B.C.’s pulp industry receives belated export market recognition

B.C. business has a wary eye on the direction of China’s economy – not least B.C.’s sawmillers. So far in 2014, their softwood lumber exports have experienced flat demand growth in China and lower prices. With stubbornly slow recovery in U.S. demand, the province’s lumber sector understandably is nervous. 

China is a fast-growing market for softwood lumber – helping offset decades of dependence on the U.S. market. Since 2007, China has been a great B.C. success story. But there is another story, largely untold. Not widely known, the annual value of B.C.’s pulp exports to China exceeds that of softwood lumber – by a significant margin. In addition, longer-term export demand outlook for B.C.’s long-fibred pulp is good. 

The province’s pulp sector is starting to get some long-overdue recognition. For the first time, pulp industry executives have been invited on the province’s annual trade mission to Asia. Based on projections of the demand outlook in China and other Asian markets, B.C.’s pulp executives should be riding in the front of the bus. 

For an overall perspective, take a look at B.C.’s “all industries” exports to Asian markets (Figure 1).

B.C. exports by “all industries” peaked in the year 2000, at $36 billion. Despite the very sharp subsequent decline in exports to the U.S., the aggregate value of 2014 exports is expected to surpass the previous peak – but with a very different mix. In the intervening years, B.C.’s top 10 markets in Asia, including the powerhouses of China, Japan, South Korea and emerging India, have more than made up for B.C.’s reduced exports to the U.S.

It’s notable that the value of B.C.’s exports to “all other countries” has remained virtually unchanged over the past several decades. Clearly, B.C.’s trade mission sales efforts in Asia are essential to maintaining the province’s overall positive trade balance. 

B.C.’s forest sector is an important contributor to this success, not just in softwood lumber but also in pulp exports to the top 10 Asian markets.

Figure 2 shows the situation for softwood lumber. Both major export market regions are vital. In 2014, however, only 52% of B.C. lumber export shipments were destined for the U.S., while 43% were sold to Asia top-10 markets (Figure 2).

The impact of the U.S. housing market crash on the B.C. lumber industry is clearly illustrated. B.C.’s sales to U.S. markets remain well below their 2004 peak level. Asia top-10 markets, notably China, have picked up some – but only about 35% – of the U.S. market value gap. In addition, the lumber industry in the U.S. South has become much better positioned and a much stronger competitor.

A lot depends on how much the Canadian dollar depreciates against its U.S. counterpart. But analysts have concluded that B.C.’s lumber industry is no longer the potent, highly competitive force it used to be. Apart from stronger competitors, B.C.’s lumber production costs are rising sharply – as firms compete for diminishing supplies of higher-quality sawlogs.

The slow decline for Canadian lumber in Japan has been a significant market loss for B.C. In the mid-1990s, Japan imported from B.C. the same amount of lumber, by value, as the U.S. will import in 2014. Fortunately, other Asia top-10 markets – notably China, South Korea and the Philippines – are now making up for what B.C. has lost from Japan’s decline.

Japan is still an important market for B.C. lumber, but its relative decline has hit the B.C. coast region particularly hard. That’s why the coast region exports large volumes of logs, notably to China and Japan. 

Looking at Figure 2, investors might be hard-pressed to understand why B.C. lumber stocks are receiving the high valuations they enjoy today. It’s all to do with lumber price expectations. 

On the demand side, the B.C. lumber industry has gained around $1 billion in net sales from Asia top-10 markets since 2004 – thanks primarily to China. The U.S. market would have to recover to around 80% of its former peak level (in terms of B.C. sales revenues) for the B.C. lumber industry to return to the status quo of 2004’s peak demand. Analysts think this is highly probable.

Will there be any further growth in Asia top-10 markets, beyond 2014 levels?  Most analysts are bullish and expect modest to lively rates of demand growth – not just in China but among the new Asian tigers of demand growth. Canada’s domestic lumber market is comparatively steady and doesn’t affect the math.

The outlook for U.S. and Chinese demand for softwood lumber is of keen interest to stock market investors awaiting the still-elusive lumber super-cycle – and its predicted all-time record lumber prices. But the other side of that story is sharply diminished supplies of viable sawlogs at B.C. sawmills – and, at future cycle peak demand, shortages and higher prices elsewhere.

Evidence points to a fundamental shift in supply that will create much higher lumber prices on a trend and cyclical basis. For stock investors, this is exciting. Some become positively giddy at the prospect of U.S. and Asia top-10 markets for softwood lumber coinciding in timing.

In this outlook, the dark cloud on the government policy horizon is that B.C.’s lumber industry will decline in importance and lose some of its global competitiveness. Further downsizing of B.C.’s Interior spruce-pine-fir lumber industry is inevitable and, in terms of total manufacturing capacity, mill rationalization (matching surviving mills with the remaining economically accessible fibre) has been underway for some time (Figure 3).

In part, this is why B.C.’s long-fibre pulp sector is attracting belated attention. First, because of its Asian export market growth potential. Second, because the pulp sector, along with bioenergy and wood pellets, can use, where necessary, dead and dry trees that don’t make the grade as sawlogs for construction markets.

Figure 3 shows the importance of Asian markets for B.C.’s pulp industry. Without growth in this market region, there would be no other growth worldwide to compensate for declining sales revenues from the United States. The U.S. market is limited as a market for Canadian pulp exports. This is not expected to change.

China is a significant success story for the B.C. pulp industry and will account for $2 billion (60%) of the industry’s total sales in 2014. Japan is a still-significant, but overall declining, market for B.C. pulp. Fortunately, there is significant growth in other emerging Asia top-10 markets such as Indonesia, South Korea and India. So B.C.’s pulp is not just selling into a single market.

In China and other Asian growth markets, large new state-of-the-art printing paper, tissue and paperboard super-mills are proliferating rapidly. Globally, this is where the action is taking place.

But Asia top-10 countries are short of fibre and need to import large volumes of fibre and pulp. Much of their supply comes from imported recycled fibres. A growing percentage is sourced from very large super-sized pulp mills, notably low-cost plantation short-fibred hardwoods recently built in the Southern Hemisphere.

In this global marketplace, long-fibred pulps from B.C. and elsewhere are essential as “make-up” pulps to provide desired papermaking characteristics such as strength and bulk.

Supplying rapidly growing Asian markets from higher-cost B.C. pulp mills presents challenges. That’s why large investments are being made in B.C.’s pulp industry by Asian investors with different approaches and new business models, such as Paper Excellence.

In the short term to 2016, the outlook for B.C. pulps is clouded by the huge new capacity emerging globally in low-cost plantation hardwoods. Beyond that, along with biofuels, long-fibred pulps manufactured in B.C. seem to be positioning for sustainable long-term export market growth.

For stock investors, some of the most exciting bets for the future appear to be fully integrated, fibre-rich lumber and pulp producers in B.C. – namely, Canfor and West Fraser. Despite slow growth in demand for softwood lumber in China during 2014, its appetite for pulp seems insatiable for the foreseeable future.

With its strong sales efforts in Asia and innovative new investment, it’s nice to see B.C.’s pulp sector being acknowledged at last.

Peter Woodbridge is president of Woodbridge Associates Inc. His company provides market research and management consulting services globally to forest product manufacturers, distributors, remanufacturers, homebuilders, financial institutions and senior levels of government.