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The new oil? Wood fuel makes a quiet comeback

As investments go, wood has not been pretty over the past decade or so. That's actually a massive understatement. Wood fell out of the ugly tree and hit every branch on the way down.

While the great commodity boom multiplied the price of most resources, wood is flat to down depending on the yardstick.

The history books herald good news, though: Bear markets in the forest generally lead to amazing gains. Over the past century, these recoveries have leaned toward total average returns of 100 per cent.

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Wood has begun to recover recently, but there's a long way to go: Since 1900, the shortest recovery from a bad downturn in the forest is 12 years. The next upswing has great promise.

In fact, wood could be the new oil , and I say that for two reasons: The first is that it may be on the verge of a big move similar to oil's trajectory from $20 (U.S.) to $150 a barrel.

And the second, which will contribute to the first, is that wood is literally going to become – or resume its role as – a source of energy.

There are lots of reasons to be bullish on wood, most of which – demand in China, which has changed its building code in favour of lumber, for example – are not exactly well-kept secrets.

But there's also a stealthy factor that makes wood look even better: biomass. For millennia, before we discovered the virtues of fossil fuels, we used wood for energy. Because fossil fuels are cheaper to extract and have more energy per unit, wood fuel use disappeared.

It's now staging a quiet comeback, thanks to environmental regulations.

In Europe, for example, wood is used increasingly to feed power plants. The European Union has a mandate of getting 20 per cent of its energy needs from renewable sources within eight years. Other stats:

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-Rio Tinto Alcan faces a tough choice at its smelter in Lynemouth, England. The smelter has a very efficient 420 megawatt power station that runs on coal. New environmental rules will increase the cost of firing the plant with fossil fuels to unsustainable levels so Rio Tinto is planning to switch to biomass. The company is test-firing wood pellets with encouraging results.

-North Yorkshire-based Drax, the biggest coal plant in Britain, burned a million tonnes of biomass last year, twice the amount of previous years and about 10 per cent of its coal consumption. Other plants are also increasing their use of wood pellets.

-U.K. wood fuel production is only 1.5 million tonnes so imports will have to play a role.

-Three years ago the EU's biomass use provided 80 million tons of oil equivalents, according to Wood Resources International. By 2020 it could reach almost twice that. As that biomass is largely derived from wood chips, that means a lot more demand for trees.

-Germany's goal of getting out of nuclear in favour of renewables also adds momentum. And it's not just the Europeans. Asia is also starting to clamour for biomass. South Korea is calling for a 30-per-cent reduction in greenhouse gases and increasing its use of wood pellets from next to nothing to five million tons over the next decade.

The pace of change in North America is slower, but accelerating. New York and Connecticut are considering the sale of smaller plants to firms who intend to convert them to wood fuel.

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All this points to rapidly rising biomass demand, and wood pellets are among the most competitive sources of biomass.

In fact, there's now a wood chip price index, which will help increase trading in the commodity, which already stands at 80 million tons a year, or more than $10-billion worth. Wood fuel users are already starting to compete with lumber and pulp and paper for supply.

So the thesis is that forests are becoming more valuable, and not just to build houses in China.

How does the investor benefit? Companies that own or have rights to forests should do well. A lumber company, for example, has more potential customers and its tree waste, which has historically been bought by now-shrinking paper makers, has a new market.

Those who don't own trees will suffer.

If you agree with the thesis, do what I'm doing: Look for names that are positioned to prosper in the next wood bull market and avoid those that will get hurt.

This is an early-stage, long-term idea and it has its risks. But as trees go back to their roots, so to speak, there's money to be made.

Fabrice Taylor publishes The President's Club investment newsletter, focusing on off-the-radar small to mid-cap companies trading at a discount to net asset value. His letter and The Globe and Mail have a distribution agreement. He can be reached at fabrice.taylor@gmail.com.

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More

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