The Forest and the Trees
January 1, 2007 By Pulp & Paper Canada
Canada has traditionally been, and still is, the world’s largest single exporter of lumber, pulp, paper and wood products. Our share of the global market in these commodities has hovered around 20% fo…
Canada has traditionally been, and still is, the world’s largest single exporter of lumber, pulp, paper and wood products. Our share of the global market in these commodities has hovered around 20% for the past two decades, and we continue to be a dominant player in the sector. The industry is of vital importance to the national economy; based on year-to-date trade data available from Statistics Canada, the sector’s export revenues are expected to add up to $40 billion in 2006. In 2005, exports of forestry products represented over 3% of the country’s GDP. Moreover, it currently employs about 272,000 people and, overall, probably contributes directly and indirectly to the employment of one million Canadians.
The past few years, though, haven’t been easy.
In just one subsector — newsprint exports — our global market share has dropped by half. Among our problems are the tougher competition from Europe and from Central and South America, the perennial softwood lumber dispute with the United States, and falling prices caused by world oversupply. But the industry has a tradition of resilience and is capitalizing on its strengths. The British Columbia interior, for example, has turned itself around by re-equipping with new technology and manufacturing processes. In spite of all adversity, the BC interior had the most profitable forestry segment in North America in 2004.
What exactly are our strengths? “We have several,” says David Gray, vice-president of Mill & Timber Products, a sawing company located in Surrey, BC. “The Canadian forestry industry has an excellent infrastructure of transportation, supply and materials. We have immediate access to everything we need, from replacement motors to lubricants. We have a rule of law, which means that we meet our contractual obligations. We have a workforce that’s educated for the high-technology side of the industry. Those factors aren’t present in many of the places we’re competing with, and having them provides us with a significant advantage.”
Altogether, in fact, the value-added sector in forestry accounts for one-third of Canada’s total annual shipments of wood products. It’s rapidly becoming more important in the Quebec industry as well, according to Michel Vincent, director of International Trade for the Quebec Forest Industry Council. “In this province especially,” says Vincent, “we have to work rapidly toward value-added products because of the U.S. tariffs, which apply to the lower-grade wood that makes up more than a third of Quebec’s harvest. We’re better off keeping this wood here in Quebec and to find ways to use it in new products.”
Paradoxically, though, the pressures of globalization and the softwood tensions with the United States may be contributing to Canada’s ability to maintain its long-term strength in the sector. Jim Farrell, director general of Natural Resources Canada’s Policy, Economics and Industry Branch, thinks there’s a good argument for this possibility. “Because of these pressures,” he observes, “we’ve had to invest in ourselves in order to be more competitive.”
Still, some parts of the industry are proving to be more competitive than others. “The balance sheets are all over the map,” says Farrell, “but for the country in general, they show that newsprint, paper and pulp companies aren’t making money, while companies whose primary product is lumber and panels, mainly in Western Canada, are seeing profits.”
Business not as usual
Several domestic factors lie behind the industry’s spotty performance during the past few years. One, which was many decades in the making, has been our conviction that we could remain the world’s largest forestry exporter just by doing what we’d always done. Back when newsprint was made almost exclusively of black spruce, and when eastern Canada had a corner on this type of wood, that might have been true. Now, however, paper technology can make newsprint and writing paper out of almost any wood, and even out of non-wood fibre. As a result, non-Canadian companies that have access to huge eucalyptus and pine plantations in South America have abruptly become dangerous competitors.
As a result of our relaxed attitude in the past, says Vincent, we didn’t innovate quickly enough. “During the 1990s, the Quebec sawing industry was one of the most advanced in the world. But for the past five to eight years, our investment level has been too low. That’s been partly because of the costs to our producers of the U.S. tariff, but the bottom line is that we didn’t advance as fast as we should have.”
Low rates of innovation can be blamed at least partly on low rates of reinvestment, adds Farrell. “Lack of reinvestment has certainly been a huge problem during the past 10 years.” He pointed out that newsprint companies, for instance, had an average rate of return on capital of 3.5-4% which was not enough to appeal to financiers as a good investment. “Without investment in a capital-intensive industry,” he explained, “you can’t compete. That’s a big challenge, because you can get into a death spiral in terms of productivity and competitiveness if you don’t reinvest. My hope is that as we move out of the current phase of closures, transitions and restructuring, our companies will become fewer but larger, and although they’ll produce less, they’ll do so at a lower cost. That will give them some breathing space to generate cash flow that they can reinvest in themselves and use to attract outside investment.”
Riding out the storm
Another problem, especially for pulp and paper companies, is energy costs. This part of the industry is one of the heaviest users of electricity in Canada’s entire manufacturing sector, and the price of electricity keeps going up. Ontario, for example, has one of the highest electricity costs in North America. Again, it’s a problem that has its roots in the assumption that the future will resemble the past. Energy was so cheap for years that the industry tended to not pay much attention to it, but now it’s expensive. That expense is another factor that’s undermining our pulp and paper industry’s ability to compete abroad.
Then there’s the question of regulation, which varies from province to province. In Quebec, says Vincent, inappropriate regulation has made it harder for the industry to adapt to changing conditions. “Every tree growing in the forest belongs to a particular mill,” he points out. “You can’t sell it to a competitor or another mill, or redirect your wood to other mills to be more efficient. British Columbia had similar problems in the early 1990s, but out there they realized that if they wanted to consolidate the industry, they’d have to let the industry do what it needed to with its wood.”
Then there’s the rise in the value of the Canadian dollar, which has brought problems including difficulties with labour flexibility in some parts of the sector.
In addition, there’s a pine-beetle epidemic that has already affected more than eight million hectares in British Columbia. In some ways, as David Gray says, the past few years have been “a perfect storm” for the industry.
Light on the horizon?
Storms do end, though, and there are opportunities ahead that will brighten the forestry industry’s future. One of these is the potential for exporting Canadian timber and timber-construction technologies (both residential and non-residential) to new markets that have little or no background in this type of building. Katharine Funtek, deputy director of the Department of Foreign Affairs and International Trade’s (DFAIT) Market Support Division, sees these markets as holding great promise.
“China is one such potential customer,” she observes, “and the forestry sector is working with provincial and federal government departments to position Canada in that market. For example, we’re having a lot of success with the Chinese government in establishing regulator
y requirements, such as fire and construction codes, for building with wood.
The construction side of the industry, adds Funtek, is one we should push more aggressively. Many earthquake-prone countries, such as Japan and Pakistan, could improve public safety if they used Canadian wood technology for residential and non-residential construction; properly put together, wood-framed buildings can ride out an earthquake that turns concrete and brick structures into lethal avalanches of rubble. “This is an area where we have a lot of strength,” Funtek says, “and we ought to be getting the message out more energetically than we have been.”
A diversity of threats
The chief external threats to Canada’s forestry industry are from low-cost suppliers of fibre and of the major wood commodities: pulp and paper, newsprint, wood products and lumber. With these products now being manufactured and exported by countries as diverse as Russia, Germany, China, Chile and Brazil, globalization is clearly a factor that affects the health of our forestry sector.
“What globalization has done,” says Mill & Timber’s Gray, “has been to flatten out everybody’s market opportunities. We used to ship wood to places like South Africa and Australia, but now there are suppliers who are closer to those markets than we are, and who are displacing us because their resource or transportation costs — or both — are lower than ours. Softwood fibre is common, and once people learn how to make things from it, they’re our competitors. That’s going to continue, and it’s one of the realities we all face.”
“Globalization,” adds Montgomery, “can be a one-way street, in the sense that customers like China can be willing to take our raw materials, but don’t want to buy our value-added products. Instead, they start manufacturing these products themselves, and they eventually do this so cheaply and so well that it’s difficult for us to get into the market.”
Speaking of China, one major threat to our penetration of this market is Russia, whose immense eastern forests aren’t far from the Chinese border. That means it’s cheap to ship Russian lumber to market; moreover, while the Canadian forest industry invests substantial sums in sustainable forestry practices, the Russian forestry industry is almost completely unregulated and spends little or nothing in this area. These advantages, added to Russia’s cheap labour, will make it difficult or impossible for us to compete in the Chinese market on price alone.
Competition from all directions
Similar cost problems are cropping up all over the globe. While the Russian forestry industry is pretty much on its own in terms of government support, the same can’t be said for the Scandinavian countries. In Sweden in particular, the forestry industry has always had a close relationship with the government in terms of regulation and policy. Among other initiatives, Sweden has supported the wide-scale planting of new forests, and has helped its forestry industry develop innovative technology that is now being exported around the world. This collective, public-private strategy has been successful in keeping the Swedish forestry sector extremely competitive.
The squeezing of our markets is especially acute in pulp and paper manufacturing. Some firms are still profitable, but today our competitors are investing in plants that can be three times the size of Canadian ones, resulting in large economies of scale. Moreover, modern technology lets anyone make decent paper products out of lower-grade, cheaper fibre, and the overall result is that our competitors’ cost of production is much lower than ours. We’re also under threat at the resource supply end; in Brazil, a tree can grow to usable size in seven years; here, it takes 20.
Adapting to adversity
But despite the problems we’re living with at the moment, there’s room for cautious optimism. Several broad strategies can help us adapt to the changing world market, just as we’ve adapted before.
“We have to keep investing in research and development to make sure we can introduce new products and take advantage of our strengths,” says Vincent. “That’s what we’re doing in Quebec, but it takes time and investment to make the switch.”
Farrell agrees. “A Canadian firm has to think hard about what it can do, not just today, but five to 10 years out. It has to be something that can’t be turned into a commodity, manufactured in Shanghai, and arrive in the United States two weeks later. The companies that are doing well have thought that through, have relied heavily on efficiencies all along the value chain, and have found niches that can’t easily be commodified.”
At the same time, our producers will have to do all they can to bring costs down by, for example, eliminating production at the high end of the cost curve. Government encouragement and support in the areas of tax policy, industrial policy and regulation can also certainly help, as is so clear from the Scandinavian example. Obviously, too, we have to keep seeking out new alternatives to our traditional market, the United States. Softwood lumber, for example, is a widely traded commodity, so if market conditions are poor at a given time in the United States, they might be better in Europe or China.
The future, in other words, holds promise, because Canada’s forestry industry makes fine products and will continue to do so. As Gray says, “It’s been difficult, but we’re still here. Just keep at it and we’ll have a future. We’ll always have trees.”
Excerpted with permission from the spring 2006 edition of EDC’s ExportWise magazine (www.exportwise.ca) with some statistical information updated.
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