Supply Disruptions Drive Lumber Prices
By lynn Michaelis
In this update, I needed to shift the focus to lumber prices. Since the overall economy is pretty much on track with the last update published in the January-February 2018 issue, I wanted to spend more time on the one situation that is much different than expected and important to pallet producers—the high lumber prices. I will return to the general economy for a brief update on wages and interest rates later.
So, why are lumber prices so high? At the end of 2017 lumber prices moved up dramatically. Initially the increase in prices was thought to reflect the forest fires and the imposition of the import duty for Canadian lumber shipped into the United States. The surge was expected to be temporary, but prices have gone even higher in the first half of 2018.
As mentioned, two factors pushed prices higher in 2017. First, there were massive forest fires, particularly in western Canada that curtailed production and logging. Second, there was the 20% duty imposed on U.S. imports of Canadian lumber. According to Random Lengths, the price for Canadian lumber represented by the Western Spruce Fir (SPF) 2x4 price jumped from $310/thousand board feet (mbf) in January of 2017 to $460/mbf in December. The 48% jump in prices was a bit shocking, but could be explained by those two factors. With demand expected to remain relatively flat and a rebound in production given high profit margins, market prices were expected to fall back to levels consistent with underlying production cost in 2018.
But that did not happen. SPF prices moved even higher this year. The last report by Random Lengths puts the SPF 2x4 market prices at $598/mbf—or roughly double the price in early 2017. The U.S. lumber prices (Douglas fir green 2x4 and the Southern Yellow Pine 2x4) have followed.
The culprit for the surge in price is not higher lumber demand. The domestic consumption for lumber in the U.S. and Canadian markets has not increased that much in 2018. With housing starts expected to continue improving at slow rate, demand does not go much higher in 2019 either.
Part of the increase in domestic demand has been offset by declines in lumber exports to China. Russia and New Zealand have been displacing U.S. and Canadian lumber in that market due to the higher prices.
The surge in prices is also not due to extremely high operating rates. Lumber capacity in North America (U.S. plus Canada) is estimated to be about 75 billion board feet. With demand near 68 billion board feet, the operating rate is about 88%. Historically, it takes operating rates well above 90% to sustain the kind of high prices currently being experienced.
This leaves industry analysts groping for some good explanations as to why prices have moved this high. Several factors appear to have created this severe shortage and are also making it difficult to correct the problem. First, not only did the forest fires hurt production in 2017, but because of the severity of the fires and large areas involved, it has been difficult rebuilding log inventories. Second, the industry is struggling with labor shortages. In line with other small businesses, the industry is having a tough time finding loggers and mill workers at the current wage levels. Thus, logging and mill output has not been able to ramp up despite high profit margins. Third, the inventory in the distribution channel has been depleted and is extremely low relative to sales. Finally, there have been transportation disruptions (particularly getting train cars) that have made it difficult to restock those inventories.
These high prices are not sustainable, however. The prices will lead to higher production eventually. Given the high profit margins, producers are scrambling to find ways to increase output. Several major plant expansions have been announced in the U.S. South as well. Prices should fall back to levels consistent with the overall operating rate and production costs later this year or by early 2019.
Economic Outlook: Labor Shortages Lead to Higher Wages and Eventually Higher Interest Rates
As mentioned earlier, the economy is pretty much on track. The overall economic growth as measure by Gross Domestic Product (GDP) is up nearly 3% since last year. Consumer spending remains very healthy. Spending by business on investment has also picked up. Government spending is finally positive as well.
As discussed in the last update, industrial production of manufactured goods continues to do well. Growth has been very strong over the last 6 months and is up 2.5% from year ago levels.
Everything is pointing to strong economic growth to continue through 2019. Consumers are very optimistic. Businesses have seen their profits improve due to lower taxes. The small business optimism index is extremely high. Thus, businesses should keep pushing investment levels higher. Finally, tax revenue is surging for State and Local governments (S&L). Historically, when they get it, they spend it. The S&L governments account for 11% of GDP vs only 7% for the Federal Government.
But there is the dark side to this otherwise bright picture. The labor market is getting extremely tight and wage rates are finally starting to show the strain. Unemployment fell to 3.9% last month, the lowest level in 18 years. Job openings are also hard to fill. Currently job openings exceed 6 million jobs, 20% above previous peaks in 2001 and 2007. The biggest problem facing small business today is “labor quality”—that is a euphemism for hard to get good workers at the wages being offered. In a Wells Fargo Small Business survey, two of the business manager’s priorities over the last year were boosting wages (employee retention) and hiring new workers. To show how bad things are getting, there was a recent article in the Wall Street Journal about local governments providing economic incentives to get people to move to their town.
Although this is great news for workers and for outlook of consumer spending, this is creating a challenge for businesses that wish to expand output. The lack of labor supply is mentioned by builders as to one reason they have not been able to build houses at a faster rate. The forest products industry is not able to expand production as rapidly as it might like to.
Regarding economic growth, the situation will remain very challenging and wages will accelerate further over the next two years. This means inflation will move higher as well. Recently the inflation rate tracked by the Federal Reserve hit their target rate of 2%. As inflation moves higher, the Federal Reserve may be forced to move rates higher and faster than currently planned.
The Bottom Line
Lumber prices should move lower into next year. Demand growth for pallets should be positive as well. However the cost of labor and loans will move higher through 2019.
(Article written and produced for the May-June 2018 edition of PalletCentral)
Lynn Michaelis is president of Strategic Economic Analysis, a company which assists business managers in thinking about the future. He can be reached via email or phone:206-434-8102