Deep in the woods

Among the issues facing the timber industry: beetle infestation in western Canada, demand for biomass and—of course—housing starts.

The UBS Global Paper and Forest Products Conference, held Sept. 14-15 in New York City, brought together the timber industry’s heavyweights to talk to investors about their companies’ positions in the pulp, wood products and lumber markets. But in between the growth potential posturing and the balance sheet reassurances, timber company executives shared their predictions and observations on a number of topics, including the Canadian pine beetle infestation and its effect on U.S. lumber sales, Europe’s hunger for pellet fuel, how to steal Chinese export business away from the Russians and what a “normal” year in housing starts should look like from a logger’s perspective.

Below are some excerpts from the presentations made at the conference:

Rick Holley, president and CEO of Plum Creek Timber, talked about how his company has cut back on its logging in Oregon and the South to make it through the downturn. With 5.4 million acres of forest in 19 states, Plum Creek is one of the largest timberland holders in the United States.

Like other lumber producers, Plum Creek reduced supply during the downturn, deferring the harvest of 1.5 million tons of sawn lumber last year and 0.5 million this year. The company also increased its holdings by purchasing $200 million worth of timberland holdings over the past three years. Much of that was focused in the South.

“I think the South is a winner, and you also have land values there that, over time, I think, will appreciate at a faster rate than elsewhere in the country,” Holley said. “So we’ll continue to look [there] for opportunities to buy.”

The effects of the pine beetle infestation in western Canada are starting to reverberate through the supply chain, and Holley predicted a big win for U.S. producers.

“Historically, [Canada] provided about 35% of the structural lumber used in the United States, and eastern Canada has already reduced its allowable cut by 20%. Now you don’t feel that in the market today, because the demand is so poor. Production is down already, but when demand improves, you are going to feel the impact of eastern Canada having 20% less product in the marketplace. But even more importantly, over half the production of lumber [in Canada] is in British Columbia.… They have 70 million acres—seven zero—of pine beetle forests that have been devastated there. It’s hard to imagine how big that is, but it’s going to have a huge impact on the industry in Canada. It’s already being felt. They are accelerating the harvest of some of these trees so they can use them before they totally decay and are not useful anymore.

“So what’s going to happen in B.C. is their harvest will come down by about 50% over the next period of time, and stay at that level for about 60 years until those forests regenerate themselves. This [has] a huge impact on the North American supply-demand situation for lumber. So the Canadian [harvests], which are historically around 35% of the supply, are going to be a much smaller percent of the supply in the future, and that differential will have to be made up by U.S. manufacturers. And I believe [it will be] predominantly in the U.S. South and probably some on the West Coast. This is a really big deal.”

When asked what the “new normal” for housing starts will be, Holley admitted he was no Harvard expert, but his estimate was in line with that of other forestry executives who spoke at the conference.

“It’s kind of 1.5 million, maybe it gets to 1.6 million. If it gets higher than that, it’s just an anomaly. You’re not going to see 2.2 million like we saw a few years ago. You shouldn’t have seen it the first time, and I don’t think we’ll see it again.”

One of the emerging markets for U.S. forestry companies is in Europe, Holley said, where a move away from fossil fuels has created demand for wood pellets. Plum Creek has a supply agreement with one European utility to provide 1 million tons of wood fiber a year to be pelletized in the United States and taken to Europe and burned alongside coal as a heating source.

Holley: “The European utility is going to pay us basically market price, pulp wood prices, plus a premium for the supply agreement. They will take care of the log and haul costs, so we’ll deliver those trees, or the biomass… to a designated pellet facility, which will pelletize it and ship it to a port and take it by ship to the utility in Europe. And these plants in Europe—some of them to are going to be dedicated 100% to renewable energy. We talked to several other European utilities, so I think this is just the first.”

Although not as well-known as Plum Creek or Weyerhaeuser, Rayonier is a timber REIT (real estate investment trust) with 1.5 million acres of pine in Florida, Georgia, Alabama, Texas and Oklahoma. Headquartered in Jacksonville, Fla., the firm also has holdings in Washington State (hemlock, Douglas fir), New York (hardwood), and joint-venture Radiata plantations in New Zealand.

Lee Thomas, Rayonier’s chairman, president and CEO, also told analysts at the UBS conference that he was seeing more timber being turned into biomass for energy production.

“We see it particularly in the Southeast, driven largely by European demand for U.S. biomass,” Thomas said. “As an example, [there is] a big pellet plant being built in Waycross, Ga. It’s right in the middle of one of our big timber areas. We’re already beginning to see that have an impact as far as pulp wood pricing is concerned.

“Now, these are big plants. These are half-a-million-ton-a-year plants, and you’re talking 1 million to 1.5 million tons of wood going into that plant to get half-a-million tons of pellets, but it’s all feeding utilities in Europe, driven by their regulatory requirements.

“And over time, we think we’ll see a similar kind of [mandate] developing in the U.S.”

On the subject of housing starts, Thomas came close to his fellow forest executives in terms of estimates. But he went as far as attaching a date—a distant date.

“Our analysis suggests that improvement in housing [will go] back to what we think the underlying demand is:… new start units in the 1.4 million to 1.5 million range. We don’t think we’ll get there until maybe 2014 or 2015.”

In the meantime, Rayonier is looking overseas. In addition to its wood pulp exports for the European pellet market, the company is shipping hemlock and, to a lesser extent, Douglas fir, as well as Radiata out of New Zealand.

“I think a lot [of the demand] is being driven by China. We’ve actually seen improvement as far as demand out of India. We’ve always had a great market in South Korea. But the China market is one that’s really come on. I mean out of New Zealand three years ago we were selling no logs into China, and today they’re our largest customer.

“To a certain extent, China is driven by what’s happened with Russia. Russia typically was the primary supplier to China and still is, but you’ve begun to see the cost of Russian logs go up as their cost of harvesting has gone up. And then they have the 25% tariff, which they collect on logs being exported.

“So I think China saw cost increasing for Russian logs but also began to worry about supply and began to say, ‘We want to diversify our supply base.’ And that’s when we really began to see the demand pick up in New Zealand about three years ago and then roll into the West Coast, as well.”

Although Weyerhaeuser executives were focused on the company’s REIT conversion, its forestry holdings—more than 6.5 million acres worldwide—are an integral part of that process. The Federal Way, Wash., company sees itself as well-positioned to squeeze revenue from its timber interests in the South, Pacific Northwest, Canada, south China and Uruguay.

Some of these holdings are partnerships or provincial licenses, which can be dicey. Company president and CEO Dan Fulton elaborated when questioned by an analyst.

“The activity that we have in China is very small. As I mentioned, it’s a joint venture—it’s less than 50,000 acres. We are educating ourselves on how to do business in the forestry sector in China. We have a partner [that] is a state-owned forestry company. Experience to date has been outstanding. We see opportunities there. The challenge in China is that the government owns the land. There are scattered parcels and really no large assemblages whatsoever, so the hard work in China is to pull together assemblages and to be able to do so in a manner that earns adequate returns. But, to date, we’ve been pleased.

“Historically, most of you know, we have been involved in New Zealand and Australia. We exited those markets for a variety of reasons, and our focus in the near term in global timberlands expansion would be to build on the positions that we already have in those other markets.”

In the best of all worlds, Weyerhaeuser can focus on harvesting its domestic acreage, which comprises the vast majority of its holdings. But sustained demand for lumber from U.S. home builders is taking a while to materialize, Fulton said.

“It’s going to be a slower recovery than we would have anticipated just 12 months ago,” Fulton told analysts. “I’m a little bit more cautious, and we are operating our businesses and managing our costs in an environment where we need to earn margins at this level of starts. If we’re successful at doing that, then we’ll benefit as things pick up. That translates, also, into the timber business, because we continue to defer harvest that’s related to wood products prices and wood products demand.”

But looking further down the road, Fulton predicted a shortage of lumber in the U.S. once home building kicks into gear. “Historically, about one-third of the lumber needed for U.S. home construction has been supplied by Canada. As U.S. housing starts begin to recover, we’ll be faced in the future with a shortfall in Canadian harvest levels as a result of the pine beetle infestation in western Canada. The net result of this situation should be increased demand for U.S. saw timber, which should positively impact both volume and price.”

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