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The Shoeshine Column: Carter Holt's log price gamble may hit a jam

Friday 6th October 2000

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Carter Holt Harvey's "price leadership" strategy was always going to make enemies. After all, the idea is to jack up the prices people have to pay for its products.

So no surprises when sawmillers complained recently to the Commerce Commission that the forest products giant was abusing its position.

Carter Holt has been buying every log it can get its hands on, pushing up prices, according to some accounts, 30%.

As the intention is to raise the price at which it can sell its own logs in the domestic market its tactics look highly successful. But it's also playing a risky game.

It's not so much that the forester need fear the wrath of the Commerce Commission, although it seems a little blatant that a large player should throw its weight around like this.

Section 36 of the Commerce Act prohibits abuse of a dominant market share but the commission hasn't so far shown any interest.

One of the tests it uses to establish "dominance" is whether a player can impose ssnips - small but significant non-transitory increases in price - without losing significant market share. On the face of it that's exactly what Carter Holt is doing.

But despite the big buy-up there are, industry participants reckon, still plenty of alternative sources of timber, including the possibility of imports.

Nor is Carter Holt bothered about the risk of losing great chunks of market share. It has already lost some in the Asian log market using similar tactics. That's all part of the gamble on which price leadership is based.

The theory is that a large enough player can lift prices unilaterally. To make this worthwhile you have to be confident the extra cash you generate will more than offset the revenue your competitors will be able to grab from you if they choose to maintain their prices at the old level.

This will happen if enough of your competitors follow your lead and pocket the extra cash. In the tree-growing business there is in any case a limited extent to which the revenue-grabbers can increase production to meet expanded market share.

Those with a sense of the ironic might wonder how the strategy fits in with Carter Holt's predatory pricing (pricing at under cost to force out smaller competitors) of its Pink Batts insulation product back in 1994, a tactic that copped it a $525,000 fine when the commission took it to court.

But that was a long time ago - Chris Liddell became chief executive only last year and the company doesn't own Pink Batts any more.

The looming problem for Carter Holt - and the likely reason it's trying to jack up prices now - is the coming boom in wood production.

According to Ministry of Agriculture and Forestry estimates, by 2020 New Zealand's annual supply of recoverable wood will double to 35 million cu m with most of the increase coming in the next three years.

The harvest increase will be fastest in Northland, where it is expected to rise 400%, the East Coast, and the southern North Island.

These forests, planted during the 1970s as joint ventures between the Crown and iwi, now have a variety of owners, notably Carter Holt, Weyerhaueser, Rayonier, and Ernslaw One.

Although Carter Holt's own harvest will expand rapidly the wood glut means there will be many more players coming onstream with wood supply than there are now. Competition in the domestic market will get a lot hotter but demand won't have grown much so most of the increased harvest will have to be exported.

The real risk to Carter Holt in trying to push up domestic prices now is in building a huge lumber stockpile it can't sell at economic prices.

Some industry sources say there are already signs this is happening. Carter Holt is reported recently to have bought 90,000 tonnes from Rayonier.

One of the dangers is practical - construction-grade logs lying around in timber yards develop sap stain, rendering them useless for anything except pulping.

The greater danger is economic. A large part of the cost of growing a tree is incurred in the last few weeks of its 28-year life in harvesting and transport expenses. So the efficient use of capital dictates you sell your trees as soon as possible after they're cut down.

Carter Holt's "price leadership" campaign amounts to a gamble it's big enough to leverage the entire domestic market. If it can't, serious damage is going to be done to its margins.

At least it's having a go instead of just sitting back and taking prices. Foresters use the P50 line - the line above which, on the evidence of prices over the past 30 years, log prices should be for 50% of the time - to determine whether their timber is "cheap" or "expensive."

At the moment prices are where they have historically been for only 30% of the time, so forestry assets are arguably heavily undervalued.

Carter Holt might pull it off. Asian markets are recovering steadily from the demand collapse of 1997 and 1998.

But the demand recovery has to be balanced against the huge new annual supply of radiata pine that will become available over the next few years.

It doesn't have to be absorbed all at once - foresters can tailor supply to meet demand to some extent by leaving mature trees standing.

But it remains to be seen whether Carter Holt's big gamble will make shareholders any better off in the end.

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