The lumber market outlook for 2022: Price rallies, falling demand and capacity concerns
Fastmarkets’ senior economist, Dustin Jalbert, provides insights into the state of the lumber market today and explains the price rallies, falling demand and concerns for future supply.
The lumber market is not only facing a decline in demand, but also seeing supply curtailed as market conditions shape up to be similar to what we have seen in 2019. What does this mean for market participants?
Dustin Jalbert, senior economist at Fastmarkets, explains the reasons behind the lumber price rallies of 2020-22, the drivers of falling demand and the repercussions this could have on future lumber supply.
What has driven the lumber price rallies from 2020 to 2022?
There have been two major lumber price rallies that we’ve seen over the last two years, each driven by a different set of factors.
2020-2021: Demand and supply disconnect
The demand growth in the second half of 2020 and early 2021 was driven by a DIY boom fueled by a mix of government stimulus money and people having more time and disposable income to spend on their homes during the pandemic. People’s spending pivoted from the service side of the economy to home improvements. New housing construction also took off as home purchases soared in the midst of the pandemic.
Meanwhile, the supply side of the wood products market was under pressure. Mills curtailed aggressively early in the pandemic for fear that the housing market was going to see a significant downturn. However, the reality turned out to be the opposite. Demand picked up quickly and mills struggled to ramp up production. Challenges with getting furloughed employees back on the job, and manufacturing operations being disrupted by multiple waves of Covid all contributed to the slow recovery in output.
This disconnection between demand and supply, along with a major drawdown in inventory at the wholesale and retail portion of the supply chain, fed into the record volatility and prices we saw in 2021.
2021-2022: Transport and logistics constrains
The price rally into 2022 that we are seeing now is more tied to transportation and logistics constraints, rather than a disconnect between demand and supply.
The outset of the price rally began in mid-November 2021, when historic flooding and landslides in British Columbia disrupted critical transportation networks for this key supply region for wood products. In addition, there was a record-breaking Omicron wave and unfavorable weather conditions through the winter months, which caused further challenges to the already disrupted supply chains and transportation. With the inventory already thin, this set off a second rally in lumber prices.
Now, halfway through 2022, we are seeing the prices correct as transportation issues subside, the Covid wave subsides and the demand cools.
What are the causes of the fall in lumber demand in North America?
There is a lot of concern amongst industry participants that we are entering a broader economic recession, as well as a downturn for the wood products industry. Whether or not there will be a recession is still up for debate, but it seems very likely the industry will experience a decline in lumber demand this year.
The first reason for the drop in demand can be attributed to the rapid rise in interest rates we have seen over the last few quarters. The federal reserve is becoming more hawkish as it tries to address the highest inflation we have seen since the 1970s. Higher interest rates lead to higher mortgage rates, which in turn impact housing affordability. We have seen this play out through the sales data of new and existing homes, and we are expecting housing starts to come off significantly for the rest of 2022.
The second reason behind the declining demand is the weakening of interest and spending in the repair and remodeling space. The high inflation environment is significantly impacting the discretionary spending of households as more of their paycheck is tied up by essential purchases, such as energy and food, which are also increasing in cost. In addition, the money that had pivoted to the goods side of the economy during the pandemic is shifting back to the service economy as more people choose to travel, eat out in restaurants and go to events. As a result, home improvement spending is being curbed, which is having a really big impact on the DIY side of the market and, in turn, on lumber demand.
What does this mean for the supply side of the market?
Whenever we see demand declines like this in the marketplace, it always brings with it the risk of capacity closures.
As prices decline and demand falters, we are seeing sawmills respond with curtailments in parts of North America. This is particularly prominent in areas like British Columbia, and to a lesser extent in areas like the US West Coast or some high-cost mills in Eastern Canada.
In addition, the most exposed mills in British Columbia are also facing timber constraints due to a declining allowable annual cut level. On top of that, the newly implemented old growth policy will bring additional complexity and supply implications.
Looking back to the market slowdown in 2019, we lost over 2.5 billion board feet of annual production capacity in North America. Today, we are seeing a similar level of deterioration in market demand. While we do not think it will be quite to the same degree in sawmill closures this time round, we could still see a significant number of permanent curtailments announced over the next 6-12 months. The warning signs are certainly flashing for another wave of closures, but it remains to be seen the scale of impact we’ll see on the supply side of the market.