Where will all the capacity go?

When Canadian structural panel manufacturer Grant Forest Products Inc announced in June that it planned to build two greenfield OSB mills in South Carolina, it brought the number of new plants or major capacity expansions in the North American structural panels industry announced so far this year to eight.
Most industry watchers expect some of these projects to fall by the wayside, but add together the total volumes of the confirmed or very likely new mills and major expansions (excluding two potential mills in British Columbia and the Chatham Forest Products project in New York, all of which Ainsworth’s Lumber Co Ltd is considering launching) and North America is looking at around eight billion ft2 of additional OSB capacity in 2008, by when most economists, within and outside the industry, expect the North American housing market to have receded from the record highs of 2004.
Forest industry analysts in the US and Canada, concerned about the effect on share values of companies heavily exposed to OSB, have questioned whether the sector has any self-restraint. At the very least, it seems to be fuelling its ‘feast and famine’ reputation, and the surge in capacity is likely to slash OSB prices from the healthy levels seen in 2004 and much of this year.

Private firms lead growth plans
In fact, the biggest players have been very restrained in re-investing the massive profits they made on the back of the OSB boom.
Louisiana-Pacific Corporation (L-P) and Norbord Inc (total North American capacities 5.8 billion ft2 and 3.7 billion ft2, respectively) each have only one major capital project under way: L-P’s new mill in Alabama and Norbord’s Cordele, Georgia, expansion. Similarly, Weyerhaeuser Co, which has total OSB capacity of 4.1 billion ft2, has not made any out-of-the-ordinary capital expenditure announcements in this sector; most of the new capacity announcements so far have been made by private companies including Grant, Ainsworth, Tolko Industries, and Huber Engineered Woods.
L-P is still the largest manufacturer by some margin, with 13 facilities in the US and Canada, rising to 14 when its joint venture with Canfor Corp comes on stream in Fort St John, BC later this year.
The company is openly acquisitive – indeed, for more than a year L-P’s executives have expressed their frustrations to industry analysts at the lack of OSB acquisition prospects at the right price.
L-P’s US$0.125 per share dividend announcement on August 8 fuelled speculation by Vancouver-based forest industry analyst Paul Quinn that L-P could be “taking a hard run at a potential acquisition– most likely Norbord. Mr Quinn, of Salman Partners Inc, observed in a research note, that at the end of the second quarter, L-P had almost US$1.3bn in cash or short-term investments on its balance sheet, “or the equivalent of US$11.60 per share in cash.At the end of quarter 2, 2005, he noted, “L-P’s cash position exceeded its debt by almost US$550m.”
Mr Quinn had expected L-P to issue a special dividend of one to two dollars per share after its board meeting on August 5. The fact that the special dividend did not happen, and that there was no increase to the regular dividend, combined with comments by L-P’s ceo Rick Frost during a Q2 conference call on July 27, suggested L-P could be planning to use its surplus cash for an acquisition.
“We have long suspected that Norbord is the probable target, given its size, the willingness of Brascan to sell its ownership interest and potential operational synergies,Mr Quinn said.
In addition to giving L-P a greater than 40% share of the North American OSB market by the end of 2006, he said, purchasing Norbord: “would allow L-P to permanently close or sell its older firstgeneration OSB mills and avoid the significant capital expenditure in the balance of 2005 and 2006. Also, the acquisition would result in substantial operational efficiencies and would give L-P increased pricing power in the marketplace.”

Cautious approach
Norbord or not, L-P’s acquisition aspirations/expectations, and the need to conserve its cash, could go some way to explaining why, amid the OSB boom, the largest producer has announced only the one 700 million ft2 new mill in Alabama, due to go on stream in 2007.
This mill was announced in early May 2004, well before the latest rush of new capacity announcements. At the same time, L-P revealed it was converting its Hayward, Wisconsin, OSB mill (capacity 500 million ft2) over to producing SmartSide siding. Since then, several other players have indicated they are likely to include ‘valueadded’ products in their OSB capacity growth – a trend that could prove to be critical should commodity OSB supply and demand get out of balance.
In an interview with Forestweb earlier this year, L-P’s vice president for OSB, Jeff Wagner, did not seem overly concerned about all the new production.
“It’s a cyclical market. It always has been,he said. “Structural panel producers know how to manage that.”
Mr Wagner also said some of the proposed or rumoured new mills could get pushed out into later years, and even if they did not, plywood producers would likely be squeezed first – not just by increased OSB capacity, but by the investment needed to meet the new MACT (maximum achievable control technology) regulations which come into force early next year – cited as a factor in L-P closing its Woodland, Maine, OSB mill in April.
According to Paul Quinn, the most  likely OSB projects to be delayed or aban-doned are  at least one of Ainsworth’s two in British Columbia and the proposed Lisbon, New York, mill.
However, as we went to press, it was announced that Ainsworth had completed its acquisition of Chatham Forest Products, together with the necessary permissions for the New York mill.
Ainsworth’s acquisition of Voyageur Panel, closely followed by the three Potlatch Minnesota OSB mills last year, pushed its OSB capacity up to 3.3 billion ft2 (including half the 820 million ft2 output of its Alberta joint venture with Grant, Footner Forest Products) and gave it a huge boost up to fourth in the North American OSB league table.
But Ainsworth’s executive vice-president Michael Ainsworth has insisted the C$200m investment to add a 600 million ft2 second line at Grande Prairie, Alberta, was the only concrete capital commitment this year, and that it would only embark on further projects as each one is completed.
So although Ainsworth says it has already secured harvesting rights for Crown timber to feed its proposed OSB mills in Quesnel and Prince George, with a combined capacity of 1.5 billion ft2, there are no guarantees they will be built, even if accepted by the provincial government.

Some attrition expected
Grant’s two new South Carolina mills, on the other hand, each with a capacity of around 800 million ft2, are a fairly safe bet. New York-based forest industry analyst Chip Dillon of Citigroup Smith Barney observed at the time of Grant’s announcement that the company claims to have no debt. It also owns about 30% of Ainsworth, although it has no board representation and claims no influence, he said.
In a June interview, Grant’s executive vice-president Peter Lynch said the mills would both produce commodity grade OSB, though Grant produces a mix of value-added products at its Canadian mills and will look at making value-added products in South Carolina also. “We’ll have the technology to produce value-added, but primarily they will, at least initially, be focused on commodity grade,he said.
Even if not all the new capacity announcements result in product ‘hitting the street’, Mr Lynch acknowledged there was likely to be “a material increase in supply of OSB over the next 12 months.”
After what he called “a fallow period in North Americaof very little investment in new mills in recent years, Mr Lynch said the additions would “inevitably impact on the market”. Although expecting increased demand in terms of housing and house sizes in North America, he expected “some attrition in the panels industry as a whole…We go through a period of indigestion and then through a period of digestion, then we move forward”.

A long-term view of the business
He also noted that the nature of capital investment into OSB facilities meant planning and building them could not be governed by short-term market conditions, adding: “This growth is something that we have had in mind for quite some time.”
Vernon, BC, based Tolko Industries Ltd has now selected the proposed site for its new 800 million ft2 OSB mill near Slave Lake in Alberta – about five kilometers east of the company’s existing Slave Lake OSB plant. Tolko had confirmed on June 23 its intention to build a new mill at Slave Lake, at a cost of more than C$200m, as part of a major expansion of its Alberta facilities announced last December.
Construction of the new Slake Lake facility is due to begin next spring with a view to completion by summer 2007.
When Tolko announced its plans for Slave Lake in June, Dave Knight, its regional woodlands manager for High Prairie, Meadow Lake and Slave Lake, confirmed the company’s existing 240 million ft2 Slave Lake mill would convert over to producing value-added products.
Intriguingly, in a statement on its website dated August 5, Tolko described the new mill as an “Engineered Wood Facility (EWP)”, suggesting possible value-added products there, as well as commodity OSB.
Tolko’s Sheila Catlin confirmed on August 18 that the wording of the August 5 statement, using EWP, was “carefully chosen”. When asked if it was possible value-added products might be produced in addition to commodity OSB at the new mill, she said: “potentially yes”. Ms Catlin confirmed the plan at present was still to convert the original Slave Lake mill over to value-added production.
When Tolko announced its plans, it also said it had entered into an agreement with  Buchanan Lumber to develop a valueadded hardwood plant near High Prairie, Alberta. Mr Knight said that plant would produce hardwood veneer and had possible implications for development of valueadded products at High Prairie OSB mill.
Elsewhere, since announcing on March 14 it planned to build a new 700 million ft2 OSB mill in South Carolina or Georgia, Huber Engineered Woods has provided no further details, though, being a notoriously private sort of private company, that doesn’t mean its intentions have changed.
Montreal-based Kruger Inc, since towards the end of last year, has been neck-deep in controversy over its plans to build a 750 million ft2 OSB plant in timber- starved northern Ontario to replace its Longlac plywood and waferboard mills, and Ced-Or Corporation claims progress with the funding of its planned new, albeit small, mill in Temiscamingue, Quebec.
Meanwhile, the availability of huge volumes of timber in British Columbia as a result of the raised annual allowable cut in the Interior by 27% to deal with the mountain pine beetle epidemic makes the province an investment hot-spot right now for wood processors not dependent (as sawmills are) on good quality wood.
The licenses Ainsworth gained to feed its two BC plants are for Crown timber available as a result of the beetle epidemic. It would be surprising if other companies were not also looking to the same source.

Canfor plans more value-added
Canfor Corp – Canada’s largest, and the world’s third largest, lumber producer – recently announced its intention to move, through acquisition or joint ventures, into more value-added or engineered wood products. And although the company has not suggested it is planning to move more strongly into OSB, the possibility surely can’t be ruled out.
Canfor today has just one OSB mill, PolarBoard at Fort Nelson, BC, acquired as part of its merger with Slocan Forest Products last year. It has a capacity of 535 million ft2 and was undergoing a C$26m upgrade to increase that to 650 million ft2.
By the end of this year, Canfor will also have its share of the 820 million ft2 Fort St John, BC, joint venture with L-P; and it has plywood capacity of 440 million ft2.
When announcing Canfor’s first quarter 2005 financial results, ceo Jim Shepherd said it planned to broaden its geographic customer base into new markets, and provide its customers with the “one-stopshopthey are asking for – which means supplying them with a whole range of products in addition to lumber.
Canfor has specifically mentioned possibly I-Joists and LVL, though with the modern American home requiring 16,000ft2 of panels and 7,300 linear ft of other engineered wood products, according to a presentation Canfor gave to analysts in May, it is not inconceivable that structural panels might feature in its plans.
Most OSB manufacturers will not generally admit to being concerned about the looming production growth; most say they just get on with the business of selling OSB from their own mills to meet current strong housing market demand.
A spokesperson for Langboard Inc, which expects to have its new OSB line at Quitman, Georgia, up to full capacity in early 2006, increasing production to 440 million ft2, said in an interview earlier this year the company had little concern about any shortage of demand, notwithstanding the new Georgia-Pacific Corporation mill in Hosford, Florida, which came on stream in May, or the fact that a lot of the proposed new capacity is in southern US.
“Our major market is the extreme southeast – Florida and Georgia mainly. You can’t tell what the market will do from day to day, but there’s plenty of places for it [the OSB] to go,he said. “The market’s a pretty elastic place, and the market we have close to us is pretty flexible and pretty strong.”
Certainly current economic indicators do not suggest an imminent downturn in US housing – the key OSB demand driver.
Although sales of new single-family homes edged down in August, the Washington, DC, based National Association of Homebuilders (NAHB) insists builder confidence remains strong.  And existing-home sales were at the highest  pace on record in the second quarter  of 2005, according to the National Association of Realtors (NAR).
The latest figures from the US Department of Commerce, released on August 24, estimate that July home saleswere up 27.7% on July 2004, and up 6.5%on the June 2005 rate.
However, there are concerns that some regional US housing markets are overheated, with diminishing affordability, particularly for first-time buyers, and that this could lead to a dramatic market correction when interest rates begin to rise in earnest.
In a research note in May, Paul Quinn suggested the housing markets of California, Florida and parts of the eastern seaboard were likely to see a rapid price fall when and if the current US housing boom starts to flag.
Even without a dramatic fall in those major housing markets, most economists expect a decline in housing this year and next from their record 2004 highs.
The APA forecast in April that housing starts this year will total 1.885 million, down about 3.5% on last year. New residential construction represents more than half total panel demand, and in the US and Canada combined is forecast to consume 23.3 billion ft2 of structural panels, including 17 billion ft2 of OSB and 6.3 billion ft2 of plywood.
APA’s forecast in the longer term is for 21 million housing starts this decade, compared to 18 million during the 1990s. That should result in an additional 35 billion ft2 of structural panel demand, or 3.5 billion ft2 more per year than during the 90s.
Without even taking into account the impact of structural panel imports – softwood plywood and OSB imports last year totalled 1.89 billion ft2, representing 4% of the North American market, and are expected to reach 2.4 billion ft 2 by 2010 – it is hard to see how the additional eight billion ft2-plus in capacity due to come on stream in 2007-2008 can be absorbed.
“We expect that OSB prices will fall back to cash cost levels in 2006,said Mr Quinn, noting that “a significant housing market correction will bring OSB prices and earnings [of OSB producers] back to normalised levels in a hurry.”
Even if housing starts could “possibly be back up in 2007”, it would not be enough to absorb “five to six billion ft2 of active capacity,APA director of market research Craig Adair said in an interview in March – before the news of Norbord’s Cordele expansion and the Grant and Tolko mills added another three billion ft2.
Mr Adair predicted the closure of more plywood mills and older OSB mills.
“I’ve never been good at predicting OSB closures, or which plywood plants will close,he said, “but surely by 2007 some of the smaller mills will be hard pressed to survive.”