Forestry smoking, but not just from fires

Lumber prices have been on fire lately, despite the fact that the commodity’s key driver, the U.S. housing market, remains in a slump. Some have pointed to speculative trading based on the wildfires sweeping British Columbia, but there is more to the story.

The more likely causes are low log inventories and the closure of mills.

The forestry sector was largely shut out of the commodity rally of recent years, which saw the price of oil, metals and fertilizer components race steadily higher.

The U.S. home-building boom leading up to the 2008 financial crisis wiped out what gains forestry had seen, and long-running trade battles left the Canadian logging industry high and dry.

The price of finished lumber is now on the rise, not due to any major demand increases, but because forest fires in British Columbia may soon all but shut down the supply side.

Timber companies are already preparing to shut down operations, should fire threaten their immediate environs. The majority of the province’s landmass is currently rated as being at “high” or “extreme” risk of wildfire.

The lumber industry bellwether — western spruce-pine-fir 2×4 lumber, traded on the Chicago Mercantile Exchange — has surged in recent days, rising 16% from July 24 to July 31. But Patricia Mohr, vice-president, economics and commodity market specialist at Scotiabank, says it is likely too early to blame the fires in B.C. for the spike.

At the outset of week that saw the surge, West Fraser Timber announced that it was idling three of its mills, not due to wildfire risk, but as a response to continuing market weakness and a stronger Canadian dollar.

“It’s probably fair to say that lumber traders and retailers in the market are watching the forest fire situation quite closely,” she says. “The log inventories in B.C. and the U.S. Pacific Northwest are quite low. There isn’t a lot of supply of logs or lumber in the distribution network.”

With much of the province under fire alert, the provincial fire service is cautioning against forest activity, which could further constrict the supply of logs coming to market.

While the effect of such slowdowns may not be apparent in a sluggish market, construction retailers will begin restocking for the spring building season around December. Another rally could be in the offing.

“Demand for building materials across North America is quite soft. It’s improving — its bottomed — but it’s not high,” says Mohr. “Actual construction of housing usually ebbs as you move into September.

“I’m hopeful that early next year we’re going to have a much bigger rally in lumber prices, as housing starts to come back.”

That being said, investors should probably tread carefully in the forest sector. Even after the fires are out, the industry will face many of the same challenges as before the fires. There’s a good chance that the U.S. housing market will not recover until unemployment is tamed.

Even if there is an economic upturn, it could still be bad news for forestry if rising demand for oil and minerals drives the Canadian dollar back to parity.

“The falloff in demand from the U.S. housing market has been so severe that it’s put a lot of companies under financial strain,” says Mohr. “It is a risky investment at this point, but I do think there will be an improvement.”

(08/05/09)