Market Commentary

Q3 2010

Summary
Summer held on as long as it could but eventually the heavens opened up and the rain began coming down.
It was welcome relief for the farming sector and given that temperatures hung in there through May, many did manage to get some much needed grass growth.
The seasonal change signalled a shift in the log market with building export inventories in China pushing CFR prices downwards from April.
As we head into July wharfgate returns continue to slide and we have now seen a 15% reduction in A grade log price from the April peaks.
Inventory levels are saturated and the only way to continue to move wood at the moment is by discounting price.
This is being led by the major exporters who struggle to make sales for large supply volumes.

Domestic
Most Domestic sawmills managed to correct their log inventory shortfalls towards the end of May as export supply began to taper on reduced prices.
There still remains some nervousness around how quickly supply dried up in Q1 and that seems to be keeping domestic log prices flat in Q3.
If export price and demand starts to show signs of recovery in September then it will be interesting to see the approach taken by both forest owners and sawmills towards securing logs in the run up to Christmas.


China
Over the month of June, the arrival volume of both logs and lumber from all sources of supply into the key China market has been maintained at peak levels.
Conversely, the consumption of logs and lumber has reduced as hot season construction activity slows – and the effect of the major Government stimulus package of 2009 comes to an end, with some consequent additive cooling of demand.

The end result is inventory build in both the log and lumber markets, to the point where port storage is that full that it is causing delays in discharging vessels as we look for alternative yard space.

Total Log and Lumber volumes remain higher than at any other period in recent history.
In addition, lumber imports have increased rapidly from a level of around 500km3 a month to around 1.2 million m3 –and this has a multiplier effect as there is no conversion loss on lumber ( ie an additional 1 million m3 of logs = say 700km3 of lumber , whereas an additional 1 million m3 of lumber = 1 million m3 of lumber )

With inventory levels at around 2 months, log and lumber buyers are now in the position where they do not need to buy further stock  -and can only be induced to do so via reduced price, and this is occurring in both the log and lumber markets.

In addition, the market has now lost short term confidence  - with buyers expecting further price reductions and therefore delaying a commitment to purchase, increasing the downward pressure on price.

The end result is that US$CFR prices are down far more sharply than had been expected. Even as little as one week ago – with exporters fixing July prices at US$125/jas versus a June price of around US$137/jas m3.

Conversely there have had minor movements in our favour in the freight and forex markets  - but nowhere near enough to balance the plummet in CFR price.

In summary;

• US$CFR price down US$12/jas on benchmark China A, with higher price reductions in low volume demand grades such as bark-on pruned, partial pruned and pulpwood.
• Freight costs down from the low US$50’s into the med US$40’s
• Forex down marginally to under 69c on average.
• NZ$AWG prices down $9/jas for sawlog grades and pulpwood  - with higher reductions in partial pruned and bark-on pruned, which are in very low demand. This is a significant reduction  - but the decrease in US$CFR price warrants an even higher price reduction.

Outlook for August & September ?

The market will recover by September at the very earliest. Consumption will increase by September, but inventory levels are likely to remain high by end August and as a result our forecast is for demand and price to recover by October/November.

August US$CFR prices could possibly be lower than July??  Not that NZ exporters will openly want to promote this view in the market, but that is the likely reality given inventory levels, the fact that supply levels from all sources will remain elevated at least over July and also that consumption will remain relatively low over July/ August.
Some of New Zealand’s supply volume is being managed downwards in July and August.
This will be useful, as it means that New Zealand can make sales at the required level. However, the market finds the lowest common denominator – and any exporter than has higher levels of inventory than sales will drag the market down.

On the reasonable assumption that US$CFR price will fall further in August, NZ will need the combined costs of freight and forex to also fall to prevent NZ$AWG prices falling further. This is possible, but it is not something that can be forecasted reliably. Freight and forex movements are notoriously unpredictable.
Therefore, it is probable that August NZ$AWG pricing will also be down over July.

September ?  - should see a better balance of inventory, supply and demand and on this assumption we would expect September pricing to be flat.


Korea  - the economy in Korea is weak relative to that of China, and log demand is lower  than trend in 2010. Korea pricing will follow that of China and will track down at similar levels.

India  - has already suffered a correction from top quartile to bottom quartile pricing, and is now also entering the monsoon season. India demand is significantly up over 2009, but it also has adequate levels of inventory. We do not expect to ship volume to India in July due to the inventory position – but are planning 2 vessels in August which will assist us in managing supply levels down in China.

Japan  - is showing steady demand, as always. This is due to the tight control that the Japanese trading houses exert on supply into Japan, with the result that demand and supply are well matched and the market remains relatively steady  compared with the sharper swings experienced in both China and Korea. This is useful, but Japan volumes are now in the 600km3 a year range, making it the 4th largest market for NZ log exports  -and therefore one that does not exert a major influence on our overall market.

Despite the significant fall in NZ$AWG pricing, July prices remain high on an historic basis and are still above trend.
In comparison with the same time last year AWG prices remain $15/jas ahead.
Last year the trend was further reduction in August with stabilisation occurring in September and October before beginning to rise in November right through until April.

The Freight Market

The freight market has weakened over June, with the benchmark Baltic Handysize index falling back from close to 1500 to around 1250 – which is a significant move, but one that has not as yet translated into significantly lower rates for our Handysize loggers operating out of New Zealand.

The overall Baltic Dry index has reduced from 4156 at the end of May to 2406 at the start of July.

Our rates have proven to be resilient, in part because of the large supply/demand imbalance for bulk cargo ex NZ – with a far higher level of outward demand for logs versus the inward demand level for fertiliser, PKE, cement etc.

Rates have fallen from the low US$50’s into the high US$40’s – which has only partly offset the large drop in US$CFR pricing.

We do expect freight rates to come down further, as we look to be entering a period of lower global demand – and we need this to occur to underpin August NZ$AWG pricing.


Forex

Forex continues to be volatile, driven by the heightened levels of risk in global financial markets. The “risk-on” “ risk-off” seesaw in investment is causing even more rapid changes in the value of the NZ$ than is usual – with the currency having traded between the 66-71c range in June alone.
Forex is currently in the mid 69c range – and our average Forex position has improved slightly over June, which has also assisted in reducing the slide in NZ$AWG price.

 


It is critical to our market and NZ$ pricing prospects that the combined costs of freight and forex continue to reduce towards trend levels – being in the mid US$30’s for freight and the mid 60’s for forex. At these levels, we could sustain US$CFR pricing in the order of US$125/jas m3 for China A, which is a highly competitive position in Asian markets, and also generate an historically competitive NZ$AWG price.