Panel m arkets to tighten in 20 10

By Greg Lewis RISI

I\TORTH American structural panel

I \ markets continue to lansuish as the economy is mired in recesiion and construction markets remain exlremely weak. This precipitous decline in demand has caused significant capacity curtailments across the industry. There have been a number of permanent and indefinite closures, producers are running very limited production schedules and buyers are hesitant to carry inventory.

Significant downtime and limited buying means that when markets do turn around, expected in 20 10, the rebound will be swift. It will take time to ramp up production at idled facilities, the overall capacity base will be smaller due to closures over the previous two years, and buyers will be anxious to rebuild inventorv in anticioation of stronger demand. The net reiult will be a swift jump in prices and a return to positive profitability for both OSB and plywood producers.

The plunge in construction markets and the current recession has been brutal for North American wood panel producers. For all of 2008, structural panel demand will total just 34.0 billion sq. ft. (3/8-inch basis), a t4%o drop over 2007. With demand down so much, domestic panel production is sharply lower. Through the first three quarters of the year, North American panef production ran at about TOVo of capacity as producers have significantly curtailed output. There have been a number of permanent capacity closures, with additional curtailments, both temporary and permanent, certain to come over the next quarter or two.

Looking ahead, we expect 2009, on the whole, to be weak as well, with panel demand of just 31.9 billion sq. ft.. although some improvement in construction will come as the year progresses. We expect housing to bottom in the first quarter (U.S. conventional starts around 710.000-715.000 units SAAR in January and February), and then to move slowly back above 1.00 million unirs (SAAR) by the end of the year. In 2010, construction markets will pick up steam, totaling more than 1.4 million units for the year.

There are a number of reasons why we anticipate the turnaround in construction in 2010. A detailed explanation can be found in RISI's upcoming 5-Year North American Wood Panels Forecast and North American Lumber Forecast. Briefly, there is growing pent-up demand for housing (e.g., the accumulation of demand for additional housing, estimated around 1.80 mitlion units per year this decade, including mobile homes, in excess of production). Through 2009, we will have underproduced housing units by about 850,000 units since 2000 (assuming about 865,000 starts next year). That includes the overproduction during the boom earlier this decade.

Second, with interest rates low and home prices falling, home affordability continues to improve and will remain very favorable in 2009 and 2010. Third, inventories of unsold new homes continue to decline. This has come as housing completions for sale have been below new home sales for the past year, and we expect this to continue into 2009. Finally, we expect the government and large Iending institutions will take aggressive steps to reduce the rate of foreclosures. We believe this process will move quickly over the next several months as it is in both the government's and lenders' interests to limit the downward effect of foreclosed properties on home prices.

With residential construction on the rebound, other enduse markets improving and the overall economy on the upswing, North American wood panel demand will move higher in late 2009 and in 2010. OSB demand will jump in particular, given its dominant share of the strengthening residential construction market. The rebound in plywood demand will be more muted, given its continued loss of market share, but positive nonetheless. We expect North American structural panel demand will jump 25Vo to 4O.O billion sq. ft. in 2010.

We expect markets will quickly tighten as demand improves because buyers will be quick to jump back into the market as inventories entering the upturn will still be very low. Also, capacity closures that have occurred over the past year and that will continue in 2009 will mean a lower North American capacity base entering the upturn. We expect structural panel capacity will end 2009 around 40 billion sq. ft., down from a peak in excess of 47 billion sq. ft. in 2005-2006. Stronger demand and lower capacity will mean much higher demand/capacity (D/C) ratios in 2010, compared with 2008-2009. (See chart at riSht)

Just as important as permanent closures is the extent of indefinite capacity curtailment. It will take time to start up lines that have been down for many months, or even years, bolstering order files as new orders increase. The net result will be a swift jump in prices and positive producer profitability on full-loaded costs. Capacity will continue to ramp up over 2010, but growing demand will mean further upward pressure on prices and improving margins. From our last completed forecast (September), we estimated 2010 profitability for OSB producers at 20-307o. That, combined with plywood margins of 1O-20Vo, will mark the most profitable year for the industry since 2005.

- Greg Lewis is direcktr of wood products for RISI, informtttion provider for the global Jbrest products industry and publisher of Crow's Market & Price Service, which rffirs free trial subscriptions at www.risiinJb.com/crows. He can be reached at (781) 734-8939 or s.Lewis@ risiinftt.com.