Hancock Timberland Investor

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1 Hancock Timberland Investor First Quarter 2007 The Potential Impact of Russian Log Export Taxes on Pacific Rim Log Markets On February 5, 2007, the government of Russia announced it would begin a stepped increase in log export taxes over a period of two years as part of its new Forestry Code. With Russia supplying an estimated 70 percent of the Pacific Rim demand for logs, export duties as proposed could have a significant impact on log supply and pricing in markets that rely on Russian logs. The available supply of softwood timber in the Russian Far East is estimated to be more than double the volume typically harvested each year. Additionally, to date, only a fraction of these harvested logs have been processed into secondary products in Russia. Most logs are exported in raw form to the Pacific Rim and Europe where remanufacturing of secondary processing (sawnwood, plywood, furniture, pulp and paper products) and the re-export of those products to other countries, has rapidly expanded. Hence, the export tariff, designed to encourage foreign investment in processing Russian logs inside Russia by raising the cost of Russian logs outside Russian boarders. Million Cubic Meters Chart 1: Sources of Softwood Logs to Primary Pacific Rim Import Markets 20 Russia North America New Zealand Other 18 Source: FAOSTAT, NZMAF China Japan South Korea Russia as a Log Supplier Almost 45 percent of the global trade in softwood logs is supplied by Russia. The main importers of Russian softwood logs are countries in Europe and the Pacific Rim. The principal importers of softwood sawlogs in the Pacific Rim are China, Japan and South Korea. Russian softwood sawlogs account for over 90 percent of the Chinese market, over 40 percent of the Japanese market and almost 30 percent of the Korean market. The other significant suppliers of softwood sawlogs are the U.S. West Coast and New Zealand. (See Chart 1). By far the largest market for Russian softwood logs is China. Russian pine and larch logs are extensively used in construction applications such as scaffolding and concrete forms, along with residential uses such as wood doors and window frames. Almost two-thirds of the logs from Russia destined for China pass through the gateway cities of Manzhouli and Suifenhe in Northern China for primary processing. A reported 460 sawmills and timber processors have set up shop in these two locations alone. The second largest Asian market for Russian softwood logs is Japan, importing approximately 4.6 million cubic meters of larch, pine and spruce. An estimated 80 percent of these logs are used in the production of plywood. (Continued on page 2) Hancock Timber Resource Group First Quarter 2007

2 The Potential Impact of Russian Log Export Taxes on Pacific Rim Log Markets (Continued from page 1) The third largest market for softwood log exports from Russia is South Korea. Over time, a gradual substitution of softwood for previously used tropical hardwood in the South Korean plywood industry has occurred. In doing so, South Korea has become a significant importer of softwood logs. The New Tax In early February, the Russian government announced a log export tax schedule, structured as a gradual, stair-step approach over the next two years. As proposed, softwood log export taxes would increase from a January 2007 level of a minimum 6.0 per cubic meter, or 6.5 percent of declared value, to a minimum of 10.0 per cubic meter or 20 percent of declared value on July 1, The Russian government has proposed to further increase softwood log export taxes to a minimum of 15.0 per cubic meter or 25 percent of declared value on April 1, 2008, and finally a minimum of 50.0 per cubic meter or 80 percent of declared value on January 1, If implemented, it is the last increase that could render much of the industry based on Russian logs uncompetitive in the global marketplace. Who are the winners and losers? With a 70 percent market share, it is likely that the delivered cost for industrial grade logs from Russia generally set the market price for these logs in the Pacific Rim region. This marks a departure from the past when softwood log exports from the U.S West Coast generally set the market due to the dominant position of Japan as the end market for softwood logs, and the dominant position of the U.S. Pacific US$ per cubic meter Table 1: Proposed Russian Log Export Tax Schedule Tax* Percent / Minimum /m3 January All logs except aspen and birch July Softwood Logs Hardwood Logs Aspen Logs April Softwood Logs Hardwood Logs Aspen Logs January Softwood Logs Hardwood Logs Aspen Logs * tax based on the value of the timber at the Russian boarder Northwest as the principal supplier to Japan. Included in Chart 2 are softwood log costs delivered into Japan from the U.S. Pacific Northwest, New Zealand and Russia, and softwood log prices in China delivered from Russia and New Zealand. Over the last four years, prior to an export tax, Russian log prices Chart 2: Pacific Rim Softwood Sawlog Prices $350 $250 $150 $50 Source: RISI, HTRG Research Note: Prices in Japan are wholesale log prices at the mill. Prices in China are CIF steadily climbed as demand for imported logs in the Pacific Rim increased. With these higher log prices came large profits for Russian log exporters, spurring expansion of log export volumes. From 2002 to 2006, log exports out of Russia grew over 35 percent. For other log exporters in the Pacific Rim, Russian log prices have set the Russian Larch in Japan NZ Radiata in Japan NZ Radiata in China US PNW Hemlock in Japan US PNW Douglas-fir in Japan Russian Larch in China Potential prices with export tax Jan- Jul- Apr- Jan (Continued on page 6) Hancock Timber Resource Group First Quarter

3 Quarterly Average Regional Composite Prices for Softwood Sawtimber Stumpage (U.S.$ per MBF) $1,000 $900 $800 $700 U.S. Pacific Northwest Export New Zealand Export U.S. Northeast U.S. Pacific Northwest Domestic U.S. South Figure 1. Softwood Sawtimber Stumpage Prices Sawtimber prices in the U.S. were down first quarter from first quarter levels last year, as weakness in housing-related wood products demand continued. Demand for timber in the Pacific Rim notably Japan and China continued strong first quarter, raising U.S. dollar prices for Douglas-fir and hemlock in the US Pacific Northwest and radiata pine in New Zealand. Sources: Log Lines, Timber Mart-South, New Zealand Ministry of Forestry and HTRG Analysis Quarterly Average Prices for U.S. South Lumber and Sawlogs ($ per MBF lumber scale) Southern Pine Saw Logs Southern Pine (Westside), Kiln Dried, 2x4 #2, Random Length Lumber Southern Pine Chip-N-Saw Logs Figure 2. Lumber and Sawlog Prices in the U.S. South Southern pine lumber production continued at all-time highs, despite first quarter curtailments in some locations in the U.S. South. Declines in production have lagged the slowdown in housing demand, resulting in severe drops in lumber pricing. Southern pine chip-nsaw delivered log prices continue to take a hit during the slump in housing demand with prices first quarter not holding up as well as the larger size sawlogs. Sources: Random Lengths and Timber Mart-South Quarterly Average Prices for U.S. Pacific Northwest Lumber and Sawlogs ($ per MBF - lumber scale) Douglas Fir, Green 2x4 Lumber Hem-Fir (Coast), Kiln Dried, 2x4 Lumber Douglas-fir Sawlog Whitewood Sawlog Sources: Random Lengths and Log Lines Figure 3. Lumber and Sawlog Prices in the U.S. Pacific Northwest Prices for lumber in the U.S. Pacific Northwest continued correcting downward, with Douglas-fir green 2x4s off 24 percent from 2006 first quarter levels. Hemlock lumber is priced at similar discounts compared to last year, with prices for kiln dried 2x4s down to $259 per MBF, a 26 percent drop from year-ago levels. Delivered sawlogs continue to find shelter from the full effects of the weaknesses in lumber prices, as timber prices are buffered by narrowing lumber manufactures margins. Still, Douglas-fir domestic logs were off 5.0 percent from last year. Hemlock logs remain flat. Hancock Timber Resource Group First Quarter

4 Quarterly Average Regional Composite Prices Softwood Pulpwood Stumpage ($ per ton) $40 $35 $30 $25 $20 $15 $10 U.S. Pacific Northwest U.S. Northeast U.S. South Figure 4. Softwood Pulpwood Stumpage Prices Constrained supply drove softwood pulpwood prices up in the South, as generally wet weather limited logging and lower production of lumber reduced residual chip supply available for pulp and paper mills in the region. Lumber production declines effected softwood pulplog prices in the US Pacific Northwest as well, keeping prices at historically high levels. $5 -$5 Sources: Log Lines, Timber Mart-South and HTRG analysis -$10 Quarterly Average Prices for Market Pulp ($ per metric ton) and U.S. Pulp Logs ($ per 10 tons) $900 $800 NBSK Market Price $700 Douglas-fir Pulp Logs Southern Pine Pulp Logs Sources: FOEX Industries Ltd., Log Lines and Timber Mart-South Figure 5. Market Pulp and U.S. Pulp Log Prices The price for market pulp, as measured here by the FOEX index for Northern Bleached Softwood Kraft (NBSK) rose again for the seventh consecutive quarter, reaching $760 per metric ton, a high not reached for nearly a decade. Delivered pulpwood prices first quarter were up slightly in the US South and down in the US Pacific Northwest from the prior quarter, yet both up by $10 per ton over first quarter last year. Quarterly U.S. Timberland Values ($ per acre) $2,500 U.S. Pacific Northwest $2,000 $1,500 U.S. South $1,000 Source: NCREIF Q1 Q1 Q1 Figure 6. U.S. Timberland Values in Private Property Markets As timberland appraisals most often occur in the second and fourth quarters of the year, first quarter timberland values as reported by NCREIF should be used with some caution. With this in mind, US Pacific Northwest timberland values were unchanged from last quarter. In the U.S. South, timberland values increased by $35 per acre from last quarter levels. A rise not unexpected, as the ex-international Paper properties, all in the US South, were submitted to the NCREIF Timberland Property Index for the first time this quarter, adding $3.7 billion to the Index. Hancock Timber Resource Group First Quarter

5 Quarterly EBITDDA Multiples for Privately Traded Timberland (trailing 4-quarter EBITDDA) U.S. South Figure 7. U.S. Timberland Valuation Multiples in Private Property Markets Price-to-earnings multiples in both the US South and Pacific Northwest rose first quarter. Timber income was down in both regions first quarter as compared to income levels first quarter last year. Therefore, the current rise in timberland values in the South and the historically high timberland values in the Pacific Northwest, pushed up multiples again for the quarter. 10 U.S. Pacific Northwest 5 Sources: NCREIF and HTRG Research Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Monthly Securitized Timberland Share Value (Indexed to 100 at start date) Rayonier Crown Pacific Timberwest The Timber Company Plum Creek Deltic U.S. Timberlands Figure 8. Hancock Securitized Timberland Index Share prices for public timber-focused companies moved up-and-down slightly throughout the quarter, but on average, were similar to last quarter, resulting in little movement in the overall Securitized Index Index Source: HTRG Research 0 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Quarterly U.S. South Timberland Values ($ per acre) $1,400 $1,200 $1,000 $800 Private Property Market Public Equity Market Figure 9. U.S. South Timberland Values in Public Equity and Private Property Markets Southern timberland values in public and private markets moved in opposite directions first quarter. Lower log and manufactured wood product prices kept results for Plum Creek the major driver of our public timberland market sample down slightly compared to last quarter, pulling public timberland values down by $34 per acre. Private timberland values, as measured by the NCREIF Timberland Property Index, rose to $1,295 per acre. Sources: NCREIF and HTRG Research Hancock Timber Resource Group First Quarter

6 The Potential Impact of Russian Log Export Taxes on Pacific Rim Log Markets (Continued from page 2 price floor. Prior to the first export tax on logs exported from Russia at the start of this year, New Zealand radiata competed head-to-head with Russian larch. If fully implemented, Russia s new export taxes are expected to constrain export volumes, and further increase the cost of products produced from Russian logs. This would raise the floor price for log exports to the Pacific Rim. Importers are evaluating the full effect of the tax increases, and alternatives. For instance, in Japan, plywood manufactures must weigh the option of converting to the use of currently higher-cost U.S. Pacific Northwest Douglas-fir or hemlock, or New Zealand radiata pine as raw material costs evolve. While it is too early to identify market winners and losers, increasing Russian softwood log export taxes is already changing the dynamics of the Pacific Rim Research Team Courtland L. Washburn, Ph.D Managing Director and Chief Investment Officer cwashburn@hnrg.com Robert W. Hagler Director of International Investment Strategies & Economic Research bhagler@hnrg.com Mary Ellen Aronow Senior Forest Economist maronow@hnrg.com Hancock Timber Resource Group is a division of Hancock Natural Resource Group, Inc., a registered investment advisor and wholly owned subsidiary of Manulife Financial Corporation. softwood sawlog market. Pending price increases have renewed interest in whitewood (hemlock/fir) exports from the U.S. Pacific Northwest and British Columbia, increased demand for industrial grade radiata pine logs from New Zealand and Australia, and opened the door for alterative markets for pruned radiata pine from New Zealand, Australia and Chile throughout the Pacific Rim region. This piece is taken in part from our larger report entitled The Potential Impact of Russian Log Export Taxes on Pacific Rim Log Markets. NOTES: Figure 1. The composite price for southern sawtimber is based on quarterly average Timber Mart-South published prices for pine sawtimber and chip-n-saw stumpage. Pacific Northwest prices are derived from quarterly average Log Lines published prices for whitewoods and Douglas-fir with internal analysis of logging costs for stumpage calculations. New Zealand export prices are based on New Zealand Ministry of Forestry quarterly average published prices for radiata unpruned A, J, and K sort export logs with internal analysis of logging costs for stumpage calculations. Northeast sawtimber prices are calculated from internal analysis. Figure 2. Quarterly southern pine (Westside), kiln dried, 2x4 #2 lumber price published by Random Lengths. Timber Mart-South published southern pine sawlog and chip-n-saw log prices converted to lumber scale using RISI historical lumber recovery rates as published in their North American Lumber Forecast. Figure 3. Quarterly Douglas-fir, green 2x4 lumber (Portland rate) and Hem-Fir (coast), kiln dried, 2x4 lumber prices published by Random Lengths. Douglas-fir and whitewood sawlog prices derived from Log Lines published priced for #2 and #3 sawlogs in various regions in the Pacific Northwest converted to lumber scale using RISI historical lumber recovery rates as published in their North American Lumber Forecast. Figure 4. Pulpwood composite prices are derived from quarterly average Timber Mart-South published prices for southern pine pulpwood stumpage, Log Lines published whitewood and Douglas-fir pulp logs with internal analysis of logging costs for the Pacific Northwest, and HTRG analysis of spruce/fir pulpwood in the Northeast. Figure 5. Quarterly NBSK pulp priced derived from daily list prices reported by FOEX industries Ltd. Southern pine pulp log prices published by Timber Mart-South. Pacific Northwest Douglas-fir pulp log prices published by Log Lines. Pulp log prices expressed in multiples of 10 to accommodate market pulp pricing scale. Figure 6. Regional NCREIF timberland market value per acre is derived by dividing the total regional market value at quarter end by the number of acres reported in that region. Figure 7. EBITDDA multiples are calculated using NCREIF timberland value per acre at quarter end divided by trailing four-quarter average NCREIF net income per acre. Figure 8. The Hancock Securitized Timberland Index (HSTI) uses a base-weighted aggregate methodology (similar to that used to construct the S&P 500) to calculate a market capitalization-weighted value for seven publicly traded timber-intensive forest products companies. Base weights were adjusted for the emergence of new companies or at the beginning of each year. Dividends are not reinvested. The companies included in the HSTI have no investment relationship with Hancock Timber Resource Group. Figure 9. Public equity values are derived from our Timberland Enterprise Value per Southern Equivalent Acre (TEV/SEA) calculation for five timber-intensive publicly traded companies as compared to southern timberland values per acre calculated from the NCREIF database. TEV is a quarterly estimate based on total enterprise value (total market equity + book value debt) less estimated value of processing facilities, other non-timber assets and non-enterprise working capital. SEA uses regional NCREIF $/acre values to translate a company s timberland holdings in various regions to the area of southern timberland that would have an equivalent market value. Hancock Natural Resource Group, Inc. References to expected investment performance in this newsletter are based on historical information and are based on managements projections. Potential for profit as well as for loss exists. Hancock Timber Resource Group First Quarter