Forest industry export revenues reached an unprecedented record of 4 billion euros in 2022. That will not be repeated in 2023, as the year has been marked by a decline in timber product prices. Future challenges and solutions lie in EU guidelines and the ability of entrepreneurs to adapt quickly to the situation.

This is what the new executive director of the Latvian Forest Industry Federation, Artūrs Bukonts, says in an interview with Dienas Bizness, pointing out that under conditions of rapid inflation (rising costs), many companies in the sector have only been able to survive thanks to previously accumulated reserves (profits), but these reserves are not inexhaustible.

What is the current situation in the sector?

Over the past few years, significant changes have already taken place, which essentially forced the entire sector to change, starting with forest owners, logging and forestry service providers, and ending with timber processors. Furthermore, these changes are continuing in 2023.

The year 2019 is referred to in the industry as the last 'normal' one, because it was followed by an unprecedented global pandemic, while by the end of 2021, we saw an unforeseen rise in inflation. That, however, was nothing compared to the price jump that began after Russia's full-scale invasion of Ukraine on 24 February last year. The war caused fear in European timber product markets where, not knowing what the near future would bring, there was an increased demand for wood products – foreign buyers wanted to fill their warehouses in the shortest possible time for the sake of security. Of course, this 'exercise' in the market was not performed by one or a few players; it was a massive phenomenon, resulting in increased demand and, subsequently, prices. Last year, one could witness the incredible: the price of lower-quality or energy wood reached a level that occasionally made one wonder whether to produce building materials from sawlogs or wood chips.

The European Union logically imposed sanctions on Russian and Belarusian timber products, which came into effect last summer. While Latvian companies stopped importing wood and its products from these countries as early as the spring, the flow of wood in Europe only stopped after the sanctions came into force in July. At the same time, by the end of the summer, all warehouses in Europe were filled and overflowing because actual consumption was significantly lower than the projected volumes. Namely, the European Central Bank began to fight the highest inflation the eurozone had seen in decades by raising interest rates, which sharply 'trimmed' construction, the most significant consumer of wood products (about 50%). Furthermore, in a situation where goods are in stock and the reduced demand does not allow for further price increases, potential buyers chose to wait and buy less, which is why a significant drop in prices began. This is already visible in Latvia too. Although the consumption of wood products has not fallen quite so significantly, demand has decreased due to the overflowing warehouses. Traders' inventories are being 'reset' to previous norms, and such finished product warehouses have begun to form at manufacturers as well. It should be added that while this business model is more applicable to Scandinavian than Latvian sawmilling manufacturers, finished product stocks now exist for manufacturers in Latvia as well. There are forecasts that the situation will normalize within the coming months, approximately in the second quarter of 2023.

The European Central Bank is fighting inflation, and interest rates continue to rise, making money more expensive.

As a non-specialist, it seems a bit strange to me that inflation caused by external factors (energy prices) is being fought by reducing people's purchasing power. However, it is an indisputable fact, the effect of which will force every mortgage holder or any other borrower to reckon with much higher interest payments than in previous years. In essence, Europe has grown accustomed to living with the European Central Bank interest rate at 0%, but that is no longer the case, and it seems it will not be again. Of course, this situation raises the question of whether people will be willing to take the risk and build a house, or whether they will instead choose to buy an apartment in an apartment building. It seems some will choose the apartment. It must also be taken into account that rising costs (inflation) of all kinds will slow down, or at best postpone, many potential clients' desire to renovate their existing homes – during the pandemic, there was a very high demand for this market and 'do-it-yourself' wood products. At the same time, there is a significantly important and tangible shortage of residential housing in Europe. These are seemingly opposing vectors, yet both will influence construction, much like the European Green Deal, which on one hand forces more sustainable building, but on the other wants to limit the availability of raw materials in forests. Society is now very well aware that wood is the most sustainable alternative to any other structural building material, yet that is precisely why it is objectively more expensive and, therefore, currently not the first choice for the development of public buildings or large high-rise commercial projects here in Latvia.

What could 2023 be like for Latvian timber processors?

The year has just begun; it would be very risky for me to forecast events for the whole year under current conditions. It is clear that changes are happening in the wood product market and manufacturers will have to adapt to them. Wood product prices have already fallen, but there is no reason to hope they will return to the level of a few years ago, especially if their production costs have increased. There is hope that the wood product market will revive in the spring, as traders' warehouse stocks will have depleted. At the same time, at least the first few months of 2023 will be a relatively complicated and difficult time for manufacturers, because costs will remain relatively high, but finished product prices have already fallen, and it seems there will be situations where manufacturers will have to use some of the money earned in 2021 and 2022 to avoid stopping production.

That is the harsh reality – at one point you manage to earn well, but in the next, you have to put that super-profit back, because especially for large and medium-sized companies by Latvian standards, stopping production for several weeks or even months makes restarting it very problematic. Yes, unlike in Norway, Finland, and Sweden, no production facility in the sector has closed in Latvia. True, we have reduced volumes, and smaller companies have stopped operations temporarily.

Is the situation affected by the removal of Russian and Belarusian wood products from European circulation?

Calculating the imposition of sanctions on wood products from these two countries and their proportion compared to the total European consumption of wood products, we must conclude that there is an impact, but it is not huge because demand has fallen and warehouses are full. Of course, this issue requires detail. Furthermore, if wood products have appeared in Europe from countries that have relatively few forests and where wood processing is also relatively conditional, there are suspicions of sanctions evasion. A completely different picture emerges when looking at timber product manufacturers operating in Latvia that consumed industrial wood products produced in Belarus and Russia for their own production. The most significant position of impact is coniferous sawn timber, of which 750.4 thousand m³ were imported from Belarus in 2021, and 613.1 thousand m³ in 2020, while 352.4 thousand m³ were brought in from Russia in 2021, and 228.4 thousand m³ in 2020. In total, both countries contributed more than 1 million m³, or just over 72%, of the total 1.49 million m³ import of coniferous sawn timber. Plywood from Russia was imported in the amount of 57.9 thousand m³ in 2021 (nearly 53% of the total import volume of this product), which is indeed less than in 2020, when the volume was even higher – 65.1 thousand m³. Reorienting was not easy because there were significant price differences between wood materials produced in Latvia and those in Russia or Belarus, as a result of which several players in the sector faced existential questions because they had to significantly increase the prices of their final products. It was not easy for manufacturers of wooden building structures and furniture to implement these changes, especially if there was high demand from buyers of sawn timber and panel materials in Europe at the time and there were simply no extra wood products in warehouses not covered by buyer contracts. Currently, this issue has been partially resolved, but as a result, many wood products have a different – much higher – sales price.

But Latvia imported enough energy wood from Russia and Belarus!

That was the case. At the same time, it must be taken into account that not all of the import volume was consumed in Latvia. A portion of the wood chips and wood pellets for burning was indeed consumed in our country, while a part was essentially re-export – Latvia imported it and then delivered it to other European countries. With the drying up of the flow of wood for burning from Russia and Belarus, as well as concerns about the availability and prices of natural gas, prices for energy wood – wood chips, firewood, briquettes, and pellets – rose significantly in 2022, not only in Latvia but throughout Europe. Although people in Latvia complained about high wood pellet prices – around 600 euros/t – they were significantly lower than in Central Europe, where in some countries the maximum price exceeded 850 euros/t. Currently, the hype observed last summer and autumn has subsided, and wood fuel prices have also already fallen, yet they have not reached the level that was there several years ago. Who could have imagined that the price of firewood would reach 80-90 euros/m³, if 20-25 euros/m³ was previously considered a normal price? Can it be said right now that a price of 50-60 euros/m³ is low, or is it still high? Energy independence and energy security mean that the consumption of wood chips for burning in Latvia will increase from 6 million loose cubic meters per year to about 8 million loose cubic meters. In a way, this is and will be an opportunity for forest owners to earn money by selling low-value wood. At the same time, the fall in prices for all wood assortments will mean that some forest owners, especially private forest owners, will reduce their logging volumes. This means that smaller volumes of available wood will create pressure on wood prices. At the same time, it will also mean that the largest forest manager, JSC “Latvijas valsts meži”, should not have problems with the capacity for forestry works and, therefore, their execution, which was a very significant problem in 2022, when logging service providers tried to work for private forest owners who paid a higher price than what was stipulated in the contracts signed with JSC “Latvijas valsts meži”. In such a situation, service providers should return to work with JSC “Latvijas valsts meži”.

Competition between wood consumers will not decrease.

Yes, competition, in all likelihood, will even increase between sectors – cellulose, panel manufacturers, timber processors, and energy producers. Last year, the very high prices for energy wood essentially raised the purchase price for all other sectors as well. The greatest risk of being left without wood raw materials was faced by the so-called borderline sectors; for example, energy wood can be used for the production of cellulose and then paper, as well as for panels, and in the case of small logs, also for beams (sawn timber). But if energy producers pay more than others, then it is logical that wood of this quality will go precisely to this sector. Wood raw material was also necessary for cellulose production, and again there were unprecedented paper pulp prices in Latvia – 120-140 euros/m³, which did not allow for a reduction in the purchase price of sawlogs and veneer logs, even though sawn timber and plywood prices in foreign markets had already fallen. Many believed that these paper pulp purchase prices were artificially inflated, not dictated by the market. Namely, economics in production only emerge if a few percent of the total cellulose wood raw material required for production is bought at such cosmic prices. It is possible that precisely because this assortment's purchase price rose so quickly and sharply, it fell just as quickly. Forest owners in Latvia and the Baltic countries can be pleased with the realization that the cellulose factory owners' plan to replace birch with eucalyptus in paper production has ended in failure. There are also not very positive examples, such as furniture parts produced from birch, which are no longer produced due to the high price of that roundwood, because the price offered to foreign buyers seemed too high and they chose to produce these parts from other tree species.

Wood harvesting quantities in Latvia will also be affected by the new EU policy.

Of course it will, and not just in Latvia, but in the entire European Union. Despite unprecedented inflation and challenges in the energy sector, no one in the European Union is planning to cancel the previously set plans for CO2 emission reduction, the implementation of a circular economy, etc. Since wood is the building material that is a kind of carbon sequesterer (bank), it seems logical that this fact creates an even greater advantage for even greater use of wood in construction, as stated in the European-scale initiative (New European Bauhaus). At the same time, there is a counter-movement from the same EU, which provides for a greater emphasis on the preservation of biological diversity, and thus the area of forests where economic activity – timber harvesting – is allowed will actually decrease. In essence, timber harvesting volumes in the European Union will fall, and in all likelihood, wood product prices will increase because there will be a shortage of them. For now, however, it is unclear how this contradiction – the deficit of wood products – will be compensated. If it is implemented through an increase in the volume of imported wood products, the question is – from where: from Canada, the USA, or from countries where there are questions about the reduction of rainforest areas? In the context of a circular economy, there will be increasing pressure on the reuse of wood: when one product reaches the end of its life cycle, it turns into raw material for another product. For example, furniture that has served its time, wooden building construction elements, etc., will be used in the production of wood chip panels, but fresh roundwood will be used minimally or not at all. This process has already begun and can be seen now, only it will gradually gain momentum. It must be said that the EU Green Deal, which is aimed at lower greenhouse gas emissions and higher sequestration, is in contradiction with the European Union's biodiversity guidelines. Currently, many compromise solutions dictated by desperation have arisen between climate and biodiversity policies, created as environmental and economic sectors attempt to prove their justification to politicians. Unfortunately, nature conservation is currently not planned but fragmented, which is why it is very expensive and inefficient. If we do not want someone from above, without or with minimal understanding of the economic, social, and environmental role of the forest sector, to dictate how things are to be, then the only solution is for non-governmental environmental organizations and the forest sector to sit at the negotiating table, initially at least to agree on something small, which could then be used as a basis to expand such an agreement. Unfortunately, as long as environmental advocates consider forest owners, loggers, and timber processors as mercantile money-grabbers, and the latter consider the former as clueless city dwellers who do not want to allow the cutting down of almost a single tree, nothing good will come of the constant conflict in which civil servants working in ministries, as well as politicians, are drawn. Of course, there will be some 30% of issues where the viewpoints of both sides will be radically different, but that is not an argument for not talking and not being able to agree on 70% of issues. I think that entrepreneurs in the sector are not in contradiction with the representatives of non-governmental environmental organizations when we look for solutions for creating higher value-added and more sustainable wood products or when talking about raising requirements (fewer emissions, etc.) for logging machinery used for work in Latvian forestry operations.

What are the biggest challenges for the sector in the perspective?

The availability of wood resources – both in the context of the requirements set by the EU and the claim submitted to the Constitutional Court regarding the compliance of the changes made by the Cabinet of Ministers last summer regarding the reduction of the diameter for final felling with Article 115 of the Constitution (The State protects the right of everyone to live in a favorable environment by providing information about the state of the environment and by caring for its preservation and improvement). It is too early to evaluate what the Constitutional Court will decide. At the same time, forestry regulation in Latvia (when and what you are allowed to do on your property) at the state level is very strict, whereas competitors in Scandinavia have no special state requirements. For example, in Finland, there is no tree diameter or age restriction; the only condition is that the harvested areas must be regenerated. In other words, in Finland, a forest owner can harvest when they want. In Sweden, there is also no tree harvesting diameter restriction, and trees can be felled from the age of 45, 50, 60, 65, 70, 80, 90 years depending on the growing conditions. The only country where a tree harvesting diameter restriction still exists is Estonia. Namely, for pine, it is 28 cm, for spruce – 26 cm, for birch – 22-26 cm. In Latvia, the following felling diameter is now set: for pine – 30 cm, for spruce – 26 cm, for birch – 25 cm. It must be taken into account that for those forest owners who want to harvest the forest by diameter, not by age, there are additional requirements to leave 8 ecological trees instead of the previous 5 trees. In order for future stands to be climate-resilient and productive, the forest stand will have to be regenerated with high-quality planting material. According to studies, quality planting material provides 20% higher forest productivity, which means more carbon sequestered. The minimum number of trees per hectare when regenerating the forest has been reduced – for spruce and birch, instead of the existing 2000 trees, there must be 1500 trees. For pine, there will henceforth be 2000 trees, not 3000 as before. The 'boom' in withdrawing felling certificates experienced last year is more related to the project of raising the state duty for felling certificates (initially even 20-30 times, but in the end, a reasonable solution was found) hovering in the air at that time, not the opportunities to harvest forests by diameter. Another challenge will certainly be the availability of labor. Borders are open, and competition between sectors for attracting relevant specialists only increases. For example, a young person interested in high-capacity machinery can work as a forest machine operator, as a road construction machinery operator, or with agricultural machinery.

The challenge on our side is to create better jobs than others. Although a year after graduating from technical school, about 70% of 50-60 young people work in the forest machine operator profession, a worrying picture emerges after the second year of work, when only about 30% remain in the profession. Of course, it will never be the case that 100% will work in the profession, yet the fact that within two years the work of a forest machine operator is abandoned and another occupation is found forces one to look for answers to the question of why this is happening (hard work, inadequate remuneration, unsuitable working hours and conditions, etc.) and also appropriate solutions. The challenge is and will be inflation – rising costs, especially in a situation where product sales prices have already fallen. There are companies that have a small number of employees if calculated against the volume of wood processed, but their employees have significantly higher wages than medium and small companies, yet the latter are the largest employers in the regions. For example, Latvia is almost the only country in the region where fireplace wood production has been preserved. On the one hand, it counts as the processing of low-quality roundwood and requires a lot of manual labor, because the product must be split, dried, and packaged, yet the buyer of this product is a relatively wealthy European: fireplace wood – that is exclusive! In the industry, there is a constant discussion about whether the amount of tax paid per 1 m³ of roundwood processed indicates a high social responsibility of the entrepreneur or if it is proof of low labor efficiency in production.

Unlike Scandinavia, the forest sector in Latvia lacks chemical wood processing; this lack (the high price of electricity) should be thought about at the state level, especially if wood is currently being evaluated in the perspective of substitutes for fossil (oil) products. In any case, the forest was, is, and will be green gold, because the possibilities for using wood will only grow, which means that there will be no reason for its prices to fall.