The Stafford Timberland Diaries - Recent trends impacting wood supply and demand in China Issue No. 25 - Stafford Capital Partners
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The Stafford
Timberland
Diaries
Recent trends
impacting wood supply
and demand in China
Issue No. 25
September 2018 www.staffordcp.com
Contents
China’s wood demand and supply 4
The drivers behind demand for wood products in China 5
Sawnwood 8
Wood-based panels 11
Pulp & paper 14
Conclusions 17
About Stafford Capital Partners 18
2
www.staffordcp.com
Background
Stafford Capital Partners has USD 2.4 billion of assets under management in its timberland business1,
and has invested into timberland assets equivalent to just over 500,000 hectares. The bulk of this area is
located in the United States (75%), followed by Latin America (15%), and Australia/New Zealand (10%).
Stafford estimates that the equivalent of 17% of these assets are effectively supplying logs that service
Chinese demand for wood products, either directly through log or woodchip exports, or indirectly in the
form of locally manufactured sawnwood or pulp, which is subsequently exported to China. Whilst certain
of these regions and/or species groups supply a higher proportion than others (See Figure 1), it is evident
that China represents an important market for Stafford’s timberlands.
Figure 1: Estimated proportion of log supply from Stafford’s timberland investments destined
for Chinese markets
Source: Stafford Capital Partners
The past year has highlighted a range of issues expected to impact heavily on future wood supply and
demand dynamics in China’s wood processing industries. We therefore believed that it was important to
share some thoughts on what these might mean for Stafford’s investors, and this Diary will hopefully serve
to give some useful perspective on this evolving market.
1
As of 2018 Q2
3
China’s wood demand and supply
The production of key wood-based products in China has soared during the past 16 years, with
consumption of raw material (logs, woodchip, and sawmill residues) increasing by an average of 33 million
m3 RWE2 per annum (See Figure 2).
Figure 2: Production and trade of key wood products in China
Source: FAOSTAT
In 2016 the production of sawnwood, wood-based panels, and wood pulp in China utilised approximately
469 million m3 RWE, equivalent to one quarter of the world’s industrial roundwood production. China
imported 49 million m3 of logs in 2016, which dwarfs the next largest importer, Germany (at 9.2 million m3).
It has also become the second largest importer of woodchips after Japan, receiving 19 million m3 RWE in
2016. Despite these comparatively high levels of imports, the data suggests that 85% of wood raw material
demand for Chinese production was still met from domestic resources.
However, from the start of 2017, China implemented a ban on any harvesting of its natural forest which
supplied around 50 million m3 per annum, and this year also introduced far more stringent criteria on the
import of recovered paper which is crucial to its paper & packaging sector. In addition, Russia, which
supplies 20% of China’s log imports, is stepping up export duties in a drive to stop the flow of lower-value
logs out of the country.
Chinese consumption of wood
raw material has increased by
33 million m3 per annum.
2
RWE = Roundwood equivalent is a measure of the volume of logs (roundwood) used in the manufacture of wood-based products
4
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These developments are expected to have far-reaching implications on China’s wood raw material supply
and on its wood processing industries, with 30% of its supply coming from sources that are set to decline
over the next few years (See Figure 3).
Figure 3: Wood raw material supply to Chinese processing industries (2016)
Source: FAOSTAT and Stafford analysis
The drivers behind demand for wood products in China
Before starting to look at individual wood-processing sectors it is helpful to pause and consider the
underlying fundamentals which have driven Chinese demand for wood products, and which will continue to
shape this demand in the next few years.
The urbanisation of China’s population
In 1978 the Chinese government introduced sweeping reforms to its collective farming system. This allowed
for individuals to be allocated their own plots, to take full responsibility for production, and perhaps most
importantly also the opportunity to retain surpluses. These reforms led to a marked increase in agricultural
productivity, but as more efficient practices were adopted they exposed a huge surplus of labour that had
been masked under the previous system. Much of this excess labour headed to towns and cities, where
they were absorbed by the growing industrialisation that began to take place.
By 2017 the urban population accounted for 58% of the total, with the Chinese government expecting it
to reach 70% by 20253. This is not a particularly high target when compared to regions such as North
America (82%), the European Union (75%), and Russia (74%). However, the scale and pace of China’s
urbanisation sets it apart, with the urban population increasing by an average of 20 million people per
annum since 2000. In the space of less than 20 years the total increase in China’s urban population has
been greater than the entire population of North America. Should the urban component reach the targeted
level of 70% by 2025, it would add a further 184 million, or some 23 million people annually, to the urban
population (See Figure 4).
3
https://en.wikipedia.org/wiki/Urbanization_in_China
5
Figure 4: Development of China’s urban population
Source: UN and World Bank
This sustained growth in China’s urban population has been a key driver behind the demand for new
housing, and for the wood products used in construction and furnishings. An added factor is the
reconstruction of existing, low-quality housing in urban areas. In 2017 the government renovated 6 million
units in these so-called “shantytowns”, with a further 5.8 million planned for 2018.
Despite past concerns that speculative building had led to an oversupply of housing and a potential bubble,
inventory has fallen sharply from its peak in 2015 (See Figure 5), and the market remains highly resilient.
Figure 5: Residential properties for sale and sold in China (2011-17)
Source: National Bureau of Statistics of China
The government has instituted various austerity measures to stabilise the market, and more recently is
reducing subsidies and moving ahead with long-delayed plans to impose an annual property holding tax.
This will likely dampen real estate’s appeal as an investment, and lead to some flattening of construction
activity. A sharp drop-off is not expected, however, and demand for construction timber is likely to remain
at least close to current levels4.
4
https://blog.pimco.com/en/2018/06/chinas-property-market-bubble-or-balloon
6
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China’s emergent middle class
In 2010, less than 10% of China’s urban families were considered “middle class”5, however this is expected
to reach 57% by 2020, and to continue expanding to 67% by 2025 (See Figure 6).
Figure 6: Expected development of China’s middle class
Urban households in China (million)
Avg. Annual
Class Income (USD) 2010 2015 2020 2025
Affluent >$34k 6 10 18 38
Upper middle
$16k-$34k 15 76 141 182
class
Mass middle
$9k-$16k 124 111 73 59
class
Poor
Sawnwood
Total sawnwood consumption in China during 2016 was circa 110 million m3 (approximately one quarter of
the world’s sawnwood production). As might be expected, sawnwood demand is closely correlated with
the housing and construction sectors (See Figure 7).
Figure 7: Historical development of Chinese housing construction and sawnwood consumption
Source: National Bureau of Statistics of China, FAOSTAT
A significant part (30%) of the country’s sawnwood demand is imported (See Figure 8). Locally produced
sawnwood is also heavily reliant on imported raw material, with some 45% of sawlogs processed being
sourced externally. In all this implies that 61% of China’s sawnwood demand is imported in one form or
another.
Figure 8: China’s volume of imported vs. domestically produced sawnwood
Source: FAOSTAT
8
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China’s sawmilling industry is based on small-scale, simple technology (See Figure 9). This offers some
benefits in reducing capital requirements, allowing production to be scaled up and down easily, and also
being easily relocated. This latter point has been particularly advantageous recently as the industry has
migrated further inland from coastal areas.
Figure 9: Typical Chinese saw sets; capable of processing 50 m3 of logs per day
Source: Stafford
This migration has come about partly because of the crackdown by Chinese authorities on polluting
industries, but also due to higher labour and land costs in these coastal areas, and the fact that much of
the new construction activity is now concentrated inland.
Whilst the sawmills might have moved closer to sources of demand, it has also taken them further from
coastal ports, adding significantly to their delivered cost of logs. As an example, barge transport to
Chongqing adds USD 16-29/m3 (depending on varying congestion charges along the Yangtze river) to
mill delivered log costs, a 10-20% increase on the price of USD 138/m3 for New Zealand A-grade logs at
coastal ports7 (See Figure 10).
Figure 10: Logs arriving by barge in Chongqing; 1,800 km up-river from Shanghai
Source: Stafford
61% of China’s sawnwood
demand is imported.
7
Based on McKinsey’s definition of annual household income as being between USD 9,000-34,000
9
Despite the strong demand that is likely to persist for sawnwood within China, its sawmilling industry faces some difficult challenges: 1. From the start of 2017 China effected a complete ban on the harvesting of natural forest. It is estimated that these forests contributed around 50 million m3 of logs per year, and the ban is therefore expected to have a severe impact on domestic log supply. 2. It will be challenging to maintain existing levels of log imports over the next 5 years, much less increase enough to offset the reduction in domestic log supply mentioned above. The principle reason for this is that log imports from Russia, which accounted for 11 million m3 (or 20%) of log imports in 2017, are likely to become prohibitively expensive as phased increases in log export duties are applied. Russia is pushing to see more processing of logs take place domestically and is therefore raising export duties on logs from 25% in 2018, to 40% in 2019, 60% in 2020, and 80% from 2021 onwards. This could effectively put an end to the supply of logs from Russia to China within the next 3-4 years, although we expect that it will still be available to China in the form of sawnwood after having been processed in Russia. 3. Chinese sawmills are already struggling to compete with imported construction timber due to increasing costs for labour and raw material. Going forward the substitution of imported logs by sawnwood is likely to accelerate. Much of the increased sawnwood supply will initially come from Russia, although there are already grave concerns that accessible log supplies in the Russian Far East have been heavily over-exploited, and that considerable investment into logistical infrastructure will be required to extend this supply. In the coming years we expect sawnwood production in China to decline in parallel with tightening log supply. Demand for imported logs should remain healthy, although probably subject to higher levels of pricing sensitivity than has been the case in the past, noting that sawmills will be attempting to manage rising input costs. 10
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Wood-based panels
This sector has seen staggering growth within China, increasing 11-fold from 2000 to 2016, and reaching
the point where the country is now responsible for half of the world’s wood-based panel production. China
is also by far the world’s leading exporter of wood-based panels (See Figure 11), although it is worth noting
that these exports represent only around 7% of its total production volume.
Figure 11: Top 20 global exporters of wood-based panels (2016)
Source: FAOSTAT
Whilst a significant volume of wood-based panels will be exported in other forms, such as furniture, crates
& packaging, flooring in trailers and shipping containers, etc., it highlights the importance of domestic
consumption for the sector. It perhaps also puts into perspective the relatively modest impact that
antidumping and countervailing duties imposed by the United States on hardwood plywood from China at
the end of 20178 may have on the industry (China exported 2.7 million m3 of plywood to the United States
during this year – or just over 2% of its total production).
More than half of China’s wood-based panel production consists of plywood, for which the primary end-
use is in construction (See Figure 12).
8
https://www.woodworkingnetwork.com/news/woodworking-industry-news/verdict-china-dumped-subsidized-plywood-injuring-usmills-says-itc
11Figure 12: Chinese wood-based panel production by type (above) and plywood end-use (below)
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!
Source: Kurpiel & Wan
China’s wood-based panel
industry is by far the largest
wood consuming industry in
the country.
12www.staffordcp.com
China’s wood-based panel industry is estimated equivalent North American or European products
to have utilised over 320 million m3 RWE in 2016, that will normally be re-used more than 30 times.
making it by far the largest wood consuming
The opportunity for China to improve the quality
industry in the country. However, unlike the
of its plywood is interesting, not least because of
sawmilling industry, which relies heavily on
the scope to make substantially more efficient use
imported logs, most of the raw material for wood
of its available wood raw material. For example,
panel production is sourced domestically. China
if the life expectancy of plywood used in concrete
has approximately 8 million hectares of poplar
formwork were doubled from 3-5 to 6-10 times
plantations, and a further 4 million hectares of
(still well short of the norm elsewhere), annual
eucalyptus plantations. Although the quality and
demand for plywood could reduce by 20 million m3,
management of these plantation areas may be
thereby reducing the need for some 30 million m3 of
variable, and log diameters are relatively small, they
eucalyptus and poplar logs per annum.
constitute the primary source of supply for China’s
wood panel industry. To some extent this process has already started,
spurred on by the far tougher enforcement of
Whilst the particleboard and medium-density
environmental regulations that commenced in
fibreboard (MDF) sectors have benefitted from
China last year. The China National Forest Products
considerable investment into modern facilities
Industry Association reported towards the end of
during recent years, plywood production is
2017 that almost 5,500 mills, or more than half of
characterised by a low level of capital intensity and
the country’s plywood mills, were expected to close
a highly fragmented manufacturing base, with more
as a result. However, the impact on total production
than 10,000 mills estimated to be in operation. In
capacity appears to be limited thus far, since these
many instances part of the production, such as
mills are being replaced by new facilities using
peeling and drying the veneer sheets is outsourced
upgraded technology and improved management.
to what is essentially a “cottage industry” (See
Figure 13). Such a development would align well with
the Chinese government’s ambition to steer
This obviously presents difficulties in maintaining
its economy away from the low-cost mass
consistent quality standards, and consequently
manufacturing for which it has been associated,
much of China’s plywood has been of rather low
towards higher value-added manufacturing based
quality. In the case of film-faced panels used for
on innovation and the adoption of more advanced
concrete formwork, a panel will generally only be
technologies.
re-useable 3-5 times. This compares poorly with
Figure 13: A typical small operator producing veneer sheets from eucalyptus logs in China
Source: C.Bosworth (Miro Forestry)
13Pulp & paper
China produced 109 million tonnes of paper and packaging in 2016, or a quarter of global production. The
country is a significant global producer of wood pulp (See Figure 14), and it is estimated that the industry
uses approximately 17 million m3 of wood, primarily eucalyptus from domestic plantations, each year.
Figure 14: Top 10 global pulp producers (2016)
Source: FAOSTAT
This domestic wood supply is relatively insignificant, accounting for only 4% of the total raw material
requirement for paper & packaging production in China. The industry is far more reliant on recovered waste
paper, which makes up almost three-quarters of its raw material requirement (See Figure 15).
Recovered waste
paper accounts
for three quarters
of the Chinese
pulp and paper
sectors raw
material.
14www.staffordcp.com
Figure 15: Source and type of raw material utilised in Chinese paper & packaging production (2016)
Source: FAOSTAT
This high exposure to recovered paper is being severely tested following China’s implementation of a ban
on imports of unsorted waste paper grades from the start of 2018, and the introduction of stringent quality
criteria for other grades.
These measures reflect the concerted effort being made to address the country’s growing environmental
problems. But since China was the destination for 50% of the world’s recovered paper exports, they have
also had serious ramifications for the global waste paper markets, with prices falling steeply and substantial
volumes of material accumulating in major exporting countries. Recovered paper imports from the United
States, which accounts for almost half of China’s imports, have fallen by 42% in the first half of 2018
compared to the same period in 2016 (See Figure 16).
15Figure 16: Recovered paper exports from the United States to China
1.4
1.2
1.0
tons
0.8
Million
0.6
0.4
0.2
0.0
J
J
Jan
an
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
an
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
2017
2018
Source: USDA Global Agricultural Trade System
If imports from other key suppliers such as Japan 3. Increase pulp imports – Replacing the shortfall
and the UK fall by a similar margin, Chinese paper with virgin pulp would require approximately 10
mills will be faced with a shortfall of 12.4 million million tonnes. The global supply of market pulp
tonnes, or 11% of their total raw material mix, currently stands at around 70 million tonnes
in 2018. The immediate response from supplier per annum and has grown by just over 2% (1-2
countries has been to try and develop alternative million tonnes) per annum over the last 10 years.
markets in countries like India and Thailand, rather Securing such a large volume in the short-term
than rushing to invest into more advanced recycling therefore seems improbable and would be highly
infrastructure. This leaves Chinese mills with some disruptive to the marketplace.
difficult alternatives to consider:
4. Invest in offshore pulp & paper production –
1. Increase domestic supply of recovered paper Chinese companies are already investing into
– Actual recovery rates for paper in China several projects in Russia, and Shandong
are believed to be close to 70%. The realistic Sun Paper is planning to build a new USD 1.8
upper limit is generally considered to be 80%, billion mill in Arkansas, which would be the first
which may suggest that a further 7-8 million greenfield pulp & paper mill built in the US South
tonnes could be recovered. However, prices for since 1985. However, these are highly capital-
domestic recovered paper have soared since intensive project with lengthy lead times, and
the import requirements were changed, making which don’t necessarily address the problem of
it a much less attractive proposition. keeping mills in China operating effectively.
2. Increase woodchip imports – Replacing the 5. Lobby for recovered paper import requirements
entire fibre shortfall with wood chip would to be relaxed – A real possibility given that the
require a volume of approximately 35 million m3. pulp & paper sector is relatively concentrated,
This is double China’s current imports, a volume with some large and influential companies.
which already accounts for 43% of the Pacific
Inevitably the solution is likely to comprise a mix
Rim woodchip trade. With Australian supply set
of the alternatives described above. However, a
to decline as marginal plantations are converted
final option links back to the potential for improved
back to agriculture, and new pulp capacity in
plywood quality described in the previous section.
Chile, Indonesia and possibly Vietnam diverting
The implicit reduction in log demand that this could
wood volumes into local production, it will be
realise may allow more wood to be diverted into
challenging to maintain the current woodchip
domestic pulp production. In fact, if the figure of 30
trade volumes, let alone realise such a large
million m3 were achievable it would go a long way
increase.
towards filling the gap left by reduced recovered
paper imports.
16www.staffordcp.com
Conclusions
It is evident that China’s wood-based industries are in the process of being transformed
by a multitude of factors, with the situation perhaps best summarised as follows:
1. Whilst China’s future demand for wood 6. Reduced domestic sawmilling activity will
products may grow at a somewhat slower have negative knock-on implications for the
rate than in the past 10-15 years, it will be wood-based panel industry, since MDF and
sustained by ongoing urbanisation and the particleboard producers consume large
rising disposable income and living standard of volumes of sawmill residues (mostly slabs and
its population. off-cuts).
2. Chinese wood processors are expected to 7. There may however be some opportunity for
see existing raw material supply streams the wood-based panel industry to rationalise
fall by up to 70 million m3 (15% of total RWE its raw material usage, particularly though the
consumption) over the next few years9. modernisation and improved product quality of
its plywood sector. However, any volume freed
3. This is equivalent to almost four times the total
up through such a process will most likely be
annual log export volume from New Zealand,
targeted by the pulp & paper sector, which in
and it is highly unlikely that alternative supply
turn needs to find alternatives to the reduction
sources from which to import such a large
in its supply of imported recovered paper.
volume of logs can be developed.
8. The sustained demand for wood products in
4. In the face of restricted log supply and rising
China and the rapidly worsening raw material
costs the most likely scenario is that the
situation is likely to accelerate the search by
Chinese sawmilling industry will downsize over
Chinese companies for processing facilities and
the next few years, with lost production being
wood resources overseas. This could result in a
replaced by increasing sawnwood imports.
notable shift in forest product value chains, with
5. Interest in imported logs will remain firm, a higher proportion of China’s demand being
although this is likely to be an increasingly met through value-added processing closer to
price-sensitive market whilst sawmillers the actual log supply. From the perspective of
compete with cost-competitive imported forest owners this is a positive, since it should
sawnwood. eventually translate into more diverse and
stronger wood markets closer to existing forest
resources.
The sustained demand for
wood products in China and
the rapidly worsening raw
material situation is likely
to accelerate the search
by Chinese companies for
processing facilities and
wood resources overseas.
9
Assuming that the ban on natural forest harvesting in China removes 50 million m3 of log supply, that Russian imports of 11 million m3 are
phased out by 2021 when export duties reach their maximum planned level, and that sawmill residues of 9 million m3 from processing this
combined volume are no longer available.
17About Stafford Capital Partners
Founded in 2002, Stafford Capital Partners is a leading alternatives investment manager with $5.4bn AUM
at the time of print across timberland, infrastructure, agriculture, sustainable capital and private equity.
This includes deployment and management of eight successive timberland funds and two co-investment
pools invested in over 170 underlying assets across 13 countries. This is a unique and unrivalled position in
the asset class and is a source of great pride for the team.
To find out more about our business, please contact:
Stephen Addicott Daan Oranje
Partner Partner
London Sydney
stephenaddicott@staffordcp.com daanoranje@staffordcp.com
Marek Guizot Carter Coe
Investment Manager Principal
London Austin
marekguizot@staffordcp.com cartercoe@staffordcp.com
18www.staffordcp.com
19Private and Confidential The information in this document is for private circulation only and does not represent investment advice and should not be relied upon for investment decisions. This document neither constitutes an offer to sell nor a solicitation to invest in any of the Stafford Funds. It is for information purposes only and is not a recommendation. This document does not constitute an offer to sell or a solicitation to invest in any jurisdiction where the offer or sale would be prohibited or to any person not meeting the required investor criteria. Any opinions expressed are given in good faith but are subject to change without notice. No representation or warranty, express or implied, is made as to the accuracy, completeness or correctness of any information in this document which has not been verified. Stafford Capital Partners Limited (formerly Stafford Timberland Limited) is a company registered in England (Company Reg: 4752750) with a registered and trading address at Fourth Floor, 24 Old Bond Street, London, United Kingdom W1S 4AW. It is authorised and regulated by Financial Conduct Authority (Firm# 225586). Stafford Capital Partners is a member of the United Nations’ Principles for Responsible Investment (UNPRI). These principles are an internationally agreed upon framework to help institutional investors incorporate Environmental, Social and Governance (ESG) qualitative considerations into investment decision-making and ownership practices. Stafford Capital Partners is acknowledged by the UNPRI, when compared against our peers, as incorporating a solid framework for ESG considerations into its investment decision process (selection, assessment and monitoring of investments). For more information about UNPRI, visit www.unpri.org. We are obliged to protect personal data, preserve confidentiality of personal and sensitive data, and prevent the loss of data. Please read our statement on personal and sensitive data that is linked on our website www.staffordcp.com/legal. If you have any questions about our personal and sensitive data policy and framework or if you wish to exercise your rights in respect of your personal data, please email our Data Protection Officer on privacy@staffordcp.com. This document is printed using vegetable based inks onto sustainably sourced paper.
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