Don't Fall Asleep on a "Boring" Lumber Market
You might wake up to a Nightmare
The lumber market has been as uneventful as I can recall in my thirty plus years in the business. You might even call it boring. That being said, I still fret over the potential for volatility, probably from past experiences, but it is important that we don’t get lulled to sleep when the market is in equilibrium, especially for this length of time. The current market levels, while not profitably optimum for producers, are still better than lumber returns during the building recession we all suffered through from 2008 -2011. But while these levels may be sustainable for the short term, producers want to move this market up and improve their return on investment and will most assuredly look for every opportunity to do so in the coming year.
First, let’s take a look at Contract Lumber’s Framing Lumber Index as a benchmark for market perspective over the last eighteen months. Our index tracks seven key reported commodity framing items using mill pricing (no freight or profit). Each of these products is weighted in respect to their total cost of an average 2,500 square foot home’s framing material package. These seven products are then averaged to produce a single, trackable number called our Framing Lumber Price Index. The actual index number is less important than the trend or comparative value it communicates. For instance, if you bought out a project in July 2013 and were preparing to build the same project in December, 2014, the index offers a quick look at how your basic lumber package compares, short of changes in freight consideration. It has become a functional tool to help communicate lumber material impacts on the building process.
Since July 2013, the C/L Commodity Lumber Price Index has traded within a $50 range. That is almost unheard of stability in a commodity market that historically has fairly wide swings throughout the course of a year. The index level has primarily remained between $300-$350 per thousand board foot over the past 18 months. In the 18 months prior to that (Jan 2012-Jun 2013), our index had experienced over a $200 mbf swing in pricing, the epitome of volatility.
So, what has contributed to this recent stability? No examination of the lumber market (or any commodity product) can ever be undertaken without delving into a relationship between supply and demand. Ultimately, that is what controls market movement. Oversupply drives pricing down…excess demand spikes pricing. Of course, it is more complicated than that, but at the end of the day, the relationship between supply and demand dictates market movement. The obvious conclusion taken from the past 18 months in the lumber market is that supply and demand have been in balance. But it is a delicate balance, at best.
Demand has been reasonably steady throughout the year, albeit, less than analyst projected. Many producers have increased capacity in anticipation of a robust housing recovery. What we have experienced is anything but robust as demand has been muted. Housing starts have failed to reach analyst expectations the past two years coming out of the recession. In fact, if it wasn’t for a strong performance in the multifamily construction sector the lumber market could have been in freefall. Multifamily has propped up housing starts toward the million mark as the anemic single-family market has sputtered. Through September of this year, multifamily housing starts averaged (Seasonally Adjusted Annual Rate – SAAR) 354,000 units, over 36% of the total housing starts. For historical perspective, in 2005 there were 353,000 MF starts that accounted for 17% of the total housing units that year. Times were certainly different as we were at the peak of the U.S. housing boom, topping 2 million starts. The point is, ramped up lumber production to handle the 1.2-1.4 million housing start predictions has put pressure on lumber commodities. Late in 2013 and earlier this year, producers were able to export their wood to steady the market but off-shore demand, especially in China, has faded drastically. The result has been a lumber market unable to build momentum in the second half of the building season as many producers had hoped for and analyst projected.
Oriented Strand Board pricing, in particular, has been stagnant this year. During 12 straight weeks from August 19th through November 11th, the 7/16” and 3/4” T & G OSB market printed flat, a stretch almost unheard of in one of the most volatile commodity market’s imaginable. Forecasts for housing starts to top 1.2 million units this year spurred five OSB plants to restart but with starts falling short there has not been sufficient demand to absorb the additional production and OSB has remained a value throughout the year. Don’t expect that trend to follow in 2015. Widespread whispers of curtailments due to OSB mills losing money have started to circulate but mills want to make production reductions quietly for fear of losing labor and to maintain some much needed cash flow. Most believe it is just a matter of time before we return to more historical housing numbers and when we do, they want to be in position to reap the benefits.
Transportation issues have provided a significant hurdle to the lumber industry throughout 2014 and may have contributed in some fashion to market stabilization. Rail car availability played havoc with on-time shipments and forced dealers to get out in front of their anticipated needs. This very well may have allowed for a more even flow of lumber into the market and certainly forced higher inventory levels, in general, in addition to increasing freight costs. These factors may have helped artificially elevate lumber prices beyond what the market activity would suggest. Another transportation problem certainly helped elevate dealer’s lumber costs. Trucking rates escalated to outrageous levels this past year despite a reduction in diesel fuel costs. Equipment and driver availability are generally thought to be the source of higher shipping costs with little relief in sight. Attrition among smaller, independent trucking companies that typically service the lumber industry, has decimated shipping options. Larger commercial carriers tend to focus on moving freight that pays better or limits routes that provide back-hauls. Couple that with the fact that the average age of a truck driver in the U.S. is fifty-five years old, according to the Bureau of Labor & Statistics, and it’s obvious this problem is in its infancy.
When looking forward to 2015 it’s hard to envision any drastic changes to the demand side of the equation. Hopefully we see some stronger single-family recovery that’s buoyed by the first time buyer market. If that happens we could actually achieve another manageable housing uptick in starts pushing 1.2 – 1.4 million units. Expect multi-family strength to continue, although the nature of that business will play havoc on month-to-month starts data. The same cast of characters will again be present to offer momentum-building resistance to the housing recovery. Difficulties with first-time buyer from both an interest and qualification standpoint, new home inventory shortages, construction loans and labor shortages will all be contributing factors.
Expect lumber to continue bouncing around a bit because, well, that’s what commodities do. I would be hard pressed to think we could have another 18-month period like the last – void of volatility. The key is vigilance! Don’t build budgets without doing your due-diligence. Don’t assume, just because the lumber market may be flat that other factors aren’t at play that can burden your costs. It would be wise not to doze on this market as the balanced state we seem to be operating in today is sure to meet a wobble or two in the coming months.