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in late 2010 and well into 201 1. to levels well above those in the South, severely damaging the competitive position of the lumber and plywood producers in the Coast region. In turn, these high prices tripped off a series of market responses that will erode support for log prices in the Coast.

The damage done to lumber and plywood producers in the Coast is clearly illustrated in the chart at lower right, which contains the log costs at the mill in both the West Coast and the South. While these costs have languished at cyclical lows in the South, costs for Douglas-fir logs at the mill have increase 617o from the third quarter of 2009 to the third quarter of 2011, which moved them from near parity to a 667o premium compared to these same costs in the South.

These higher wood costs in the Coast damaged the competitive position of the region's converters in the U.S. domestic market. In the case of lumber, growth in offshore exports dampened the impact of high log costs. And the growth in offshore lumber export markets kept lumber prices in the Coast high relative to comparable items in the South.

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In turn, the higher prices for coastal lumber have driven the Coast's share of the U.S. domestic market lower. In the first half of 201 I , shipments from the Coast were up 4.57o from the year-earlier pace, but after netting out exports, the shipments into the U.S. market were up a more modest 2.17o. Over this same period, softwood lumber shipments from the South, net of exports, were up ll.l%o. So, the Coast's share of the U.S. market stalled at20Vo, while the South's share increased from 367o to 39Vo.

Consider that the gains were made at the expense of Canadian lumber producers, so this was a missed opportunity to capture share of the U.S. market.

As long as the spread for wood costs between the South and West stays high, converters in the region will continue to lose share of the U.S. domestic market. This means that log prices in the Coast region will be increasingly dependent on the growth of lumber and log export demand to maintain current levels-no/ the level of exports, but the growth, because it will have to continue to expand and fill in the void left by continuing erosion in demand in the U.S. market.

Here lies the rub. Growth in lumber and log exports has stalled and evidence is pointing to a setback in both of these markets. The Chinese govemment's efforts to rein in the housing market through reducing credit availability have taken hold with floor space under construction down 2.lVo in October and floor space sold down 9.97o, with smaller cities retreating faster than the major cities, according to Dragonomics.

And in the wood supply chain, this tightening has been manifest in buyers' inability to secure letters of credit (LCs) for lumber and log purchases. We have also heard stories of LCs not being honored after the wood is delivered and being pulled when it is in route. Finally, log and lumber inventories continue to back up at the ports as demand slumps. We expect exports to move lower through the end of this year and the first half of 2012, reflecting these recent developments. This is in line with the more tempered outlook for export demand in our forecasts in 2011.

One part of the equation not addressed here is the timber supply response. When growth in log supply first stalled and log prices started to erode, private log owners were quick to throttle back timber sales and suppoft log prices. Through the end of the year and well into 2012, these sales will have to be even lower to offset the anticipated slump in offshore exports and this has to be done in lockstep with the drop in demand. This typically does not happen as supply responses usually lag behind any setback in demand.

Consequently, downward pressure on the wood costs in the Coast region is expected to mount and log prices are expected [o move lower.

- Bob Berg is R1S1's principal economist Jor lumber and quthor of its monthly Lumber Commentary and its Five-Year and I S-Year North Americctn Lumber Forecasts. He can be reached at (781) 734-8914 or bberg@risi.com.