Pulp and Paper Canada

Finally: Is there light ahead?

July 1, 2008  By Pulp & Paper Canada

The facts are clear. In response to world market conditions, lumber producers have sought to cut costs and close money-losing mills in the wake of slumping demand from the battered US housing market. …

The facts are clear. In response to world market conditions, lumber producers have sought to cut costs and close money-losing mills in the wake of slumping demand from the battered US housing market. Rising costs of everything from gasoline and electricity have subsequently raised the cost of operations from coast to coast.

Giants such as Canfor and Tembec have cut production and laid off hundreds of mill workers to help reduce costs. Meanwhile, some companies, including AbitibiBowater and Domtar, have restructured or merged paper operations with major US companies as a way to become more efficient.


It’s part of an overall global trend of manufacturing and production drifting southward to Asia and South America, benefiting emerging nations like India, Brazil and China. “It’s not going to change soon,” says Craig Campbell, leader of PricewaterhouseCooper’s performance improvement practice for the global forest and paper industry. “What’s happening with the forestry sector is no different than what has happened with other industries like shipbuilding and textiles going to Asia. It’s a natural evolutionary migration from North America and Europe to the southern hemisphere.”

One of the strongest factors affecting the industry is the well-reported US housing slowdown. Housing starts in the US are down by more than half since its peak of two million starts in 2005 (see sidebar, US housing slowdown hits home). Canadian lumber shipments -which represent 95% of US imports -are expected to decline by six billion board feet from its peak in 2005, reports the Western Wood Association, the Portland, Oregon-based lumber trade association.

“The slow recovery for housing and lumber markets should continue for the balance of this decade,” says Kevin Binam, association economist. For example, prices for benchmark random length spruce, pine and fir two-by-fours remain in the US$200 range, about half its peak price of US$400 reported in 2004 and 2005, says Madison’s Lumber Reporter, an industry paper.

Coupled with a stronger Canadian dollar, and it’s easy to see why the Canadian industry continues to face tough times. “The Canadian dollar has increased in value 57% against the US dollar since its low in 2002,” Campbell says, costing the Canadian forest industry over $2 billion in reduced revenues.

According to Campbell and other financial analysts, the Canadian forestry sector has to continue looking at best practices, including streamlining its supply chain in order to reduce costs. But it may well be that the Canadian forestry sector will have to ride out the north-south migration of manufacturing work and products, and wait until Canadian lumber, pulp and paper products eventually become a highly desirable commodity.

Part of the solution is to consolidate operations through mergers and acquisitions. Analysts like Gail Glazerman with UBS Investment Research’s Global Paper & Forest Products in New York predict an increase of mergers and acquisitions this decade, with companies selling non-core assets and making acquisitions focused on specific grades. This has happened before in the go-go 1990s, and it might take place again soon.

The wild card, as it were, is the world’s fibre supply. “Emerging markets are the key,” Glazerman says. “If demand in these markets starts to follow the path of other basic materials, there could be opportunities.”

Having a clear vision

Such are the facts on the ground, the hard cold reality of numbers and financial details. Change and opportunity rarely take place based on economic reality, but because of the need for change. Change takes place when there is a real need, and the forestry sector is poised to undergo fundamental (if not exciting) changes. It’s not a Pollyannaish outlook, as some might argue, but a visionary view of the future.

There are three areas that Canadian companies can look to with great hope and excitement: 1) Foreign markets 2) Bio-energy and 3) Sustainable development. Of the three, the last might hold the greatest unrealized potential, owing to Canada’s vast natural resources and prudent environmental planning. It might take a visionary to understand what future awaits Canada’s forestry sector.

One such visionary thinker is Avrim Lazar, president and CEO of Ottawabased Forest Products Association of Canada. “There is no doubt that current economics in the Canadian forestry sector are grim,” Lazar says. “However, when you look out at the horizon, at where global economics are quickly going, it’s clear that the industry’s longer-term prospects are excellent. And strangely, the future of Canada’s most distressed sector provides the most compelling story of how privileged Canada will be in tomorrow’s world economy.”

Lazar’s argument, simply put, is that natural resources that are produced in a sustainable way will become the most prized products in tomorrow’s global economy, notably as incomes in developing nations triple in the next 20 years. “This march of the world’s poor in developing countries out of a subsistence existence and into the modern economy has long been part of humanity’s dream, but it will put pressure on the planet,” he says. “Just look at where we are today, with prices for energy and natural commodities rising and the evidence of the harm we are doing to the planet all around us.”

The increasing global wealth will bring a global demand for paper and wood that is projected to grow significantly over the next 20 years. And because emerging economies will be forced to use more of their land for agricultural purposes to feed their citizens and to use it for a growing biofuels market that will increasingly rely on cash crops like sugar cane, corn and palm oil, it is clear there will be a severe global land shortage. The story for water is, if anything, more sobering.

The news is great for Canada’s forestry sector, which has a vast and sustainable forest, Lazar says: “The world will turn to Canada and other boreal nations that have a vast forest base, energy and water for the supply of forest products.”

Canada is also in a privileged position to meeting its commitment of a zero carbon footprint by 2015. “The world is rapidly moving to a place where demand for forest products will have to be met by countries that can produce those products sustainably and without displacing land that could otherwise be used to grow food or fuel,” Lazar says. “Few countries are as well-positioned as Canada to meet demand in this way.”

Fueling bioenergy

Equally important, there’s the promise of bioenergy, biofuels and other possible bio-products, which can possibly be manufactured in the mill, using either existing infrastructure or a modified form that can be done with strategic investments.

For example, workers in New Brunswick’s forest industry are looking to the promise of bioenergy and assorted bioproducts as a ticket to the future. The forestry sector lost an excessive number of jobs nationally during the past five years, with more than 3,100 cuts in New Brunswick due to a series of mill closures in communities such as Fredericton, Miramichi, Dalhousie, and Bathurst.

Things will likely get worse before they get better, says Mark Arsenault, president and CEO of the New Brunswick Forest Products Association, in a recent Times & Transcript article. “We know that the bottom of the curve is not there yet. But we are very optimistic for the coming years.”

A group of forestry industry leaders met in Ottawa in June to advise mem- bers of a standing committee on natural resources, who subsequently tabled their report in the House of Commons about the future of the forestry sector. The report makes 23 recommendations for revitalizing the industry, which includes asking Prime Minister Stephen Harper to convene a national summit on forestry and the need to explore more intensive use of bioenergy from wood products. The report focuses on the emerging bioeconomy -pr
oducing ethanol and plastics from wood-waste and powering mills through green technology.

One of the most significant and ambitious bioenergy projects is by Iogen Corp., a private company based in Ottawa, which plans to develop a commercial-scale cellulosic ethanol plant in Saskatchewan. “Iogen is a world leader in cellulosic ethanol, with proven cellulosic ethanol production experience since 2004,” Brian Foody, Iogen president, announced in March 2008. “We believe that our technology will help reduce greenhouse gas emissions in the transportation sector, provide economic growth opportunities for farmers and increase energy diversity.”

The company has signed agreements with Royal Dutch Shell, Goldman Sachs and Petro-Canada. It has also applied for funding under the federal government’s NextGen Biofuels Fund, which funds up to 40% of the cost to establish a large-scale commercial biofuel plant.

Finding foreign markets

Russia might prove a worthwhile market for logs. For example, TimberWest Forest, a BC forestry company, is taking advantage of Russia’s log export tax to replace some of the business lost as a result of the US lumber market collapse.

The Russian government has imposed a 25% export tax on unfinished logs, which took effect on April 1, and plans to raise it to 80% by 2009. The tax’s purpose, however, is to try to boost more domestic log production in Russia -the world’s largest exporter of logs. It typically ships to such countries as China, Korea and Japan.

Chinese sawmills have already reported that they are finding it difficult to source Russian logs, opening up another potential market for BC wood. Paul McElligott, TimberWest president, is cautiously optimistic of the turn of events

“TimberWest has received numerous inquiries for fir logs manufactured to Japanese peeler lengths from Japanese plywood manufacturers in response to the anticipated increase in the Russian log export tax,” McElligott said in a recent conference call with analysts. “If the Russians follow through with this 2009 export tax increase, the peeler business in Japan should develop more rapidly for TimberWest.”

Peelers are logs that are processed, or peeled, into wide veneer strips that are chiefly used for plywood. Peelers are among the most valuable logs. Fir peelers sell on the Vancouver log market for between $120 and $150 a cubic metre, double the $60 to $70 a cubic metre for a standard second-growth fir log.

More positive news is coming out of British Columbia. The west coast province, which has suffered greatly in the last few years from diminishing returns, is turning a disaster into something positive. The mountain pine beetle outbreak has killed millions of acres of lodgepole pine, BC’s most commercially harvested tree. West Fraser Timber is looking to join forces with Epcor Utilities to build a power plant near Houston, BC, which would be fueled by pine beetle-killed wood.

There is a lot of work being done on how next to use the wood destroyed by the mountain pine beetle. For example, Pinnacle Pellet is one of a few private BC companies that has turned shavings from beetle-affected wood to pellet fuel, a practice that is popular in Europe and is gaining credence in North America.

The University of Northern British Columbia has received government funding for a pilot project comparing beetle-wood pellets to natural gas for fuel. “There are a lot of creative people out there right now trying to come up with ways to salvage the value of that wood,” Bruce McIntyre, leader of the forest, paper and packaging practice at PricewaterhouseCoopers in Vancouver.

To be sure, executives and decision-makers of forestry companies will face some tough decisions in the months to come. Facts and figures, economic and financial reports and analysis and forecasts will fill their desks and credenzas, as well as their time. All, undoubtedly, have their value. Yet much has to be said for how one looks at the facts and figures and the charts and PowerPoint presentations. An ancient Jewish saying might help put things into clearer focus. “Think good, and it will be good.”


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