Forestry and Lumber Key Sectors of our National Economy

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By Angus Gillespie

For many generations, the lumber industry has provided a way of life for Canadians, not only for domestic use but also exporting our wood products to our other countries. By far the strongest regions for this industry have consistently been British Columbia, Ontario and Quebec – and it’s a pattern not likely to change any time soon.

According to the Conference Board of Canada, profits this year are expected to double that of last year which would mean an additional 6,000 more jobs.

A major factor for the increase in exports is the U.S. market, where a recovery in the housing market has resulted in a marked increase in the need for wood.

“Canada has been diversifying its export markets away from the United States for several years, and gains in export sales will be responsible for industry growth in the next few years,” said Michael Burt, Director, Industrial Economic Trends with The Conference Board of Canada during an interview with CBJ.

Since the Softwood Lumber Agreement (SLA) took effect six years ago, Canadian wood exports south of the border have declined more than 60 per cent.

Through the first nine months of 2011, total wood exports to the U.S. were down 11 per cent, or almost $500 million, compared with the same period in 2010.

In January, 2011 Canada lost its second arbitration case brought forth by the United States under the SLA and adjudicated by The London Court of International Arbitration tribunal.

Additionally, the U.S. made claims that British Columbia has been selling timber at prices below those determined by the pricing system developed under the SLA. The U.S. government has been staunch in its assessment that this action represents an uneven playing field.

Buoyed by its tribunal victory, American produces demanded just under $500 million in compensation.

Global Outlook

“The overall fragility of the American economy and continued U.S. softwood lumber litigation are contributing to Canadian wood producers’ search for further export markets,” Burt continues. “Ongoing demand in China – and Japan’s need for wood to rebuild following the March 2011 earthquake and tsunami – will support growth in Canadian wood exports to these Asian countries.”

Other markets have already started picking up the slack created by Lower American demand has resulted in other markets picking up the slack. Last year, 63 per cent of our wood exports went to our neighbours to the south between January and September, down from 86 per cent six years ago. Following a parallel timeframe, the Chinese market has gone from 1 per cent to 13.5.

The most recent industry outlook by The Conference Board of Canada works on the assumption the U.S. and European governments will implement policies necessary to avoid another serious global downturn, although to say optimism in that regard is high would be considered cautiously optimistic, at best. The possibility of a bleak future has gained momentum in recent weeks with further headlines on the European debt crisis, particularly in countries such as Italy, Greece, Spain, Portugal and Ireland. This type of crisis invokes a ripple effect that hits consumer confidence. In fact, confidence levels have recently dropped to levels not seen since the height of the 2008-09 recession. The last 30 months would best be categorized as guarded optimism, but most people seem to have been expecting a relapse in Europe was a likely possibility.

The Canadian economy is largely driven by exports and so the damage elsewhere would definitely impact on us here. This would impact on the housing market, bringing down housing starts as well as domestic and international demand for wood products.

Demand is expected to increase in the U.S. but arduous, ongoing battles over softwood lumber have played a significant role in convincing Canadian producers to find other markets to sell their products.

Meanwhile, the Conference Board of Canada’s Index of Consumer Confidence continues to fluctuate in these uncertain economic times. After rising steadily in the first quarter of 2012, the index reversed course sharply in April, rose in May, and then fell again in June, dropping 6.8 points.

Infestation Concerns

One issue moving forward is evidence of the spread of pine beetles, which up until now has been largely confined to Alberta. Aside from that, growth within the industry has been relatively flat in the prairie provinces of Manitoba and Saskatchewan and Alberta attributed in part because they are in a battle with other industries for labour where compensation can be lucrative such as the oil sands.

“There may be more impetus to increase cutting activity in Alberta going forward just to try and control the pine beetle problem that may be developing there,” Burt notes. “To try and control pine beetle they ramped up the number of trees they’re allowed to cut to try and get as much value out of the trees that have been killed by pine beetles as possible.”

A viable concern for those within the industry is the likelihood of the infestation spreading to other regions. It’s always a possibility, but as of now there has been no documented proof that the problem has spread outside Alberta.

“it’s hard to keep track of but essentially they spread over the mountains into Alberta; their primary food source is Lodgepole Pine, which grows on the mountains,” Burt reveals. “At some point in Alberta you transition from mountain-type forests to boreal forest.”

The question and concern now is whether the beetles can transition from Lodgepole Pine, their traditional food source, to other types of pine that grow in boreal forests like Jack pine. If they can do that, then there is the possibility of the infestation being able to spread across the country. As of now, there is no evidence to support that is happening.

Asia-Pacific Partnership

With the United States still feeling the effects of the global economic slowdown, our neighbours to the south have been importing less lumber and so, as with many other Canadian industries, forestry and lumber have been looking to other potential markets. It should come as no surprise that China once again goes to the top of the list. It’s a huge country with enormous infrastructure requirements. Burt sees China as being a key trading partner in the future.

“It’s primarily a B.C. story but it’s been a big source of growth for the industry over the last couple of years,” Burt says. “It accounted for 13.5 per cent of our exports last year. The next biggest market after that is Japan but it hasn’t been a major source of growth for the wood products industry for many years – basically back to the 1990s because their economy has been rather moribund for quite some time.”

“China is one of these markets where they are fibre poor – they don’t have a lot of domestic supplies of trees so they have to import all of their logs, trees and wood from somewhere else, so we’ve benefited from that both in terms of lumber and pulp production as well.”

“A couple of years ago, Russia was a major source of logs for China but Russia raised their export tax on logging exports to try and encourage people to build sawmills Russia,” Burt continues. “But this was done in an environment where there’s a lot of excess capacity in North America and so we kind of stepped into that void. Over a span of three years our exports mushroomed to China.”

To accentuate the point made by Burt, statistics show that in 2008 the value of exports came in at about $200 million; they had more than quintupled to almost $1.2 billion in 2011. But the pot of gold for the Canadian industry has likely reached its peak because the Russians have since made readjustments, no doubt realizing they overestimated their position and are now seeking to recapture some of that lost market share, permeated largely by greed and the thought they were the only legitimate trading partner in the game.

“Russia has reduced their tariff and so we don’t expect to see the same amount of growth in China,” Burt states. “We aren’t going to see another quintupling of exports to China.”

Despite the fact Russia is now looking to make amends, and will no doubt get some of the market share back in a relationship with China, Burt believes Canada should be able to maintain its solid exporting situation with China moving forward.

“I don’t expect to see large drops in the exports to China, but I don’t think it will be the same source of growth that there has been in the last couple of years.”

Most of the wood products going to China are being used in the construction industry for things like framing of forms for concrete. But as with all nations, the Chinese economy has also been slowed as well as cyclical factors that will see a slowdown in the near future.

A positive for the forestry and lumber industry is that there really hasn’t been a whole lot of arduous negotiation with the Chinese communist government, likely because of the inherent immediate need they had to receive it.

“Generally speaking, it’s something they need so they’ve made sure the wheels are moving,” Burt states. “They need it for the construction industry and their furniture industry need wood inputs but again they don’t have a lot of domestic sources of supply so they have to import that wood from somewhere. When talk about furniture a lot of it is hardwoods coming from southeast Asia rather than Canada but China needs those raw material inputs so they try to ensure they can get the resources they need.”

“The softwood lumber dispute is not going to go away but we did renew the current agreement through 2015 quite recently so the good news is that the Americans seem to be working within the terms of that agreement,” Burt says. “There’s a dispute right now regarding how much of the lumber coming out of B.C. is being graded as the lowest grade.”

In basic terms, the Americans think the grading is not right and so the stumpage fees being applied are also not correct. However, both sides are working within the parameters of the dispute mechanism system sourced out to a third-party system in the U.K. that has been set up to mediate such disagreements.

Projections

The latest projections for the Canadian forestry industry indicate that in 2011 the industry lost just over $100 million but pre-tax profits in 2012 are expected to come in at $200 million, so it’s a movement of a small loss to a relatively modest profit.

“Pricing has improved in the last few months and there will probably be a correction later in the year, just because there’s a lot of excess capacity whenever prices move up like this in the last few years producers start to make more lumber and prices start to move back down. There’s definitely going to be some benefit from higher prices, plus we have seen some pretty good construction activity here at home and residential construction activity in the U.S. is showing improvement. The levels are still very low in the U.S., but they’re moving in the right direction.

“Residential construction activity is the main use for wood products and some of it is used for things like making forms for concrete. Even indirectly a lot of it is tied to residential, so example wood that goes into furniture, most of that ends up being used for residential purposes.”

“Housing starts is a good indicator, but the caveat to remember is that new construction is only about half of total residential construction activity, the other half being renovations.”

“Out of necessity the industry has had to try and diversify in the last few years. But as the economy improves in the U.S. there is going to be a significant increase in construction activity so we do have quite a positive outlook for this industry in terms of growth over the next three to four years and that’s largely driven by exports to the U.S. rising as the housing market there improves.”

Burt went on to say that over the next five to 10 years there will be a noticeable decrease in the amount of allowable cuts. That could well result in supply shortages in some areas, including the interior of B.C.

“Canada-wide there is not a shortage of supply,” Burt confirms. “Where some of this excess capacity that we’re not using right now is in places like the prairie provinces where the industry has not been as developed as it has been in B.C., Ontario and Quebec.”

Burt believes a number of other regions have the potential for increased development, including the likes of New Brunswick, but there will be a cost factor involved – and it’s going to be significant, which is just a part of doing business.

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