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Competition and Capacity to Pay

September 10, 2014
Author: Stan Parton

Every market participant has a different capacity to pay - the highest price a facility can pay for wood raw material and continue operating at a profit. Determined by the quantity of wood raw material a facility needs to produce a finished product and the price at which that finished product can be sold, this concept can impact the supply available to a facility.

A significant portion of wood raw material received at a mill is “lost” in the manufacturing process. Depending on the finished product, bark loss can be as high as 15 percent, while moisture and processing loss can be in the 33 to 55 percent range. Lumber mills also “lose weight” in a milling process that turns round logs into square lumber.

This “yield loss” affects all forest products manufacturers and has a multiplying effect on the cost of goods sold. The inverse of yield loss is conversion factor, which can range from a low of two to five tons of ‘bark-on’ logs to one ton of finished goods. 

In sustained periods of constrained supply, the demand source(s) with the highest capacity to pay will receive the available supply. As such, it is important for new market entrants to understand a local market’s capacity to pay when evaluating the feedstock risk for new facilities. 

Take a hypothetical local market with no excess wood and four sources of demand, each consuming 250,000 tons of the 1,000,000 tons of sustainable supply. Each competitor can pay up to $50, $100, $150, and $200, respectively. Scenarios for potential market entrants include:

  • A new market entrant that can pay only $35 per green short ton will be priced out of the market and should build elsewhere.
  • A new market entrant with a consumption requirement of 250,000 tons should be prepared to pay, on average, $50 per ton.
  • Assuming all four competitors are willing to pay up to their capacity, a new market entrant with a consumption requirement of 1,000,000 tons should have a capacity to pay in excess of $125 per ton.

These examples illustrate that capacity to pay, along with the sustainably harvestable volume of a wood basin, should be considered when calculating supply availability.

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