The Canadian forest fightback: from lumber slump to timber triumph?

With stories of closing paper mills and logging camps, not to mention hefty tax duties, recent times have been particularly tough for the Canadian forest industry. Eve Lazarus takes a look at how companies have responded to the latest setbacks

The village of Port Alice in the northern part of Vancouver Island is pretty typical of many coastal towns in British Columbia. It exists because of the forest industry. The town has two main employers - the Western Pulp Mill and Western Forest Products, both owned by Doman Industries and straddling two of Canada�s biggest exports - lumber and pulp.

The head count from the 2001 census shows a population of 1,126, down considerably from just a handful of years ago. There are a couple of dozen homes for sales, small businesses are either closing or slashing hours of operations and the town�s one gas station closed down a few years ago leaving behind a gas pump. In 1998 the mill operated for 228 days. In 2002 it ran only 116. This year the mill closed at the end of February due to a lack of orders for its products. Management has not announced a start-up date.

While the Canadian forest industry is largely made up of pulp, paper and board manufacturing, lumber, panel, logging and forest management, British Columbia�s chief exports are lumber and pulp. Not so long ago, the Courtenay-based Industrial, Wood and Allied Workers local union used to be the largest in the country with 5,600 members. That�s no longer the case. Union numbers nose-dived last year as six sawmills and two logging camps closed. One in three of the members is now out of work.

Port Alice is one of about 1,200 forestry dependent communities in Canada, in an industry that directly provides close to quarter of a million full-time jobs with sales revenue exceeding $54bn. About a third of all softwood lumber needs in the US are supplied by Canada and the resulting trade is worth $10bn a year. More than half of all these shipments originate in British Columbia, making towns like Port Alice particularly susceptible to the vagaries of the market.

The province has a population of about four million and encompasses 95m hectares, about double the size of California. Forests cover roughly two-thirds of the province. The coastal region of British Columbia, an area of about one-quarter of the province, logs high value woods such as Western hemlock, red and yellow cedars and Douglas fir. The interior harvests mainly Lodgepole pine stands that typically are used as 2 x 4 or dimension framing lumber.

Brian Zak, President of the Coastal, Lumber and Forestry Association of British Columbia says production has gone from some 2.8bn board feet a year down to less than two billion.

�Since 1992 our cost has gone up by 82%, our annual allowable harvest level has been reduced by 25% and the protected area and parks on the coast has ballooned from 6% to over 17%,� says Zak.

The interior faces more challenges. The mountain pine beetle infestation has already infested an area three-quarters the size of Sweden - about 108m cubic metres of wood to date. The unrelenting bark beetles kill mature trees by boring their way through the layer between the bark and the wood, leaving behind a blue dye that renders the wood useless for high-end markets.

Right now the industry as a whole struggles with a global recession and European competition, but the biggest single threat is a crippling 27.2% softwood lumber duty imposed by the US, Canada�s largest trading partner. The duty that comprises a 19% countervailing duty and 8% anti-dumping component has already cost companies $1bn since it was implemented last May.

Take a 27% duty, throw in Japan�s recession since 1997 - Canada�s major market after the US - the entry of European companies not subject to duties in the US and a market where supply of lumber continues to outstrip demand into the mix and it should all add up to disaster.

But, instead of finding a floundering industry, these challenges have acted as a catalyst for change. Canadian companies are taking a low-cost, high volume strategy and generally producing 2002 revenues that have surprised analysts.

Forest product companies began slashing costs last summer to counteract the anti-dumping component of the softwood lumber duty. By lowering unit costs, they hope to stop US allegations that they have been selling below production costs. The companies have largely achieved cost cuts by adding extra shifts - sometimes running production around the clock, shutting down high cost mills and upgrading technology. The result has pushed lumber production up and prices down to 10-year lows at a time when housing demand in the US is at its highest level since the mid-1980s.

Slocan Forest Products, West Fraser Timber Company and Timberwest Forest all had strong balance sheets in 2002 and Canadian Forest Products earned $11.5m that year in spite of paying out $108m in duties. International Forest Products turned in its best performance in eight years with a $40m profit.

Steve Crombie, director of public affairs for Interfor, says the results surprised everybody �including us�. He says they�ve introduced shift flexibility, increased production in order to keep unit costs down, now fill specific orders instead of making product and then trying to sell it, kept inventories low, upgraded equipment and no longer break for coffee and lunch.

Interfor has also permanently shut down two logging operations and a logging camp in British Columbia, sold a small manufacturing facility, taken weeks of downtime in numerous mills and moved one of the operations to the US.

�I think other companies are trying to do the same sort of things to be creative and innovative and find a way to create new market segments so that we can stay in business,� he says. �The worry is that people will look at our results and say everything is fine, everything is fixed and that�s not the case.�

Interfor paid out more than $24m in duties last year, money that could otherwise have gone a long way in reinvesting in both the company and the country.

After what seemed like a promising start and weeks of negotiations between Canada and the US, talks to resolve the softwood lumber trade dispute broke off at the end of February. However, if negotiations stay derailed, there are still some bright spots.

Canada is expecting positive rulings on legal challenges currently before the World Trade Organisation and the North American Free Trade Agreement challenging the tariffs. Decisions are expected in the next few months.

The rising value of the euro has driven up the cost of Scandinavian engineered wood products to the benefit of the province�s coastal mills, which produce timbers for traditional post and beam housing. Scandinavian exporters are also cutting back from the Japanese housing market as a result of currency fluctuations, giving British Columbia producers a fresh crack at regaining lost market share.

A sudden and sharp drop in pulp inventories has mills turning away business. Prices jumped by $20 (US) in February and by $40 (US) a ton in March. Mark Bishop, forests analyst for Raymond James Ltd in Vancouver, says that since last autumn, pulp was considered the best opportunity for recovery.

�We�ve had a couple of short term recoveries and then declines in pulp and so far it�s very difficult to determine if this is just another mini-cycle or if we are heading into a sustained rally for pulp,� he says. �But if we get even modest demand growth in the US and get out from under the overhang of this concern over war, there is probably enough demand to sustain a recovery.�

In February, the Government of British Columbia announced a $275m Forest Transformation Fund. Details have not been announced, but it�s expected that new policies would include the introduction of a market based pricing system for timber sales on crown lands; eliminate requirements that forest licensees process their timber in specific mills or mills they own; eliminate minimum cut requirements that force companies to cut and process timber even when lumber markets are depressed; and eliminate constraints to sawmill closures, making it easier for companies to shut down operations.

Changes that, as it happens, are very similar to the demands from the US that were on the table during the softwood lumber negotiations.

Eve Lazarus is the Vancouver correspondent for Toronto-based Marketing magazine.