Wood Supply Agreements, Part I: Pricing Mechanisms and Market Analyses

9 05 2013

This is the first in a two-part series related to wood supply agreements and their relevance to analyzing timber markets.

In his 1989 book Liar’s Poker, Michael Lewis wrote, “Risk, I learned, was a commodity.  Risk could be canned and sold like tomatoes.”  This represented a prevailing view among the sophisticates of Wall Street prior to the mortgage bubble and collapse of AIG.  Though the view of risk “as a commodity” varies over time, it remains critically important to managers and investors exposed to timberlands and wood-using assets.  One tool employed to mitigate risk in timber-related industries is a wood supply agreement.

Forest industry managers and bioenergy project developers sometimes use wood supply agreements to manage the costs and flows of logs and other woody raw materials to manufacturing facilities and bioenergy plants.  Integrated forest products firms also used them to work through the operational impacts of timberland divestitures.  A typical agreement comprises a contractual obligation by a supplier to provide agreed-to volumes of wood to a buyer, who commits to purchase this raw material at the contract price.

Most agreements reflect a tradeoff between security and flexibility.  In guaranteeing volumes, the supply agreement secures supply for the mill and a market for the timberland manager.  The aspects subject to negotiation include product, volume, timing, and price.  Product specifies the species and “specs” of the product to be delivered.  Pine pulpwood or hardwood logs?  Volume specifies the amount of wood covered under the agreement, whether it is fixed or a range.  Timing specifies the timeframe covered, and the time periods for actually delivering the wood.  Price specifies the method and manner for pricing the wood delivered, and the process of updating and communicating this price.

The “pricing mechanisms” built into wood supply agreements are of central importance.  They have influenced many a bonus, ulcer and sleepless night.  How can fair prices be calculated over time that account for actual market activity while minimizing the “penalties” for being locked into a set marketing arrangement?  Existing supply agreements attempt to balance two competing aspects of pricing wood based on available data.  The first asks the question, “How does the market price this wood?”  The second asks, “What is the value of this wood in the market?”  The first is the question of the wood buyer, and the second is the question of the stumpage seller.

Common approaches include rolling averages, indexing, and blended indexing.  Rolling (moving) averages are used within the forest products industry, and in other heavy industry settings, to calculate transfer prices and for raw material supply agreements. One advantage of a moving average is that it reduces the peaks and valleys associated with changes in log prices.  One disadvantage is that, for any given month, the transfer price lags the actual market price, though this should balance over time.

Recent issues related to supply agreements have focused on reduced confidence in the data underlying a supply agreement and concerns about conflicts of interest associated with pricing mechanisms or indices provided by the same firm that collects and reports the underlying price data.  These issues become relevant when conducting due diligence on timber markets or wood baskets as they can affect the ranking and risk assessments associated with potential or existing wood procurement strategies.

For investors and analysts evaluating wood and timber markets, Forisk offers “Timber Market Analysis” on August 12th in Atlanta, a one-day course for anyone who wants a step-by-step process to understand, track, and analyze the price, demand, supply, and competitive dynamics of timber markets and wood baskets. For more information, click here


The Rise and Fall of Wood-Based Biofuels, Part I

16 04 2013

This post includes an excerpt of the research in the February/March/April edition of Wood Bioenergy US (WBUS) and is the first part of a two part series on liquid biofuels.

In May 2011, Forisk and the Schiamberg Group evaluated the viability of 36 wood biofuel projects in the United States.  The study emphasized the unlikely and problematic development of the wood biofuels sector while singling out projects with drop-in fuels and specific technology types as having investment potential for investors.  As of April 2013, 13 of the original 36 projects have been cancelled and 12 remain in the planning or construction stages.  Four have been shut down.  Since the 2011 study, ten new wood biofuel projects have been announced.  New projects emphasize feedstock flexibility beyond wood raw materials and focus on multiple, existing end markets including diesel, sugars and industrial chemicals.  Analysis of potential wood use highlights the minimal relevance of the biofuels projects to timberland investors in the U.S. today and over the next ten years (Figure 1).  


Newly announced wood biofuel projects have become increasingly less ambitious and less relevant to forest industry firms and timberland investors.  Analysis comparing projects in 2013 to those from 2011 find that current projects use less wood and scale at smaller production levels.  Meanwhile, the traditional forest products industry is reopening closed plants and building new capacity in response to increasing housing demand.   

In the bioenergy sector, wood pellets provide a ready, realizable market.  The enthusiasm for wood biofuels from a few years ago has been replaced with well-earned skepticism and caution. For timberland investors, potential demand and wood-based revenues from biofuels have been discounted.  For traditional forest industry firms, biofuel worries have been replaced by demands to be treated fairly in legislation or mandates that could affect wood raw material costs.  And for biofuel investors and project developers, the needs to produce product for existing markets that can produce cash today have strengthened business models and modified expectations for potential growth in the next five years. 

WBUS Market Update:  As of April 2013, WBUS counts 456 announced and operating wood bioenergy projects in the U.S. with total, potential wood use of 125.0 million tons per year by 2023.  Based on Forisk analysis, 293 projects representing potential wood use of 75.4 million tons per year pass basic viability screening.  To download the free WBUS summary, click here.

2013 Forisk Timber Price Forecast: Assessing Forest Supplies and Price Elasticities

9 04 2013

This is the sixth in a series related to Forisk’s 2013 forecast of softwood stumpage prices in the United States.

When housing crashed in the United States, forest owners and timberland investors deferred harvesting sawtimber, the logs needed to manufacture lumber.  In 2012, Forisk added a “forest supply module” to its forecasting of pine stumpage prices to estimate potential supply effects on timber prices.  Today, the theory that pine grade accumulated, possibly to excess, on the stump in the U.S. South is holding water. Historical research and quantitative relationships reinforced the notion that (1) stumpage prices would lag increased demand and pricing for softwood lumber and (2) excess forest inventories could further dampen pine sawtimber price recovery.

Quantitative evidence confirms that pine grade stumpage prices lagged increases in softwood lumber prices.  And the slow recovery of pine grade prices in 2012 showed greater dampening than estimated by the Forisk Forecast. South-wide, actual 2012 pine sawtimber prices in the South were 1.6% lower than Forisk’s estimate.  At the state level, pine sawtimber prices were, on average, $0.21 per ton lower than forecasted by Forisk.  While we cannot claim or confirm causality – we cannot prove that oversupplies produced slower growth in pine grade prices –we can establish the relative consistency in the story of demand-versus-supply across states.

States with the most severe pine grade “oversupplies” showed material decreases in their price-to-demand relationships over the past five years.  In other words, stumpage prices became less sensitive to increases in demand in those states for which a quantitative basis exists for significant excess inventories.  This includes states, for example, such as Georgia and Mississippi.  While these estimates do not specify the situation in any given wood basket or for any given timberland property, they do support the evidence that supplies have affected stumpage markets selectively.

In 2013, our research into the effects of forest supplies on stumpage prices focus on distinguishing “supply effects” from “demand effects.”  Why?  The key is to avoid double-counting the impact of excess supplies.  If prices temporarily become less responsive to demand in a given state or market, we can “plausibly” attribute this, in part, to the supply situation.

To learn more about the 2013 Forisk Forecast or Forisk’s market-specific stumpage forecasts tailored to individual wood-using facilities or timberland ownerships, contact Brooks Mendell at bmendell@forisk.com, 770.725.8447. 

2013 Forisk Timber Price Forecast: Framing the Outlook

5 04 2013

This is the fifth in a series related to Forisk’s 2013 forecast of softwood stumpage prices in the United States.

In the 2013 Forisk Forecast published in March, four key themes frame the outlook for the next ten years:

  • Timber price performancehow did timber markets perform in 2012 relative to Forisk’s expectations for 2012?  A detailed self-assessment provides a necessary testing of key assumptions.
  • Capital investment:  where have forest industry firms decided to allocate capital for 2013 and moving forward?  Since timber forecasts are applied locally, capital flows reinforce which states will have the “iron in the ground” to satisfy growing demand.
  • Forest supplies: what have we learned about the relative supplies of pine grade and pulpwood and their actual or perceived impacts on stumpage markets?  In the past two years, we observed an eroding of the price-to-demand response in states that corresponded with excess pine grade inventories.
  • Demographics: how do current demographic trends in the U.S. compare to our historic understanding of how population changes relative to wood demand and housing?  At the end of the day, we must confirm the expectation of fundamental demand for wood products.

In the South, the Forisk Forecast includes state-by-state, year-by-year prices for 11 Southern states for pine sawtimber, chip-n-saw and pulpwood. In the Northwest, the Forisk Forecast includes Douglas-fir and Western Hemlock prices for Oregon and Washington. Select expectations include:

  • Lumber Production: while the U.S. South lost lumber production market share to the Pacific Northwest in 2012 on a relative basis, capital flows continue to indicate that long-term trends for capacity and production will grow faster in the South.
  • Demand from Pulp/Paper, OSB and Bioenergy: by 2023, the pulp/paper sector will account for less than 80% of pulpwood/chips demand, while bioenergy and OSB use 11% and 10% in Forisk’s Base Case.
  • Log Exports: the Pacific Northwest remains the colossus among U.S. regions; the U.S. South managed to nudge its share from 2.5% in 2011 to 2.9% in 2012. (Hold the champagne.)
  • US South, Pine Sawtimber: South-wide prices are forecasted to increase 7% in 2013 and 34% by 2023.  Alabama, Florida and Louisiana lead Southern states across the $30 per ton benchmark in 2014 and 2015 based on state-wide pricing.
  • Pacific Northwest, Douglas-fir: in the Base Case, delivered #2 domestic sawlogs are forecasted to increase 3% in 2013 and 23% in Coastal Oregon and 20% in Washington through 2023.  Oregon average annual prices maintain a $41/MBF spread over Washington.

To learn more about the 2013 Forisk Forecast or Forisk’s market-specific stumpage forecasts tailored to individual wood-using facilities or timberland ownerships, contact Brooks Mendell at bmendell@forisk.com, 770.725.8447. 

Forisk Forecast Scorecard: 2012 versus Actuals

27 03 2013

This is the fourth in a series related to Forisk’s 2013 forecast of softwood stumpage prices in the United States.

How did Forisk’s Forecast perform in 2012?  For pine stumpage prices in the U.S. South, the Forisk Forecast was within 2% regionally across all products.  Analyses of eleven state-by-state forecasts relative to Timber Mart-South shows that Forisk was, on average, $0.21 per ton lower than the actual pine sawtimber prices and $0.33 per ton higher than the actual pine chip-n-saw prices.  For pine pulpwood, Forisk’s estimates for eleven state-level prices for 2012 had, on average, $0.00 per ton difference from the actuals, with seven states realizing slightly higher prices than forecasted by Forisk and four states realizing lower prices than forecasted by Forisk.

20130327 Forisk Forecast Scorecard

For delivered softwood prices in the Pacific Northwest relative to those reported by Wood Resources International and the Oregon Department of Forestry, the Forisk Forecast was within 1% for three out of four state-product forecasts for 2012, and within 2% for the fourth state-product. Across categories in Oregon and Washington, Forisk underestimated the actuals for 2012 by, on average, $4.41 per MBF or 0.8%.

To learn more about the 2013 Forisk Forecast or Forisk’s market-specific stumpage forecasts tailored to individual wood-using facilities or timberland ownerships, contact Brooks Mendell at bmendell@forisk.com, 770.725.8447. 

2013 US Timberland Ownership: Descriptive Statistics

21 03 2013

According to Forisk tracking of timberland ownership in the United States, 117 firms currently own or manage in excess of 100,000 acres of timberland. These firms feature the following descriptive statistics:

  • As a group, they own/manage 86.2 million acres of timberland.
  • On average, they own/manage 736,589 acres of timberland.
  • The median ownership is 312,000 acres.

Assuming an average per acre value of $1,500, each firm owns or manages on average $1.1 billion in timberland assets.

Analysis of private timberland in the U.S. affirms the concentrated nature of large ownerships.  While U.S. Forest Service research by Brett Butler concludes that 10 million family forest owners account for 264 million acres (35%) of U.S. forestland, Forisk research indicates that the 286 largest owners alone account for 92.1 million acres.  Each of the top ten own or manage in excess of 2 million acres.

The top 10 timberland owners as of January 2013 include:

20130321 Timberland ownership

For detailed data on US timberland ownership and more information on Forisk’s 2013 US Timberland Owner List, click here.

Thomas Jefferson and Timberland Ownership in the United States

15 03 2013

Through executing the Louisiana Purchase in 1803, President Thomas Jefferson proved himself, among other things, the preeminent timberland acquisition professional.  In this bold embrace, he more than doubled the size of the United States by acquiring 820,000 square miles of land west of the Mississippi from France for $15 million dollars.  That equals 524.8 million acres at 2.9 cents per acre (or just over 50 cents per acre in today’s dollars).

[Picture an excerpt from Jefferson’s resume:  Experienced negotiator and real estate professional.  Acquired over half a billion acres of fertile soil and natural resources. Includes land in 14 states such as Arkansas, Colorado, Iowa, Texas, the Dakotas (both) and Wyoming.  Creator of the swivel chair.]

The Louisiana Purchase was opportunistic.  U.S. negotiators wanted to buy New Orleans, but Napoleon needed financing to wage war on England.  So he rejected the New Orleans proposal and countered with a deal to sell all of France’s North American land holdings.  The U.S. team, led by Secretary of State James Madison, took the offer and closed the transaction.  Bada bing, bada boom.

Forisk’s ongoing research of timberland investment vehicles highlights how private timberland owners and ownership have changed over time since the days of powdered wigs.  Today, timberland investment professionals scour the landscape and courthouse documents for the next purchase in Louisiana or in Arkansas or in Texas.  As of 2013, Forisk counts 217 owners that each own and manage 25,000 acres or more for a total of ~91 million acres of private timberlands.  Of these acres, 18% are owned by the four public timber REITs (Plum Creek, Potlatch, Rayonier and Weyerhaeuser).

For detailed data on US timberland ownership and more information on Forisk’s 2013 US Timberland Owner List, click here.