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There is a subtle economic shift going on in China that most investors are unaware of. While many investors are focused on Chinese high tech, medical, and financial opportunities, most overlook one basic commodity. This basic commodity is in short supply domestically and over 50% of domestic demand is imported, historically 80% of imports came from one country, and the imported price has tripled in the past 3 years. The China market is seriously transitioning to alternative North American suppliers. For example, shipments from just the province of British Columbia increased 4 fold in the month of Jan ’10 over Jan ’09, and annual shipments have tripled since 2007 to $365 million. The product is: Timber.

China is, and will be for some time, a net importer of timber and logs. Although the government has a stated goal of being self-sufficient by 2015, the current supply deficit, along with organic demand growth of 10% annually, makes achieving the goal extremely difficult. China is developing a timber plantation industry focused on cultivating faster growing trees, but many are in the early stages of maturity. In addition, the easiest method to increase forest carbon sequestration is to reduce domestic timber harvest levels, thereby maintaining the forest cover. These factors will ensure a robust timber import market for the foreseeable future.

As a low cost raw material, logs are used in various manufactured forest products, such as 2 x 4 lumber, plywood, furniture, and the various pulp products. Countries with timber assets seek the value-added jobs that manufacturing forest products bring, and there is a trade-off between exporting the raw logs or the finished 2 x 4s.

Most Asian buyers, China included, seek the raw logs to preserve its domestic manufacturing base. To maintain and promote manufacturing in the log exporting areas, some governments are imposing higher tariffs on exports of raw logs, while attempting to reduce illegal logging.

Russia has been in the process of implementing such a plan since 2006. Russian log prices to China have tripled in 3 years due to higher transportation costs (harvests are getting farther away from the border) and a substantial increase in Russian export tariffs. Although recently delayed after pressure from the Finland government, log export tariffs were expected to be increased again this year by an additional 80%.

Log importers in China have been moving away from Russian suppliers. As domestic log market prices increase from Russia, other timber areas are being seen as more competitive and more reliable. New Zealand and Western Canada have been the most recent recipients of this shift.

Ponder some of these factoids and statistics:
  • China now trails only the US in wood consumption and China is the #1 importer of timber products in the world. More than half the timber shipped anywhere in the world is destined for China.
  • The hottest market for wood last year was China, which increased imports from non-Russian sources by 75%, thereby passing Japan as the largest importer of wood products in Asia.
  • British Columbia softwood exports to China reached 1.63 billion board feet in ‘09, more than twice the record 784 million shipped in ’08, and the BC government has a goal of 4.0 bil by the end of 2011. The values of sales have nearly tripled from about $113 million in 2007 to more than $327 million last year.
  • Canada’s wood exports to Asia accounted for 23% of all exports in the 4Q of ’09 compared to 13% in ‘08, and only 7% five years ago.
  • New Zealand’s total log exports increased from 1.3 million cubic meters in 1980, to 1.9 mil cubic meters in 1990, to 5.9 mil cubic meters in 2000, to around 10 mil meters in ’09. It is estimated that about 50% of this volume is shipped to China. The value of log exports to China rose from $236 million in ’09 to $530 mil in ’10. Log exports were up by 31% y-o-y for the month of February, and export prices are now 30% higher than what domestic sawmill are willing to pay. In early 2010, some New Zealand sawmills reported log shortages as the log export boom continues.
  • The State of Virginia is opening a forestry information office in China to promote local forest product exports.
  • Rayonier (NYSE:RYN), a major US timber company with assets in the Olympic Peninsula of Washington, surprised analyst during a recent meeting by commenting that China exports are favorable affecting log prices and demand in the US and Canada.
  • West Frasier Timber Company (OTCPK:WFTBF, WFT.TO), a large Canadian forest product company, offers its website in Chinese.
Over the next few years, there could be a major shift in the international trade flows of logs, positively impacting North American timber companies, especially those with West Coast assets. Investors looking for companies that could benefit from this shift should focus on timber companies with assets in the Western US and Canada. A good place to start is the following list of companies:

Plum Creek Timber (NYSE:PCL) – Largest private US timber landholder with 1.7 million acres in Washington, Oregon, and Montana.

Rayonier (RYN) – Owns 400,000 acres of West Coast timber and 26% interest in a 350,000 acre timber plantation in New Zealand. For more information on RYN, see my article dated April 23, 2010.

Weyerhaeuser (NYSE:WY) is converting to a REIT and owns, manages, or leases almost 20 million acres worldwide; 6.2 million in the US, 15.2 mil in Canada, 345 thousand in Uruguay and 45 thousand in China. The focus of the new REIT will be to maximize their timber assets. WY owns a shipping company, Westwood Shipping Line, which operates four vessels sailing from the West Coast to Asia, mainly carrying wood products. WY tried to unload Westwood in 2008, but found no buyers and still operates the Asian shipper. These assets may become more valuable as shipping logs from the US West Coast to China improves.

Sino-Forest (OTC:SNOFF, TRE.TO) is the largest timber company in China with substantial import business. For more information on SNOFF, see my article dated March 29, 2010.

TimberWest (OTC:TMWEF, TWF.TO), a small timber company in Vancouver BC, has recently leased a ship to facilitate its exports to Korea and China. TMWEF is the largest private timber landholder in Western Canada. Log export shipments exceeded domestic and US shipments for the first time last year. For more information on TMWEF, see my blog dated Feb 17, 2010.

Pope Resources (NASDAQ:POPE) is a micro-mini cap, 150 year-old timber company in Washington and owns 150,000 acres of timberland around Seattle. POPE also offers timber asset management services for passive investors and manages private placement timber investment funds. Investors should note liquidity may be an issue with this thinly traded stock and should trade using multiple limit orders.

As a commodity, wood pricing is market based and the current increase interest in North American timber assets is price driven. If the Russian government was to reduce export tariffs, and therefore China’s pricing, the current competitive advantage would dissipate. However, that is doubtful. A major shift in worldwide timber supply is more likely underway.

As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: Author holds long positions in RYN, WY, OTC:SNOFF, POPE, OTC:TMWEF

Source: China's Subtle Shift in a Basic Commodity Import