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.


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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

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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