By Keith Norbury

A decade after the mountain pine beetle devastated the interior forests of B.C., the most accessible of that dead wood has already been turned into marketable lumber. The industry has reached a turning point just as the U.S. housing market is stirring from its Great Recession slumber, and demand from emerging lumber markets remain solid, according to industry insiders. A looming fibre shortage has implications not just for construction-grade lumber producers in B.C., but for lumber producers across Canada and the rest of the world. “The industry is going down a path it hasn’t been down before,” said Mark Kennedy, a Calgary-based forest products analyst with CIBC World Markets Inc.

Pine beetles cut a wide swathe

Beetles killed just over 59 per cent of the pine beetle forests in the B.C. interior, Mr. Kennedy pointed out. Since those forests represented about half of the province’s softwood inventory, the beetle infestation affected about 30 per cent of B.C.’s standing softwood timber.

“The industry has been processing primarily beetle-killed timber for the past ten years,” Mr. Kennedy said. What’s unclear is whether five years from now, mills will still be able to turn the beetle-ravaged wood into saleable lumber, Mr. Kennedy said. Meanwhile, production of lumber from green timber is falling off because of a lack of supply (the beetles having killed most of it).

“To put some perspective on it, back in the last U.S. housing peak of 2005, the B.C. interior was producing about 15 billion board feet of lumber a year,” Mr. Kennedy explained “And last year, in 2013, that number was about 12 billion board feet. That includes production from beetle-killed timber.” As soon as the mills are forced to rely on green timber only, the best estimates are that production will drop to 9.5 billion board feet, he said. “Lumber prices are high enough now that if mills had adequate fibre supply, they could run and make money,” Mr. Kennedy said.

A lack of fibre, however, has forced timber giants Canfor Corp. and West Fraser Timber Co. Ltd. to announce mill closures in the B.C. interior. Canfor closed its Quesnel mill in March, eliminating 208 jobs, and West Fraser’s Houston mill is also slated to close, eliminating 225 jobs.

Beetle-free regions face other challenges

Can coastal B.C. timber take up that slack? No, said Mr. Kennedy. B.C.’s coastal forests produce higher-grade lumber, such as Douglas fir and cedar, suited for finishing work rather than framing buildings or concrete forming. “There’s really nothing on the coast that can make up for this reduction we’re going to see in the interior,” Mr. Kennedy said. Similarly, Saskatchewan and Alberta timber is “pretty well maxed out,” he said.

Since the last U.S. housing peak in 2004-2005, annual production from B.C.’s interior has declined by some 5.5 billion board feet, to about nine billion board feet. Meanwhile, Quebec and Ontario had their combined production drop by 4.5 billion board feet, to about 7.5 billion. Much of that was because Quebec reduced its annual allowable cut by about 35 per cent. “It was mostly because they came to the realization that in the 1990s and 2000s they have been over-cutting their forests,” Mr. Kennedy said. “To have a sustainable forest harvest they had to ratchet down the cut pretty dramatically.” The 2010 Canadian Boreal Forest Agreement, a pact between 19 Canadian forest companies and seven environmental organizations, also set aside expanses of forests in Quebec and Ontario to protect habitat for such creatures as woodland caribou, he noted.

On the B.C. coast, producers don’t have a fibre problem, said Rick Jeffery, CEO of the Coast Forest Products Association. “They have an access problem and an economic problem.” He blames that on parks, conservation measures, and forest-practices requirements that “have reduced the size of the working forest.”

Coastal producers also have “cost issues,” which they are working hard to address. In 2011, those costs totalled $599 per thousand board feet, which compared with $609 in 2010, according to a November 2013 PricewaterhouseCoopers report on the economic impact of the B.C. coastal forest industry. In comparison, production costs in B.C.’s interior range from $300 to $350, Mr. Jeffrey said. Fortunately for coastal producers, their products also fetch a much higher price, around $700 per thousand board feet. “While coastal producers have a cost issue, they also produce very high-value products,” Mr. Jeffery said.

Peak lumber not expected to meet demand

A fibre crunch has been anticipated for decades, even before the pine beetle catastrophe. Mr. Kennedy said that North American production capacity is expected to peak at 65 billion board feet annually, compared with about 75 billion during the last housing peak. So that means a drop of ten billion board feet because of reduced fibre availability. “We aren’t going to be able to produce the same volume of lumber in 2017 or 2018 that we were able to produce in 2005 because of these issues,” Mr. Kennedy said.

Elle Xu, Forest Products Manager with Canada Export Centre, said she expects Canada’s forest industry will slowly drift away from B.C. — to Alberta, Saskatchewan, and eastern Canada. Canada Export Centre’s Saskatchewan sawmill is doing really well, she said, “because in that area there are not that many sawmills, and they can digest the local volume very quickly.” Most of that production is destined for the local market and the U.S., while about half of the output from the company’s other mill in Quesnel, B.C., is going to Asia. On the whole, only about five to 10 per cent of production from the two mills, which totals substantially more than 150,000 cubic metres annually, goes to China.

So much depends on U.S. housing recovery

The big question on the minds of everyone involved in the lumber trade is when U.S. housing starts will return to historical levels. For 50 years, those starts have averaged about 1.5 million units a year, Mr. Kennedy and others pointed out. During recessions, starts would drop to about a million, but rebound to 1.5 million within three years. During the most recent recession, though, the trough was much deeper, closer to half a million starts. “And here we are in 2014, this will be the fifth year into a recovery, and most forecasts this year for U.S. housing are only at 1.1 million starts,” Mr. Kennedy said. Nevertheless, he expects starts to recover to that historical level of 1.5 million within three or four years. And when that happens, “the whole lumber supply chain is going to be stretched tighter than a drum,” Mr. Kennedy said.

Another factor that will tighten the drum is exports. During the last U.S. housing boom, North America actually experienced net imports of lumber, Mr. Kennedy said. It sounds like bringing coal to Newcastle, but North America was then importing more lumber from Europe, about 3 billion board feet, than the 2.5 billion board feet that North America was shipping to Asia. “In 2013, net exports from North America were 6 billion board feet. That’s equivalent to 500,000 housing starts being put on ships and sent offshore in terms of lumber,” Mr Kennedy said.

Meanwhile, imports to North America of lumber from Europe have fallen off, to about 400 million board feet annually, while growth in North American exports have been almost entirely to China, Mr. Kennedy said.

Weaker Canadian dollar expected to help

“We’re hearing that the U.S. market is supposed to be really good,” said Morley Strachan, President of Coast2000 Terminals Ltd. in Vancouver. “It may divert some lumber from the export markets to domestic markets because you get higher margins here.” Making those margins even more attractive is the recent weakness of the Canadian dollar which has declined to about 91 cents U.S. recently compared with $1.01 at the start of 2013.

Alex Jovanovic, President of Seatrade Shipping Ltd., a small international freight-forwarding and logistics firm based in Vancouver, said he was reading that “the U.S. housing recovery is not as strong as it looked about three or four months ago.” In fact, fears of another housing bubble are frequent fodder for news reports or economic punditry. “They screwed up before,” Ms. Xu said. “Why should we think they won’t screw up again?”

Mr. Kennedy also pointed out that Canadian producers are still stinging from a 25-year battle over softwood lumber tariffs with the U.S. Now that Canadian producers have footholds in the Chinese market, they don’t want to give that up. “It’s too important from a strategic basis because they don’t just want to rely on the U.S.,” Mr. Kennedy said, noting that West Fraser and Canfor sell 25 to 30 per cent of their B.C. production to China.

Strong demand from the Far East

No wonder Canadian lumber producers are hedging their bets by continuing to foster markets in Asia. “Even though the U.S. market is looking healthier and things are more optimistic and positive down there, the Canadian industry, especially in the west here, still stakes a lot of importance on developing its export markets into China, Japan, (and) places like that,” said Paul Newman, Executive Director of Market Access and Trade for the Council of Forest Industries, which represents companies in B.C.’s north and interior.

As Mr. Jeffery pointed out, the Chinese government is forging ahead with an ambitious program, some would call it a huge social engineering experiment, to move 15 million rural Chinese residents a year into cities. And that will require lumber, for concrete forming, framing and finishing of housing, offices and other buildings. “What we’ve seen in the last few years is the social housing side has taken precedence over the commercial or private housing side of housing,” Mr. Jeffery said. On top of that, the government has tried to control the price of housing by restricting access to credit for people to buy second and third homes. But that’s had a dampening effect on the commercial housing market.

China remains a strong market for Canadian lumber, although volume gains are marginal, Mr. Newman said. He and others have, however, noticed China is beginning to buy higher grades of lumber. “As lumber prices have gone up here in North America and elsewhere in the world, Chinese customers have also been prepared to pay the higher prices,” Mr. Newman said.

Lumber prices holding steady

According to the Random Lengths framing lumber composite price index, compiled by an Oregon-based company, the average lumber price for 2013 was US$384 per thousand board feet. That was up from US$322 in 2012, US$272 in 2011, and US$222 in 2009. The 2013 figure was the index’s highest annual price since 2005, when it hit US$387.

A higher lumber price also means that Canadian producers pay a lower or no export tax on lumber sold to the U.S. That tax was established in 2007 as part of an agreement that ended a 25-year lumber trade dispute between the two countries. “The export tax is structured to be regressive. The tax is at its maximum when lumber prices are at their weakest,” Mr. Kennedy said. At its maximum, the tax is 15 per cent. But once the lumber index price surpasses $355, it becomes zero. “In 2013, Canadian exporters only paid a tax for four out of the 12 months and even then, it was only about the five per cent level,” Mr. Kennedy said. “Where lumber prices are today it’s not expected we’ll pay any tax in 2014.” That deal expires Oct. 31, 2015, and it is not clear what might replace it. However, Mr. Kennedy said, “By the end of 2015, if the U.S. is back at 1.4, 1.5 million housing starts, they will be begging for Canadian lumber.”

Across the Pacific, China is also expected to come begging for Canadian lumber. And if China wants more Canadian lumber in the future, it is going to have to pay for it, Mr. Strachan said. “Forest products will always go where the margins are better and that’s a function of price and cost,” Mr. Strachan said. That formula now favours U.S. markets over Chinese.

Mr. Jeffery said the Chinese are “very price sensitive.” They can also pick and choose where they buy their wood. Last year, prices increased beyond levels the Chinese were willing to pay, Mr. Jeffery said. “They started being noisy about that, and orders dropped off, demand dropped, and things recalibrated as markets do,” Mr. Jeffery said.

Ms Xu said exports to China were “significantly reduced” at the end of 2013 because of high prices. But she also has noticed that the Chinese are now willing to pay more. So she expects their volumes to increase in early 2014.

What about those forests in Siberia?

While Russia has 25 per cent of the world’s softwood resource, mostly in Siberia, it isn’t capable of meeting China’s lumber demand despite its geographic proximity, Mr. Kennedy said. Russia has problems with graft, labour reliability and infrastructure, for example. Not the least of those is that Chinese and Russian railways are of different gauges, which requires transferring logs between railcars at the border.

Russia has also already harvested its “low-hanging fruit,” he said. “To move a log from eastern Siberia into the coastal cities of China costs about $90 a cubic metre,” Mr. Kennedy said. “That’s just to move a raw log, that’s just transportation costs, whereas to move 1,000 board feet of kiln-dried lumber from Prince George into Beijing is about $35 a cubic metre.” As a result of such high costs, Russia’s annual logs exports have dropped in the last decade from 25 million cubic metres to about 11 million, Mr. Kennedy said. Tiny New Zealand actually shipped more logs to China in 2013 than did Russia, he said. North American lumber is also helping to replace that diminished Russian timber supply, which Mr. Kennedy attributed to a punitive log export tax imposed by Russian President Vladimir Putin. It was intended to create more log processing opportunities in Russia “but has really just served to crank down their volumes overall,” Mr. Kennedy said.

Mr. Jovanovic, however, noted that China has other alternatives, such as Australia and southeast Asia, besides buying lumber from Canada. He likened the situation to the global coal market. “Canada thought that it was the only player,” Mr. Jovanovic said. “Well, there are others.”

Lumber market changes affect transporters

Demand from China has also had a huge impact on the way lumber is transported. “With the increase in exports to China, that volume is almost all shipped in containers,” said Dave Lucas, Vice-President of Operations for Western Stevedoring, part of the Western Group, which also includes Coast2000. He estimated that about 93 per cent of lumber exported from the lower mainland of B.C. now leaves in containers.

That has had a huge impact on Western Stevedoring’s Lynnterm operation in North Vancouver. A breakbulk facility capable of handling a billion board feet of lumber annually, it is now operating at about a tenth of its capacity, Mr. Lucas said. As part of Western’s strategy to deal with that transition, it acquired Coast2000 a few years ago. Western is in turn owned by SSA Marine of Seattle.

Canada’s two major railways also move a lot of wood. Lumber accounts for five per cent of Canadian National Railway’s total revenues and 36 per cent of its forest products revenues, said an email from Mark Hallman, CN’s Vice-President of Communications. CN expected to move about 110,298 carloads of lumber in 2013, a six per cent jump over 2012, and 47 per cent higher than in 2009. About 10 per cent of CN’s overall revenues relate to the U.S. housing market, Mr. Hallman said. And 60 per cent, or about 66,175 carloads, of the lumber it handles goes to U.S. markets from Canada.

“Lumber shipments to Asia, including China, have increased significantly over the past five years,” Mr. Hallman said. Those Asian markets now represent 20 per cent of CN’s lumber business compared with three per cent in 2005. “As the U.S housing market continues to improve, it is expected that Western Canadian lumber producers will maintain their footprint in Asia, and continue to pursue both domestic and overseas markets,” Mr. Hallman added.

Mill closures and fibre shortages have created a challenge for CN as it has tried to enlarge its lumber business, Mr. Hallman said. To address that, CN is “providing extensive transloading and intermodal transportation solutions to non-rail served lumber producers and receivers,” he said. CN has also improved “network capacity in key lumber corridors within Western Canada” in order to operate more efficiently in severe winter weather.

Canadian Pacific Railway, meanwhile, obtains about three per cent of its revenue from forest products, with lumber accounting for 31 per cent of the latter, said spokesperson Ed Greenberg in an email. Forest products revenues rose seven per cent in the first three quarters of 2013, to $157 million, compared with the $147 million in the same period in 2012. That followed a two per cent increase in 2012 to $193 million from $189 million in 2011.

Super cycle anticipated, or not

Increased U.S. demand from improved housing starts, combined with continued growth in demand from China has some analysts predicting a “super cycle” within the next few years. Mr. Jeffery doesn’t buy that. He said lumber products are commodities that are subject to the same basic supply and demand functions as other commodities. “There is an upper limit to the price that can be achieved for commodities like lumber,” Mr. Jefffery said. Nevertheless, Mr. Jeffrey said a revival of the U.S. housing market is welcome news for B.C.’s coastal lumber producers. While they don’t sell much structural lumber, like 2x4s, to the U.S., Mr. Jeffrey noted that “a rising tide floats all boats.” So a healthy U.S. housing market also buoys increased demand for industrial lumber, such as railroad ties, utility poles, sound-abatement fencing, and oil-field matting, which are made from coastal B.C. timber.

Demand and supply from Europe

When one thinks of timber, the wilds of British Columbia more readily spring to mind than the forests of Bavaria. However, Mr. Kennedy pointed out that western Europe’s sawmilling capacity of 60 million board feet is almost equal to North America’s capacity of 70 million. “But because of their weak economy, their sawmills are only operating at about 70 to 75 per cent of operating capacity, versus mills here that are running closer to 85 per cent.”

The tentative Comprehensive Economic and Trade Agreement, or CETA, that Canada signed with the European Union in October 2013 would also eliminate European tariffs averaging 1.2 per cent on Canadian forest products. Western Europe already has much higher fibre costs, $100 to $110 per cubic metre for timber versus half that for an equivalent log in North America, Mr. Kennedy pointed out. “Because of their much higher fibre costs, you would need to see lumber prices over $450 (per thousand board feet for spruce-pine-fir grade or SPF) to really start to see European lumber coming into North America,” Mr. Kennedy said. Should U.S. housing starts return to historic levels, however, it wouldn’t shock Mr. Kennedy to see prices reach those heights. And that will be good news for Canadian producers, at least for those with access to green timber, such as the major forest companies.

Mills were already quite profitable at a price of $370 for SPF. “So at $450 or $500 they’ll really be producing good cash flows,” Mr. Kennedy said. “Now stumpage rates are going to go up too. So they aren’t going to be able to keep all of that. But they’re still looking at a pretty optimistic future, I think.”