In This Issue

• Introduction
• Clarky's Comment
• Big Safe-Start Programme Aims to Keep Forests Safe
• Processing of Emission's Trading Scheme Applications
• The Carbon Market
• The Log Market
• PF Olsen Welcomes Three New Team Members and One Departure

Introduction

Welcome to the first edition of Wood Matters for 2010. Please rest assured that you did not miss a January edition (which did not eventuate due to the combined impact of high work levels and leave associated with the Christmas break).

In this edition Peter Clark reflects on the emergence of what looks like a positive year for forestry and outlines some of the challenges we need to overcome to leverage this to best advantage for forest growers.

We report on a very successful Safe-Start programme and provide an update on processing of applications for the Emissions Trading Scheme and have commentary on the Carbon Market.

In addition, we have our regular Log Market commentary.

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Clarky's Comment

2010 has started well with recovery of house construction starts in NZ and Australia now inevitable. Both countries face a catch-up from low building activity in 2009 plus increased immigration. Meanwhile China's infrastructure boom has kept up demand for export logs.

Improving wood products demand is seeing price rises in both processed wood products and log prices.

What are the risks we need to be aware of as harvesting activity picks up further in 2010?

1. China may slow its economy down. That is possible but is not likely to cause a catastrophic reduction in demand. Firstly China needs to keep up 8% growth simply to provide the jobs for those entering the workforce and migrating from rural to urban centres. Secondly NZ pine has taken market share from both Russian and China domestic log supply and is becoming more firmly established in the China market.
2. Russia may choose to reduce or eliminate the existing €15/m³ duty on log exports. There has been no suggestion of this but it would certainly adversely affect NZ pine exports to China if it did occur.
3. Log storage restrictions are now common at most NZ log export ports. These restrictions have the effect of making new exporters uncompetitive with established exporters and therefore reduces price competition. If you don't have a level playing field and either competition amongst the log traders purchasing logs at wharf-gate in NZ, or direct access to the market (such as PF Olsen's Market-Direct strategy), log price rises can just translate into higher margins for the log traders. Some ports are actively increasing log storage facilities and providing a fair process for allowing new exporters to operate. Others appear satisfied with the status quo; that does not bode well for many forest owners as our annual log harvest rises steadily to 30 million m³/annum over the next decade.
4. Some parts of society are calling for a ban on Methyl Bromide (MeBr) fumigation. If implemented this would cause a massive loss of log export trade until an alternative was found. Alternatives are being researched now but so far there is no obvious answer. Chinese biosecurity authorities have rejected an application by MAF to have deck cargo (that cannot be treated with Phosphine) fumigated once the logs arrive in China. The Stakeholders in MeBr Reduction (STIMBR) is working with Indian authorities and MAF Biosecurity to investigate replacing MeBr with Phosphine. PF Olsen is actively involved in trials to find new solutions.
5. The frequency of intense rainstorms and transition of harvesting into steeper, more erodable country with marginal road access will present engineering challenges and add cost as society demands higher standards of protection of our clean waterways. Forestry protects erodable soils throughout the growing cycle but exposes these soils during the brief harvesting and inter-rotation period.
6. The full roll-out of random drug and alcohol testing in the forest industry in 2010 means some labour will need to be stood down. While this may cause short-term disruption and labour shortages in some crews, the end result should be a better, safer and more productive workplace for all.

There is an air of optimism in the NZ forest industry at present that is quite different from this time last year. Our focus this year must be on operational excellence and working with government and contractor stakeholders to:

• alleviate infrastructure constraints;
• improve safety;
• implement R&D and productivity improvement initiatives.

Material progress in these initiatives, along with a strengthening wood market, could make 2010 a good year for forest owners.

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Big Safe-Start Programme Aims to Keep Forests Safe

January started with twelve regional Safe-Start events all across New Zealand (from Winton to Kaitaia). Traditionally January sees a high rate of accidents in forestry work as workers have to switch from holiday relaxation and festivities to the physically demanding and potentially hazardous forestry and harvesting operations.

"Our data shows Safe-Start to be an effective way of assisting with this transition and raising awareness of increased risk as people return to work; injuries are much fewer than what was seen a decade ago.", says Nic Steens, PF Olsen's Health and Safety Manager. "We also use the opportunity to provide information, inspiration and reminders from a range of presenters".

Whilst each programme varied at different locations, the event in Rotorua was notable for both its size and very interesting programme. An estimated 350 people attended the breakfast-based session held at the Heritage Hotel on Monday 11 January 2010.

"The benchmark is very high ...world class safety management and individual responsibility are requirements, ...we do not want to pay the price of injuries..." said Don Huse (OTPP Board Member) as he addressed the audience of forest worker employees and contractors.

Our second speaker, to quote John Stulen, CEO of FICA (the Forest Industry Contractors Association)... "Mike Sabin, Director of Methcon Group Ltd spoke about his son's terrible head injury and recovery during 2009 - and a heart wrenching story it was - told with emotion by Mike in 50 minutes but with images and video of his son over 9 months of recovery the talk felt like 20 minutes." Mike said... "We are all just one 'accident' away from disaster ...one wrong step, one short cut too many, one absent-minded oversight can, and often will, be difference between life and death, avoidable injury and certain harm. You don't get to choose what the outcome will be once the incident has occurred." He also reiterated the need for workers to be drug-free "The potential for forestry accidents is huge - why take drugs to increase that potential."

Methcon provide drug awareness information to New Zealand businesses. This message was appropriately timed to coincide with the commencement of new random drug testing procedures introduced by PF Olsen, collaboratively with its many contractors. "We are working together on the 'drug problem' - to stem the incidence of drug-related accidents and make our operations safer places to work" says Nic Steens. "Testing to date shows (nationally) around 25% testing positive for impairing drugs (methamphetamine and marijuana). Workers testing positive are removed from safety sensitive work until they can furnish a negative test result and must enter rehabilitation and follow-up testing for a period of two years. For sure, this will place pressure on our capacity but we are committed to the programme which will benefit those that persevere."

Each Safe-Start event includes safety and operational awards.

Safety Awards: (Contested by all CNI operations)

• Top Crew: S&R 53 (Simon Walker) - OTPP, VG Harvesting Crew
• Most Improved Crew: Black Hawk 50 (Graeme Black) - OTPP, VG Harvesting Crew
• Safety Innovation: R Smith Logging Contracting (2007) (Bryan Smith) - OTPP VG & CNI Distribution Contractor
• Safety Leadership: (3 equal first)
• Raumati Morgan - Intawood (OTPP Forest Management)
• Kevin Mickleson - Manmac (Rotorua Harvest Management)
• Warwick Gibbs - Gibbs and Olsen 32 (OTPP Harvest Management)

Operational Awards: (Contested by OTPP Harvesting operations)

• Top Crew: H&R Harvesting 127 (Rodney Hubbard)
• Most Improved Hauler: Maungawaru 8 (Dale Gilbert)
• Most Improved Ground Based: Hohneck Tractor Logging 10 (Kas Hohneck)

Congratulations to all award recipients!

PF Olsen would like to thank the ACC and forest owners such as OTPP, VG and CHH Pulp and Paper for their continued support for these initiatives. Without their support, it would be very difficult to produce events of this quality.

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Processing of Emission's Trading Scheme Applications

Thank you to those that have engaged PF Olsen to process their applications for post-1989 and pre-1990 forest land.

"Whilst we are very busy working to the [pre-1989] deadline of 31 March 2010 we are pleased to have previously invested a lot of time liaising with the Ministry of Agriculture and Forestry and clarifying the rules", says Richard Quinlan, Land Information Manager for PF Olsen (see photo left). "We have also done a lot of work developing new functionality in our GIS (Geographic Information System) to make sure that we are both conforming to the ETS rules, but at the same time maximising the area in the application."

An example of maximising the area is using "buffering" which adjusts the stand boundary relative to its expected growth. "We understand that few other applicants are using "buffering", adds Quinlan. "It's also important that we try to get applications right first time to avoid MAF spending a lot of time on the application, and potentially charging additional fees."

In terms of the pre-1990 free allocation, partial compensation NZUs, applications can only commence once the mapping standards and the Allocation Plan (not expected any earlier than April 2010) are finalised.

For those that have decided not to join the ETS yet, we reiterate our advice that unless you have an urgent desire to sell your NZUs in the near-term there is no urgency to join the ETS. You can enter the ETS up until 2012 and still claim your NZUs from 2008.

Many post-1989 forest owners will still be unsure if they should join. As covered in prior correspondence, and Wood Matters, some of the factors to consider are:

1. Composition of forest holding (especially age-class structure).
2. Expected returns from harvesting (to offset the carbon liability at harvest).
3. Access to, and cost, of carbon insurance.
4. View of the future of the carbon market.
5. Attitude to the risk associated with the carbon liability at harvest.
6. Desire to generate revenue from carbon sales.

This year PF Olsen will be able to assist forest owners with evaluation of points 1, 2 and 3 above, and continue to provide information and commentary about the carbon market, 4. As mentioned previously, we hope to be able to offer opportunities to hedge, or lay-off the carbon price risk associated with carbon through pooling-type structures (point 5 above) to allow forest owners to enjoy carbon revenue without the carbon price risk.

Some important dates:

• 31st January 2010 - last day to notify MAF of deforestation of pre-1990 forest in 2008/09. Thereafter MAF notification is required within 20 working days of deforestation.
• 31st March 2010 - final date for submitting voluntary post-1989 emission returns and mandatory pre-1990 emission returns as a result of deforestation in 2008/09.

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The Carbon Market

With the relative certainty of the NZ Emission's Trading Scheme (especially in comparison to the failed Kevin Rudd-backed Carbon Pollution Reduction Scheme (CPRS) legislation), there is growing activity in the market. Nigel Brunel of OM Financial gave a "conservative" estimate that about 1 million tonnes of New Zealand Carbon traded for between NZ$20-NZ$21 per tonne in January. Brunel states that trades have included both New Zealand Units (NZUs) and Assigned Amount Units (AAUs) and buyers have been both foreign governments and domestic compliance buyers.

With CERs (December 2010 delivery) currently trading in the European market at just below € 12 (NZ$ 24), the New Zealand based credits are relatively cheap. However, it won't be until 1 July 2010 that stationary energy and liquid fuels enter the ETS and have to start accounting for emissions, initially at 50%.

The market is still relatively ill-liquid. Supply of NZUs can only come from forestry and many of the claims for 2008/2009 sequestration will not be available until the second quarter of 2010. The larger volumes of NZUs that will come out of the free allocation to pre-1990 forests owners wont be available to trade until the second quarter of 2010 at the earliest (and maybe later).

A perusal of the NZ Emission Unit Register shows there are 708 account holders (only some of which may have units and/or trade). The following transactions occurred in 2009:

• Units transferred out of New Zealand
  • 571,451 AAUs (most of these are the Ernslaw sale of NZUs converted to AAUs and sold to Norway)
  • 568,469 ERUs
  • 401,000 CERs
• Units transferred into New Zealand
  • 1,000 AAUs
  • 401,000 CERs

EITG reported in the recent Carbon Monitor that suggestions that the former Soviet Union (or FSU) may loose its large holdings of AAUs (also known as "hot air") could result in a collapse in AAU prices. They note that January quoted prices for AAUs of €8 (around NZ$16) are well below the €12 CER price. This could affect the attractiveness of converting forestry NZUs to AAUs for export.

On a more positive note, EITG report good acceptance and demand in Europe (at a price) for New Zealand forest AAUs.

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The Log Market

Strong Start to 2010

January and February saw increases in log prices both from export logs and domestic logs (pruned and structural). There are strong indications that export prices will lift again in March. The A-grade price is currently over 100/JAS m³ at main NZ ports and is forecast lift by 10% in March.

China now comprises some 70% of NZ log export volume so is a critical player in the market. Radiata prices in the Chinese market (US$ CFR prices) now exceed the record levels achieved in Q3/Q4 of 2008. Exporters are expressing some concern from May onwards, based on:

• - Potential cooling of Chinese demand from government credit restrictions and the onset of the hot season (a seasonal reduction in demand and price is typical around April/May).
• - High Radiata prices stimulating competing supply of logs from Russia and logs and lumber from the US and Canada.

However, a number of positive factors may more than offset these negative factors:

• + High level of long-life infrastructure projects on the go.
• + A pledge by the government to demolish city slums and build more affordable low rent housing.
• + Increasing cost of getting Russian logs to market and current 25% tariff (and still the prospect of a tariff increase).
• + A strategic shift in purchasing strategy to more sustainable NZ Radiata log supply.
• + Increasing economic activity in North America could result in more logs and lumber consumed domestically.

On balance, it is not expected that Chinese demand will collapse although prices could ease. However, increased demand and prices from Korea and India will tend to cushion such downward pressure.

Foreign exchange and ocean freight have stabilised in recent months. The NZ$:US$ cross rate is currently fluctuating in a band just below 0.70 and ocean freight is being fixed in range of early to late US$40s/JAS m³ depending on load and discharge port configurations.

For the first time in a year the NZX Agrifax Combined Log Price Index, which measures returns from the whole forest, has lifted to just above NZ$77/tonne. In January of last year it was 78/tonne (its peak for 2009). The minimum value in 2009 for this index was reached in June when it was at NZ$72/tonne.

Trying to Avoid the Hype

It appears that a number of main-stream media have picked up on Issue 25 of the TimberFed News (December 2009) and are over-sensationalising the strength of the timber and log market.

Yes, the China market has significantly increased importation of New Zealand Radiata but this was in a context of very sluggish demand from Japan and Korea for most of the year. And whilst at-wharf-gate prices have firmed with A-grade moving from around NZ$80/JAS m³ to $90/JAS m³ through last year, this increase was off a low base.

A strong export log market and increased production levels by New Zealand wood processors will put pressure on supply of domestic log grades and we are seeing strengthening prices. But bear in mind that despite much stronger exports of sawn timber to Asian markets, the prices paid in these markets are typically much lower than Australia, USA and Europe. This will constrain the ability of domestic processors to increase log price and stay viable.

Too much hype about the market can lead to irrational actions, such as flooding export markets with too much supply, and starving the important domestic processing sector of much needed logs. If export log markets crash, the relative stability of the domestic log market is very important.

"The last thing we need is a stampede of forest owners for harvesting", notes Peter Weblin, PF Olsen's Marketing Manager (see photo below). "It appears that with some forest owners, there appears to be a switch - either it's "on" or it's "off" - with regard to harvesting intentions. Often it's when A-grade hits $100 that the switch goes on. When large numbers of forest owners rush for harvesting, especially when they are not harvest-ready, they end up with either undesirable harvesting results from too much haste, or going on a waiting list to get capacity. A very frustrating situation for all parties."

Whilst a strong market provides welcome increased returns for forest owners, it increases volatility and the probability of a strong market correction. High market volatility creates unintended negative consequences which the industry pays for subsequently.

Forest owners who have taken our advice and become harvest-ready are in the best position to make the most of the strong market situation. If you are not harvest-ready, then now is still a good time to do so, but the process may take longer than usual, and there is no guarantee the market will still be strong when you are ready to harvest.

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PF Olsen Welcomes Three New Team Members and One Departure

Recent staff developments have resulted in one secondment to Malaysia and three new appointments:

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