The present markets and sources of timberland returns.

How does the forestry market work? In this section we give you some background information on the current markets and expected developments as well as an overview of the different and unique sources of timberland returns.

Background on the present teak markets

Africa will continue to produce teak from plantations but quality tends to be low. Latin American teak plantations have been expanding and are likely to do so for the foreseeable future. Latin America contains most certified teak worldwide (over 75% under the Forest Stewardship Council (FSC) scheme). At present several high-input investment companies are planting teak on a relatively large scale. As a result, an increasing proportion of Latin American teak is likely to be distinguished by good management, which should translate into high quality.

By carrying a certified label, teak from Latin America should be able to access lucrative international markets that are not open to uncertified teak or other tropical hardwoods. Latin American teak plantations have been expanding and are likely to do so for the foreseeable future.

Present markets for teak are likely to modify considerably in the medium and long term future. Life Cycle Analysis (LCA) techniques should give teak a competitive edge over other materials like metals, brick and plastics in a world that will be even more conscious about the environmental impact of commodities at all stages of production from initiation to waste disposal.

Teak should also hold its own in relation to other woods which do not have the long term natural durability of this species.

Sources of Timberland Returns

In order to understand a timberland investment, it is important to understand the fundamental components that comprise returns. Timberland returns are mostly driven by the following three factors:

(1) Biological Growth
The first factor is biological tree growth. Timber is a renewable resource and, if managed well, will increase in value as it matures. Trees grow in volume and turn into higher value products as they grow. This non-financial source of return is unique to the timberland asset class as growth occurs regardless of macroeconomic conditions or financial market performance. There are not many assets or investments that can make this claim. According to research compiled by the International Woodland Company (IWC), biological tree growth accounts for approximately 65%-75% of the timberland return.

(2) Macroeconomic factors
The second factor is timber price change due to macroeconomic factors such as population growth, construction activity, interest rates and the overall level of economic activity. Unlike most other commodities, timber does not need to be harvested at the end of a growing season. If the price of timber is down, it can temporarely be “stored on the stump” and will continue to grow and increase in value. It does not cost extra to store since warehousing costs do not enter into the equation. By taking advantage of positive market conditions, management can maximize the return from the investment, which in turn contributes to lower volatility. IWC estimates that timber price change accounts for approximately 25%-30% of the timberland return.

(3) Land value
The third factor is related to land value. Most often, the value of the land represents a very small portion (2%-5%) of the total timberland investment value, so it typically contributes least to timberland return. Land value is based on more a supply-demand dynamic than timber.

Teak- the high grade tropical hardwood

As teak is the only proven high-grade tropical hardwood specie successfully grown commercially and on a relatively large scale in plantations, it will continue to be grown under a variety of arrangements ranging from high scale / high input / high production industrial plantations on excellent soils, to low scale / low input / low productivity on sub optimal sites.

We present the species within the context of the overarching tropical hardwood sector. Also we describe the supply base and the productivity of this base to estimate the total harvest supply. In view of predicted increasing demands for tropical hardwoods, coupled with the limited ability of natural forests to supply the level of output required, plantation development offers a complementary solution.

Teak, being the principal tropical hardwood plantation species, known for its excellent wood properties, is likely to maintain its leadership position as a plantation species for the foreseeable future. Natural teak forests amount to about 30 million ha of which only only 16 million ha in Myanmar are producing commercial teak. In the future, it is anticipated that the maximum sustainable supply of teak from natural forests is likely to be in the order of 400,000 m3 or less per year. The total area of teak plantations worldwide is around 30 million ha and that the area is increasing slowly.

Myanmars production from the natural forests is in the order of 450,000 m3 (assuming that the annual allowable cut of 400,000 m3 is harvested and an estimate of 50,000 m3 of illegal exports to China). Total production from teak plantations is about 9 million m3. Based on a total plantation area of 3 million ha producing 3 m3 per ha per year vs. 0.02815 m3 production from the natural forrests. Experience sindicates that a plantation is over 100 tomes more productive as natural forrests. The global teak harvest is therefore estimated between 9 and 10 million m3.

The quality of teak in the market is generally poor; best material originates from natural forest thought the quality has been decreasing steadily. The proportion of the annual harvest being supplied onto domestic markets is unknown as is the total volume being supplied to the international markets. The emerging picture can only be understood from a mosaic of information snippets.

Future markets may be driven by a lack of tropical hardwoods, as natural forests become depleted and more inaccessible. Demand for substitute material from plantations is likely to be high. To satisfy current demand for tropical hardwoods totally from plantations would require about 9 million ha. Markets for teak produce are likely to modify considerably in the medium and long term future. Application of LCA techniques, the opening up of carbon trading markets and the continued – and probably increasing – demand for certified wood, are factors that must be considered.

*Source: ‘Investing in Timberland: Another Means of Diversification’ by Jeff Mortimer – CFA J.P. Morgan
**Source: ‘TEAK MARKET CENTRAL AMERICA FOCUS’ by Raymond M. Keogh – Head of Coillte International Teak Unit

For the abovementioned reasons, Central American Timber Fund is focused primarily on teakwood plantations, as this timber has proven to be one of the best species to choose for in a plantation-environment.