The continuing story of the amazing Chinese panel markets

The late-2008 boost to spending and consumption in China provided by massive spending on infrastructure and other labour- and material-intensive schemes was reflected in 2009 by a rapid acceleration in economic activity, particularly in the second half of the year and into 2010.

From rates of around 6% in late 2008 and early 2009, GDP growth accelerated to close to 12% in the first quarter of 2010 before settling back to a somewhat slower, albeit still double-digit, pace through much of the rest of the year.

The global benefits of China’s rebound were especially apparent to commodity producers around the world. Close to 5% global GDP growth in 2010 would not have been possible without China’s successful stimulus policies.

However, during 2010 we saw fears of property bubbles and inflation reignite in China. Chinese authorities took several steps to defuse a potentially dangerous property bubble and to rein in rising consumer inflation. At year-end, it was not clear if China’s government had successfully met these concerns.

Strong growth in the developing world has boosted inflation fears, not only in Asia but also in Europe and Latin America as 2011 began.

Discussions of inflation that focus on ‘core inflation’ alone do a disservice as they tend to be too sanguine; food and energy are indeed part of every household’s living costs and the volatility in these costs cannot be simply treated as an aberration of little consequence.

Higher oil and road fuel prices have the same effects as any tax increase; they reduce consumer spending on other products and services. Volatility in oil and food prices damages consumer confidence. The danger for the fragile developed world economic recovery in particular is that higher overall inflation in the face of slow wage/salary growth will quickly result in another wave of retrenchment and slower economic activity.

However, higher inflation in the developing world than in the developed world (along with currency appreciation against the US dollar and euro) will help adjust relative production costs, thus re-balancing international trade. But this adjustment will take place only over the medium- to long-term and will initially do little to reverse the deteriorating trade and fiscal deficits of the US and Europe.

Economic growth slowed in China through 2010, but as the year ended, inflation was continuing to build. The question for China-watchers is whether the fear of inflation will outweigh fears of slow employment growth. If so, this shift will result in continued increases in domestic interest rates and more restrictive economic policies designed to reduce inflation.

Following GDP growth for the whole of 2010 of approximately 10.5%, growth is forecast to slow to 9.6% in 2011. There is a large risk that growth will deteriorate more than anticipated if policies are tightened more than the consensus assumes. Growth of one to two points lower than forecast (dropping to around 8%) is possible before the year-end.

It is estimated that China’s industrial sector grew by over 14% in 2010, following a relatively subdued increase of 11% in 2009. Furniture production also rebounded in 2010, though our preliminary estimates would indicate slower growth than for overall industrial output . For furniture, an increasing share of production was dedicated to servicing the domestic market.

Getting a good reading on Chinese real estate markets is never easy, particularly the need to distinguish between new construction and sales/purchases of housing and non-residential structures.

Over the past few years in China, there have been major swings in construction activity that were not directly tied, for example, to purchases of apartments. The huge swings in real estate vacancy rates impact our estimates of wood product consumption in construction end-use markets, particularly for wood product demand for finishing (as distinct from wood demand related to concrete forming and so on).

The assessment of Cambridge Forest Products Associates is that we witnessed another large inventory swing in 2009-10, resulting in significant excess inventory of residential units in the second half of 2010 as buyers reduced purchases in the face of higher interest rates and more restrictive policies designed to limit speculative activity. Consequently, forecasts for housing and nonresidential construction activity in 2011 need to be cautious as fears of property bubbles and restrictive policies will likely limit growth here.

Panel production
Questionable data are not confined to the macro-economic sphere. China’s State Forest Administration reports annually on production of forest products, including panels and lumber. Data for 2009 were surprisingly strong, given the weak economic environment early in the year. Rather than dropping year-on-year, total reported production in 2009 jumped 18% to 105 million m3.

Several observers have questioned the accuracy of this report, wondering, for example, about possible double-counting of plywood and blockboard production.

Possibly the 2008 data under-reported production and thus over-stated the increase between 2008 and 2009. Also, the reported data would support the contention that there was a massive inventory swing between 2008 and 2009 and that consumption was probably substantially higher than production in 2008 (as inventories were liquidated) and lower than production in 2009 (when inventories were at least partially rebuilt).

For 2010, the forecast calls for a moderate drop in total panel production to 100 million m3, largely reflecting a drop in plywood output. However, this projection needs to be treated with caution; we would not be surprised to see that total panel production climbed at least 5% over 2009’s record levels!

Plywood is projected to remain the largest-volume panel produced in China, closely followed by MDF/HDF. Blockboard output is also expected to climb (as a domestically-made replacement for poor quality lumber) and particleboard production seems to be gaining, despite Chinese consumer preference for MDF.

Panel exports
Rising production of panels has been supported by a recovery in exports, particularly of plywood and MDF/HDF, from the cyclical lows recorded in 2009. Total 2009 Chinese panel exports of 8.33 million m3 represented 8% of total production, but this share was down from 13.5% in 2007. The export share should recover to around 11% in 2010 as exports rebound to at least 11 million m3.

The fastest growth in panel exports is in MDF/HDF, but plywood remains the largest-export panel product, exceeding MDF/HDF by a factor more than two.

Panel Consumption
Chinese consumption (domestic plus export) of panels survived the Great Recession surprisingly well (at least given the reported production data for 2009).

After climbing rapidly through 2007 to a record 86.9 million m3, total panel consumption (plywood, blockboard, MDF/HDF and particleboard) edged slightly higher over the next two years to 87.5 million m3 in 2008 and 90.2 million m3 in 2009. By Chinese standards these increases were relatively insignificant, but compared to most other panel markets, the ability to record an increase, rather than a significant drop, in 2008-9 was notable.

China returned to a more ‘normal’ growth path in 2010. Estimated consumption of over 101 million m3 was 13% above 2009, continuing the sequence of record-breaking years set over the past decade.

While our forecast continues to call for growth in consumption over the coming two years, we have tempered growth rates to reflect the less-than-certain economic environment expected in that period. This forecast is deliberately conservative and we would not be surprised to see significantly higher consumption.

Nevertheless, as the Chinese economy matures, it has to be expected that the extended string of back-to-back years of double-digit growth in wood based panels will be broken and that growth rates will moderate. However, consumption of 107.8 million m3 in 2011 and 116 million m3 in 2012 will still represent annual growth of 7% and 8% respectively; a robust growth rate by almost any other market’s standards!

Turning to the individual panel types consumed, plywood will remain the largest category, but with the slowest growth rate. From 34.2 million m3 in 2009, consumption in domestic and export markets will rise to around 40 million m3 by 2012 (+17%).

The second largest panel product will remain MDF/HDF, consumption of which will climb 30% from 30 million m3 to over 39 million m3 (approaching plywood volumes, but probably not exceeding them until after 2012).

Particleboard volumes are expected to jump from 11.5 million m3 to 17.6 million m3 over the 2009-12 period (a 53% increase), while blockboard records an increase from 14.5 to 18.1 million m3 over the same period (+25%).

We will be refining our forecasts for the Chinese panel markets over the next several months to better understand the intra-panel market dynamics briefly discussed here. It is our suspicion that revisions to our outlook are more likely to be on the up- than the down-side.

However, the basic story of slowing growth as markets mature will remain in place, reflecting the flattening growth rates in construction and furniture markets in particular. Wood based panels cannot be expected to buck this long-term macro-economic trend and Chinese panel producers will need to further adjust their business strategies over the coming decade to meet the changing reality.