The financial crisis and subsequent recession, particularly in construction, led to capacity and construction cutbacks. The industry is going through a structural reform, with unprofitable facilities closing and logging and processing firms merging. The industry is bouncing back from the lows thanks to increased globalisation, demand from China and the use of wood for fuel. Consumption of the main forest products rose by 4.1% in North America, by 6.6% in Europe and by 6.3% in the Commonwealth of Independent States in 2010. Chinese imports of logs, lumber, woodchip and pulp hit record levels last year and the United Nations Economic Commission for Europe (UNECE) Timber Committee expects the upturn in wood and paper markets to continue over the course of 2012.
The global recovery has been far from uniform, however. Consumption of European softwood rose 12.5% in 2010, while the demand for plywood shot up in the Russian Federation by 46.5% over the same period. Sale prices have risen as a result, but so have input costs. UNECE says prices remain 30% off their mid-1990s peak as the cost of transport and energy bites into profitability. Weak property markets continue to take their toll on recovery in geographical markets. The US housing market is a key driver of demand for wood. Despite the property sector’s slow return to health, the US wood product industry expects revenue improvements this year, according to the Institute for Supply Management.
Regulatory issues are also playing on the sector’s ability and willingness to prepare for future growth. Climate change policy will have a major impact, although the lack of progress in developing a successor to the Kyoto Protocol means more conjecture than action at present. The Reducing Emissions from Deforestation and Forest Degradation (REDD) programme is also under review.
In Europe, some wood prices have been rising as the region pushes the use of woody biomass as a renewable energy source. The increases have prompted a review into market dynamics and European policy effects. A voluntary carbon market for forestry projects hit record transaction levels in 2010 but remains a tiny fraction of the $141.8bn global carbon market. The European pulp and paper industry joins the European Union Emission Trading Scheme next year. The EU will not be dishing out free credits for electricity production, with severe competitive implications for Combined Heat and Power (CHP) wood production. As an investment, timber is doing well in many markets. IPD Index reports that 2010 forestry returns in the UK were at their highest levels since 2007. At 20%, forestry outperformed commercial property markets for the fifth consecutive year. Over three years, forestry returns were 12.6%, while gilts delivered 7.7%, equities produced just 1.4% and commercial property fell 2.5%. IPD also notes that UK timber prices are on the rebound, up 38.5% in the year to March 2011. Forestry returns are closely linked to these prices, although it remains a more stable, lower correlated asset than timber itself is.
Such figures are encouraging pension schemes to renew their interest in forestry or to appoint specialist managers for the first time. In the UK, the £9.2bn Pension Protection Fund (PPF) is mid way through a recruitment process to help diversify its alternative portfolio, currently 20% of its total portfolio. It is looking at a small group of specialists to handle investments in land and the operations necessary to cultivate and market agricultural products, or to grow and sell timber. The PPF expects returns to be a mix of capital appreciation yield. Other pension schemes are already ahead of the PPF in establishing forestry as an investment class. US and Canadian pension funds are long established investors. In Europe, Nordic and Dutch pension providers lead development.
The California Public Employees’ Retirement System (CalPERS) has forestland investments of around $2.3bn as part of its real assets investment portfolio. Forestland makes up around 1% of total CalPERS investments. Investments are undertaken with partners Lincoln Timber Company and Sylvanus, a closed fund operated by Global Forest.
“Under the CalPERS asset allocation strategy, the aim of real assets is to provide long-term income returns that are less sensitive to inflation risk – it’s an inflation hedge. We see forestland as a diversifier in the total portfolio, and a source of stable income during falling equity markets,” said a CalPERS spokesperson.
The weak US housing market has hit CalPERS’s returns on forestland assets, however. Three year returns to the end of Q3 2011 were -1.6%. One year returns were -7.3%, leading the forestland portfolio to underperform its benchmark by 1344 basis points.
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