8th Timberland Summit

8 T H T I M B E R L A N D I N V E S T M E N T W O R L D S U M M I T

N E W Y O R K , N E W Y O R K

O C T O B E R 2 6 , 2 0 1 0

Long-Term Risks

Jack Lutz, Ph.D. www.forestresearchgroup.com

Don MacKay, Ph.D., CFA www.forestresearchllc.com

I n t r o d u c t i o n

W h a t a r e t h e r i s k s ?

H o w d o y o u m i t i g a t e a g a i n s t t h e r i s k s ?

Managing Long-Term Risks

S u p p l y r i s k : A r e w e g r o w i n g t o o m a n y t r e e s ?

D e m a n d r i s k : W i l l d e m a n d o v e r w h e l m s u p p l y ?

D a m a g e r i s k : W h a t w i l l c l i m a t e c h a n g e d o t o y o u r t i m b e r l a n d ?

N e w p r o d u c t r i s k : H o w w i l l n e w p r o d u c t s i m p a c t m a r k e t s ?

Risks

S h o r t a n s w e r : n o b o d y k n o w s ( e x a c t l y )

• Poor data

• Complex questions/answers

T h i s w o r k s h o p i s l e s s a b o u t p r o v i d i n g a n s w e r s a n d m o r e a b o u t l e t t i n g y o u k n o w w h a t t o w a t c h

L o n g e r a n s w e r : S u p p l y / d e m a n d i m b a l a n c e s d i f f e r o v e r t i m e , s t i l l n o a n s w e r f o r c l i m a t e c h a n g e r i s k , a n d n e w p r o d u c t s m a y h e l p

L o n g e s t a n s w e r : ( s i t b a c k )

Risks

D a t a i s l i m i t e d , h a s q u a l i t y i s s u e s , e t c .

• But it is the best, most comprehensive and consistent available

W e w i l l b e u s i n g t i m b e r p r o d u c t i o n a s a n i n d i c a t o r o f b o t h s u p p l y a n d d e m a n d

• So does it measure supply or demand?

• We’ll use export and import data to support our thoughts

Overview of Supply and Demand

Overview

World wood production is increasing, except

1992: USSR dismantled

2008 global economic crisis (largely US)

This graph shows top 10 log producers, plus Australia, NZ and UY

These countries have accounted for 75% of global log production since 1961

Bigger chart on next page

Roundwood (Log) Production

Source: UN FAO

Roundwood (Log) Production

Source: UN FAO

Overview Top 10 Lists

Who are the big players?

Logs

Lumber

Panels

Pulp

Many common names (e.g., Brazil, Canada)

These can shift a rank or two from year to year (2008 and 2009 are unusual)

Where do the “TIMO Countries” fit?

Some of the favorites are not very big on a global scale

Overview

Top 10 Producers 2009

Includes US, Brazil, Canada, Chile

Other TIMO favorites

Australia 13

New Zealand 16

Uruguay 33

Roundwood (Log) Production 2009

Source: UN FAO

Overview


Includes US, Canada, Brazil


Chile 13

Australia 15

New Zealand 21

Uruguay 70

Sawnwood (Lumber) Production 2009

Source: UN FAO

Overview


Includes US, Canada, Brazil

Wood Panel Production 2009

Source: UN FAO

Overview


Includes US, Canada, Brazil, Chile


New Zealand 19

Australia 20

Uruguay 23

Wood Pulp Production 2009

Source: UN FAO

Overview Some TIMO Countries are small

players in the global markets

If Uruguay doubles timber production, the impact on the world is relatively small

If Brazil doubles timber production, the impact on the world is relatively large

But how small a change in global volumes can change prices?

1%?

5%?

(We don’t know…yet)

Questions?

A r e w e g r o w i n g t o o m a n y t r e e s ?

Supply Risk

Supply-Side Risks

Are we growing too many trees?

Too many trees would have a negative impact on timberland investments (Duh!)


A few years ago, there was great concern that plantations in Brazil represented a great “wall of wood” about to hit the market

Described more recently by a colleague as more like a “hedge”

Timberland investors are spreading all over the world

But many are in traditional tree-growing areas

How much “new” forest is there?

Supply-Side Risks


Country Studies

Country Studies

Are they growing more trees?

Are they exporting more logs or converted products?

Is the domestic market consuming more of the production (demand)?

Or are exports displacing production somewhere else?

Forest/plantation area data are updated infrequently

So we’ll use log production as an indicator of expanding wood supply

Supply-Side Risks


Country Studies

Country Studies

Some TIMO favorites have expanded production

Brazil has room to expand

Others may be at their limit(?)

Some limits are based on policy, not geography

Supply-Side Risks


Country Study:

Uruguay

Country Study: Uruguay

Small, maturing timberland market

Uruguay has become very popular for US-Based TIMOs/Investors

Forestry area is limited by legally designated forestry soils (~4 mm hectares)

But only 753,000 hectares of plantations by 2009

So could be 5X larger

`

Assuming 20 cm/ha/year, this represents Y% of global log production

Uruguay Plantation

Supply-Side Risks


Country Study:

Uruguay

Supply-Side Risks


Country Study: Uruguay

Uruguay Planting

Driven by government policy and incentives

Planting has come in waves

Eucalyptus peak in 1998

Pine peak in 1999

Eucalyptus peak in 2007

Supply-Side Risks


Country Study:

Uruguay

Uruguay Log Production

Put log production chart here

- Uruguay production has increased

3,350%.

- From 0.02% of world production to

0.50% of world production

- Message: major timberland

program, minor impact on world

markets

Source: UN FAO

Supply-Side Risks


Country Study:

Uruguay

Uruguay Product Production

Converting Capacity

- 97,000% leap in pulp production, to 0.6 %

of world production

- Could make a difference to your pulp

mill(s)

- Panel production up 10,000% to 0.3% of

world production

Source: UN FAO

Supply-Side Risks


Country Study:

Uruguay

Uruguay Log Exports

Converting Capacity

•Up ~5,000% since 1990

•~50% of log production since 1995

•7th-ranked log exporter in 2009

•4% of global log exports

•0.5% of global log production

Source: UN FAO

Supply-Side Risks


Country Study:

Brazil

Mature and developing market

Major TIMO investments

But

Some plantations substituting for natural forests, not “additional” fiber (but at 10X yield)

Some plantations feeding non-traditional markets

Fuel (grain/soybean drying)

Charcoal for pig iron, etc.

Recent oil/gas finds off the coast could replace wood fuels

But infrastructure is not in place to transport oil/gas to interior

Country Study: Brazil

Brazil Log Production


Supply-Side Risks


Country Study:

Brazil

- Brazil production has increased 850% since 1960

- From 1.7% of world production to 8.0% of world

production

- Room for further increases

- Message: major timberland program, large

impact on world markets

Source: UN FAO

Supply-Side Risks


Country Study:

Brazil

Brazil Product Production

Converting Capacity

Increasing presence in all products

•(How much domestic vs. export?)

Source: UN FAO

Supply-Side Risks


Country Study:

Brazil

Brazil Log Exports

Ranked 49th in world log exports in 2009

Exports products, not logs

Supply-Side Risks


Country Studies

Country Study: New Zealand

Small, mature timberland market

At their forest limit?

Clearing some forest to grow cows

Some forests to store carbon

Reduced fiber production?

Supply-Side Risks


Country Study:

New Zealand

New Zealand Log Production


New Zealand production has increased 314%.

•From 0.5% of world production to 1.4% of world

production

•Little room for further area increases

•Message: major timberland program, small

impact on world markets

•Carbon sequestration?

Source: UN FAO

Supply-Side Risks


Country Study:

New Zealand

New Zealand Product Production

Converting Capacity

Increasing presence in lumber and panels

•Big jump in panel % in 2002 due to

reported sharp drop in world production

(suspicious data point)

Source: UN FAO

Supply-Side Risks


Country Study:

New Zealand

New Zealand Log Exports

Log Exports

•Up ~300% since 1990

•~30% of log production since 1990

•3rd-ranked log exporter in 2009

•7% of global log exports

•1.4% of global log production

Source: UN FAO

New Zealand Wood Exports

Source: NZMAF

New Zealand has diverse export markets

•Majority of logs to China, India, Japan and Korea

•Much lumber to Australia, China, Indonesia, Japan, Philippines, US, Vietnam

•Much pulp to Australia, China, Indonesia, Japan, Korea, Taiwan

Supply-Side Risks


Country Studies

Supply Discussion

(Ignore the demand side for now)

Large increases in production from many countries will not have a major impact on global supply

Doubling the harvest in New Zealand or Australia will add 1.5% to the world timber supply

1. Not a big number

2. Can they do it?

Doubling the harvest in Brazil will add 8% to the world timber supply

Possible, but not instantly

Could all go to fuel or charcoal

Supply Discussion

Supply-Side Risks


Country Studies

Supply Discussion

Greater impact may come from shift in converting capacity

What happens when your local pulp mill closes because of cheaper pulp from Brazil?

Longer term: wood can replace non-renewable materials (which replaced wood in the past)

Oil: fuel, plastics, industrial chemicals

Concrete and Steel: building

Note: Global log production up 16%, 1993-2007, Log export volume up 84%

Supply Discussion

Supply-Side Risks


Country Studies

Supply Discussion

Policy Impacts

Policy Impacts

Policy impacts are an issue because they can be entirely separate from the physical supply

US National Forests taken off-line beginning about 1990.

~25% of US softwood supply

Resulted in major shift of sawmill capacity from PNW to South

Policies can be removed as quickly as they are imposed

e.g., Russia

Supply-Side Risks


Country Studies

Supply Discussion

Policy Impacts

Russian policy is an uncertainty

What will they do? Can they really do that? When will they do it?

Current near-future looks like log export tariffs

An attempt to increase domestic conversion of logs to lumber

Announcement of tariff in early 2007 (effective early 2008) pushed prices up

Postponement of tariff dropped prices to previous levels

(chart on next slide)

Policy Impacts

Supply-Side Risks


Country Studies

Supply Discussion

Policy Impacts

Impact of Russian tariff policy on European timber prices

Future 80%

Tariff

Announced

80% Tariff

Postponed

Source: Wood Resources Quarterly, Estonia Forest Service

Supply-Side Risks


Country Studies

Supply Discussion

Policy Impacts

Policy Impacts

Can sustainability policies halt illegal logging?

Estimates of 10-15% increase in timber prices if illegal logging is stopped globally

What happens to carbon sequestration if Kyoto Protocol is not extended?

NZ govt says it will continue its program

Supply-Side Risks


Country Studies

Supply Discussion

Policy Impacts

Mitigating Supply-Side Risk


Location, location, location

Locate where demand for timber is strong/increasing

Avoid industry rust belts

Have domestic/export market flexibility

Supply-Side Risks


Country Studies

Supply Discussion

Policy Impacts


Summary

Supply-Side Summary

Lots of trees growing

Some are substitutes for natural forests

Some may sequester carbon for 99 years and not be available for fiber production

Not likely that any oversupply is long-term

Partly because demands will increase, which we will talk about next

Questions?

W i l l D e m a n d O v e r w h e l m S u p p l y o r D i s a p p e a r ?

Demand Risks

Demand-Side Risks

Will demand overwhelm supply or disappear?

Will demand overwhelm supply?

Is there any downside for timberland investors in this case?

Will timber be displaced by other materials?

Many examples

Paper vs. plastic bags

Styrofoam vs. paper cups

Downside for timberland investors, but

Timber is renewable

Wood is cost-effective in many locations/applications

Wood can replace other materials

Demand-Side Risks

Demand-Side Risks


Demand-Side Risks

Log production (and wood consumption) has increased over time

Bumps in 1990 and 2006

Expect demand to increase as population increases

Can we be more specific than that?

Not really (to be continued)

Source: UN FAO

Demand-Side Risks


Country Studies

Country Studies: US The US is the largest consumer of wood

products in the world

The current fall-off in global timber consumption is largely a function of the drop in US housing starts

US housing starts use 20% of global softwood lumber production

another 10% of global production is used for other purposes in the US

60% of North America softwood lumber production

US housing starts are down ~67%

So world softwood lumber demand is down ~14%

Demand will recover when the US starts building houses at a normal rate again

Demand-Side Risks


Country Studies

Country Studies: US

Starts are at 1/3 of long-term average (1.5 mm units/year)

Source: Census Bureau

Demand-Side Risks


Country Studies

Country Studies: US

Household formation has slowed Due to unemployment

But kids (and parents) want to get out of the house

Avg housing starts exceed avg household formation because some new houses replace old/substandard housing

Housing starts avg 1.5 mm/yr

Households avg 1.3 mm/yr


Demand-Side Risks


Country Studies

Country Studies: US

Household formation will pick up when people can get jobs


Correlation = -0.30, lagging unemployment by 6 or 12 months = ~-0.40,

lagging housing by 6 or 12 months = ~0.0. So housing is a leading

indicator of unemployment?!?

Demand-Side Risks


Country Studies

Country Studies: the BRICs

What do we find if we look at the four biggest developing countries?

Are they using more and more wood each year?

The results are mixed

Demand-Side Risks


Country Studies

Country Study: Brazil

As we saw earlier, Brazil is a major wood products producer.

As developing country, consumption of wood products is increasing in Brazil

But Brazil is still a net exporter

Demand-Side Risks


Country Studies

Brazil Production and Consumption

•Brazil exports very few logs (<1%)

•Next slide removes logs so we can see detail on the

other products

Source: UN FAO

Demand-Side Risks


Country Studies

Brazil Production and Consumption

•Brazil consumes

•90% of lumber it produces

•60% of pulp

•70% of panels

Source: UN FAO

Demand-Side Risks


Country Studies

Brazil Consumption (Demand) Change in production and consumption

Increases in production exceed increases in consumption in most cases

But consumption is increasing strongly

Prod Cons Prod Cons

Logs 55% 55% 12% 13%

Lumber 51% 34% 8% 8%

Pulp 25% 105% 87% 46%

Panels 198% 159% 47% 34%

Since 2000Since 1990

Demand-Side Risks


Country Studies

Country Study: Russia

Russia is not growing as quickly as Brazil(!)

Following data is Russia only, not the USSR

Demand-Side Risks


Country Studies

Russia Production and Consumption

•Russian log production reached USSR levels in

2007, then fell off sharply

•Russia is world’s largest log exporter

Source: UN FAO

Demand-Side Risks


Country Studies

Russia Production and Consumption

•Lumber consumption has fallen steadily

•Panel and pulp consumption has increased slightly

(until global financial crisis)

Source: UN FAO

Demand-Side Risks


Country Studies

Russia Consumption (Demand) Change in production and consumption

Data suggest Russia will not drive demand for wood for a while

Prod Cons Prod Cons

Logs -31% -41% 7% 21%

Lumber -64% -94% -5% -77%

Pulp 3% -12% 16% 20%

Panels 16% -2% 81% 89%

Since 1992 Since 2000

Demand-Side Risks


Country Studies

Country Study: India

Data from India are puzzling

Consumption is about equal to production

Because exports are roughly equal to imports

(Is there a reporting issue?)

Demand-Side Risks


Country Studies

India Production and Consumption

•Erratic production and consumption

•Is this “real” or a reporting issue?

Source: UN FAO

Demand-Side Risks


Country Studies

India Production and Consumption

•Consumption of pulp and panels is

increasing

•Lumber consumption increased

after 2000, but still lower than mid-

1990s

Source: UN FAO

Demand-Side Risks


Country Studies

India Consumption (Demand) Change in production and consumption

With nearly 10X the population, India’s reported wood consumption is well below Brazil’s

Prod Cons Prod Cons

Logs -5% -3% 24% 19%

Lumber -15% -15% 87% 87%

Pulp 133% 146% 45% 59%

Panels 569% 595% 626% 515%


Demand-Side Risks


Country Studies

Country Study: China

China is a major wood products producer.

5th largest log producer in 2009

3rd largest lumber producer

Largest panel producer

7th largest pulp producer

But it consumes more than it produces, especially since 2000

(But how much of the wood China imports gets re-exported in the form of furniture, etc.? So is in really China that is consuming the wood?)

Demand-Side Risks


Country Studies

China Production and Consumption

•Large log supply gap

Source: UN FAO

Demand-Side Risks


Country Studies

China Production and Consumption

•Net exports of panels

•Large gap between production and consumption for

lumber and pulp

Source: UN FAO

Demand-Side Risks


Country Studies

China Consumption (Demand) Change in production and consumption

China’s panel production in 2000 was ½ of US production.

China’s panel production in 2007 was 1.5X US production

China’s panel production in 2009 was 2X US production

Prod Cons Prod Cons

Logs 5% 35% -1% 20%

Lumber 24% 51% 299% 209%

Pulp 245% 512% 92% 127%

Panels 2566% 1274% 316% 199%


Demand-Side Risks


Country Studies

Country Study: The BRICs Combined

As we saw earlier, Brazil is a major wood products producer.

Demand-Side Risks


Country Studies

BRIC Production and Consumption

•Large log supply gap

Source: UN FAO

Demand-Side Risks


Country Studies

BRIC Production and Consumption

•As a group, the BRICs produce about what they

consume

Source: UN FAO

Demand-Side Risks


Country Studies

Demand Discussion

Demand Discussion

The fact that the BRICs are fairly balanced suggests demand will not overwhelm supply or disappear in the long-term

A return to normal levels of housing starts in the US will revive demand there

Increased demand for wood energy and maybe biochemicals

Demand-Side Risks


Country Studies

Demand Discussion

Policy Impacts

Policy Impacts

Will policy encourage or reduce demand?

Encouragement

Plant trees to sequester carbon

These trees will not be available for fiber production

Wood is a green material

Will increase demand for wood as a substitute for other products

Discouragement

Some rograms do not recognize wood as a green material

Demand-Side Risks


Country Studies

Demand Discussion

Policy Impacts

Mitigating Demand-Side Risks


Again: location, location, location

Invest where you have exposure to global markets

Lowers risk from dealing with single market

Grow multiple products

Sawlogs, pulpwood, fuelwood, etc.

Product diversification

Demand-Side Risks


Country Studies

Demand Discussion

Policy Impacts


Demand-Side Summary

Demand-Side Summary

Again: location, location, location

Invest where you have exposure to global markets

Lowers risk from dealing with single market

Make sure there is transportation infrastructure

Diversification - grow multiple products

Sawlogs, pulpwood, fuelwood, etc.

Questions?

Climate Change

W H A T R I S K S F R O M C L I M A T E C H A N G E ?

Climate Change Risks

Typical natural risks

Largely well-known and manageable

Insects and disease

Fire

Weather

Wind, ice, drought

In US (managed timberland) timber volume loss due to these causes is between 0.5% to 0.75% annually

Will climate change impact this?



Uncertain path

Changes in precipitation and tree ranges

Changes in growth and yield

Increased pathogens and fire?

Financial opportunity from carbon sequestration and protecting water supplies


Uncertain Path Uncertain path

Models differ

Magnitude of increase in temperature uncertain

Effect of increase in temperature on regional/local climate is uncertain


Uncertain Path



Changes in precipitation may make some growing areas unsuitable

Or allow trees to be grown in areas that are now unsuitable

Will radiata pine still grow as well in Chile and/or New Zealand?

How quickly will change occur?

Will your next plantation survive for 30 years?

Or should you put the next plantation in Canada?


Uncertain Path


Changes in Growth & Yield


Changes will impact how the trees grow

No certainty on how much or when

(Refer back to question about where and when to plant the next plantation)

May improve growth rates

Will it boost growth too much?

(changes in wood density and quality)

May reduce growth rates

Too little precipitation

Have you modeled that in your financial analysis?


Uncertain Path



Increased Pathogens?


Warmer temperatures allow insects to survive over the winter

A major contributor to the current mountain pine beetle outbreak in BC

Other changes may stress and weaken trees

Make them more susceptible to attacks by insects and disease

Dryer weather will increase fire risk


Uncertain Path




Upside from Sequestration


Carbon sequestration increased opportunities for timberland investment

Increased forest area will not produce fiber (for 99 years?)

So sequestration plantations provide investment opportunities without increasing the wood supply


Uncertain Path





Mitigating Climate Change Risk


Diversify

Geographically: different hemispheres

Forest types: Eucalypts may thrive where pines fail, or the other way around

Management changes

Reduce timber volume and shorten rotations?

Questions:

Will good tree areas become bad?

Or will they become better?

Should you buy Sahara desert land?


Uncertain Path






Climate Change Risk Summary

Climate Change Risk Summary

Climate change will increase the uncertainty around how trees will grow

Where will the best timber-growing regions be?

Carbon sequestration offers an opportunity to invest in trees in a way that will not increase the supply of trees (and outpace demand)

However, the returns from growing trees to store carbon are different than the returns from growing trees to store fiber.

Different markets, cash flows, etc.

Questions?

“New” Product Risk

W h a t W i l l H e l p ?

W h a t W i l l H u r t ?

Wood Energy

Overview

In some industrialized countries, 50% of wood demand is for wood energy!

In developing countries, may be 90%

US, Canada, Finland, Sweden are largest users of wood for industrial bioenergy

Plantations will be a big factor

Roughly 10% of planted wood is for bioenergy

Use of wood for energy projected to increase

87

History Long history of using wood for

heat

But, also a long history of using trees for chemicals and pharmaceuticals

Oaks for tanning and dyes

Naval stores (pine resins)

Hardwood distillation industry Methanol

Acetic acid

88

0

2

4

6

8

10

12

14

1924 1925 1926 1927 1928 1929 1930 1931

Millio

n g

allo

ns

Year

Wood Distillation Synthetic

US Methanol Production 1924-1931

Zeisberg 1933

History

Methanol

0

10

20

30

40

50

60

70

80

90

100

1923 1925 1927 1929 1931

Millio

n p

ou

nd

s

Year

Wood Distillation Synthetic

US Acetic Acid Production 1923-1931

Zeisberg 1933

History

Acetic acid

Solid and Liquid Biofuels and Chemicals

Solid fuels

Pellets (wood or grass)

Torrified wood

Liquid fuels

First generation

Biofuels, such as ethanol, from food-related biomass

Oilseed based biodiesel

Second generation

Non-food sources

Agricultural residues

Woody biomass

91

Fuels and Chemicals

92

Worldwide investment in biofuels and biochemicals

Industry

Old Town Fuel and Fiber

Catchlight - Weyerhaeuser/Chevron

US federal funding

Other countries

China

Type of trees preferred varies

Hardwoods may be preferred

Current Situation Key biochemical industry trends

Supporting growth Long-term oil and natural gas prices

Limited supply of oil

Increasing concern around greenhouse gas emissions

Government funding (US, Europe, Asia)

Inhibiting growth Financial Crisis of 2008

Shifts in supply and demand for chemicals

Technology is developing

Woody biomass supply challenges

Results?

World Oil Price, US$ per Barrel

Source: Energy Information Administration

World Oil Prices

Natural Gas US$ per Thousand Cubic Feet

Source: Energy Information Administration

Natural Gas Prices

Woody Biomass as a Supply Source

Many biochemical technologies are untested, with unknown economics

Biomass is typically sourced over a wide area

Moisture content can be high, drying may be required

Supply less certain than other types of feedstocks, also seasonality

Transportation and storage can be more challenging than other feedstocks

New Product Risk Summary

Mostly around solid and liquid biofuels and chemicals

Technology varies considerably - can be simple like pellets or complicated like acetic acid

New products likely to be an upside risk for timberland owners

Return increase to timberland owners may be modest, but likely to be positive!

Questions & Discussion

Documents

8th Timberland Summit