Splendours and Risks of the Russian Timber Business

The famous tale “The Snow Queen” by Hans Christian Andersen starts from a story of a bad goblin making a devil’s mirror. Everything good that was reflected in this mirror seemed to dwindle while ugly things became conspicuous. Timber business as a magical mirror exposes peculiarities of the developing Russian market. It offers fabulous opportunities, but it is hiding many secrets and traps.

According to the official statistics Russia houses up to a quarter of the world’s total forest and a half of the world’s coniferous wood. Amount of land covered with forests is estimated at 774 mln hectares. Wood resources are 80 billion cubic metres of which 44 billion cubic metres are the mature forest ready for exploitation. Not all forest, of course, can be harvested. The amount allowed to be cut is determined by the forestry authorities and is around 500 mln cubic metres a year. Historically these figures have never been reached. These days no more than 160 – 170 mln cubic metres of timber are actually cut. It appears that potentially timber business may well be compared to the oil and gas industry.

Today Russia is exporting mostly logs and planks, raw materials with little added value. The irrationality of such an approach is obvious. Wood cutting is a difficult and, perhaps, the most economically ineffective stage in the production chain. There is no money in logs; it is in more sophisticated products.

Over 90% of all domestic timber companies are small enterprises with an aggregate market share of around 40%. Such companies can be described as those with relatively small initial investments, cheap workforce and rather voluntaristic attitude to taxation. Among the timber sold by the companies there may be some of an unclear origin.

Small unorganised producers of logs, always having cash flow problems, are a source of cheap logs for foreign traders, especially those on the Russian borders. However, there is a trend on consolidation and enlargement of timber businesses. Today nine timber and paper companies with aggregated sales over 2 billion dollars are among the largest Russian corporations. These are: «Ilim Pulp Enterprise», Syktyvkarskiy LPK, Arkhangelsk CBK, JSC ‘Volga’, Continentalinvest, Kondopoga, Svetogorsk, Solikamskbumprom, Segezhskiy CBK. Less than 10% of all companies control 60% of the market. Investments into the timber industry are growing faster than in other areas of economy.

The most vulnerable point of the Russian companies is the underdevelopment of the national market and, consequently, dependence on foreign, first of all, European buyers. This, however, may change. Russia with a population of 140 mln people is one of the most promising markets. During the last two years Russian economy has been growing at 7% per annum. The real estate prices have been growing at rate 15-20% which growth is followed by increase in demand for timber.

On the other hand the Chinese market is becoming very important. The border between China and Russia extends approximately 4,000 kilometres, from the south western Primorski Region in the Russian Far East to the Chita and Altai Regions in eastern Siberia. Timber imports from Russia to China have increased nearly 50 times in 10 years from around 350 thousand cubic metres in 1995 up to 17 mln cubic metres in 2004. According to some researchers over the next few years the demand for the Russian timber in Asia will increase dramatically. By 2025 China could be facing a deficit of 200 million cubic metres of wood every year. To satisfy the demand, China will continue looking northward to Russia, and if the current trends are maintained Russia will become the single largest supplier of wood to China.

It is now clear that exploitable forests in Russia are not that inexhaustible as it may appear from the official statistics. Most of the Russian forests can not be harvested without substantial investments into infrastructure. Today 70% of harvesting is done in the European part of Russia and the Urals. At the same time these regions house less than 30% of the resources. It sounds paradoxically but Russia may face a deficit of wood.

The eminent English historian Arnold Toynbee believed that the destiny of a nation is determined by the decisions made by the national elite. Russia to some extend depends on its timber industry, and some regions, such as Arkhangelsk or Kareliya for example, depend on the timber almost entirely. It is quite clear that the extensive way when mostly raw materials are exported is a way to where the worst antiglobalists´ dreams come true.

The Russians seems to realise that. The new forest code, which is now being debated in the State Duma, is designed to support domestic companies: a contract of forest lease is to be concluded at an auction and for a longer period of time, the concept of less control from authorities over exploitation of forest assumes responsible leaseholders. It is expected that the enlargement of the industry would reduce the amount of illegal cut and related crimes such as tax evasion and smuggling. It seems inevitable that export duties will be increasing on logs and reducing on sophisticated timber products. Despite the fact that the regulation of the forestry is deemed to be in the mutual competence of the Federation and regions, the trend is on centralisation. Regional authorities still take part in control over the local forestry but apparently they are loosing influence. The legislator’s idea perhaps is to establish a uniform regulation of the forestry all over Russia and, at the end of the day, to restrict local corruption.

It can be expected, therefore, that in the near future the timber industry may face remarkable changes. Small producers may be forced out of the business and resources to be shared between vertically integrated companies.

It may put foreign traders in the position of a difficult choice. On one hand they may decide to exploit the opportunities and expand on the market. Currently less than 1% of Russian timber companies owned or controlled by foreign enterprises have 25% of the market. Paradoxically the course of events is favourable, first of all, to foreign companies. Despite the growing domestic market and appearance of very promising Asian markets, distribution will remain the weakest point for the Russian companies. Growing domestic producers have a great appetite for know / how in timber processing, development of construction materials, furniture, frame houses, and that is again the great opportunities for foreigners. Assistance from such institutions as EBRD, specialised funds or export credit agencies allows western companies to enter the Russian market with relatively small own investment. On the other hand, reluctant to invest into this no doubt difficult market, they may soon find themselves in a position of rivalry for resources with a consolidated group of local enterprises, backed by the state.

Autumn, 2005