Biomass investments make sense as currency hedge for some Canadian forest products producers
By Brendan Lowney, Forest Economic Advisors

Why would a country that has the world's second largest store of proven oil reserves along with abundant and cheap sources of hydroelectric power take such a keen interest in the wood biomass sector? In recent years, the province of Ontario definitively shifted its policy focus from traditional wood products manufacturing to wood biomass. Provincial officials in British Columbia are also keen to promote wood biomass, although the shift in emphasis has not been as decisive there. Surely, the structural decline in the paper sector and the cyclical decline in the wood products sector have played a role in this decision-making process. But that is not the whole story.

The economic viability of bioenergy is to a large extent, connected to oil prices--the higher the better. Moreover, oil prices have clearly become the key driver for movements in the Canadian dollar (see graph).

The nearly 60% appreciation of the loonie versus the U.S. dollar over the past decade has pushed Canadian pulp, paper and wood products producers up their industry cost curves relative to their U.S. counterparts.

If you believe that rising real oil prices are likely to keep the Canadian dollar above parity for a considerable period (as we at FEA do), then the emphasis on biomass in Canada makes sense. Investments in biomass are much more likely to pan out in world of high oil prices, a strong Canadian dollar and a weak competitive position for Canadian forest products producers. On the other hand, if oil prices and the Canadian dollar revert to levels that prevailed in the 1990s, then Canadian producers will be profitable enough to write off what will turn out to be bad biomass investments with ease.

This insight occurred to us while hosting the first of what will be many, Forest Products Forums in Portland Oregon in September. During the event, Ken Shields the CEO of Conifex made some insightful comments on the viability of the wood biomass sector in British Columbia. Conifex clearly believes in the economics of bioenergy and has backed this belief with its investment dollars. It has recently invested $70M to convert a newsprint mill in Mackenzie B.C. into a biomass cogeneration facility.

The rational for this investment may not seem clear given that B.C is a significant producer of hydroelectric power that also happens to be adjacent to a booming oil industry in Alberta. However, Confefix believes that it has identified tangible synergies between forestry, sawmilling, cogeneration (CHPO) and other Bioenergy business. Shields also pointed out that the firm's desire to pursue biomass projects is consistent with provincial objectives.

Recent increases in oil prices have been primarily driven by strong demand from emerging countries and that demand growth appears almost certain to outstrip supply in the coming decades. Thus, Canadian forest products producers are wise to plan for a world with a strong Canadian dollar. We expect to see many more biomass investments north of the border in the years ahead.

Brendan Lowney is principal and macroeconomist of Forest Economic Advisors and a frequent speaker with Industry Intelligence's i2live online speaker series.

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