This is the third in a series related to the analysis of timber markets and wood baskets.
Wood procurement managers and timberland investors juggle, at a minimum, stumpage contracts, fee harvests, and open market transactions to manage risk with wood supplies and forest-related cash flows. With clear skies, flexible foresters and loggers, and wide-open mills, these managers may enjoy periods of relative calm as wood flows and mill raw material needs match perfectly. However, foresters worry and investments can suffer during periods of stormy weather or tumultuous market conditions.
To mitigate price risk, procurement and timberland managers employ a range of financial and operational strategies, including supply agreements, transfer price mechanisms, fee (company land) ownership, direct timber procurement/sales and supply/market diversification. All of these approaches, whether developed for annual budgeting or longer-term strategic planning, require a perspective on market-specific costs and prices. Forecasts of pine and hardwood prices in local markets can include hauling, logging and administration costs that account for estimated changes in diesel prices and inflation. We can sum stumpage, cut-n-haul, and admin costs to estimate total delivered wood costs.
In comparing dozens of procurement budgets and timberland investment pro-formas, we observe two common errors that adversely affect the ability to apply localized delivered price forecasts for planning.
- First, forecasts built off spot (current market) pricing can miss trends or bake-in outliers. To address this, take time to check the current price relative to historic peaks and valleys. Also check end market prices to manage against basis risk, which includes, for example, the risk of rising raw sawlog prices relative to lumber prices. Sound familiar, anyone? Also, assess whether or not there are local-specific events that have nothing to do with broader trends – such as weather or mill changes or road outages – that temporarily distorted current prices. Don’t build a forecast on a local bubble.
- Second, delivered models that mix real and nominal prices distort procurement budgets. Avoid mixing real (without inflation) stumpage forecasts with nominal-based logging and hauling costs. This happens.
A basic timber market analysis provides a simple risk management tool for identifying and evaluating analytic and investment exposures, including the building and testing of market-specific forecasts. Localized forecasts of delivered prices requires an understanding of (1) current, baseline stumpage and logging costs by specie and product in the market; (2) the relationship between diesel prices and logging (harvesting) and hauling costs; and (3) actual hauling distances in the market. [A previous post summarizes research published in the Journal of Forestry and research by Forisk that documents how logging costs can vary over time and across markets.]
Forisk will address localizing data and forecasts during “Timber Market Analysis” on August 4th in Atlanta, a one-day course for anyone who wants a step-by-step process to understand, track, and analyze the price, demand, supply, and competitive dynamics of timber markets and wood baskets.