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February 18, 1983

Northwest Timber Dilemma
In the last few years, the lumber industry of
the Pacific Northwest has suffered from its
worst slump since World War II. Lumber
mills have been forced to close or to curtail
operations in response to the downturn in
the demand for timber products, As of
January 1, for example, 82 outof 197 mills in
Oregon were closed, In fact, softwood
lumber production in the Pacific Northwest
has dropped nearly 35 percent from its peak
level in 1 978, Although there are now signs
that the lumber industry is reviving, the
recovery remains jeopardized by a variety of
special demand and supply problems,

Demand problems
The forest products industry depends on the
housing industry for almost half of the
demand for its products, Thus, when high
interest rates and the recession precipitated a 40-percent decline in housing starts
between 1 979 and 1981 , the effect was
transmitted directly to the forest products
industry, A strong dollar futher depressed
sales by weaken i ng the competitive position
of U,S, producers in world export markets,
The downturn in demand affected the economies of the Pacific Northwest dramatically
because of their dependence on a thriving
forest products industry, Over one-fourth of
total manufacturing employment in Washington and Oregon (which together produce
over half of the nation's softwood lumber),
for example, is in the forest products
industry, Cutbacks in mill production
caused massive job layoffs, raising unemployment rates in some timber processing
areas of the two states to nearly 30 percent,
and contibuting to state unemployment
rates that are above national levels,

Supply problems
For lumber firms on the west side of
the Cascade mountain range, weakened
product demand hit at a time when timber
processors were facing sharp increases in

production costs, These cost increases were
a legacy of the unique stumpage and mill
capacity environment of the Pacific
Northwest.
Of the 740 million acres in the nation classified by the u.s. orest Service as forestland,
F
two-th irds or 488 mi Ilion acres are classified
as commercial forestland, Across the nation,
only 28 percent of this commercial forestland is publicly owned; the remainder is
privately owned, In the western half of
Washington and Oregon, however, national
and other public forests account for 49
percent of the available timberland, and
over one-half of the mills in the region
depend on publicly owned timberfor their
supply, Public policies toward timber contracting and harvesting thus have a major
impact on the production costs of Northwest
producers,
Timber harvesting rights on most public
lands (and some private) are awarded by the
landowner through a competitive bidding
process, Mills bid for the stumpage, and the
bid becomes the fee for removing standing
timber. Contracts in the Northwest typically
extend for three years (although a few longer
terms exists), If it is successful in bidding
for the stumpage, the mill obligates itself to
remove a specific quantity of timber within
the I ife of the contract and to pay the bid
price at the time of harvest.
Stumpage contract prices in western Oregon
and Washington nearly doubled between
1977 and 1 980 on forest service lands,
When product demand subsequently collapsed, the implicit stumpage market value
fell below contract stumpage costs,
In other regions of the country, lumber
producers are protected from such price
collapses by a price escalation adjustment
system in which contract stumpage fees are
adjusted periodically to follow shifting

I

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§§

Ia@lThm1
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§@lTh
Opinions expressed in this newsletter do not
necessarily reflect the views 01 the management
01 the Federal Reserve Bank of San Francisco,
or of the Board of Governors of the .ederal
Reserve System,
market prices, In some cases, forexample, if
the lumber price index falls, rates are
reduced by 100 percent of the difference
between the quarterly price index and the
base index, If the index rises, prices are
adjusted upward, but by only 50 percent of
the difference, As a result, the system largely
protects the producer from market downturns but also reduces potential profits
should the market value of timber riseduring
the life of the contract

from the market and redesignate it for
wi Iderness or other non-commercial use,
During the 1960s, the amount of public land
available for commercial harvesting
increased, leading to expectations of a continued availability of timber. But changes in
public policies, some due to environmental
concerns, caused approximately 5 percent
of commercial timberland to be withdrawn
from production between 1970 and 1977.
Expecting further cutbacks in allowable
harvests, lumber companies placed increasingly high values on the rights to harvest
timber on public lands,

The contracts in western Oregon and Washington did not contain this type of price
adjustment mechanism, Indeed, in the early
1970s, when stumpage prices were generally increasing, Northwest producers
enjoyed the profit-making opportunities of
their contracts and did not press for the
inclusion of a price escalation mechanism,
When the demand for wood products began
to fall, Northwest lumber producers were
left facing the worst of both worlds:
decimated demand for their products and
vast and costly obi igations to harvest timber,

Finally, competition for the crucial public
harvesting rights was stiffened by what many
in the industry considered an excessive
number of mills for the region. In an environment of over-capacity and little direct control over the timber supply, survival depends
upon wresting the available supply from
rival processors. Given the length of the
lumber contracts involved, gaining access to
the supply of stumpage was a do-or-die
proposition for many mills hoping to profit
from the demand anticipated in the early
1980s; it added to the vigorous bidding
competition and the resulting upward spiral
of costs,

The bidding mess
The high contract-cost problem can be
traced to three factors, First, the prospects for
continued growth in home construction had
contributed to aggressive bidding by Pacific
Northwest forest products companies,

The industry reaction
It can be argued that the situation facing the
Pacific Northwest timber industry is simply
the consequence of some unfortunate forecasting errors by the region's producers and
does not warrant public intervention,
However, the magnitude of the problem and
its consequences for income and employment in the Northwest have spurred the industry to seek relief from the government

The then-strong foreign demand encouraged this enthusiasm, In recent years, over
20 percent of the total softwood log harvest
in the Northwest has been exported as foreign markets proved extremely lucrative.
lumber harvested from most publicly
owned land is ineligible for export, Thus,
lumber companies expected private lands to
be increasingly committed to meeting
export needs, thereby redUcing the supply of
lumber available to meet domestic needs.
Demand for publicly owned timber harvesting rights was further stimulated by this trend.

In particular, the industry has sought-and
obtained in some cases-short-term extensions of harvesting obligations in existing
contracts. Many of the contract termination
dates are quickly approaching, and the
industry has estimated that it wou Id lose
over $2 bi II ion if it were forced to fu Ifill its
contracts while timber market values are

Second, lumber companies feared that
government would withdraw timberland
2

U. S. FOREST SERViCE
TIMBER CONTRACT PRICES
,
COASTAL NORTHWEST

SOFTWOOD LUMBER PRODUCTION
COASTAL NORTHWEST

9000 ... _

,

8500
350

8000

300

7500

250

7000

200

6500

150

6000

100
1977

1978

1979

1980

1981

5500
1977

. .
1982

1978

1979

1980

_
1981

..
1982

above current or future market value in an
auction. Since the contracts extend for a
secure length of time and contain a price
escalation (and de-escalation) mechanism,
producers bear little price risk. Canadian
producers thus are largely protected from
the variations in supply price that have
devastated the Northwest market.

depressed.Of course, the contract extensions that have been obtained (typically one
or two years) merely postpone the industry's
cash-flow problem unless the market for
wood products rebounds smartly as the
recession unwinds.

Canadian competition
The industry is also petitioning the U.S.
government to shield it from what it considers subsidized competition from Canadian imports. Canada's share of the U.S.
softwood lumber market rose from 13 percent in 1961 to 30 percent in 1981 . The
share rose partly in response to exchange
rate changes favorable to the Canadians. But
u. s. producers allege that it is the government subsidy of Canadian imports that is
injuring the domestic industry, and they
have detailed these allegations in a complaint filed before the U.s. International
Trade Commission (lTC).

Conclusion
Of course, the flip side of this coin is that by
sharing the risk with the public sector, the
Canadian lumber processors also forego the
profit opportunities of fixed price contracts.
Still, some industry observers in the U.S. feel
that some redistribution of risk-bearing may
be necessary to maintain a healthy lumber
industry in the long-run, and that the incorporation of a price escalation mechanism in
Northwest timber contracts would be one
step in this direction. Indeed, at the end of
March, the Forest Service will initiate an
experimental price adjustment system in
western Oregon and Washington.

In this regard, it is interesting to contrast U.S.
and Canadian public timberlands policies.
The Canadian Crown-Provincial Government owns nearly 90 percent of Canada's
commercial forest land. Instead of bidding
for timber harvest rights, Canadian companies are granted long-term rights to
harvest timber through a negotiated tenure
system.The stumpage fee paid is the government appraised market value of the standing
timber, derived (much as it would be in
a regulated industry) by examining endproduct market values, estimated production and harvesting costs and a fair profit.
This fee is adjusted monthly to incorporate
changes in market values. Historically, the
stumpage fees generated by this system have'
been considerably lower than those paid by
Northwest producers. This differential is the
basis for the allegation that Canadian producers receive an implicit subsidy.

The issue of unfair Canadian competition is
still not resolved. The ITC issued a preliminary finding of injury on November 22,
1 982. Next, the Department of Commerce
must determine by early March whether or
not Canadians implicitly receive a government subsidy. Depending on thedetermination, the U.S. will decide whether to impose
duties or take other actions.
These developments do not erasethe cumulative gap of over $2 billion between the
average contract price and the current price
for uncut timber on government land. Still,
there is tentative hope for a recovery. The
recent increases in home building activity
should increase the demand for wood products, and, since softwood lumber inventories were at their lowest level in ten years
on January 1 , should lead to a pick-up in
lumber prices and harvesting activity. I f
the demand for lumber and wood products
recovers further, the worst could be over for
the Northwest lumber industry.
Jennifer Eccles and Randall Pozdena

At the very least, the two systems implicitly
incorporate different patterns of risk-sharing
between producers and public stumpage
suppliers. In the Canadian system, there is
no risk that stumpage prices will be bid
3

1 006

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BANKINGDATA-TWELFTH
FEDERAL
RESERVE
DISTRICT
(Dollaramounts millions)
in
selected
Assets Liabilities
and
large Commen:ial
Banks

.'

.

loans(gross,
adjusted) investments'"
and
Loans
(gross,
adjusted) total#
'.,.,...
Commercial industrial
and
Real
estate
loans'to individuals
Secu'rities
loans
U.S.Treasury
securities'"
Othersecurities'"
Demanddeposits--:-total#

Demand
deposits
""--adjusted
Savings
deposits-'total
Timedeposits;,....tbtal#
Individuals, & corp.
part.
(largenegotiable
CO's)
Weefdy
Averages
of Daily figu ....
Member Bank
ResefVe
Position
Excess
Reserves
(+l/Oeficiency(- l
Borrowings
Netfreereserves l/Netborrowed(l
(+
-

Amount
Outstanding
2/2/83
164,183
143,046
45,416
57,279
23,815
2,831
7,635
13,502
40;175
27,202
59,851
75,446
66,692
25,815

Changefrom
,year ago
Doar
II
P
ercent

Change
from
1/26/83
601
550
310
89
26
77
74
- 23
2i 507
110
2,333
__
1,939
-1,699
- 522

"

Weekended
2/2/83

4.0
4.9
8.1
1.4
1.2
42.5
23.3
11.5.
- 1.7
- .7
94.3
- 17.2
- 18.7
- 28.7

6,334
6,636
3,409
814
291
844
1,444
- 1,746
713
- 196
29,048
- 15,687
- 15,343
- 10,388

Weekended

Comparable

1/26/83
170
4
166

60
237

-

177

* Excludes
trading
account
securities;
# Includes
items shown
not
separately;
Editorial omments aYbeaddressed
c
m
to
TOng)
ortotheauthor•• , . Free
copies'
ofthis
andother
Federal
Reservepublkations beobtainedbycalling writingthe Public
can
or
Information
Section,
Federal
,Resen'e
BankofSan
Francisco,P.O!
Box7702, San
Francisco94120. Phone
(415) 974-2246.

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