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Clarky's Comment - June 2014, Safety and Log Prices

Safety and Log Prices

This month I have two significant events to comment on. The Independent Forestry Safety Review (IFRS) panel has released its initial report for public consultation, and we have witnessed a massive decline in export log prices, arising from oversupply to China.

That the two events occurred together is coincidental but it did cause me to reflect on both the volatility of forest owner returns and on the linkage of that to safety during the harvesting phase. The IFSR does not comment on the forest industry's profitability or the volatility of earnings but I believe these both impact on worker safety.

That the industry is of low profitability should not be a matter of dispute. It is evidenced by the current trend of deforestation and virtually zero new planting.

More material for safety during the harvesting phase is the cash returns i.e. revenue in excess of costs. For first rotation steep hill country requiring access roads, new skids and hauler logging, cash returns can be modest. The same applies to many smaller farm blocks.

While the maxim of "Do it safely or don't do it at all" will be accepted by most, forest owners and agents are operating in an environment that a small movement in log price, exchange rate or bulk shipping costs will mean the difference between a positive or negative cash return on harvest. Under these circumstances ways to minimise capital expenditure on roads that are only used once, or to restrict harvesting to the summer months to save on roading rock are entirely understandable. My point is that a sustainably profitable industry, that has lower volatility in earnings would provide a better foundation for investments in good roading infrastructure, longer term contracts and for contractors to invest in training and modern reliable equipment.

The reasons for the low profitability and earnings volatility are complex. But this does not mean that nothing can or should be done to improve the situation. Areas where government leadership and policies could make a material difference include:

  • More equitable treatment in land use policies such that planting was encouraged would assist with confidence in future wood supply that is in turn important for investments in wood processing.
  • In the absence of a functioning climate change policy, a wood-first policy for government buildings would be a boost to domestic demand for engineered wood products. A domestic market is an important enabler of larger investments for export markets. Such a policy has already been advanced by the Labour party.
  • Support for forestry skills training.

There are others and it is great to see the National government's recent announcement of a commitment to road improvements, including regional roads as improved transport efficiency is very important for forestry profitability.

Some forest owners are now facing negative stumpages and must make decisions whether to cease harvesting or retain harvesting capacity that can be hard to bring back once prices improve. That is a tough decision and will no doubt be driven by perceptions of how low the prices will go and for how long before a recovery. To answer that we need to look at the underlying causes of the price drop and what might cause a price recovery.

  1. Our pine logs are a commodity. When prices rise, supply increases. That is what happened to cause too much inventory at China ports. Similarly as prices fall supply drops off. But there is a 3-4 month lag effect because of all the logs on boats and at ports and in the bush, and the time it takes to slow or stop harvesting activity.
  2. Our pine log consumption is closely linked to construction activity in China. The Chinese government has become concerned about inflation in apartment prices and in too much supply i.e. the classic housing bubble experienced by many countries in the past. To address that it tightens credit. This slows housing starts and reduces demand for our pine logs. But that effect has not been too dramatic as construction activity and off-take of pine logs from ports continues at relatively high levels.
  3. There has been no collapse of the construction industry in China. Nor would the Chinese government want to see that, given the on-going need to relocate workers from low-paying rural work to higher paid urban industries. According to the "Australia in the Asian Century White Paper" we can expect continued strong economic activity in China and other Asian nations through to 2025 and possibly well beyond.

My crystal ball in these matters is always a bit murky but it appears that what we have here is a classic commodity response to a temporary oversupply that will quickly rectify in response to a drop in supply. That drop in supply is likely to commence in June/July and China port inventory levels start to drop off then.

The extent and steepness of the fall and likely rise that will follow, is exacerbated by the fact that many of New Zealand's log sales involve multiple traders at both the supply country and China ends. These traders make money on a rising market and lose money on a falling market due to the time differential between their buy and sell. More sales to end-users would allow supply and demand to be much better matched to avoid the overshoot of inventory in China that was the main cause of this price drop.

One feature of China that is not shared by many Western nations as they have attempted to avoid or recover from housing bubbles is the responsiveness of local construction firms to central government signals. It takes only a small sign of credit squeeze or encouragement from the central government to slow or increase construction activity.