By Keith Norbury
Canada’s lumber production and trade has steadily increased since bottoming out in 2009 in the wake of the global financial crisis. Expected to add fuel to that rising trend in 2015 are a stronger U.S. economy and increasing U.S. housing starts, a sagging Canadian dollar, and the global drop fuel prices, according to forest industry experts and analysts. Looming over those prospects, however, is uncertainty about whether or not Canada can forge a new softwood lumber agreement with the U.S. after the current deal expires later this year.
It’s a big business
Canada’s forest products industry is split almost 50/50 between lumber and pulp and paper, said David Lindsay, President and CEO of Forest Products Association of Canada, which represents the country’s major forest products companies. “It’s a big business,” Mr. Lindsay said. “We export huge volumes. Our total production is something like $55 to $57 billion, and more than $35 billion of that goes to international sales.”
According to Statistics Canada, the country’s sawmill production has been on a more or less steady increase since 2009. In that year, production was 45.45 million cubic metres. In 2014, it had risen to 59.62 million cubic metres. More than 97 per cent of that volume in 2014 was softwood lumber, and over 90 per cent of that was spruce, pine, and fir. Volumes in 2014, however, were still well below the 80 million plus levels of 2004, 2005, and 2006. Total lumber shipments, meanwhile are within one or two per cent of production levels. Sometimes shipments are slightly higher, such as in 2009 or lower, as in 2014.
The value of Canada’s lumber exports in 2014 was higher than it had been since 2006, according to Industry Canada’s Trade Data Online. Those 2014 lumber exports totalled C$8.67 billion dollars, more than C$1 billion greater than the $7.66 billion in 2013, and more than twice the value of the C$3.94 billion in exports in 2009. As has been the case historically, the U.S. market accounted for the majority of those 2014 exports with a 65.8 per cent share.
U.S. housing starts slowly rising
Annual U.S. housing starts peaked at just over two million in 2005, according to the U.S. Census Bureau. They were still strong, at 1.8 million in 2006. They subsequently dropped to less than 1.4 million in 2007, and to 905,000 in 2008 before scraping bottom at 554,000 in 2009. The effects of that crash on Canada’s lumber exports were profound, resulting in a “huge drop in demand,” Mr. Lindsay said. Since then, they’ve inched upward, finally edging above one million last year. “So U.S. housing starts are coming back,” Mr. Lindsay said. He hesitated to call the market “robust” instead characterizing it as a return to “a reasonable level of demand.” “Depending on how the global economy’s going, the U.S will continue to grow at a fairly good rate,” he predicted.
Considering that the historic annual average for U.S. housing starts has been 1.5 million, the present market of around one million still represents a major slump, said Jim Lopez, CEO of Tembec Inc., a Montreal-based company, which has four sawmills in Ontario and three sawmills in Quebec. “So you think about it from that standpoint, the demand for new homes is still poor,” Mr. Lopez said. Nevertheless, U.S. demand has doubled since the market hit bottom, Mr. Lopez noted. As a result, most of the mill capacity that was shut down during the slump is back online. That’s notwithstanding “seasonal fluctuations” this winter when heavy snow pounded the eastern side of the continent. “But we have a relatively balanced market. And our forecast is not for a major comeback in the short term,” Mr. Lopez said. “I think that U.S. housing will continue a very slow but steady improvement in the coming years. And if that happens, it will continue to lead a slow steady recovery in the lumber business and, obviously, earnings for producers of lumber.” A quarter of Tembec’s $1.5 billion in annual sales are in the lumber category, with 38 per cent of the firm’s total sales going to the U.S. Lumber places second to Tembec’s business in specialty cellulose, which accounts for 34 per cent of its revenues.
Mark Kennedy, a Calgary-based forest products equity analyst with CIBC World Markets Inc., said that the pace of the U.S. housing recovery continues to be the biggest driver of Canada’s lumber industry. “We just have to continue to show patience on that front,” Mr. Kennedy said. “But I have no doubt that it’s still going to get back to 1.5 million starts. Maybe it takes until 2018, but I’m still convinced we’re going to get there.”
Canadian National Railway, meanwhile, expects its U.S.-destined volumes of lumber “to increase at the same pace as U.S. housing starts,” said Mark Hallman, the railway’s Vice-President of Corporate Communications. “CN expects a low double digit volume growth going to the U.S. in 2015.”
A tale of two markets
Canadian forest companies worked very hard during the U.S. housing slump to diversify their markets by increasing sales to China, Mr. Lindsay pointed out. In 2005-2006, annual sales to China were less than $2 billion. Today they are $4.7 billion. Now, as the U.S. economy picks up steam, Canada’s forest industry is looking at a “tale of two markets,” Mr. Kennedy explained. He expects U.S. housing starts to “notch up” again in 2015, by about 150,000 starts. That would push them to 1.15 million, which is still well below that historical average of 1.5 million. On the other hand, he said, exports markets “have taken a turn for the worse.” And by that, he means Asian markets. “We’re seeing a bit of a slow down in the Japanese housing market and, more importantly, a bit of a slowdown in the Chinese market for both logs and lumber,” Mr. Kennedy said. “And that’s being driven by their real estate slowdown, hence construction slowdown.” Trade Data Online figures bear that out: Canadian lumber exports to Japan dropped to $783 million in 2014 from $899 million in 2013.
Mr. Kennedy said the gains in lumber exports to the U.S. appear to be offsetting the losses in Asia, although it varies from company to company. But generally speaking, the U.S. gains, combined with a weaker Canadian dollar, “should still more than offset the weakness we’re seeing in some of these export markets,” Mr. Kennedy said.
Beware of effects on overseas markets
Rosalyn Kunin, an independent consulting economist based in Vancouver, cautioned that Canadian producers might be tempted to abandon their recently cultivated Asian markets once the U.S. market resumes full steam. During earlier U.S. housing slumps, Canadian producers also turned to Asia only to drop those new markets and head south as soon as the U.S. market picked up. “And then at the next downturn we were hit on the head all over again,” Ms. Kunin said. “So right now, I am sincerely hoping that as the U.S. market picks up, Canadian lumber producers will not all give up en masse on Asia and other markets, but they will keep that customer base. And that also gives them a slightly better position in the bargaining for a new (softwood) lumber agreement.”
One reason that shippers might shun Asian markets is that it is becoming more costly to ship containers through the often congested port of Vancouver, said Adrian Samuel, President of Coast2000 Terminals Ltd., which is part of the Western Group. That, combined with increasing demand for their products from North America, is encouraging shippers to sell in North America, at the expense of (Asian) export markets,” Mr. Samuel said.
Mr. Lindsay, however, said that the leaders of many Canadian forest companies have told him they value customer diversification and are “very cognizant” about keeping their Asian customers. He also applauded Canada’s recent trade deal with South Korea, and noted that those in the industry are also exploring markets in India. “I think we’ve learned that you cannot be totally dependent on the U.S. market,” Mr Lindsay said.
Russia poses possible competition
If CN’s business is any indication, though, a shift away from Asia has already begun. The railway’s lumber export traffic to Asia — mainly out of B.C. and Alberta — now accounts for 15 per cent of its lumber total. That compares with 20 per cent in 2012 and 2013. That decrease coincides with 10 to 14 per cent increases in lumber traffic to the U.S. in the past couple of years, Mr. Hallman said.
And while the overall value of lumber exports to China increased in 2014 to C$1.49 billion, China’s share of lumber exports dropped to 17.14 per cent compared with 18.93 per cent in 2013, according to Trade Data Online. Meanwhile, fluctuating exchange rates are having a big impact on the Asian market, Mr. Kennedy said. The Russian ruble has declined about 45 per cent in the last three or four months. The euro has also lost about 22 per cent against the U.S. dollar while Canada’s buck has dropped about 20 per cent in the last few months.
“It’s very easy for the Russians to compete for Chinese export markets, given the significant devaluation they’ve seen in their currency in the last four months,” Mr. Kennedy said. Russia, however, is limited in how much it can exploit that market. While Russia has about a quarter of the world’s softwood timber, it suffers from corruption, poor labour reliability, and substandard infrastructure, including rail lines of a different gauge than Chinese ones, Mr. Kennedy pointed out last year. So while the weak ruble makes it easier for Russia to compete on its existing markets in China, “they can’t necessarily substantially ramp up their volume in the short term because of those logistical challenges.”
Middle East markets prove challenging
New Future Lumber, which has offices in Halifax and Moncton, is concentrating on selling softwood lumber — spruce, pine, and fir — harvested in the Maritime provinces to markets in the Persian Gulf region such as Saudi Arabia, Egypt, Jordan, Israel, and Pakistan. “It’s challenging, just the same as every other market,” said Paul Sibley, the company’s Vice-President. “You just kind of have to go after the niche and develop some good relationships with some good customers.” His partner, company President Mazin Louis is originally from the region, where he has done business for about 15 years. Mr. Louis and Mr. Sibley started doing business together about nine years ago and formed their company in 2008. At that time, the Gulf was fairly stable market compared to the U.S., where the housing market had collapsed. “So we focused on that market and built some relationships. Right now it’s worked out for us and we don’t want to abandon that market even if the U.S. market does come back,” said Mr. Sibley, whose company also has its own sawmill, called MP Atlantic Wood Ltd., in Dieppe, N.B.
At present, about 70 per cent of New Future’s production, which includes construction and furniture grade lumber, is exported to the Gulf Region. The rest is sold in the Maritimes. “We’re competing against the Scandinavian countries so it’s a tough market to be in,” Mr. Sibley said of the Gulf. Asked if the current unrest in the region is having an impact on business, Mr. Sibley simply answered: “Yes.” So it’s no surprise that the company is looking at expanding into Europe and into the U.S. “But we don’t want to be considered fair weather friends,” Mr. Sibley said.
Shrinking loonie bolsters profits
The shrinking Canadian dollar has been a boon to Canadian lumber producers, even though production has only been marginally higher this year over last. “Even if the volumes haven’t gone up because of other circumstances, suddenly lumber will be more profitable,” Ms. Kunin observed. The lower dollar also makes Canada more competitive in Asian markets, she added.
Russ Cameron, President of Independent Wood Processors Association of B.C., said the low Canadian dollar has “absolutely” benefited association members who make specialty value-added products like siding, mouldings, and panels. “And the converse was true when it was high, when it was $1.05,” Mr. Cameron said.
Dealing with currency fluctuations isn’t a problem for the small wood processors, he said. “We’re really nimble. We sell service and specialty products. But what we can’t deal with is a Canadian-imposed tax,” Mr. Cameron said, referring to penalties imposed at times under the 2006 Canada-U.S. Softwood Lumber Agreement.
Mr. Lopez of Tembec said the effect of the lower Canadian dollar depends on the product. In some cases, the price differential goes straight to the bottom line. In other cases, a producer will use the difference to become more aggressive in building market share. “Here’s my rule of thumb: you keep about half of it,” Mr. Lopez said. “The other half tends to go away mainly in price.” Also, as the company’s Canadian revenues increase in the U.S. it also charges a higher price to its Canadian customers in Canadian dollars. “So the markets really move pretty much in unison as currency changes,” Mr. Lopez said.
Battle looms over lumber treaty
While the weak Canadian dollar gives lumber exporters a competitive edge, it also makes lumber producers in the U.S. nervous, Ms. Kunin pointed out. “The Americans are going to be even more concerned about access to their markets because we will have that competitive edge,” Ms. Kunin said. That huge differential will make it much harder for Canada and the U.S. to negotiate a new softwood lumber agreement, she said. The current deal, signed in 2006 and extended in 2012, is now set to expire this Oct. 12. Should the parties not renew the agreement or fail to forge a new one, the terms of the existing agreement will extend for another year.
South of the border, the U.S. Lumber Coalition has voiced its opposition to renewing the agreement. The lobby group’s Executive Director, Zoltan van Heyningen, was quoted in Business in Vancouver last November as saying, “We are not in favour of extending the current agreement because as it is currently structured, we see problems moving forward.” That position seems at odds with comments Mr. van Heyningen made on a Youtube video in 2013 when he called the 2006 softwood lumber agreement a “source of pride” for his organization “because it allowed the industry and the communities that depend on that industry to fare a lot better than they otherwise would have.”
Mr. Kennedy said he’s not sure what the U.S. objections are about. Over the last three years, delivered log prices in the B.C. Interior have risen 60 per cent, whereas in the U.S. South, the increase has been around 10 per cent, he said. “So there’s no way you can argue that there’s any kind of free ride being given to the Interior lumber producer,” Mr. Kennedy said.
Mr. Lopez is also puzzled by the U.S. Lumber Coalition’s objections, considering that B.C. and Quebec implemented considerable reforms in their lumber pricing in advance of the 2006 deal. “What we have now are systems in those provinces that resemble a free-market system,” Mr. Lopez said. “So I would say that the number of irritants, trade irritants, between Canada and the U.S. have diminished greatly since the signing of the last softwood lumber agreement.” For that reason, Mr. Lopez is optimistic that the parties will transition quickly into a new agreement.
But even without a deal, Canada will find markets for its lumber, Mr. Kennedy said. “So the person that’s going to get disadvantaged the most, if there’s some sort of artificial trade structure put in place, is going to be the U.S. consumer again.” Canada, though, isn’t as dependent on the U.S. housing market as it used to be. During the last peak in the housing cycle, Canada had a 35 per cent share of the market. Should starts again reach those levels of 1.5 million starts annually, “the most we could take would be 25 per cent of the market,” Mr. Kennedy said.
Some Canadians dislike softwood deal too
Not everyone in Canada’s lumber industry is a big fan of the current softwood lumber agreement. Mr. Cameron said independent wood processors “just got slaughtered” by the deal, especially during periods when the agreement triggered an export tax. The tax, or export charge, varies depending on price. It can be as high as 15 per cent when the index price of lumber dips below US$135 per thousand board feet. But once the price surpasses US$355 per thousand board feet, the tax disappears. (Another option allows for a combination of export charge plus a quota.) According to the Random Lengths framing lumber composite price index, compiled by an Oregon-based company, the index price hasn’t dipped below US$355 since July 2013, although in February 2014 it came close when it sat at US$358.
While Cameron and his group “are enjoying having no tax for the last two years,” they’re worried that a new agreement would result in a higher cutoff for imposition of the tax. Mr. Cameron and his group would be happy if the deal isn’t renewed. He said Canada has always won lumber trade disputes with the U.S. under the North American Free Trade Agreement and at the World Trade Organization. He is confident that if the U.S. were to impose such duties in the absence of a softwood lumber deal, that Canada would again receive refunds. “However, if they sign a deal and Canada imposes a tax on B.C.-produced value-added products, we don’t get any refunds,” Mr. Cameron said. “That money’s gone.”
While the Canadian government acknowledges that it won those cases, it was the harms caused during the challenges, “as well as the time and cost involved in such challenges,” that led to the 2006 Softwood Lumber Agreement, according to a backgrounder on the website of Foreign Affairs, Trade and Development Canada. The agreement provides for charges and quotas on Canadian lumber while prohibiting the U.S. from launching any new countervailing and antidumping cases.
Also noting Canada’s winning history in lumber disputes, Mr. Lindsay said he hopes the U.S. lumber interests “come to their senses because they’re not supporting the forest industry, they’re supporting the legal community.”
Lower oil prices
Lower oil prices should make a difference to lumber companies, Ms. Kunin said, although she couldn’t begin to guess how much of the savings “are being passed on to the ultimate customers.”
Mr. Lindsay of Forest Products Association of Canada doesn’t think lower fuel prices are benefiting the industry at all, “unless the railway companies are now going to give us a fuel discount.” However, he couldn’t comment specifically on what fuel surcharge deals individual forest companies might have signed with the railways. Mark Hallman of Canadian National said by email that lower fuel prices didn’t have any impact on the railway’s business. That’s because its contracts include a fuel surcharge that fluctuates based on the fuel cost. However, he noted that the low Canadian dollar improves customers’ margins when they ship to the U.S.
Mr. Lopez of Tembec said the biggest impact of fuel prices is on the inbound freight. The company spends a lot of money hauling logs to its sawmills. A fuel index applies to car-tractor prices, so when the cost of diesel goes up, the company pays more, and when diesel prices drop, the company pays less.
“That said, as you are aware of, it’s amazing how robust diesel prices have been relative to gasoline. I’m not an expert in this, so I couldn’t even venture a guess as to why that is, but I’m frustrated by it,” Mr. Lopez said. On the other hand, Tembec hasn’t noticed any benefit in fuel prices on its outbound transportation. That’s because it pays for that fuel in U.S. dollars. So the stronger U.S. buck eats into any fuel savings.
Lumber mills called “captive shippers”
Depending on the location of the mill, about 30 per cent of the cost of forest products is in transportation, Mr. Lindsay said. For an inland operation, such as northern Manitoba, the costs are even higher.
Total annual production in Canada is about 58 million tonnes of forest products. About 28 million of that goes by truck, and 28.5 million by rail. The remainder is intermodal traffic. “So we’ve got almost an even split between rail and trucking,” Mr. Lindsay said. A large majority of the mills in remote communities are in the forested northern hinterlands of the provinces. The most practical way to move products from those mills is by rail. That’s because it takes three or four trucks to match the capacity of just one rail car. And each truck requires a driver.
“A mill in any given week might require 10, 12 rails cars,” Mr. Lindsay said. That would be the equivalent of 30 or 40 trucks and drivers, who need to make a round trip. The logistics of having that many drivers and trucks in a small remote community “is almost impossible,” he said. As a result, these mills are “captive shippers.” “They’re captive to the railways because their big bulky commodities have to go by rail,” Mr. Lindsay said. “And so they’re subject to whatever the railway companies are able to make available for service or are able to charge them.”
CN’s Mr. Hallman said the railway handled about three per cent less lumber in 2014 than the year before. He blamed the reduction mainly on a severe winter in which customers elected to haul more export lumber by truck than in previous years. Even so, the railway shipped three per cent more lumber in 2014 than in 2012. The record shipments of grain that the railway handled last year didn’t have a significant impact on lumber shipments by rail, Mr. Hallman said. “During winter months when extreme cold weather affects our network and our ability to run our operation normally, we do have to look at all of our traffic and prioritize it,” Mr. Hallman said via email. “But this does not stop us moving the lumber traffic that is offered to us.” The vast majority of CN’s lumber traffic — 64 per cent — moves from Canada to the U.S., with only two per cent travelling from the U.S. to Canada, Mr. Hallman said.
Mr. Kennedy said transportation was a bigger challenge for Canadian forest companies in the first quarter of 2014. “It doesn’t seem like things are as dire right now,” Mr. Kennedy said, noting that in February CN and Unifor had averted a railway strike with a last-minute agreement. “But companies have also been working to put into place more contingency plans.” Mr. Lindsay noted also that Canada’s climate and geography are other factors that make it difficult to move products from far inland to tidewater. “It’s a big country,” Mr. Lindsay said.
The shift in lumber trade away from the U.S. and toward China in recent years has also created transportation challenges, Mr. Lindsay said. “We have more than doubled our sales to China,” Mr. Lindsay said. “That offset some of the reduction of demand in the United States. But, of course, railway lines that go north-south can’t be used to go east-west.”
Tembec, however, exports very little lumber outside of North America, said Mr. Lopez. “When you are landlocked like us, the expense of going overseas is quite prohibitive,” Mr. Lopez said. His company does, however, experience railcar shortages. They weren’t as pronounced this winter as last year, when the company shut down some mills and reduced shifts on others. “This year we went in with our eyes wide open and we came with a more balanced sales plan, balancing truck and rail cars,” Mr. Lopez said. “Other than the sporadic shortages of railcars we’re in a much better position this year and our transportation issues are relatively minor.”
Mr. Hallman said a major challenge for CN last year was a greater than expected increase in long-cycle lumber traffic to the U.S. as opposed to short-cycle domestic lumber traffic. The increased average cycle reduced the railway’s ability to find enough empty cars during the first quarter of 2014 “despite removing from storage all of the cars that we had in there, in some cases for more than five years,” Mr. Hallman said. The railway also added 950 cars to its “centerbeam” fleet, a 10 per cent improvement, and implemented initiatives to reduce the average fleet cycle, Mr. Hallman said. For example, an ordering process for high- and low-velocity lanes basically supplies 100 per cent of the demand for fast-cycle lanes. And a pipeline management process stops the sending of cars to congested destinations until backlogs are cleared. “Both of these initiatives have the same goal: Reduce cycle time and increase car supply to CN’s customers,” Mr. Hallman said.
They also sound like examples of what Mr. Lindsay characterized as “right sizing the transportation system,” which was the subject of a panel discussion he took part in recently in Ottawa. Right sizing includes identifying the bottlenecks on rail lines as well as protecting rights of way and access in the rural and remote communities where many mills are located, he said. “Making sure that the carriers’ obligations to supply rail service is an issue that we’re concerned about.”
Dealing with bottlenecks at ports is also critical. Port Metro Vancouver is particularly stretched, he said. As more forest products move east to west, companies need more capacity on west coast tidewater to access markets in Asia and India. “There’s no one silver bullet here,” Mr. Lindsay said. “There needs to be a good discussion about a whole mix. We’d like to see increased competition for rail freight services. We’d like to see more multi-modal transportation capacity. The hubs of the ports need to be expanded.”