Today’s blog entry is brought to you by Joe Taggart – Managing Director, Institutional Advisory Group, LandVest Timberland Division

SOFTWOOD LUMBER PRICE INCREASES SIGNAL INVENTORY SCARCITY

Since the beginning of the year, a broad range of softwood lumber products have shown substantial price gains. Since December 31st, 2009, the Random Lengths’ Framing Lumber Composite Price (a weighted price average of 15 key framing lumber items) has increased $57, or 23%. Each of the last four weeks has reported double digit gains, including a $21 increase in the February 5th report.

In annual terms, the gains are even more impressive. Since early February 2009, the Composite Index has increased from $190 to $305, a year over year increase of 61%.

Since most economists agree that there has been little increase in actual or perceived demand, the 1st quarter price spike in softwood lumber is being driven almost totally by supply-side issues.

Since housing starts began to retreat from their high of over 2 million units in 2005, lumber has followed suit with a steady and significant decline in volume and pricing. In addition to a number of production curtailments and temporary closures, there have been several permanent closures which have removed in excess of 10 billion board feet of softwood lumber capacity from the North American manufacturing complex.

The result has been an historic contraction of total softwood lumber available to the United States. In 2009, total U.S. softwood lumber production was about half of that produced in 2005. Total softwood lumber imports to the U.S. in 2009 were about 1/3 of the 2005 level. At the same time, total softwood lumber exports increased by 7% from 2005 to 2009.

Softwood lumber markets are highly volatile, and have experienced a number of significant cycles over the past 35 years. The current cycle, however, is different in at least three key aspects: Duration, Availability of Capital, and Source of Raw Material.

The duration of the current event has lasted longer than most historic cycles, which has caused more attrition among manufacturers. At the same time, the current cycle has coincided with the collapse of global credit markets. The broad economic decline has cut-off the necessary debt capital for many manufacturers. While this has forced the closure of over 130 North American mills, it has also forced the remaining operators into more disciplined inventory management. Traditionally, many mills would continue to operate through market downturns, storing their finished inventories for better markets. The lack of credit to finance inventories, however, has caused manufacturers to work on just-in-time inventory positions.

Perhaps the least noted-phenomenon affecting the current cycle is the impact of institutional timberland ownership on manufacturing. Since 2000, forest products industry timberland ownership has declined from about 52 million acres to a current total of about 17 million acres (public & private industry). During past down-market cycles, integrated manufacturers could transfer company owned timber, at below market rates, to subsidize manufacturing facilities. Now that most of these timberlands are in the hands of institutional and private investors, owners have become more disciplined in holding their timber on the stump for better markets. With timberland owners holding their wood on the stump, lumber manufacturers are having a hard time sourcing the raw material for production.

The end result is that although lumber markets continue to struggle in the face of sluggish housing demand, there is still a baseline level of lumber that needs to be produced to meet current needs. The razor thin inventories maintained by manufacturers over the last several months do not allow for any elasticity in the supply/demand balance. Although we have not yet experienced any noticeable increase in demand, we do have a significant lack of supply, even for our current needs.

What does this mean for timberland owners?

Even at the current level of demand, producers are going to have to scramble over the next few months to rebuild lumber inventories along the distribution chain. This should translate to a noticeable increase in spot market stumpage rates over the next three months. The duration and amplitude of this spike will be driven in large part by regional weather (operating) conditions, and the level of builder interest in the spring. For now, timberland owners who have merchantable volumes of softwood timber, on good, operable ground, should anticipate a favorable late winter/early spring.

In the timberland transaction market, it will be interesting to note how buyers and sellers will respond to the market spike. Over the past year, investors have shown only modest interest toward properties that have higher components of merchantable timber, fearing that they were trading acquisition dollars for standing timber value in a down market cycle. As stumpage markets rebound, buyers may find unique arbitrage opportunities with properties like the Trinity Timberlands in Texas, or the Surry & Appomattox Timberlands in Virginia, which have high components of immediately harvestable softwood stumpage, yet are priced to reflect the weaker market conditions of 2009.

However long the current spike in softwood lumber prices lasts, we believe that it signals the start to a gradual improvement in lumber and stumpage values. Although it may be 2011 before markets return to more of a normal operating cycle, we anticipate that timberland unit pricing will have corrected itself by then, suggesting that the best investments of the next cycle will be made in 2010.

Select Timberland Investment Properties

Trinity Timberlands, Trinity Timberlands, Three tracts totaling 14,144± acres, East Texas

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The Surry Timberlands, 5,815± acres, Richmond and Petersburg, Virginia

Click here for more information on the Surry Timberlands

Appomattox Timberlands, 3,160± acres (7 Tracts 116± acres - 1,386± acres), Central Virginia

Click here for more information on the Appomattox Timberlands

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