One of the lessons of the last twenty years is that the forest products industry is no longer just a local market. It has become a global market where exports from one country to another can have a major impact on sales. From monetary policy to government mandates to energy development, the global wood and lumber markets are always in flux.
And the emergence of a significant building boom in Asia over the last ten years has helped to offset the reductions taking place in more traditional markets, such as North America and Western Europe. Of course, the largest driver in the Asian market is China with its massive population and industrialization. How will geopolitical changes impact the softwood and hardwood industries in North America?
The Pallet Enterprise recently sat down with a noted expert on the global lumber industry to hear his take on the Asian market as well as the importance of sustainability certification programs and the Euro zone economic crisis. Bob Flynn, the director of international timber for RISI, gave his insights on these key issues and more.
Pallet Enterprise: What are the international timber markets doing right now? From what I understand they had been growing and are starting to contract.
Flynn: Looking at the softwood market in Asia, you have China that is 65-70% of the market. And the rest is made up of countries, such as Japan, Korea and India. China is the big driver in Asia, and the Chinese government during the third quarter of last year started tightening up credit and loans for the construction industry. They were trying to control what they perceived was a bubble in construction levels. At the same time, the inventories of logs and lumber were quite high in China last August. The oversupplies have had to be worked down over the last year. For the first seven months of this year, China’s imports of softwood logs was down 15% compared with the same period last year. And lumber has been fairly flat, down about 1% this year.
This is a trend we have been seeing in the Chinese market for a number of years. A growing share of imports has been in lumber form rather than log form. Chinese imports this year are up to about 45% lumber compared to raw logs.
Pallet Enterprise: Why this transition from logs to lumber?
Flynn: Well, there are several reasons. The availability of inexpensive lumber coming from Canada has been a factor. This has resulted from the lack of demand in the United States combined with the fact that there is no 15% duty on Canadian lumber going to China like there was to the United States. Sawmills had a built-in incentive to push lumber to the Chinese market. Plus, there was a lot of low-grade lumber on the market thanks to the pine bark beetle. Although that material may not be desired in the U.S. market, it was perfectly acceptable in China.
At the same time, on the Russian side, you have this log export tax. The brief history there is that Russia wants more processing done in the country instead of exporting unprocessed logs. Starting in 2006 they claimed they were going to rapidly push up a tax on unprocessed logs. In April of 2008, Russia raised that tax to 25% of the log value, and it was scheduled to go to 90% in January of 2009. Since the global economic collapse, the Russians have not pushed up the tax any further. Having that 25% export duty was enough to produce a shift in Chinese-Russian softwood trade.
A lot of the small Chinese companies picked up these little sawmills that had been built near the border crossings and moved them into Russia to rough cut or square up the logs in Russia to avoid paying that tax. The Russian volume has moved very quickly from being almost entirely logs to a balance between logs and lumber.
Pallet Enterprise: What have been the recent trends with hardwood lumber in Asia?
Flynn: The majority of the softwood in China is used in construction, 85-90%, whereas the hardwood is used for interior applications and furniture. Construction over there includes a lot of low-end concrete form work, which utilizes mostly softwood lumber.
Hardwood lumber is down about 1% this year in China. The overall Chinese market is about 2/3rds softwood and 1/3rd hardwood. The hardwood and softwood markets in China have overall been relatively stable even though the amount of unprocessed logs is down a lot.
Pallet Enterprise: You mentioned Chinese authorities reducing the spending on housing and working down wood inventories. So why haven’t lumber volumes dropped significantly?
Flynn: You have to be careful with China because their economy has been growing at 9.5-10% per year. And it is now growing at 7.5% per year. This is a major slow down as far as China is concerned, but it is still growing twice as fast as the U.S. economy.
China is not like the U.S. housing market where housing starts went from 2 million per year to only 500,000. The rate of increase has greatly reduced, but China has not stopped building housing units, which are primarily apartment buildings.
Pallet Enterprise: I have read about ghost towns in China where investors have over built interior cities. Some have speculated that the housing market is a major bubble that could burst. What is your assessment of the housing situation and supply in China?
Flynn: There is an enormous amount of wasteful spending in China. When you have the government directing everything that is sort of to be expected, but you simply cannot compare the housing market in China with the United States where we have to sell over supply before you start building again. In China, there are several major distinctions. First, the big housing bubble has been developers building apartment units for investors. The Chinese have very little opportunity for investment. They have a very high savings rate although they get very little on their savings accounts. For the most part, the Chinese are not allowed to invest overseas. They have a limited number of investment products.
It is quite popular for people with money to buy 2,3,5,8 apartments just for an asset. Although they may sit empty, at least they have a physical asset that has been going up in value. At the same time there has been an oversupply of housing for the upper and middle level people who can afford it. There has been an absolute shortage of housing for the lower classes, especially in rural and migrant communities. So the Chinese government has a massive program of subsidized housing. They are continuing to build millions of units per year aimed at lower income people. While the Chinese government is tightening credit for more expensive housing it is increasing spending on lower-scale housing.
In China, a lot of these projects are built because some government official wants to promote the local economy. And the construction may be totally unrelated to market demand. This results in ghost houses being built where there is no real demand. Those housing units may never be occupied. And it isn’t that those units must first be occupied before more will be built. Developers build where they think there is an opportunity and/or where the government directs them to build.
Construction is a critical part of the Chinese economy, and the Chinese government can’t really afford to let the entire thing collapse. One last point on the housing, within the past year there was a major highway overpass that collapsed in China. The incident killed a few people and injured some others. Complaints arose about the poor quality of construction and inadequate materials being used because developers took shortcuts. Of course, we heard the same thing a few years ago when there were big earthquakes and a number of buildings collapsed in China.
There are tens of millions if not more apartment buildings in China that were built in the 80s and 90s that probably should be replaced because they were built with poor standards to begin with. They were not built to last. In addition to the housing that needs to be built for low-end residents, there is going to be a big boom in replacement housing for outdated and inferior quality units. There may be problems with getting credit or loans for upper scale housing projects. That will likely keep Chinese construction relatively slow this year because there is a government transition. And you aren’t going to see any massive building or stimulus spending during this transition year for the Chinese government. But next year, the new leadership takes over and is going to want to give the economy a boost. Hopefully, they won’t overdo it like the Chinese government did the last time.
One reason you have had such a hot market in 2010 and 2011 in China is because in 2009, when the global economy collapsed, the Chinese government turned its banks loose and ordered them to start making loans at an aggressive rate. And they overstimulated their housing sector. Most economists do believe that this time the Chinese government is being more restrained. Even next year, we are expecting the growth in the Chinese housing market to be more controlled. This idea that there is a massive amount of surplus housing in China and that they are not going to build more for the next five years is not accurate. It doesn’t work that way in China. Over supply may sit there and never be occupied. But that isn’t going to stop them from ordering the state banks to start making loans and begin building things again. China is not a free market economy, and you can’t analyze it as if it were.
Pallet Enterprise: Are there any new regulations or trends that we haven’t talked about that could have a major impact on the Asian market?
Flynn: You will hear a lot of talk about Russia joining the World Trade Organization this year. As part of that, they agreed at least with the European Union to reduce their log export tax. Does this mean Russia will reduce the tax for China? Will this lead to a wave of Russian logs going into China?
The answer is “No.” The total log volumes have mainly shifted over to lumber. The amount of wood coming from Russia has stayed about the same. Also, the Russians have not said that they are going to reduce the log export tax for China. They have only committed to do this for the European Union at this point. To get more volume out of Russia, it will take more investment in infrastructure. Certainly if prices or demand rises sharply, then individuals and companies will make that investment over time. But the stress there is time. Nothing is going to change too drastically out of Russia over the next three to five years.
In China, its real shortage of wood is on softwood. And if you look at China’s imports, it’s almost 70% softwood compared to 30% hardwood. China has this problem because it has overcut its softwood forest. China has no choice but to wait for these softwood plantations to grow, and those trees grow relatively slowly. There is no ability within the country to increase softwood supply.
On the hardwood side, China has planted huge areas of fast-growing hardwoods, such as popular and eucalyptus. So for low-end uses, China has a lot of that material. Eucalyptus is used mainly in plywood. Very little of it is used for lumber.
Pallet Enterprise: And even given its hardwood resources, China lacks the diversity of species that the United States has… right?
Flynn: Yes, China has much less variety of hardwood species, and it has cut down already a lot of the high-value hardwoods that the country once had. From the extent that China needs hardwood of any value, that material will need to be imported. China does import a lot of logs from Africa and Papua New Guinea. Every year those volumes are becoming harder to obtain due to either over cutting or regulations within the supplying countries to try to limit log exports. The future looks quite good for quality hardwoods, and there is only so many countries that are capable of supplying top quality hardwoods.
Looking at hardwood lumber for the first seven months of 2012, China gets the largest percentage of its lumber from Thailand. Most of that is entirely rubber wood or other low quality species of hardwood. The second largest supplier is the United States with a 20% market share. Following that is Indonesia (14%) and Russia (13%).
China has so overcut its domestic quality hardwoods that they can’t possibly supply its needs. There is no real domestic market to protect even if they wanted to do so. Probably our biggest competitor for the quality hardwood market in China is Russia. The American Hardwood Export council has done a fantastic job promoting American hardwoods in China. The United States retains a dominant supplier of quality hardwoods to China.
Pallet Enterprise: How could the European financial crisis impact the global lumber markets? Could it reduce global demand?
Flynn: Yes, in terms of affecting the overall economic growth, not just in Europe, but countries supplying products to Europe including China and the United States. The Euro zone is the main story, and the biggest cause of concern. By slowing economic growth in this region, it will impact overall demand for forest products.
Pallet Enterprise: What if the Euro zone completely collapses? Will there be enough demand from other parts of the world to pick up the slack?
Flynn: The biggest impact from something like a collapse of a major economic zone is the receding of investor confidence while major institutions put their plans on hold. Uncertainty can cause delay, which reduces construction spending for the moment.
It could push the global industry back into a recession and be bad news if uncertainty in Europe spills over into other parts of the world.
Pallet Enterprise: Increasingly you hear industry leaders talking about the importance of sustainability. What do they mean by that term? And isn’t it still really a vague concept?
Flynn: For the most part sustainability means having certification whether it is FSC, SFI or PEFC. In some markets certification is important, especially pulp and paper. In other markets it is still mostly just talk. If you are producing furniture to sell to Europe, you must have FSC certification. Certain grades of paper companies are pushing in that direction.
Sustainability is a vague term in some ways, but it is growing in popularity. In the United States, demand for green certified wood products lags behind Europe. There is an increase in this country in green building, but it isn’t an overwhelming trend.
Pallet Enterprise: There has been a lot of discussion recently over the Lacey Act and efforts to stop the trade of illegally harvested wood. Is there a trend for similar laws to develop in other countries? What is the impact of laws like the Lacey Act on the international forest products market?
Flynn: In Europe, the government has passed a law similar to the Lacey Act that goes into effect next March. That is a big expansion of coverage. Australia has been debating a law.
Certain companies don’t want to take any chances that they could get caught doing something that could be deemed dealing in illegally harvested wood or lumber. There really haven’t been many actual cases brought under these laws. Even the Gibson case wasn’t really a precedent setter, yet the requirements that transactions be on the books has had some impact on the trade.
There is a feeling by some that the laws can make a difference over time. But to date, it has been very small.
Pallet Enterprise: What is happening globally with the biomass market? I hear that Europe continues to be a major player in terms of importing biomass for energy.
Flynn: The demand for pellet imports in Europe is increasing although it is increasing at a much slower rate than most of the forecasts had projected. There were a lot of new biomass power plants that supposedly were going to be built in the United Kingdom. But the startup dates keep getting delayed and delayed. The European governments are under a lot of stress, and they may not be interested in accelerating how early they have to pay for all of this. Frankly, there has been a lot of disappointment by the biomass promoters.
On the biofuel side, it seems like a lot of the projects are making progress. When you talk cellulosic ethanol or diesel, it is by no means certain that those companies are going to end up using wood as opposed to plant material, corn stalks, switch grass, etc. We are forecasting that consumption for wood energy is going to continue to increase. But we certainly aren’t forecasting this demand will put pulp mills out of business or cause the wood panel industry to have to pay twice what it is used to paying.
Pallet Enterprise: Besides Europe, where else in the world is wood energy being pushed by governments?
Flynn: In Japan and Korea, the governments have various programs to promote wood energy. But it is one thing to have a policy; it is another thing to translate that policy into building plants and spending money. Companies are taking a pretty cautious line because governments can and do change policy. If you make decisions based just on policy you could get burned.
Having said that in South America, particularly Brazil, they use a huge amount of wood for energy, not because of any government subsidy program but because of the huge areas they need to dry agricultural crops or use wood to help make steel. It is more economical to grow the wood than to import diesel or transport expensive fuels. There is quite a bit of biomass moving forward in South America. But the main driver is economics not government policy.
For more information on RISI or its reports, call Bob Flynn at 253/565-4846, email rflynn@risi.com or visit www.risi.com.
