A Long-Term Analysis of Hardwood Lumber Prices by William G. Luppold Jeffrey P. Prestemon and John E. Baumgras 1

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1 A Long-Term Analysis of Hardwood Lumber Prices by William G. Luppold Jeffrey P. Prestemon and John E. Baumgras 1 ABSTRACT This study examined the interrelationship in prices of eight hardwood species using descriptive analysis and the Johansen method for testing cointegration. The descriptive analysis found that the lumber prices of the various hardwood species seem to follow independent trends largely due to changing domestic and international markets. Still, there might be a substitution mechanism that keeps prices of various species close to one another over the long run which may be revealed using cointegration. The cointegration analysis revealed that prices for various species of hardwood lumber are not cointegrated. However, there were several situations in which cointegration was found. Prices of high-grade lumber of all eight species examined were cointegrated with the price of black walnut. Prices of open-grained species were found to be cointegrated with one another. The price of yellow-poplar prices also were found to be cointegrated with several open- and closed-grained species. INTRODUCTION Hardwood lumber and timber has traditionally been treated as a commodity without respect to species (Haynes 1990). Although this assumption may be useful for policy analysis, it may be less relevant for forest management decisions. Hardwoods are a broad collection of species with variations in color, density, and other physical properties. Because hardwood lumber demand is influenced by style, different species are dominant at different times (Frye 1996). As a result the relative price of different hardwood species has varied over time (Table 1). The variation in hardwood lumber and subsequent timber prices makes timber management difficult. It takes 60 to 80 years for hardwood stands to achieve the minimal diameter and quality attributes desired by sawmills. This lengthy production cycle makes it difficult for forest planners to decide on what species to favor during the regeneration period following a partial cut or clearcut. If we can determine that hardwood lumber prices are independent or interrelated, this information may be useful to forest managers when projecting future market conditions. In this paper we examine if hardwood prices move independently of one another or are interrelated. Prices of hardwood lumber will first be examined using a descriptive approach that integrates changes in lumber prices with changes in fashion and international demand. This analysis is followed by a cointegration analysis of hardwood lumber prices. The concluding section of the paper will summarize important findings. HISTORIC ANALYSIS OF HARDWOOD MARKETS AND PRICES In the 1950 s and 1960 s walnut was the most valuable species and other closed-grained species (cherry, hard maple, and soft maple) were priced higher than open-grained species (oak and ash). During this period, walnut was the most commonly shown wood at the furniture markets followed by maple (hard and soft) and black cherry (Table 2). Yellow-poplar was valued more than the oaks (red and white) and maple because this species was used in combination with walnut, cherry, and mahogany veneers. Although furniture made from white oak was exhibited at furniture markets in the late 1940 s and early 1950 s (Table 2), oak furniture did not sell well. In 1973, walnut was still the most expensive hardwood species while the oaks, the maples (hard and soft), and yellow-poplar traded at similar prices. The high price of walnut may have resulted from a low supply caused by previous over cutting rather than from strong demand because it was being used less by furniture manufacturers. The early 1970 s also was a period of turmoil for both the general 1 The authors are, respectively, Project Leader, USDA Forest Service, Northeastern Research Station, 241 Mercer Springs Road, Princeton, WV 24740; Research Forester, USDA Forest Service, Southern Research Station, P.O. Box 12254, Research Triangle Park, NC 27709; and Project Leader, USDA Forest Service, Northeastern Research Station, 241 Mercer Springs Road, Princeton, WV 24740

2 economy and the hardwood lumber market. Wage and price controls imposed by the Nixon Administration caused shortages of nearly every species, resulting in sharp increases in prices after the controls were lifted. In addition the adoption of floating exchange rates during this time caused an increase in exports of oak and other species. The most significant change during this period was the increase in red oak furniture showings. Table 1. - Nominal prices for Number 1 Common hardwood lumber for select hardwood species Year Ash Beech Birch Black Hard Soft Red White Yellow- Black cherry maple maple oak oak poplar walnut Source: Data base maintained at the Northeastern Research Station s Forestry Sciences Laboratory at Princeton, WV, under the agreement with the Hardwood Market Report, Memphis, TN. Table 2. - Percentage of predominant species on exposed surfaces in bedroom and dinning room furniture show at major US furniture shows, 1946 to 1999 (Source: Frye 1996, 1999). Year Walnut Mahogany Maple Cherry Oak Other a/ Shown at Grand Rapids, Michigan b/ Shown at Chicago, Illinois 1948 to 1959 c/ Shown at High Point, North Carolina 1960 to present

3 As the 1970 s progressed, red oak became a major species used in domestic markets while white oak was being exported to Europe in increasing amounts. The maples became less important as furniture species while cherry maintained a continual presence at the furniture market (Table 2). In the 1980 s, demand for oak continued to increase while showings of maple and walnut furniture continued to drop. In the 1980 s, prices of red and white oak continued to increase in value while the maples sold at relatively low prices. Red oak continued to be used by domestic manufacturers while white oak was exported. The export of white oak caused the price of high-quality white oak to increase but the price of The ebb and flow of lumber prices for individual hardwood species over the last 50 years can be attributed to style. But what if style is partially dependent on price resulting in a long-term species substitution mechanism that eventually bring together the prices of different hardwood lumber species? Or, do hardwood lumber prices truly move independently? Given these questions, how do we test if hardwood lumber prices are interrelated or independent? Another way to examine the strength of the relationship between two wood products is to test whether their prices, expressed in linear combination, form a stable statistical relationship in the long run, that is, whether they are cointegrated. Consider the following expression of the linear combination of two time series of product prices, {p 1t } and {p 2t }, that are both nonstationary, integrated of order 1: [1] p 1,t = a + Bp 2,t + e t If there exists a linear combination of p 1 and p 2, a unique pair of values for a and B such that the resulting residual series, {e t }, is I(0) (i.e., it is stationary), the two I(1) prices can be considered cointegrated with parameters a and B. This means that the price pair has a stable, long-term relationship that endures even following substantial changes in levels of the series. Equation [1] introduces a concept attributed to Engle and Granger (1987) that should allow tests of long run relationships between two nonstationary series posited to possess a common trend. Although, there has been little analysis of the interrelationship of hardwood lumber prices in this manner or in others, there has been numerous studies of regional mid-quality white oak did not increase as fast as that of red oak (Table 1). Yellow-poplar prices remained low during this period due to relatively low demand and increasing sawtimber inventories. In the early 1990 s, showings of maple and cherry at the High Point, North Carolina furniture market began to increase. In addition, white hard maple was being used with cherry veneer. Oak showings hit nearly 30 percent in the early 1990 s resulting in a noticeable spike in the price of red oak lumber. By the end of the decade, black cherry was the highest value species followed by hard maple, mid-grade walnut traded at the same price as red oak while white oak traded at price levels comparable to those of soft maple. softwood lumber prices and price relationships of softwood lumber imports. These studies can provide insight on the current analysis since softwood species also differ in physical attributes. COINTEGRATION ANALYSIS OF SOFTWOOD MARKETS Uri and Boyd (1990) surmised that the market for softwood lumber is national and that price movements in one region matched price movements in other regions. Using multivariate cointegration tests to examine regional softwood lumber price, Jung and Doroodian (1994) concluded that the law of one price 2 held in the U.S. softwood lumber market. Hseu and Buongiorno (1992) examined the interrelationships between different species of softwood lumber by studying elasticities of demand of imports from Canada. They concluded that each of the six species studied (one of which was an aggregate) behaved like a distinct economic good. In general, price elasticity of substitution between species was statistically significant though small in magnitude. Hänninen (1998) examined whether the law of one price behavior could be isolated in soft sawnwood (softwood lumber) imports into the United Kingdom. Hänninen s cointegration analysis using the Johansen (1991) method did not support the law but revealed differences over the long run between the softwood lumber supplied by different countries. 2 The law of one price states that prices of homogenous commodities are equal throughout the world (or the United States in the case of Jung and Doroodian 1994) when adjusted for exchange rates and transportation costs.

4 The literature suggests that aggregate regional prices may be interrelated but prices of specific species may not. The literature also suggests that cointegration analysis may be a useful method to test the interrelationship between the hardwood lumber prices. Cointegration is especially relevant because there are no reliable estimates of hardwood lumber production and demand by species. Our approach is to test this cointegration conjecture across many species grades for higher quality hardwood lumber (grade First and Seconds or FAS and grade Number 1 Common or 1C) based on the relationships described in equation [1]. Prices of grades FAS and 1C were selected for this analysis because they seem to be more indicative of the value of timber than prices of lower quality lumber. DATA The price series used in this analysis are Appalachian lumber prices from 1953 to 1998 as reported by the Hardwood Market Report 3 for ash, black cherry, hard maple, soft maple, red oak, white oak, yellow-poplar, and black walnut. For cointegration testing, nominal prices are transformed by natural logarithm. Nominal, rather than deflated ( real ) prices were used because a deflation can impose a filtering process that can result in spurious patterns and spuriously significant relationships among variables (Schnute 1987). The logarithmic transformation is justified such that if prices of two products are initially very different but are equally affected by inflation, then they have a constant ratio over time but not a constant difference. This transformation also is appropriate for economic time series that are assumed to be logarithmically normally distributed (e.g., Engle and Granger 1987). ARE HARDWOOD LUMBER PRICES COINTEGRATED? Equation [1] was estimated using maximum likelihood techniques outlined by Johansen (1991). Results of the between-species tests of cointegration for grade FAS and 1C are shown in Tables 3 and 4, respectively. While most combinations of species were found not to be cointegrated, there were exceptions that could be explained. Red oak was found to be cointegrated with white oak and hard 3 A historic series of hardwood lumber prices (1953 to present) are maintained at the Northeastern Research Station s Forestry Sciences Laboratory at Princeton WV, under an agreement with the Hardwood Market Report, Memphis, TN. maple and soft maple were found to be cointegrated. These results were expected because red and white oak are similar in appearance as are hard and soft maple. Yellow-poplar was found to be cointegrated with ash, black cherry, red oak, white oak, and black walnut, supporting the notion that yellow-poplar is used with other species. Black walnut was found to be cointegrated with all species examined. This species historically has been the premier hardwood, particularly in high-end applications. These results suggest that the FAS prices of all other hardwood lumber might have somehow been set as a function of the price of black walnut. Many of the significant between-species cointegration statistics of 1C in Table 4 also can be explained. Red and white oaks were found to be cointegrated but hard and soft maple were not. Yellow-poplar was found to be cointegrated with five species and had a high log ratio statistic (but more than 1 cointegration equation) with soft maple. Black walnut was found to be cointegrated with all the open-grained species and yellow-poplar. Ash was found to be cointegrated with red oak, white oak, walnut, and yellow-poplar. IMPLICATIONS AND CONCLUSIONS The analysis of lumber prices for various grades of eight Appalachian hardwood species found that the many species were not cointegrated with one another and that independent markets exist for these species. However, there were some notable exceptions. Grade FAS black walnut was found to be cointegrated with FAS lumber of most other species. Mid-grade walnut was found to be cointegrated with the oaks, ash, and yellow-poplar. After black walnut, yellow-poplar had the greatest number of cointegrated relationships between species. This finding weakly supports a previous finding by Luppold (1983) that yellow-poplar is a complementary species in the production of furniture. Grade FAS yellow-poplar was cointegrated with black walnut, black cherry, and open-grained species. Grade 1C yellow-poplar was cointegrated with all species except black cherry and soft maple. In general, the oaks and other open-grained species tended to be cointegrated with one another, while closed-grained species tended to be cointegrated with little other than FAS walnut and, in several cases, yellow-poplar. The lone exception was that FAS hard and soft maples were found to be statistically related.

5 Only half of the relationships examined showed no interrelationships between species. What this means in terms of forest management is ambiguous. However, if relative hardwood lumber prices are erratic over the next 50 years, as they were over the past 50 years, then the selection of the best species for regeneration appears to be more of an act of faith than a predictable outcome. Still, the initial management premise we attempted to establish -- that forest managers should not concentrate on regenerating and managing for specific species but expend resources on maintaining stand quality for species most suited for a specific site -- might be valid. First, prices of FAS lumber are cointegrated with the species that historically has been the most valuable (black walnut). Second, previous research has shown that high-quality timber has increased in value faster than timber prices in general (Luppold and Baumgras 1995). Literature Cited Engle, R. F., and C. W. J. Granger Cointegration and error correction: representation, estimation, and testing. Econometrica 55(2): Frye, L The most popular furniture woods: the historic perspective. Wood and Wood Prod. 100(14): Frye, L. ed Wood unlimited news. April. Haynes, R An analysis of the timber situation in the United States: USDA For. Serv. Gen. Tech. Rep. RM-199. Hseu, S., and J. Buongiorno Price elasticities of substitution between species in the demand of U.S. softwood lumber imports from Canada. Can J. For. Res. 23: Johansen, S Estimation and hypothesis testing of cointegration vectors in Gaussian vector autoregressive models. Econometrica 59(6): Jung, C., and K. Doroodian The law of one price for U.S. softwood lumber: a multivariate cointegration test. For. Sci. 40(4): Luppold, W. G The effect of changes in lumber and furniture prices on wood furniture manufacturers lumber use. USDA For. Serv. Res. Pap. NE-514. Luppold, W.G., and J.E. Baumgras Price trends and relationships for red oak and yellowpoplar stumpage, sawlogs, and lumber in Ohio: Nort. J. Appl. For.P 12(4): Schnute, J Data uncertainty, model ambiguity, and model identification. Nat. Res. Mod. 2(2): Hänninen, R. A The law of one price in United Kingdom soft sawnwood imports-- a cointegration approach. For. Sci. 44(1):17-23 Uri, N. D., and R. Boyd Considerations on modeling the market for softwood lumber in the United States. For. Sci. 36(3): Table 3 - Results of cointegration analysis for grade First and Seconds Appalachian hardwood lumber Specie Black Yellow- White Red Soft Hard Black walnut poplar oak oak maple maple cherry Log ratio rank Ash c/ b/ Black cherry b/ b/ Hard maple a/ b/ Soft maple a/ Red oak c/ b/ b/ White oak b/ b/ Yellow-poplar b/ a/ Significant at the 10-percent level b/ Significant at the 5-percent level c/ Significant at the 1-percent level

6 Table 4 - Results of cointegration analysis for grade Number 1 Common Appalachian hardwood lumber Species Black Yellow- White Red Soft Hard Black walnut poplar oak oak maple maple cherry Log ratio rank Ash b/ c/ b/ b/ Black cherry b/ Hard maple Soft maple c/ a/ Red oak b/ c/ b/ White oak b/ c/ Yellow-poplar c/ a/ Significant at the 10-percent level b/ Significant at the 5-percent level c/ Significant at the 1-percent level