Softwood: the more things change, the more they stay the same

Markets without competition: BC companies control log prices

Recent headlines have shouted about British Columbia’s attempts to go it alone and cut its own softwood lumber deal with the United States, abandoning the much touted Canadian unity.

While these headlines may have been breaking news to some folks, they’ll be an old story to anyone reading Dogwood Initiative’s bulletins. We reported that BC would go it alone over three weeks ago.

While the press is reporting this go-it-alone approach as a “bold” move by Premier Campbell and Forest Minister de Jong, in fact it was Dogwood Initiative and other members of the Coalition for Sustainable Forest Solutions that first suggested this line of attack. Back in 2001 we suggested that BC negotiate a policy-based deal focused on three main issues:

  • reallocating 50% of major logging tenures to diversify the industry and create preconditions for competitive timber pricing;
  • ensuring a majority of BC’s timber flowed through expanded auctions and regional log markets that would provide a place for smaller operators to buy and sell logs competitively, with no one operator or sector being able to dominate the market; and
  • benchmarking environmental laws and regulations to prevent new subsidies through deregulation.

Given that half the softwood exports come from BC, we suggested that if BC could negotiate policy changes that would diversify control of the wood supply and set log prices competitively, the province could then apply to the U.S. Department of Commerce for a “changed circumstances” review that could result in tariffs being reduced below the current 27%. The other provinces would have to change their policies accordingly, or BC would have a competitive advantage over them.

We spent a lot of time educating government and industry officials in Canada and the U.S. about the intricacies of BC forest policies–particularly the way tenure holders manipulated stumpage–and about specific ways to fix the policies. (Ironically, U.S. officials were much more interested than Canadian officials, but that is a different story.)

Our approach was working until U.S. trade envoy Grant Aldonas arrived on the scene. Aldonas took over after the first U.S. trade negotiator failed to secure a deal , and after Bush confidante Marc Racicot, who briefly managed the softwood file before leaving to run the Republic National Committee, failed to broker a deal.

Aldonas was the administration’s rising star, the hero who was going to break down the historic partisanship, beat the powerful industry-lobby Coalition for Fair Lumber Imports into submission, and produce a substantive deal that would address underlying problems through policy-changes, not interim quotas as in the past.

Theoretical but unrealistic market reforms

We were optimistic, until our first meeting, where it became clear that Aldonas was not interested in how forest policy really worked on the ground. Instead, he believed in the pristine market that exists only in an economist’s mind. Regardless of the issue raised, all he wanted to talk about was “price distortions” and auctions. But Aldonas seems unconcerned about the fundamentals of market design that are essential to ensure competition in the real world as opposed to in text books.

Like the Canadian trade negotiators who, behind closed doors, negotiated NAFTA and committed Canada’s water and energy without consulting others on those subjects, Aldonas has been trying to negotiate softwood without understanding forest policy in general and the provincial systems in particular. Other agencies within the U.S. government have attempted to point out Aldonas’ s misconceptions, but he remains unpersuaded.

Hence it is no surprise that Aldonas is enthusiastic about the so-called market-based pricing reforms being implemented by BC. His unwavering faith in markets and his reluctance to study the underlying fundamentals, make him susceptible to the rhetoric about BC’s new pricing system. As an economist he should know better; by definition a market in timber can’t exist without competition. What is being spun as a timber market is in fact only an expanded number of cut blocks available to highest bidder at auction.

An expanded auction of cut blocks and a real competitive log market are quite different things, as we have pointed out repeatedly.

The growing consolidation in Canada (link to news coverage) should raise real questions about market design, because it creates new disincentives against bidding higher.

Impediments to true competition in BC

Since Aldonas is unconcerned with forest policy, he continues to ignore the structural impediments to competition built into the BC system. To illustrate: say you are a value-added entrepreneur that wants to buy specific types of logs for a factory that makes tables, chairs or guitars. To borrow money you need a stable, guaranteed supply of specific types of logs. If say you need six large clear cedar logs a month, you have two options: (1) beg for wood from a logging company (as you do now); or (2) bid on a cut block. Who would you likely be bidding against? Small operators and companies like Hayes which is positioning itself to move into the big leagues in BC forest operations.

Whoever wins the auction would have the same problem: What do you do with the logs you can’t use? To not lose your shirt, as a value-added manufacturer you would need to sell all the non-cedar logs from the cut block. When you tried to do this you would face the same dilemma as the small operators–your only option would be to sell unneeded logs to the closest mill for whatever price the mill was prepared to pay. This means that before you or anyone else bids at auction you better have a firm agreement from the nearby mill to purchase your logs–and the price they are prepared to offer you will determine what you can afford to bid.

Given the recent consolidations in the industry due to mergers, you probably have only one (or perhaps two) potential purchasers to choose from. Since the mills know that whatever they offer to pay for your logs will ultimately determine what you can bid, which in turn determines the “market-based” stumpage rate they will pay for timber from their tenures, they have a real incentive to keep prices low. They can drive a hard bargain, as your only other option is to try to export your logs or to incur the large costs of trucking logs a long way to another mill.

This is how the large companies’ control of mills and their consequent control of log prices will inevitably drag auction prices downward, and allow major tenure holders with milling operations far too much influence in setting prices for the wood they cut.

While these scenarios and the conflicts created by increased consolidation are obvious to any analyst with knowledge of BC, Aldonas remains unconcerned. In fact, he has indicated to me on more than one occasion that he anticipates huge consolidations in the BC and North American industries.

What
‘s next for BC?

While the recent news should concern you if you care about the future of BC, the likelihood of a softwood deal in the near future is remote. Why? Politics of course.

  • First, regardless of what the media says, the Canadian logging industry is intractably split on the best approach, with BC on one side and eastern provinces including Quebec on the other. With an impending federal election in Canada, it is unlikely that Prime Minister Paul Martin will let himself be placed in a position in which he will have to choose sides.
  • The upcoming election in the U.S. is also too close to call, and it is unlikely the Bush Administration will want to risk alienating softwood states by forcing a deal.
  • Second, despite the rhetoric of Aldonas, the powerful Coalition for Fair Lumber Imports (CFLI) still controls the softwood agenda. Although Aldonas is enthusiastic about the BC changes, the CFLI is not. They understand that the proposed system is easily manipulated by the growing power of large tenure holders. They understand that tenure holders will be able to control the market and will not have to bid aggressively for logs. They understand that the system will not result in prices that reflect the true market value of BC timber. Although Aldonas has some influence, he does not have the political muscle to force a deal over the objection of the CFLI. And the CFLI will not allow BC to get a tariff break based on currently proposed changes.
  • Finally, when push comes to shove, the Canadian government will not let BC go it alone. In the unlikely event that BC could negotiate reduction based upon current policy changes, eastern Canada particularly Quebec would be at a huge disadvantage. Martin’s government would never let that happen, particularly in an election year.

Pundits will be churning out column inches over the next while about the ins and outs of the BC-only negotiations. Don’t hold your breath waiting for a deal. The real negotiations won’t begin until after the U.S. election in November. Lets hope Grant Aldonas is no longer in change of the file then.

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