Russian Forestry and Wood Supply Operations Analysis

A COMPLEX VIEW A COMPLEX VIEW products have a good potential for investors and some investment activity for these products is likely to occur. The devaluation of ruble led to another significant, if temporary, consequence for the industry: an increase in consumption at the end of 2014 and probable higher demand in the first quarter of 2015, as people are trying to convert the declining ruble into "solid goods" such as cars, home improvement, furniture, white goods etc. With this factor, current retail volume is still higher than it might have been (and higher than it is expected to be in the second half of 2015). Judging by the sales of cars, it is as if we are in "2009 again" in 2015 - but with two significant differences: the first is that 2014 was "a little bit like 2009" as well; the second is that car producers are more optimistic now (yet) than they were in 2009 (fig. 4). A similar dynamic to car sales (with much fewer extremes, however) was seen Fig. 4: Sales and production of cars and light commercial vehicles in Russia, January to January, 2007-2015 Thousands 180 160 140 120 ■Sales of personal cars in Russia Production of personal cars in Russia 100 80 60 40 20 0 Jan Jan Jan Jan Jan Jan Jan 2007 2008 2009 2010 2011 2012 2013 Jan Jan 2014 2015 Source: AEB in furniture consumption and in home improvement and renovation activity. Furniture consumption naturally supports domestic furniture production and thus the level of demand for particleboard, plywood and MDF while renovation activity supports demand mainly for OSB, HDF (in the form of laminate flooring consumption) and plywood. In 2014, the increase in new residential housing was staggering - up by nearly 30 per cent in the first half of the year and some 15 per cent by the year's end (measured in m²). It should be noted, that even 15 per cent growth looks a bit counterintuitive (which raises some concerns about the quality of the data). However, the drivers here were about the same as in 2008/2009 namely, the anticipation of growth in the first half of 2008, the start of a large number of new construction projects, and then (once the crisis became apparent) the urge to finish and sell all ongoing projects as fast as possible to overtake falling demand and the rising cost of capital. In 2015, we are likely to see a significant decline, following the pattern of 2010, as the urge to finish current projects goes hand in hand with less than little interest to start new projects - those which could have accounted for the bulk of volume in 2010 (and 2015) (fig. 5). Over 75 per cent of total residential housing and over 80 per cent of individual (low-rise) housing is built in Western Russia, i.e. all of Russia excluding the Siberian, Ural and Far East Federal Regions. The share of construction across the country is relatively stable year-to-year and the concentration of demand in Western Russia dictates the location of the new projects focused on the domestic market, and hence, for example OSB and MDF production. Furniture production is not easy to track as most of it does not appear in the statistics at all (small manufacturers, some "gray" production) or it appears as services, especially for built-in and fit-in furniture. It is easier to estimate the dynamic of furniture production through consumption of wood-based panels (below) and through the import-export of furniture. The import of furniture predictably went down (by some 7 per cent) in 2014 compared to 2013, while imports from CIS countries accounted for some 15 per cent of the total import volume. This segment actually grew - up 6 per cent in 2014 as compared to 2013. Fig. 5: New residential housing in Russia 1000 dwellings (left) and million m²/a (right), 1987-2014 1 200 90 ■Flats ■Flats ■Individual, except wood based ■Individual, except wood based 80 ■ Wood based ■Wood based 1.000 800 600 400 200 0 1987* T 1990* 1995 2000 2001 2002 2003 2004 2005 T 2006 2007 m 2008 2009 2010 70 60 50 40 30 20 10 0 1987* 1990 1995 2000 T 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014e * Excluding over 100 000 auxiliary buildings and summer houses Source: Pöyry Management Consulting, Russian Statistics Committee HARVESTING OPERATIONS: opportunistic growth On the global scale, the situation in the forestry and harvesting business might be evaluated through sales of harvesting machinery - the larger the sales, the healthier the business and the brighter the prospects. Sales of harvesting machinery developed from rather gloomy in 2011-2012 to cautiously optimistic in 2013 and on to quite positive in 2014. Europe is recovering (mostly due to Scandinavia). Sales to South America (specifically, Brazil) and Russia were increasing rapidly in 2013 and - at a slower pace - in 2014. The main driver here, understandably, is growing mechanization due to greater pressure on production, including per-person production (fig. 6). The key forestry markets on the global scale are stable, and changes do not happen overnight. However, relatively greater activity is expected in South America, Oceania, South Africa and Russia in the mid-to-long term. In the latter case we can probably only talk about the longer term, due to the current investment climate and position of the Russian currency, as well as due to lack of infrastructure to make the volumes grow fast. Russia has the world's largest "deposit" in terms of forested area (some 800 million ha, approximately 22 per cent of the global total) and growing stock (app. 24 per cent). About one third of the growing stock (some 29 billion m³ out of 83 billion m³) is concentrated in mature and overmature industrial forests. Softwood forests account for approximately two thirds of the forested area. Annual allowable cut (AAC) of some 650 million m³ is utilized by only some 30 per cent due to the poor commercial availability of many areas (a lack of forest roads, difficult terrain, and a lack of consumers nearby, as well as a lack of other roads). Actual cuts differ significantly from region to region while remaining more or less stable inside given regions. The greatest harvesting is seen in Siberia, the North-West and the Volga Federal Regions. Those three regions make up approximately three-quarters of the total volume in Russia. Out of the three main regions, AAC utilization is the highest in the North-West (over 35 per cent of the annual allowable cut) and the lowest is in Siberia (some 15 per cent). Fig. 6: Global wood supply and demand: the growing economy and demand for traditional forest products in Asia and the bioenergy sector in Europe create massive trade flows Equator Supply deficit Stable supply Increasing supply Source: Pöyry Management Consulting Annual allowable cut is increasing in line with (estimated) growing stock in mature and overmature industrial forests: in example, AAC was on the level of 510.6 million m³/a in 2002 and grew to some 633.4 million m³/a in 2010 vs. growing stock of 23.1 billion m³/a in 2002 increased to 28.6 billion m³/a in 2010 (a 24 per cent increase in eight years in both cases). However, the quality of the data is not up to the best standards. In Russia, official harvesting volume in mature and overmature forests grew in 2014 by over 4 per cent compared to the previous year, reaching nearly 120 million m³. Total harvesting volume, including thinning, was close to 200 million m³. "Gray" and illegal harvesting is likely to add up to some 20 per cent to this number (World Bank and WWF estimates). Exports grew from 19.0 million m³ in 2013 to 20.9 million m³ in 2014, a 9.8 per cent increase. In monetary terms, export volumes increased by 8.3 per cent in current USD. In the first half of 2014, export volumes grew even faster - some 17.7 per cent compared to the first half of 2013 by volume. The highlight of the year for the sector was the ruble devaluation followed by better margins for exported wood and thus a push towards growing export volumes and growing ruble prices, especially in regions like Russian Siberia and the Far East. However, non-integrated harvesting companies remain quite cautious and the favorable situation is not likely to lead to significant growth in harvesting capacity due to general unpredictability in the legislative field as well as due to the sharp increase in the cost of capital. On the other hand, we are likely to see an increase in harvesting capacity for integrated players - and thus further rise in the share that the big integrated players have in the harvesting sector in Russia. Some further efforts to decrease the level of illegal cutting was seen on the part of the Russian government in 2014, specifically the legislative act 415 FZ. It was introduced on July, 1st 2014 to be in full force from January, 1st 2015 and tightens rules concerning illegal harvesting (larger fines, the introduction of a unified information system, unified lease agreements etc.). Other promising changes in the forestry sector included the introduction of pilot regions in Russian Siberia and the North-West to move away from extensive forestry (large areas, clear cutting, low maintenance) to intensive forestry (Scandinavian model) as well as larger spending on improving the accuracy of forest resources data - with the goal of reaching a frequency (of data gathering) of no less than once-a-decade for the key regions. It should be noted however, that many initiatives in Russia develop from "best intentions and right words" to "just additional uncertainty, bureaucracy and burden for the forest industry players" with amazing speed. The fresh results in this area have yet to be seen. In general, over the last decade, wood supply developed from the notion that "there is enough wood in this country for any project" to significantly restricted in some geographical areas and industries (specifically, sawmilling and plywood production in Western Russia) - and it keeps tightening. Now we see that wood supply prospects are the first-priority "must-check" for almost any project of any scale in any locality. The most significant restrictions are seen in Western Russia (Central, North-West and South) while their effects are felt a bit less in Siberia and the Volga Federal Region. The situation differs significantly from product to product and from the macro-scale to the micro-scale. Sawlogs and plylogs are in the highest demand almost everywhere, while the situation with pulpwood varies from one end of the spectrum to the other: in some regions leaving pulpwood in the forest is not regarded as an embarrassing practice while in some others the price of pulpwood goes hand in hand with small-diameter sawlogs. As an example, short-radius delivery pulpwood is in high demand around pulp mills in Siberia and in the North-West - up to the point that cooking small and medium diameter sawlogs is not a rare practice. 10 10 #6 (2015) RUSSIAN FORESTRY RUSSIAN #6 (2015) FORESTRYU 11