|ETF||% Producers||Expense Ratio||Daily volume||Close 9/17/09|
Even given my cursory analysis of each fund’s holdings, WOOD stands out as clearly superior to CUT for investors interested in a Forestry ETF as an investment in Biomass, because of the significantly higher exposure to producers than consumers. CUT does have better liquidity, but that hardly makes up for the lower expense ratio of WOOD, and high exposure to wood consumers.
Even the 60% exposure of WOOD to biomass producers is not enough so that I think these funds are a good way to invest in the sector. It would be theoretically possible to get exposure just to producers by going long WOOD and shorting CUT, but such theories tend to work a lot better in theory than in practice.
Hence, I feel the best approach to get exposure to wood producers is with individual stocks. Most of the holdings of these two funds are international, but there are still a few US-listed ones. With the caveat that I have not researched any of these companies, here are the US-traded holdings of the two funds that seem to be mostly wood and pulp producers, as opposed to biomass consumers:
|Company/Ticker||% of WOOD||% of CUT||Notes|
|Aracruz Celulose S.A.(ARA)||4.73%||4.97%||Brazilian wood pulp producer|
|Plum Creek Timber Co. Inc. (PCL)||5.55%||2.24%||US Timber REIT; in DJ Sustainability index|
|Potlatch Corp (PCH)||6.5%||1.35%||US Timber REIT; Forests are FSC certified|
While a portfolio of only three stocks is not very diversified, few investors are likely to commit more than 10% of their portfolio to forestry, and devoting 3% or less of your portfolio to a single company should bring adequate diversification. The loss of global exposure (the ETFs contain several Japanese and European companies as we
ll as US and Brazilian ones), but this loss seems worth avoiding significant exposure to an industry (paper and packaging) with a significant input (pulp) that we expect to become more expensive due to competing uses.
Just as farmers are now benefiting from higher corn and soy prices because of the production of ethanol and biodiesel, it seems fairly certain that timber companies will benefit from higher prices for both lumber and previously unused slash. Nevertheless, there remains a question of when. Cellulosic ethanol plants are still in the pilot stage, with not nearly enough being produced to make a difference to the forestry industry’s revenue. In contrast, cofiring wood and using it for heat are both established industries. At the moment, however, these uses for wood tend to be driven by the prices of alternative fuels (coal and heating oil), and not by reduced carbon emissions.
Although forest waste and sawdust can be practically free at the source, the cost of gathering and transport often means that they are nearly as expensive as the alternatives at the point of use. In order for the industry to overcome the logistical barriers, a price on carbon emissions is probably necessary. For US investors considering Plum Creek or Potlatch, it probably makes sense to wait until we see action from the US on climate change before investing.
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The problem with using wood for transportation fuel is the same as using wood pellets for firing thermal generation: at sustainable harvest levels, US forests can yield about 5 quads per year, which is equivalent to the energy currently stored in the Strategic Petroleum Reserve.
According to Wikipedia:
“As of August 31st, 2009, the current inventory [of the Strategic Petroleum Reserve] was 724 million barrels (115,100,000 m3). This equates to 34 days of oil at current daily US consumption levels of 21 million barrels a day.”
In other words, if wood-based cellulosic ethanol was the only user of wood residue and did not have to compete with pellets and other uses, it could offset about 1 month of gasoline consumption per year.
I believe that cellulosic biofuels based on woody feedstock is a no-go, at least in a North American context. There may be Brazilian and Australian eucalyptus growers that can make this work out due to much shorter periods to bring trees to maturity. But as far as I understand it other feedstocks probably have greater potential.
The other thing to keep in mind of course is percentage of revenue or profit. Even if some of these firms get into biomass-for-fuel, will that part of their business be needle-moving? An investor needs to make sure that they understand other dynamics that, for the time being, have a far greater impact on the stocks of these companies than biofuels does.
I agree about the % of NorAmer forest products which is likely to go to cellulosic fuels, but think that even this small (volume) diversion (along with wood pellets and cofiring) has the potential to have a large price impact.
About 30% of the US corn crop goes to ethanol, but the price of corn is currently dominated by oil prices; this is because the demand for corn as a feedstock for ethanol is extremely elastic when the resulting corn ethanol price is near parity with gasoline.
I expect that we could see something similar with wood. If a large number of coal plants are converted to cofire wood chips (a relatively cheap proposition), then the price of carbon credits which will drive the demand for fuel switching between coal and wood will drive the price of wood chips.
This is an old economic principle: the marginal unit of demand sets the price.