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Log Market - September 2012

Many commentators are describing the log market this year as being remarkably stable, driven by particularly steady demand and price in the export log market. That, in itself, is a little worrying for a contrarian, although perhaps you can "get what you wish for" – at least for a while. This month prices rose marginally for export logs and remained steady for domestic logs.

Once again the demand and price for export logs is being lead by China, so again, our commentary is focussed on this market, along with a look at what is happening to another commodity, iron ore.

Export Log Market

Logs have fared a lot better than some other hard commodities such as iron ore. Prices and demand for iron ore and steel have fallen heavily this year, especially in the past two months. As the price of steel falls, many of China's steel makers become unprofitable and either need government assistance, or they reduce production, or close. This reduces the demand and price of iron ore. One of the outcomes of this has been a major fall in iron ore supplies from Brazil, in lieu of increased supply from Australia. This has lead to a significant drop in tonne-kilometre freight demand due to Australia being closer to China, and consequently a big drop in the cost of ocean freight. Lower ocean freight costs have, in turn, benefited the returns on export logs.

So why hasn't the Chinese timber market suffered the same type of price falls as iron and steel. Firstly, the supply of logs has been constrained this year. Whilst supply from New Zealand has been pretty similar to levels of last year, supply from North America has reduced due to lower prices than last year, and better domestic demand. Secondly, timber hasn't been subjected to the massive over-investment in capacity and the stockpiling of product as has the steel industry; a function of inefficient steel makers and not responding to market signals.

Wood Markets Group August news release reports that recently released statistics indicates that a "soft landing" is being achieved in China's construction industry. It goes on to say that the bulk of the data suggests that China's wood products sector is expanding after hitting a bottom in the first quarter of 2012. Most of this sentiment is coming from what appears to be renewed strength in the real estate market. However, there was also surprisingly strong data from the furniture makers – Chinese furniture exports increased by 26% in the first half of 2012 as compared to the same period last year; export volumes to the US were up 29% and to ASEAN countries up 26%. The stand-out surprise was volumes to Europe up 48%, a tremendous performance considering the struggling Eurozone economies. Most other exports from China to Europe, are down considerably.

Demand and prices for lumber have increased in Canada and the US. West coast Canadian saw mills are continuing to increase lumber exports to China and inland provinces are benefiting from increased demand from the US. During the past 12 months, according to Wood Resources International, southern yellow pine (SYP) prices have gone up almost 37%, while spruce-pine-fir (SPF) prices in Canada have increased by about 35%.

These positive aspects must be tempered against a background of still considerable uncertainty regarding global growth. National Australia Bank (NAB) in its September commodities update pointed out that GDP in Europe looks to be heading for another contraction in the third quarter of 2012, while the Chinese economy has slowed notably and the US economic recovery remains sluggish. The NAB goes on to say that the subdued outlook will continue to weigh on commodity prices - it is forecasting a decrease of 21% for the non-rural commodities index over 2012, in US$ terms. [We note, however, that 55% of this index weighting is iron ore, thermal coal and metallurgical coal.]

So long as global growth doesn't drop significantly from current expectations, it seems believable that the timber and wood products sectors could fare better with the US economic recovery lead by the housing market and as disaster-affected regions such as Fukushima and Christchurch increasingly exert their extra-ordinary demand for building products over the next few years.

Log stocks at China ports are reported at 2-2.5m m³ which is not super-lean, but there is an expectation of reducing stock levels as the traditionally higher demand season kicks in.

Charter rates of bulk freight sectors continued to drop until about two weeks ago when Capesize started to show signs of a small recovery, and a week ago the same for Handysize (the sector which carries NZ logs to Asia). As an offset to lower charter rates, oil prices have been in a general uptrend since lows reached in May. The net impact has been slight falls in ocean freight rates for logs over the month, and expectations of rates to remain at around this level for the foreseeable future. RS Platou is forecasting net bulk carrier fleet growth for the remainder of 2012 and into 2013. This means more vessels chasing cargo and will continue to keep charter rates soft.

(source: HSBC)

The Baltic Dry Index (BDI) is down nearly 56% since the beginning of 2012. The Baltic Handysize Index (BHSI) is down a lesser 18% - this is the index of most relevance to shippers of New Zealand logs to Asia.

The NZ$/US$ exchange rate has traded in a tight range for the month or 0.79 – 0.82. We note that whenever sentiment for global growth improves (such as when the European Central Bank recently announced its unlimited bond buying programme), the NZ$ strengthens – this is an annoying correlation apparently driven by risk sentiment. It doesn't make much sense, but it is a reality for exporters for the time being.

Domestic Log Market

There is little change in the status of the domestic wood products market since last month. The outlook remains similar with constrained domestic and Australian demand but improved conditions in the US and a steady Asia. The persistently high NZ$ challenges manufacturers' margins for export product.

The June quarter saw the volume of construction work undertaken all around New Zealand rise in seasonally adjusted terms by only 0.7% after falling 0.4% in the March quarter. The emerging trend is increasing residential work and decreasing non-residential work. Increased activity in Christchurch is expected to start to be seen in third quarter figures and beyond, as the rebuild gains momentum.

(source: BNZ)

With regard to other economic indicators, a positive trend was seen in commercial vehicle and tractor registrations, up 36 and 43% (respectively) from a year earlier and up 9 and 7% (respectively) in seasonally adjusted terms.

Due to most pricing being quarterly-based, there was little change in domestic log pricing for September. Negotiations for October-Dec 2012 supply will commence shortly.

It was fascinating to see the Takapuna houses in the hit TV show The Block recently sell under the hammer for mostly over $800k and the top house sell for well over $900k. These are for old renovated homes on handkerchief-size sections. One cannot help but think that the excesses of the last housing boom have not been shaken out. NZ housing is repeatedly reported as amongst the least-affordable in the world, but there is relatively little new construction going on to alleviate the housing shortage. This is despite historically low interest rates (cheap money) and high demand for housing. Perhaps it relates to the high number of developers who got into financial difficulty after the prior housing market peak and would-be new developers sitting on their hands/cash until there is more certainty – although who would know when that is!

The BNZ, in its latest confidence survey, recorded a slight increase (in confidence) on the month prior. A net 17% expect the economy to be in better shape in a year's time (13% last month). The BNZ go on the say that the results are consistent with a range of other indicators suggesting the NZ economy is set to grow at about the new trend rate of 2%. This is in contrast to the average rate of 3.5% achieved between 1992 and 2007 when many special factors combined to produce the credit boom.

Pruned log demand remains high in many areas. Other grades are steady. Canterbury has strong demand for structural log grades.

Export grades were up $1-2 on average, and the domestic grade average price was unchanged.

Indicative Average Current Log Prices

Log Grade$/tonne at mill$/JAS m³ at wharf gate
Pruned (P40) 138 152
Structural (S30) 98  
Structural (S20) 92  
Export A   102
Export K   96
Export KI   88
Pulp 56  

Note: Actual prices will vary according to regional supply/demand balances, varying cost structures and grade variation. These prices should be used as a guide only.