LUMBER FUTURES

Roughly one-third of all U.S. lumber comes from Canada and the two countries have argued over trade terms for over two years. On December 6, 2005, the U.S. Commerce Department reduced the tariff on Canadian softwood from 20% to 11%, pressured by adverse rulings from both NAFTA and the World Trade Organization. While it is a step in the right direction, the battle is not yet over. The U.S. will likely continue to appeal the rulings against them at taxpayer and consumer expense.

Lumber prices had an impressive rise in 2004, supported by a strong North American housing market and a rising Canadian dollar. This year however, support for prices has eroded. Lumber supplies are said to be plentiful and there are concerns about the future of housing demand now that mortgage rates are moving higher. Also, it seems obvious to everyone but the U.S. government that they will eventually have to reduce the tariff. In the first eleven months of 2005, housing starts were up 6% from a year ago after a 6% increase in 2004. New home sales in the first eleven months of 2005 were up 7% from a year ago after posting a 9% gain in 2004. On May 5, 2005, the USDA released a new rule which would allow more logging and mining activity in undeveloped areas of national forest, but it is not clear yet what effect the rule will have on actual production.

"The cost issue has been a very important factor this year," said Paul Leclair, chief economist at the Pulp and Paper Products Council.

"There's a bunch of factors combined that are hurting the industry significantly; I'd be extremely surprised to see profits this year."

Consultants PricewaterhouseCoopers said earnings by the leading Canadian forest companies collectively fell to a paltry $71 million in the third quarter, compared with $883 million earned a year ago.

Based on previous natural disasters, it is believed that reconstruction of houses and buildings destroyed by the hurricanes will take up to five years. Actual demand for lumber is thus expected to increase only modestly in the short to medium term relative to pre-hurricane scenarios. The September spike in prices is expected to be reversed in coming months.

"Protectionism in all its guises, both domestic and international, does not contribute to the welfare of American workers. At best, it is a short-term fix at a cost of lower standards of living for the nation as a whole," he (Fed Chairman Alan Greenspan) said.

Trade Lumber Futures

In recent years, lumber prices have reacted to supply and demand imbalances with frequent and often extreme changes. Domestic lumber supplies have been constrained due to mill closings, the spotted owl controversy, and other environmental concerns. In Canada, lumber supplies have been limited as provinces move toward sustainable yields, where only enough trees can be harvested as can be replaced in 40 or 50 years. And on the demand side, due in part to economic conditions and interest rate policies, housing starts over the past decade have ranged from record highs to 36-year-lows.

Highly volatile lumber prices can mean opportunity for large profits. But in an industry like lumber, where costs are high and margins are tight, volatile prices also can mean risk of devastating losses. In 1969, the Chicago Mercantile Exchange became the first exchange to offer price protection to the forest products industry with the listing of random length lumber futures contracts.

The lumber futures contract traded at the CME calls for on-track mill delivery of random length 8-20 ft. nominal 2 x 4s. Primarily, the deliverable species is Western Spruce-Pine-Fir, although other Western species -- such as Hem-fir, Englemann Spruce, Alpine Fir, and Lodgepole Pine -- may also be delivered. Mills must be located in the states of Oregon, Washington, Idaho, Wyoming, Montana, Nevada or California, or the Canadian provinces of British Columbia or Alberta. The acceptable grades are Standard and Better, or #1 and #2 of the structural light framing category; or construction and standard of the light framing category. Grade #2 or standard grade may not exceed 50% of the lumber delivered. Wood must be kiln dried to a moisture level of 19 percent. The random-length tally must conform to size percentage limits. Lumber of each length, for the most part, must be banded together, poly or paper wrapped and loaded on one 73’ flatcar.

Available Trading Months: Principal trading months for lumber futures include January, March, May, July, September, and November.

Humans have utilized lumber for construction for thousands of years, but due to the heaviness of timber and the manual methods of harvesting, large-scale lumbering didn’t occur until the mechanical advances of the Industrial Revolution. Total world harvest, including softwood and hardwood, is currently around 4 billion cubic meters per year.

Lumber is produced from both hardwood and softwood. Hardwood lumber comes from deciduous trees that have broad leaves. Most hardwood lumber is used for miscellaneous industrial applications, primarily wood pallets, and includes oak, gum, maple, and ash. Hardwood species with beautiful colors and patterns are used for such high-grade products as furniture, flooring, paneling, and cabinets and include black walnut, black cherry, and red oak. Wood from cone-bearing trees is called softwood, regardless of its actual hardness. Most lumber from the US is softwood. Softwoods, such as southern yellow pine, Douglas fir, ponderosa pine, and true firs, are primarily used as structural lumber such as 2 x 4s and 2 x 6s, poles, paper and cardboard.

Plywood consists of several thin layers of veneer bonded together with adhesives. The veneer sheets are layered so that the grain of one sheet is perpendicular to that of the next, which makes plywood exceptionally strong for its weight. Most plywood has from thee to nine layers of wood. Plywood manufacturers use both hard and soft woods, although hardwoods serve primarily for appearance and are not as strong as those made from softwoods. Plywood is primarily used in construction, particularly for floors, roofs, walls, and doors. Homebuilding and remodeling account for two-thirds of US lumber consumption. The price of lumber and plywood is highly correlated with the strength of the US home-building market.

The forest and wood products industry is dominated by Weyerhaeuser Company (ticker symbol WY), which has nearly billion in annual sales and a market capitalization of over billion. Weyerhaeuser is a forest products conglomerate that engages not only in growing and harvesting timber, but also in the production and distribution of forest products, real estate development, and construction of single-family homes. Forest products include wood products, pulp and paper, and containerboard. The timberland segment of the business manages 7.2 million acres of company-owned land and 800,000 acres of leased commercial forestlands in North America. The company’s Canadian division has renewable, long-term licenses on about 35 million acres of forestland in five Canadian provinces. In order to maximize its long-term yield from its acreage, Weyerhaeuser engages in a number of forest management activities such as extensive planting, suppression of non-merchantable species, thinning, fertilization, and operational pruning.

Lumber futures and options are traded on the Chicago Mercantile Exchange (CME). The CME’s lumber futures contract calls for the delivery of 111,000 board feet (one 73 foot rail car) of random length 8 to 12 foot 2 x 4s, the type used in construction. The contract is priced in terms of dollars per thousand board feet.

Prices – Lumber futures prices rallied through most of 2003, with the market posting a new 2-1/2 year high late in the year. Lumber prices closed 2003 at .60, up 44% from the 2002 close of .70. The market was driven by the extremely strong US home-building market seen all year. Despite the rally, the market remained slightly below the 3-year high of .00 posted in May 2001 and well below the record high of .50 posted in March 1993.

Supply – US softwood lumber production in 2003 was on track to fall 1.2% to 35.607 billion board feet from 36.025 billion in 2002. The US leads the world in the production of industrial round wood with 405 million cubic meters of production in 2002, followed by Canada with 197 million cubic meters and Russia with 128 million cubic meters.

The US also leads the world in the production of plywood with 15.494 million cubic meters of production in 2002, followed by Canada with 2.475 million cubic meters and Russia with 1.808 million cubic meters.

Trade – US imports of softwood in 2002 rose to 20.986 billion board feet from 20.075 billion board feet in 2001. US imports of hardwood in 2002 rose to 739 million board feet from 645 million board feet in 2001. Total US lumber imports in 2002 rose to 21.774 billion board feet from 20.737 billion in 2001. The majority of US imports were of spruce with 1.046 billion board feet in 2002, and cedar came in second with 648 million board feet.

US exports of softwood in 2002 fell to 848 million board feet from 968 million board feet in 2001. US exports of hardwood in 2002 fell to 1.219 billion board feet from 1.222 billion board feet in 2001. Total US exports in 2002 fell to 2.312 billion board feet from 2.351 billion board feet in 2001. The largest US export of softwood was of southern pine with 205 million board feet in 2002, followed by Douglas fir with 111 million board feet.