Timber Duty Plan Roiling Europeans

Russian Timber GroupThe increase in duties on timber, like that being harvested here in the Irkutsk region, has brought complaints from EU customers like Finland and Sweden.
While the fallout from Russia's conflict with Georgia and troubled financial times are likely to dominate the agenda at an EU-Russia summit opening Friday in Nice, some participants are likely to be interested in a more prosaic topic -- timber.

More specifically, after the EU agreed Monday to reopen talks on a new cooperation agreement with Russia, its officials remain keen on preventing a hike in tariffs on Russian timber exports, which is scheduled to take effect on Jan. 1 and which Finland, Sweden and other EU states say poses a threat to their lumber and pulp and paper industries.

"Export tariffs are the main individual trade policy problem between the EU and Russia," Finland's minister for Foreign Trade and Development, Paavo VКyrynen, said by e-mail Monday. "The forum for finding a solution is the WTO accession process, and at the EU-Russia summit this will be in negotiations."

On New Year's Day, Russian duties on exported logs are set to increase by more than 300 percent, from 15 euros to 50 euros per cubic meter -- or 80 percent of the log value.

The increase, one in a series of hikes that began in July 2007, is aimed at reducing the incentive for companies to export raw timber. Instead, the government wants to foster the development of a domestic wood-processing industry or even the shift of some of the foreign companies' operations to Russia.

"I respect [Russia's] ambition to diversify, to modernize their industry, but closing one's borders is the wrong way to go," Swedish Trade Minister Ewa Bjorling said by telephone last week. "[Sweden] opened up its border to more international trade, and that's how we created our prosperity, and that should be the same recipe for other countries."

European Union leaders are looking to make that point in Nice.

"Under the EU-Russia relations agenda item, we usually also discuss trade issues and, like in previous summits, we also have every intention to talk about Russia's WTO accession this time, in particular, in relation to export duties on wood," said Timo Hammaren, head of the trade division for the European Commission's delegation to Russia. "However, I don't think there will be a very lengthy discussion on the export duties taking into account the short time available for the summit discussions."

Vayrynen said he still hopes that the summit will help advance Finland's short-term objective -- to get the Russian government to at least postpone the Jan. 1 tariff hike.

"After that, a more comprehensive solution should be found in a speedy fashion," he said. "I have all along been of the opinion that export duties hit the Russian economy and Russian economic operators in a manner that is not in their interest. No doubt, the economic downturn will exacerbate these problems."

Bjorling also hopes that the summit will move EU-Russian partnership talks forward.

"I think it will be in general a strong topic in economic relations between Europe and Russia," she said. "We want to move our long-term partnership talks forward."

While not expecting any "fast-track" solutions at the summit, Bjorling said she was still optimistic about getting the tariff plan scrapped.

A spokeswoman from Russia's Ministry of Industry and Trade said Russia is "always open to dispute over the question, however our position is clear -- we are still intending to gradually increase the tariffs on timber."

Russian Timber Group
A Valmet CTL forwarder gathering timber in the Amur region. Russia exports one-quarter of its timber harvest annually, about 50 million cubic meters.
The subject is likely to be raised when Finnish Prime Minister Matti Vanhanen meets with Prime Minister Vladimir Putin on Wednesday during a visit to Moscow.

Paul Vandoren, deputy head of the European Commission delegation to Russia, said new EU Trade Commissioner Catherine Ashton plans to meet with Economic Development Minister Elvira Nabiullina to discuss timber tariffs among other trade issues in Nice.

The Ministry of Industry and Trade could not confirm the meeting but said Nabiullina is planning to attend Thursday's EU-Russia industrialist round table.

According to data from LesProm, a timber trade and research organization, in the first six months of 2008 Finland was the destination for 24 percent of Russia's timber exports, with Sweden accounting for another 3.5 percent, putting them in second and fourth place, respectively.

Russia supplies almost 80 percent of Finnish timber imports.

"We are already at the limit of what we can manage," Bjorling said in reference to the export tariff. "It was tough enough before the financial crisis started. I think that now the crisis will make the international community more pragmatic, which shouldn't result in any higher tariffs."

Industry experts say export tax increases, coupled with the global economic slowdown and tightening of credit, have already created serious problems for many Russian harvesting companies.

"The crisis has caused European wood-processing companies to reduce production. They are demanding less wood, so Russian companies are harvesting less," said Yuri Gerasimov, Russian forestry expert at the Finnish Forest Research Institute.

Russia fells close to 200 million cubic meters of timber annually and exports a quarter of that harvest each year. According to data from LesProm, timber export volumes for the first three quarters of 2008 were down 8 percent from the same period in 2007.

When the export tariff rises from 25 percent to 80 percent, foreign companies will be forced to stop buying, triggering a huge surplus that will both lower domestic prices for wood and discourage logging, Gerasimov said.

North-west Timber Company
The North-West Timber Company's pulp-and-paper mill near Kaliningrad.
"Before, there was competition with Europe. European companies were paying higher prices for Russian logs, so the Russian processing companies had to pay higher prices as well," he said. "That maintained the prices in the logging industry. But now that the competition is fading away, the Russian companies can drive the prices down."

"The weakest logging companies, well, they will just disappear," Gerasimov said.

Bars, a small logging company in Siberia's Sverdlovsk region, has already reduced production.

"It's a bad situation all around," said an assistant to the head of Bars, who would only give her name as Valentina. "Processing companies are delaying payments to us, and without money, we can't operate, we can't sell them the logs."

Sergei Meklutsans, sales manager at Yuniper, a small lumber company based in the Leningrad region, said the company felt a fall in European and domestic demand for lumber in early 2007, about the same time that the first new tariffs were announced.

Now, Yuniper has altered its business model to focus on timber transport.

"Transport services are in greater demand, and the rates are better," Meklutsans said. "We currently have 12 trucks and are looking to buy more."

Russian pulp and paper producers, however, are benefiting from low prices on raw materials.

Yuri Murashko, deputy general director for external relations of the North-West Timber Company, a leader in the Russian pulp and paper industry, said he would be very happy to see the tariffs go up in January.

He said North-West Timber used to buy 95 percent of its timber from Belarus and Lithuania, with the small remainder purchased from domestic logging companies.

"But now, there is more timber here in Russia, and the prices are better. Over the past year, we have been buying about 40 percent from Russia," Murashko said. "What we bought last year in Russia for 60 euros a cubic meter we are now buying for 40 euros."

It is unclear, however, for how long Russian lumber and pulp and paper companies will benefit.

"This stock will exist for a short time because of the surplus of logs," Gerasimov said. "But when that stock runs out, the logging companies will have to stop cutting because they can't sell at that price and still turn a profit."

A report by Wood Resources International, a consulting firm, said Russia does not have the production capacity to process the surplus timber that would otherwise have been exported.

Without enough buyers, the Russian forestry industry is going to suffer, with "huge negative ramifications for thousands of Russian loggers, forest managers and workers involved in the transportation of wood," the report said.

Hammaren, of the European Commission, said the increase on export duties would have "harmful effects on the Russian side, because Russia doesn't have the sufficient industrial capacity at this stage to produce enough pulp domestically. This will cause more unemployment on the Russian side in specific regions, such as Karelia."

But some market players have faith that both the financial crisis and the tariff increase will successfully catalyze the modernization of Russia's export-oriented timber industry and make it more profitable in the long term by forcing consolidation in the fragmented harvesting sector.

"I think it is a draconian way of forcing change, by just forcing an effective ban on a particular date, but it's a principle I am very supportive of," said Leo Hambro, CEO of the Russia Timber Group, one of the country's largest harvesting companies. "There is continued resistance to the introduction of new export duties, but people may be looking at this on a short-term basis."

He predicts that the majority of Russia's 20,000 harvesting companies will soon be forced out of operation, propelling a consolidation of land resources among stronger, more efficient and profitable companies.

"In the long term, [the tariff] is creating a structural change in the industry that will remove fragmentation," Hambro said. "It will develop a stagnated industry and increase the labor pool for infrastructure projects that are required for the development of Russia's regions."

The Russian Timber Group is only a few months away from completing construction on a sawmill it began building in 2006.

"The tariff increases gave us the extra push to diversify out from harvesting, to focus business on value-added operations, and this is where all businesses in the sector should be focusing on because that is where you make your money."