Quarterly Economic and Revenue Forecasts
UPDATED: February 13, 2019
This quarterly forecast includes our analysis of current economic conditions and our objective projections of future revenue for state trust funds and their beneficiaries.
For Economic and Revenue Forecasts from 2013 and prior years, contact the Office of Budget and Economics by phone at 360-902-1730, by fax at 360-902-1775, or by email at firstname.lastname@example.org.
February 13, 2019
Lumber and Log Prices. Lumber prices in 2017 increased through the year from $350/mbf to $490/mbf, averaging $425/mbf for the year -- significantly higher than previous years and the highest prices in real terms since the height of the previous housing boom in 2005. Prices continued to increase through the first half of 2018, averaging $569/mbf through July, peaking at $635 before dropping markedly to $324/mbf in November. Prices since increased to $340 in December, suggesting that November may have been the nadir.
Prices for the "typical" DNR log were also markedly higher in 2017 than previous years, climbing from $578/mbf in January to $719/mbf in December, averaging $611/mbf for the year. Prices for DNR logs increased in the first quarter of 2018, averaging $722/mbf, before falling slightly in the second quarter to average $706/mbf. Prices have fallen markedly since peaking at $700/mbf in July, to $519/mbf in December. Unlike lumber prices, it appears that the bottom was not reached in November.
Log and lumber prices were expected to weaken in the final two quarters of 2018, but they were still expected to stay above recent years' averages, before climbing back to near early-2018 levels in early 2019. That is, obviously, no longer the case. The steepness of the price decline was surprising and appears to be due to a confluence of a number of factors that undermined upward pressure. As discussed in the main forecast, throughout the latter half of 2018 housing starts stalled, house prices growth flattened (and declined in some areas, like Seattle), and lumber mills built significant inventories of both logs and lumber. The updated forecast for prices suggests that prices will recover from their current lows in 2019, and will average something close to 2017 prices. Prices are expected to continue increasing through mid-2021, though they are not expected to approach the highs seen in 2018.
Timber Sales Volume. FY 18 sales volume ended at 496 mmbf, slightly above the June forecast. Sales plans in the current and outlying years have not changed, so absent a new sustainable harvest calculation, sales volume forecasts remain at 500 mmbf. Unfortunately, with the drop in timber and lumber prices and the weak demand, a number of DNR's recent contracts have been passed over at auction with no bidders. It is DNR's intention to bring more than 500 mmbf to auction in FY 19, however, given the number of contracts with no bidders, 500 mmbf was determined to be a reasonable estimate of what will actually sell.
Timber Sales Prices. Auction prices for FY 18 totaled $458/mbf, well above the FY 17 average of $346/mbf. The sales price forecast for FY 19 was increased to $370/mbf in the September forecast, due to the strong prices in the first half of 2018 that were forecast to wane, but not collapse. This was pulled back to $360 in November, which was still achievable given the sales to-date available for the November forecast. Given the weakness in sales to-date, the stumpage price is further reduced in this forecast to $350. The sales price forecasts for outlying years are unchanged at $340/mbf despite expectations for increases in log prices. This is because there are a number of risks to house prices and the broader economy that could adversely affect log and stumpage prices.
Timber Removal Volume and Prices. Harvest volume forecast are altered significantly. Timber removals for FY 19 are reduced by 30 mmbf to 520 mmbf because harvests to-date have been much lower than expected. It is still possible that harvests will rebound; harvests in the first six months of FY 18 looked very similar to what we've seen in FY 19, but then picked up markedly in the latter six months. However, the market situation is expected to be much different this year, with prices increasing much more slowly and much weaker housing starts.
The volume not harvested in FY 19 is essentially pushed out to outlying years.
Timber removal prices for FY 19 are decreased to $373/mbf, due in part to the decreased price expectations as well as an increased proportion of the harvest to-date being lower priced timber. Prices in outlying years are not meaningfully changed. These removal prices reflect changes in both the sales prices and removal timing.
Timber Revenue. The changes to the timber sales price in FY 19 has meaningfully reduced projected revenue in FYs 20 and 21. Revenues for the 2017-2019 biennium are forecast to total $396 million, an increase of 0.1 percent (less than $1 million) from September's forecast. Forecast revenues for the 2019-2021 biennium are decreased by 1.2 percent ($5 million) to $396 million.
Non-Timber Revenues. In addition to revenue from timber removals on state-managed lands, DNR also generates sizable revenues from managing leases on uplands and aquatic lands.
The non-timber uplands revenue forecast for FY 19 is increased by $1 million due to higher than expected revenues in irrigated agriculture, and orchards and vineyards. These increases have offset a small decrease in commercial leases due to maintenance costs. Non-timber uplands sources in all other years are unchanged.
Aquatic lease revenues in FY 19 are increased slightly, with a better outlook in water- and non-water-dependent leases outweighing a small decrease in other aquatic leases. Outlying years are increased due to increased expectations for non-water-dependent leases.
FY 19 geoduck revenue is decreased in all years due to an update price forecast reflecting recent price weakness. This price weakness appears to be due largely to the tariffs China implemented in mid-2018 and may disappear if the tariffs are lifted.
Total Revenues. Total revenues for the 2017-2019 Biennium (FYs 18-19) are decreased by 4.1 percent ($23 million) to $526 million. Revenues for the 2019-2021 Biennium (FYs 20 and 21) are essentially unchanged at $539 million.
Notes to the Forecast. There are a number of sources of significant uncertainty for DNR revenue and the overall economic activity. These include DNR-specific issues, such as the as-yet undetermined sustainable harvest volume, as well as broader economic issues including the trade difficulties with China, a slowdown in Chinese economic growth, a recent slowdown in the housing market and significant political uncertainty surrounding the U.S. Federal Government.
While the sales volume estimates are based on the best available internal planning data, they are subject to adjustments due to ongoing operational and policy issues. In particular, these issues are likely to affect sales volumes in outlying years, where the assumed sustainable harvest volume of 500 mmbf might be too high.
The most concerning factor in this forecast, and likely for forecasts in the near future, is the combined problem of the slowdown in housing construction and the decreasing exports to China.
Chinese imports of U.S. logs and lumber started in meaningful amounts in 2010 and provided support to prices in the worst years following the Recession in 2008-09, when housing construction was very low. However, Chinese imports have dropped dramatically since 2014. While Chinese demand has been dropping, domestic housing demand has been picking up speed and seems to have more than offset the decrease in China-bound exports. Indeed, it appears that the strong log and lumber price growth from 2017 and the beginning of 2018 was due largely to housing construction, but that housing construction growth has stalled.
In August, China proposed another round of tariffs in response to new U.S. tariffs. Currently these proposed tariffs include hardwood logs and products and some softwood products, though not softwood logs. These tariffs will likely undermine the domestic price of logs and will put pressure on processing industries. These are on top of tariffs announced in June 2018 on U.S. goods that included both agricultural products and geoducks, both of which are significant DNR-managed asset classes. Although it is not yet clear that these tariffs have affected timber revenues, though it is likely, it does appear that the tariffs have affected geoduck prices and therefore revenues.
China is still a major market for Washington timber and lumber, and the demand drop represents a continuing downside risk for the forecast. Aside from the trade tensions discussed above, other things could undermine Chinese demand, such as a further slowdown in Chinese economic growth or continued loss of Pacific Northest market share to international and Southeastern U.S. competitors.
Continued growth in domestic housing demand was expected to offset the continued decline in China-bound exports. If housing construction does not resume its growth, as optimistic analysts have forecast, and Chinese exports continuing to decline, then log and lumber prices will not recover and could continue to fall, in which case even our conservative current stumpage forcast may be optimistic.
A potentially major concern for the overall U.S. economy, which would affect DNR revenue, is the continued political uncertainty surrounding the U.S. Federal Government. The government was recently shut down from December 22, 2018, to January 25, 2019, the second federal government shutdown of the current U.S. administration. Although the shutdown itself is likey to only meaningfully negativly affect GDP growth in the first quarter of 2019, it is a presage to more uncertainty. Particularly because the deal to open the government only lasts until February 15 and the U.S. administration has expressed a willingness to shut down the government again if the two leading parties are not able to come to a budget agreement.
The Congressional Budget Office estimated that the cost of the shutdown was around $11 billion in lost GDP revenue, all but $3 billion of which will likely be recovered. That is an insignificant amount compared to the overall size of the U.S. economy. However, if the government were to shut down again, the impacts are likely to be non-linear -- that is, they may be small while a shutdown is short, but may grow substantially as it progresses or it is repeated.
During the shutdown, there were reports of businesses facing delays in getting license approval, decisions about regulations, import licenses or approval for new products. These delays were cleared up quickly after the shutdown ended, but the losses and uncertainty that the shutdowns cause could grow dramatically if they start affecting businesses cash flows.
The direct impact of the shutdown on DNR will mostly come from the affect on the housing market, potentially delaying the expected recovery in the first quarter of 2019. Single-family home loans through the FHA and all types of VA loans were still funded through the shutdown, though potentially with delays, while some other types of FHA loans were not processed. Most conventional mortgages are not backed by the federal government and were processed as usual, though tax transcript processing at the IRS was disturbed and caused delays in application processing.
To be clear, in the end, the effects of the Federal Government shutdown were likely minimal and were likely insignificant compared to the size of the economy. However, shutdowns cause meaningful instability in an economy and could have significant unforseen impacts if they happen too often.
An additional negative impact of the shutdown is that it has delayed release of important economic data. For instance, data on new houses sold and months supply of housing was only recently updated to November. This delay in economic data makes it more difficult to get a grasp of whether the apparent weakness in the housing market was a seasonal blip or something that is becoming a stronger trend.
If the current malaise of the housing market is only temporary, a meaningful recovery in construction would offer some upside potential to this forecast. Unfortunately, there are a number of significant impediments, on both the supply and demand sides, to a strong recovery in prices and starts. Constraints on demand include persistently stringent lending standards, a continued tough labor market for younger workers, enormous student loan debt, poor wage growth, and, now, increasing interest rates. It has been surprising how high prices have risen given these constraints. Additional, supply side impediments constraining construction growth include a lack of skilled labor or readily buildable land.
Since the expiration of the Softwood Lumber Agreement (SLA) in late 2015, the U.S. and Canada have been without a trade agreement that covers lumber. As of late 2017 a U.S. ITC finding cleared the Department of Commerce to impose duties, which have been set at 20.23 percent. Although Canada has appealed the finding to a NAFTA panel and has filed a complaint with the WTO, much of the short-term uncertainty about trade costs is gone. Without a breakthrough on the new SLA negotiations or a finding from the WTO or NAFTA panel, the markets are unlikely to see the price volatility that the previous duty uncertainty caused. Additionally, at current lumber prices, the duties shouldn't be significant enough to reduce Canadian production.
Aside from the tariffs pushing down geoduck prices, which they appear to have done, China has twice instituted bans on Pacific Northwest shellfish on food safety grounds -- paralytic shellfish poison (PSP) and arsenic contamination. It's not clear that either of these bans significantly affected prices or harvest activity. However, it is entirely possible that China could re-enact a more forceful ban on geoduck that would have a dramatic effect on geoduck prices, and therefore revenue.
As always in the geoduck fisheries, PSP closures create uncertainty around harvest volumes as well.
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