Economic Outlook
Just when many thought the economic “sharks” were well-fed and that it was “safe to get back in the water,” we seem to be heading toward the bottom of the second leg of a “W”-shaped economic downturn.

A wave of failures, bailouts, and takeovers defined September. The government takeover of Fannie Mae and Freddie Mac, the failure of Lehman Brothers, and the bailout of insurance giant AIG, have all taken a toll on financial markets. Over the last 10 days, Congress has been working on an economic stabilization plan that will “bailout” financial institutions buckling under the weight of bad mortgage-backed securities, with a price tag of anywhere between $500 billion and $1 trillion. While Congress was still debating whether to approve this bailout, however, both Washington Mutual (WaMu) and Wachovia crumbled. Washington Mutual became the largest bank ever to have failed in the United States. And though JP Morgan Chase bought WaMu’s solid assets—their deposits and branches—the federal government is left holding their bad debts. Wachovia’s banking assets were sold to Citigroup, and though the government insists the sale of Wachovia’s assets was not technically a “failure,” the details are telling. Citigroup paid $1 per share, or $2.2 billion for the assets and assumed $42 billion of losses from Wachovia’s riskiest mortgages (which it will write down). The Federal Deposit Insurance Corporation (FDIC) will assume responsibility for ALL losses above $42 billion, and in return get $12 billion in preferred stock and warrants.

At the end of September, three banks dominate the U.S. market: Bank of America (which bought Merrill Lynch), JP Morgan Chase (which bought WaMu), and Citigroup (which bought Wachovia). Two days ago, the House of Representatives failed to pass the stabilization plan and the Dow had its highest drop ever at 777 points. Though Congress will continue to work on a recovery package, no one really knows what will happen in the coming days and weeks.

The U.S. economy is clearly in unchartered territory here; the waters appear more shark infested than ever, and they are made murkier still by the depreciating U.S. dollar. (Here’s one modest positive: a weaker U.S. dollar could boost exports and improve the trade deficit.) Signs suggest the U.S. economy is in a recession, and the time it will take to return to real growth could very well be measured in years rather than months.

What does this mean for the housing market? Not much that is good. Recent forecasts have been for the housing market to recover beginning at the end of 2Q2009; it now looks as if that won’t happen until late 2009 or even the beginning of 2010.

To cut through the murkiness and tame the sharks, subscribe to F2M’s monthly 4Casts, which cover the fundamentals affecting the U.S. economy and their effect on wood fiber markets. Click here.

The Effects of Russian Timber Tariffs on Global Wood Supply
Russia is the third largest forest harvester in the world, after only the United States and Canada. Despite this ranking, the overall statistics for the forest industry in Russia do not look good:

  • Russia produces up to 150 million cubic meters of wood products annually, only about a third of the government’s estimated total annual allowable cut of 576 million cubic meters per year.
  • Russia accounts for 22 percent of the world’s wood trade in terms of volume, but only 3 percent in terms of value.
  • Russia has the capacity to process only 2 percent of its annual harvest; as a result of its minimal processing capacity, it exports logs instead of higher priced forest products, like paper, furniture, doors and windows.

Faced with these facts in 2006, Russian President Vladimir Putin said, “Our neighbors continue to make billions of dollars out of Russia’s forests. We, meanwhile, are doing little to develop our own wood processing industry. We still have not put in place new customs duty regulations that would encourage the establishment of processing facilities on Russian soil rather than exports of unprocessed wood.”

Never subtle in dealing with problems military or economic, Putin and his government implemented a new Forest Code in February 2007. Most industry observers believe that this measure signals “a fundamental structural change in the global market for logs.” The code’s provisions include disincentives for exporting logs and incentives for increasing timber processing facilities and investments within the country.

  • Disincentives include:
    • Increases in export taxes: on February 5, 2007, taxes increased from 6.5 percent to 20 percent; in April 2008, they increased from 20 percent to 25 percent (roughly $22 per cubic meter); in January 2009, taxes are scheduled to increase from 25 percent to 80 percent (roughly $73 per cubic meter)
    • Decreases the number of customs houses along the borders that can process exports, leading to increased transportation costs and wait times
  • Incentives include:
    • Provides companies that invest in Russian forestry projects with a guarantee of wood fiber supply through an auctioned based lease system
    • Extends lease terms from 50 years to 99 years
    • Provides companies that invest in projects valued at $193.7 million or more with leases not subject to auctions
    • Allows companies that process a certain amount of harvests from leased lands to export some logs at a reduced tax rate
    • Provides infrastructure development for investment projects valued at $193.7 million or more

The effects of this legislation have already begun to be felt around the world. Russia exported $2.9 billion of logs in 2005. A total of 81 percent of Russian logs went to these three countries--46 percent went to China, 22 percent to Finland, and 13 percent to Japan. In the 1Q2008, however, after timber tariffs started to climb, Russia’s exports to Europe dropped 44 percent, and its exports to Asia decreased by 15 percent. International Wood Markets Group President, Russ Taylor suggested that “the effect of the proposed tax increase in North America could exceed price increases caused by the withdrawal of U.S. National Forest timber to save the habitat of the northern spotted owl” in 1993, when prices hit $495 per thousand board feet.

For more on how the 2007 Forest Code is affecting the wood supply chain in Europe, Asia and North America, click here.

The Shortage of Mill Residue in the Northwest Market Area
Pacific Northwest pulp mills, board plants and users of wood fuels have long relied on sawmill residuals as the primary source of raw material. The depressed housing market—and the resulting 22 percent curtailment of regional lumber mill production—has dramatically reduced the availability of wood residues. This scarcity of residuals has both given rise to higher fiber prices and brought about a number of innovations in supply chain management.

Traditionally, residue has supplied more than 80 percent of northwest wood chips for pulp. Since 2006, however, the annual volume of sawmill residual wood chips in the Pacific Northwest has declined by more than 1,700,000 bone dry tons. Although this phenomenon has contributed greatly to the shortfall, other demands such as wood energy have aggravated the situation. Today over 45 percent of the Northwest Region’s total pulp mill supply comes from whole log chips.

One of the reasons for the surging whole log chip supply can be traced to the December 2007 windstorm. Salvage of blow down timber created an abundance of low value wood to feed Western Oregon and Washington whole-log chip plants. Presently west side wood yards and chip inventories are flush and storage piles at over-flow capacity. As a consequence third quarter 2008 chip prices have declined slightly in much of the region. Because of permanent mill closures and deeper long-term production constraints, supply in the inland west remains more uncertain, and this has prompted an up-the-Columbia-River material flow.

While the harvest of salvaged timber has been abundant to date, it is also finite. As clean-up of the salvage nears conclusion—projected to occur sometime in 2009—wood chip supplies could easily become acute. Unless housing recovery kick-starts sawmill productivity, further supply disruption and higher prices are a distinct possibility.

Supply of wood fuels is also becoming an issue. Only 18 months ago sawmill residue bark value was irregular; while occasionally in demand on the spot market, much of this material was traded for merely the hauling cost. Because of the expansion of several new wood fired electric co-generation plants in western Oregon, this has changed; these plants now require more than 150,000 additional green tons of fuel annually. Coming at a time with declining availability, average prices have more than doubled to the high $40’s per bone dry ton.

For the rest of Gordon Culbertson's article on the shortage of mill residues in the Pacific Northwest, click here.

New Customer: The Federal Bureau of Land Management
Last month, Forest2Market began providing the federal Bureau of Land Management (BLM) in western Oregon with current pricing data for delivered logs by species and grade.

The BLM, which oversees 2 million acres of forestland in western Oregon, will use the information to appraise the value of timber and set minimum bid rates for monthly timber sale auctions. Federal law requires these lands to be managed for sustainability, which requires periodic timber harvests.

The BLM provides a reliable timber supply for many mills in the region. The timber is auctioned to the highest bidder – generally a lumber or plywood manufacturer or a logging company. This year alone, the BLM will sell a total of 236 million board feet of timber in six districts in western Oregon.

Pete Stewart to Speak at Texas Forestry Association Annual Meeting
Pete Stewart, Founder and CEO/President of F2M, will be speaking at the Annual Meeting of the Texas Forestry Association, which is being held October 22-24, 2008.

Correction: In last month’s story, “All Wood is Woody Biomass, Isn’t It?,” the Renewable Fuel Standards were mistakenly reported in millions of gallons per year, instead of billions of gallons per year. The actual standard more ambitiously calls for 36 billion gallons per year of renewable transportation fuels by 2022, with 16 billion gallons of that total coming from cellulosic sources.

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