality and then deducting all forms of depreciation and obsolescence. The net value is added to the land value to produce the value conclusion. Mr. Johnstone’s preferred method for finding this value is the “model” approach, whereby one considers the cost of building a hypothetical modern plant of similar functionality and utility as the subject mill, (that the existing mill would be replaced with, if it were possible). It is based on the principle of substitution which holds that a buyer would not pay more for the existing mill, than the cost to build a modern replacement of the same productivity.
30Mr. Johnstone’s choice for such a model is Domtar’s mill in Marlboro, South Carolina. That mill produces a similar amount of pulp as Espanola. Marlboro produces more paper; however the two small paper machines at Espanola take up the same amount of space as the one paper machine at Marlboro. The Marlboro plant requires only 583,598 square feet, compared to the 1.254 million square feet of the Espanola plant. A number of processes and tanks that are outside at Marlboro and need to be inside in Canada would require additional enclosures of 203,971 square feet for a total size of 787,569 square feet. These structures were then costed using ACS as if they were in a northern climate like Espanola, resulting in a RCN of $46,652,104. The difference between this figure and the RCN for the overbuilt Espanola facility ($90,217,215) is said by Mr. Johnstone to represent the F/O on the order of 48.3 per cent inherent in the disjointed, inefficiently laid out Espanola plant.
31The winter-adjusted Marlboro RCN of $46,652,104 is then depreciated by 41.1 per cent, roughly the same amount used by MPAC for physical depreciation, to $19,220,544. After adding $1.3 million for yardworks, Mr. Johnstone deducted a total of 65 per cent F/O and E/O based on excess operating costs, to arrive at a figure of $7,804,133. After deducting $817,000 for the cost to cure asbestos issues and adding the land value of $137,000, he arrived at his indicated value of $7,124,000, rounded.
32Mr. Johnstone provided only a portion of a rationalization approach. In it he provided for a deduction of only 15.8 per cent for F/O from the RCN, resulting in a building cost new of $75,086,216. He testified that this ACS derived figure cannot account for all the F/O in the Espanola plant, and that is why the model approach is a better method for quantifying such F/O.
33Mr. Johnstone emphasized the appraisal text admonition that a valuator must search for market evidence to support his conclusions; that the market will recognize depreciation from all sources and that a valuator must use his best judgment to quantify that amount.
34Fourteen sales of northern fibre mills were provided in support of his cost approach conclusion. He contended that the sales suggest the value of a pulp and paper mill, after machinery and equipment are removed, would typically sell for only a small fraction of its cost approach RCN.
Mr. Frank Lutz
35Counsel for MPAC, Jack Jamieson called as his valuation witness, Mr. Lutz, who was qualified by the Board as an expert in the assessment of large industrial and resource properties. Mr. Lutz made several visits to the mill and costed the mill on a building by building rationalization approach. He stated that he made allowances for changes in use and for flow issues. He contended that the losses in productivity due to disjointedness were adequately accounted for with the 5five per cent piecemeal allowance. He asserted that the $18 million dollar allowance he gave for F/O was adequate.
36Mr. Lutz allowed 30 per cent for E/O rather than the MPAC guideline maximum of 40 per cent on the grounds that the mill was operating at full capacity, with minimal downtime. He objected to Mr. Johnstone’s 60 per cent E/O because it was based on a comparison of excess operating costs with a single mill, for the single year 2008, and it used only softwood pulp as a measure, even though both mills produced hardwood pulp as well.
37Mr. Lutz did not consider the sales to be of much assistance as most were failing or closed mills and therefore had a different highest and best use from the operating mill at Espanola. He highlighted the difficulty of extracting the value of the realty alone from many of those transaction prices. He was similarly un-impressed with the model approach for a variety of reasons.
38The ACS cost approach was used to value the mill on a building by building rationalization method. His RCN for the Espanola mill at $89,857,576 is for all practical purposes the same as Mr. Tsoi’s $90 million and change. Both sides were clearly costing the buildings with the same program/methodology.
39Mr. Lutz applied a 19.64 per cent deduction for F/O and 42.9 per cent for physical depreciation to arrive at his building net value of $33,683,103. He allowed 30 per cent for E/O resulting in a building net value of $23,578,172. Mr. Lutz was not persuaded that asbestos was a serious issue and so made no allowance for it. Adding land value to the building value resulted in his final indicated current value of $24,957,000.
Analysis - Model vs. Rationalization
Model Approach
40The use of a model is an accepted method within the cost approach, according to the appraisal literature. Mr. Johnstone's preference for the model approach is reflected by Lee Fuller, author of the article at Tab 6-A of Exhibit 7 entitled "Valuing Special-Purpose Properties - What Do the Experts Say? The author confirms the well-accepted definition of “replacement cost” as the cost to build a facility of equivalent utility, using current standards, design and layout. This is in contrast to “reproduction cost” which is the cost to construct a replica of the building being appraised with no radical change in the construction, quality, amenities or any other aspect. In that approach "We appraise what is there, not a substitute model". Mr. Fuller goes on to note his preference for estimating replacement cost using "recently constructed examples of buildings with utility similar to the building being appraised" but that in the absence of such examples "very few appraisers would have the technical knowledge and experience to, in effect redesign an actual special- purpose building..." and so must fall back on reproduction cost of the existing facility. In the case of Espanola, such a real example is provided with the as-built plans for Marlboro, and the re-design for climatic purposes was undertaken by an engineer with input from knowledgeable Domtar personnel.
41The principle of substitution underlies the cost approach to valuation and holds that a willing buyer would pay no more than the cost to build a facility of like productivity and functional utility, using modern materials, standards, design and layout. The question is whether the facility standing at Espanola or a reasonable facsimile with some corrections for super adequacy, piecemeal, and some buildings removed is representative of what that willing buyer has in mind as a substitute. This is the top-down rationalization approach, a series of subtractions from what is currently there, that Mr. Lutz refers to as replacement cost.
42I find it difficult to envision a buyer effectively reproducing the existing mill, with some adjustments. Optimal functionality would not be achievable by taking the current mill and simply removing some buildings, changing some ceiling heights and making the other changes permitted by ACS. Due to the age, layout and disjointedness of the Espanola plant, I agree with Mr. Johnstone that a prudent buyer, considering the cost to build a replacement, would employ the bottom-up approach of costing an optimum facility of similar productivity from scratch. This is what the model method produces, often a hypothetical layout from plans alone. In the present case, there are as-built plans of an actual mill of similar productivity that rules out some of the guesswork that is a natural by-product of anything hypothetical.
43I am persuaded that using a real model with some hypothetical add-ons provides a more accurate estimate of building cost, than a totally hypothetical model. Even the add-on buildings are still based on enclosing the actual processes in the pulp and paper making at Marlboro. The cost of a fully winterized Marlboro replica provides a maximum value that a willing buyer would pay for the functional utility of the Espanola mill. The difference between that value and the costing of the existing mill should represent all of the F/O inherent in that mill. Employing the modeled value of a replacement mill should effectively wring out all the F/O that is present in Espanola.
Rationalization Approach
44The rationalization or building by building method works well enough where the facility being costed bears a reasonable likeness to what might replace it, with some adjustments. I accept the evidence of Domtar's witnesses that the Espanola mill bears little resemblance to any replacement. In this case, the rationalization approach provides a value that is closer to reproduction cost than to a true replacement cost as defined in the appraisal literature.
45MPAC's guidelines regarding the five per cent maximum allowance for piecemeal construction is an arbitrary limit, that appears to be applied as a standard with little regard for reality. I am not convinced that a five per cent allowance adequately represents the F/O in an aging, disjointed, and poorly laid out facility like the Espanola mill. I accept Mr. Johnstone's opinion that ACS adjusted by arbitrary guidelines simply cannot capture all of the F/O from the inefficient flow of production through the mill. The further a property moves away from optimal utility, the more difficult it will be to capture F/O with arbitrary standards and guidelines.
46It is unclear if MPAC is equipped to employ a model approach. Mr. Lutz is very good at what he does, but he is limited by MPAC's standards, guidelines and policies. They may work well in most applications, but in the context of a single property appraisal of a large special purpose property, MPAC’s method does not conform to appraisal theory and practice as well as Mr. Johnstone's focused analysis. These deficiencies in MPAC’s approach were clearly illustrated through Mr. Milligan’s textbook cross-examination of the assessor. I conclude that for the Espanola mill, the model approach gives a better picture of the quantum of F/O that resides in the existing facility.
Analysis - Functional Obsolescence (F/O)
Marlboro
47I accept Mr. Lo's costing of the Marlboro mill with additional enclosures for the northern climate. Mr. Lo conceded that he neglected to enclose a wood chip conveyor that would have added $1.2 million to the cost. He alleged, with Mr. Mosher's approval, that his "ultra-conservative" estimate of what needed to be enclosed would cover that oversight. I am not so sure that such a sizable omission would be so easily digested within the overall number. In addition, it occurs to me that an appraiser using the model method ought to err towards oversizing any enclosures. Indeed the Fuller article suggests that "approximately five to 10 per cent of the manufacturing floor space should be available for expansion." I infer that Mr. Lo's ultra conservative sizing incorporates that 5 five to 10 per cent, rendering it merely conservative as it should be. The addition of $1.2 million to the Marlboro RCN results in a building net value of $47,852,104. Adding yardworks in the amount of $2,880,403 results in a sub-total of $50,732,507.
Excess Operating Costs
48Mr. Johnstone contended that not all F/O is eliminated by using the model RCN, because the buyer would pay the price for a mill with the functional utility of Marlboro, but would still be faced with the operating costs of the functionally obsolete parts of the actual Espanola plant as acquired. Extra costs of heating, operating, maintaining, and material handling need to be quantified, capitalized and deducted as a penalty. Mr. Johnstone used the extra labour cost over Marlboro's costs, plus $1 per square foot to maintain the extra space. This reasonable exercise was not seriously challenged by MPAC counsel and will result in a deduction of five per cent to be applied after physical depreciation.
Analysis - Physical Depreciation
49A disagreement between the parties arose over whether age-related physical depreciation should be deducted from the value of the Marlboro RCN. Mr. Lutz testified, and Mr. Jamieson contended, that an adjustment to the modeled cost for depreciation should not be necessary because the use of a model with a hypothetical new mill eliminates the need. On the question of depreciating the modeled value, Mr. Lutz asserted that it cannot be new and old at the same time. I disagree with this assertion because every replacement cost new less depreciation (“RCNLD”) is both new and old at the same time. That exercise always projects a hypothetical new cost and then makes it old to reflect the reality of the age of the existing structures being valued. The cost of a new Marlboro replica is the maximum a buyer would pay. A buyer purchasing the Espanola mill is not getting a new hypothetical winterized Marlboro replica for that price, but is paying for the functional equivalence, but at the real age of the existing Espanola plant.
50The example from the AIC Course Manual entitled Depreciation Analysis (Exhibit 36) Lesson 3 page 14, comparing the model and rationalization methods, confirms that the same amount of physical depreciation is deducted from both the model RCN and the standard RCN. The parties are in general agreement that the Espanola buildings and yardworks are approximately 42 per cent good. This results in depreciation in the amount of $29,424,854 and a RCNLD of $21,307,652. Deduction of the five per cent F/O due to excess operating costs reduces that figure to $20,242,269.
Analysis – External or Economic Obsolescence (E/O)
51External Obsolescence as it is now generally referred to, is defined as an impairment of the utility or saleability of a property due to negative influences from outside of the property. The appraisal literature confirms that while it may be simple to identify, it is the most difficult form of depreciation to quantify for special-purpose properties, and is largely a matter of subjective judgment of the valuator.
MPAC E/O
52MPAC's guideline recognizes the numerous challenges to the assessed values of wood fibre milling facilities, largely on the basis of under-utilization of production capacity. For the 2008 base year, MPAC put in place an E/O of 40 per cent on "most" of these facilities to improve equity among these industries. Mr. Lutz was not able to report on the rationale for this figure. It compares to a 45 per cent E/O that MPAC allows on automotive assembly plants in Southern Ontario. Mr. Lutz allowed a 30 per cent E/O in his analysis of the Espanola mill, and justified not giving the maximum 40 per cent on the basis that the mill is running at full capacity.
53The fact that the mill is running at full capacity does not translate to profitability, however. It does not attenuate the external factors listed below that result in declining prices and escalating costs simultaneously, which led to many years of red ink, and/or declining profits save for one anomalous year in 2010. This general downward trend, requiring continuous re-structuring or "re-purposing" is the uncertain future that a willing buyer must contemplate.
54On the other hand there is some evidence to suggest that there may be some life left in the pulp and paper industry. Domtar Espanola has diversified into making a variety of over thirty different technical and specialty papers, that Mr. Johnstone concedes "may temper the impact" of E/O. Most of the pulp from Domtar's mill at Dryden, Ontario goes to making paper towels and toilet paper, a market that would seem immune to the paper-reducing effects of the digital revolution. The "re-purposing" of the Plymouth mill to make "fluff pulp" for the super-absorbent polymers used in adult diapers may be a growth industry, given current demographics. Terrace Bay has been re-purposed by an Indian company to produce "dissolving pulp" for use in textile production. These examples tend to show that the future of the fibre industry may not be quite as dire as Domtar's witnesses’ project.
55Given the general uncertain state of the industry however, it seems to me that 45 per cent sets a floor level for E/O in the pulp and paper industry, if for no other reason than to achieve some measure of equity with the substantially less threatened auto industry.
Domtar E/O
56A major deduction of 60 per cent was judged by Mr. Johnstone to represent the E/O for Domtar Espanola based on a number of factors described by Domtar's witnesses:
ever-increasing wood fibre costs
unfavourable changes to the dollar exchange rate
escalating transportation, energy and other costs
stagnant markets
highly efficient, large output competitors coming on stream
57I am not convinced that the E/O figure employed in Mr. Johnstone’s model approach is appropriate. Mr. Johnstone applied a 60 per cent deduction to the modeled value for E/O. This figure was calculated largely on the basis of the difference in operating costs between the Espanola mill over the Marlboro mill in the production of pulp and paper for a single year. The immediate question posed by Mr. Jamieson was whether it is appropriate to use only one plant and one year for this purpose, rather than using the costs of a cross-section of mills over a number of years. There was no evidence led on whether the model approach envisions a comparison of business-related costs between the subject property and the optimal level of a single example represented by the Marlboro facility.
58A review of the various graphs in Exhibits 6, 7, 22 and 27 showing a comparison of the fibre costs for various mills across North America places Marlboro and/or South Carolina at or very near the bottom in wood costs. The two hardwood charts in Exhibit 27 in particular show a clear and substantial cost advantage that Marlboro had over all the other mills on the graph. Also of note is that the year 2008 on which the Mr. Johnstone's EO analysis is based, displays the largest differential between Marlboro costs and Espanola costs. For Espanola in 2008, softwood costs were at their highest level, and hardwood costs at the second highest level in the ten years from 2002 to 2012.
59In determining replacement cost and F/O, I accept that an optimal model such as Marlboro can be used, because for replacement cost one would strive to achieve the hypothetically perfect or optimal facility. However I agree with Mr. Jamieson’s cogent argument that using the same optimal model's business costs to estimate E/O in Espanola is an extension of the model approach that is flawed and unsupported by appraisal theory. For a special-purpose property such as a fibre mill, external or locational obsolescence should compare the subject location to the rest of the continent, and not to the most low cost jurisdiction to be found. Using the Marlboro costs effectively extends the model method to not only placing a winterized Marlboro replica in Espanola for costing purposes, but then moving the whole works back to South Carolina to avail it of that jurisdiction's cost advantages. The appraisal literature does not support such a narrow definition of "external".
60There are several references (underlining added) in Mr. Fuller's article that suggest a broader reference would be appropriate in quantifying E/O: "...a process that compares actual operating costs and/or profits of the operating entity with norms"; "...operating information on the subject property and a representative sample of competitors are needed"; and "decisions about economic obsolescence should be based on an understanding of the industry and the characteristics of the property relative to industry norms".
61Mr. Fuller makes specific reference to the pulp and paper industry, noting that the "industry has fallen on hard times, and production has shifted to lower cost countries." In Domtar's case this shift is to the United States. I conclude from the excerpts above, that in determining the E/O for Espanola, Mr. Fuller would advise a cost comparison with a representative sample of Domtar mills across the U.S. and not just the lowest cost jurisdiction in South Carolina.
62The quantification of a 60 per cent E/O required numerous other assumptions beyond the cost differential. Mr. Johnstone’s current value of the cumulative operating cost penalty was calculated over five years, at a discount rate of 15 per cent. It was then apportioned to the realty based on an estimated 10 per cent ratio of building value to equipment value. The $11.7 million E/O that resulted required a series of subjective assumptions by the valuator and was premised on an over-stated and arbitrarily selected cost differential figure, and so is not persuasive.
Analysis – Quantifying E/O
63I have determined that an appropriate E/O for Domtar Espanola is between 45 per cent and 60 per cent. Without having detailed information from a representative sample of other mills in North America, I will extrapolate from the graphs and charts referenced above to estimate a more reasonable E/O. There is sufficient information on different wood costs, which is by far the largest component and which represents the most significant locational disadvantage of Espanola. The focus will be on the excess fibre costs of Espanola over fibre costs that can be considered more in line with industry norms.
64Mr. Johnstone determined Espanola's excess wood cost over Marlboro to be U.S $120 per metric ton or 72 per cent higher. Figure 9 of Exhibit 6 appears to bear out that in 2008, Ontario wood costs were about 75 per cent higher than in South Carolina. It is a lower differential of 69 per cent when Espanola is compared to the median value of the US mills in that one year. The chart from Exhibit 22 comparing 2012 fibre costs shows Ontario wood costs 82 per cent higher than South Carolina where costs actually appear to have declined, but only 46.3 per cent higher than the median value of the US mills represented by a mill in Arkansas. A review of the four graphs in Exhibit 27 displays the trend in wood costs for several years from 2005 through 2011 for several mills. On average, hardwood chips cost roughly 30 per cent more, and hardwood logs about 48 per cent more in Espanola than in Marlboro. Softwood chips and logs averaged about 63 per cent and 61 per cent higher respectively than in Marlboro. These averages over many years demonstrate that the 72 per cent higher wood costs from 2008 were not representative, but were in fact the largest differential in those seven years. The chart on page 15 of Exhibit 22 confirms that 2008 was by far the highest cost for softwood in the decade from 2002 to 2012.
65On all four graphs on Exhibit 27, the line representing the cost of wood at the mill in Arkansas appears to generally run through the middle as a median value similar to the 2012 chart. The difference between Espanola and that mill for hardwood chips and logs is negligible, as the lines intersect at various points, effectively tracking together. The cost for softwood logs to Espanola over the median is in the 25 per cent to 30 per cent range. The cost premium for softwood chips over the median trend line was in the range of 42 per cent using median values to almost 47 per cent on average. While I recognize that these percentages are rough estimates, they are based on real numbers, and are sufficiently instructive to draw the inference that the 72 per cent higher wood cost compared to Marlboro in 2008 is not a sufficiently reliable representative value on which to base a determination of external obsolescence. This is particularly so given that Espanola has little cost disadvantage compared to the other mills with respect to the hardwood logs that are a significant portion of their operation.
66Mr. Johnstone’s cost comparison in Table 8 is based on the comparative costs of producing softwood pulp, which represents the majority of the mill’s output. I will base the analysis on Espanola’s softwood chip costs being approximately 45 per cent more in the years surrounding the valuation year, than the cost of softwood chips to a representative sample of mills across North America. Applying this percentage to the figure for Espanola wood cost in Table 8 of $286 per tonne results in a representative wood cost for other mills of $197 per tonne.
67To test this figure I approached the problem from the other direction, using the median cost of the Arkansas mill over the cost at Marlboro which is approximately 19.5 per cent. Grossing up the Marlboro cost of $166 per tonne by 19.5 per cent, results in a more representative cost of $198 per tonne, effectively the same result. Using $197 per tonne, the cost differential of Espanola over the other mills is only $89 per tonne instead of the $120 per tonne differential over Marlboro used by Mr. Johnstone.
68I accept Mr. Johnstone's expert judgment on the five year period and the discount rate. Applying these factors to the $89 per tonne differential results in a cumulative operating penalty of $104,421,000. Mr. Marcoux corroborated that it is appropriate to allocate between 10 per cent to 20 per cent of this figure to land and buildings. A 10 per cent allocation of the operating penalty results in an external obsolescence amount of $10,442,100. This figure represents a 53.5 per cent E/O relative to Mr. Johnstone's final RCNLD of $19,501,789 and a 51.6 per cent E/O relative to my estimated RCNLD of $20,242,269. It is interesting to note that in dollar terms the E/O of $10.44 million is almost equivalent to Mr. Lutz's final E/O of $10.58 million. The sub-total value of the Espanola facility after E/O but before land value is added is $9,800,169. When land value of $136,927 is added, the result is $9,937,096.
Analysis – Asbestos
69The evidence of the Domtar witnesses, confirmed by an engineering report of Golder and Associates, indicates there is a substantial amount of asbestos in the mill. Much of this is of the non-friable or stable variety that poses no immediate danger, which Mr. Marcoux conceded would be more of a maintenance issue for a willing buyer of an operating mill. I accept Mr. Jamieson’s submission that the Golder Report does not provide a cost to cure, and that Mr. Johnstone is insufficiently qualified to provide one. I find there is insufficient evidence to support the estimate provided, and so will not allow an adjustment for asbestos.
Analysis - Sales Evidence
70There are significant problems in gleaning any useful information from the sale of pulp and paper mills in recent times. The main reason for this is the fact that most have been sold through bankruptcy, receivership, creditor protection or at the very least are distressed or even closed. This raises the very real question of whether these troubled facilities can be compared to a fully operational and somewhat profitable outfit like Domtar Espanola on the basis of differing highest and best uses.
71It is not only the willing buyer that must be considered in this equation. It is questionable that as a willing seller, Domtar would be prepared to give away the Espanola mill at the fire sale prices in evidence while it is still profitable and has the financial feasibility to attract a willing buyer prepared to carry on the current business or re-purpose to a more profitable one. I conclude that an operating mill would be expected to sell at a somewhat higher level than the prices of those distressed mills in evidence.
72The other main issue is determining just what the "sale amount" represents. It most often includes machinery and equipment, and can also include timber rights, inventory, liabilities and a host of other non-realty items that are subject to adjustment of up to 90 per cent. The reported values for the 14 sales in evidence range from negative $18 million (i.e. vendor paid purchaser to take the mill) to positive $27 million. It is interesting to note that these two values (some $45 million apart) were for the same mill at Terrace Bay, the earlier sale in 2006 and the more recent one in 2012.
73The recent sale of Terrace Bay is a case study in the difficulty in isolating current value from the transactions involving these businesses. The mill was in creditor protection since 2009, with a monitor seeking bids for the going concern. An Indian company named Aditya Birla put in a successful bid, reported by Indian news sources "to be both $300 million US and $110 million US." ForestTalk.com reported the total value of the transaction to be $27 million, but a forgivable debt to the province in the amount of $24.2 million means the "purchase price for the mill is $2 million...". Complicating matters was a late bid from a Chinese company in the amount of $35 million on the same conditions as the Aditya Birla deal. Mr. Johnstone came up with four separate possible values for the realty at Terrace Bay after adjustments for the forgivable debt, fibre supply, machinery and equipment, ranging from negative $1 million to positive $5.4 million. He contrasted these figures to the assessed value of Terrace Bay in the amount of $23 million leading to extremely low assessment to sale ratios in all four cases.
74Another example of the care one must exercise in using reported sale figures was the sale price listed at $300,000 for the St. Mary's Paper mill in Sault Ste Marie. On the appeal of that property's assessment before this panel, it was evident that this figure reported on the Land Transfer Tax Affidavit was grossly under-stated. I re-iterate my impression from that appeal, that about the only thing one can infer from the sales data is that pulp and paper mills generally sell at a massive discount to their ACS cost-derived values.
75Mr. Johnstone wrote that "the sales evidence supports the conclusion that significant amounts of depreciation should be applied in the cost approach". I agree and have applied such significant amounts through acceptance of his functional obsolescence analysis and a reasonable adjustment to his external obsolescence allowance. I find nothing in the sales evidence to suggest that the land and buildings of Domtar Espanola could not have sold for $9,937,000 rounded, to a willing buyer in and around 2008.
CONCLUSION
76The Board hereby reduces the LT portion of the current value from the various returned values for the four years in question to $9,937,000. I recognize that this is a substantial reduction to the assessments as returned. At the outset of the hearing Ms. Townsend, the clerk-treasurer-administrator for the municipality, sought to impress on me, “the substantial impact to our funding models and our costing formula” and desired a result that would be fair to both parties. I understand the impact on the assessment base for the Town, but can only say that those financial implications are not a material consideration to the issue of current value. Fairness should result from the property being assessed at its market value. If all properties, including other mills, are assessed at their market values, then there is fairness and equity between and among them.
77It is fair to say that for the people involved with a declining industry like the fibre industry, there are no winners. There are many losers and among them are Domtar employees, contractors, suppliers, managers and investors. The decline in property value attributable to the decline in the industry will cause the municipality to lose a significant portion of its assessment base, and that is unfortunately the town’s share of the cost resulting from that decline.
“J. M. Wyger”
J. M. Wyger
Member
/lp
INTERIM DECISION RELEASED ON: January 30, 2013