[Tembec Spruce Falls]

Canada has always been blessed with huge natural resources and the timber industry is a big part of that. However there has been somewhat of a perfect storm for the Canadian timber industry as the effects of a collapsing US dollar coupled with disappearing housing starts in the US (part of subprime debacle) take hold, which of course are not independent of each other. Couple that with increasing energy and transportation costs, lower cost producers from South America and you have an industry that looks a lot like the steel industry of the 1980s.

Canada is going through a structural change reducing capacity in framing (Chetwynd), finished (Queensboro) and pulp and paper production (Miramichi) among many others this year and the reduction of capacity will continue into 2008. (The tragedy is that this change comes on the backs of small communities where layoffs can have a devastating effect on communities who cannot easily replace jobs).

However it would be a brave person to bet against the long term prospects of the forestry market simply because it is a fundamental commodity to growth. Timber demand is never going to go away, it merely changes over time but the long term growth prospects continue to improve. There simply is no alternative to wood for household and commercial buildings, pulp and paper, manufactured and finished wood products. It has gives a home a feeling that is almost impossible to replace with man-made products such as concrete and provides a level of finish that creates a valuable home.

More importantly biomass is a real alternative to fossil fuels. The political winds for biomass are improving dramatically and look even better with the advent of a democratic administration in the United States which presents new opportunities for rural Canada (and the US). Even if you don’t believe in peak oil, the political winds are starting to shift against the previous hegemony of the Oil Industry where both environmental and security needs are being taken more seriously.

When you have a product that in the long run demand curve will continue to increase, the question is not if the market will come back into equilibrium but when. The Canadian dollar has come back from it’s historical highs and now is trading at and around parity. The street expects this level to exist for a period of time. What kills investment is volatility in exchange rates, not the level of the exchange rate. It is like petrol prices, what consumers look at is relative prices, not absolute prices. Once the exchange has stabilized in a range then investment decisions are easier to make.

Companies are working on restructuring plans to reassess capital and production needs such as the Tembec’s restructuring. Although the company is being handed over the bondholders, this will significantly enhance the balance sheet and allow opportunities for wealth creation that are simply not possible at the moment.

Finally it is reality that will take hold. Forestry products are up there with the food and energy industries as fundamentally at the core of economic activity throughout the wood and short run changes are par for the course (anyone remember $US1 petrol?). Although this is cold comfort for many who lose their jobs, the key to how the future will shape is a strong investment cycle at this stage of transition.

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