Forest Products Association of Canada fpac.ca
Competition and
Consolidation in Canada’s Forest Products Industry
1
Executive Summary
3
Introduction
4
Increased Competition in Export Markets
6
Newsprint: A Challenging Competitive Situation
9
Solid Wood Products: Competitive Pressures
11
Size Matters
14
Forestry and the Environment
15
Forestry, Free Trade, and Competition Policy
18
What’s Needed
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Forest Products Industry
Executive Summary The Canadian forest products industry is a major contributor to Canada’s economy, creating sustainable economic activity, wealth, and employment across Canada. The industry is particularly important to the economic well-being of rural Canada, providing high-wage employment based on technologyintensive production processes. It is also one of Canada’s leading exporters, to the United States and around the world. The industry’s continued ability to compete in global markets, against global competitors, will have a profound impact on the economic vitality of hundreds of communities across Canada.
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The industry’s future competitiveness will depend on its ability to maintain and increase its position in the U.S. market and to compete in emerging highgrowth markets abroad. In some market segments, such as newsprint, this will require a revitalized capital stock combined with rationalization of existing capacity. In other segments, such as solid wood, changes in the U.S. market require an ability to serve larger, more consolidated customers.
Increased competition from new offshore producers presents a more challenging environment for the Canadian forest products industry. As with many commodities, real prices for forest products are steadily declining and the number of competitors in global markets is steadily increasing. While Canada attempts to seize opportunities in the global market it is also struggling to maintain share of its largest market—the United States.
In this environment, size matters—and Canadian companies are small by international standards. For example, Canada’s largest company, Abitibi-Consolidated, is only one-third the size of the largest Finnish company and does not rank in the top 20 companies in the world. Consolidation can provide critical competitive advantages, such as increased efficiency; asset, product, or geographic diversification; and lower capital costs. Diversification can reduce cash flow volatility and improve market access, and larger firms are better able to attract capital for innovative investments.
The markets for forest products are increasingly global, and Canada’s share of those markets is increasingly challenged by Europe and Asia: pulp and recovered paper are flowing from North America to China, higher grade papers are flowing to North America from Europe and Asia, and solid wood products are being shipped to Asia and returning as finished products. Canada’s domestic market is no less a part of the integrated global market.
Recent mergers in the newsprint sector have demonstrated the potential benefits from consolidation, realizing important efficiencies that are greater than projected. Despite a significant increase in measured concentration among Canadian newsprint producers as a result of these mergers, there has been no negative impact for consumers because prices are set in a competitive North American marketplace. In the solid wood sector, one result of Canada’s
Competition and Consolidation in Canada’s Forest Products Industry
Competition and
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Consolidation in Canada’s
fpac.ca
Forest Products Industry
Executive Summary softwood dispute with the United States has been the achievement of significant cost reductions through consolidation of production within companies, which has allowed the Canadian industry to remain competitive despite punishing tariffs. Canada’s industrial, trade, and competition policies can facilitate the renewal of the forest products industry. A policy environment that creates a positive business climate, supports access to markets, and allows for consolidation would ensure a vibrant forest products industry into the future. As part of this policy approach, it is essential that governments allow Canadian firms to make business decisions, including the decision to consolidate, that will support their long-term competitiveness. This means: • Recognizing that consolidation is a legitimate option for Canadian firms seeking to improve their competitive position. • Implementing competition policy in a way that recognizes the specific characteristics of markets for forest products—that they are integrated through free trade, with prices that are globally determined, and with limited barriers to entry.
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Competition and Consolidation in Canada’s Forest Products Industry
(continued)
• Modernizing the Competition Act to better recognize the global nature of Canadian export markets and to reflect a balanced set of policy objectives, including efficiency and competitiveness. • Eliminating policies that could distort market decisions, including forest management policies that tie access to resources to the maintenance of specific production facilities and subsidies that encourage the maintenance of inefficient capacity. • Avoiding overlap among different levels of government when conducting regulatory merger reviews. Canada’s forest products industry is at a turning point. Within the global industry, further consolidation is widely expected in the short to medium term. Will such consolidation bring about Canadian companies that are profitable and that can compete both in North America and beyond? Or will other countries become increasingly dominant? We believe that if industry and governments work together to create a forward-looking policy framework the Canadian industry can continue to be a global force.
Competition and
Consolidation in Canada’s Forest Products Industry
Forest Products Association of Canada fpac.ca
Introduction The forestry sector is a cornerstone of the Canadian economy. With total sales of CDN$51 billion in 2003, the industry accounts for 3% of Canada’s GDP, and it generates 900,000 direct and indirect jobs in 1,200 communities across the country. The industry takes on even greater significance in rural Canada. For 350 communities, the forestry sector is the predominant employer, and in 2002 its average wage was $53,600—70% higher than the average wage in Canada. As well, the forest products sector is the major integrator of high-technology equipment and related skilled employment in rural Canada. The vast majority of Canada’s forest products are exported. The industry competes in an increasingly global market, where the number of competitors is growing and the pressures to innovate and reduce costs to remain competitive are relentless. Globalization, freer trade, and the emergence of new competitors have pushed forest products companies worldwide towards consolidation.
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Competition and Consolidation in Canada’s Forest Products Industry
This paper looks at the issue of consolidation in the forest products industry in Canada as a strategy to remain competitive, innovative, and environmentally progressive. There have been a number of recent mergers in both the pulp and paper and the solid wood sectors, and it is widely held within the industry that future consolidation will be critical to Canada’s ability to retain a globally competitive industry. Therefore, the potential impact of Canada’s industrial, trade, and competition policies on the industry is compelling for future investment, employment, and the economic vitality of rural communities.
The forest products industry is the main
source of economic activity in 350 communities across Canada.
Competition and
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Forest Products Industry
Increased Competition in Export Markets Global demand for forest products is expected to increase by US$4 billion to US$7 billion annually for the next decade. This growth represents an important opportunity for Canada’s export-oriented forest products industry. In 2003, forest product sales were valued at CDN$51 billion, of which CDN$40 billion were exports. Forest products accounted for 10.4% of Canada’s total exports, and the industry’s net exports represented 65% of Canada’s trade surplus. The largest market for Canadian forest products is the United States, which accounts for 78% of our exports. Other major markets are Europe and Asia; a small proportion of Canadian production is consumed domestically.
In the last 15 years, competition within the global forest products industry has increased dramatically. Canada’s traditional competitors have been the United States and Scandinavian countries; however, new technologies enabling the processing of nontraditional fibre have allowed large-scale new capacity to come on stream around the world. Between 1990 and 2000, the number of countries exporting newsprint nearly doubled, from 33 to 57, and those exporting solid wood products increased from 111 to 180. In offshore markets, Canada now competes with expanding exports from Brazil, Chile, and New Zealand. Canada’s share of U.S. imports has dropped by 12 percentage points since 1990, from 74% to 62%. Clearly, other exporters are gaining ground. Set against the growing market for forest products, the evidence suggests that Canada is not keeping pace.
Canada’s share of U.S. imports, its largest market, has dropped
by 12 percentage points since 1990.
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Competition and Consolidation in Canada’s Forest Products Industry
RUSSIA’S POTENTIAL PRODUCTION IS GREATER THAN THE ENTIRE CANADIAN INDUSTRY Although Canada’s forest resource is just over 25% of the size of Russia’s, Russian roundwood production is only about 40% of Canadian volumes. Reflecting the performance of the Russian economy in general, output from the forest sector contracted sharply through the early to mid-1990s but has shown signs of steady recovery in recent years. Despite infrastructure
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Increased Competition in Export Markets
(continued)
limitations and business-climate issues, Russia’s abundant, high-quality and very inexpensive wood fibre, combined with low labour and energy costs, has enabled the forest sector to attract growing amounts of investment capital from both foreign and domestic sources. With its vast and underutilized forest resource, Russia has the potential to have a dramatic impact on global markets in the future. The Russian government’s objective is to increase the value of production of its forest industry from its current level of about US$10 billion to US$100 billion over the next two decades. By comparison, the value of shipments from the Canadian forest industry is currently under US$40 billion. If the Russian Federation achieves its desired growth, its success could have serious implications for the global supply of key Canadian forest products exports, particularly in European and Asian markets. CHINA DOMINATING GLOBAL TRENDS AND ACTIVE IN THE UNITED STATES Since at least the late 1990s, China has dominated global changes in consumption and production for most key commodities, especially newsprint, printing and writing papers, and pulp, and it will continue to dominate global paper and paperboard capacity over
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Competition and Consolidation in Canada’s Forest Products Industry
the next two to three years. Almost all of this new capacity is based on recovered paper. Although focused on becoming self-sufficient and serving its domestic market, China will have to import the base fibre. Even so, its evolution will be felt the world over. The Chinese wood-processing sector is booming; however, as a result of a restricted timber harvest, it must import the raw materials. Low costs allow Chinese processors to be competitive in world markets; exports to the United States and key world markets are rising in a variety of products, especially furniture. China is now the #2—after Canada— exporter of wood products to the United States, and at the same time one of the fastest growing importers—mainly of logs and lumber for domestic processing but also of selected finished products. Over the coming years, as China and Russia become dominant players and South American producers with fast-growing fibre supplies increase their presence in world markets, the competitive environment will become increasingly challenging for Canada’s forest products industry.
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Newsprint: A Challenging Competitive Situation The market for newsprint is challenging, considering both the decline in demand in North America and the emergence of powerful buyers. North American demand appears to have peaked in the late 1980s; since 2000, it has receded by 14%. The key factor driving newsprint demand is advertising, which in turn is cyclically linked to the overall strength of the North American economy. Many industry analysts believe, however, that the most recent decline is structural, reflecting the move to electronic media for some advertising, the emergence of big box stores (which advertise less), and the decrease in newspaper readership. This long-term decline in demand has resulted in a shift in production from newsprint to printing and writing papers. Over the past decade in Canada, the newsprint share of pulp and paper production has dropped to 28% from a high of 36% in 1992. Not surprisingly, the drop in demand is reflected in a long-term decline in real prices. U.S. newsprint prices peaked in 1982 in constant dollars; they have been declining in real terms and flat in nominal terms for the past decade.
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Competition and Consolidation in Canada’s Forest Products Industry
Looking ahead, the industry will continue to face challenges on the demand side. Information technologies are changing the market for paper products and, in turn, the market for advertising. In Canada, important newsprint customers are introducing fees for online versions of their daily newspapers— signalling market acceptance for this alternative to the ‘real thing’.
Forest Products Sales by Product Group 15
Volume of Product ($ billions)
DECLINING DEMAND AND PRICES
12 1992 2003
9
6
3
0 Market Pulp
Newsprint & UGW
Other Paper/Board
Lumber
Panels
Source: The Forest Industry in Canada 1996, 2003, PwC.
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Newsprint: A Challenging Competitive Situation
(continued)
On the supply side, the substantial capital investments required for any newsprint operation make transitions difficult and costly. Suppliers must continually invest in new equipment to increase efficiency and reduce costs. Current capital expenditures continue at below depreciation levels, resulting in a declining capital stock. Significant improvement depends on improved market conditions, resolution of the softwood lumber dispute, the closing of mills with high cost structures, and the consolidation of production into more efficient facilities. CORPORATE CONSUMERS EXERCISE SIGNIFICANT MARKET POWER One of the factors driving down newsprint prices has been consolidation among key newsprint purchasers. In the United States, Canada’s largest newsprint market, there has been substantial consolidation among buyers: Industry consolidation in restructuring among publishers preceded the consolidation of producers through the last two decades. Large buyers of newsprint like Gannett and Knight Ridder drove the market down to historical price lows and forced closure and conversions of many newsprint mills across North America. The largest five publishers now control nearly 75 percent of all newsprint purchases. Michael Ducey, Newspapers & Technology, The
International Journal of Newspaper Technology, September 2002.
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Competition and Consolidation in Canada’s Forest Products Industry
The same phenomenon has occurred in the Canadian media sector. In Vancouver, for example, Canwest Global operates The Vancouver Sun, The Province, and the National Post and owns the number one-rated television channel, BCTV. Buyers of newsprint are generally large relative to their suppliers. Both U.S. and Canadian buyers of Canadian newsprint typically exceed the market capitalization of Canadian suppliers. Further consolidation among Canada’s newsprint firms will not change the current marketplace dynamic— characterized by smaller Canadian forestry firms selling to much larger U.S. and Canadian publishers.
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Newsprint: A Challenging Competitive Situation
(continued)
MARKET CAPITALIZATION – A CASE OF DAVID AND GOLIATH Corporate Consumers Gannett Co., Inc. Tribune Co. New York Times Knight Ridder Transcontinental Torstar Canwest Global
Producers $32.6 $21.6 $9.4 $8.2 $1.7 $1.9 $1.1
billion billion billion billion billion billion billion
Abitibi Domtar Kruger Cascades Norske Canada Tembec Papiers Stadacona
$4.2 billion $4.0 billion Private Company $1.1 billion $953 million $950 million Private Company
NYSE and TSX valuations in Canadian dollars as of June 1, 2004.
The leverage for buyers is not restricted to these market giants, as buying clubs have become the standard means for smaller players to aggregate purchases and secure competitive pricing. Large buyers and buying groups account for close to 60% of the total purchases of newsprint in North America. At the same time, major publishers own or control a significant amount of newsprint supply in the United States; for example, three publishers own SP Newsprint, which has capacity of close to one million tonnes annually.
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Competition and Consolidation in Canada’s Forest Products Industry
Buyers also typically purchase from more than one producer to secure the best price and ensure a stable supply.
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Solid Wood Products: Competitive Pressures FIGHTING TO MAINTAIN SHARE OF THE U.S. IMPORT MARKET The United States is also Canada’s main market for solid wood products. Canadian producers account for 63% of U.S. wood products imports, and the fortunes of the Canadian industry rise and fall largely with U.S. demand. From a 75% market share in 1990, Canada is losing ground to fierce competition from offshore producers. China, Brazil, and Chile—all of which have experienced tremendous export growth since 1990— are the next-largest providers of wood products to the United States. The leading factor in the decline of Canada’s market in the United States is the decrease in share of softwood lumber imports—from 98% to 83% since 1990, which can be attributed to the series of trade disputes and increasing competition from offshore producers. The current Canada–U.S. trade dispute concerns duties as high as 27% on Canadian exports, giving a clear competitive advantage to offshore producers. Even worse, the absolute value of Canada’s softwood exports to the United States has slid in recent years. The biggest beneficiaries are Chile, Brazil, and New Zealand; however, European countries produce similar species lumber as Canadian producers and also represent important competitors in global markets, including in the United States.
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Competition and Consolidation in Canada’s Forest Products Industry
Interestingly, the United States has essentially dropped out of the softwood export market; for example, Japan is the largest offshore softwood lumber market for both Canada and the United States, but Canadian exports are 10 times more than American exports. While economies of scale in the solid wood sector are not as large as in the pulp and paper sector, significant economies can be gained in production. Recently, for example, producers in British Columbia have reduced costs by consolidating production in larger facilities, enabling them to continue to compete in the U.S. market despite the impact of the ongoing softwood dispute. The emergence of large buyers such as national U.S.-based homebuilders and building supply retailers such as Home Depot and Lowe’s is enhancing the relative power of buyers on the market. The business model associated with larger buyers may also favour larger suppliers that can meet greater capacity requirements in areas such as customer service, distribution, and availability of supply. Over time, these factors may push towards further consolidation in this segment of the market.
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Solid Wood Products: Competitive Pressures PROVINCIAL POLICY AND THE UPSTREAM MARKET In Canada, 94% of forest resources are publicly owned, primarily by the provincial crowns. Each province regulates harvesting levels and practices within its jurisdiction; however, because the federal government oversees the Competition Act, there is frequent overlap between levels of government during merger reviews. For example, both the B.C. Ministry of Forests and the federal Competition Bureau reviewed the recent merger between Canfor and Slocan. The B.C. government, which owns the resources and has a policy interest in maintaining a competitive marketplace and a sustained economic base, approved the merger and the associated transfer of forest licences. The Competition Bureau then undertook a distinct review of the transaction.
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Competition and Consolidation in Canada’s Forest Products Industry
(continued)
From the industry’s perspective, it would be helpful if the provincial and federal authorities effectively coordinated the substance and timing of their respective reviews. The market simply does not understand the reasons behind a discordant result.
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Size Matters In this environment of increased competition, declining long-term demand and prices, and increased market power of buyers, size matters. One way for firms to address the competitive challenges is to consolidate. Consolidation can afford critical competitive advantages:
Canadian firms are very small relative to their global competitors. Not one rates in the top 10 forest products companies in the world, whereas three Nordic companies do. For example, Abitibi is Canada’s largest forest products company and the world’s largest newsprint producer, with a market capitalization of about CDN$4.2 billion and operations across North America; however, its market capitalization is only 33% of that of the largest Finnish companies— UPM-Kymmene and Stora Enso—and just 15% of that of the largest U.S. company—International Paper. The top four forest products companies in the world are American, and they compete head-to-head in the North American market against much smaller Canadian companies.
• Increased efficiency from operational flexibility and lower per-unit production costs. • Asset diversification, which reduces volatility of cash flow. • Product diversification. • Improved market access through geographic diversity. • Lower capital costs.
Forest Products Companies by Ranking of Net Sales, 2003 $30,000
$25,000
US Millions
$20,000
$15,000
$10,000 #21
$5,000
#23
0 )
)
A US
( er
ap lP
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)
SA
c Pa
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yC le er
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rk la
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a or St
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i (F
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e
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m ym -K M UP
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sa lo
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en
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er ct
&
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) SA (U
) an
an
iti Ab
b
s. on -i C
(C
r ta om
(C
D
Source: PwC Global Forest and Paper Industry Survey, 2004 Edition.
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Competition and Consolidation in Canada’s Forest Products Industry
Competition and
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Consolidation in Canada’s
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Size Matters
(continued)
CONSOLIDATION EASES CAPITAL COST LIMITATIONS Credit ratings from Moody’s and S&P demonstrate that larger firms in the sector, with higher market capitalization, have better credit ratings. Borrowing costs are, of course, linked to credit ratings, and the market deems larger firms to be better credit risks. In addition to the enhanced credit rating that goes with size, the market places a share premium on the largest firms. Higher market capitalization also leads to higher trading multiples, which in turn allow Country Firms
United States Europe Canada
access to lower cost investment capital—a significant advantage in mature industries with narrow profit margins. In fact, the recent merger of Canfor/Slocan led CIBC World Markets to increase their target trading multiple from 5.25x to 5.50x. CIBC World Markets also indicates that the average target trading multiple for Canadian forest products companies is 5.5x, whereas the target for U.S. companies averages 6.5x. U.S. and European companies, which are much larger than their Canadian counterparts, also have greater profitability.
# of Top 100
Aggregate Return on Capital Employed
Aggregate Return on Equity
27 28 11
4.7% 3.9% 3.9%
9.3% 5.5% 4.4% Source: PwC Global Forest and Paper Industry Survey, 2004 Edition.
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Competition and Consolidation in Canada’s Forest Products Industry
Competition and
Consolidation in Canada’s Forest Products Industry
Size Matters
fpac.ca
(continued)
NORDIC GOVERNMENTS HAVE SUPPORTED CONSOLIDATION As a result of the competitive advantage to be gained, there has been considerable consolidation in the forest products industry worldwide. For example, between 1990 and 2002 the average capacity of the top five European paper firms more than doubled, from under 3,000 kilotons to over 7,000 kilotons, and since the early 1990s Finland, widely recognized as the most successful forest products producing nation, has undergone a period of rapid consolidation and now has only four major forest product companies. Consolidation in the Nordic countries has been encouraged by their governments as a rational business strategy to ensure the long-term competitiveness of the industry. For example, Sweden’s official website boasts: Swedish forest product companies have thus participated actively in the restructuring and consolidation process…. In recent years, world-leading Nordic forest products companies have been formed by Swedish and Finnish companies. The consolidation process is continuing, for example by allowing companies to specialize in well-defined product areas for the purpose of gaining larger market coverage. Intercontinental consolidation has also begun, and the largest Nordic companies are becoming global. (http://www.sweden.se/templates/FactSheet____3702.asp Sweden.se is Sweden’s official Website for information about Sweden to the outside world.)
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Forest Products Association of Canada
Competition and Consolidation in Canada’s Forest Products Industry
In Canada, there have been a number of mergers in the last five years. Two recent cases of proposed mergers and acquisitions in the newsprint industry went before the Competition Bureau—both were approved, one with conditions. Subsequent analysis has shown that in both cases the companies achieved important synergies from those mergers. The Norske Canada purchase of Pacifica Papers generated $115 million in synergies, and Abitibi-Consolidated achieved $294 million through its acquisition of Donohue. In each instance, the realized synergies exceeded the projected synergies that prompted the mergers. These annual cost savings make both companies more competitive against global giants. Consolidation has also been accelerating in the solid wood sector in British Columbia, with the recent merger of Canfor and Slocan and pending mergers between West Fraser and Weldwood and Tolko and Riverside. One of the drivers of these mergers is the consolidation of buyers, who are demanding increased security of supply, better services and inventory management, and lower prices. Consolidation in the forestry sector is certain to continue at a global level. Larger companies have access to lower investment costs and have lower unit production costs. This has been the experience of forestry companies in Canada and around the world, and it’s a trend made all the more significant as trade barriers are taken down.
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Forestry and the Environment Size matters for environmental performance, too. Improved environmental performance requires costly investments that can be difficult for smaller firms. Canada’s forest products sector has made tremendous progress in recent years in reducing greenhouse gas emissions, reducing water consumption, and effectively eliminating dioxins and furans from discharged water. Investments in new technologies have made these remarkable achievements possible. Canadian producers have moved biomass, or wood waste, to the top of the country’s (non-hydro) renewable energy list—powering 55% of the energy used by our pulp and paper operations. New processing technologies, from little pumps to big wood dryer systems, power boilers, or paper machines, are invariably more energy efficient than the equipment they replace. A collaborative research program with the federal government has monitored emissions from 20 Canadian pulp and paper mills over the past decade. Since 1992, new investments and technologies have cut particulate emissions by more than 50%, sulphur dioxide emissions by nearly 20%, and total reduced sulphur by more than 40%.
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Competition and Consolidation in Canada’s Forest Products Industry
If Canada as a whole achieved the pulp and paper sector’s record on greenhouse gas reductions, the country would have met its Kyoto commitment a decade ago. Our sector has reduced carbon dioxide emissions by 28% since 1990, while increasing total production by 30%. Investing in innovation and industrial renewal is important to sustain this progress. Over the past decade, the pulp and paper sector has invested more than $30 billion in technological renewal. While these investments carried with them environmental benefits, a good number were specifically designed to improve economic performance. Accelerating the renewal of manufacturing operations would bring more environmental progress while improving our industrial competitiveness.
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Forestry, Free Trade, and Competition Policy When the Macdonald Royal Commission urged Canada to take a leap of faith into free trade with the United States, the commissioners were mindful of the emerging power of global competition and the implications for Canadian companies. “Given the small size of Canada’s domestic market, a high degree of concentration is necessary in certain industries if Canadian participants in these industries are to compete effectively against foreign enterprises at home and abroad.” It is the challenge of government to balance the imperative to “promote the efficiency and adaptability of the Canadian economy” with the possible consequences of corporate concentration. In small economies, companies have trouble getting big enough to be efficient against global giants. Having the world’s most aggressive anti-trust legislation has not stopped U.S. companies from growing to positions of global leadership in virtually all economic sectors, including forestry; in fact, the world’s four largest forestry firms are American. Clearly, the size of a nation’s economy is a contributing factor to the size of companies.
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Competition and Consolidation in Canada’s Forest Products Industry
In small economies, the balance between anti-trust legislation and industrial policies is delicate. Therefore, to provide effective domestic competition while facilitating successful participation in global markets, the application of competition policy must focus on proper market definition and be coordinated with freer trade policies. In New Zealand, the Manager of the Competition Bureau has noted, “while efficiency should be the sole objective of competition policy in small economies, it is important that this objective is not pursued through competition policy alone… Open trade and investment policies have the potential to significantly mitigate the disadvantages of small size in the area of competition policy.” Access to foreign markets continues to be a driving force in Canada’s trade policies. As this country’s leading contributor to our trade surplus, the forestry sector continues to support free and open trade. With the list of exporting countries growing in all areas of the industry, healthy competition in this sector is in place and secure.
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Forestry, Free Trade, and Competition Policy In the forest products industry the market in which Canadian firms are competing is at minimum a North American market and, more realistically, a global one. Canadian producers export most of their products to the United States, where they face a dynamic and competitive commodity market. Producers are price-takers, and Canadian producers are small relative to the market. With established shipping routes, U.S. producers or other Canadian producers provide competitive pressure within the Canadian market. In Canada, consolidation must be consistent with the Competition Act. In the administration of the Act, it is imperative that the global nature of markets for Canadian products be recognized. Recent mergers in both the newsprint sector and the solid wood sector have been met with conditions imposed by the Competition Bureau. It is not clear that those conditions were based on an accurate understanding of the global market dynamics in forest products.
(continued)
The October 2004 Speech from the Throne signalled the federal government’s ambition to help “businesses do business in Canada” and committed the Government to modernizing the Competition Act. In considering how to do so, the Government should aim to ensure that the Act both recognizes the global nature of Canadian export markets and reflects a balanced set of policy objectives, including efficiency and competitiveness.
In small economies, with free trade, global markets provide strong competition discipline.
Determinations of the Competition Bureau can have serious implications for Canadian competitiveness, as well as for the affected market participants. It would be a lost opportunity if Canadians moving towards further efficiency-enhancing consolidation were frustrated by an inaccurate appreciation of global forces. In the forest products industry, markets are globally integrated, large players can be national champions, prices are set globally, and consolidation can be a critical success factor for Canadian companies.
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Competition and Consolidation in Canada’s Forest Products Industry
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A Case Study North American Market for Newsprint There have been two recent mergers involving Canada's newsprint industry—the acquisition of Donohue by Abitibi and the merger of Norske Canada with Pacifica Papers. Both mergers were reviewed by the Competition Bureau and, in both cases, a key issue for the Competition Bureau was the proper definition of the newsprint market. In response, FPAC has commissioned new research from Charles River Associates (CRA) that explores the nature of the newsprint market in North America. The CRA study applied econometric analysis of newsprint pricing before and after the recent mergers and acquisitions as part of its assessment of the market. The study concluded that Canadian prices track U.S. prices closely and adjust quickly to divergences, suggesting that Canada and the United States are essentially one market. Canadian newsprint firms compete with U.S. newsprint firms for Canadian customers’ business. Thus, the relevant geographic market for considering the competitive effects of any potential mergers among Canadian newsprint firms must extend beyond the Canadian border. Within the North American context, mergers involving Canadian suppliers are less likely to lead to significant changes in concentration of the North American industry. The prospect of enhanced profits driving transactions is likely to stem from lower costs. History has demonstrated that cost improvements are passed on to newsprint customers.
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Competition and Consolidation in Canada’s Forest Products Industry
The study determined that modest transportation costs play a key role in defining the North American newsprint market. “Modest transportation costs are a key factor in linking Canadian newsprint prices so closely to U.S. newsprint prices...” Even a 5% increase in newsprint prices in Canada would be sufficient to attract new U.S. supply to meet Canadian newsprint demand. CRA’s analysis of the North American newsprint market included a careful review of pricing before, during, and after the two Canadian mergers. Despite a substantial increase in the measured cancellation of the Canadian industry after those two mergers, there was no impact on relative prices in Canada. We find no evidence that the mergers in 2001 led to an increase in Canadian prices relative to U.S. prices. We interpret these results as providing strong evidence of an integrated North American newsprint market. These results, taken as a whole, provide conclusive evidence that Canadian firms operate in an integrated market where the imperatives of consolidation and domestic competition are compatible. Free trade in the North American newsprint market has created the market conditions needed to protect Canadian consumers. It has also imposed the imperative that Canadian producers attain the highest level of global efficiency. Further consolidation within the industry in Canada could make Canadian firms more competitive internationally, while maintaining a robust Canadian market.
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Consolidation in Canada’s Forest Products Industry
Forest Products Association of Canada fpac.ca
What’s Needed Canada has a wealth of natural resources, and its forest products industry provides a critical foundation for the Canadian economy. To sustain this contribution, it is essential that government policies do not constrain the changes that are essential to the industry’s competitiveness. The premium on size has increased in the past decade for a number of reasons: lower trade barriers have made markets more accessible; new technologies have enabled the processing of lower grade fibre; the number of exporting countries has risen sharply; and the long-term decline in real prices has increased the premium on cost reduction. To invest in high-growth emerging markets, companies require enough scale to manage the risks and to make the necessary up-front investments. As the global trend towards consolidation continues, Canada needs to ensure that government policies allow Canadian companies to make the appropriate business decisions to respond to developments in global markets for forest products. The challenges to all segments of the forest products industry are clear. The industry operates in a North American market—where the vast majority of our sales are to the United States. There is continuous pressure on prices in all segments of the industry. Similarly, the softwood lumber dispute and increased offshore competition are challenging the woodmanufacturing sector. The dramatic appreciation of the Canadian dollar will require additional adaptation for the entire industry.
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Competition and Consolidation in Canada’s Forest Products Industry
These threats to companies operating in the forestry sector have great consequence to Canada. At a national level, the forestry products sector remains a leading contributor to Canada’s balance of trade. Nearly one million Canadian workers are linked to the sector’s fortunes. The industry is particularly key to the well-being of rural Canada—as the primary employer, bringing well-paid jobs and much-needed technology to remote corners of the country. To compete in this environment, Canadian industry must be able to adapt quickly to renew and rationalize its capital base, improve its cost structure, and enhance its marketing strength. All of this may require further consolidation. This competitive imperative is consistent with a robust domestic market. Firms in this sector operate within a competitive North American, and increasingly global, market. In global commodity markets, domestic firms are price-takers, and the achievement of efficiencies in production is essential to the industry’s competitive success and the corresponding benefits to consumers and communities across Canada.
Competition and
Forest Products Association of Canada
Consolidation in Canada’s
fpac.ca
Forest Products Industry
What’s Needed
(continued)
From a policy perspective, it is critical that governments allow Canadian firms to make business decisions, including the decision to consolidate, that will support their long-term competitiveness. This means: • Recognizing that consolidation is a legitimate option for Canadian firms seeking to improve their competitive position. • Implementing competition policy in a way that recognizes the specific characteristics of markets for forest products: that they are integrated through free trade, with prices that are globally determined, and with limited barriers to entry. • Modernizing the Competition Act to better recognize the global nature of Canadian export markets and to reflect a balanced set of policy objectives, including efficiency and competitiveness. • Eliminating policies that could distort market decisions, including forest management policies that tie access to resources to the maintenance of specific production facilities and subsidies that encourage the maintenance of inefficient capacity. • Avoiding overlap among different levels of government when conducting regulatory merger reviews.
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Competition and Consolidation in Canada’s Forest Products Industry
Canada’s forest products industry is at a turning point. It is widely expected that the next five to ten years will bring further consolidation in the global industry. Will this consolidation bring about Canadian companies that are profitable and that can compete both in North America and beyond? Or will other countries become increasingly dominant? The answers lie in both business strategy and government policy. A forward-looking policy framework that supports the competitiveness of the Canadian industry is an essential element of the outcome.