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Financial State of the Forest Industry and Delivered Wood Cost Drivers

I Introduction

A. Background

The following description of the background of this project has been excerpted from the Terms of Reference for the project, included as Appendix A of this report:

The forest industry has historically been subject to market cycles. There is a growing concern at this point in the current cycle, however, that the longer term competitive position and financial viability of the industry may have been permanently impaired by increases in wood costs resulting from both higher timber prices (stumpage and royalties) and increased logging costs.
At the December 5, 1996 meeting of the Forest Sector Strategy Committee, and at a December 18, 1996 meeting with a number of deputy ministers, senior industry representatives presented a paper entitled "Industry on the Brink" which, among other things, presented estimates of profitability of the industry by sector through the first nine months of 1996.
The presentation argued that the industry is not making an adequate return on capital and that its financial viability is being crippled by:

high stumpage; and
lack of recognition of cost impacts on industry from the Forest Practices Code and other factors.

Reflecting their concern about the information presented, the government representatives indicated their intent to undertake a project to identify cost drivers that could help in determining solutions to the problems facing the industry. Industry representatives indicated their willingness to cooperate in this project and that their books would be open to those undertaking it.

The resulting terms of reference were designed to answer the following key questions:

What are current (1996) logging costs and how much have they increased over the last four years?
What are the particular cost drivers associated with these increases and how do they vary on a regional or company-by-company basis?

The objective of the project is to provide a sound factual basis on which industry and government can discuss options for possible solutions to the problems facing the industry.

It should be noted that this study is only concerned with costs and the reasons why costs have increased. No attempt has been made to evaluate the benefits associated with forest practice changes, and the fact that certain provisions have been observed to cause costs to increase in no way implies that those provisions are (or are not) justified or effective.

B. History of the Forest Practices Code

The Forest Practices Code of British Columbia Act (FPC Act) has been developed over a number of years, and is still undergoing refinement as operational difficulties of implementing the Code are addressed by government. A brief history of the evolution of the legislation is as follows:

In the spring of 1989, the government requested that the British Columbia Forest Resources Commission (FRC) examine the state of the province's forest land base and recommend improvements to the way it is managed.
The FRC issued their report entitled "The Future of our Forests" in April 1991.
Following the issuance of their report, the FRC was asked by government to conduct public meetings to develop a consensus on the framework for a Forest Practices Code for British Columbia. Six regional workshops were held in various locations around the province to receive public input regarding the framework for the Code. The FRC subsequently produced a summary report reflecting the areas of consensus achieved during the workshops.
Following the receipt of the report, several Code working groups were established by government to draft the various components of the Code, including components of the Act, Regulations and guidebooks. Representation within these working groups was drawn from specialists within a number of government agencies.
In October 1993, the government issued a discussion paper on B.C.'s first Forest Practices Code to solicit public comments. It was the government's stated intent at that time to implement the Code by the fall of 1994.
In November 1993 the government issued "Proposed Forest Practices Rules" for public review and comment. Following this review, many of the concepts identified in this document were subsequently incorporated within the Act and draft Regulations.
On July 7th, 1994 the FPC Act passed third reading in the legislature and was widely distributed as a public document at that time.
Also in 1994, the government passed the Silviculture Practices Regulation (this replaced the Silviculture Regulation, which had been in place since 1988). The forest practice requirements included in this Regulation were later incorporated within the Forest Practices Code.
The FPC Act and a number of accompanying Regulations came into force on June 15, 1995. The Act included, among other things, transitional provisions which governed how and when its provisions would be applied.
Since proclamation of the FPC Act, several guidebooks have also been released which provide suggested approaches to meeting the legislated requirements.
Since the introduction of the Code, a number of amendments to the Act and Regulations have been made to address implementation issues identified in the original versions of these documents.

The Terms of Reference related to the analysis of delivered wood costs part of this study stated: "The identification and quantification of cost drivers, including but not limited to, elements of the Forest Practices Code, is the primary objective of this part of the project." The evolution of the Code resulted in certain regulations, standards and guidelines which became key aspects of the Code being implemented in some areas of the province before the FPC Act was proclaimed on June 15, 1995. Because of this, our methodology was developed to provide a mechanism to differentiate "Code-related" from "non-Code-related" cost drivers (see Section II.B.3).

C. Project scope

The project was divided into two separate phases:

Phase I:Review of financial performance
The scope of this phase was limited to performing an overview analysis of certain financial information included within the "Industry on the Brink" presentation and putting the overall results in context.
Phase II:Analysis of increases in delivered wood costs (1992-1996)
The scope of this phase included:

Collection of data on delivered wood costs in 1996 for selected Coastal and Interior logging operations;
Comparison of 1996 delivered wood costs with 1992 costs for the same operations to identify the specific cost elements responsible for the change in delivered wood costs;
Qualitative analysis of the cost drivers responsible for the change in delivered wood costs, based on a sub-sample of the selected Coastal and Interior logging operations.