SOFTWOOD LUMBER: ONTARIO'S STAND

UNCLAS SECTION 01 OF 03 TORONTO 001144 SIPDIS SENSITIVE; SIPDIS PASS USTR FOR MELLE, MENDENHALL, CHANDLER E.O. 12958: N/A TAGS: ETRD PGOV CA SUBJECT: SOFTWOOD LUMBER: ONTARIO'S STAND REF: (A) OTTAWA 311 (B) VANCOUVER 358 (C) OTTAWA 172 (D) 05 TORONTO 1716 (E) TORONTO 1126 Sensitive But Unclassified -- protect accordingly. ¶1. (SBU) Summary: While major Canadian softwood industry officials are pushing the Harper government to return to the negotiating table, Ontario forestry association representatives are concerned that a negotiated settlement will prove elusive. At the same time, the Ontario government struggles to keep its softwood lumber industry alive. Despite past (and likely future) job losses and mill closures, the industry will survive in Ontario. End Summary. ¶2. (SBU) Canadian softwood lumber firms are small and have a narrow profit margin by global standards. Canadian exporters, feeling the effects of growing competition from new exporting countries, are anxious for Canada to resolve the softwood lumber trade dispute with the United States. Meanwhile, associations representing the Ontario softwood lumber industry expressed concern to us about the difficulty of achieving a lasting settlement, despite their sincere desire to put the dispute behind them. Challenges to Negotiations -------------- ¶3. (SBU) Ontario officials tell us that the difficulty of a settlement is two-pronged. First, natural resources, including softwood lumber, are under the jurisdiction of the provinces, making it impossible for the federal government to unilaterally dictate softwood lumber policy. On a positive note, as reported in ref (A),British Columbia (BC) Premier Campbell, Ontario Premier McGuinty, and Quebec Premier Charest have consulted one another and jointly approached the federal government about the elements of an acceptable agreement. Ontario forestry association reps highlighted the other difficulty in reaching a timely settlement -- they firmly believe Canadian industry should hold out to receive all of the cash deposits being held by the U.S. under the "Byrd Amendment" per recent WTO and NAFTA rulings. The association reps suggested that some of the money collected should be put aside to create a North American softwood lumber marketing board to build a stronger North American softwood lumber market in the global economy. Ontario Forestry Sector as Compared to other Provinces -------------- -------------- ¶4. (SBU) Ontario is Canada's second largest producer of softwood lumber, after British Columbia. It is second to the Province of Quebec in pulp and paper production. Ontario trees are considered small in comparison to those of other provinces, especially BC; the growing season is also shorter in Ontario than in BC. These small Ontario trees have to be moved long distances from the north to markets in the south via ground transportation. Ontario cannot compete with BC's cheap wood, which is filling the market as a result of Ontario's infestation by Mountain Pine Beetles. BC mills are much larger than Ontario mills, benefiting from economies of scale, and distances to market are much shorter than in Ontario. Ontario: We Aim to Assist, Not Subsidize Forestry Producers -------------- -------------- ¶5. (U) Ontario's forest-products industry employs some 30,000 people directly and an estimated 200,000 people indirectly, and has annual sales (including exports) of around C$27 billion. In many parts of Northern Ontario, forestry is the only economic engine; representing 75% to 85% of the tax base. In recent years, forest products have been Ontario's second largest contributor to the provincial balance of trade after the auto sector, according to the Ministry of Natural Resources' (MNR) Advisory Council on Forest Sector Competitiveness 2005 report. More than 4,000 Ontario forest industry jobs have been lost in the last year due to mill closings, in a continuing downward spiral of job losses over the years. The government has been seeking ways to help the industry overcome the challenges of the recently strengthened Canadian dollar, the emergence of lower-cost offshore softwood producers and skyrocketing Ontario electricity costs. ¶6. (U) As with other OECD countries, Canada's (including Ontario) stated policy has generally moved away from adding production capacity toward more broad-based strategic practices such as assisting research and development. TORONTO 00001144 002 OF 003 ¶7. (U) In the Ontario Government 2006 Budget, delivered on March 23 (ref (E)),provincial Finance Minister Duncan announced that, in addition to the federal government's November 2005 offer of a C$1.5 billion, five-year national program to help forest companies, workers and communities, the Ontario Government will offer its own aid package. This package consists of C$350 million in loan guarantees to stimulate new investment in plant and equipment; C$150 million in grants to encourage power co-generation, energy conservation and more value-added wood products; C$28 million annually to help fund forest access roads; C$10 million annually to fund enhanced forest resource inventories; C$5 million over five years to promote new and innovative wood products; and would streamline forestry- related regulations and approval processes. In addition to these initiatives, the Ontario Government recently announced increased funding for forest access roads from C$28 million to C$75 million per year; a one-time C$70 million refund in stumpage charges; and a three-year C$3 million annual reduction in stumpage charges for white birch and veneer- grade poplar. In addition, the Ontario Government is proposing to parallel federal tax measures to support co- generation. ¶8. (SBU) Electricity costs are higher in Ontario than almost any other jurisdiction in North America. In response to this, the Ontario Government announced a three-year extension to a proposed revenue limit on a portion of Ontario Power Generation (OPG)'s assets to help stabilize electricity costs across all industries in Ontario; electricity costs have been blamed for recent mill closures in Ontario's forestry sector (Note: OPG is owned 100% by the Province of Ontario, and produced 70% of Ontario's electricity in 2005. End Note). What These Announcements Mean -------------- ¶9. (SBU) The Ontario lumber mills that have avoided closure are highly leveraged and, without provincial loan guarantees, face great difficulty in acquiring financing from banks for needed capital investments. The loan guarantees, as well as the other government offerings, above, were recommendations in the MNR's Advisory Council on Forest Sector Competitiveness 2005 report (which contained twenty six recommendations, and have all been implemented by the Ontario Government). The Advisory Council on Forest Sector Competitiveness was led by Don Roberts, a leading forestry analyst from CIBC World Markets (ref (D)). ¶10. (SBU) The C$350 million in loan guarantees and C$150 million in grants aim to create more energy independence in the industry by promoting energy conservation and co- generation from biomass (using black liquor),a process used widely in Europe. This approach should lessen industry dependence on coal-generated electricity, and enable better use of wood fiber through better pulping techniques. ¶11. (U) Starting in May 2006, when OPG's revenue on energy produced by unregulated facilities (includes "intermediate and peaking hydro" as well as coal stations; excludes "baseload hydro" and nuclear power generators) exceeds C 4.6 cents per kilowatt hour, the province directs that OPG issue a rebate to all Ontario electricity consumers, including residential, commercial, institutional and industrial consumers. In May 2007, the revenue limit will be increased to C 4.7 cents per kilowatt hour and in 2008, to C 4.8 cents. The revenue limit differs from a price cap because OPG's generation output is bid on by distributors in the open electricity or spot market, where the price varies according to supply and demand. The total amount of the rebate will depend on the difference between the market price and the revenue limit, as well as how much output is produced by OPG's non-regulated plants. ¶12. (SBU) The C$75 million funding for forest access roads is earmarked primarily for fire access roads and roads connecting communities that do not have access to existing paved roads. These provincial forest roads are used by a variety of industries. The Ontario Government covered the cost of these roads, until former Premier Bob Rae's NDP Government downloaded them to industry in the early 1990s. ¶13. (SBU) Most of the trees harvested (88%) in Ontario are located on public or crown land, a resource managed by the provincial government on behalf of the people of Ontario. The cost of updating forest resource inventories (FRIs) was downloaded to industry by the provincial Conservative Government of former Premier Harris in the 1990s. The current Liberal Government of Premier McGuinty has set aside TORONTO 00001144 003 OF 003 C$10 million to pay for FRIs. MNR expects these inventories will be compiled through satellite images and topography, rather than through more costly labor-intensive methods. ¶14. (SBU) Ontario government officials hope that innovative value-added wood products will boost Ontario's forestry industry. They cite oriented strandboard (OSB) (a composite construction material made of poplar strands or wafers and resins, developed in the 1970s, but now used extensively in housing construction),and engineered lumber as products that could help offset the industry losses from declining demand for newsprint. Stumpage Fees -------------- ¶15. (SBU) The Ontario Government announced on February 22, 2006 that it would retroactively reduce stumpage fees for all softwood and hardwood species for 2005-6 by refunding C$70 million to the industry, and for three years, reduce stumpage charges by C$3 million annually for white birch and veneer-grade poplar located on crown land. The stumpage fee is paid by companies or individuals to the MNR for the privilege of cutting trees from public land. The stumpage fee reduction was not something that was recommended in the report from the MNR's Advisory Council on Forest Sector Competitiveness. Natural Resources Minister Ramsay hopes companies will use the capital infusion to invest in their Ontario facilities. ¶16. (SBU) Both birch and poplar trees are fast-growing and considered under-utilized species. These reductions, combined with road construction, are expected to reduce the cost of wood delivery for Ontario producers by more than C$4 per cubic meter on average over the next three years. The cost of delivering wood to mills in Ontario is about C$55 per cubic meter, compared with a worldwide average of C$35. Comment -------------- ¶17. (SBU) The province's investments have come too late for many mills, including Abitibi-Consolidated's 80 year old Kenora mill, which shut down just before Christmas, eliminating 320 unionized jobs from that remote community. The company blamed the shutdown on high production costs in Kenora, especially high electricity costs. On the other hand, top energy professionals do not expect Ontario's electricity crunch to be resolved until subsidies are replaced by full-market pricing for electricity. Critics say that reducing stumpage fees is not going to solve the industry's electricity problem, though sawmills may benefit more than paper mills because they do not consume as much energy. ¶18. (SBU) Ontario's latest forestry policy is not going to stop the inevitable closure of older, smaller Ontario sawmills. To remain competitive, Ontario producers will have to shift their focus to state-of-the-art and mega mills through mergers and acquisitions. Abitibi-Consolidated is still the fourth largest softwood lumber producer in Canada, after Canfor, West Fraser Timber and Tolko, producing 2,108 million board feet in 2005. Through consolidation and focusing on new markets, the Ontario softwood lumber industry will survive, but not without casualties. The Ontario Government believes their investments are not trade- distorting subsidies under WTO rules. However, Ontario Natural Resources Minister Ramsay's decision to reduce stumpage fees has raised suspicion among U.S. producers. TUNIS