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Thematic investing

Seeing the wood for the trees

Seeing the wood for the trees

March 2018

The Advisory Board

Pictet Asset Management's Timber Advisory Board analyses why wood product prices keep rising.

There’s no shortage of wood in the world. For all the concerns about deforestation, the decline in forest area is primarily a threat to the world’s biodiversity, but not (yet) to the production of wood. Commercially productive forests are rarely converted to other uses, while planted forests are expanding at a solid clip. So why then do wood product prices keep rising?

According to the Pictet-Timber Advisory Board, it boils down to supply constraints. A lack of sawmills, transport hurdles, changes in the nature of demand have each had a role to play in keeping prices high. Which is why, for instance, hardwood pulp prices have risen by two-thirds since 2008.

And then there’s the significant matter of protectionist politics, such as the import tariffs imposed by the US administration on Canadian sawnwood imports, or the environmentally motivated import restrictions for recycled fibres into China. As a result, prices are likely to remain high for some time to come. 

Supply restrictions and bottlenecks everywhere

While there’s plenty of wood across less populous parts of the world, there isn’t enough near to where there’s demand.

Germany, for instance, is expected to have a wood shortage by 2020.

reach for the sky

Prices for wood products, $ per 1,000 bf/sq ft/kg of product

timber framing lumber, osb panels, hardwood pulp
Source: Bloomberg, Risi, Random Lengths. Data as of 19.02.2018

In some cases, a change in timber use has led to these imbalances. In Europe, ever more wood is being used as fuel, reversing a long-term secular decline. Demand has risen to a point where wastage from mill and logging operations – which is typically converted to fuel – is insufficient to meet it. Which is why an increasing amount of pulp wood is going into energy generation. Forest dead wood is also being consumed to its limits. And in some places there is heavy demand for wood as a source of energy. This is particularly true in Japan, as it has mothballed its nuclear plants, which at their peak generated 30 per cent of domestic electricity supply. Elsewhere, the push away from plastics has renewed interest in wood-derived products as the raw material for new packaging materials that are sturdier than paper but just as biodegradable.

There are constraints on how many containers can be stuffed full of timber and transported around the world to feed this demand. Sawn timber uses container space more efficiently, but here too there are limitations. Sawmills are running at full tilt worldwide.

Sometimes several factors come into play at once. Take Indonesia. Not only is productivity flat in Indonesian mills, but timber plantations are increasingly being replaced by ones devoted to palm oil production. Disease has driven down yields at existing timber plantations while major forest fires hit supplies. Consequently, domestic mills face rising wood costs, reducing the incentive for fresh investment to boost productivity.

China, Canada and the US

In the Canadian province of British Columbia, by far the country’s largest producer and exporter of wood products, a major bark beetle infestation has prompted the government to massively reduce the amount of forest it allows to be felled, a restriction that’s likely to remain in place for many years to come. At the same time, US President Donald Trump’s administration has imposed hefty import duties on Canadian sawnwood imports.

Tight supply has bumped up against rising demand. The US housing market is booming again. House builders are by far the main source of wood product demand in the US and new home starts are climbing back towards their 40-year average.

With Canadian producers now less able to respond, US lumber and wood product prices have been squeezed ever higher over the past year.

With Canandian producers less able to respond, US lumber prices have been squeezed ever higher.

At some point, the vast pine plantations that have been established across the south of the US over the past few decades will make up for the shortfall in Canadian timber. But building or expanding sawmills takes time. There are few sawmill equipment manufacturers and their order books are full to the brim. And increasing the workload of existing US sawmills is extremely difficult, with skilled labour hard to find. Which suggests US producers are some way from replacing Canada-based sources.

As with other commodities, China plays a major role in the timber market. It is a significant and growing net importer of wood fibre in all its forms. Chinese demand has, in turn, led to heavy Chinese involvement in timber production. At the same time, Beijing is taking domestic environmental issues increasingly seriously. Not only is the government imposing ever stricter restrictions on timber harvesting from domestic forests, but old polluting pulp and paper mills and other wood processing plants are being restructured. Beijing is also looking to ban mixed waste paper imports. 

The wooden age

Wood may be one of humanity’s oldest and most basic materials, but both production and demand continue to flourish, even in an era of high tech. Though there’s theoretically still plenty of wood in the world, a host of natural, technical and political supply imbalances and bottlenecks have been driving up prices for most wood and forest products to record levels. This is unlikely to change anytime soon.