Forestry Program

Russia, China and the Rest of the World

Sten NilssonIIASA, Laxenburg, Austria

6 June 2006, 47th Session of FAO ACPWP, Rome, Italy

Forestry Program

Russian Economy

Source: Bailey, 2005.

Forestry Program

Russian Economy

Source: Bailey, 2005.

Forestry Program

Russian Economy has Stabilized and is Now 15th Largest Worldwide

Source: IMF World Economic Outlook, April 2005; Economist Intelligence Unit.

1 Real GDP GDP calculated in 2004 prices, 2004 average RUR/USD.

Favorable macroeconomic environment in Russia (I)… has per capita GDP well in

range of emerging markets, …… and is showing continuous growth

GDP 2004 (in B$) GDP per capita 2004 (in $) Real GDP1 per capita (in K$)US

JapanGermany

UKFrance

ItalyChina

CanadaSpain Korea

MexicoIndia

AustraliaBrazil

Russia

Russian economy is 15th

largest worldwide, …

US

Japan

Germany

Portugal

Mexico

Poland

Latvia

Turkey

Russia

China

India

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

11,7334,6682,707

2,1262,018

1,6811,649

996993

681676

661618

600583

39,934

36,575

32,694

16,375

6,506

6,227

5,822

4,251

4,051

1,269

608

5.7

5.5

5.2

4.9

4.6

4.3

4.0

3.8

3.5

3.4

3.2

2.9

2.8

CAGR~6%

CAGR~6–7%

Forestry Program

Currency

Source: Bailey, 2005.

Ruble is 7% strongerNearly 50% inflationRuble based costs up 55%

Forestry Program

Relative Costs

The Purchasing Power Parity concept is one approach to estimating the long-run exchange rateOver the medium term, the Chinese and Indian currencies are likely to appreciate the most. The Russian and Brazilian currencies also have upward pressure … ability to export may be underminedThe Canadian, European and Japanese currencies may be slightly over-valued

Indi

a

Chi

na

Rus

sia

W. E

urop

e

Can

ada

Bra

zil

Japa

n

-90%

-70%

-50%

-30%

-10%

10%

30%

Overvalued

Undervalued

Percent Change from the Current to the PPP Implied Exchange Rate (2006)

Forestry Program

Monetary PolicyMore cash than Russia can handleDouble-digit inflationToo high interest ratesLess investmentsIn the worst case bank crisisMonetary policies may shift towards decreasing inflationHowever, in general Russia will not remain a cheap output country for long

Forestry Program

Population Development

128

132

136

140

144

148

2002 2004 2010 2025

Source: Beloglazov, 2005.

million people

Poor economic conditions, illnesses, alcohol

10 million people in reproductive ages are infertile

Forestry Program

The Forest Products Industry is Still Far Below the 1990 Level

Forest Sector Share of GDP in 2004: 2.5%Source: Hassler, 2005.

Forestry Program

Production

+29%20.918.917.716.617.516.275Lumber (million m3)

+231%2550223319781808148411021597Plywood (1000 m3)

+251%3930360331982732233515685568Particleboard(1000 m3)

+202%12601158108810319126231546Fiberboard(1000 m3)

+195%7020678963775921531235958325Paper/Board(1000 tons)

3.02.62.4Hardwood(million m3)

Difference1998/20052005200420032002200019981990

Lumber production is sticking outIs it correct?Why?Lack of capacity?

Pent up demand? Lack of quality logs? Most corrupt?

Forestry Program

Domestic Demand

-52%6.77.613.112.313.959.3Lumber (million m3)

+213%8388186675483941092Plywood (1000 m3)

+244%393636182574220016164825Particleboard(1000 m3)

+268%121011567956944511020Fiberboard(1000 m3)

+229%496546943421349021656381Paper/Board(1000 tons)

Difference1998/2004200420032002200019981990

Why is the domestic demand for lumber decreasing? Wherever I go in Russia construction, reconstruction, repair, etc., is in full swing so why is the demand for lumber not growing? Priority of export of lumber?

Forestry Program

Export

+180%190018661916188516601056993Pulp (1000 tons)

+167%2950270724592500229817672761Paper/Board(1000 tons)

+304%14.012.210.28.97.84.615.7Lumber (million m3)

+208%1530143812011140973737527Plywood (1000 m3)

+252%252219185158135100743Particleboard(1000 m3)

+220%381331264236278173365Fiberboard(1000 m3)

+237%47.340.937.536.530.820.031.4Logs (million m3)

Difference1998/20052005200420032002200019981990

Still low value added export

Forestry Program

Forest Products Industry in Russia: Characteristics

Top 5 companies produce about 40% of overall pulp and paper products

000

000

000

00

00

0

0

Source: Graves, 2005.

Forestry Program

Pulp and Paper Industry Highly Consolidated

5 largest paperboard producers have 48% of the production

5 largest paper producers have67% of the production

5 largest pulp producers have78% of the production

Forestry Program

Pulp Production

100100100100100Total Costs2627242426Other Fixed Costs1015151412Personnel3741393837Fixed Costs1212131414Other Variable Costs106131215Energy181218130Minerals and Chemicals2429172334Fiber6359616263Variable Costs

CWFUWFLWCSCNewsprintCost Breakdown (%)

Source: Merrill Lynch Research.

Forestry Program

New InvestmentsAmazur Pulp Mill, Chita Region 400 000 tons Chinese capital starting operation summer 2006

PlansFevralsk Pulp Mill, Amur region 300 000 tons Chinese capitalAmursk Pulp Mill, Khabarovsk region 700 000 tonsChinese capital

Shopping Around in European RussiaMondi, StoraEnso, Metsä-Botnia

PapermakingForeign Investments not in sight

In GeneralWestern companies have a Latin American/Chinese focus at the expense of Russian investments

Forestry Program

Forest Products Industry in Russia: Characteristics

Printing papers and cartonboard will face the highest growth in demand

Source: FFIF, World Bank.

CartonboardNewsprintPrinting papersSanitary products

2004–2020: +6%2004–2020: +5%2004–2020: +8%2004–2020: +6%

Growth rate

0.7 0.70.9

1.5

Forestry Program

Russia Export / Import of Paper and Paperboard (million tons)

1

2

3

4

2001 2002 2003 2004

Source: Graves, 2005.

Export

Import

Forestry Program

Russia All Forests

696.0 million m3

298.1 million m3

421.1146.8

274.9151.3

• Coniferous• Deciduous

994.1 million m3567.9426.2Yearly Increment

63.1 billion m3

19.0 billion m3

49.110.1

14.08.9

• Coniferous• Deciduous

82.1 billion m359.222.9Growing Stock

544.9 million ha231.2 million ha

438.4167.4

106.563.8

• Coniferous• Deciduous

776.1 million ha605.8170.3Forested AreasTotalAsiaEurope

Forestry Program

Annual Allowable Cut (2004)(Forest Managed by Ministry of Natural Resources)

294.7 million m3

224.7 million m3

186.997.3

107.8127.4

• Coniferous• Deciduous

519.4 million m3284.2235.2AACTotalAsiaEurope

AAC for All Forested Area about 550 million m3

Forestry Program

Harvest in 2005

Official Harvest: 180 million m3

Forestry Program

ConiferousWood Costs at Landing at Railway or

Main Road over the AAC

0

10

20

30

40

50

60

70

80

0 20 40 60 80 100 120 140 160 18050 100 150 190

30 35

43

56

77

2731.5

38.5

50

69

$/m3

Million m3

Europe

Asia

Forestry Program

DeciduousWood Costs at Landing at Railway or

Main Road over the AAC

0

10

20

30

40

50

60

0 10 20 30 40 50 60 70 80 90 100 110 120 13050 100 130

1518

25

38

56

13.516

22.5

34

50

$/m3

Million m3

Europe

Asia

Forestry Program

Wood Accessibility

Including long distance transportation costs

Even with the costs of Sweden

135 million m3 coniferous;115 million m3 deciduous

Total 250 million m3

Forestry Program

Forest Map of Russia

Spruce and fir forestPine forestStone pine forestLarch forestBroadleaved forestBirch/aspen and mixed forestConverted to agriculture

Forestry Program

Accessed Forest Land in Russia

Unreviewed Draft

Increment: 1 billion m3

AAC: 0.5 billion m3

Accessible: 0.25 billion m3

Forestry Program

Low Value Added Export

Source: Revised from Graves, 2005.

In 2004 total export volume was over 43 million m3

Export Taxes31 May 2006: Min. 4€/m3 or 6.5% of export value? 1 January 2007: Min. 6€/m3 or 10% of export value

Logging volume does not exceed 1/3 of AAC

Finland, Sweden, UK

19.3 mln. m3

17.0 mln. m3

6.7 mln. m3

549178

Japan

China

AAC, 2004Logging, 2004

Forestry Program

Export Taxes RoundwoodSomewhat confusing pictureThe Russian government made a decision (number 158) on 24 March 2006 on new export taxes. The decision was published in the government’s newspaper “Russkaja gaseta” on 31 March

The new export taxes entered into force on 31 May 2006For logs with a top diameter >15 cm and length of >1 m:

the minimum tax is 4 €/m3 or 6.5% of the sales valueFor logs with a top diameter <15 cm and length of >1 m there is no taxThere are discussions of increasing the above tax in 2007 to 6 €/m3 respectively 10%

Forestry Program

Pro RussiaLow cost producer

Source: Graves, 2005.

Russia remains a low cost regionCost of pulpwood (delivered to mill)

Cost of industrial wood (delivered to mill)

Energy cost Annual wages

$/m3 $/m3

$/MWtX000 $/pers.per year

50.2 47.5 45.0

26.423.4

52.843.6 41.0

55.4

25.0

89.074.0 84.0

50.033.0

72.6 68.6 75.2

5.2

25.1

Finland Sweden Germany Chile Russia

Forestry Program

Pro Russia

Growth market

Proximity to China market

Huge unutilized forests especiallyhardwood

Low fixed costs for brownfield infrastructure

Opportunities for cost reductions

Forestry Program

Pro Russia

Source: Starkov, 2005.

Forestry Program

Pro RussiaSpecial Economic Zones (currently 20 proposals)

Social tax 26 14%

No wealth tax

No property tax

During 5 years no customs and taxes on imported goods

Federal money for infrastructure

Forestry Program

Pro Russia

Lots of opportunities for the sawmilling industry. Russia has a major low cost competitive advantage in solid wood products. Logistics the problem

Metsä-Botnia 200 000 m3

Forestry Program

Pro Russia

Mondi and International Paper have

made it in pulp and paper, StoraEnso

in wellpapp, SCA and P&G in hygiene

paper, and several are on their way

with the sawmilling industry (UPM,

Swede Wood, StoraEnso, M-real)

Forestry Program

Con RussiaThe forest sector insignificant in the Russian economy

No vision for the forest sector or the utilization of the forest resources

Ministry of Industry “Capacity Development of Wood Processing and New Forest Supplies up to 2015”

Supply problems of wood to existing mills

Forestry Program

Con RussiaSince 1990, the forest sector has been regarded as a great challenge/opportunity but the problem is that in 2006 it is still just a great challenge/opportunity notmuch has happened (one new pulp mill, one new paper machine, has become substantial net importer of paper)

Forestry Program

Con Russia

The Forest Code A disaster(full of contradictions, built on the Soviet system, lack of clear rentage procedure and division of responsibilities between State and leaseholder, not built on sustainability principles)

Forestry Program

Con RussiaThe mills are not in control of the wood supply chain (90 million ha of long-term leases)

Wood supply by sources

Source: Starkov, 2005.

Forestry Program

Con Russia

Source: Sheingauz, 2004.

Illegal Logging in RFE

Forestry Program

Russian Far East and Southeast Siberia

??Possibilities for increased harvest with current infrastructure

4–610–12Export of logs to China

21–2516–19

5–7

22–2515–17

7–9

Total Harvest (not official)of which legalof which illegal

70.066.9Official “Accessible AAC”

SES(million m3)

RFE(million m3)

Forestry Program

Con RussiaLack of road infrastructure

Investment needs in forest roads250 million $/year in order to maintain and increase the harvest

Forestry Program

Con Russia

Forestry Program

Con Russia

Forestry Program

Con Russia

Worn out transportation fleet

Ice difficulties in Northern harbors (48 days instead of 22)

The real cost will go up

Forestry Program

1998 2000 2002 2004

350

300

250

200

150

100

%

hardwood logs softwood logs spruce logs

Con Russia

Ruble based costs up 55% during 2002–2005 due to inflation and currency appreciation

Increase of pulpwood prices in Rubles since 1998

Source: Zinner, 2005.

Forestry Program

Con RussiaRuble figures for variant costs

Source: Zinner, 2005.

355.3284.0242.9206.675.849.59.9%% increment to 1998 level

from01.01.05

39.3from

01.08.0541.43

34.931.2from15.02.02

18.6from

07.07.0227.9

16.0from30.12.99

11.5from

01.08.0013.6

10.09.1factor3 Class Cargo (pulp, board, paper, school notebooks)

230.14178.4148.6122.276.450.037.5%% increment to 1988 level

from01.01.05

22.6from

01.08.0523.77

20.017.9from15.02.02

14.7from

07.07.0216.0

12.7from30.12.99

9.1from

0.1.08.0010.8

9.97.2factor1 Class Cargo (wood, coal)

from11.01.04

from01.01.03

from01.07.01

from01.11.99

from01.10.97

Railway tariff

Sep.2005 136421188210123904873633627

Dec.19981945

Rbl/man

Average monthly wage

293325342759233418621902856390Rbl/tMazut price (less VAT)

1136922855761678412275182Rbl/tCoal price (less VAT)

9 months2005

2004200320022001200019991998Unit

Forestry Program

Con RussiaPay reimbursement for reforestation, pre-commercial thinning, and thinnings (Mondi)

Support community employment programs, community social initiatives, community employment programs

Increased stumpage fees

Over-employment

Reduced energy subsidies

Increased capital costs (already high)

Forestry Program

Con Russia

Worn out industry operating at 100% is a barrier for investments. Severe underinvestment

No transparency in the ownership of the forest industry (often oligarchs mixed with fed-provincial governments and communities)

Forestry Program

Con Russia

Warlords since early 2000

Russian stakeholders not supporting foreign investments

High import duties for foreign made equipment

Taxes on exports of forest products

Still barter trade in the sector

Forestry Program

RussiaIs building big centrally controlled state companies, e.g., Gazprom

More Kremlin cronies on boards of important companies

At the same time, the government is getting more and more fragmented in the management of the Russian industry

There is no consistent industrial strategy

Forestry Program

Governance and Institutions (Political Environment)

The role of law is that those who rule are the lawThe Yukos syndromeThe Oil FluHermitage Capital Management / William BrowderCorruptionIn democratic countries the election process is known but the election outcome is unknown inRussia it is just the oppositeThe vodka price has decreased in real terms by 35% since 2000

Forestry Program

Where Does It Leave Us? Strategic investors in the sector wary of RussiaWithout strategic investors no investments in infrastructureHardly any substantial increased harvest in the mid-termOur assessment in a very optimistic moment is a maximum future harvest level of about 250 million m3

Taking into account the illegal logging already happening, an increased potential of 45–50 million m3 compared to the conventional wisdom picture of a potential increased harvest of 500 million m3

In the long-term there will be new greenfield mills in Russia. The timing of this will depend on governance/political/institutional conditionsAt that time we will have increased investments in infrastructure and with that increased harvests

Forestry Program

China in the Year of the Dog(2006)

Forestry Program

Many Chinas

• Limited compensation• Mostly jobless

+ 100 millionPoverty500–600 millionWorking

50 millionLand-expropriated farmers65 millionLaid-off workers in SEA and collectives

• No legal permanent residence• Discriminated by local employment laws• Less salary (80%)• No welfare benefits

145 millionRural Migrants240 millionRural Unemployed255 millionUrban Areas Employed

US$ 316800 millionRural PopulationUS$ 1024500 millionUrban Population

US$ 660Average per Capita Disposable Income

1300 millionTotal Population

Forestry Program

Forestry Program

Globalization giving rise to the “flat world” (Friedman, 2005)

China is the most extreme example of “spiky” nature of globalization

The remarkable growth is a product of only a handful of propulsive regions

Forestry Program

China’s Destiny: Too Few Children

0

2

4

6

8

1970 1990 2010 2030 2050

0

10

20

30

1970 1990 2010 2030 2050

No.

of e

mpl

oyed

per

60

year

old Share of Employed

% Share of Inhabitants over 60

The ratio of employed to over 60 year olds sinks rapidly

The share of over 60 year olds will triple in 2050

Source: FORMAT, 2006

Forestry Program

GDP Adjustment for 2004(December 2005)

$1.98 trillion$1.6 trillionBy Including Service SectorFirst Assessment

The adjustment corresponds to the total GDP of TurkeyOffers comfort to concerns on GDP’s reliance on investments instead of consumption

Have they got it right by now?

Still sketchy economic data

Forestry Program

What Does It Mean?There is no single national market consumers are too dispersed, too inaccessible, too different

Average per capita measures of income and demand are quite meaningless as a forecast tool on demand

There is no other important country whose likely trajectory over the next 20 years is more uncertain than Chinas

Forestry Program

China is a fantastic market but difficult to make any money?

Foreign Direct Investments in billion US$

Year

Forestry Program

China Paper Industry

New China Industry mills built after 1996 using mainly imported fiber (wood pulp and RCP)

Old China Industry mills built before 1996 using mainly non-wood fibers and domestic wastepaper

Forestry Program

New China / Old ChinaPaper and Board Production

(not total production)

Old China production still increasingNew capacities mainly in New China production

Source: Wright, 2005.

Forestry Program

China’s Fiber Use, 2004

Source: Wright, 2005.

Forestry Program

Recycled Fiber Imports, 2004

Source: Wright, 2005.

Total imports 12.3 million tonnes

Forestry Program

Over 80% of New China Paper and Paperboard Production in 4 Provinces

Source: Wright, 2005.

Industry is concentrated in the coastal provinces near to the export manufacturing zones

Forestry Program

Paper and Paperboard (million tons)Conventional Wisdom

+43%68.6a54.748.1Demand6.15.25.1Import

62.549.543.037.8Production(Barr and He, 2004)2010200420032002

a Assumes no technological leapfrogging

Strong increase in demand (p/w and paperboard)Strong increase in domestic production (new capacity)Stable import of 5–6 million tonsProfitability of Chinese mills a big unknownDifficult for Chinese mills to compete on export markets

Forestry Program

Pulp Fibers (million tons)

15.134.6

9.219.2

Demandwood pulpRCP

8.216.9c

7.912.3

5.79.4

Importwood pulpRCP

6.8a

17.8b3.59.8

Productionwood pulpRCP

2010 (Barr & He, 2004)20042003

a Assumes that China can grow enough fiber to support new millsb Assumes strongly improved collection and qualitiesc Assumes no constraints in RCP supply

China will continue to be a big market for fiber in foreseeable future but price sensitive Canada, Indonesia and Russia major players for the wood pulp import1999–2004 wood pulp import grew by 800,000 tons or on average 19%/year. 2004–2005 the increase was 4.5%

Forestry Program

Lumber (Wow)10,350 saw mills (CAF, 2004)350 have a capacity of >30,000 m3 yearOfficial production: 2002 2003 20048.5 million m3 11.3 million m3 15.3 million m3

(Fuller, 2006)Unofficial production (2003): 53 million m3

Net import 2003: 5.5 million m3

Demand 2003: 16–58.5 million m3; 2004: 20.2 million m3

(Fuller, 2006)End use consumption (2003) (SFA, 2004)Construction/Housing + Furniture + Manufacturing: 57 million m3

WE DON’T KNOW!But probably a steady growth in lumber consumptionFuller (2006) Demand in 2020: 41 million m3

Forestry Program

Wood-based Panels (Wow, Wow)Some 6000 wood-based panel millsSome 80% of the capacity is plywood370 MDF plants capacity of 14 million m3

05000

100001500020000250003000035000400004500050000

1992

1993199

41995199

619971998199

92000200

120022003

Plywood Fiberboard Particleboard Wood-based panel

Fast growing demandFast growing production increaseFast growing export of plywoodExploding export of furniture in 2003 corresponding to 8.6 million RWE

Production (thousand m3)

Forestry Program

Demand (Fuller, 2006)

20.641.0

7.020.2

ParticleboardLumber

38.816.5MDF19.616.8Plywood20202004

68.654.7Paper and Paperboard34.619.2RCP15.19.2Pulp (wood fiber)20102003

Million m3

Million tons

Forestry Program

Recent Trends in Chinese Forest Products Imports

Source: Chinese customs statistics

Forestry Program

China’s Timber Product Imports by Product Type

Source: Forest Trends, 2006

Forestry Program

China:Logs and Lumber Imports from Russia

Source: CTDA

Forestry Program

Chinese Imports of Forest Products: Actual and Potential Trends (1997–2015)

Source: Chinese customs statistics and FT projections

Forestry Program

Southern China Wood Costs

Wood Costs Purchased2002: 28–30 $/m3

2006: 45–52 $/m3

Far more expensive to produce in Southern China than anyone had expected 5 years ago

Forestry Program

Where Does It Leave Us?Production costs will increase in China

No single market many markets difficult to penetrateBe careful

China: Upward Pressure on Wagesdespite rapid growth in the labor force

Source: Bingham, 2005.

Forestry Program

Where Does It Leave Us?Highly unlikely in the foreseeable future that China can grow enough wood to support existing and planned millsChina will continue to be a big market for wood and fibers but a price sensitive oneStrong demand on paper and paperboard which China will try to meet with increased domestic productionGiven the wood supply situation in China the dependence on imported RCP, pulp logs and chips will increase (in 2005 chips import increased by >200%)

Forestry Program

ConclusionIn the future the gap between consumption and domestic supply will widen substantially

Based on Fuller’s (2006) demand outlook to 2020 an increased import of 25 million m3 logsis required for lumber and plywood production.This means a total log import of 26 million m3 (2004) + 25 million m3 = 51 million m3.This assumes no increase of domestic supply of logs 2004–2020

Can this widened gap be covered by log imports?

Forestry Program

Where Does It Leave Us?It will also increase the import of pulp substantiallyRapid growth in wood panel consumption and domestic production

Export of plywood increasingPlywood production more and more dependent on import of logsFiberboard and particleboard production will compete will pulp mills on fiber

Probably strong demand in lumber consumption/production

Sawmilling industry will be more and more dependent on imported logsProbably more and more establishments of Chinese mills abroadProbably substantially increased lumber import

Forestry Program

Pulp and Paper Investments Emerging Economies

XXX(X)Russia

XXXXLatin America

XXSE Asia

XXXXXChinaa

FinancingConstructionCost

AssetsRawMaterials Markets

Low Cost Advantage

a Lack of wood, shortage of energy, shortage of water, shortage of sites, Land-use conflicts (>60000 in 2005)

Forestry Program

Conventional Wisdom“There is no global shortage of fiber and the over supply push wood costs downwards and puts downward pressure on prices of products”

Source:Roberts, 2006

• Russia is likely the biggest “wild card” wrt wood supply

Forestry Program

Future Wisdom including Wood Fuels

Forestry Program

Recent DevelopmentsITTO (2006) assess that only 4.5% of Permanent Forest Estates of the tropical forests are managed in a sustainable mannerCIFOR (2006) investigated pulp capacity investments since 1990 and found that limited attention was paid to the issue of sustainable supply. The due diligence documents did not discuss fiber supply. Of a sample of 1585 securities, research reports only 7 paid attention to wood supply. Many mills were established without any secure fiber supplyEU Energy Strategy (2006) speaks about an additional contribution of bioenergy of 80 million ToE