World events and shifting markets increase our awareness and interest in the broader range of disruptions potentially relevant to forestry. However, as we have long taught and written, timber markets are uniquely local. For strategy development and timberland investments, we want to specify the context of the disruption to best understand its absolute and relative risks. How should we think about these?

With so many distractions competing for our attention, I often apply a simple approach to help evaluate the magnitudes of impacts on forestry or mill investments from potential changes, good or bad.

Framing Disruptions

When thinking through the mechanisms by which disruptions affect forestry cash flows, I often ask two simple questions rooted in economic fundamentals:

• Big or small? In other words, how impactful, whether positive or negative, would we expect this disruption or change to be on forest supplies or wood demand?
• Long or short? What is the likely duration, whether positive or negative, of this disruption or change on supplies or demand (in the market or industry)?

This high-level framework is directional. It focuses on the relative importance of potential disruptions. A big impact for a single forest owner can be small for the overall forestry market. Disruptions that get handled on the ground via operations tend to qualify as shorter or smaller in this framework, while anything that requires a Board meeting or an act of Congress better reflects longer-term disruptions affecting future capital allocation and strategic advantage.

Consider the impacts of natural disasters on timber markets. In August 2005, Hurricane Katrina, a Category 5 event, struck the Gulf States, brutally affecting homes, forests and infrastructure. As a disruption, how would we provide context to its impact on timberland owners? Consider our two questions to organize our thinking:

• Big or small? Big event locally; devastating to some forests and damaging to many.
• Long or short? Short-term increase in supplies; negative impact on value.

In sum, a single Category 5 disruption degrades current values through temporarily flooding the local market with damaged timber. And research indicates the impact on stumpage values works its way through the system in 12 to 24 months. The event is short-term because it did not change the long-term fundamentals of wood demand or forest ownership.

Many events disrupt locally, but not the industry and vice versa. An example is consolidation, which varies across industry sectors and geographic regions. Strategically, the issue has grown in importance as consolidation increased in most forest industry sectors over the past ten years based on Forisk industry analysis.

Figure A. Top Ten Firm Capacity by Sector in North America

To address inherent dilemmas and disagreements in strategic planning, we prioritize the tracking, aggregation and analysis of confirmable physical facts. This helps test ideas and decisions by, for example, confirming the locations and needs of wood-using mills. The capital-intensive nature of forest industry expansions depends on a solid evaluation and understanding of the current situation paired with a defensible outlook on potential disruptions.

Local or Global?

Big changes can affect us locally, globally, or both. As we have long taught, timber markets are uniquely local. For strategy development, we want to specify the context of the disruption to best understand its absolute and relative risks, whether positive or negative.

Consider the example of Hurricane Katrina, a Category 5 event. Our summary evaluation of the disruption concludes:

• Big or small? Big event locally; devastating to some forests and damaging to many.
• Long or short? Short-term increase in supplies; negative impact on value.

Figure B further refines this assessment of a major hurricane and reinforces the point that, while severe and impactful, it remains an operational exposure and requires a tactical response. The event is short-term because it did not change the long-term fundamentals of wood demand or forest ownership.

Figure B. Ranking Disruptions: Example of Hurricane Katrina

This high-level framework prioritizes the relative importance of potential disruptions. It separates the local, tactical issues from the global and strategic. Now we apply this approach to a broader set of potential disruptions.

Ranking Disruptions for Forest Owners

Our current research into forest industry and timberland investment strategies includes analysis of over 30 actual and potential disruptions relevant to physical, economic, legislative, technological, market, and geopolitical exposures. Much of this work starts with a forest owner point of view and then works through a wood user or manufacturer point of view. Much of this work highlights critical themes.

1. Tax and environmental policies matter. Overall, forestry is a strategic asset and a low margin business that requires long-term commitments. Changes in how forest management costs get expensed or capitalized materially affect the profitability and attractiveness of these investments. And environmental policies that recognize forest benefits without constraining property rights can enhance these values materially.
2. People matter. Without people to work and to consume, forests have little economic value. Anything that slows or hinders the growth of the workforce or of a healthy populace, materially reduces the net cash to owners, the long-term demand for manufacturers, and their ability to run a business.
3. Technology matters. Technology has explosive potential as a value creator. Consider that pulp manufactured from pine as we know it did not exist 100 years ago. Today, fluff pulp mills have among the strongest ability-to-pay for wood in North America. The number of patents and applications for wood fiber continues to grow.
4. Demand matters. From an economic standpoint, trees have no value unless nearby mills exist to buy them and convert them to value added products.

Conclusion

When investing in U.S. timberland or wood-using capacity, we either invest in established forests with mature wood markets, or we invest in areas that require development of the forests and/or wood markets. Using the approach outlined above helps us develop strategies and assess exposures across multiple disruptions for these situations locally.

This guest post is courtesy of Brooks Mendell, Ph.D., President and CEO at Forisk Consulting, a Georgia-based firm that specializes in forest-industry, timber-REIT, bioenergy, and timber-market research. For more information, visit www.forisk.com.