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Sean Hinton

Lumber, timber, or trees cultivated and harvested for commercial purposes, is used in a wide range of industries. Timber's end products are among the most basic yet widely used goods in the world and include lumber, paper, cardboard, and various containers and packaging materials. In addition to these staple goods, timber has recently been used in the production of cellulosic ethanol, a promising source of renewable energy.

The timber industry is unique in several important ways. First, different end uses require different types of trees. Geographic location largely determines the types of trees timber companies produce, which can limit the industries to which a company can sell its timber. For example, a timber company that operates in just one region where only paper-grade trees grow would be unable to do business with lumber companies. A second notable feature of the timber industry is that its products continue to grow until they're harvested. Unlike other goods from living sources, trees have an extremely long shelf life, allowing the timber industry to weather periods of poor market conditions with relative ease.

Due to its role as a supplier to many different industries, the timber industry itself is subject to a number of external market forces. Conditions in the markets for paper, lumber, or other timber products largely determine the demand, and therefore pricing, in the timber industry as a whole. In addition to events specific to individual markets, general changes in macroeconomic conditions, such as an interest rate increase, can have implications for the timber industry.

The chart at left shows continuos front-month futures prices for Lumber traded on the Chicago Mercantile Exchage.

Prices

Lumber Futures contracts are traded on the Chicago Mercantile Exchange under ticker symbol LB and are delivered in January, March, May, July, September, and November of ever year. (For more information on commodity tickers, check out the commodity ticker construction page.)

Companies that benefit from falling lumber prices

• The New York Times Company (NYSE:NYT), News Corporation (NYSE:NWS), Dow Jones (NYSE:DJ), Gannett (NYSE:GCI), and other companies that publish newspapers, magazines, or other printed materials benefit from falling timber prices. Paper prices are a key cost for newspapers, and paper prices rise and fall in line with timber prices.
• Toll Brothers (NYSE:TOL), Lennar Corp. (NYSE:LEN), and Pulte Homes (NYSE:PHM) are all leading companies in the residential construction industry. Homebuilders use large amounts of lumber and benefit from falling timber prices.
• SunOpta Inc. (NasdaqGS:STKL), Iogen Corporation, Abengoa Bioenergy, and Du Pont (NYSE:DD) are all involved in the development and production of cellulosic ethanol, a potential source of renewable energy. Falling timber prices make it cheaper for companies such as these to produce ethanol.

Companies that benefit from rising lumber prices

• Plum Creek Timber Company (NYSE:PCL), Weyerhaeuser (NYSE:WY), Rayonier Inc. REIT (RYN) and Louisiana Pacific (NYSE:LPX) would all benefit from rising timber prices. As suppliers of timber to various secondary, industrial customers, rising timber prices would increase profits for each of these companies.

Why lumber prices rise and fall

Housing Market

The largest end market for timber products is the construction market, particularly the residential construction market. An average new home built in the U.S. contains over 14,000 board feet of lumber.^[1] As such, conditions in the housing market can have a significant impact on lumber-grade timber prices. Increases in residential construction would increase demand and prices for lumber, while housing slumps can put downward pressures on prices as demand declines.

Interest Rates

Interest rates can impact timber prices in several ways. Rising interest rates can have a negative impact on consumer spending, especially in the housing market. As interest rates rise and it becomes more expensive to purchase a home, residential construction will likely slow, decreasing demand for lumber. This would likely lead to lower timber prices. Falling interest rates, on the other hand, could stimulate the housing market and increase residential construction by making it more affordable for people to buy houses. The increased demand would drive prices upward as a result.

Chinese Overcapacity

Declining demand doesn't necessarily lead to lower prices. Timber companies can somewhat offset lower demand by reducing production capacity, thereby tightening the supply of timber goods as well. Due to the organic nature of its products, the timber industry has a particular incentive to cut production and wait out periods of low demand. Instead of harvesting more trees and producing more end products to compensate for lower prices, timber companies can reduce output and wait for market conditions to improve. By the time demand for timber products increases again, the companies' timberlands will have grown in both size and value. Though it requires patience and a belief that the timber market will rebound, many companies take this approach, as it maximizes per-tree profitability.

Chinese timber companies, however, have not scaled back production in times of low demand. They have instead increased production capacity, building more plants and mills despite declining global demand. The Chinese demand for timber goods, particularly paper products, is currently stronger than in the global market, and much of the extra production is consumed domestically. In spite of this, the fact that China is importing less paper from other countries exacerbates the already-decreasing demand facing U.S. timber companies. Increased Chinese production capacity can put downward pressure on timber and paper prices around the world.

Perhaps the paragraph above was true when written but it is highly doubtful now. China has a serious shortage of timber at a time when it's domestic demand for lumber for housing is increasing dramatically. Historically China has imported logs and done the conversion to lumber. This, too, has been changing rapidly and today China is shifting and more lumber is being imported. This is a significant trend reversal. "Softwood lumber imports to China have increased by 81% in 2009. It is not inconceivable that China will import more lumber than Japan in 2009, a historical first. Canadian sawmills have been the major beneficiaries of this new fast-growing market, reports the Wood Resource Quarterly." ^[2]

Natural Disasters

Timber prices can be significantly impacted by natural disasters. Domestically, timber-producing regions are located in several parts of the country, exposing them to various natural disasters, including forest fires in the West and hurricanes in the East and Southeast. The risk of damaging insect infestations can also pose a substantial threat to timber companies across North America. For example, an estimated 17 million acres of lodgepole pine trees in British Columbia, Canada, have been destroyed in the last fifty years by the mountain pine beetle. These events can all decrease the supply of available timber. In the case of hurricanes and wildfires, demand for timber is likely to increase as well because of the need to replace or repair damaged property, pushing timber prices even higher. Interestingly, all three of these natural disasters are more likely to occur at higher temperatures, indicating that global warming might be a growing factor in the price of timber products.

Environmental Legislation

Environmental conservation groups often criticize the timber industry, claiming that its logging practices are harmful to U.S. forests. These groups lobby for increased legislation governing the actions of timber companies and protecting certain areas of forest lands. Congress has responded, and there are several federally protected forests throughout the country. The timber industry is always at risk of increased governmental regulation, though there have been few instances of this happening in recent years. A Democratic victory in the 2008 presidential election could spur a rise in the number of bills aimed at conserving forests. Legislation such as this would likely decrease the size of commercially harvestable timberlands and drive timber prices upward.

Definitions

TIMO: Timberland Investment Management Organization

TIMO Organizations

• Hancock Timber Resource Group

Lumber Futures on Wikinvest

References

1. ↑ "Board feet" is a measure of lumber volume equivalent to 144 cubic inches. Figure calculated using an average of 6 board feet per square foot of home multiplied by the 2005 average new home size of 2,434 square feet.
2. ↑ www.woodprices.com