Department of Natural Resources

Economic & Revenue Forecast

Fiscal Year 2019, Fourth QuarterJune 2019

Forecast Summary

Lumber and Log Prices. Lumber prices in2017 increased through the year from $350/mbfto $490/mbf, averaging $425/mbf for the year—significantly higher than previous years and thehighest prices in real terms since the height of theprevious housing boom in 2005. Prices continuedto increase through the first half of 2018, averag-ing $569/mbf through July, peaking at $635 be-fore dropping markedly to an apparent nadir of$324/mbf in November. Since then prices have in-creased to $371 in April 2019.

Prices for the ‘typical’ DNR log were also markedlyhigher in 2017 than previous years, climbing from$578/mbf in January to $719/mbf in December, av-eraging $611/mbf for the year. Prices for DNRlogs increased in the first quarter of 2018, aver-aging $722/mbf, but declined through the rest ofthe year to a low of $519/mbf in December. Priceshave recovered from that low, but are still muchlower than they were throughout 2018, averaging$553/mbf through April.

Log and lumber prices were expected to weaken inthe final two quarters of 2018, but they were stillexpected to stay above recent years’ averages, be-fore climbing back to near early-2018 levels in early2019. That, obviously, did not happen. The steap-ness of the price decline was surprising and ap-pears to be due to a confluence of a number offactors. As discussed in the main forecast, through-out the latter half of 2018 housing starts stalled,house price growth flattened (and declined in someareas, like Seattle) and lumber mills built significantinventories of both logs and lumber. Log prices areexpected to continue recovering through the restof 2019, and will average something close to 2016prices for the calendar year. Prices are expectedto continue increasing through early 2020, thoughthey are not expected to approach the highs seenin 2018.

Timber Sales Volume. Sales plans in the currentand outlying years have not changed, so absent anew sustainable harvest calculation, sales volumeforecasts remain at 500 mmbf. Unfortunately, withthe drop in timber and lumber prices and the weak

demand, a number of DNR’s recent contracts havebeen passed over at auction with no bidders. Todate, DNR has sold 424 mmbf in stumpage, leaving76 mmbf to be sold in the final auction to reach thecurrent forecast for FY 19. It is DNR’s intention tobring more than this to the June auction, however,given the number of contracts with no bidders, 500mmbf was determined to be a reasonable total es-timate of what will actually sell.

Timber Sales Prices. Auction prices for FY 18totaled $458/mbf, well above the FY 17 average of$346/mbf. The sales price forecast for FY 19 was in-creased to $370/mbf in the September forecast, dueto the strong prices in the first half of 2018, whichwere forecast to wane, but not collapse. This waspulled back to $360 in November, which was stillachievable given the sales through October. Pricecontinued to be lower in sales through January, sothe stumpage price was reduced to $350/mbf in theFebruary forecast. This was an entirely plausibleforecast, until April.

FY 19 sales through March averaged $362/mbf,however, prices plummeted in April. Prices forApril and May averaged $257/mbf. Given the salesprices to-date and the very large volume being of-fered in June, the FY 19 price forecast has beenreduced to $325/mbf, despite the expectations forincreases in log prices. Sales prices for the outly-ing years are unchanged because log and lumberprices are expected to recover from the weaknessthat dominated prices in FY 19. However, pricesare also not increased in outlying years becausethere are still a number of risks to house prices andthe broader economy that could adversely affect logand stumpage prices.

Timber Removal Volume and Prices. Harvestvolume forecast for FY 19 is meaningfully reducedand the forecsts for outlying years are altered signif-icantly. Timber removals for FY 19 are reduced by20 mmbf to 500 mmbf because harvests continueto be much lower than expected. It is possible, butvery unlikly that harvests in June outweight the cur-rent deficit.

The volume not harvested in FY 19 is essentiallypushed out to outlying years.

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Timber removal prices for FY 19 are increased to$380/mbf, due entirly to an increased proportionof the harvest to-date being higher priced timber.This was not the case through the February fore-cast, where the average price of removals was $375.Between February and May, the average removalprice was $442/mbf. Although this has increasedthe removal price in the current year, it has mean-ingfully affected prices in outlying year, FY 20 inparticular.

Timber Revenue. The changes to the timberharvest volume have reduced projected revenue inFY 19, decreasing it by $4 million to $190 million.Revenue in FY 20 and FY 21 are reduced by $17 mil-lion and $8 million respectively.

Revenues for the 2017-2019 biennium are forecastto total $369 million, a decrease of 1.1 percent ($4million) from February’s forecast. Forecast revenuesfor the 2019-2021 biennium are decreased by 6.3percent ($25 million) to $372 million.

Non-Timber Revenues. In addition to revenuefrom timber removals on state-managed lands,DNR also generates sizable revenues from manag-ing leases on uplands and aquatic lands.

The non-timber uplands revenue forecast for FY 19is increased slightly due to higher than expectedrevenues in dryland agriculture and minerals leasesoutweighting a reduction in irrigated agriculture.The forecast in outlying years is increased slightlydue to new leases in minerals and hydrocar-bons.

Aquatic lease revenues in FY 19 are increased by$4 million, due to updated geoduck auction pricesand volumes as well as higher than expected rev-enue in almost all types of aquatic leases. Outlyingyears are increased due to increased expectationsfor all types of aquatic leases except aquaculture.Price weakness in geoduck auctions were incorpo-rated into the February forecast, and are expectedto continue as long as the 25 percent tariff to Chinacontinues.

Total Revenues. Total revenues for the 2017-2019Biennium (FYs 18-19) are decreased by 0.1 percent(less than $1 million) to $535 million. Revenues forthe 2019-2021 Biennium (FYs 20 and 21) are de-

creased by 4.4 percent ($23 million) to $516 mil-lion.

Notes to the Forecast. There are a number ofsources of significant uncertainty for DNR rev-enue and the overall economic activity. These in-clude DNR specific issues, such as the as-yet un-determined sustainable harvest volume, as well asbroader economic issues including the escalatingtrade dispute with China, a continued decrease inwood-fiber exports to China, a slowdown in hous-ing starts, and a potentially weaker economic cli-mate.

While the sales volume estimates are based on thebest available internal planning data, they are sub-ject to adjustments due to ongoing operational andpolicy issues. In particular, these issues are likelyto affect sales volumes in outlying years, where theassumed sustainable harvest volume of 500 mmbfmight be too high.

The most concerning factor in this forecast, andlikely for forecasts in the near future, is thecombined problem of the slowdown in hous-ing construction and the decreasing exports toChina.

Chinese imports of U.S. logs and lumber startedmeaningfully in 2010 and provided support toprices in the worst years following the Recessionin 2008-09, when housing construction was verylow. However, Chinese imports have dropped dra-matically since 2014, year-to-date exports of un-treated Douglas-fir and Hemlock logs from Wash-ington and Oregon to China decreased by 46 per-cent between 2014 and 2018. While Chinese de-mand has been dropping, domestic housing de-mand has been picking up and more than offsetthe decrease in China-bound exports. It appearsthat the strong log and lumber price growth from2017 and the beginning of 2018 was due largely tohousing construction, but that housing constructiongrowth has stalled.

In September 2018, China and the US implementedanother round of reciprocal tariffs. These tariffs in-clude a 25 percent tariff on geoduck and wheat, anda five percent tariff on softwood logs. The tariff ongeoduck is likely the main driver of the drop in

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geoduck prices, from an average of $11.31/lb in FY18 to an average of $9.43/lb in FY 19 (a 17 percentdrop). The log tariffs, in addition to the slowdownin housing starts, likely undermined the domesticprice of logs.

China is still a major market for Washington timberand lumber and the demand drop represents a con-tinuing downside risk for the forecast. Aside fromthe trade tensions discussed above, there are otherthings that could undermine Chinese demand, suchas a further slowdown in Chinese economic growthor continued loss of PNW market share to interna-tional and Southeastern US competitors.

Continued growth in domestic housing demandwas expected to offset the continued decline inChina-bound exports. If housing construction doesnot resume its growth, as optimistic analysts haveforecast, and Chinese exports continue to decline,then log and lumber prices will likely continue tofall, in which case even our conservative currentstumpage forcast may be optimistic.

Another concern for the overall U.S. economy,which would affect DNR revenue, is the continuedpolitical uncertainty surrounding the U.S. FederalGovernment. The government was shutdown fromDecember 22, 2018 to January 25, 2019 and was thesecond federal government shutdown of the currentU.S. administration. Although the shutdown itselfis likey to only meaningfully negativly affect GDPgrowth in the first quarter of 2019, it is a presageto more uncertainty. If a budget agreement isn’treached by October, then the government will shutdown again. Additionally, the budget caps will alsoexpire, assuming there is no agreement to extendthem, which would cause across the board cutsto U.S. government spending. Given that govern-ment spending has been a major driver of GDPin 2018 and the first quarter of 2019, these auto-matic cuts may have an surprisingly large impacton GDP.

The Congressional Budget Office estimated that thecost of the 2018-19 shutdown was around $11 bil-lion in lost GDP revenue, all but $3 billion of whichwill likely be recovered. That is an insignificantamount compared to the overall size of the U.S.economy. However, if the government were to shut

down again, combined with automatic spendingcuts, the impacts may be more significant than lasttime.

The direct impact of the shutdown on DNR wasmostly likely from the effect on the housing mar-ket, potentially delaying what was expected to bea recovery in the first quarter of 2019. Single-family home loans through the FHA and all typesof VA loans were still funded through the shutdown,though potentially with delays, while some othertypes of FHA loans were not processed . Most con-ventional mortgages are not backed by the federalgovernment and were processed as usual, thoughtax transcript processing at the IRS was disturbedand caused delays in application processing.

To be clear, in the end, the effects of the FederalGovernment shutdown in 2018-19 were likely min-imal and were likely insignificant compared to thesize of the economy. However, shutdowns cause in-stability in an economy and could have significantunforseen impacts if they happen too often.

Since the expiration of the Softwood LumberAgreement (SLA) in late 2015, the U.S. and Canadahave been without a trade agreement that coverslumber. As of late 2017 a U.S. ITC finding clearedthe Department of Commerce to impose duties,which have been set at 20.23%. Although Canadahas appealed the finding to a NAFTA panel and hasfiled a complaint with the WTO, much of the short-term uncertainty about trade costs is gone. With-out a breakthrough on the new SLA negotiationsor a finding from the WTO or NAFTA panel, themarkets are unlikely to see the price volatility thatthe previous duty uncertainty caused. Addition-ally, at current lumber prices, the duties shouldn’tbe significant enough to reduce Canadian produc-tion.

Aside from the tariffs pushing down geoduckprices, which they appear to have done, China hastwice instituted bans on Pacific Northwest shellfishon food safety grounds—paralytic shellfish poison(PSP) and arsenic contamination. It’s not clear thateither of these bans significantly affected prices orharvest activity. However, it is entirely possible thatChina could re-enact a more forceful ban on geo-duck that would have a dramatic effect on geoduck

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prices, and therefore revenue.

As always in the geoduck fisheries, PSP clo-sures create uncertainty around harvest volumes aswell.

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Table 1: June 2019 Forecast by Source (millions of dollars)Timber Sales FY 16 FY 17 FY 18 FY 19 FY 20 FY 21 FY 22 FY 23

Volume (mmbf) 545 520 496 500 500 500 500 500Change - - - - -% Change 0% 0% 0% 0% 0%

Price ($/mbf) 285 346 458 325 340 340 340 340Change $ (25) $ - $ 0 $ 0 $ 0% Change -7% 0% 0% 0% 0%

Value of Timber Sales 155.3 179.8 227.1 162.5 170.0 170.1 170.1 170.1Change $ (12.5) $ - $ 0.0 $ 0.0 $ 0.0% Change -7% 0% 0% 0% 0%

Timber Removals

Volume (mmbf) 490 493 528 500 559 571 545 532Change (20) 5 7 11 2% Change -4% 1% 1% 2% 0%

Price ($/mbf) 338 313 338 380 327 330 337 341Change 6.8 (34.5) (17.8) (4.0) (2.0)% Change 2% -10% -5% -1% -1%

Timber Revenue 165.7 154.2 178.6 190.0 183.0 188.5 183.9 181.5Change (4.0) (17.4) (7.7) 1.5 (0.3)% Change -2% -9% -4% 1% 0%

Upland Leases

Irrigated Agriculture 8.7 9.1 10.4 9.0 9.0 9.0 9.0 9.0Change (0.5) - - - -% Change -5% 0% 0% 0% 0%

Orchard/Vineyard 8.2 8.1 8.5 8.9 8.2 8.2 8.2 8.2Change - - - - -% Change 0% 0% 0% 0% 0%

Dryland Ag/Grazing 5.2 5.6 6.6 6.5 6.0 6.0 6.0 6.0Change 0.7 - - - -% Change 12% 0% 0% 0% 0%

Commercial 9.0 9.7 10.9 10.2 10.4 10.4 10.4 10.4Change - - - - -% Change 0% 0% 0% 0% 0%

Other Leases 10.5 10.7 10.3 10.0 10.2 10.3 10.3 10.3Change 0.2 0.1 0.1 0.1 0.1% Change 2% 1% 1% 1% 1%

Total Upland Leases 41.6 43.1 46.7 44.6 43.8 43.9 43.9 43.9Change 0.4 0.1 0.1 0.1 0.1% Change 1% 0% 0% 0% 0%

Aquatic Lands

Aquatic Leases 11.1 10.8 12.0 13.5 11.3 11.2 11.2 11.2Change 1.5 0.6 0.6 0.6 0.6% Change 13% 6% 6% 6% 6%

Geoduck 14.5 27.9 26.4 23.6 17.1 17.6 18.0 18.9Change 2.5 (0.2) - - -% Change 12% -1% 0% 0% 0%

Aquatic Lands Revenue 25.6 38.7 38.4 37.1 28.4 28.8 29.2 30.1Change 4.0 0.4 0.6 0.6 0.6% Change 12% 2% 2% 2% 2%

Total All Sources 232.9 236.1 263.7 271.6 255.2 261.1 256.9 255.4

Change 0.5 (16.9) (7.0) 2.2 0.4% Change 0% -6% -3% 1% 0%

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Table 2: June 2019 Forecast by Fund (millions of dollars)Key DNR Operating Funds FY 16 FY 17 FY 18 FY 19 FY 20 FY 21 FY 22 FY 23

041 RMCA - Uplands 36.0 33.7 40.6 38.6 36.6 39.7 40.0 39.7Change (0.6) (4.3) (1.8) 0.1 0.0% Change -2% -10% -4% 0% 0%

041 RMCA - Aquatic Lands 11.3 17.9 17.6 16.5 12.5 12.7 12.9 13.4Change 1.8 0.1 0.2 0.2 0.2% Change 12% 1% 2% 2% 2%

014 FDA 22.8 22.0 22.1 25.3 25.4 24.4 23.0 22.7Change (0.3) (1.0) (0.3) 0.4 0.0% Change -1% -4% -1% 2% 0%

21Q Forest Health Revolving 4.4 7.3 7.2 9.4 10.2 10.0(0.2) (1.3) (1.0) (0.5) (0.2)-2% -16% -10% -4% -2%

Total DNR Key Operating Funds 70.2 73.6 84.7 87.7 81.7 86.2 86.1 85.7Change 0.7 (6.5) (2.9) 0.2 0.1% Change 1% -7% -3% 0% 0%

Current Funds

113 Common School Construction 59.7 51.8 62.6 63.0 63.0 66.3 66.0 65.5Change (2.5) (4.9) (1.9) 0.3 0.1% Change -4% -7% -3% 0% 0%

999 Forest Board Counties 55.3 58.5 59.6 69.0 62.5 59.8 56.3 55.6Change 2.0 (2.8) (1.1) 1.0 (0.1)% Change 3% -4% -2% 2% 0%

001 General Fund 4.1 2.6 2.1 2.1 4.7 4.2 3.7 3.7Change (0.7) 0.6 0.3 0.1 0.1% Change -26% 14% 7% 4% 2%

348 University Bond Retirement 1.8 1.8 3.2 1.3 1.7 1.7 1.9 1.8Change (0.2) 0.0 (0.2) (0.0) (0.0)% Change -15% 1% -10% -2% 0%

347 WSU Bond Retirement 1.4 1.7 1.6 1.7 1.7 1.7 1.7 1.7Change 0.0 0.0 0.0 0.0 0.0% Change 1% 0% 0% 0% 0%

042 CEP&RI 3.1 4.1 5.3 2.5 2.6 3.9 4.1 4.1Change 0.1 (1.0) (0.2) 0.0 0.1% Change 6% -27% -4% 0% 2%

036 Capitol Building Construction 6.7 8.2 6.2 8.7 5.8 7.4 7.8 7.7Change 0.8 (2.6) (1.0) (0.1) (0.1)% Change 10% -31% -12% -1% -2%

061/3/5/6 Normal (CWU, EWU, WWU, TESC) School 0.1 0.1 0.1 0.2 0.2 0.2 0.2 0.2Change 0.0 - - - -% Change 1% 0% 0% 0% 0%

Other Funds 0.1 0.0 1.1 0.8 1.1 0.6 0.2 0.2Change (0.5) 0.2 0.2 0.1 (0.0)% Change -39% 21% 40% 47% -4%

Total Current Funds 132.2 129.0 141.7 149.3 143.3 145.8 142.0 140.6Change (1.0) (10.5) (3.9) 1.4 0.1% Change -1% -7% -3% 1% 0%

(Continued)

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Table 3: June 2019 Forecast by Fund (millions of dollars), cont’dAquatic Lands Enhancement Account FY 16 FY 17 FY 18 FY 19 FY 20 FY 21 FY 22 FY 23

02R 14.2 20.8 20.8 20.6 15.9 16.1 16.3 16.7Change 2.2 0.3 0.4 0.4 0.4% Change 12% 2% 2% 2% 2%

Permanent Funds

601 Agricultural College Permanent 7.6 4.6 4.2 4.6 6.3 4.6 4.1 4.0Change (1.8) 0.7 (0.0) 0.1 (0.1)% Change -28% 12% 0% 4% -1%

604 Normal School Permanent 2.4 3.1 4.1 3.0 3.0 2.9 2.8 2.7Change (0.2) (0.2) (0.1) 0.0 (0.0)% Change -7% -8% -3% 2% 0%

605 Common School Permanent 1.0 0.6 0.8 0.3 0.3 0.3 0.3 0.3Change - - - - -% Change 0% 0% 0% 0% 0%

606 Scientific Permanent 5.0 4.1 7.0 5.2 4.3 4.7 4.8 4.8Change 0.3 (0.3) (0.3) (0.0) 0.0% Change 6% -6% -7% 0% 0%

607 University Permanent 0.2 0.3 0.3 0.8 0.3 0.4 0.5 0.5Change 0.3 (0.3) (0.2) (0.0) (0.0)% Change 63% -49% -29% -5% -5%

Total Permanent Funds 16.2 12.6 16.5 14.0 14.3 13.0 12.5 12.4Change (1.4) (0.1) (0.6) 0.1 (0.1)% Change -9% -1% -4% 1% -1%

Total All Funds FY 16 FY 17 FY 18 FY 19 FY 20 FY 21 FY 22 FY 23

232.9 236.1 263.7 271.6 255.2 261.1 256.9 255.4Change 0.5 (16.9) (7.0) 2.2 0.4% Change 0% -6% -3% 1% 0%

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Figure 1: Timber Forecast Charts

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Figure 2: Other Uplands Forecast Charts

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Figure 3: Aquatics and Total Forecast Charts

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Contents

Forecast Summary I

Macroeconomic Conditions 1U.S. Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Gross Domestic Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1Employment and Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4The U.S. Dollar and Foreign Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4Petroleum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Wood Markets 8U.S. Housing Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

New Home Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Housing Starts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Housing Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Export Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11Timber Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Price Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Lumber Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Log Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Stumpage Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13DNR Stumpage Price Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

DNR Revenue Forecast 15Timber Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Timber Sales Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15Timber Removal Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15Timber Sales Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16Timber Removal Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16Timber Removal Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Upland Lease Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18Aquatic Lands Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19Total Revenues from All Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Some Caveats . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20Distribution of Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

List of Tables

1 June 2019 Forecast by Source (millions of dollars) . . . . . . . . . . . . . . . . . . . . . . . V2 June 2019 Forecast by Fund (millions of dollars) . . . . . . . . . . . . . . . . . . . . . . . . VI3 June 2019 Forecast by Fund (millions of dollars), cont’d . . . . . . . . . . . . . . . . . . . . VII

List of Figures

1 Timber Forecast Charts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . VIII2 Other Uplands Forecast Charts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IX3 Aquatics and Total Forecast Charts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . X4 U.S. Gross Domestic Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Unemployment Rate and Monthly Change in Jobs . . . . . . . . . . . . . . . . . . . . . . . 26 Employment and Unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Labor Market Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 U.S. Inflation Indices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 Trade-Weighted U.S. Dollar Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 510 Crude Oil Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 611 Lumber, Log, and Stumpage Prices in Washington . . . . . . . . . . . . . . . . . . . . . . . 812 Lumber, Log, and DNR Stumpage Price Seasonality . . . . . . . . . . . . . . . . . . . . . . 813 New Single-Family Home Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 914 Housing Starts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1015 Case-Shiller Existing Home Price Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1016 Log Export Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1117 Log Export Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1218 DNR Composite Log Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1319 DNR Timber Stumpage Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1420 Forecast Timber Sales Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1521 Forecast Timber Removal Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1522 Forecast Timber Sales Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1623 Forecast Timber Removal Price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1624 Forecast Timber Removal Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1625 Forecast Timber Removal Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1726 Forecast Upland Lease Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1827 Aquatic Lands Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1928 Geoduck Auction Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1929 Total Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Acronyms and Abbreviations

bbf Billion board feetBLS U.S. Bureau of Labor StatisticsCAD Canadian dollarCNY Chinese yuan (renminbi)CPI Consumer Price IndexCY Calendar Year

DNR Washington Department of Natural ResourcesECB European Central BankERFC Washington State Economic and Revenue Forecast CouncilFDA Forest Development AccountFEA Forest Economic AdvisorsFed U.S. Federal Reserve Board

FOMC Federal Open Market CommitteeFY Fiscal YearGDP Gross Domestic ProductHMI National Association of Home Builders/Wells Fargo Housing Market IndexIMF International Monetary FundITC U.S. International Trade Commission

mbf Thousand board feetmmbf Million board feetPSP Paralytic Shellfish PoisoningPPI Producer Price IndexQ1 First quarter of year (similarly, Q2, Q3, and Q4)QE Quantitative Easing

RCW Revised Code of WashingtonRMCA Resource Management Cost AccountSA Seasonally AdjustedSAAR Seasonally Adjusted Annual RateSLA Softwood Lumber Agreement

TAC Total Allowable CatchUSD U.S. DollarWDFW Washington Department of Fish and WildlifeWWPA Western Wood Products AssociationWTO World Trade Organization

Preface

This Economic and Revenue Forecast projects rev-enues from Washington state lands managed by theWashington State Department of Natural Resources(DNR). These revenues are distributed to manage-ment funds and beneficiary accounts as directed bystatute.

DNR revises its Forecast quarterly to provide up-dated information for trust beneficiaries and stateand department budgeting purposes. Each DNRForecast builds on the previous one, emphasizingongoing changes. Forecasts re-evaluate world andnational macroeconomic conditions, and the de-mand and supply for forest products and othergoods. Finally, each Forecast assesses the impactof these economic conditions on projected revenuesfrom DNR-managed lands.

DNR Forecasts provide information used in theWashington Economic and Revenue Forecast issuedby the Washington State Economic and RevenueForecast Council. The release dates for DNR Fore-casts are influenced by the state’s forecast scheduleas prescribed by RCW 82.33.020. The table below

shows the anticipated schedule for future Economicand Revenue Forecasts.

This Forecast covers fiscal years 2019 through 2023.Fiscal years for Washington State government beginJuly 1 and end June 30. For example, the currentfiscal year, Fiscal Year 2019, runs from July 1, 2018through June 30, 2019.

The baseline date (the point that designates thetransition from “actuals” to predictions) for DNRrevenues in this Forecast is May 1st, 2019. Theforecast numbers beyond that date are predictedfrom the most up-to-date DNR sales and revenuedata available, including DNR’s timber sales resultsthrough May 2019. Macroeconomic and marketoutlook data and trends are the most up-to-dateavailable as the Forecast document is being writ-ten.

Unless otherwise indicated, values are expressedin nominal terms without adjustment for infla-tion or seasonality. Therefore, interpreting trendsin the Forecast requires attention to inflationarychanges in the value of money over time, separatefrom changes attributable to other economic influ-ences.

Economic Forecast Calendar

Forecast Baseline Date Final Data and Publication Date (approximate)

September 2019 August 1, 2019 September 15, 2019November 2019 October 1, 2019 November 15, 2019February 2020 January 1, 2020 February 15, 2020June 2020 May 1, 2020 June 15, 2020

Acknowledgements

The Washington Department of Natural Resources’(DNR) Economic and Revenue Forecast is a collabora-tive effort. It is the product of information providedby private individuals and organizations, as well asDNR staff. Their contributions greatly enhance thequality of the Forecast.

Special thanks are due to those in the wood prod-ucts industry who provided information for DNR’ssurvey of timber purchasers. These busy individu-als and companies volunteered information essen-tial to forecasting the timing of timber removal vol-umes, a critical component of projecting DNR’s rev-enues on behalf of beneficiaries.

Thanks also go to DNR staff who contributed to theForecast: Koshare Eagle, Pat Ryan, Katy Mink, TomHeller, Keith Jones, Janet Ballew, Linda Farr, andMichelle McLain. They provided data and coun-sel, including information on markets and revenueflows in their areas of responsibility.

In the final analysis, the views expressed are ourown and may not necessarily represent the views ofthe contributors, reviewers, or DNR.

Office of Finance, Budget, and Economics

Kristoffer Larson, EconomistDavid Chertudi, Lead Economist

MACROECONOMIC CONDITIONS

Macroeconomic Conditions

This section briefly reviews macroeconomic condi-tions in the United States and world economies be-cause they influence DNR revenue—most notablythrough the bid prices for DNR timber and geo-duck auctions and lease revenues from managedlands.

U.S. Economy

Gross Domestic Product

GDP is a useful indicator to track to get an ideaof how the U.S. economy is growing overall. WhenGDP is growing well, then generally there will bean increase in jobs, spending and overall economicwelfare. This can translate into growth in housingspending and construction, which influence timberprices and DNR’s income from timber. It is a use-ful indicator of how other, more directly relevantindicators, may move in the future.

Figure 4: U.S. Gross Domestic Product

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Rate

Typically, GDP growth experiences a rebound aftera recession, spiking to well above the historical av-erage. For instance, after the recession in 1991, GDPgrew 3.5 percent in 1992 and continued growingstrongly with a peak growth rate of 4.8 percent in1999. However, this has not been the case since the

end of the Great Recession in 2009. From the endof the Great Recession, during which GDP declinedin five out of six quarters, to 2017, GDP growth av-eraged a weak 2.2 percent on a real annualized ba-sis (Figure 4). This is markedly less than the annu-alized average of 3.2 percent over the previous 50years (1960-2009). The Great Recession set backeconomic growth and seriously harmed many sec-tors of the economy, with especially lasting effectson employment and wages.

The pattern of slow GDP growth was widely pre-dicted to break in 2014, then again in 2015, 2016,2017 and yet again in 2018, with economists expect-ing or hoping for a rebound. However, as each yearprogressed expectations were repeatedly reduced.However, with very strong second and third quarterannualized growth of 4.2 and 3.2 percent, respec-tively, 2018 had the strongest GDP growth since theend of the recession—2.9 percent.

Predictions for real GDP in 2019 are varied, withthe FOMC having median predictions of 2.1 percent(down from 2.3 percent in September 2018), whileothers are more bullish and expect closer to 2.7percent growth for the year. Predictions for GDPgrowth in the coming years are perhaps more un-certain than in previous years because there is somuch uncertainty around the behavior of the U.S.administration with respect to trade.The FOMC hassignaled significant concerns about GDP growththis year and have signalled that they may actuallydecrease interest rates. Additionally, there seem tobe more pundits predicting a recession in withinthe next 18 months, thought its not clear whetherthere is a hightened risk or that they are just get-ting more media attention. Constultants that DNRcontract with have a "short and shallow" recessionbuilt into their business cycle model near the endof 2020 or early 2021.

Employment and Wages

The U.S. headline unemployment rate has beentrending downward since peaking at 10 percent in2010 and is 3.6 percent as of April—the lowest itsbeen since 1969 (Figure 5).

Page 1 of 21 DNR Economic & Revenue Forecast

MACROECONOMIC CONDITIONS

Job growth through 2018 averaged 223,000 jobs permonth, higher than 2017’s average of 182,000 jobsper month. This bucks the trend for the last coupleof years which has seen slower job growth, which isexpected as the economy gets closer to operating atfull capacity. Through April 2019, the economy hasseen an average 205,000 jobs per month.1

Figure 5: Unemployment Rate and Monthly Changein Jobs

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The unemployment rate is a useful indicator be-cause it gives insight into slack in the labor mar-ket; that is, how many people are available to workbefore job growth starts driving problematic infla-tion. The labor market is the driving force behindconsumption, which constitutes about 70 percentof GDP and naturally extends to the demand forhousing, which is the major driver of U.S. timberdemand. Data and anecdotes abound that suggestthat one of the major effects of high unemploymentrates, particularly among young adults, is lower de-mand for housing as more people live with theirparents or housemates.

One continual source of consternation foreconomists over the past year has been the low un-employment rate combined with low inflation. Al-though the unemployment rate has declined andhas been below the long run normal unemploymentlevel expected by the FOMC, it has not yet trans-lated into strong wage growth, which is likely a pre-requisite for broader economic improvement andan increase in the demand for housing, or higherInflation. One possible reason for this is that theheadline unemployment rate may be underestimat-ing the number of people willing to work. Dur-ing the 2008-09 recession the number of peoplewho were underemployed or marginally attached tothe workforce increased dramatically. Additionally,from the beginning of the recession to mid-2015the labor force participation rate declined signifi-cantly, falling by three percentage points to below63 percent, where it has remained, possibly becauseworkers left the labor force after they were unableto find jobs.

Figure 6: Employment and Unemployment

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The U-6 is an alternative measure of unemploy-1These job growth numbers are from the BLS Payroll survey. More information can be found here: https://www.bls.

gov/web/empsit/ces_cps_trends.htm

DNR Economic & Revenue Forecast Page 2 of 21

MACROECONOMIC CONDITIONS

ment that includes involuntarily part-time employ-ment (underemployment) and marginally attachedworkers, who are not included in the headline un-employment rate but who, nevertheless, are likely tobe looking for work and would benefit from betterjob prospects. The U-6 has declined from a high of17.1 percent in 2010 to a low of 7.3 percent in April.This is lower than the average of 9.1 percent from2001-2006 (Figure 6). The decline in the year-on-year U-6 is the result of a drop in all three of itscomponents.

Figure 7: Labor Market Indicators

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gesince20

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employmentrate) Unemployment Rate (net change)

EmploymentWorking Age PopulationTotal WorkForceLabor Force Participation

Reductions in the labor force participation ratehelped move the unemployment rate and the U-6 lower roughly through January 2014 (Figure 7).Since then the rate has remained relatively stablebetween 62.4 and 63.0 percent and has averaged62.8 percent. The decline in the labor force par-ticipation rate is an important confounding factorwhen examining the unemployment rate and is akey consideration when forecasting whether an in-crease in employment will trigger an increase inwages and inflation. If there are many people wait-ing to search for employment until jobs are easierto find—such as when people stay out of the la-bor force and the participation rate declines—thenas employment grows, more people will enter thelabor force and there will be little or no pressureon wages despite a low unemployment rate. How-ever, if people are not in the labor market for other

reasons, then the unemployment rate is a more ac-curate reflection of the labor pool. In that case,a decrease in the unemployment rate means thatthere are fewer people looking for work, so in or-der to fill jobs companies will have to compete forlabor, pushing up wages.

The drop in the participation rate since 2008 sug-gests that the recession itself caused people to leavethe labor market, and implies that they may returnwhen things look a bit better. However, FederalReserve analysts have suggested that the decline inparticipation may be part of a longer-term trendstarting in the late 1970s and pausing during the1990s, not as a result of the recession. Indeed, ac-cording to statistics released by the Federal ReserveBank of Atlanta, many of those dropping out of thelabor force can’t or don’t want to work.

Inflation

Aside from a short period in 2012, core inflationhas been below the FOMC’s target since the re-cession in 2008. Similarly to GDP forecasts, infla-tion forecasts have been consistently too high, witheach year predicted to break the cycle of weak in-flation, only to disappoint as the year progresses.(Figure 8).

Figure 8: U.S. Inflation Indices

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ual%

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Headline CPI Core CPI Core PCE

For policy purposes, the FOMC uses the core Per-

Page 3 of 21 DNR Economic & Revenue Forecast

MACROECONOMIC CONDITIONS

sonal Consumption Expenditures (PCE) index asthe measure of inflation, which removes the morevolatile fuel and food prices. This measure showslong-term inflation at or below the 2.0 percent tar-get since September 2008. Core PCE growth av-eraged between 1.4 and 1.7 percent from 2015-2017,but rose to average 1.9 percent in 2018. However,the year-to-date annualised average through March2019 has been 1.7 percent. The FOMC expects corePCE to be in the low 2.0 percent range in 2019 and2020.

Interest Rates

Seldom in U.S. history has it been so inexpensive toborrow money for so long. From December 2008 toDecember 2015, the Federal Reserve held the fed-eral funds rate in the 0.0-0.25 percent range. Dur-ing that time the Fed pledged to keep the rates nearzero until it judged that there had been sufficientprogress toward its dual-mandate of maximum em-ployment and around 2.0 percent inflation.

An increase in interest rates will generally slowdown economic growth—business investment slowsdown because borrowing money becomes more ex-pensive, so job and wage growth slow down (con-straining consumption). Similarly, it becomes moreexpensive for consumers to borrow, impeding de-mand in the housing and auto markets. In nor-mal times, a decrease in interest rates will ex-pand investment, employment, wages, and con-sumer credit. The question of whether to raise in-terest rates is important because it is the key toolof monetary policy.

In December 2015, the FOMC raised interest ratesto 0.25-0.5 percent after determining that sufficientprogress had been made in the recovery of employ-ment and inflation and, importantly, that there wasa sufficiently strong outlook to begin lifting interestrates from their historic lows. From the December2015 rate rise, the FOMC indicated that they ex-pected a median federal funds rate of 1.4 percentin 2016, which would have been four rate increasesof about 0.25 percent. However, this didn’t hap-pen due to slower than expected inflation and wagegrowth. In December 2016 the FOMC raised rates

again to 0.5-0.75 percent. The FOMC increasedthe rate three times in 2017 and five times in 2018,leading to current rates of 2.25-2.5 percent. Theseincreases were widely expected because the FOMCcarefully prepared markets for it with each succes-sive meeting statement.

The June FOMC meeting materials show that theCommittee has become much more uncertain aboutthe strength of the economy and now expects tohold rates steady or decrease them in 2019 and2020, down to 1.9-2.4 percent. This is a signifi-cant change from the December meeting, where theFOMC expected to raise interest rates one to twotimes in 2019, leading to a federal funds rate be-tween 2.6-3.1 percent, with futher increases leadingto 2.9-3.4 percent rates in 2020.

The U.S. Dollar and Foreign Trade

The trade-weighted U.S. dollar index climbed dra-matically from 2014 through late 2016. Through2015 and 2016 this was largely due to the relativestrength of the U.S. economy, which, although fairlyweak, was growing faster than most other advancedcountries. Although the value of the U.S. dollar wasbelow its 2015 peak for most of 2016, the results ofthe U.S. presidential election pushed the exchangerate well above its previous high. From mid-2017to May 2018, the dollar dropped back to aroundits 2015 start; however, since May 2018 it increasedabove its earlier 2016 high (Figure 9).

A rising dollar means that timber and lumber fromthe Pacific Northwest become more expensive forinternational buyers and imported timber and lum-ber become less expensive. This will tend to sup-press local prices and DNR’s timber and agricul-tural revenues. Wildstock geoduck revenue will alsobe negatively affected because geoduck is primarilymarketed abroad. A falling dollar leads to the op-posite effects.

DNR Economic & Revenue Forecast Page 4 of 21

MACROECONOMIC CONDITIONS

Figure 9: Trade-Weighted U.S. Dollar Index

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ollarIndexValue

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Foreign trade and access to export markets is im-portant for DNR revenues. Chinese demand fortimber and lumber have been a major factor sup-porting lumber prices since 2010, even though DNRtimber cannot be exported directly and Chinese de-mand has been declining. Additionally, much ofthe soft white wheat produced in Washington is ex-ported to Asia and a large portion of the PNW geo-duck harvest is exported to China.

As of the previous forecast, trade tensions betweenthe U.S. and China had seemed to be easing, withreports of successful, though inconclusive, meet-ings between the countries’ representative. How-ever, since then, both China and the U.S. have in-troduced tariffs on additional goods.

Given the proposed policies of the U.S. administra-tion, and the escalating imposition of tariffs, theupcoming months and years are likely to be morevolatile for foreign trade and present a large po-tential downside risk for DNR revenue. Currently,China is the main target of U.S. tariffs and hasimposed a number of tariffs on U.S. goods. Ofthe products relevant to DNR revenue, softwoodlogs are subject to a five percent tariff, while geo-duck, wheat, and many orchard/vineyard agricul-tural products (such as apples) are subject to a 25percent tariff.

The effects of the tariffs DNR revenue will benegative—higher prices to purchasers will reduceexport demand. However, that doesn’t necessarilymean that revenue from some affect sources willgo down. It is possible that increased demandfrom elsewhere or external supply constraints willsupport higher prices or revenue. For instance,it appears that the effect of the tariffs were notlarge enough to outweigh higher revenue in or-chard/vineyard leases (which were increased lastforecast). Over time, however, the tariffs will stillput downward pressure on prices and may lead tolower revenue from crop-sharing leases, as well asundermine lease adjustments in the future, whichare tied to the price index for agricultural prod-ucts.

Chinese timber exports have already fallen from apeak of 4.1 million m3 in 2011 to 1.7 million m3 in2017 (unrelated to tariffs). Analysts had been pre-dicting that increases in domestic demand will off-set the drop in Chinese demand, however, therewould still be a large drop in overall demand ifChina were to turn away from Washington log andlumber exports entirely.

Previously, some analysts argued that access towheat and other agricultural export markets arenot in any serious danger because the U.S.’s largesttrading partners are dependent upon imports tosatisfy their demand and food prices in develop-ing countries are highly political. However, thatdoesn’t mean that they aren’t able to preferentiallypurchase from U.S. competitors, particularly Aus-tralia, which is the world’s largest exporter of softwhite wheat.

Finally, China is apparently the primary market forgeoducks so an increase in geoduck prices in theChinese market could have a large impact2. Theaverage prices of the geoduck auctions since theimposition of tariffs have been around 17 percentlower than those of the recent past, suggesting thatthe tariffs are having a meaningful impact.

2There is very little information about the geoduck market, so much of our understanding is anecdotal.

Page 5 of 21 DNR Economic & Revenue Forecast

MACROECONOMIC CONDITIONS

Petroleum

Crude oil and its derivatives strongly affect produc-tion, transportation, and consumption in the worldand U.S. domestic economies. Prices for Brentcrude oil plummeted from $108/barrel in January2014 to $30/barrel in January 2016, a 70 percentdrop. Prices spiked in late 2017 to $64/barrel—its highest price since January 2015. Prices stabi-lized between $70-$80/barrel (seasonally adjusted)between April and August, before spiking to above$85/barrel in late September. However, pricesdropped dramatically through October and earlyNovember, falling from the September peak to justabove $65/barrel - roughly 25 percent. Since then,they have recovered to $71/barrel in April.

Broadly, a drop in oil prices acts like a tax cutfor consumers and can encourage consumption.Additionally, all other things being equal, lowerpetroleum prices will decrease diesel fuel prices andwill make transportation-sensitive industries—suchas PNW logging and agriculture—more competi-tive in international markets. However, all otherthings are not equal: as discussed above, the U.S.dollar has started to increase again, which willmake PNW timber more expensive internationally,while tariffs are being introduced, making it lesscompetitive still.

Figure 10: Crude Oil Prices

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China

China is a major export market for logs, lumber,geoduck, and wheat and other agricultural productsfrom the Pacific Northwest. Since 2011, between 50and 60 percent of the softwood log exports leavingthe Seattle and Columbia River Customs Districthave gone to China. Additionally, China is (anecdo-tally) the primary export market for Washington’sgeoduck. Changes to the Chinese economy canhave a dramatic impact on the prices for logs, lum-ber, and geoduck in the Pacific Northwest.

China’s GDP and employment weathered the globaleconomic and financial crises better than mostother economies. There have been concerns forseveral years that that resilience may still prove tobe illusory, as the costs of propping up investmentand maintaining significant political control overthe economy mount and the likelihood of a dra-matic increase. However, although Chinese GDPgrowth has slowed from 10.4 percent in 2010 to6.6 percent in 2018, it has not crashed as somefeared.

There is still some concern that Chinese GDPgrowth will fall much lower, possibly even into re-cession, with some analysts looking out for a ’Min-sky moment’—a sudden sharp drop in economicactivity triggered by excess debt. This risk is mostlydue to the prominence of investment as a compo-nent of GDP, the huge amount of debt in the coun-try, and the way that debt is held. Household andcorporate debt (to non-financial corporations) bal-looned from about 110 percent of GDP in 2008 toover 190 percent in 2014, and much of it is linkedto real estate. Investment comprises almost 50 per-cent of China’s GDP. At those levels of debt a slow-down in an economy can lead to a drop in incomeand an inability to service debt en-masse, poten-tially leading to a debt crisis that would underminethat investment and have a tremendous impact onChina’s GDP.

The concern about the overall economy is ampli-fied by the U.S. administration, which has been verycritical of trade with China and has imposed tariffson Chinese goods. China is particularly vulnera-ble to changes in access to international markets,

DNR Economic & Revenue Forecast Page 6 of 21

MACROECONOMIC CONDITIONS

with exports making up 25 percent of its GDP anda large proportion of employment dependent uponlabor-intensive export industries.

Page 7 of 21 DNR Economic & Revenue Forecast

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Wood Markets

Over the past decade, timber stumpage revenuehas constituted about 70 percent of total DNR rev-enues. DNR is, therefore, vitally concerned withunderstanding stumpage prices, log prices, lumberprices, and the related supply and demand dynam-ics underlying all three. This section focuses onspecific market factors that affect timber stumpageprices and overall timber sales revenue generatedby DNR.

Figure 11: Lumber, Log, and Stumpage Prices inWashington

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In general, timber stumpage prices reflect demandfor lumber and other wood products, timber sup-ply, and regional lumber mill capacity. There is aconsistent, positive relationship between log pricesand DNR’s stumpage prices, despite notable volatil-ity in stumpage prices (Figure 11). High log pricesmake access to logs more valuable, increasing pur-chasers’ willingness to pay for stumpage (the rightto harvest). Volatility in stumpage prices arise notonly from log prices, but also from the volume oflumber and logs held in mills’ inventories and fromDNR-specific issues, such as the quality and type

of the stumpage mix offered at auction, the region,and the road-building requirements of a particularsale.

The relationship between lumber and log pricesis less consistent. Lumber prices are significantlymore volatile and both the direction and size ofprice movements can differ from log prices. Thisis due to both demand and supply-side factors. Onthe demand side, mills will often have an inventoryof logs in their yards, as well as an inventory of‘standing logs’, so they do not always need to bidup stumpage prices to take advantage of high lum-ber prices. From the supply side, land owners oftendo not need to sell their timber, so when prices falltoo far, they can withhold supply and allow theirtrees to grow and increase in quality.

Figure 12: Lumber, Log, and DNR Stumpage PriceSeasonality

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There are differences in price seasonality betweenlumber, logs, and stumpage, as illustrated in Fig-ure 12. These prices are affected by a degree ofseasonality that is largely the result of when eachof these commodities will be used. For instance,lumber prices tend to peak in spring, when hous-ing construction picks up, and decline through fallas demand wanes, while stumpage prices tend tobe highest in January-March, when harvesters arelining up harvestable stock for the summer. DNRstumpage price volatility is also affected by the fire-fighting season and the quality of the stumpage

DNR Economic & Revenue Forecast Page 8 of 21

WOOD MARKETS

mix, which varies throughout the year but tendsto be lower from July through September.

U.S. Housing Market

This section continues with a discussion of the U.S.housing market because it is particularly importantto overall timber demand in the U.S.

New residential construction (housing starts) andresidential improvements are major components ofthe total demand for timber in the U.S. Historically,these sectors have constituted over 70 percent ofsoftwood consumption—45 percent going to hous-ing starts and 25 percent to improvements—withthe remainder going to industrial production andother applications.

The 2007 crash in the housing market and the fol-lowing recession drastically reduced demand fornew housing, which undermined the total demandfor lumber. Since the 2009-11 trough, the increasein housing starts has driven an increase in lum-ber demand, though not to nearly the extent ofthe peak. Prolonged growth in starts is essentialfor a meaningful increase in the demand for lum-ber.

After stalling through late 2014, housing demandgrew through mid-2018, though it’s growth wassubdued by tight lending standards and increasingprices at the same time as stagnant or decliningreal wages for much of the population. Althoughlending standards have relaxed a little and the la-bor market is tightening, these improvements havenot yet been sufficient to meangfully increase hous-ing demand.

New Home Sales

Unsurprisingly, new home sales plummeted duringthe recession, reaching a record low of 306,000(SAAR) in 2011 before beginning a slow rise (Fig-ure 13). New home sales increased from 440,000(SAAR) in 2014 to an average of 502,000 in2015. The monthly sales for 2016 averaged 561,000homes, still well below the long-term (1963-2010)‘normal’ rate of 678,000 sales per year. New home

sales in 2017 averaged an annualized 616,000. Newhome sales averaged 651,000 (annualized) throughMay 2018, before dropping meaningfully to aver-age 593,000 for June-December. Through April,2019 new home sales have averaged and annualised677,000 sales.

Figure 13: New Single-Family Home Sales

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As low as new home sales fell, new home construc-tion fell even lower from early 2007 through mid-2011, causing the inventory of newly built homesfor sale to decline over the period. After bottom-ing out in July 2012 at 142,000 units, the inven-tory of new homes has crept up as constructionslightly outpaced sales, averaging 276,000 units in2017 and 314,000 homes in 2018. To-date 2019 av-erage inventory is higher through April at 339,000units.

Housing Starts

In April 2009, U.S. housing starts fell to record lowssince the Census Bureau began tracking these datain 1959. U.S. housing starts picked up in 2011 andcontinued to rise, largely because of increases inmulti-family starts. Single-family starts were moreor less flat after the recession through 2012, buthave been rising slowly since (Figure 14).

Page 9 of 21 DNR Economic & Revenue Forecast

WOOD MARKETS

Figure 14: Housing Starts

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Since the recession, total housing starts have beenmade up of a larger portion of multi-family unitsthan in the past. This is pertinent because multi-family structures use much less lumber than single-family houses per unit, so the slow recovery in over-all starts has had a more muted effect on timberprices than historical increases. However, it is notclear how long multi-family starts will drive totalstarts: in 2016 multi-family starts were lower thanin 2015, 385,000 and 395,000 starts respectively,while single family starts increased from 718,000 to783,000 (SAAR). In 2017, multi-family starts de-clined further, averaging 356,000 starts (annual-ized), while single-family starts averaged 852,000.In 2018, starts averaged an annualized 873,000 sin-gle family starts and 377,000 multi-family starts.Through April, 2019 starts have averaged 854,000and 357,000 annualised single family and multi-family starts, respectively.

The recovery in house prices should facilitate the‘move-up’ market, where homeowners sell their cur-rent home in order to buy a larger, more expensiveone. An increase in the move-up market combinedwith low total inventories constraining the supply ofexisting housing should in general put upward pres-sure prices and provide incentives to build morehouses. While that seems to be happening to acertain extent, it’s effect appears to be limited be-cause the price increases themselves are keepingpeople from the lower end of the market, meaning

that prices have risen so much that homeownersare beginning to have difficulty selling at marketrates.

Builder confidence is no longer an impediment tohousing starts, as estimates of confidence are con-sistent with housing starts of over 1 million. How-ever, there are significant supply impediments, suchas the shortage of buildable lots and permit de-lays. Given the lead time necessary to build houses,these are likely to cause volatility in both prices andsupply.

Figure 15: Case-Shiller Existing Home Price Index

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U.S. housing experienced six unprecedented yearsof falling or flat prices following the recession.House prices started rising again only in 2012 aseconomic and employment indicators continued toimprove. Figure 15 charts the seasonally adjustedS&P/Case-Shiller Home Price Index for the 20-city composite, which estimates national existinghome price trends. The 20-city composite indexhas increased in most months since bottoming outin January 2012—its lowest point since October

DNR Economic & Revenue Forecast Page 10 of 21

WOOD MARKETS

2002.

Nationally the Case-Shiller Index growth hasslowed significantly since May and the Seattle indexactually decreased between July 2018 and Febru-ary 2019. Seattle house prices had been growingmuch faster than national prices, increasing 11.7percent year-on-year as of December 2017, evenending 2018 with a 3.7 percent increase, despitethe fall in the second half of the year. When Seat-tle prices bottomed in February 2012—their lowestpoint since June 2004—the average existing housein Seattle was worth only 70 percent of the May2007 peak. Despite the recent decrease in prices,as of March, the average Seattle home was worthover 30 percent more than its peak price before therecession (in nominal terms).

Export Markets

Although Federal law prohibits export of logs frompublic lands west of the 108th meridian, log exportsstill have a meaningful impact on DNR stumpageprices. Exports compete with domestic purchasesfor privately sourced logs and strong export com-petition pulls more of the supply from the domesticmarket, thereby raising all domestic prices. How-ever, changes in export prices do not influence do-mestic prices in a one-to-one relationship.

Export prices are almost always higher than do-mestic prices, a difference which is referred to asthe ‘export premium’ (Figure 16). The export pre-mium is primarily due to the characteristics of theexport markets, which can include a demand forhigher quality wood, a high value placed on long-term contracts, and high transaction costs.

Note that the export prices shown in Figure 16 areweighted by DNR’s typical species mix, not thespecies mix of actual export volumes.

Since 2010, demand from China has been a majorsupport for log and lumber prices in Washington.That demand dropped in late 2014 as China’s eco-nomic health wavered, the U.S. dollar appreciatedwhile the value of the euro and ruble dropped (mak-ing U.S. timber comparatively more costly), and a25 percent Russian tariff on log exports was re-

duced. The downward trend in demand continuedthrough 2015, with Douglas-fir log exports down46 percent and hemlock (and other whitewood) ex-ports down 33 percent from 2014 (Figure 17). Ex-ports to China from the Seattle and Columbia-Snake River Customs Districts for both Douglas-firand Hemlock were 11 percent lower in 2016 than2015, 1.9 million m3, compared to 2.1 million m3 in2015 and 3.2 million m3 in 2014.

Figure 16: Log Export Prices

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The trend of decreased exports to China contin-ued in 2017 with hemlock exports from Seattle andthe Columbia River Customs Districts falling froma peak of 1.7 million m3 in 2014 to 1.1 million m3

in 2017 and douglas-fir export falling from 2.2 mil-lion m3 in 2013 to 0.6 million m3 in 2017. Ex-port volumes to China increased by two percentin 2018, while exports to Japan decreased by twopercent. Year-to-date exports through April havedecreased by 24 percent to Japan and 14 percent toChina.

The export premium appears to have shrunk since2014 due to strong demand from recovering domes-tic markets and decreased demand from importingcountries, China in particular. In the long run,the export premium may shrink further as WestCoast log exports face stronger international com-petition and export prices are pushed down. Muchwill depend on supply constraints from key inter-national suppliers, transportation constraints from

Page 11 of 21 DNR Economic & Revenue Forecast

WOOD MARKETS

the southeastern U.S, and whether tariffs are im-posed on softwood logs.

Figure 17: Log Export Volume

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Timber Supply

Since the beginning of the recession timber growththroughout the U.S. has generally exceeded timberharvest, increasing the timber inventory. However,strong log exports from the West Coast drove upharvests, so that inventory growth was slower thanin other parts of the country, particularly the U.S.South. Harvests have rebounded strongly enoughthat timber harvest began to exceed growth in 2017,so the standing timber inventory is beginning tofall. Drawing down the standing timber inven-tory will constrain the region’s ability to expandoutputs—although harvests are expected to con-tinue to increase for several years, they will notreach the levels of the mid-2000s, nor will the in-creased harvest push prices down.

Since the late 1990s British Columbian forests havebeen devastated by the mountain timber beetle,which affected about a third of the province’s timberresources. Typically, timber killed by beetles mustbe harvested within 4 to 10 years so in 2007 thegovernment increased the allowable harvest to en-sure that the dead timber was not wasted, which in-creased British Columbia’s harvestable timber sup-ply. Most of the remaining beetle kill is now un-viable and there will be no harvestable beetle kill

after 2020.

The supply from Canada will be further diminishedby Quebec’s allowable annual cut being reduced byBill 57, which was implemented in April 2013, andmay be additionally reduced by the ‘North for All’plan (formerly Plan Nord). These constraints willlikely also reduce Canada’s lumber production ca-pacity by forcing mill closures.

Price Outlook

Lumber Prices

As shown in Figure 11, lumber prices increased in2016 to average $341/mbf and increased sharply in2017 to average $425/mbf. In June 2018, priceshit $635/mbf, higher in real terms than any since2000. However, from June prices dropped dra-matically to a low of $324/mbf in November—a 47percent drop. December prices were up slightly at$340/mbf, leading to an average $488/mbf in 2018.Prices through April 2019 have partially recoveredto average $376/mbf.

A drop in prices at the end of the third quarter 2018was expected due to the end of the building seasonand increased supply from additional capacity be-ing put online, but this drop was much larger thanexpected. In outlying years prices are expected toremain around the 2017 average, but will not reachthe peaks of 2018.

Log Prices

Figure 18 presents prices for Douglas-fir, hemlock,and DNR’s composite log. The latter is calcu-lated from prices for logs delivered to regionalmills, weighted by the average geographic location,species, and grade composition of timber typicallysold by DNR. In other words, it is the price a millwould pay for delivery of the typical log harvestedfrom DNR-managed lands. The dark green line forthe DNR composite log price on Figure 18 is thesame as the light green line on Figure 11.

Readily visible on the graph is the decline in thepremium for Douglas-fir—due in large part to Chi-

DNR Economic & Revenue Forecast Page 12 of 21

WOOD MARKETS

nese demand fortifying hemlock prices. Also read-ily visible is the drop in prices from late 2014 toearly 2016. The price of a ‘typical’ DNR log movedup sharply from a two-year plateau in 2013 to$591/mbf in 2014. However, prices declined through2015 to average $521/mbf. The decline in log pricewas primarily due to the slowdown in demand fromChina and ample regional supply of both logs andlumber.

Log prices in 2016 increased to average $536/mbfand jumped even higher in 2017 to $611/mbf. Logprices peaked in July 2018 at $701/mmbf, beforealso falling precipitously to $519/mbf in December.They have recovered a little and were $551/mbf inApril.

Stumpage Prices

Timber stumpage prices are the prices that suc-cessful bidders pay for the right to harvest timberfrom DNR-managed lands (Figure 19). At any time,the difference between the delivered log price andDNR’s stumpage price is equivalent to the sum oflogging costs, hauling costs, and harvest profit (Fig-ure 11). Subtracting the average of these costs fromthe log price line gives us a derived DNR stumpageprice.

When actual DNR stumpage prices differ signifi-cantly from the derived stumpage prices, a cor-rection is likely to occur. For instance, in 2012actual stumpage prices were generally lower thanstumpage prices inferred from log prices, suggest-ing that an upward market ‘correction’ would beforthcoming. This correction seems to have oc-curred with generally higher stumpage in 2013 and2014. However, the situation reversed in late 2014,when actual DNR stumpage prices were well abovethe inferred stumpage prices. In the November2018 forecast, we noted that DNR actual stumpageprices were well above the inferred prices, suggest-

ing that stumpage prices would be lower in the nearfuture. That was correct—prices moved sharplylower from an October auction high of $430/mbf,to a December auction average of $340/mbf. Sincethen, aside from higher prices in February andMarch 2019, stumpage auction prices have con-tinued to fall, averaging $257/mbf for April andMay.

Figure 18: DNR Composite Log Prices

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DNR Stumpage Price Outlook

DNR currently contracts with a forest economicsconsulting firm that provides log and timberstumpage price forecasts, as well as valuable in-sights into the housing, lumber, and timber mar-kets. By modeling DNR’s historical data on it’sprice forecasts, we arrive at a stumpage price out-look (Figure 19, note that the FEA ‘forecast’ seriesreflects the species and class characteristics of typi-cal DNR timber; the original series were West Coastaverages, and are not shown).

It is important to note that these are nominal priceexpectations.

Page 13 of 21 DNR Economic & Revenue Forecast

WOOD MARKETS

Figure 19: DNR Timber Stumpage Price

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DNR Economic & Revenue Forecast Page 14 of 21

DNR REVENUE FORECAST

DNR Revenue Forecast

This Revenue Forecast includes revenue generatedfrom timber sales on trust uplands, leases on trustuplands, and leases on aquatic lands. It also fore-casts revenues to individual funds, including DNRmanagement funds, beneficiary current funds, andbeneficiary permanent funds. Caveats about theuncertainty of forecasting DNR-managed revenuesare summarized near the end of this section.

Timber Revenue

DNR sells timber through auctioned contracts thatvary in duration. For instance, contracts for DNRtimber sales sold in FY 2014 needed to be harvestedbetween three months and four and a half yearsfrom the date of sale, with an average (weighted byvolume) of about 25 months. The purchaser deter-mines the actual timing of harvest within the termsof the contract, which is likely based on perceptionsof market conditions. As a result, timber revenuesto beneficiaries and DNR management funds lagbehind sales.

For the purposes of this chapter, timber that is soldbut not yet harvested is referred to as ‘inventory’or ‘under contract’. Timber volume is added to theinventory when it is sold and placed under con-tract, and it is removed from the inventory whenthe timber is harvested.

Figure 20: Forecast Timber Sales Volume

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Sales volume forecasts for all years are unchanged(Figure 20). This is despite a recent increase in thenumber of contracts that were offered at auctionthat were passed-in with no bids. DNR plans onoffering for auction more than 500 mmbf, but ourvolume forecast builds in the probability that someof those contracts offered will not be sold in thisfiscal year.

FY 15 was the first year of the new sustainableharvest decade (FY 15 through FY 24) for WesternWashington; however, new harvest targets for thissustainable harvest decade have not yet been de-termined or approved by the Board of Natural Re-sources. Without an updated sustainable harvestlimit, annual Westside sales volumes are forecast tobe 450 mmbf for future years. Together with pro-jected Eastside timber sales of 50 mmbf for eachof the next several years, we arrive at a projectedannual timber sales volume of about 500 mmbf forFYs 19-23.

Figure 21: Forecast Timber Removal Volume

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Timber Removal Volume

For each forecast, we survey timber sale purchasersto determine their planned harvest timing for thetimber volume they have under contract at the timeof the survey. Given an updated purchaser sur-vey harvest schedule and harvests to-date through

Page 15 of 21 DNR Economic & Revenue Forecast

DNR REVENUE FORECAST

November, FY 19 removal volume is forecast to to-tal 500 mmbf—a decrease of 20 mmbf from theFebruary forecast (Figure 21). This change is due toharvests to-date being much slower than suggestedby previous purchaser surveys, as well as the pricedrop in both lumber and log prices.

Figure 22: Forecast Timber Sales Price

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Figure 23: Forecast Timber Removal Price

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Timber Sales Prices

The price results of monthly DNR timber salesare quite volatile (Figure 11). As discussed inthe stumpage price outlook, the DNR sales price(stumpage) forecast uses estimates from a forest

economics consulting firm. The sales price forecastfor FY 19 is decreased by $25/mbf to $325/mbf dueprimarily to the very low prices from the April andMay auctions, on a relatively large auction volume.The forecasts in outlying years are unchanged astimber and lumber markets are expected to recoverto near their 2017 levels.

Timber Removal Prices

Timber removal prices are determined by salesprices, volumes, and harvest timing. They can bethought of as a moving average of previous timbersales prices, weighted by the volume of auctionedtimber removed in each time period (Figure 23).Removal prices in FY 19 are increased by $7/mbfdue to higher than expected share of removals withhigher values. Removal prices in outlying yearsare decreased largely because of the drop in FY19 prices. Some portion of the decrease in outlyingyears’ removal prices is due to the decrease in valueof the remaining inventory, which happend becausepurchasers have been harvesting relatively higherpriced sales in the current fiscal year.

Figure 24: Forecast Timber Removal Value

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Figure 24 shows projected annual timber removalrevenues, broken down by the fiscal year in which

DNR Economic & Revenue Forecast Page 16 of 21

DNR REVENUE FORECAST

the timber was sold (‘sales under contract’ weresold as of January 1st, 2019). Revenue estimatesreflect all of the changes described above.

Projections for the 2017-2019 biennium are $369million, a decrease of about $4 million (1.1 percent)from the forecast in February, and $372 million forthe 2019-2021 biennium, an decrease of $25 million(6.3 percent).

Figure 25: Forecast Timber Removal Revenue

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Page 17 of 21 DNR Economic & Revenue Forecast

DNR REVENUE FORECAST

Upland Lease Revenues

Upland lease revenues are generated primarily fromleases and the sale of valuable materials, other thantimber, on state trust lands (Figure 26). Projectedrevenue from irrigated agriculture is decreased by$0.5 million, due to unexpected weakness in re-ciepts. However, forecast revenue is increased for

dryland agriculture by $0.7 million, due to somerevenue having been incorrectly held in cash-on-account instead of applied to revenue in DNR re-porting. Revenue for minerals and hydrocarbonleases are increased by $0.2 million in FY 19 and$0.1 million in FY 20 due to increased revenue fromnewly signed backfill leases. Revenue forecasts forall other sources remain unchanged.

Figure 26: Forecast Upland Lease Revenue

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DNR Economic & Revenue Forecast Page 18 of 21

DNR REVENUE FORECAST

Aquatic Lands Revenues

Aquatic lands revenues are generated from leaseson aquatic lands and from sales of geoduck. Onaverage, leases account for one-third of the rev-enue while geoduck sales account for the remain-der.

The aquatic lease revenue forecast is increased forFY 19 due to higher than expected revenue in everynon-geoduck source except aquaculture (Figure 27).Projected revenue in outlying years is increased forthese non-geoduck sources, which appear too con-servative given the recent revenue history.

The geoduck revenue forecast for FY 19 has beenincreased slightly based on updated harvest vol-umes, while FY 20 revenue has been decreasedslightly based on the most recent auction price(Figure 28). Outlying years’ forecasts are un-changed.

Figure 27: Aquatic Lands Revenues

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Starting in Q2 2014, our geoduck price forecastswere consistently high and prices seemed to en-ter a period of fairly low volatility. This sug-gested that there may have been some change inthe equilibrium price of geoduck—that the lowerprices weren’t just part of the natural volatility ofthe market, but a fundamental shift in the pricelevel. The consistently higher auction prices sinceAugust 2016, threw that hypothesis into question

and suggested that a new price level was somewhathigher than the average in 2014. Given the histori-cal volatility of the market, auction price forecastsare nearly one standard error below the mean fore-casted model in outlying years.

There are significant downside and upside risks togeoduck revenues, even in the near term, that areimportant to consider but difficult to forecast. Onthe downside:

• Harvests (and therefore revenues) could bedeferred or lost if geoduck beds are closeddue to occurrence of paralytic shellfish poi-son.

• A further slowdown in China’s economicgrowth or the tariffs on geoduck could lowerdemand for this luxury export in its largestmarket.

• In light of recent WDFW surveys of closedSouth Puget Sound geoduck tracts showingdeclining recovery rates, and evidence of ac-tive poaching, future commercial harvest lev-els may be further reduced.

Figure 28: Geoduck Auction Prices

$0

$4

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$/po

und

HistoricalJun ForecastUpper 1 SELower 1 SE

Page 19 of 21 DNR Economic & Revenue Forecast

DNR REVENUE FORECAST

Total Revenues from All Sources

Forecast revenues for the 2017-2019 biennium aredecreased to $535 million, while revenues for the2019-2021 biennium are decreased by $24 millionto $516 million (Figure 29).

Figure 29: Total Revenues

$150

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Total FebTotal Jun

Some Caveats

DNR strives to produce the most accurate and ob-jective projections possible, based on DNR’s currentpolicy directions and available information. Ac-tual revenues will depend on future policy decisionsmade by the Legislature, the Board of Natural Re-sources, and DNR, as well as on market and otherconditions beyond DNR’s control.

See the Forecast Summary for more details.

DNR Economic & Revenue Forecast Page 20 of 21

DNR REVENUE FORECAST

Distribution of Revenues

The distribution of timber revenues by trust arebased on:

• The volumes and values of timber in the in-ventory (sales sold but not yet harvested) bytrust;

• The volumes of timber in planned sales forFYs 19-20 by trust, and relative historicaltimber prices by DNR region by trust; and

• The volumes of timber by trust for FYs 22-23 based on provisional output of the sus-tainable harvest model and relative historicaltimber prices by DNR region by trust.

Since a single timber sale can be worth more than$3 million, dropping, adding, or delaying even onesale can represent a significant shift in revenues toa specific trust fund.

Distributions of upland and aquatic lease revenuesby trust are assumed to be proportional to historicdistributions unless otherwise specified.

Management Fee Deduction. The underlyingstatutory management fee deductions to DNR asauthorized by the Legislature are 25 percent or less,as determined by the Board of Natural Resources

(Board), for both the Resources Management CostAccount (RMCA) and the Forest Development Ac-count (FDA). In biennial budget bills, the Legisla-ture has authorized a deduction of up to 30 percentto RMCA since July 1, 2005. In 2015, they autho-rized a deduction up to 31 percent.

At its April 2011 meeting, the Board adopted a res-olution to reduce the RMCA deduction from 30 to27 percent and the FDA deduction from 25 to 23percent. At its July 2011 meeting, the Board decidedto continue the deductions at 27 percent for RMCA(so long as this rate is authorized by the Legisla-ture) and at 23 percent for FDA. At its October2011 meeting, the Board approved a resolution toreduce the FDA deduction from 23 to 21 percent.The Board decided in July 2013 to raise the FDAdeduction to 25 percent and the RMCA deductionto 29 percent. In August 2015 the Board raised theRMCA deduction up to 31 percent for the 2015-2017biennium.

The Forecast uses the 31 percent deduction for the2017-2019 and 2019-2021 biennia. This assumesthat the Legislature will approve RMCA deductionsof up to 31 percent.

Given this background of official actions by the leg-islature and the Board, the management fee deduc-tions assumed in this Forecast are:

FY 19 FY 20 FY 21 FY 22 FY 23FDA 25 25 25 25 25RMCA 31 31 31 31 31

Page 21 of 21 DNR Economic & Revenue Forecast