The Perfect Storm - Part 4
Part 4: Making Sense of Supply Side Dynamics
Photo Couresty: evergreenmagazine.com
The Lumber Production Landscape Is Changing
Last year, the softwood lumber market pulled out of one of the most severe slumps in history. The North American lumber industry was hammered by the US housing recession from 2006 through 2011 and to cope with the drop in demand forestry firms dramatically cut capacity by over 50%, closing mills and laying off thousands of workers to try and stave off deeper financial losses. Now, with the US housing market rebounding, lumber producers are struggling to meet increased demand and the result has been a significant increase in lumber pricing. In the next two installments of The Perfect Storm, we will dissect the very complex supply-side of the lumber supply-demand equation. I find the entire lumber supply chain fascinating; possibly because I've been associated with it for 30-years and have had the luxury of physically seeing all phases in action, from forest to jobsite. But mostly I love it because of the virtuous nature of the hardworking people within the industry. Yes, there is no doubt the lumber industry, just like the building industry it serves, and like most industries in this county, is significantly different now than in decades past. Privately run family operations are being replaced by corporate conglomerates. This has reduced the overall number of players in the marketplace and created the prospects of more price volatility for lumber commodities. I would also argue that a whole new strategic decision making process exists when you answer to a board of directors, many who couldn’t tell the difference between a fir and a fur. A “profit at any cost” mentality often permeates these organizations creating a win-lose culture rather than the win-win attitude that exemplifies family owned companies. Dedication to company heritage, employee stakeholders and their communities is replaced by corporate sterility. So lets explore the dynamics of the lumber supply chain and how it has dramatically changed in the last few years.
As a result, a new brand of timberland company emerged and along with them, the fundamental objectives of timberland management.
Timberrrrrrr…
One must first examine the dynamics of lumber’s raw resource, the timber harvesting and processing industry, to fully understand what influences the lumber supply chain. Several key developments are at play regarding forest management. There has been a tremendous shift over the last two decades in who controls North American timberland holdings. For generations, large corporate forest companies with their own sawmills controlled a high percentage of their log source. These integrated forest products companies owned and grew their own timberlands and harvested those lands to supply logs for their own pulp and sawmill operations. But, in the late 1980’s, with the advent of hostile takeovers, lumber concerns became vulnerable. Corporate raiders, recognizing that timberlands owned by forest products companies were hugely undervalued assets, orchestrated leveraged buyouts of several large players, including Diamond International and Crown Zellerbach. The companies were taken over, dismembered, and their assets spun for huge profits. In reaction, most other major forest products companies devised a way to stave off the raiders by selling off their land holdings to investment markets, namely Real Estate Investment Trusts, or REIT’s, and Timberland Investment Management Organizations, better known as TIMO’s. As a result, a new brand of timberland company emerged and along with them, the fundamental objectives of timberland management. No longer was the strategy to cut a certain amount of logs every year to feed the resource into your operations for cash flow. It was now all about utilizing the timber resource to maximize financial returns for the investors. This created a free-market environment where timberland owners sell to the highest bidders. They are free to export logs to markets like China where mills will pay much more for logs than U.S. mills. The obvious result has been a precipitous increase in log costs to mills which puts upward pressure on the price of lumber products.
Another, more immediate concern at the mill level, is the limited amount of logs that are available. Fall log inventories were hampered by extremely dry conditions in the forests throughout northwestern U.S. and Canada. Fire danger completely closed many harvesting operations and mills were unable to build their log decks at the same time production levels were picking up. An unusually wet and snowy winter has not allowed harvest levels to catch up so consequently, mills are reporting that logs are costing them over 45% more than this time last year. As one producer in the northwest quoted in Random Lengths said, “Short term, you cannot increase production. If you don’t have an adequate log deck now, you won’t get one for 4 or 5 months.”
Of course, access to public timber supplies has continued to dwindle in the U.S., and now has spilled over the borders to our neighbors to the north. In the latest U.S. National Forest Service report, the total acres of timber harvested on its (our) lands in 2012 was 208,649 acres. Keep in mind the NFS manages 191 million acres; thus, they harvested .1% of their lands. And the majority of the acres harvested (113,719 areas) were thinning operations yielding minimal usable timber. So, until the Forest Service and the Bureau of Land Management put some balance back into their timber management strategy, this nation will be forced to rely on private and imported sources for its logs. In addition, timber sales and their executed harvests, are routinely challenged in court by environmental groups and their success rate has tied up our nation’s forests with years of legal wrangling resulting in a continued reduction in U.S. timber harvest levels. Canada is also restricting harvest levels in it’s national forests. Historically very timber friendly, several of the Canadian provinces have plans in place to reduce the timber harvest by as much as 30%.
Another phenomena at play impacting timber harvest is the mountain pine beetle epidemic in the interior region of British Columbia. Since the early 2000’s, BC has been plagued by a mountain pine beetle infestation. It peaked in 2004 and has basically run its course in that province but there is indication that the outbreak may be spreading to neighboring Alberta. During that time millions of lodgepole pine trees were destroyed; roughly 77% of the merchantable pine in the region. During the earlier years of the epidemic, large amounts of pine trees were harvested and processed, essentially an action to salvage the timber’s value before the fiber became unusable. With the mountain pine beetle epidemic now in its waning stages, harvest levels to achieve sustainability will be dramatically reduced until reforestation can restore the forest’s health. In any event, the prospects of an ever tightening global timber supply is certainly a reality and has the potential to create havoc in the lumber industry for years to come.
Photo courtesy: ahisgett
Where Will The Lumber Come From?
There is a tremendous amount of apprehension in the lumber and building industry as we move towards the latter part of first quarter, 2013. We have seen a run up in lumber pricing over the last four months and are now seeing availability issues with key framing products and we haven’t even hit the building season yet. And, with lumber consumption expected to increase again in 2013, to 40 billion board feet, the question is, will U.S. and Canadian lumber production climb to meet that demand? A resounding number of people in the lumber industry are very skeptical that supply-side constraints can be remedied anytime soon in order to put significant downward pressure on the market. So, at least for the first half of 2013, producers seem firmly in control.
U.S. lumber production output in 2012 was up 7.9% (through November) compared to the first 11 months in 2011. Canadian lumber production through that same period was up just 5%. All this while housing starts increased by a modest 26%. The U.S. typically imports about a quarter of its lumber needs from Canada. Through November 2012, U.S. imports from Canada totaled 8.7 billion board feet, an increase of 9% . However, the dollar value of those 2012 imports over the 2011 period represented a 22% increase, an indication of the intense price spike that occurred. Long term, there is concern about Canada’s ability to increase imports to the U.S. to compensate for higher demand expectations. So, once again, where will the wood come from?
The lumber market has continued to expand into a global entity over the years and China, with its robust housing needs, has become a significant player in that development. China can only generate roughly half of its own wood fiber needs but rather than importing lumber products, China’s government prefers importing raw logs in order to stimulate their own economy through the job creation and revenues that manufacturing can provide. The Canadian lumber industry has long been reliant on the U.S. as their main source for exporting lumber. With the collapse of the U.S. housing market Canada was forced to turn toward China as a trading partner, doubling their export volumes between 2008 and 2010. Favorable ocean vessel shipping costs also facilitated the trend with one Canadian producers claiming they could ship a carload volume of dimension lumber to China for about $5,200 compared to $7,500 to transport it by rail to Chicago. China’s construction market slowed in late 2011 and most of 2012 but it appears their housing and wood demand is poised to grow after the new government’s economic policies are unveiled in early 2013.
North American lumber mill capacity was significantly depleted during the U.S. housing recession. According to data from Forest Economic Advisors, since 2008, 146 sawmills were closed across the U.S. and Canada. This represented a combined volume of 15 billion board feet, or roughly 20% of North America’s 79 bbf capacity. Of these 146 mills, 58 were permanently dismantled and taken from the potential supply pool. Of the 58, 36 were U.S. sawmills and 22 were Canadian. An additional 35 facilities were put into idled status but remain intact with the potential to revive. This included 20 U.S. and 15 Canadian operations. In another category, there were 21 more properties (12 U.S., 9 Canadian) whose closures were announced as permanent but their future seems more uncertain. These mills have gone unaltered but reopening them seems unlikely under their current ownership. Six mills were closed but whose condition and status is unknown. That leaves 26 sawmills that were placed in closed or idled status but that have since been revived and are currently operating at some level of capacity. Certainly, additional production will come back online to try and meet growing demand. However, it will take more confidence, time, and money to make it happen, not to mention workforce. Until then, tight supply conditions will test the wood products markets and you can expect higher highs and much higher baseline prices.
As always, Share your comments below on your experience with this volatile market and on the information in this article.
Be on the lookout for Part 5 of The Perfect Storm where we will continue to look at supply side dynamics, reviewing how lumber channels through distribution and the various influences to the marketplace along the way. We will also explore how builders & general contractors are coping with the impacts of this rising lumber market on their rough carpentry budgets.