US housing starts have pretty much maintained a flat pace since the expiration of the Softwood Lumber Agreement (SLA) last October. All things considered, this has been a good thing for both US and Canadian lumber manufacturers, as both sides are still operating within the one-year period when their respective governments are prohibited from taking unilateral action. As is often the case with such complex agreements, a period of doing nothing is preferable to doing the wrong thing as a reactionary measure. That said, we are quickly coming to the end of the one-year “cooling off” period, which has prompted leaders from both nations to address the issue.
Earlier this month, US President Barack Obama and Canadian Prime Minister Justin Trudeau issued a joint statement on the SLA saying that they have “instructed the United States Trade Representative and the Canadian Minister of International Trade to intensively explore all options and report back on the key features that would address the issue.” The statement notes that both representatives and their teams have been meeting diligently over the past three months, and, while these discussions have been challenging, they have also been productive.
As we have reported over the course of the last nine months, the expiration of the SLA has created a lot of segment uncertainty in a global economy that is anything but certain right now. But global demand still exists and there will always be a market to satisfy this demand, even if margins are eroded. In the current economic environment, Canadian producers are inherently advantaged in this situation considering:
- The falling value of the Canadian dollar makes Canadian lumber more appealing in the global market.
- Because of the falling value of the Canadian dollar, Canadian lumber remains cheaper for US buyers.
- The falling value of the Chinese yuan and the country’s steady demand for western lumber gives Canadian producers and exporters an edge in an enormous market.
An Important Relationship
Canada has long been the largest source of softwood lumber imports to the US, and the US is far and away Canada’s most important export market. In recent years, cross-border investment has also become more prevalent, with US companies operating lumber mills in Canada and Canadian companies making extensive investment in the United States.
But, as noted above, Canadian producers have pricing advantages not only in their in-country market, but also in the US and China—two of the largest lumber markets in the world. On the other hand, US producers are increasingly less competitive as the dollar remains strong; they are disadvantaged in the Canadian and Chinese markets due to exchange rates.
Pursuing a New Iteration of the SLA
A new SLA must reflect the different realities of US and Canadian timber management policies, as well as the US domestic market. The joint statement continues, “A new agreement must be equitable and provide a predictable business environment that gives producers on both sides of our border the ability to react confidently to changing market conditions. Any agreement must deliver a durable and equitable solution and benefit softwood lumber producers from Canada and the United States, related industries and consumers, and support the overall economic well-being of both countries. On the basis of discussions to date, our governments are committed to working to achieve such an agreement.”
The statement adds, “Efforts to achieve such an outcome will be facilitated by focusing on the following key features:
- An appropriate structure, designed to maintain Canadian exports at or below an agreed US market share to be negotiated, with the stability, consistency and flexibility necessary to achieve the confidence of both industries.
- Provisions for region or company exclusions if justified.
- Provisions promoting regional policies that eliminate the underlying causes of trade frictions, including a regional exits process that is meaningful, effective and timely, recognizing that should an exit be granted, it would be reversible if the circumstances justifying the exit change.
- Provisions to ensure information collection and exchange to create meaningful transparency.
- Institutional arrangements to administer the agreement.
- Effective enforcement tools that are neutral, transparent, binding, expeditious, and well-timed to address concerns as they arise.
- Associated commitments regarding the use of trade remedies.
- Provisions for appropriate duration and flexibility to anticipate and adapt to a range of market situations, industry innovations, and shifting demand patterns.
- Provisions to address other issues, such as product scope, remanufacturers and joint market development.”
The U.S. Lumber Coalition said that it welcomed the recent news of renewed discussions, but prefers an agreement that is "sufficiently robust to prevent Canadian producers from exceeding the target market share. The U.S. industry will not give up its rights under the U.S. trade laws in return for an agreement that fails to meet these objectives."
The tone in Canada, however, is less confident; an analyst recently told the Vancouver Sun that she questions whether the US is actually determined to settle the dispute. “President Obama has no incentive to sign a new softwood deal during his last days in office—he’d gain little but the ire of U.S. producers,” said Naomi Christensen of the Canada West Foundation. “An agreement couldn’t be struck over the last 100 days when the issue was given priority, so it’s hard to imagine anything developing over the summer.”
The former head of Canada's Free Trade Lumber Council was even more pessimistic in his assessment, per his commentary for the Toronto Globe and Mail. "Surprises are always possible, but as things stand now, Canada and the United States are not entering a new softwood lumber agreement any time soon, wrote Carl Grenier. “Last March, the President and the Prime Minister agreed to try, but the United States will negotiate only what its industry wants, and its industry wants nothing but a hard-cap quota controlling the supply of Canadian lumber available in the U.S. market. Canada, for its part, will negotiate only what British Columbia wants, and British Columbia does not want a strict quota.”
Demand, Regional Market Changes and Potential Ramifications
- With US existing-home prices also continuing to rise at a 5.4 percent annual rate, declining mortgage rates will likely provide only limited impetus for market expansion. US housing starts are forecasted to be relatively flat for the foreseeable future; demand for softwood lumber will also be limited.
- The strong US dollar (USD) means domestic softwood lumber producers stand to reap only a small slice of any additional demand, as imports are up 42 percent YTD through May.
- The US South is becoming the dominant lumber producing region due in part to limited timber supply in the Western US, and the expansion of Canadian companies taking advantage of abundant southern pine sawtimber. 2016 YTD production in the Western US is down 1.8 percent, while production in the US South is up 3.2 percent vs. the same period last year.
- While there is still sufficient capacity to influence the US market, the long-term projection is for BC production to decline (more mill closures) and fewer logs will be harvested as a result of the Mountain Pine Beetle (MPB) infestation. That said, Eastern Canada imports are also up, which is a region that has had no MPB impact.
While the US and Canadian governments say they are encouraged that both industries remain committed to working toward an agreement and will continue to consider ideas for achieving that objective, time is of the essence. The end of the one-year cooling off period is just over three months away, yet the lumber industry seems to be a long way from having a new policy in place. There is plenty of contentious history tied to this relationship on both sides—both before and after the establishment of the SLA. A potential extension of the cooling-off period may provide a brief delay in activity, but competitive factions within the larger market will ultimately find a way to gain an upper hand.
Regarding the ongoing negotiations, US Trade Representative Michael Froman and Canada's Minister of International Trade Chrystia Freeland said that, "The softwood lumber industry is important for both the U.S. and Canadian economies. It supports thousands of jobs in both countries, downstream benefits in related industries and services, such as a sustainable housing industry, and economic prosperity in many of our communities.”
The widespread economic impact associated with the softwood lumber industry cannot be overstated. Despite the current economic and political uncertainties facing both the US and Canada, finding a timely, workable solution is imperative to maintaining the North American lumber and export industries.