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Timber: An Investment Disaster?

Are Timber Investments Stable, Low-Risk Long Term Cash Growers or an Investment Mistake Waiting to Happen?

by Frank Quin

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Typically, the long-term perspective on investing in timber and timber products is uniformly positive. This sentiment is built on ‘big picture’ scenarios – of relentless global population growth, of rising standards of living in developing countries, of progressive reductions in the harvesting of natural forests and the long lead-times for plantation substitutes, all combining to drive up demand and hence price. But these projections are in the order of decades whereas for many investors returns on an investment are desired or needed in much shorter timeframes, perhaps months or even weeks.

The actual pricing of timber products over the past few years belies that positivity to some extent. With the onset of the United States sub-prime mortgage market collapse in late 2007, ushering in a global financial crisis which in turn has evolved into economic recession in many countries, demand for building timber has slumped and recovery to pre-crisis levels seems still to be a long way off. Of course, populations in the developing world still continue to grow at projected rates but their increased demand remains modest relative to the slump in demand - for new homes, for example - throughout the United States and virtually every other developed country.

There is another major factor in play to be kept in mind when considering timber investments – the continuing and future impact of technology on the demand for timber products. This applies primarily to the pulp & paper sector, after building timber the largest off-take of felled timber. The demand for pulp in the production of newsprint has fallen year-on-year since internet usage started to become ubiquitous in developed countries in the late 1990s and that trend can only continue with other major uses of paper, such as book and magazine publication. The pulp & paper industry globally is responding with research into and investment in other, non-media uses of paper products – the money in facial tissues, for example, is not to be sneezed at – but there is no holding back the relentless march of digital technology.

The challenge for anyone weighing up potential investing in timber – whether building lumber or pulp & paper – is to pick the trends and direct the investment funds to a sector, a product or an investment vehicle – or in all probability a combination – which will best perform relative to other investment options over the investor’s desired timeframe. In a later instalment of this series on timber investment, we’ll take a closer look at those trends and the options for exploiting them. For now, we conclude with a look at the threats to forests and, by extension, to timber investments and timber products.

Threats to Forests (and their Outputs)

Given the time it takes for a tree to grow from seedling to maturity –a minimum of 25 to 30 years for conifers and much longer for many hardwood species, and the fact that it is a living organism, it will be apparent that timberland – and therefore timber investments – are not without risk. At any given point in time, a standing forest faces a wide array of threats, many of which – though not all – can be managed by human intervention. We take a look at the major threats to forests and, by extension, to a timber investment. They can broadly be divided into ‘internal’ and ‘external’ threats.

Internal Threats – Disease, Pests, Fire and Climate Change

Growing trees are exposed to a large number of invasive diseases and insect pests. Oftentimes, the one creates a welcoming environment for the other as, for example, where a bark or wood-chewing insect creates wounds which allow a parasitic and toxic fungus to establish itself.

Generally speaking, the degree of exposure to disease or insect attack is related to the health of the forest in question. Stressed trees of whatever species are much more likely to succumb to opportunistic attacks than healthy ones, a phenomenon which we humans can identify with! So a forest with optimal conditions for its trees – not too dry, not too wet for example – will be greatly more resistant to biological threats than one whose trees are constantly struggling to survive. Of course, the primary forests of the world are where they are because of such natural harmony between the trees and their environment. The same cannot be said of plantation forests, especially of introduced species, a point the forestry investor must keep in mind.

Today, the perceived wisdom in the maintenance of healthy timberland is IPM – integrated pest management. IPM is described thus in the FAO publication ‘Protecting Plantations from Pests and Diseases'.

The concept or philosophy of IPM as a “rational” approach to pest control was formalised during the 1960s. Crop protection specialists had become aware of the adverse side effects of dependence on chemical pesticides, including pesticide resistance, occurrence of secondary pests, environmental damage and human health hazards. This led to the realisation that alternative approaches, including cultural, biological and genetic tactics, used either alone or in combination, were also needed to provide long-term, effective protection against damaging pests.

It will be appreciated that the competence and experience of the forestmanager in the application of IPM – along with the funding needed over the lifetime of the forest – will be critical to the effective application of these principles and the success of any timber investment.

Beyond pests and diseases, the other major internal threat to a standing forest is fire. A forest fire can wipe out a timber investment in a matter of minutes, let alone hours, but is rarely a purely natural event. Left to its own devices, Nature even at its hottest and driest doesn’t often produce spontaneous combustion. Invariably forest fires are human-generated, either accidentally or deliberately. Generally speaking, the closer a forest lies to human habitation, or to roads or other human infrastructure, the more susceptible it is to fire.

Increasingly, climate change is being recognised as a threat to the well-being of any given timberland. We can treat this as an ‘internal’ threat because a forest, once established, is unable to move itself away from the onset of weather conditions – and concomitant threats, eg, of aridity or excess moisture – which are unsuited to the particular species of trees. A timber investment in a new plantation in 2012 should therefore factor in – to the extent possible with available knowledge – the impact of global warming by, say, 2037, when that timberland is scheduled to be harvested.

External Threats – Indigenous Claims, Turf Wars, Government Intervention

In many parts of the world, forests are located in disputed territory, with the relevant dispute being more or less civilised depending on its location. More civilised would be, for example, a tribal or other indigenous claim of longstanding to afforested land in the United States, Canada or New Zealand – in the ‘developed’ world – or in Brazil or Indonesia in the ‘developing’ world. In all probability the claim is being handled by a recognised judicial or mediation process under proper law, affording a degree of certainty as to the range of possible outcomes – perhaps appropriation of all or part to the claimants with state-funded compensation to the incumbent owner, or the allowance of some right of exploitation which again can be given a monetary value. Whatever mechanism is used, the threat to the interests of anyone investing in timber in the region can be quantified at the time of investment.

But there are other such threats to a forestry investment – indeed to the forest itself – which are less civilised and predictable in nature. In parts of Africa today, and typically afforested parts because of the sanctuary they afford, warlords have taken up residence and have effectively displaced with the barrel of a gun whatever legitimate ownership and legal regime existed hitherto. Indeed, there may be more than one combatant laying claim to particular territory and the history of such turf wars shows a lamentable lack of regard to the principles of sound forest management. The hapless investor in any such forest can more or less write off that investment for the foreseeable future.

At a less extreme level, forests are inherently susceptible to government intervention in one form or another. There is, as mentioned above, the prospect of using forests to settle indigenous claims but there is also, and increasingly, the prospect of control for environmental or climatic reasons. Or the reason may be one of macro- or micro-economics. The imposition, for example, of a logging or export ban during a period of economic turmoil. Again, the lengthy period needed for a timber investments to reach maturity means that such risks need to be factored in as far as possible at the outset of the investment.

None of which is to say that investing in timber is fraught with risk! But the serious investor will take an objective and dispassionate approach to the potential threats both to the timberland and the investment before committing.

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