Russian Forestry and Wood Supply Operations Analysis

26 LOGGING LOGGING Wood Supply Operations in Russia From From Sawlog Mining to Sustainable Forest Management Sawn softwood continues to be the most traded Russian forest product in the international markets and the domestic output is continually increasing. The growth in volume has been gained through increasing exports primarily to China, European exports have not increased in recent years. Now in a short time span the weakening ruble has improved the competitiveness of Russian mills notably and exports to all markets are increasing. On the other hand, factors hindering the development of wood processing industries in Russia continue to exist below the surface. The Russian pulp industry has not been able to expand capacity even though there have been several green field investment plans. Many wood product industries are unable to operate all year and convince customers of a stable delivery of high quality products. The proximity of the Chinese market offers a permanent competitive advantage while the other advantages, such as the low cost of wood and labour are receding. Sustainable and feasible raw material procurement continues to present a challenge. Wood supply based on extensive forest management methods with little effort put to successful stand regeneration, silviculture and thinning harvests have resulted in a reduced yield and lower quality of roundwood, and an increased share of deciduous stands. Harvesting sites with sufficient volumes of good quality roundwood close to mills are being rapidly depleted, especially in Western Russia. The trend is also evident in Siberia where wood consuming industries are forced to move to new harvesting areas, which are further away and in previously unaccessed locations. As the bulk of Russia's wood consuming industries located inland are already burdened by relatively high costs of transporting processed goods to the market, they cannot afford the erosion of traditional competitive advantages, low raw material and labour costs. A realistic analysis of operational methods and the most economical supply chains is needed - for both new investments and for existing operations. Too often the analysis is based on best case scenarios and lacks a long term view. Traditional Russian wood supply operations are based on wintertime logging where the frozen ground provides accessibility for wood transportation. Roundwood transportation has been based on clearing and building simple winter roads and trails. Since the winter roads #6 (2015) RUSSIAN FORESTRY and trails need to be renewed every year, the increasing transport distances increase the annual costs of wood supply that is already burdened by low efficiency. Considerable space exists for new ways of establishing and organizing wood supply operations, utilizing the modern tools available and bringing economic analysis into the planning process. The majority of Russian forest industry companies conduct harvesting operations in winter but only a few have considered investments to facilitate year-round operations, including an access road network with proper foundations, surface and drainage that can withstand transport almost all year round. Naturally, the schedule and level of investments is different between year-round and winter operations. Roads in year round use require larger upfront investment, making it more painful for the investor. After the construction is completed and the roads are properly used, only regular annual maintenance of the main road network is needed. In the winter harvesting method the initial road constructions costs are lower in the beginning but the same roads need to be rebuilt every year. The machinery fleet size needs to be almost double due to the limited harvesting season and lower transport productivity. The fleet has to be adjusted to the peak season, or otherwise the company cannot deliver products in time and risks losing valuable customers. Comparing cumulative investments in year- round and winter-only operations often shows that winter harvesting is a cheaper option in the short term. However, in the long run the year-round wood supply operation requires lower investment inputs. A recent Indufor study showed that permanent road network investment has more favorable rates of return already after 5 years (including discounting). A permanent access road network supports also the execution of stand regeneration and further silvicultural activities related to intensive forest management. Thus, the rate of return with each option must therefore be carefully analysed, prior to choosing the operating mode. The variable costs of harvesting, transportation and loading operations are not dependent on delivered volumes, even if these operations also carry fixed costs. Fixed costs allocated to the millgate cost, such as road construction, roundwood terminal, depreciation, lease fee and overhead costs will occur in full regardless of the volume of roundwood supplied. This means that if a company is not capable of reaching production targets, or is willing to harvest only certain tree species or assortments, the relative mill gate cost per cubic meter increases. Comparison of investment flows in year-round and winter harvesting modes Annual investments in year- round and winter harvesting Annual expenditure 1 3 5 Cumulative investments in year- round and winter harvesting Annual expenditure 7 9 11 13 15 Year Year-round harvesting 1 3 5 7 9 Year Winter Harvesting 11 13 15 Source: Indufor In the example below, it can be seen that even if Forest area 2 has a significantly lower millgate cost than Forest area 3, in case the operation does not perform well during the year the wood delivered to mill from Forest area 3 is more economic. This is due to lower road construction costs (fixed cost) and a large share of barging costs (variable cost). If annual harvest targets are not met, the mill gate cost for wood rapidly increases. This has to be understood when determining the order of preference for forest lease areas. It can be argued that a large upfront investment in infrastructure is a discouragement, especially if the investor is looking for short term returns. However, considering the development of Russia's forest sector and the improving competitiveness of wood consuming industries, a new approach based on long term business planning needs to be adopted. The mentality needs be shifted from sawlog production towards investing in the realisation of forestland growth potential, and securing a stable flow of good quality wood raw material at the same time. This is the only way the forest sector can become sustainable in the long term. Jarno SEPPÄLÄ, Head of Forest Industry and Biosolutions Consulting, Indufor Matias PEKKANEN, Consultant Forest Industry, Indufor - Tapani PAHKASALO, Head of Forest Investment Services Consulting, Indufor Example of millgate cost breakdown in cost components and sensitivity analysis Millgate cost per harvesting area Forest 1 Forest 2 Lease fee and overhead Terminals Transport Road ■Road Construction & maintenance Forest 3 ■Loading and Unloading Transport - Barge Harvesting Millgate price sensitivity to AAC utilization rate 100% 95% %06 85% %08 75% 70% 65% %09 55% 50% 45% 40% 35% 30% 25% 20% 15% Forest 1 Forest 2 Forest 3 Source: Indufor RUSSIAN #6 (2015) 27 FORESTRY