The Industry in Russia – expectations

The Russian market has undergone a lengthy decline. Starting with 2015, both the furniture and renovation sectors have experienced a clear slump, in turn driving down the general demand for panels, given both these end-use markets are crucial for such panels.

Because the so-called 'garage' and other grey businesses constitute a significant portion of the industry and evade the official analyses, no accurate statistical data for these two sectors is available. However, they can still be effectively analysed if one uses valid data from an analogous industry – cars – as a reference. The connection flows from acquiring a vehicle and/or undertaking home renovation being linked to one’s family budget. Typically, there may be only enough money either to purchase a new vehicle or to improve living conditions.

During 2015-16, the demand for new cars and commercial vehicles has fallen by nearly half compared to 2011-13 , reverting to its 2009 level. However, there are differences from the 2009 crisis: first, the current economic decline is lengthier, and secondly, the share of cars manufactured/assembled domestically has risen significantly: from 67% in 2011-13 to 78% in June 2015-16.

Furniture matches such movement, dropping from US$9.6bn in 2012 to US$5.2bn in 2015 (the figures are adjusted for those opaque businesses evading the official statistics), while the share of domestically manufactured products has risen slightly: from 63% in 2012 to 65% in 2015. In spite of its insignificant growth to date, domestic output continues to expand and may have exceeded 70% by 2016 (Pöyry’s internal analysis).

Similarly, the laminate flooring segment dipped to approximately 79 million m2 in 2015 from 83 million in 2012, whereas the share of Russian laminate flooring has increased from 46% to over 60% during 2012-15.

This trend is forecast to continue. As with 0autos, the drop in usage is understandable given the downward spiral in GDP (-3.8% in 2015). Growth in new housing contradicts such downturn. However the utilisation of furniture and renovation materials within the new residential construction market is minor relative to that in the repair and maintenance sector. Thus, new residential growth is not the determining factor for growing (or forecasting) furniture and renovation markets.

Current expectations for when the economy rebounds are not very promising. A further 1% decline in GDP is expected in 2016. The IMF forecasts the Russian economy will take until 2020 to recover to its 2014 level. Such a growth rate would be the second worst among the world’s top 25 economies. Only Argentina (100.3%) is expected to be worse.

Export Opportunities – Over View

Russian exporters have dramatically improved their positions since late 2014, with the ruble depreciation being primarily responsible.

Over this relatively short time period the competitiveness of the Russian forest industry has improved for ex-works deliveries. Such improvement can be as much as 150% for certain cost items compared to competitors who operate in euro or US$ zones. In Q3, 2014, the average exchange rate was 48.1 RUB/ EUR and 36.3 RUB/US$. In Q1, 2015, the ruble dropped 48% to 70.3 RUB/EUR and by 74% to 63.1 RUB/US$. Producers in Ukraine and Belarus found themselves in a similar situation, as prices for key cost items expressed in local currencies (such as labour, wood, energy) remained almost unchanged, while those for non-domestic items (eg resin) increased significantly (although below the increase in exchange rates).

How long is this situation going to continue? Can one realistically expect any significant changes before 2020? These two questions are difficult to answer, even if one assumes that the political environment inside and around Russia is stable during this time frame. The price of oil is the key uncertainty (besides political stability and factors relating to the investment climate). Oil has become the lynch pin for exchange rate behaviour, and its uncertainty is especially acute.

A high scenario of US$90-100 per barrel, and a low scenario of US$20-30 per barrel, should both be viewed as not improbable. A steady growth of the Brent price to US$60 per barrel until 2020 is the basic assumption that Pöyry currently uses for its management consulting projects. In this case the ruble exchange rate in real terms (ie net of inflation) 'should' reposition to around 50-55 RUB/US$. This would somewhat erode the current benefits realised by Russian exporters but is expected to be compensated for by the improvement in domestic demand.

Impact On Wood Based Panels

Let us briefly assess the demand and supply balance for basic wood based panel types in the Russian market and how the general economic situation impacts this industry’s development.

• Particleboard is the major wood based panel produced and consumed in Russia. In 2015, production reached 5.3 million m3, whereas consumption equalled 4.7 million m3. From the start of 2015 through the first half of 2016, production levels remained flat, growth being as little as 1.1% (after adjusting the Rosstat data).
• Official Rosstat data does not reflect the production of particleboard in a clear manner, as it is published in equivalent m3, plus some of the figures actually refer to OSB. Said data reports 2015 production declined by 0.2% year-on-year, equating to 6.8 million m3. However, the true decline was 4%, with production being the 5.3 million m3 noted earlier.
• Net exports (the amount by which exports exceed imports) grew 14% in 2015 to 0.6 million m3, after adjustments. Russia’s net exports can further increase, driven by the current in-country low demand (and reduced prices).
• Russian pricing remains at an extremely low level; nearly all mills operate at or below their break-even point. The situation is expected to result in a significant number of small mills closing, with remaining production becoming more consolidated.

Russia’s top five particleboard producers have a unit capacity of 0.4 to 0.8 million m3/ year and a combined capacity of 2.7 million m3/ year. These five lines are responsible for onethird of Russia’s total particleboard capacity.

Four of them were commissioned after 2005 and belong to western companies (Kronospan Group, Egger and IKEA). Another third of total capacity comes from lines in the 0.15-0.4 million m3 size range, while the remaining 33% are lines smaller than 0.15 million m3. Note that half these small lines are more than 30 years old, meaning there is potential for large-scale decommissioning due to attrition in the coming years. Operational efficiency will be the key survival factor.

• MDF: Over the past 10-15 years, MDF panels have been rapidly gaining a foothold in the Russian market. In 2015, production accounted for approximately 2.0 million m3, nearly equal to the consumption level. 2016 is expected to see a minimum 10-15% growth in production and a nearly similar increase in net exports.
• Official data on MDF published by Rosstat is virtually meaningless, as it is expressed in equivalent m2, while no coefficients accepted by all producers exist to translate this into commonly-used units; nor is there a clear classification that would appropriately distinguish between MDF and other fibreboards.
• 2015 net exports went positive for the first time since 2009, reaching some 0.1 million m3. A further growth of net exports in 2016-18 seems inevitable, as new lines will eventually reach design capacity, in spite of relatively low domestic demand for MDF.
• Pricing within Russia remains depressed, influenced by total MDF capacity increasing from 2.6 million m3 in 2014 to 4.1 million m3 in mid-2016, given several new large-capacity lines came on-line almost simultaneously. This should result in prices declining further.
• Russia’s top five MDF lines each have a unit capacity of 0.4 million m3 or more, with their total output equating to 2.2 million m3, or just over half of all MDF capacity countrywide.

Only one of these lines – Swiss Krono in Sharya – is more than 10 years old, whereas the others have been commissioned during 2014-2016! Four of the top five lines belong to western owners: Kastamonu, Egger and Swiss Krono. The large MDF lines command a much greater market share compared to the particleboard segment, while having a weighted average age of only six years. This does not provide any space for the industry to remain in balance through attrition.

Thus competition is expected to increase dramatically in the coming years, given that total production capacity exceeds four million m3, whereas current demand is only two million m3.

• OSB is the fastest growing panel market in Russia, both in terms of production and consumption. The first Russian OSB mill came on line in 2012, when consumption had already exceeded 0.5 million m3. Starting with 2013, imported OSB panels have been steadily replaced by domestic products. In 2015, OSB production reached 0.7 million m3, double that of 2014; consumption was about 1.1 million m3.
• 2015 domestic production more than doubled versus 2014, whereas consumption increased by one-third.
• 2016 should see further production growth, driven by the expanding utilisation rate of newly-commissioned mills, as well as by the start-up of a new line in Torzhok (Taleon Terra, 0.5 million m3/year). In 2017, yet one more line is forecast to come onstream in Ufa (Kronospan Group, 0.5 million m3).
• Russia’s net imports of OSB have always been positive, given internal production began only recently. Net imports can decrease dramatically in the coming years or even go negative, as the domestic installed capacity significantly exceeds the current internal demand.
• Pricing in Russia is significantly lower, by 15- 20%, than in Europe. Exporting appears to be an economically viable sales option for all Russia’s large mills; Russia may very soon become a net exporter of OSB panels.
• Russia’s total OSB capacity in 2015 will equate to 2.0 million m3/year on the start-up of mills in the Tver region and Bashkortostan, with domestic consumption of 1.1 million m3/year. Russia will then have four large OSB lines (the annual capacity of each is 0.5 million m3) and three small ones, each with a capacity around 0.2 million m3. The weighted average age of Russian OSB mills is less than two years!
• Plywood is one of the key wood based panels exported by Russia. In 2015, production reached 3.6 million m3, of which birch plywood accounted for about 3.3 million m3. The year-on-year growth was only 1.8%, compared with over 11% during 2010-14. Consumption fell to 1.5 million m3 against 1.7 million in 2014.
• With imports being close to zero, exports grew to slightly below 2.2 million m3 in 2015, up from 1.9 million m3 in 2014.
• Birch plywood production is expected to increase by a further 3-4% in 2016 and to continue growing during 2017-20, mainly driven by start-up of new capacity.
• Sveza is the largest birch plywood producer in Russia (and globally), with the company’s six mills accounting for 1 million m3, or nearly one-third, of Russia’s total 2015 production. About 20% of the country’s production comes from the next top five producers .
• Competition driven by the growth in supply of OSB, as well as concerns over the longterm availability of high quality plywoodsuitable timber, pose major obstacles for plywood producers.

The importance of this final factor will grow in the future. It is unique to the plywood sector given that the remainder of the wood based panel industry can rely on wood of virtually any quality.

Conclusions and Opportunities

The next two to three years will not be easy for Russia’s particleboard, OSB and fibreboard producers. In practice, not a single manufacturer can feel fully comfortable.

However, short- to mid-term problems for manufacturers offer opportunities for investors with experience in the industry. In the coming two to three years, many good assets might be open for sale or partnering.

Country-specific risks are not low, but in case of an acquisition of existing mills the risks are still lower than for a greenfield investment.

Birch plywood production is a different case, being in a relatively more comfortable position. The key limiting factor for the growth here is not the market situation but potential lack of high-quality birch logs.