q1 2018 issue no. 2 - greenwood...

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Q1 2018ISSUE NO. 2

US housing market recovery

Gains continue in PNW timber markets

Consolidation in Brazilian pulp sector

Plantation teak a growing share of Indian consumption

Policy changes in CA carbon market

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US Housing Market: Is the re-covery losing steam?Housing comprises the most important end-use market for US wood products. Roughly two-thirds of the demand arises from new residential construction and repair and remodel activity. Regular recipients of our timber market analysis will recall our outlook on the recovery in new residential con-struction: slow and steady. Initially, the pace of recovery appeared to track that of recent prior recessions. However, with the release of each month’s data on housing starts over the past several years, we became increasingly aware of what appeared to be a fall in the rate of recovery. Today, the housing market is hovering around 1.3 million starts and some market participants joke that “we are ten years into a four-year expected recovery”. Here we describe evi-dence of a slowdown in the pace of the US housing market recovery and discuss the underlying causes. Though the overall pace of recovery may be slowing, the housing sec-tor continues to drive growth in demand for wood products and we find single-family starts in the South and West to be areas of particular strength.

WHAT DO THE HOUSING DATA TELL US?

Total US housing starts from Jan. 2000, through the nine-year recov-ery-to-date, to March 2018 are shown in Figure 1. Underlying demand for housing, based largely on population dynamics, is commonly figured at 1.5 million units per year. Assuming this level of underlying demand, there would appear to be an unmet demand of some 4-6 million units since the Global Financial Crisis (GFC) (FEA; GWR Research). Despite this over-

2 GREENWOOD RESOURCESFIELDNOTES

hang of unmet demand, casual observation suggests that sometime in late-2014 or early-2015, the pace of recovery started to lose steam.

By estimating a linear regression over the recovery period, we are able to test if a “structural break”—a statistically significant change in the recovery trend—occurred. Using 108 monthly observations from April 2009 to March 2018, we test for structural breaks in total, single-family, and multi-family starts at April 2015. For total starts, test statistics provide evidence of a struc-tural break in the series as illustrated in Figure 1. Table 1 shows the pace of recovery, measured as the monthly increase in the annualized rate of housing starts, pre- and post-break. The pace of recovery in total starts fell from 8,190 to 3,580 units per month, indicating that the average pace of recovery was cut by more than half. The cause is the collapse of multi-family starts, which is more volatile and currently declining—multi-family may have been overbuilt as its share of total starts has been well above historical averages. Contrary to the overall trend in total starts, the rate of increase in single-family starts is up about 40% since April 2015.

If the rate of recovery had continued at the pre-break level, the underlying demand of 1.5 million units would have been reached by early-2020. At the current pace,

that level will not be reached until mid-2022.

TABLE 1. AVERAGE MONTHLY CHANGE IN HOUSING STARTS (UNITS, SAAR)

Pre-break recovery April 2009 – March 2015

Post-break recovery April 2015 – March 2018

Total starts 8,190 3,580 Multi-family starts 4,570 -1,460 Single-family starts 3,560 5,050

NOTE: ALL COEFFICIENTS STATISTICALLY SIGNIFICANT AT 0.90 LEVEL.

In addition to the overall changes in the housing recov-ery, there is also substantial regional variation. The most robust growth in single-family starts post-break has been in the West, where the rate of increase has nearly dou-bled compared to the pre-break period of recovery. In the South, single-family starts are also increasing at a faster rate, but the change is more moderate by com-parison.

What do these changes mean for overall demand for wood products? According to FEA, in 2017, a sin-gle-family unit used 15.7 mbf of lumber while the small-er multi-family unit, sharing walls and a roof, used about 4.8 mbf. Factoring in these differences, it appears that the rate of increase in the demand for wood products used in new housing has fallen by about 7%. Demand is

FIGURE 1. US HOUSING STARTS, JAN 2000 – MAR 2018

SOURCE: US CENSUS; GWR RESEARCH.

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still increasing, to be sure, but at a slower rate.

Despite underlying demographic demand, rising house prices, an aging housing stock, and a limited invento-ry of houses for sale, builders have not responded ag-gressively with construction of new houses. Why not? Answers can be found on both the supply and demand side of the equation.

CONSTRAINTS ON HOUSING DEMAND

Affordability is an issue for an increasing number of home-buyers as wage growth has not kept up with the dramatic appreciation in home prices in major cities across the country. The Case-Shiller housing price index increased 5.5%/year since bottoming out in 2009. While real median family income recovered strongly out of the recession, only in 2016 did it get back to the prior peak seen in 1999. Figure 2 shows that wage gains since then have been modest in comparison with the increases in housing prices.

FIGURE 2. CASE-SHILLER HOME PRICE INDEX AND NON-FARM WAGES (% CHANGE Q/Q)

SOURCE: FEDERAL RESERVE ECONOMIC DATA; GWR RESEARCH. NOTE: NON-FARM WAGES ARE A FOUR-QUARTER MOVING AVERAGE.

Financing costs have started to rise as well: the average rate for a 30-year fixed-rate mortgage is up from the mid-2013 low of 3.4% to 4.6% in most recent April 2018 report (but still low by historic standards). As a result, the monthly payment on a $200,000 median-priced new house with a 20% down payment has increased by almost 16%, far outstripping wage gains over the same period.

Finally, the nation’s biggest demographic cohort—the Millennials, age 25-34—is just reaching the age of peak household formation, with the median age of a first-time home buyer 32. However, Millennials are pair-ing up and marrying later—which could mean fewer households per capita and a delay in household forma-

tion—and may be expressing a desire to keep renting for both financial and life-style reasons.

CONSTRAINTS ON HOUSING SUPPLY

New housing supply is limited by a lack of construction labor, stagnant labor productivity, a shortage of build-able lots and increased building costs.

Labor constraints. Unemployment is at decadal lows. During the recession, construction workers exited the sec-tor to find other work, and many are reluctant to move back to this volatile industry. A large fraction of construc-tion labor is foreign borne (Passel and D’vera, 2015) and the current political climate is less favorable toward immigrant populations, both legal and illegal. Figure 3 shows that the trend in labor productivity has remained relatively flat since 2013, suggesting that technical inno-vation in construction methods has not offset the scarcity of labor. In early-2018, the hourly cost of construction labor was increasing at 3.2%/year (Federal Reserve Economic Data). With flat productivity, this means that the total labor cost of a residential building is rising.

FIGURE 3. RESIDENTIAL CONSTRUCTION LABOR PRO-DUCTIVITY

SOURCES: FEDERAL RESERVE ECONOMIC DATA; GWR RESEARCH.

Lack of buildable lots. Particularly for the important wood-using single-family segment, municipalities pro-vide much of the basic infrastructure for large new de-velopments—roads, trunk water and sewer services and stormwater drainage. The recession hammered state and municipal tax receipts and they are only now recov-ering to pre-recession levels. The costs of other public services, including public pensions and health insurance are rising, squeezing out the money available for pre-de-velopment infrastructure. Under these circumstances, the new federal infrastructure program, with its emphasis on state and local cost share, is unlikely to help much.

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WHAT DOES THIS MEAN FOR TIMBER PRICES?

The housing recovery has slowed, but not ended and there are clearly areas of strength, particularly in single family housing. We believe there will be a continued movement back towards the underlying demographic demand of around 1.5 million units annually. Growth will be fueled by a continued economic expansion and a large reservoir of underbuilt housing since the GFC. But, full recovery is going to take longer than previously anticipated. Repair and remodel activity, the other ma-jor source of wood products demand, remains strong. We mentioned earlier that lumber prices are at all-time highs. Shouldn’t this be good news for timber owners? Yes, eventually and to varying degrees, depending on the underlying market tension in specific investment re-gions across the US. The why and when of that answer is the topic of another edition of Fieldnotes.

Rising costs of construction. The cost of materials used in building houses is rising much faster than inflation. The prices of dimensional lumber stand at all-time highs. Tariffs on steel have pushed up the cost of fasteners, rebar and roofing as well as structural components used in multi-family. The producer price index for cement has risen 35.4% off its mid-recession low. Additionally, since their bottom in January 2016, oil prices have more than doubled, raising the input costs for plastics and construc-tion adhesives.

FIGURE 4. CHANGE IN COST OF BUILDING MATERIALS (INDEXED, JAN. 2009=100)

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SOURCES: FEDERAL RESERVE ECONOMIC DATA; RANDOM LENGTHS.

NORTH AMERICAUS HOUSING• US housing demand continued its slow but steady

upward trend, reaching an average annualized rate of 1.3 million starts in Q1 2018. Starts remain be-low the long-term average of 1.5 million, but have continuously inched upward since 2008.

• Single-family housing starts, which represent approx-imately 70% of total housing starts, were up 6.9% in Q1 2018 compared to the same quarter a year earlier. Similarly, the multi-family sector is up 6.8% in the first quarter.

• Residential improvement expenditures of $146 billion were slightly lower in Q1 2018, down 1.3% com-pared to Q4 2017 but remain within close range of pre-recession levels of $150+ billion (2009 USD) (FEA, 2018).

• Housing and residential improvement demand is fundamentally sound, backed by millennial-led de-mographics, years of underbuilding, and an aging housing stock. Yet, supply constraints have restrained the pace of recovery. The Research Note in the first section of this issue addresses these constraints in de-tail.

FIGURE 5. US HOUSING STARTS

SOURCE: U.S. CENSUS; GWR RESEARCH.

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LOG MARKETS• In Q1 2018, log prices in the Pacific Northwest

(“PNW”) sustained last year’s strong, positive mo-mentum and remained at historic highs. Domestic Douglas-fir and whitewoods (i.e., hemlock and true firs) sawlog prices increased 6.2% and 7.1% quar-ter-over-quarter with impressive gains of 28% and 29% on a year-over-year basis (RISI).

• PNW log exports during Q1 2018 decreased 19% compared to first quarter figures from last year. The decline is mostly driven by a reduction in volumes to China due to a combination of very strong domestic log prices and increasing supply from other regions. Consistent with the decline in log export volumes, prices have cooled off but remain high. Douglas-fir prices to China were up 3.6% quarter-over-quarter and 23% on a year-over-year basis. Hemlock pric-es to China were flat to slightly down with a 0.2% decrease compared to Q4 2017 but 23% higher compared to Q1 2017.

FIGURE 6. WEST COAST LOG EXPORTS BY DESTINA-TION

SOURCE: U.S. CENSUS; FEA; GWR RESEARCH

• US South timber prices experienced modest price gains in both pine sawlog and pulplog markets in Q1 2018, but remain historically low. Southern pine sawlog and pulplog prices increased 1.2% and 1.1% on a quarterly basis with annual increases of 1.6% and 1.4%, respectively. Low timber prices in the region, combined with healthy lumber consump-tion in the US, continue to attract mill investment to specific regions in the South.

• Growth in sawlog exports from the South continues to increase. Contrary to the long held (and previously

correct) belief that US South pine exports represent only a small portion of the market share compared to PNW exports, year-to-date southern yellow pine ex-ports to China account for 37% of all US log exports to China (ERA, May 2018)..

LUMBER MARKETS• In line with expectations, US lumber consumption and

production started the year up compared to first quar-ter of last year. During Q1 2018, softwood lumber production totalled 9.5 BBF, an increase of 15% com-pared to Q1 2017. Softwood lumber consumption of 11.5 BBF faced a modest but positive increase of 2.3% compared to Q1 2017.

• Production in the US South continued gaining steam, totalling 5.2 BBF during the first quarter, an increase of 11% on a quarter-over-quarter basis and 14% above last year’s first quarter levels. Continued invest-ment in manufacturing both greenfield and existing mills are expected to further buoy growth in US South lumber production.

FIGURE 7. SOFTWOOD LUMBER PRODUCTION

SOURCE: U.S. CENSUS; FEA; GWR RESEARCH.

• Lumber markets continued posting gains and remain strong, with prices at record highs. In Q1 2018, Random Length’s Southern Pine and Western Spruce-Pine-Fir lumber composite increased 8.9% and 7.6%, respectively (Figure 7). In tensioned timber markets like the Pacific Northwest, some of these gains have transferred to log markets. In the US South, due to excess inventory, margins have largely remained with the manufacturing sector. However, specific sub-re-gions with relatively stronger domestic markets and access to export markets, are likely to experience gains in the near- to medium-term.

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newables are likely to boost biomass demand.

• In energy markets, global crude oil prices continued their upward trend through Q1 2018 and, for the first time since 2014, ICE’s Brent crude index reached $75/barrel. The recent run-up in prices has largely been driven by the turmoil in the Middle East and uncertainty around the impact of sanctions on Iran following the US withdrawal from the Iran nuclear deal.

FIGURE 10. EUROPEAN ENERGY

PRICES SOURCES: EEX; ICE; HAWKINS WRIGHT.

LATIN AMERICAPULP MARKETS• In March 2018, Suzano announced they had en-

tered into a deal to acquire Fibria for BRL 36 billion (USD 11 billion). The deal remains subject to regu-latory review by Brazilian and international anti-trust agencies, but approval is expected. Hawkins Wright (April 2018) reports that the merger will create a BEKP supplier that will control as much as 45% of the global BEKP market.

• China’s continued efforts to clean up air and water pollution may further increase demand for pulp im-ports. In Issue 1, we highlighted new restrictions on imported recycled paper and container board. Haw-kins Wright (April 2018) reports that, as a result of these restrictions, imports of wastepaper during the second half of 2017 fell to 10.8Mt, down 27% com-pared to the first six months. This policy shock has contributed to increased price volatility and the sub-stitution of wood pulp for recycled fiber may increase demand for imported pulp.

FIGURE 8. SOFTWOOD LUMBER PRICE

SOURCE: RANDOM LENGTHS; GWR RESEARCH. NOTE: AVERAGES ARE FOR THE PERIOD Q1 2000 TO Q1 2018.

EUROPEBIOMASS MARKETS• Despite the seasonal softening of demand, pellet

prices in both residential and industrial heating mar-kets held steady through April. Hawkins Wright (April 2018) reports that the end of the residential heating season has provided some relief to tensioned Europe-an pellet markets, though inventories remain low.

FIGURE 9. EUROPEAN RESIDENTIAL HEADING PELLET PRICES

SOURCES: DEPV; PROPELLETS AUSTRIA.

• Growing support for biomass demand is expected as European nations develop climate and energy poli-cy consistent with the EU 2030 Framework, which includes EU-wide targets and policy objectives for the period between 2020 and 2030. In-line with the Framework, Austria’s recently released draft cli-mate and energy policy includes a major role for biomass in the decarbonization of heat. Austria aims to produce 100% of heat from renewable sources by 2030. Additionally, incentive programs in France and Finland to encourage households and district heating companies to switch from coal and oil to re-

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FIGURE 11. BRAZIL BLEACHED HARDWOOD KRAFT PULP (BHKP) EXPORTS, 2017-2018YTD

SOURCE: BRAZIL MINISTRY OF INDUSTRY, FOREIGN TRADE AND SERVICES

• In 2018 year-to-date, Brazilian BHKP export volume and value are up compared to the same period a year earlier. For the first four months of the year, ex-port volume is up 17% and export value (USD) is up 54%. These gains reflect continued strong global de-mand, most notably from China for tissue production, and improved pricing in BHKP markets.

• UPM-Kymmene Oyj is proceeding with the second preparation phase of the potential new pulp mill in Uruguay. These preparations include, for example, mill permitting, pre-engineering, and infrastructure permitting. UPM’s current pulp capacity is 3.7 mil-lion tonnes/year across mills in Finland and Uruguay. UPM’s single existing mill in Uruguay (Fray Bentos) has a capacity of 1.3 million tons/year and the pro-posed mill would have a capacity of 2 million tons/year.

TROPICAL HARDWOODS• Teak imports to India finished 2017 at a record

high, according to official trade statistics (Figure 12). Plantation-grown teak from Latin America makes up a steadily increasing share of total imports, rising to nearly two-thirds in 2017.

• The growing importance of plantation grown teak re-flects the increasing scarcity of natural grown teak, particularly from Myanmar. Recent data from Myan-mar reflects this trend. For the 11-month period from April 2017 to February 2018, Myanmar reported a sharp decline in forest product exports. Teak exports make up about 40-45% of total export value and analysts report that forest products exports could be down by as much as 40% for the fiscal year as whole

(ITTO, April 2018)

• In 2018, Indian imports of teak have been impacted by ongoing issues in the Indian financial sector. As a result of the banking scandal at state-run Punjab Na-tional Bank earlier this year, access to credit through-out the economy has been restricted. The withdraw of credit facilities has impacted teak importers ability to finance purchases. However, in spite of these chal-lenges, ITTO (April 2018) reports that demand for imported logs is stable and C&F prices are holding steady.

FIGURE 12. VALUE OF TEAK IMPORTS TO INDIA

SOURCE: GOVERNMENT OF INDIA TRADE STATISTICS.

ECOSYSTEM SERVICE MARKETS• In the US, the California (CA) carbon market remains

the major driver of demand for forest-based carbon offset credits. However, price risk in carbon markets is closely related to policy risk. The California Air Re-sources Board (ARB) determines both total demand for carbon offset credits and the relative demand for offset credits both within and outside of California. In 2017, the CA state legislature approved an ex-tension of the cap-and-trade program beyond 2020 and through 2030 (AB 398), improving market sta-bility and policy certainty. The extension, however, decreased the share of offsets, including those gener-ated from forests, that compliance entities can use to meet their allowance requirements. It further reduced the number of offset credits that can be used from permitted projects outside California. Though these policy changes introduce downside price risk, the January 2018 addition of Ontario to CA’s cap-and-trade program and proposed State programs (e.g., Oregon and Washington) may bolster markets.

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Africa S. America C. America Rest of World


FOREST SCIENCEREMOTE SENSING TO IMPROVE FOREST IN-VENTORY SYSTEMS• Remote sensing of timberland using LIDAR—Light De-

tection and Ranging—laser technology is a source of accurate data suitable for forest inventory and assess-ment. LIDAR is an advanced land surveying method that uses pulses of light sent from an airborne laser to the forest below where the pulse reflects off the forest canopy and is collected back at the instrument.

• In collaboration with Virginia Tech’s Forest Productivity Cooperative (FPC), GWR is using LIDAR technology to make high-resolution inventory maps of forest as-sets in the US South, including estimates of canopy height, basal area, and timber volume as well as to evaluate forest health. Preliminary results from the data analysis show the potential and advantages of using LIDAR technology for forest management. Re-sults from the research will be presented at the FPC’s Annual Meeting in Raleigh, NC in August 2018.

FIGURE 14. LIDAR FOREST INVENTORY IMAGE

SOURCE: GWR RESEARCH.

• Well-developed regulatory carbon markets in Europe and the US provide information on pricing that can be incorporated into traditional financial analysis of investment opportunities. Figure 13 describes car-bon price under the EU’s Emissions Trading Scheme. Prices surged in early-2018 following the European Parliament’s approval of post-2020 reforms to the EU ETS scheme targeting the oversupply of allowances. European carbon have stayed strong through May, though are down slightly from their April high of €14/tCO2.

FIGURE 13. EU EMISSION TRADING SCHEME CARBON PRICE

SOURCE: BLOOMBERG.

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nomic growth in Colombia is expected to strengthen in 2018. This outlook continues to be supported by: (1) the recovery in oil prices, boosting investment and economic output; (2) the reduced pace of public aus-terity measures; and (3) lower inflation and interest rates, increasing consumer spending and improving credit conditions.

• Colombian Presidential elections are scheduled for May 2018. Current presidential front-runner Ivan Duque’s business-friendly economic policies might improve the country’s investment environment, though his party’s views on the FARC peace deal have intro-duced some uncertainty regarding the possible future of the peace process.

POLAND• Poland’s economy continues to expand at a rapid

pace, growing by an impressive annual rate of 4.6% in 2017. Capital Economics’ GDP Tracker, which is compiled from the monthly activity data, suggests that the Polish economy expanded by about 5% year-over-year in Q1 (April 2018). Strength in the labor market suggests that inflation is set to pick up over the course of 2018.

• The European Commission (EC) remains concerned about the rule of law in Poland and that recent re-forms to the Polish judicial system have compromised its independence. Poland has until June to settle the dispute with the EC. Potential consequences if Poland fails to comply include the loss of Poland’s EU voting rights and EU funding, potentially impacting medium- and long-term growth.

FIGURE 17. GDP GROWTH

SOURCE: CAPITAL ECONOMICS.

COUNTRY UPDATESFIGURE 16. INFLATION

SOURCE: CAPITAL ECONOMICS.

BRAZIL• Brazil’s economic recovery appears to be advanc-

ing at an increasing pace and the economy is now growing by around 2.2% year-over-year—its fastest rate since 2014. Inflation averaged just 2.8% year-over-year in the first quarter of 2018, relatively low compared to historical levels, but is expected to grad-ually climb up towards the mid-point of the 2.5-6.5% target range.

• Brazilian presidential elections are scheduled for Oc-tober 2018. The April 2018 ruling by Brazil’s Su-preme Court to imprison left-wing populist Luiz Inácio Lula da Silva (Lula), effectively ends his bid for the presidency. Lula, however, still leads in most election opinion polls, with market-friendly, fiscal reform can-didates trailing. At this stage, the presidential election field is wide open.

URUGUAY• Uruguay’s economic data was positive in the first

quarter of 2018. GDP figures released in April 2018 show that growth jumped from 1.9% year-over-year in Q3 2017 to 2.9% year-over-year in Q4 2017. After increasing over the past six months or so, headline in-flation declined from 7.1% year-over-year in February to 6.7% year-over-year in March.

COLOMBIA• Colombia’s GDP grew by 1.8% in 2017 and head-

line inflation dropped from 4.1% year-over-year in Q4 2017 to 3.1% year-over-year in Q1 2018. Eco-

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FIGURE 18. FOREIGN CURRENCY EXCHANGE RATES RELATIVE TO THE US DOLLAR, INDEXED FROM 2014

SOURCE: BLOOMBERG; GWR RESEARCH.

FX RATES• The USD maintained its relative strength in currency

markets through May 2018 compared to long-term trends. In 2018 year-to-date, Latin America and Eu-ropean currencies shown below were mixed—the Colombian peso, Brazilian real, Uruguayan peso, Euro and Polish zloty were down 1-7%, while the Colombian peso was up 6%.

• Since the currency collapse of 2014-2015, the Euro, the Polish zloty, and the Chilean peso have regained much of their relative value against the USD. In con-trast, the Colombian peso, Brazilian real, and Uru-guayan peso, remain 25-30% below January 2014 levels.

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CLP/USD EUR/USD PLN/USD COP/USD BRL/USD URU/USD

REFERENCES

ERA Forest Products Research. May 2018. Timber Prices Quarterly.

Hawkins Wright. April 2018. Forest Energy Monitor.

Hawkins Wright. April 2018. Outlook for Market Pulp.

ITTO. 1-15 April 2018. Tropical Timber Market Report, Vol. 22 (7).

Passel, Jeffrey S. and D’Vera Cohn. 2015. “Immigrant Workers in Production, Construction Jobs Falls Since 2007: In States, Hospitality, Manufacturing and Con-struction are Top Industries.” Washington, D.C.: Pew Re-search Center, March.

RISI. April 2018. World Timber Price Quarterly.

IMPORTANT INFORMATIONThe information presented herein represents the opinion of GreenWood Resources Capital Management, LLC. This material is not intended to be a recommendation or investment advice, and does not constitute a solicitation to buy or sell any product or service to which this information may relate. Any information contained herein obtained from third party sources is believed to be reliable, however GreenWood Resources Capital Man-agement, LLC makes no warranty as to its accuracy or completeness. GreenWood Resources Capital Management, LLC is a registered investment advisor and an affiliate of Nuveen, LLC.

a nuveen company

1500 SW First Avenue, Suite 1150Portland, OR 97201

greenwoodresources.comPhone: (800) 279-4509

Gwen Busby, Ph.D.Director, Economics Research

Rogelio IrigoyenPortfolio Manager

Rafal Chudy, MS

Economist

Clark Binkley, Ph.D.Chief Strategist

q1 2018 issue no. 2 - greenwood...

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