Sawmills in US South have 25-30% margin and those in Eastern Canada just around 10-15%

October 16, 2017
BC Interior has an advantage over the West coast of USA, but mainly because of currency. If there were any subsidies, American companies would be buying mills in Canada and they are not. There are three companies in BC that have purchased 48 sawmills in the U.S since 2004. Interview with Russell Taylor, President at Wood Resources International.

- In August International Wood Markets Group was sold to Forest Economic Advisors. Why did you decide to sell the company?

- I think that it is mainly a succession strategy. FEA is very heavily focused on North America. We're focused on North America too and we do a lot of international reports and research. So the idea was to consolidate our experiences and expand the international exposure for FEA. It's very much a win-win situation. FEA is focused on solid wood products such as lumber, OSB, plywood, MDF, engineered wood products. It is a meaningful development for the combined companies with more coverage for the North America market with more and more expansion in export markets, so it will yield some very strong forecasts.

- Will there be any drastic measures in the methods of analysis after the merger?

- It is business as usual, but first, we’re going to figure out our strong sides and then the combined groups will have a bigger footprint and we will look at some deeper analysis around various topics, market research, etc.

- In April the Trump administration set countervailing duties of up to 24% on Canadian imports. Additional duties of as much as 7.7% followed in June. How did this change the US market and which countries' markets most benefited from the CVD?

- Starting in late January, 90 days prior to the start of CVD, lumber prices started to rise and basically were up by to 20-25%. Since late January they have stayed at very high levels ever since and basically some product prices hit all-time highs. So, obviously, the countervailing duty has pushed up prices. The anti-dumping duty (ADD) started in late June and added another 7%, so that's again supported higher prices. The Canadian exports are relatively flat after increasing substantially in 2016; this year the Canadian sawnwood export trend is flatting out as the duties have an impact on some smaller companies. The imports from Europe, in particular, have increased, because of higher prices so they can now come into the US market. These exporters are from Germany, Sweden, but to a much lesser extent, Russia. But countries in Latin America, like Chile and Brazil, have also displayed some substantial increases as well.

- What arguments do the American and Canadian sides have in the dispute?

- Talking about the basis of the claim, Wood Markets knows the answer because we know and have the facts. Americans are always using the data to tell us their story. The Canadian side is telling its story to them. We got completely different and conflicting answers. But I can tell you that the highest sawmilling margin in North America has been US South – since 2008. They're claiming that Eastern Canada has subsided lumber prices to make its business better. But Eastern Canada has the worst earnings results in North America. So, we would ask "Why? How is it possible that the US South has claims against Eastern Canada?” Because the average margin in the US South is around 25-30% earnings this year and Eastern Canada has been around 10-15%. The West coast of the USA has the highest log prices in North America, which squeezes the margin because the logs have been bought by Japanese and Chinese buyers, pushing up the log price. In BC Interior we don't have high log prices due to smaller timber that is located far away from sawmills, plus mills are still processing significant volumes of older dead timber from the mountain pine beetle infestation. Oregon, Washington, and BC Interior have had somewhat similar operating results following the global financial crisis, but since 2015, with the currency devaluation of the Canadian dollar - like with the Russian ruble – it has achieved a 20-25% currency advantage. And now BC Interior has an advantage over the West coast of USA, but mainly because of currency. If there were any subsidies, American companies would be buying mills in Canada and they are not. There are three companies in BC that have purchased 48 sawmills in the U.S since 2004. U.S. South produces about half of all American lumber. For example, last year BC Interior produced 12 billion bdft and U.S. South produced 17 billion bdft.

- How have American imports and Canadian exports changed in connection with the introduction of the CVD?

- Canadian exports have been relatively flat, because of duties and because of production levels which in the U.S. are increasing. Canadian exports to the USA are also flat, with no changes, but there is increase to Japan, Korea, Taiwan and few other markets. Meanwhile, the Europeans, particularly Germany and Sweden, have increased their exports to the USA displaying a double or triple increase in volume compared to the previous year. Russian volumes have also grown by up to three times but from very low levels. Brazil has increased its export 54% in the first six months of this year. Last year this country exported 100 million bdft. It’s still relatively small volume and it comprises 0,2% of the U.S. consumption, while Canada has 97,5% of it. Canada is by far dominant importer of the U.S. market.

- Will the sanctions prevent Russia from increasing the export of lumber in the US?

- No, there is nothing preventing Russia from exporting into any markets, including U.S. It is more about a “war” about the flow of capital between two countries not flow of wood products. So, that's should be fine.

- In August, Canadian producers received a deferment from an implementation of final import duties until November 14. What was the reason for such a decision and whether the two sides will be able to agree on lower tariffs?

- U.S. trade law allows for preliminary duties that are put on for only four months and then they had to the decision to make when they will do the final duties. In all previous such situations, the U.S. has always extended the deadline by 60 days. After 14 November they need another 45 days to determine the final duties which will be probably announced around 3rd January. We had expected that it will be the normal process that we saw in the past. There will be more time to analyze the situation and politicians will also have more time to negotiate a possible deal. So, this extension is normal but whether they make a decision or not - it is very difficult to predict. It's all politics.

- How did the introduction of duties affect the US wooden housing market?

- It did not impact the housing market much. Lumber prices were up by 20-25%. At the same time, prices of OSB were up more - by 35%. The duties helped prices pushed up but the strong demand is also up, so the extra cost on house is relatively small - around $5,000 for lumber and OSB to the consumer. However, when you pay $1 million for a home it's a small increase but it can be a significant increase for a lower priced, starter home.

- How will the hurricanes and fires in western Canada affect the prices of lumber in the US?

- The forest fires reduced the log supply because a lot of logging has been shut down for about 6 weeks – longer in some locations. The log supply for mills is going to get lower, and for some sawmills, it is great problem because they will not be able to increase their wood supply until winter logging starts up. That could support firmer prices during the winter season. The current tight supply may hold prices at high levels after September. The hurricanes have already caused big increases in prices of OSB and plywood because these products are used to board up houses. For 3-4 weeks after the hurricane, they normally spike and this has been the case in September. Perhaps there will be a smaller increase of lumber prices but not so much, because a lot of lumber is not used to solve problems after a hurricane. Once insurance claims are finalized, then the rebuilding starts and this should be later in 2018 and that could cause a small increase in U.S. consumption.

- Is Canada's share of USA sawn softwood market declining?

 - From 1991 to 2006, Canada's market share of U.S. sawn softwood consumption was always in the range of 32-34%. It fell in 2009 to 23% and since then it has moved higher - again back to 32%. In 2016 there were no duties on Canadian lumber to the U.S., so more production moved back into the U.S. market. Going forward in 2017 production is not increasing in Canada, shipments to the U.S. are not increasing but consumption is growing. So Canada's market share will start to ease a little bit. Production will not increase because in BC Interior we have the problem of pine beetle, which killed 20% of our total trees. So, BC Interior which has 45% of Canada's production will see a steady decline in output for the next 5 years. Already 25 sawmills have been closed in the BC Interior since 2006 and we expect around 3 or 5 another mills to close to 2025. Production declines will continue. The rest of Canada will have some increases in production, but relatively small. So overall Canadian production is expected to remain relatively flat, especially with duties on lumber exports in the U.S. It is unlikely that we going to see an increase in export volumes from the USA as prices are very already high. The decline of Canada’s market share of U.S. sawn softwood consumption will probably get down to around 26% over the next five years.

- How big is the problem of pine beetle in BC? How is it possible to solve it?

- It is like forest fires which cover a large territory and quickly expands. This process cannot be controlled. Nothing can kill a pine beetle, only a cold winter. We have not had a cold winter since 2000. These beetles have been expanding and they have killed about 20% of standing trees in BC and 60% of all pine trees have been killed. Some of them have been salvaged, but these trees are now too old to be economically processed. So, in BC Interior production will be declining further for the next 10 years. And so pine beetles are really a big issue, causing a lack of sawlogs.

- What are the prospects for New Zealand? Will this country take a significant share in the US market?

- New Zealand is a relatively small supplier to the U.S. market. It has about a 0.2% of the US market. Last year New Zealand shipped to the U.S. 90 million bdft while Canada shipped 15 billion. New Zealand shipped a lot of volume to the U.S. market prior 2005 and since then it has been going down. Their export volumes to Australia are still stable as I recall. In 2006 New Zealand and Chile have found new markets for their wood, like China, Philippines, and Europe and now they do not need U.S. market like they did 10-15 years ago. Also, they don't ship structural lumber, they ship non-structural or appearance grade lumber. Besides, they ship moldings to the US molding market.

- What is the potential of Brazil and Chile?

- Brazil has a volatile currency rate. When the currency is weak, U.S. market looked very good for them. Brazil also delivers to the US market large volumes of plywood. Brazil seems to be definitely trying to increase its volume to the U.S. market. In 2016 Brazil was actually third largest lumber exporter to the U.S. after Canada and Chile, which had 200 million bdft compared with 109 million bdft of Brazil. Chile's volume was down by 35%, Brazil's was up by 54%. So, this year Chile and Brazil are going to be close, but volumes are still tiny relative to total U.S. consumption.

- What are the shares of Germany, Sweden and the other European exporters?

- In 2016 Germany exported 80 million bdft and Sweden had 100 million bdft of US exports – it is still relatively small. But through five months of this year, Germany upped its volume by 150% and Sweden upped by 80%. In addition, Austria also increased its exports to the US by 100% from a very low level. The Czech Republic also increased shipments by 140%. So, we can see that European volumes are starting the move now. Starting in February, prices will be high enough for Europeans players to come into the U.S. market because of the import duties on Canada. We expect higher prices next year and thereafter we expect to see much larger increases of lumber from Europe to the U.S. market. Russia has very small export volume, but it also tripled so far this year from the very low level. And I think personally, that for Russia, markets will be more suitable in European, Chinese and Japanese markets because the net prices are going to be higher into those markets than into the U.S.  Consequently, there will be more opportunities elsewhere. Some Europeans companies are telling me that they need very high prices in U.S. market before going there because they get high returns with their product line into other markets.

- What about the Asian markets? What trends are currently observed in this region?

- We see a good sawnwood rebound of the demand in China in particular. China is the engine which is driving Asian imports. Last year Chinese sawn softwood lumber imports reached the record level of 21 million m3 and Russia was the dominant supplier with over 50% of market share of softwood lumber. It gained 30% last year which is a huge growth. Europeans also gained an increased with smaller volumes. But Canada, which is the second largest supplier, is declining for the third year in a row. It has been declining by 10-15% every year since its peak in 2013 when it had a high volume of supply. So far in 2017, Canada is off 14%. So, we can see that Canada has better market’s returns in markets like the U.S. The companies in Sweden and Finland are finding a good fit in China with their furniture grade lumber and they get good returns from China, therefore their volumes are going up. In Japan, housing starts have been increasing. In 2016, there were 925,000 new housing units and this year is forecast to reach about 950,000 units. That is a surprise because the demographics suggested that housing starts would be lower, but they are moving high, and it is a good opportunity for exporters to Japan as well.

- How has the cost of Russian sawnwood changed in China?

- Prices have been very steady. We've seen how they bounced a little bit with Chinese New Year, but overall, the price trend has been gently higher. With good prices, you get higher export volumes too. So, that's the real attraction of China.

- What problems can Russian exporters face in China?

- With the ruble devalued, they gained a huge competitive advantage. Logistics cost to China that were previously very expensive before the devaluation and they quickly reduced and production costs also got reduced. Market prices are in U.S. dollars but they went lower, but Russian exporters have been able to be very profitable. At the same time, they increased their capital expenditure at mills and in harvesting equipment. So, they got more efficiencies now with their low-cost sawmills. With new equipment, they can also get better recoveries. Really, Russians have no problem with China, because they're making money and I believe that Russian exports will continue to grow and Russia will remain the dominant player in the Chinese market. It is hard to say how much this growth will last, but it has been quite spectacular so far.

- What are the current trends in the Japanese market?

- Lumber imports in Japan have been declining slowly. For example, in the late 1990s they were around 10 million cubic meters per year. In 2016 Japan imported 6 million m3. So imports have declined slowly and steadily. But since 2014 we have seen an increase in imports in Japan and that's a good sign. The Russian volumes there have been very steady but at low levels. Japan has some of the highest prices on lumber in the world, but it's very difficult to meet its grading and quality standards. I know that a lot of Russian companies face with this problem. But the new equipment and technology being employed now in Russia make it easier. Russia has about 20% market share of the Japanese imports. Its volume has grown since 2000. At the same time the Canadian share has been declining, and the European share has been increasing. So, Europe and Russia have a chance to grow more in the Japanese market going forward, because they have the right wood quality, flexible sizes, and the right technologies.

- How much did European producers increase their share in Japan in 2016?

- European volumes have been increasing steadily since 2007. Finland has the largest market share - 35%. Of the other European volumes, Sweden has about 30%, Austria has15% and the rest of the countries have about 25%. So, among Europeans, Finland and Sweden are two major players there as they are in China.  It's a little bit like British Columbia – they are focused on the best market returns that are achievable. This becomes a matter of market priorities. For the Europeans, the top market now is China for volume, and the second market is Japan because of higher returns. BC ships to the U.S. market firstly in terms of volume, to China secondly and Japan thirdly (but achieves the best returns). In Europe shipments, for example, from Sweden to Germany are called exports but they are not exports from Europe, but it is still called exports from Sweden. Such terminologies are somewhat misleading when it comes to comparing exports from Europe with export from other countries.


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