Contents

- Asian Crisis and Strong US Housing Market Reshapes US Wood Industry
- Director's Notes
- CINTRAFOR Co-Sponsors 1998 Gruenfeld Wood Product Marketing Conference
- Economic and Environmental Impact Assessment of Forest Policy in Western Washington

Asian Crisis and Strong US Housing Market
Reshapes US Wood Industry

by Rosemarie Braden, Research Analyist, CINTRAFOR

Declining Asian markets and the resulting oversupply of timber in the US continue to depress export volumes and prices for wood products from the Pacific Northwest (PNW). Even as US housing starts returned to the high levels experienced during the mid-1980's, between 1996-1998, wooden housing starts in Japan declined 27 percent (table 1). Since almost one-third of the PNW's forest products industry export revenues are derived from Japan, the Asian economic crisis has had a profound impact on the PNW's forest products sector.

Japan's volume of imported lumber had been increasing rapidly until the third quarter of 1997. Total imported lumber volumes declined over 35 percent from 1996 to 1998, and lumber imports from the US declined 57 percent from 1997 to 1998, and 70 percent from 1996 as Japanese manufacturers shifted toward domestic inventories and lower cost producers. Softwood lumber imports from the PNW declined from approximately 1.9 million cubic meters in 1996 to less than 600,000 cubic meters in 1998.

Softwood log exports from the US to Japan exhibit a similar trend. Exports declined from a high of over 8 million cubic meters in 1996 to 4.5 million cubic meters in 1998, a 45 percent drop. Softwood log exports from the PNW declined 40 percent, from 6.2 million cubic meters in 1996 to 3.7 million cubic meters in 1998. The long-term loss is even greater. Since 1989, softwood log export volume from the US to Japan dropped 64 percent and export volume from the PNW declined 67 percent.

The decline in log and lumber prices over the past two years has had the greatest impact on the log and lumber market, with revenue losses for these two products from the PNW totaling $1.3 billion. However, smaller losses in other global markets and among other products, have resulted in a $2 billion drop in revenues from total forest product exports from the PNW to all countries since 1996.

Other suppliers have experienced more moderate losses. Since the Asian economic decline, devalued currencies in Southeast Asia, South America, Russia, and Canada have helped these suppliers maintain their market shares. For example, since 1996, lumber imports to Japan from Europe, New Zealand, and Chile have declined 14 percent, 13 percent, and 5 percent, respectively. More stable pricing and the fact that all European lumber is kiln dried have also increased demand for European lumber. Precut lumber and building systems are being more widely used in Japan, which has increased demand for greater precision that comes with kiln dried lumber. While only 2,000 cubic meters of Japan's lumber originated in Europe in 1990, imports from Europe increased to more than 2 million cubic meters by 1997, and to 1.1 million cubic meters in 1998.

Prices for US timber have adjusted dramatically with the decline in worldwide demand for wood products. Timber prices in the PNW dropped to below $400/mbf ($100/cum), little more than half of peak values, even as southern US timber prices continued to rise, eliminating the traditional premium that western wood has received by serving export markets. The strong US housing market has maintained high prices for wood from the Southern US. Southern pine lumber prices now exceed fir prices in some US markets, which suggests that the US South has replaced the West as the high cost-producing region. The high number of US housing starts has prevented regional product prices from falling further. Much of the surplus wood in world markets has been diverted back to the strong US market, but has not yet produced any major decline in southern production or southern stumpage prices.

On a positive note, North American style 2x4 housing's share of Japan's total housing starts remained stable during the past two years and increased almost every year during the decade prior to 1998 (table 1). As shown in figure 1, PNW revenues from secondary products to Japan, which includes prefabricated wood buildings and wood-based building materials, have declined 37 percent from $154 million in 1997 to $96 million in 1998. The relative strength of 2x4 housing suggests imported wood-based building material exports will rebound once the economy recovers. Since the cost of construction in Japan remains much higher than the cost of construction in the US, there is a great opportunity to more effectively use US 2x4 construction technology and materials to reduce housing costs.

Table 1. US and Japan Housng Starts, 1996-1998 (thousands of units).

	1985	1996	1998	1996 - 1998 Change
US total units	1,714	1,477	1,616	9%
Japan total units	1,236	1,643	1,198	-27%
Japan wooden units	592	754	545	-27%
Japan 2x4 units	26	94	68	-28%
Japan 2x4 share of total	2%	6%	6%	0%
Source: Japan Wood Information Center

The most significant area of growth in forest products trade in recent years has been in secondary manufacturing. Deregulation in Japan's construction sector stimulated demand for imported wood-based building materials as a way to lower home construction costs. Export revenues from secondary processed wood products shipped from the PNW to Japan increased more than than 50 percent per year between 1993-1996. Even with recent losses, revenues from secondary wood products in 1998 are still 100 percent above 1992 levels.

Figure 1. Leading secondary wood product exports from the PNW to Japan, 1989-1998 (US Dollars).

Exports to Canada partially offset the impact of losses in the Japanese market in 1997. However, PNW export revenues from primary and secondary wood products to Canada declined 15 percent in 1998, probably a result of the decline in the purchasing power of the Canadian dollar relative to the US dollar (figure 2).

While China is still an emerging market for PNW producers, China was the only growing export market during 1998. Export revenues from all wood products from the PNW totaled almost $106 million in 1998, a rebound from a low of $69 million in 1992. Policy reforms and changes in the Chinese market contributed to a decline in imports of secondary manufactured wood products after 1989. Prior to 1989, widespread speculative investment, including an increase in construction activity, resulted in many non-performing loans and threatened to weaken China's economy. In 1989, China instituted conservative fiscal policies, tightened the wide availability of credit, and slowed the entire Chinese economy. Rapid growth in the construction industry and wood products markets declined and the market for lower cost wood substitutes quickly developed. The market for wood products is only recently recovering.

Policy reforms intended to stimulate residential housing construction and China's 1998 logging ban are expected to stimulate wood products markets; higher prices and increased imports are expected. Imports of secondary manufactured forest products should increase in the next five years, assuming rapid domestic economic development continues.

Figure 2. Leading export destinations for primary and secondary processed wood products (US Dollars).

In 1993, China launched its Affordable Housing project, which brought rental prices for government housing closer to market prices. The project has also encouraged people to buy their own houses and will likely promote economic growth in the housing market over the next three to five years. Housing investment will also have a multiplier effect on associated industries, especially wood for construction, furniture, and interior use. Housing reform is a major national undertaking, however, which will only gradually bring new opportunities for foreign firms that export wood products to China.

Prior to the Asian economic crisis, Korea represented a growing market for North American style 2x4 homes and wood-based building materials. While the number of wood frame homes being built was small, the growth was substantial and US suppliers dominated the market. The number of western-style wooden housing starts increased from 97 units in 1994 to approximately 800 units in 1996 and an estimated 1,100 homes in 1997. US manufacturers supplied almost two-thirds of the wood-frame home sector in 1997. Many importer/wholesalers and industry analysts in Korea expected the number of wood frame homes in 1998 to reach 1,500, if Korea had not entered a recession. The actual number of wood-frame homes built during 1998 was approximately 750.

Construction almost came to a complete standstill and the Korean economy plummeted after non-performing loans crippled Korea's banking sector. Many of the country's largest conglomerates were forced to divest their holdings in order to cover losses from failed speculative investments. Exports of solid wood and pulp and paper dropped from $230 million in 1996 to only $86 million by the end of 1998. Exports of secondary processed products from the PNW to Korea declined from almost $14 million in 1996 to $5.5 million in 1998.

Following the economic downturn, the Korean government implemented several economic stimulus packages to attract foreign capital and restructure Korea's financial and business sectors as a means to restore economic stability. These programs appear to have had positive results, as reflected in the improved demand for logs and lumber. While US exports to Korea are still down, Korean imports of lower cost radiata pine logs from New Zealand and Russian larch have increased, and the price of radiata logs between September and the end of 1998 has increased 20 percent. Lower cost producers are clearly more competitive than US suppliers in the Korean log and lumber market. Even in 1996, when the Korean economy was healthy and demand for wood products was high, Korea represented only 8 percent of total US log export volume and 5 percent of PNW log export volume. This in an indication of the inability of US suppliers to compete with lower cost Southeast Asian, New Zealand, Chilean, and Russian suppliers.

While the Asian economic crisis has severely curtailed exports and halted many of the inroads made into emerging markets, long-term opportunities remain. Research regarding 2x4 construction technology and wooden building materials shows there is a need for continued technology transfer to teach construction experts in Asia how to use North American products and construction systems.

Economic recovery is beginning in some countries as Asian governments have instituted new stimulus programs. Even then, old ways of doing business may die hard and large conglomerates in Asia may be slow to adapt to new requirements. Since many of the structural problems in Asian economies still remain, recovery is expected to be slow. There are many indications that the economic recession has at least bottomed out. It is important to maintain business relations with existing clients and continue to promote US products and construction techniques to gain market share when the market recovers.
 

Director's Notes:

by Bruce Lippke

It comes as no surprise that 1998 exports of wood products from the Pacific Northwest (PNW) have declined sharply since the industry's high-point in 1995 and 1996. Deregulation in Japan's construction sector stimulated demand for secondary manufactured product exports to Asia with increases of more than 50 percent per year from 1993-1996. Since the market contracted with the Asian economic crisis, revenues from exports to Japan have declined 50 percent since 1996. Even exports to Canada, which helped offset some of the decline in Asia during 1997, are down almost 20 percent since 1996, the result of the Canadian dollar's diminished purchasing power. Demand for wood products is still weak across one-third of the world but log and lumber prices appear to have bottomed out, although there is little expectation for a quick return to strong demand conditions. Fortunately demand in the US has remained strong, providing a floor for the weak global markets. The impacts are clearly apparent in the PNW economy. During the past two years, total PNW export revenues from primary and secondary products have declined 41 percent, a loss of about $2 billion to mostly rural, timber-dependent communities.

While the Asian economic decline is the primary cause of recent price and volume declines, harvest constraints were the cause of 20 percent market share losses earlier in the decade. Economic and Environmental Impact Assessment of Forest Policy Changes in Western Washington, which appears in this month's newsletter, is a synopsis of SP27, a paper that explains why the impact of new regulations for salmon protection are likely to affect the private sector much more than the earlier regulations to protect the spotted owl and marbled murrelet. This time however, markets will probably be too weak to result in immediate price increases like those that offset much of the volume decline during the early 1990's.

Washington State has become one of the worst states in the nation in terms of the growing income disparity between urban and rural communities. The gap in income between King County and timber-dependent rural counties, increased 37 percent from 1979 to 1993. The impact of the Asian economic decline and riparian regulations can be expected to make this disparity worse (see FS30). As Washington's environmental regulations have become more restrictive, international suppliers are becoming more important to the US, both in terms of competition and supply. Argentina's Forest Products Industry: A Country Profile (WP67) analyzes Argentina in terms of foreign investment opportunities and the country's ability to become a major supplier of wood products. CINTRAFOR has also released several new factsheets on the decline in Asian markets and the potential impacts of riparian regulations.

Restoring high valued export markets and increasing the share of value-added products still provide the greatest opportunity for the PNW forest sector. Recognizing the importance of the Asian market to PNW producers, CINTRAFOR will host a 1999 conference on the Asian housing market, modeled after the very successful 1996 Japan Export Housing conference, which featured US Ambassador to Japan, Walter Mondale. CINTRAFOR also co-sponsored, with Jay Gruenfeld and Associates, the 1998 International Wood Products Marketing Conference which focused mainly on primary products and Pacific Rim markets. CINTRAFOR is now the primary sponsor of the conference, and has recently released proceedings from the conference as SP30.

CINTRAFOR Co-Sponsors 1998 Gruenfeld
Wood Products Marketing Conference

by Rosemarie Braden, Research Analyist, CINTRAFOR

The December 1998 Gruenfeld Conference marked a significant event for CINTRAFOR. Jay Gruenfeld, the conference's founder and primary organizer, generously gifted sponsorship of the wood product marketing conference to CINTRAFOR. The conference fits the College of Forest Resources strategic plan to "better coordinate, focus, communicate, and market" its outreach efforts. The conference was considered a significant success with almost 170 participants and speakers from industry and academia.

The goal of the conference was to present information on the changing international markets and issues affecting the competitiveness of Pacific Northwest (PNW) forest product producers in Pacific Rim markets. A common message among most of the presentations was that Asia's declining economies and devalued currencies substantially reduced Washington's forest product revenues. Predictions for recovery in Asia were not optimistic either. Lynn Michaelis, chief economist for Weyerhaeuser Co., characterized Japan's economic status as a depression rather than a recession. He described Japan's bad bank loans as five to ten times worse than the American savings and loan crisis, and non-performing loans represent 15-30 percent of Japan's GDP. In comparison, the US's non-performing loans during the savings and loan crisis represented 3 percent of GDP. The Japanese government appears to be prolonging Japan's economic downturn by not taking aggressive steps to stimulate their markets and restructure the banking system. Estimates for a full recovery in Asia range from two to seven years.

Competition from other regions of the world has also eroded the PNW's share of Asian markets, as the Japanese have found new sources for lower priced logs. For example, according to Ivan Eastin, Associate Director for CINTRAFOR, for the first time, Russia is supplying as much log volume to Japan as the US, and New Zealand is catching up. While Russian larch and radiata pine are lower quality woods, they are being used as substitutes for Douglas fir and hemlock.

Despite the bleak outlook for Asia, a growing US economy, low interest rates, and strong domestic lumber demand have helped offset some of the losses in the Asian market. Michaelis reasoned that the strong US economy made 1998 "one of our 'good' bad years". Craig Adair, Manager, Market Research for the APA - The Engineered Wood Association, also reported good news for the engineered wood products industry. The strong US housing market made 1998 the best year so far for engineered wood products, and the US is the dominate supplier of engineered wood products to Japan, including LVL and wood I-joists.

Speakers also discussed the potential for emerging markets such as Korea and China; competitive suppliers such as Russia, New Zealand, and Chile; certified forest products; forestland investments; and forest policy. Conference proceedings are available through CINTRAFOR as SP30.

Economic and Environmental Impact Assessment of Forest Policy in Western Washington

by Bruce Lippke and B. Bruce Bare, CINTRAFOR

The decade of the 1990's witnessed frequent forest management policy changes differentially affecting federal, state and private lands with the intent of protecting, first the northern spotted owl, then the marbled murrelet, and more recently salmon and bull trout. Efforts to protect the owl and murrelet, which have been mostly dependent upon old forest structures, focused first on federal, and then state and private lands. The impacts on private lands were considerably smaller given their limited inventory of old forest structures. Harvest levels were reduced by 80 percent on federal forests and by roughly 40 percent on state lands, such that today, private lands account for about 85 percent of the harvest on 60 percent of the unreserved forestland.

Large additions to old forest upland reserves and enlarged no-harvest zones around streams have attempted to protect critical habitat. The economic impacts from these changes have been large, resulting in rural job losses and an increasing disparity between timber rural and urban incomes. The expectation is that future changes driven by salmon protection may be even more severe --with much of the impact falling on private forest landowners.

Policymakers have generally opted to endorse a management strategy that largely depends on reserving certain land types and habitats from active management, following the strategy first adopted on federal lands. Active management alternatives to improve environmental and habitat conditions have recently received attention by researchers; and they may be both more effective at protecting habitat, and less costly than reserve strategies. Forest stands are dynamic and ultimately change in structure through growth, natural disturbances, human interventions and/or management. An assessment of the cumulative effectiveness of past and proposed policies to meet biodiversity and habitat conservation goals can provide a yardstick to measure the environmental and economic impacts under different policy and management approaches.

Simulation of Forest Management Alternatives for Riparian Protection: Simulations provide one method to assess the impacts of policy change and have been prepared for a range of regulatory and management alternatives affecting western Washington for the next 200 years. Assessments of critical habitats, biodiversity, harvest levels and economic impacts demonstrate the environmental/economic tradeoffs between alternatives. For the impacts of riparian management on private lands, current practices are first simulated as a baseline (Case 1). The practical consequences of current regulations result in essentially no-management buffers of 85ft along fish bearing class 1-3 streams with the buffers covering about 2-3 percent of the forestland. Possible alternatives to increase salmon habitat include enlarged riparian management zones (RMZs) covering both fish bearing and non-fish bearing streams, with either no-management (Case 2) or active biodiversity management within the RMZ (Case 3) to restore riparian functions that existed in pre-European settlement times. The RMZ widths for Cases 2 and 3 shown in Table 1 are 150ft on class 1-3 (larger fish bearing) streams, 100 ft on class 4 streams, and 50ft on class 5 (generally intermittent and non-fish bearing) streams.

Table 1. Economic and environmental impacts from riparian management alternatives on private lands in Western Washington (5,712,000 private acres, assuming no owl and murrelet protection).

The economic losses associated with the no-management RMZ are substantial. Impacts are shown for: (1) harvest losses which directly affect mill activity, (2) both short term and long term rural jobs which are most important to community economic activity, (3) net present value (NPV), the measure of economic importance to forestland owners, (4) tax receipts of interest to the government, and (5) old forest (late seral) structures as an aggregate proxy for environmental affects valued by society. Harvest losses over the first 20 years from no-management within the RMZ (Case 2 compared to Case 1), measured in percentage change, exceed the percentage of total acres in the RMZ, a typical effect of harvest scheduling problems when there is a reduction in mature forests of harvestable age. The first twenty-year job and harvest losses in rural communities average 23 percent -- 16,500 job losses and 840 million-board ft. per year. The number of jobs in the long term increases because more intensive management in the early years increases the available harvest and jobs over time. The long-term job losses under Case 2 are 10 percent or 7,500. Harvest losses are reduced under active management using biodiversity thinnings within the RMZ (Case 3 vs. Case 1), hence the first 20 year job losses are cut to 10,800. In the long term, jobs increase rather than decrease as a consequence of labor intensive thinning to enhance biodiversity, which also produces larger trees with higher quality wood and supports increased value-added processing.

The NPV loss to private owners for Case 2 is $5.6 billion or 20 percent (slightly less than the harvest loss), but is reduced to $3.2 billion or 11 percent under Case 3. Tax receipts are proportional to the economic activity, with losses of $185 million per year under Case 2 and $117 million under Case 3. The environmental improvements in Case 2 are very modest until the10th decade, whereas more active management to replicate old forest functionality under Case 3 achieves similar levels by the 5th decade. The 5 percent increase in riparian acres with late seral structures by the 5th decade under Case 2 costs $1,100 million for each additional 1.0 percent of late seral riparian acres and under Case 3, $61 million. Using this ratio as a measure of economic efficiency, active management to increase old forest functionality within the RMZ results in an eighteen fold improvement.

The simulation suggests near term job losses and NPV reductions in the range of 20 percent if active management is not allowed (Case 2); but may only suggest a lower bound since the simulation leaves out many important effects that could substantially increase the costs even more. The RMZ width could be as wide as in the Northwest Forest Plan on federal lands, twice as wide as the illustrated RMZ, a potential doubling of the impact. Unstable slopes could also add another 5-10 percent of all acres to those in the RMZ, for a 50 percent increase in economic impact. The addition of protection on unstable slopes and secondary streams results in disconnected harvest units that may not be economically accessible--a substantial increase in management costs. And, there are increased costs associated with road, bridge and culvert improvements. The simulation therefore provides at best only a lower bound on the cost estimate to satisfy regulatory requirements or an environmental restoration goal. Also, since the simulation only estimates the average effect across owners, there will also be a substantial disproportionality. Some small owners will feel no impact, and some will feel almost 100 percent loss of their economic potential if their lands fall almost entirely in the affected RMZ. Active management within the RMZ offers the potential to grow large trees faster for stream recruitment while maintaining a more diverse understory, resulting in a faster restoration of pre-European environmental conditions at a substantially lower cost than no-management zones.

Simulation of Forest Management Alternatives Across all Forestlands: It is instructive to apply these same active management principles to all owner groups and upland, as well as riparian acres, to create at least as much restoration of old forest conditions for upland species as will result under current or proposed regulations. Case 4 provides a low harvest constraint base case for comparison across all owners and acres, with the same RMZ protection as Case 1. Case 5 provides a characterization of proposed regulations based on a reserve strategy. It includes the impact of minimum regulations to protect the owl and murrelet; the proposed no-management RMZ along streams for state and private owners (as was shown in Case 2 for private lands); and the Northwest Forest Plan (NFP) on federal lands. Case 6 simulates active biodiversity management by the state and private owners in the uplands and is like Case 3 in the riparian zones. Case 7 allows active management on one-third of the federal lands, an aggressive adaptive management approach. For proposed regulations, (Case 5 compared to Case 4), jobs for the first 20 years are down 40 percent, but only 22 percent in the long term. These losses include the affects of proposed riparian no-management RMZs that were estimated in Case 2 and hence are cumulative effects of prior uplands protection and proposed riparian protection. NPV losses are heavily weighted to federal lands as a consequence of the Forest Plan. The 22 percent impact on state lands includes protection of habitat within circles around owl sites as well as the no-management RMZ. On private lands the impacts are larger because unlike state lands, they do not have a surplus of mature acres to harvest as an offset to the exclusion of mature acres for habitat protection.

Table 2. Economic and enviornmental impacts from riparian and upland management alternatives in Western Washington (9,429,000 acres across all owners).

The economic losses under the active biodiversity management alternative (Case 6) are significantly lower than Case 5, while the late seral habitat measures are better. As a result, both upland and riparian environmental measures are achieved at lower cost. Over the long term, the impact on jobs is positive rather than negative, because the higher quality wood from that portion of the acres being managed to produce larger trees and habitat supports additional processing and jobs, as does more intensive forest management. These economic benefits are, however, primarily in the long term. The tax receipts in the first 20 years are off 26 percent or $386 million; compared to 38 percent and $558 million for the proposed regulations (Case 5).

The environmental benefits of Case 6 show a substantial improvement in late seral structures by the 5th decade and even more so by the 10th decade. The economic efficiency for an additional 1.0 percent of the acres in late seral structures by the 10th decade improves from a $927 million cost under Case 5 to $227 million under Case 6, a four fold improvement.

If one-third of the federal ownership now under reserve management is opened to active habitat treatments (Case 7), all of the costs are reduced substantially while sustaining the same habitat protection. The rural job losses are reduced to only 13 percent, a gain of 36,000 rural jobs from proposed regulations. The economic efficiency to restore habitat across all owners is doubled over Case 6, for a nine fold improvement over proposed regulations.

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