Has pessimism gone too far in region's panel markets?

This is not to say that the condition of forest products markets in the US is not critical. The sub-prime mortgage crisis has triggered a landslide of defaults and foreclosures and these will get worse before they get better (starting after mid-2008). Greedy lenders over-played their hand and are now paying for their excesses, but the fall-out for the broader construction industry, the people who work in it, and its suppliers, has made them unfortunate victims of these excesses.This market correction is particularly nasty (comparable to that of 1980-82), but housing starts will not drop to zero, and markets will recover as they always have done (Fig 1).   Housing markets the key Most readers are familiar with the negatives facing the US housing market; high inventories of unsold new and existing homes, falling prices, tighter lending requirements, a US economy in or close to recession, higher inflation resulting from oil at over US$100/barrel and surging food prices. These factors will combine to make US recovery slow and hesitant, at least in its early stages. However, there are positive factors supporting housing. First, the underlying demand remains strong and growing (unlike the early 1990s when the demographic underpinnings for housing were still weakening). US housing demand through at least the middle of the next decade will average 1.90 million units per year or higher. In contrast, total housing production in 2007 fell to 1.44 million units (single family, multi-family and mobile homes) and will flirt with the one million mark in 2008. Consequently, the excess production recorded in 2004-5, of approximately 500,000 units (2003 and 2006 housing production were each close to underlying demand), was largely offset by the 2007 shortfall of around 450,000 units. In 2008, housing production will be 750,000 to 900,000 units below underlying demand, and a shortfall of at least 250,000 units can be expected in 2009, even as housing markets recover. On the other hand, if US housing remains weaker than expected in 2009, then this shortfall will be even greater, resulting in even higher probability of a strong rebound subsequently. The resulting cumulative production shortfall of over a million housing units constitutes pent-up demand which will positively impact housing markets - and wood panels demand - after 2009. Housing production will therefore again exceed the two million mark (most probably in 2010-2011) as contractors struggle to meet underlying demand. The benefits of such a recovery for North American wood products demand are obvious. Critics will argue that this housing bust is different. That is true; all cycles have their unique characteristics, but the foundations for a turnaround are already being laid. Mortgage rates are not high; qualified buyers can secure a 6%, 30-year fixed-rate mortgage, while adjustable rate mortgages are available at still lower rates. By historical standards, these rates are not a barrier to market participation. Falling home prices will be a boost for demand as buyers take advantage of a 'buyer's market'. The aggressive cutting of interest rates by the Federal Reserve and the fiscal boost being provided by the Federal government will haul the US economy out of recession after mid-year and overall housing activity will consequently be in recovery before the year's end. If oil prices tumble from their early 2008 record highs before the year-end (highly likely given the level of speculative activity in the oil markets), then the US recovery will be boosted as inflationary pressures abate and consumer confidence rapidly recovers.   North American panel markets For many market participants outside the region, the North American obsession with housing may be hard to comprehend. However, unlike Europe, Asia and Latin America, where the primary markets for wood panels are more evenly divided between all end-use markets, in the US new residential construction and repair, remodelling and additions together often constitute more than 80% of total domestic market demand for products such as OSB or wood I-joists. Wood panels are either used directly in construction (in the typical wood-frame house system employed in North America) or in furniture and fixtures installed or purchased for a home. The two-year drop in consumption resulting from lower levels of housing construction has been reflected in lower production and imports. The pattern being experienced in 2007-8 is not new, though; these cycles have all been experienced several times over the past 40 years. Given our preliminary estimates of 2008 structural panel production (OSB plus softwood plywood), the peak-to-trough fall will be 21%, similar to the 19% decline recorded 1978-1982, but greater than the cyclical declines recorded 1988-1991 and 2000-2001 (Fig 2). For the OSB industry, this is the first economic cycle where the drop in economic activity has overwhelmed growth in market share, resulting in an estimated 17% peak-to-trough drop in North American production (Fig 3). This drop, in combination with a surge in new capacity, largely explains the angst being experienced in the region's OSB industry. Meanwhile, North American softwood plywood production of little more than 11 million m3 in 2008 will be 27% off from 2005, and 51% lower than the peak of 22.6 million m3 recorded in 1987. Non-structural panel (particleboard and MDF/HDF) demand will also suffer a significant cyclical retreat through 2008. However, this drop reflects a more complex story than for structural panels. Even during the housing boom of 2003-6, particleboard production dropped as the attrition in the North American furniture industry cut into the single largest end-use market for particleboard and MDF. In contrast, thin panel (HDF) production edged higher even as output of thick MDF slipped. Initially, the drop in thick MDF was mitigated by growth in mouldings but this strength has atrophied over the past two years, along with the housing market. Consequently, particleboard production in North America will experience a peak-to-trough drop of 20% between 2005-8, while MDF's loss will be a more moderate 12%. More significantly, particleboard production in 2008 will also be 27% below its 2000 peak, reflecting the drop in furniture production since the late 1990s.   Forecast outlook 2008 will be an atrocious year for the North American wood products industry, but recovery in demand and prices should be underway before the year's end and will strengthen in 2009. This recovery will re-establish profitability and several new production and consumption records will be set in 2010-11 (Fig 4). Currently, there is little or no more downside risk; prices are already below cost and most of the decline in consumption has already occurred. At this point, the main issue is too much supply. The attitude of producers needs to be, "If I don't have an order, I don't produce". Piling product into warehouses is equivalent to 'shooting yourself in the foot'. Extended indefinite capacity closures, short-time working and intensive management of inventories will enable pricing to recover to at least cash-cost levels and provide opportunities for moderate profitability in periods of seasonal strength during 2008. Sustained recovery in production will not be justifiable until there are clear reports of increased housing activity and general strength in the economy. Such strength is unlikely to show before the spring of 2009, at which point a combined cyclical recovery and the seasonal upswing will help propel wood panel markets out of the abyss and into the sunlight.