Jan. 26, 2012

By Peter Barynin

RISI Viewpoint: Southern pine sawtimber -- can stumpage go any lower?

SAULT STE. MARIE, ON, Jan. 26, 2012 (Viewpoint) - By Peter Barynin, Principal Economist, North American Timber

Record low sawlog prices. Pine sawtimber stumpage ended 2011 down 10% year-over-year to average a dismal $24.30/ton (fourth quarter US Southern weighted-average). Adjusted for inflation, these prices are the lowest they have been since the early 1960s! It did not surprise us that stumpage failed to make gains in 2010 and 2011 based on our expectations for housing to continue to grossly underperform historical standards. In mid-2010, RISI's North American Timber Forecast reported that "for the remainder of 2010 and into 2011, [US Southern] sawlog prices will give back the gains achieved in early 2010 based on anemic demand for sawlogs and weak lumber and panel prices." We went on to say "stumpage will wallow...until demand sustains forward momentum." We were correct about giving back the gains. What surprised us was the significant step downward in stumpage values as we progressed through 2011 (Figure 1).

The "floor" of the supply curve defines downside risk for timber suppliers. By definition, a price floor is the lowest price at which a commodity will be sold. If you know where the cost floor is, then as a seller, you know your downside risk on receiving prices. In the case of timberland owners, rationalizing acceptance of the floor price requires consideration of numerous complexities. Intuitively, the floor price includes the costs associated with producing wood for sale, i.e., harvesting, as well as the cost of forest establishment and management or acquisition cost. However, things gets more complicated when we factor in supplier expectations for future prices (how high and how quickly prices will recover), alternative land uses, discount rates, ownership structures and return expectations, fertilization costs, forest health and the list goes on. These factors not only impact the landowner's decision on when to harvest, but how to manage their forests and, ultimately, the level of future investments in reforestation and silviculture. To put the risk of incorrectly assessing the floor in perspective: for all sawtimber sold US South-wide to produce lumber and plywood, a 10% decline in clearing prices amounts to approximately $150 million in lost revenues annually.

Where's the floor? Estimating the floor of the supply curve is murky territory in any commodity market. Timber is no exception. Figure 2 depicts the sawtimber supplied and the associated price for that volume supplied, indicating the supply curve for southern sawtimber markets during 2000 to 2011. Consistent with economic theory, we see higher demand requires (or commands) a higher price in bringing the additional volumes of timber to market. At face value (with all other things held constant), this suggests that we need US housing starts to return to 1.3 million units to see real sawtimber stumpages return to $45/ton. (Note RISI's current base case assumes housing remains below 1.0 million units through 2013.)

From 2009 through mid-2010, the floor appeared to be around $31/ton (real dollars). The clustering of market clearing prices for sawtimber stumpage during this period indicated a floor. Prior to 2009, this floor was difficult to estimate because the South had not experienced harvest demand at these low levels in over a generation. As we moved through 2011, it became apparent the floor was considerably lower. Figure 2 depicts this free fall where real stumpage prices declined another 23% while harvest demand remained fairly stable. Wow! Last year's weather conditions can in part explain the decline, since dry weather improves harvesting conditions and lowers the cost of accessing wood. Nevertheless, it's difficult to rationalize the recent price declines as purely weather driven.

Recent experience does not bode well for future sawtimber prices. The current low stumpage values are more evidence that the supply curve for Southern pine sawtimber has shifted out and down over the last five years, meaning more logs for less. Going forward, sawtimber inventories will continue to expand throughout the duration of this housing depression, again suggesting the South should be able to produce greater volumes of timber at the same price. In this environment, improved demand or a regional shift in forest products manufacturing capacity needs to come to the rescue to serve as a catalyst to higher clearing prices for Southern sawlogs. However, these scenarios are not part of our base case. At the same time, we have a hard time seeing another round of prices ratcheting down from current levels, even in a scenario where demand slips more.

- Peter Barynin, Principal Economist, North American Timber, works out of his Sault Ste. Marie, Canada, office and can be reached at Tel: +1.705.949.8023. See RISI's North American Timber Forecast for more details affecting future log values.

RISI's cost benchmarking application, Analytical Cornerstone 4.0, can help you determine how falling sawlog prices will impact the cash manufacturing costs of lumber and plywood producers. Visit www.risi.com/benchmarking to learn more about this powerful tool.