Opinion: Few products represent a commodity more than a log

Export logs on a vessel sailing into the sunset without a committed sale is known affectionately as "distressed cargo". Photo / File

It's hard to find a product that represents a commodity more than a log. Logs are traded by many different entities in New Zealand and we trade with one primary export market, China.

These trading entities (exporters) are hugely important and exist by making a margin on the trade of logs between the forest owner and the wholesaler or end-use customer. As this form of trading is high volume, low margin, the trader generally needs to have significant economies of scale to make a reasonable profit.

These traders gain supply market share by either owning the resource, paying the best prices, having long-term contracts/relationships with suppliers, or a combination of all three.

The issue with margin trading is that it becomes a numbers game in which, when supply and demand are out of balance, it's a race to the top of the price scale and once the ceiling has been hit, it becomes a race to the bottom.

The race to the top is trying to buy as much as possible on a rising market and selling it for more than you have bought it for all the while having to continually outprice your competitors who are trying to do the same - nothing new in that.

The race to the bottom in the log trade is especially painful as, when the market tips, customers stop answering the phone, traders have committed vessels and supply that needs to move off ports.

The worst place for a log trader to be is when they have a vessel sailing off into the sunset without a committed sale – known as "distressed cargo". This then becomes a game of which trader is going to settle first and at what level – the race to the bottom.

The buyers know that so long as there's distressed cargo in the market, the race isn't over and pants are going to be dropped all over the place. The successful traders bank their wins while preparing for their losses and both can be eyewatering.

Unfortunately, logs are not like iron ore or coal, they have a relatively short shelf life so need to be sold within a matter of weeks after arriving at the port. To compound issues, port companies have a charging mechanism for port space which increases exponentially with time and traders must commit to vessels based on expected deliveries. If a trader is short on volume for a vessel, they may have to cosy up to a competitor to buy or swap some volume and there's generally only one winner in that situation.

The following graph illustrates the A grade export price over the past 10 years. It doesn't take a rocket scientist to realise that when there's a sharp upswing in price, there's generally a sharp "correction" that follows. While we have had some very stable periods, specifically late 2015 to early 2019, the last two years have been very volatile due to several factors, in addition to old mate Covid.

Export_A_Grade

So, what does this mean for a forest owner? If you have a larger resource, you can ride the averages, slow production during poor markets and increase during high-price periods which will give you a better than average overall price.

If you are one of the thousands of small resource owners, you may only have a harvest timeframe of a month or two. Brilliant if you can time it on the upswing side of the graph but not so flash if you're on the downhill side and, as crystal balls are hard to come by, it can be very difficult, if not impossible, to pick these trends. The weatherman can be more accurate than some of our best industry experts.

There are several methods for forest owners to alleviate this risk so that exposure to market fluctuations is reduced or eliminated. These include fixed pricing on a forest or tonne basis for all or a portion of the harvested volume.

These fixed price points can be set based on historical averages or predicted future price points. What is important to note, however, is that this is still margin trading and, as a forest owner, you will be giving away some margin to compensate for risk.

This is an easy conversation when the fixed price offer is at or better than the spot or long-run average as it appears the margin taken for risk is negligible. The conversation can become uncomfortable when there's rapid and/or sustained market increase and the spot market climbs well ahead of the agreed fixed price.

In this situation, the trader is enjoying a larger margin and the forest owner can feel aggrieved that they have missed out. Unfortunately, this is the opportunity cost of passing risk to another party.

Following June's record high export prices, July and August have seen a significant correction that was largely unforeseen during a period of relatively low Chinese inventory.

Many forest owners will be quietly chuffed that they had fixed longer-term pricing, and many will wish they had. If you're about to start harvesting, it's imperative to talk to your Forest Manager and fully understand all the sales options available to suit your risk profile.

Whatever the decision at the time, it's important to be comfortable with it and not to look back. Hindsight is a brilliant thing; it comes free with a crystal ball.