Executive Summary

A. Introduction

In response to concerns about the current financial state of the forest industry and the effect that increases in delivered wood costs have had on the competitive position and financial viability of the industry, this study was commissioned to examine the financial state of the forest industry and provide answers to the following key questions:

• What are current (1996) logging costs and how much have they increased since 1992?
• Why have they increased? What are the particular cost drivers that have led to increases in logging costs? How do they vary regionally?

These questions were addressed by collecting delivered wood cost information for 1992 and 1996, comparing the costs for the two years and collecting qualitative information about logging cost drivers from a sample of Coastal and Interior logging operations.

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 regulatory changes which may have caused costs to increase.

B. Approach and workplan

The methodology employed in the study of delivered wood costs and cost drivers was to first collect delivered wood cost information from Coastal and Interior logging operations of major licensees (Note: the study did not include purchased wood costs or logging costs on private land). This was done using surveys which were completed by 94 operations across the province, 36 of which were Coastal and 58 were located in the Interior. Appendix C includes a list of study participants.

Since corporate information systems do not collect cost information in a way which makes analysis of cost drivers possible from that data, the question of why costs increased during the period was addressed through qualitative information. A sample of about one-third of the participating operations (See Appendix F) was surveyed with a questionnaire, which asked woodlands staff to use professional judgment to estimate the impact of various cost drivers on each of several cost categories during the period. The sample of operations was chosen to be geographically representative and to include at least one operation from each participating company. The information was collected during site visits to improve consistency of allocation of costs among the cost drivers.

The questionnaire collected information on the impact, in percentage terms, of the applicable cost drivers on the observed 1992 to 1996 cost increase in each of the cost categories. That information was then aggregated on a regional and provincial basis and is presented here in the form of average unit cost increases ($/m³) due to the various cost drivers. These results combine quantitative cost information with subjective, qualitative estimates of percentage impacts and are intended to be indicators of trends and orders of magnitude. While the numerical results are presented in the form of $/m³ to make the results useful to the user, the presentation is not intended to imply that the results are accurate to the level of $0.01/m³.

For the purposes of comparing and contrasting results regionally, the study includes three regions: Coast, Northern Interior and Southern Interior. The Interior was divided by including operations south of a line running east to west from immediately north of Valemount to immediately south of Quesnel in the Southern Interior, and those farther north in the Northern Interior.

C. Increases in delivered wood costs: 1992-1996

Figure 1. 1996 B.C. delivered wood costs in $/m³

The log costs before stumpage presented in Figure 1 are somewhat higher than the estimates included in the "Industry on the Brink" presentation (see section 1.A), possibly due to the inclusion of additional participants in this study. The stumpage amounts are somewhat lower because the presentation used estimated stumpage levels for the month of December while the amounts reported above are averages for the year. Stumpage rates increased with higher lumber prices over the course of 1996.

The following tables indicate the unit cost and percentage changes in delivered wood costs over the period 1992 to 1996.

Figure 2. Analysis of increase in delivered wood costs (1992-1996)

Figure 3. Percentage increase in B.C. delivered wood costs ($/m³):1992 to 1996

It is clear that stumpage (which includes royalties) shows the largest percentage increase in total log costs across the province and in each region. Within log costs before stumpage, the cost categories with the largest percentage increases were forest management and engineering ($2.65/m³ or 146%) and road expense ($4.84/m³ or 94% ). Both were significant in all regions, with the greatest impact on the Coast due to more difficult terrain and complex planning.

The logging and transportation cost category increased by $8.95/m³ (34%) overall. Increases in this category were highest on the Coast, somewhat less in the Southern Interior and lowest in the Northern Interior, reflecting the degree of difficulty in operating conditions in the various regions.

Forest regeneration increased by $1.69/m³ (70%) over the period. The Coast and Interior amounts in this category are not directly comparable because the Interior amounts were collected on an accrual basis while the Coast amounts are on a cash basis. However, both have increased significantly.

D. Cost drivers

Within the context of this study, we have adopted the following working definition for the term "Code-related cost driver" to reflect the evolution of the forest practices regulatory environment which was eventually given the force of law within the statutory framework of the Forest Practices Code of British Columbia Act (FPC Act) (see Section I.B. of this report).

"Code-related cost driver" refers to cost drivers which correspond to provisions of the Code and to costs associated with implementing and administering the Code. As explained below, these cost drivers have been used to capture the increased costs associated with the set of regulatory provisions which have been gathered under the statutory framework of the Code, regardless of when the provision first took effect. For the purpose of our analysis, it was not considered relevant whether any given provision affected costs only after the Code took effect in June, 1995 or began to influence costs earlier in the study period.

Throughout this report, "Code" is used to refer to the FPC Act and the associated Regulations and guidebooks (where specifically referenced in the FPC Act or approved operational plans).

"Non-Code-related cost driver" is used to refer to all other factors which affected costs during the 1992-1996 period.

Within the "Non-Code-related cost driver" category, there is a cost driver labeled as "Impact of pre-Code guidelines" or "pre-Code". For our analysis we have differentiated "Code-related" and "pre-Code" cost drivers as follows:

Code-related cost drivers: If the 1992-1996 cost increase was related to guidelines, standards or regulations which were incorporated substantially unchanged into the Code when it came into effect, then that cost increase was allocated to a "Code-related" cost driver corresponding to the relevant provision of the Code. For example, the Silviculture Practices Regulation came into force in 1994 and has now been incorporated into the Code. The cost drivers associated with this regulation such as soil conservation requirements and the penalties related to issues governed by the Silviculture Practices Regulation were deemed to be "Code-related" cost drivers.

Pre-Code cost drivers: If the 1992-1996 cost increase was related to guidelines, standards or regulations which were changed substantially before being incorporated into the Code, then that cost driver was deemed to be a pre-Code cost driver. Examples of pre-Code cost drivers include parts of the Coastal Fisheries Forestry Guidelines, the Kamloops Regional Road Standards and the Okanagan Timber Harvesting Guidelines. The pre-Code cost driver was compiled in the "non-Code-related" cost driver category.

See Appendix E for more information regarding the Code-related/pre-Code cost driver differentiation and the definitions of the various cost drivers.

In defining the various cost drivers and while conducting the site visits, care was taken to ensure that the reasons costs have increased were appropriately allocated among the cost drivers, particularly with respect to the split between Code-related and non-Code-related drivers. In those cases where logging contractors are employed, respondents were asked to use their knowledge from the contract negotiation process to indicate what the root causes of contract rate changes were and to allocate the increases to the various appropriate Code-related and non-Code-related cost drivers.

Figure 4 summarizes the impacts of the various categories of cost drivers.

Figure 4. Increase in delivered wood costs by cost driver (1992-1996)

1. Code-related and non-Code-related cost drivers

For the province as a whole, $8.40/m³ (41%) of the non-stumpage logging cost increase has been attributed to non-Code-related cost drivers while $12.22/m³ or 59% has been attributed to Code-related impacts.

For the Coast, the Code-related cost drivers account for $19.68/m³ (64%) of the increase, which is higher than the provincial average and the other regions due to the operational difficulties of coastal terrain, more streams and more streams with high fish values, and a greater emphasis on non-timber harvesting forest values. The range of Code-related cost driver impacts varied from 48% to 82% of the cost increase.

In both the Southern and Northern Interior the Code-related/non-Code-related split is similar with approximately 54% of the increase explained by Code-related cost drivers. The range of Code-related cost driver impacts was 35% to 64% of the cost increase.

2. Non-Code-related cost drivers

Price and rate increases explain the largest share of the cost increase of any non-Code-related cost driver category, accounting for $4.72/m³ province-wide. This includes inflationary increases due to prices and wages, but does not include logging contractor rate increases, except to the extent those increases are due to price and wage increases affecting the contractors. Other cost drivers affecting contractor rates have been captured in all the relevant cost driver categories. This cost driver reflects an 11.5% increase, which is in line with the general rate of inflation for the period.

Items under company control accounted for cost increases of $1.40/m³ province-wide. This is largely the result of historical logging patterns resulting in current harvesting being somewhat more distant and dispersed with increased access costs, lower quality timber and often more difficult terrain. In addition, business decisions have affected costs. In the Northern Interior, the move to more merchandising in the woods and choosing to operate in more difficult terrain to demonstrate operability and preserve AAC levels has increased costs, with the expectation of increased value or future returns. On the Coast, camp shutdowns and other cost control measures have reduced costs.

Non-Code-related regulatory cost drivers have accounted for increases of $1.11/m³ over the period. The largest factor in this category is the increased costs associated with restrictions on burning of debris at Coastal dry-land sorts. Otherwise, this category is characterized by a number of relatively small increases to costs due to contractor regulations, WCB requirements, and other environmental requirements.

Tenure administration cost drivers accounted for increases of $0.53/m³ province-wide. On the Coast, the effect was largely due to the combined impact of AAC reductions resulting from the Timber Supply Review, and partitioned cuts established during AAC determinations which resulted in an increased use of more costly logging techniques to access lower quality timber. In the Southern Interior, the cost increases result from moves to new planning cells with increased access, planning and operating costs. This category is not significant in the Northern Interior.

Land use issues have not been a significant cost driver to date ($0.35/m³), although they have had a significant effect on AAC in some areas. Land and Resource Management Plans and the Protected Area Strategy have resulted in substantial cost increases for a few operations due to the loss of areas which had roaded access and where there had been considerable pre-harvest planning and engineering work done prior to area designation.

3. Code-related cost drivers

The Code-related cost drivers have been split into those primarily related to forest practices in the field and those associated with planning requirements and government administration related to the Code. Overall, planning and administration cost drivers account for $4.52/m³3 or 22% of the cost increase and forest practices cost drivers account for $7.70/m³ or 37%. Planning and administration cost drivers account for a greater proportion of the cost increase on the Coast (27%) than in the Interior (16 to 17%), due primarily to greater complexity in planning issues and the nature of the terrain.

a) Planning and administration

Increased planning requirements in the form of additional plans, amendments to approved plans, various assessments and increased inventory requirements are the largest cost driver within this category and the largest of all Code-related cost drivers. Increased planning accounts for $2.57/m³ province-wide and $5.45/m³ on the Coast.

Administrative delays in the approval process for operational plans, cutting permit applications, road and other permit applications increase costs because the resulting reduction in standing timber inventories (volume in approved cutting permits) reduces flexibility and results in operational inefficiency in a number of logging phases. Administrative delays account for $0.83/m³ province-wide.

The penalty systems component of the Code causes cost increases through company training and due diligence activities put in place to reduce the risk of enforcement actions under the Code, as well as overly conservative practices undertaken to ensure compliance. This cost driver also accounts for an $0.83/m³ increase province-wide.

Differences in Code interpretation and requirements among Districts and between the MoF and MELP are not a large cost driver in any region, accounting for $0.29/m³ province-wide.

b) Forest practices

The most significant forest practices cost drivers are cut-block size, road & landing requirements, soil conservation requirements, riparian management requirements and green-up requirements. These are important in all regions of the province, with the single exception that green-up requirements were only found to be a major cost driver on the Coast.

Cutblock size restrictions have the greatest impact on the Coast ($3.00/m³ or 10%) and in the Northern Interior ($1.94/m³ or 14%). The impact is less significant in the Southern Interior because cutblock size had already been reduced prior to the study period in much of the region. Smaller cutblocks mean increased planning requirements, more roads and less efficient harvesting.

The road and landing requirements of the Code were a major cost driver in all regions, representing cost increases of $1.91/m³ or 9% province-wide, $3.22/m³ or 11% on the Coast, $1.38/m³ or 8% in the Southern Interior and $1.12/m³ or 8% in the Northern Interior. Cost increases are due to higher road building standards, reduced ability to use roads under certain conditions and increased road maintenance and deactivation requirements.

Soil conservation requirements account for $1.70/m³ or 8% province-wide. This cost driver is most important on the Coast ($2.00/m³ or 7%) and in the Southern Interior ($2.45/m³ or 14%). In the Northern Interior, due to the proportion of winter logging, this is a somewhat less significant cost driver ($0.82/m³ or 6%).

Riparian management requirements account for $0.80/m³ or 4% province-wide. It is most significant on the Coast ($1.22/m³ or 4%) due to more streams, more streams with high fish values and a greater reliance on higher cost hand falling and cable yarding methods. In the Southern Interior it accounts for $0.51/m³ or 3% and in the Northern Interior for $0.63/m³ or 5%. It is lower in the Southern Interior due to the fact that forest practice guidelines in place before the study period already required significant riparian management practices.

Green-up requirements are most significant on the Coast because the longer logging history means that there is less operational flexibility remaining as a result of the interaction between green-up requirements and the pattern of historical development. This driver accounts for $1.25/m³ or 4% on the Coast but less than $0.25/m³ throughout the Interior.

Visual quality objectives were only found to be a major cost driver in the Southern Interior of the province. On a provincial basis, they can be expected to have more of an impact over time, since a number of operations have tended to avoid operating in these higher cost areas while alternative operating areas are available. However, as constraints in other operating areas force companies to operate in visually sensitive areas in order to achieve their harvest obligations, the costs associated with this driver are expected to increase.

The "other Code" cost driver, which relates primarily to cost increases resulting from the pre-free growing spacing requirement, has not yet become a major cost driver on a provincial basis. However, as the number of stands which require pre-free growing spacing increase over the next few years, the impact of this cost driver is expected to increase.

There are three cost drivers which are almost solely related to biodiversity:Forest Ecosystem Networks, Identified Wildlife and Wildlife Tree Requirements. None of these is a major cost driver in any region at this time, which is in part due to the fact that these requirements can sometimes be accommodated within other Code requirements, such as the dual role played by some Riparian Management Areas in providing wildlife tree patches. Also, the Forest Ecosystem Network and Identified Wildlife provisions of the Code are closely related to landscape level planning, which is not yet fully implemented in the Province and has had limited effect in most areas during the subject period (other than resulting in some area deferrals, costs associated with moving into other operating areas and administrative delays in plan approvals). For identified wildlife in particular, there has yet to be any formally identified wildlife, although taking wildlife species and habitat requirements into account in planning is already fairly widespread. It seems likely therefore that the impact of the Forest Ecosystem Network and Identified Wildlife cost drivers on logging costs will become more significant in the future.