By Alan M. Field

When the U.S. and Canada agreed in ­January to extend their 2006 Softwood Lumber Agreement (SLA) for an additional two years, the governments of both countries touted the move as a stabilizing force at a time when the Canadian forest products industry was struggling with stagnant demand in the U.S. and a strong Canadian dollar. “The industry is of the view that at a time of ongoing market uncertainty, it is a good idea to extend the deal by another two years (to 2015) to provide a degree of certainty in market access to the U.S.,” said Avrim Lazar, President and Chief Executive Officer of the Forest Products Association of Canada (FPAC). Lazar said the softwood agreement has provided predictability and stability in terms of getting access to the U.S., which still buys about two-thirds of Canadian forest-product exports. “The truth of the matter is that by renewing this deal, the government has got it right,” says Lazar. SLA went into force on October 12, 2006, and was set to expire on October 12, 2013.

Nevertheless, few people in either Canada or the U.S. see the extension of SLA as a long-term solution to a conflict that has been perhaps the most acrimonious trade dispute between the two countries over the past few decades. André Tremblay, President and CEO Québec Forest Industry Council (QFIC), damned SLA extension with faint praise: “It does not solve the problems of market or economic conditions, but at least our companies exporting softwood lumber to the United States are now aware of the rules that will apply until October 2015.”

Brian Masse, the federal New Democratic Party’s spokesman on international trade issues, said that the extension of the Softwood Lumber Agreement was “a lost opportunity to fix the deal, but we didn’t take it. We are left with another two years because they put it on the backburner until 2015.” Only then will the two countries have another opportunity to decide whether to extend the current SLA or reshape the agreement to address more fundamental issues plaguing the lumber industry. “There should have been an agreement that benefits both the U.S. and Canada,” said Mr. Masse. “There should have been more jobs for Canadians as a result of the agreement.” Both Canada and the U.S. recognize that SLA is flawed, he added, but both countries “just didn’t want to reopen negotiations, which were contentious and difficult. It was a sellout then, and it is a sellout now. We had won the last arbitration case, and despite that, we signed an agreement.”

What is so fundamentally wrong with SLA? On the one hand, said Mr. Masse, “We [Canadians] are being brought back again and again into the courts” by U.S. plaintiffs who successfully cite Canadian violations. SLA stipulates that any disputes under the Agreement are to be resolved through a commercial-type binding arbitration process before the London Court of International Arbitration (LCIA), using arbitrators who are neither citizens nor residents of the United States or Canada. In 2011, LCIA ruled that subsidies provided by the Ontario and Quebec governments to lumber manufacturers in their provinces violated the terms of SLA. LCIA also ruled against timber pricing practices in the British Columbia Interior that circumvented SLA. In each case, the judgments involved millions of dollars in damages. “If we continue to have SLA, we’ll continue to have lawsuits,” said Mr. Masse.

Meanwhile, the Canadian lumber trade is not growing, added Mr. Masse. According to a report by the Estey Centre for Law and Economics in International Trade, Canada’s lumber exports declined by 9 per cent from 2006, when SLA was first signed, through 2011. Worse, argued Mr. Masse, Canada has been losing out on the opportunities to add more value to its forest products sector. “We shouldn’t be just shipping out raw trees” to China or elsewhere “and then buying back tables from China. We should have some value added in Canada.” Much of Quebec’s furniture manufacturing sector has disappeared, he said, because Chinese furniture makers can purchase Canadian wood at such low prices. “We need to look at the overall agreement and decide how we’ll use this resource in the future.”

Rather than focus on the tired old issue of softwood, the Canadian government has been pushing the Keystone XL Pipeline Project, in hopes of boosting Canadian energy exports to the U.S., argued Mr. Masse. “The Canadian government has abandoned the softwood issue so it could just rubber stamp this deal now. The government was not prepared” to deal with the flaws in SLA.

Complicating the task of forging a valuable agreement, he added, some U.S. housing industry companies, such as The Home Depot, source a great deal of their lumber from Canada and would benefit from current Canadian subsidies that lower the prices they pay for it. “A lot of the companies lobbying in Ottawa are really American companies that have assets on both sides, and they just wanted a deal” – not necessarily a deal that made sense for Canada, said Mr. Masse.

Irreconcilable differences

Zoltan Van Heyningen, Executive Director of the U.S. Lumber Coalition, argued that there is no real debate about the fundamental difference between the U.S. and Canadian positions. The lumber sectors of Canada and the U.S. “operate on two very different principles,” he said. “In Canada, the government owns a majority of the fibre, which contributes 70 per cent of production costs. So the Canadian government’s goal is to maintain employment by lowering fibre costs to the level where it can compete. In the U.S., it is the market that determines prices.” Given the fact that the Canadian industry relies on the U.S., its closest and largest market, the key question, said Mr. Van Heyningen, is this: “How do you allow those two industries to co-exist?” There are only two answers to that question, he argued: “Either you have trade cases” – such as the lawsuits filed successfully against Canadian provinces – “or you have trade agreements. What is the alternative to SLA? Only the resumption of more trade cases [lawsuits].”

According to Mr. Van Heyningen, the continuing lawsuits against Canadian provinces are perfectly justified by the terms of SLA. “Contrary to Canada’s SLA commitments, several provinces have modified their timber pricing systems in ways that reduce timber prices below those that would have existed had the systems [operating on July 1, 2006,] been faithfully implemented,” he said.  The most significant of those violations were in the British Columbia Interior, which accounts for about half of Canada’s total softwood lumber exports to the U.S. The government of B.C. has taken several steps to cut wood costs for B.C. Interior lumber producers, thus “sustaining uneconomic production and significantly depressing U.S. lumber markets,” added Mr. Van Heyningen. These steps include the huge expansion of nominal stumpage rates; additional reduction in prices for high-quality timber; other stumpage reductions; and the introduction of ‘lump-sum’ pricing on administered timber sales.

Mr. Van Heyningen acknowledges that the government of British Columbia has asserted that many of these actions have been taken in order to manage the massive outbreak of mountain pine beetles, which have significantly affected some portions of the B.C. Interior forest. Although SLA authorizes changes to forest-management systems in order to respond to environmental and other challenges, those changes must “not result in timber pricing moving further away from market values,” said Mr. Van Heyningen. “It would appear that British Columbia has used the excuse of the pine beetle outbreak to reduce Interior timber prices even further below market value since 2007, resulting in cost savings of hundreds of millions of dollars” to lumber producers in the B.C. Interior.

For its part, the U.S. Lumber Coalition argued that in addition to circumventing substantial portions of SLA’s export measures, “Canada has also in some cases simply failed to fully impose the export measures in the first place.” Overall, noted Mr. Van Heyningen, “Canada has failed to comply fully with SLA’s transparency obligations. SLA obliges both the Canadian and U.S. governments to exchange data crucial for monitoring compliance with the agreement.” Despite that requirement, for many kinds of data “Canada is far behind the schedule of disclosures mandated by SLA.” Echoing those sentiments, Steve Swanson, Chairman of the Coalition and President of the family-run, Oregon-based Swanson Group, said, “The Softwood Lumber Agreement is a compromise agreement that is not ideal from the U.S. industry’s perspective. Nevertheless, we support the extension of this agreement with the expectation that Canada will improve its record of compliance with this trade agreement.” However, Mr. Swanson warned that if Canada does not ultimately comply with SLA, “the U.S. government must continue to take appropriate enforcement steps to effectively address trade agreement violations by Canada.”

The possible impacts of the proposed Trans-Pacific Partnership on SLA

Might the Softwood Lumber Agreement be affected by the Canadian government’s participation in the new Trans-Pacific Partnership (TPP), a multilateral Asia-Pacific Rim super-free-trade treaty that is now in its early stages of negotiation? The U.S. Lumber Coalition sees it as a tempting opportunity to force the Canadian softwood sector to make some fundamental changes in the way it does business. In a January 13 letter to Donald W. Eiss, Chairman of the Trade Policy Staff Committee of the Office of the U.S. Trade Representative – the executive branch agency that makes U.S. trade policy – three attorneys of Washington, D.C.-based Picard Kentz & Rowe LLP, counsel to the U.S. Lumber Coalition, outlined their strategy for applying pressure on Canada through TPP. “The Coalition welcomes Canada’s expression of interest in joining the Trans-Pacific Partnership (TPP) negotiations,” wrote attorneys Andrew Kentz, David Yocis and Jordan Kahn in the letter.  “Unfortunately, the softwood lumber sector remains one of the relatively few areas where significant trade friction remains between the two countries … These trade-distorting Canadian policies are mostly unaddressed by, or specifically exempted from, the disciplines of the existing free-trade agreements” between Canada and the U.S. “The Coalition believes that Canada’s participation in the negotiation of a ‘high-standard, 21st-century’ trade agreement” – such as TPP – “can provide a meaningful opportunity to address these policies and reduce trade friction in this important sector.”

The attorneys went on to describe “several opportunities to address key aspects of this ongoing dispute in a more permanent fashion” – rather than continue to extend SLA, with all its weaknesses, again and again in the future. They proposed the following:

First, they proposed that “TPP should not exempt Canada’s log export restriction from any disciplines on export restraints.”  Existing U.S. free-trade pacts – including NAFTA – impose significant limitations on the ability of America’s free-trade partners to impose restrictions on exports.  Canada continues to maintain significant restrictions on exports of logs, they wrote. “The Coalition believes that no similar exemption for Canada’s log export restrictions should be maintained in a TPP agreement.” As a result of this exemption, domestic log prices inside Canada are significantly lower than world market prices, they wrote, which has, in turn, had a “substantial market-distorting im­pact on log-consuming industries, such as softwood lumber.”

Not only might the Coalition’s position become the U.S. negotiating position in talks to establish TPP, but other major lumber-producing countries could well pressure Canada to end these exemptions, wrote the Coalition’s lawyers. One such country is New Zealand, which will also become a member of TPP. “New Zealand is one of the world’s largest exporters of softwood logs and exports a much higher percentage of its softwood timber harvest in log form than Canada,” the attorneys wrote. Japan, which has also voiced interest in joining TPP, is another major consumer of both softwood logs and softwood lumber from Canada. The attorneys expect that both New Zealand and Japan will be pressing the issue with Canada during TPP negotiations.

Second, they proposed that the trade laws governing lumber should apply fully to all TPP partners, including normal provisions for judicial review. The challenge: although U.S. free-trade pacts uniformly provide for the application of anti-dumping and countervailing duty laws to imports from partner countries, NAFTA uniquely provides for international dispute settlement panels to substitute for domestic judicial review. This process, known as the Chapter 19 dispute settlement, “is unconstitutional as a matter of law,” wrote the attorneys, “based on the outdated Canadian concerns that have long since been addressed elsewhere” and proven “unworkable in practice.” A TPP agreement that includes Canada “should put an end to this highly problematic provision … Canada cannot plausibly claim that it would be unable to protect its interests in a fair and impartial judicial proceeding in the U.S. in the absence of Chapter 19.” Summing up, they wrote, “Chapter 19 is a failed experiment” and TPP negotiations “would be an excellent opportunity to terminate this unfortunate project” and bring U.S. law covering ‘unfair trade’ into harmony with law that applies to other members of TPP.

Third, they proposed that Canada put an end to provincial ownership of timber. Provinces like British Columbia, where Crown land makes up 95 per cent of the land base, are in fact, running state-owned enterprises (SOE) when they sell timber rights, said the Coalition’s attorneys. That makes these enterprises the legal equivalent of Chinese (and other) state-owned enterprises, which are often targeted by U.S. and other private-sector companies as unfair competitors. “It is undeniable that Canada’s provinces, when they sell timber, are deploying their natural resources to promote the interests of the government rather than on a purely commercial basis,” wrote the authors. As a result, “The application of meaningful disciplines on SOEs to Canada’s provincial public timber sales programs should be an important goal of TPP negotiation with respect to Canada.”

Such arguments may have carried little weight in the negotiations between Canada and the U.S. that led to the creation of SLA in 2006, but they may prove significant in the multilateral forum that will emerge with the conclusion of the Trans-Pacific Partnership. Having failed to persuade Canada’s provincial and federal governments to change their traditional approach to owning and managing timber resources, the U.S. Lumber Coalition views the upcoming TPP as an opportunity to pressure Canada’s leadership to impose fundamental structural changes in the lumber sector. If Canada should not be responsive, it may not be able to reap the much broader benefits of such a far-reaching trade pact in other sectors of the Canadian economy.