Industry Observations: Markets Work

This is the second article in a three-part series that provides observations of forest business conditions and impacts during the COVID-19 crisis. The author, Todd Mullis, is Business Operations Manager at Forest Resource Consultants. He has over 25 years of experience managing mill and wood procurement operations in the pulp, paper, and lumber industries.

In the first article of this series, we introduced how changing business conditions resulting from COVID-19 were impacting the basic fundamentals of supply and demand.  As we continue to deal with economic uncertainty in the current business climate, our second article presents an overview of general market principles that help us understand potential changes in forest industry dynamics.  I’ve often shared with others that markets do not like uncertainty.  In my lifetime, I can’t remember a period with more economic uncertainty than we face today.

Markets Work

I fondly remember purchasing my first VCR in 1995 for $350.  At that price, VCR makers were reaping great profits which incentivized other companies to begin manufacturing VCRs.  As time passed, VCR manufacturers became more efficient and, many years later, a much-improved VCR was selling for $75.  How did a much-improved VCR sell for a fraction of the previous cost many years later?  Let’s use our VCR cost example as a segue to explore market fundamentals within the forest industry and more specifically on market dynamics resulting from the COVID-19 crisis.

Adam Smith, a famous economist in the 1700’s who was known as “The Father of Economics” stated in his work that competitive and free markets do a good job allocating resources to maximize profits.  Smith stated simply that if left to their own devices, markets work!  A functioning market is a basic foundation of our free market economy, and what makes markets work is the relentless pursuit of profits by participants.

As we think about markets in our industry, I’ve always used the term hyperlocal in specifically describing timber markets.  Wood is a heavy bulk item that is expensive to handle and transport.  Wood is comprised of roughly 50% water that will eventually be extracted no matter the end product.  Why transport water that doesn’t end up in the finished product any further than necessary?  Hence, this is the reason mills are located within and adjacent to the resource and not in highly populated metropolitan areas that are closer to consumers – a simple example of markets at work.  An additional forest industry driver for participants looking to maximize profit is the minimization of freight costs for raw materials purchased and finished products sold.  Attempts to minimize freight costs is most often the largest determinant of where forest products mills purchase wood as well as where it’s finished products are shipped.  Mill locations, access to raw material, and proximity to consumers all work together to create working markets across our industry.  Once again – markets work!

Let’s drill down further and examine pine pulpwood markets across the US South.  Stumpage prices for pine pulpwood vary greatly from east Texas to southern Virginia.  Pine pulpwood markets in southeast Georgia, where there is a high concentration of pulp and paper mills and strong export markets for finished products, are drastically different than markets in northern Mississippi.  Timber-Mart South reported that pine pulpwood stumpage prices in the first quarter of this year were almost four times higher in southeast Georgia than in northern Mississippi – talk about a big difference if you are a landowner!  Supply and demand fundamentals have worked in tandem to set the market price for both areas.  Once again – markets work!

To highlight specific COVID-19 impacts in our industry, let’s look at several drivers impacting pine pulpwood markets across the US South.  Due to strong demand for their products, pulp and paper mills are running at extremely high operating rates leading to more demand for pulpwood.  More demand for finished product leads to more demand for wood.  One would think that more demand for wood also equal higher prices – maybe or maybe not.  Remember that all timber markets are hyperlocal. Knowing this, let’s explore other contributing market factors.

Oriented Strand Board (OSB) production is down sharply as construction activity has been drastically reduced.  This has resulted in reduced pine pulpwood demand at OSB mills.  In many markets, this pine pulpwood supply is now available to service the increasing demand at pulp and paper mills.  One contrasting example is to compare timber markets in east Texas where there are more OSB mills relative to pulp and paper mills and southeast Georgia where there are many concentrated pulp and paper mills with no OSB mills.  When considering these market factors, it is easy to see there is much greater potential for pine pulpwood stumpage price increases to occur in southeast Georgia as opposed to east Texas.  Market dynamics will work in these areas, and prices will adjust accordingly.

Another factor impacting pulpwood markets across the US South is the reduction in sawmill operating hours and/or or possibly even temporary shutdowns in some areas.  As discussed in our last article, fewer operating hours among sawmills has decreased sawmill residual chip availability for pulp and paper mills and has left supply chain participants (wood dealers, loggers, truckers, etc.) looking for new markets to deliver wood.  From my experience during the Great Recession, I would expect that decreased residual chip volume will be replaced with pulpwood delivered by supply chain participants looking for new destinations.  Once again – all timber markets are hyperlocal and local market conditions will dictate whether there is opportunity for an increase in pine pulpwood stumpage prices.

As a final example of markets working, let’s revisit gasoline prices prior to the onset of the Great Recession in late 2008.  According to Department of Energy (DOE) data, regular gasoline in the lower Atlantic region of the US was selling at a historical high of $4.03/gallon in July of 2008.  As the Great Recession emerged in the second half of 2008, fuel stockpiles rose while fuel demand plummeted.  By the end of 2008, the DOE reported that regular gasoline prices in the lower Atlantic region had dropped sharply to $1.60/gallon – a 60% drop in six months!  A short time afterward, I read an article detailing the market dynamics that lead to such a sharp drop in gasoline prices.  A quote at the end of the article summed up the price change succinctly – “Nothing takes care of high prices like high prices.”  Once again – markets work!

Now that we have reviewed the business fundamentals of supply and demand and markets dynamics, our next article we will explore how market incentives are driving management behaviors in the current COVID-19 economic environment.

Until then, stay safe and healthy!

 

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