Forecasting Stumpage Prices and Timberland Investment Performance Requires Local Knowledge of Wood Demand

Last week, I met with the CEO of one of world’s largest forest management and consulting firms.  We ended up discussing a mutually perplexing question, “why do some timberland investors prioritize macro issues like housing at the expense of understanding market-specific issues such as local wood demand, mill risk and actual forest inventories?”  While housing market forecasters have, once again, delayed expectations of the anticipated home building recovery, Forisk analysis of local timber markets affirms the primacy of micro-market, investment specific factors over regional and national trends.

Shifts in forest supplies and wood demand influence regional timber markets. The extent to which sub-regional markets, such as mill-specific wood baskets or property-specific timber markets, are influenced by regional or macroeconomic changes remains unclear.  Previous analyses by USDA Forest Service and University researchers such as Bob Abt, Fred Cubbage, Tom Holmes, David Newman, Jeff Prestemon, and Runsheng Yin, estimate a price elasticity of demand for softwood stumpage ranging from -0.50 to -0.57 and a price elasticity of supply ranging from 0.29 to 0.50.

This implies that for every 1% change in price, changes in demand or supply will be considerably less than 1%. [This also implies that for every 1% change in demand, prices changes would exceed 1%.]

In 2005, Forisk Consulting began collecting mill-specific wood demand data on a quarterly basis throughout the US South.  In 2008, we expanded this coverage to the continental United States.  Today, our team manages an ongoing research program that collects and confirms data on 3,196 announced and operating wood-using forest industry and wood bioenergy mills throughout the US.  We believe this to be the most comprehensive and current tracking of US forest industry health and demand available in the world.

How has this research helped the forest industry and timberland investors?  We have found that local market performances have wide ranges of price-to-demand elasticities and mill risk profiles, beyond those established in regional or national analyses.  The differences across markets are statistically significant and provide a rigorous basis to adjust market-specific discount rates, stumpage price forecasts and expected rates of recovery.

For example, the expected price effect from a demand shock (i.e. a new mill) in a sub-regional market depends heavily on:

1. Available forest inventories and growing conditions; and
2. The competitiveness and distribution of wood-using mills in the local market.

Competitive markets with multiple mills can aggravate and prolong the impact of a demand shock on prices.  Alternately, competitive markets provide the best uses of new capital for timber and forest industry investments when benchmarked against ranges of wood baskets and timber markets across multiple performance criteria.

Despite Wet Weather, Pine Grade Markets Recover; Use of Woods-Direct Chips Increasing

Southern demand for pine grade timber raw materials rebounded 6.1% during the 1st quarter of 2010, according to the Wood Demand Report, after reaching five-year lows the previous quarter.  Data providers reported that “markets have turned around” while others confirmed restarting production during the past few quarters.   Several mill managers expressed concern that, while markets improved, they feared that mills may overproduce in the near-term, thereby suppressing potential price recovery for end products such as lumber and plywood.

Pine pulpwood demand increased 1.1% South-wide during the quarter at both pulp and OSB mills.  In addition, the 1st quarter produced the highest reported consumption of in-woods chips for both pine and hardwood since 2006.  Consumption of both products has increased gradually over the past few years.

Looking ahead, we expect increasing consumption to continue.  Pulpwood demand in the US South is projected to recover in two years and reach pre-decline highs by 2013, according to the ForiskForecast.  Demand by pulp and paper users will be modest, and OSB producers will “consume more as the housing market recovers,” according to Dr. Tim Sydor, Forisk’s Forest Economist.  The primary growth in pulpwood demand will be from wood bioenergy customers.  We project wood bioenergy producers in the South will consume a pulpwood equivalent on par with OSB producers by 2015.