International Trade Committee on July 31st, 2006

[The Chair, Conservative, Leon Benoit]

Welcome again, everyone.

We're now on meeting number 20 of the international trade committee of the House of Commons, dealing, of course, with the softwood lumber agreement, signed July 1, between Canada and the United States.

On the last meeting of today, we have three witnesses coming, all as individuals. We have John Duncanson, analyst, forest products; Stephen Atkinson, managing director, paper and forest products research, BMO Capital Markets; and Simon B. Potter, partner, McCarthy Tétrault LLP.

We'll just go to your presentations, gentlemen. Mr. Duncanson first.

[John Duncanson, Analyst, Forest Products, Jennings Capital Inc., As an Individual]

I'm actually a forest products analyst with Jennings Capital Inc.

Thank you for the invitation to address the committee. On behalf of Jennings Capital, I specialize in the analysis of the paper and forest products sector from a Canadian as well as a global perspective. I have a total of 34 years of experience as a former lumber industry executive in Canada and a forest products analyst. I make judgments about the near- and medium-term prospects of companies in the sector in the context of the overall economy of a country or a region.

I believe in the market, full stop. In my opinion, the three most important forces shaping the market in forest products today are supply, demand, and the strength of the Canadian dollar. From the point of view of the economic future of Canadian forest companies, in particular the lumber companies, I think these three factors are much more important than the dispute with the United States over softwood lumber and the proposed settlement.

I realize that my views in this regard are quite different from those of most of the financial analysts in this sector, who have been attaching more importance to the dispute and the deal. I don't believe trade restraints are ever good, but I think it is probably better to have an agreement than to have the uncertainty of changing duty rates and regulatory interventions that distort the market. The long-running lumber dispute with the United States has produced years of upheaval, hardship, and poor stock performance for the Canadian forest industry. It has interfered with capital investment in the industry and, as such, has threatened the livelihood of thousands of Canadians. To the extent a deal can change that situation, I support it.

I have seen the statements from both sides, from the U.S. industry, from the U.S. government, and from the government here, that the negotiations are over, the deal is final and nothing can be changed. I hope this is not in fact the last word.

I realize the key elements of the deal are not to be changed. I don't like the idea of an export tax, but I don't like quotas either. The last time both systems were tried, they were not satisfactory for the Canadian lumber industry. However, maybe the combination of an export tax and quotas based on a selling price trigger will work better to satisfy both the U.S. and Canadian lumber interests than either the export tax or quota system did on its own.

I don't really know if this new combination will be successful, but I do think it is time to move forward. Having offered this qualified endorsement, I do think there are aspects of the deal, as currently written, that need to be changed. I hope that between now and September the text will be massaged and the deal will become more commercially viable.

Thank you.

[The Chair, Conservative, Leon Benoit]

Thank you, Mr. Duncanson.

We will change the notice of meeting so that you are seen as representing Jennings Capital.

Stephen Atkinson, perhaps you could go ahead with your presentation, please.

[Stephen Atkinson, Managing Director, Paper and Forest Products Research, BMO Capital Markets, As an Individual]

Thank you very much. It's a privilege to be here today. I do feel a little out of place because I don't have any political affiliation.

I look at North American stocks. The weighting of my U.S. stocks that I follow is eight times that of the Canadian. A good reason for that is that the Canadian sector has been shrinking, as we all know.

My job is to find companies that can earn their cost to capital; it's not a responsibility I take lightly. The business has to be viable. We are in a global economy or global environment, and what it says is that you've got to be low cost; if you're high cost, you go bankrupt, and that's what we've been watching.

For instance, in eastern Canada the wood costs are more than double what they are in the U.S. south. At the same time, the margins on pulp, for instance, while they are resilient, are over 40% higher, so it's only a matter of time before they continue to get squeezed out.

I figure the best thing I can do today is make a few recommendations on what would be required to change my view of the Canadian sector. Right now my recommendations are essentially to invest in Canadian companies that have U.S. assets or companies that are not in Canada at all when it comes to pulp and paper.

If you look at the U.S. coalition for a minute, and the lumber or timberland owners, or whatever you want to call them, GP dropped out as being too expensive, and of course IP want out; they've been citing costs. The fact that they, International Paper, sold their timberlands and are in the process of selling their lumber--and I think it's noteworthy that IP did not support the challenge to the constitutionality of NAFTA--to my mind, means the major funder, the funder that's reportedly been putting up over 50% of the moneys, may be leaving. The coalition is now looking for new members. Certainly Canada, with its $500 million donation, should request a seat.

The point is that when you're looking at investing, are you going to invest in an industry that is taking $500 million and giving it to its competition? You are going to look at the competition first, and the beneficiaries. It's just natural.

The other point is that while we look on this as eternal--meaning eternal litigation--the coalition may not be able to attract enough members to continue it. That's why, from a conceptual point of view, I do question it.

To go back to what's been happening, I wrote a report in April 2002 that said the U.S. timberland owners--because it is the timberland owners, not the lumber guys--don't want an agreement; they just want litigation. Certainly everybody else has seen that. We know that. They really were creative, because they had two duties--the anti-dumping and the countervailing--and basically the lumber industry was being charged with having wood costs too high and too low at the same time. But, you know, it worked.

Right now we're asking how we can get out of it. The U.S. is saying they are going to make their best effort over the next 18 months to tell you what a market-based system is, or what one is that works for you. I look at that and say that maybe I should wait 18 months if I'm going to recommend that anybody invest, because you do have this uncertainty. At the same time, for me, more critical than anything else is how you get out.

The other thing that disturbs me, as I mentioned, is that the timberland owners are the guys funding the lobbying. The tax rate on timber in the U.S. for the smaller producers is as low as 14%, and for the lumber producers it's in the low 30% range. Clearly, what you want to do is make as much money as possible off the logs and make as little off the lumber, meaning if you can force a higher lumber price or higher cost, then you can sell your logs for more. It's logical; it works.

When we talk about what I read in the document, of 60% of the lumber producers signing, I'm saying, hey, the guys who are funding account for 15% of lumber production, so I don't know whether they have to sign. That disturbs me as well.

So what do I expect to happen? Well, we have what appears to be the export charge, where B.C. is going to run flat out, and you have the volume restraint, which will be the rest of Canada. When I say B.C., I just mean the B.C. interior, which is about half of our production.

So it's the worst of all worlds. You can't be half pregnant. It's either that you have a quota or you don't. If you have one running flat out and the other part of the world doing, shall we say, volume restraint, it's not going to work. You're just going to have low prices; that's all it is.

The way I look at it is that, yes, Canfor and the companies with the pine beetle will run flat out. Canfor will shut down the lumber mills in the non-beetle region. Northern Ontario and Quebec will get beaten up, especially in pulp.

You see, the insidious thing about all of this is that when you knock out the lumber mills, you reduce the chip supply. When you reduce the chip supply, the wood cost goes up. When the wood cost goes up, down go the newsprint mills and bankrupt go the pulp mills. So the way I look at it right now is that something has to give on the wood costs. Canada has to have the flexibility to be able to lower the wood costs, because as you just think about it, if you knock out the lumber mills and the wood costs keep going up, then that's it: northern Ontario, and certainly the pulp mills in the region, won't be around.

To summarize where I am, then, it is that looking at the agreement doesn't make me feel very good about recommending stocks to investors, so basically I'm going to have to wait for another day.

Thank you.

[The Chair, Conservative, Leon Benoit]

Thank you, Mr. Atkinson.

Mr. Potter, may we have your presentation?

[Simon Potter, Partner, McCarthy Tétrault LLP, As an Individual]

Thank you very much, Mr. Chairman.

I shall address you in English as my presentation was written in English. Of course, I shall answer your questions in both languages.

I'd like to thank you, Mr. Chair, and all the members, for receiving me today and allowing me to give you some thoughts on this complicated matter. I'd like to speak with encouragement to you all. It is a very complex agreement, a complex problem. There are large pros and large cons on both sides of it, and I think it's a challenging task to come to grips with this thing. My purpose here today is to help you to do just that.

I have prepared a paper for you today, which I do not propose to read but which, I believe, has been circulated to you. It is lengthy and detailed. I hope that if you need anything else you will feel free to call upon me, and I will get whatever information you need in order to look into the context and background of this agreement.

First of all, we should remember that this is an enormous dispute. It has been called by some--and I think it probably is--the largest and longest-lasting trade dispute in the history of the world. We here in Canada speak of our $5 billion that is held as deposits in Washington. That, of course, is a huge sum of money. We should remember that those deposits were collected by the United States in an effort to raise prices, and that the prices did not rise on only the one-third of the softwood lumber sold in the United States coming from Canada; there was nearly certainly a collateral effect on the other two-thirds. That is to say, the coalition nearly certainly profited to the tune of several tens of billions of dollars through the collection of those deposits by extracting from the American consumer prices that otherwise would not have been paid. That happened even though the International Trade Commission decided several times that there never was actually any injury caused by Canadian exports to the United States; there was only a threat of injury, and that finding was found to be unsubstantiated.

That consideration is important because it proves that the minister who spoke earlier was completely correct in predicting that there will be a Lumber V. It is impossible to think that the members of the coalition will see, through simple arithmetic, the prospect of increasing their profits by $10 billion and decide that they probably don't want to have a Lumber V. There is going to be a Lumber V if there is no settlement to prevent it. So he was right on that point.

In the interest of fairness, I found a point on which he's wrong, and I'll come to that too.

You heard from various people on both sides of the question, who have said there's great cost and great uncertainty if we take the agreement, and great cost if we don't take it. Both sides are right, frankly. This is a very difficult choice. There are very great costs and problems associated with this deal. I propose to give you my personal view of what some of those problems are and to finish with a suggestion of how they might be approached by those who really want to have the deal.

First of all, there are some problems. These are outlined beginning on page 5 of my paper. In brief, what we have first of all is, as the minister told you this morning, a term sheet of April 27, 2006. A good part of the industry went along with this term sheet and said that, yes, that looked fine, and they would support an agreement that followed that term sheet. Later we had a July 1 proposed agreement, and a good part of the industry said, sorry, they were not in favour of that; they could be in favour of that only if there were changes.

It is important to know that what changed was not the mind of the industry associations; what changed was the deal. The deal that is before us now is in several ways not the deal that was announced by the term sheet of April 27.

First of all, the April 27 term sheet spoke of a seven-year arrangement, and even the Prime Minister announced to the House of Commons that he had brought home a seven-year arrangement, a guarantee of peace for seven years. The fact is that the agreement has article XX, which gives to the United States the power to terminate the agreement after 23 months, on one month's notice.

With great respect, I disagree with the minister when he says, well, that's nothing different; in fact, it's better than what you would have under normal international law principles, because any treaty can simply be terminated on, as a rule of thumb, a year's notice. There is a great distinction, in my view, to be made between denouncing a treaty and tearing it up when there is no clause of termination in the treaty and simply using a power of termination that is explicitly provided in the treaty.

I submit to you that members of the industry might very well feel less at lease when an explicit provision allows the United States, without cause, without explanation, or without arbitral support of any kind, simply to pull the plug after 23 months. The industry, after all, agreed to pay $1 billion to buy seven years—maybe nine—of peace, and now it wakes up and finds that maybe it's not all that seven years, that maybe it's only 23 months of security. I think that's a major problem.

Secondly, option B, the quota scheme, is not what was announced on April 27. We now see that option B, the quota scheme, will be administered on a strict monthly basis, with a limited carry-forward or carry-backward provision from month to month—limited at 12%.

I'll come back to that in greater detail in a few minutes. But that is a problem for an industry that does not have volumes that are constant month to month, and that has demands presented by clients that change very rapidly.

You've already heard about standstill and anti-circumvention. I propose not to deal with those except to speak about the solutions I propose to you.

My conclusion is that this deal is not a good deal. It's very difficult, but it can be made acceptable to those who find it important to leave the uncertainty and the costs of the past several years and to go to a land where there will be greater certainty and greater ways to plan. There are things that can be done.

First of all, it ought to be clarified exactly how the option B quota regime will work, and it ought to be clarified in a such a way that everyone is reassured that quota will not be left uselessly on the table from month to month—orphan quota withering away, unused and never recuperated.

Secondly, it ought to be made clear that the power of early termination in Article XX will not be used except as a last resort and only if it is absolutely clear that the agreement is not working.

Thirdly, the standstill provision should be made—by promises, clarifications, or reassurances—to apply to more than just early termination by the United States under Article XX.

Fourthly, the anti-circumvention provisions should be made a bit more appealing by some kind of reassurance—a clarification that forestry management changes on a provincial level that bring the province closer to a free market will in no event be considered circumvention. That would go a long way toward reassuring people.

Let me speak to you very quickly about the option B quota. Quota that is administered on a strict monthly basis gives you 12 times as much chance of losing quota through non-use as does quota administered on a yearly basis. The April 27 document did not say how it would be administered; here we see the deal, and it's monthly, strictly monthly, with a 12% carry-forward. What Canada had asked for was quarterly, with 10% at the end of the quarter. It's obvious that a total flexibility between January and February, and a total flexibility between February and March, and a 12% of a quarter between March and April is a much easier thing to manage than a 12% carry-forward month to month.

Secondly, annex 5 is drafted in a vague enough fashion that some people might interpret it to mean that if you do not use quota in, let's say, June and you can only carry forward half of it into July, the other half is lost. We must find a way to make sure that this interpretation does not apply, and it seems to me that ought to be easy if both countries are in a world in which everyone wants to live within the limits that were imposed and that were limits decided by the ITC to be non-injurious to the American industry.

So my conclusions are that there should be no impediments to the clarifications I propose, that they are important clarifications, and that with them a great many members of the industry will see the point of taking the view the minister has expressed this morning.

Without these clarifications, however, many will prefer simply to go on winning in the litigation.

Those are my remarks.

[The Chair, Conservative, Leon Benoit]

Thank you, Mr. Potter, and thank you all for your presentations.

We'll now go to questioning, starting with Mr. Temelkovski for seven minutes.

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

Thank you very much, Mr. Chairman.

Thank you for coming out today.

Mr. Duncanson, you mentioned supply and demand and a dollar figure. With the price of the dollar fluctuating so much, do you think this becomes a better deal for Canada as the dollar has risen so much, or is it better for the Americans?

[John Duncanson]

It makes the Canadian industry less competitive.

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

Less competitive. And the billion dollars left on the table...?

[John Duncanson]

Are you asking my views on that?

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

Yes.

[John Duncanson]

I don't like it any more than anybody else in this room does, but it is the cost that has to be expended to guarantee the softwood market in the United States.

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

Maybe Mr. Atkinson can tell us, how do you expend the billion dollars when you're buying and selling stocks?

[Stephen Atkinson]

How do you recommend it? Well, one of the things I was speaking to Simon about is what one of my U.S. clients said to me: that if, let's say, you invest in a company and then that company gives $500 million to its competition and you suffer because of that—i.e., through litigation or through, shall we say, predatory pricing—are you acting in the best interests of your shareholders and are you liable? That puts a certain amount of pressure, possibly, on the Canadian industry.

The other point he made was that with the latest ruling of the U.S. Court of International Trade, which he takes very seriously, what he's saying is that the Canadian government should be very prudent as to where the $1 billion goes, because there could be some liability.

Actually, his final conclusion—I may as well share it with you—was this: why not give the money to the victims of Hurricane Katrina? That way, the industry would not incur any liability.

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

I was in the financial business for 20 years and I understand you follow trends in your business. When one country receives a judgment in their favour and the other country does not follow through, and it happens again and again, would you call that a trend?

[Stephen Atkinson]

Yes.

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

Would you anticipate that it will repeat itself again?

[Stephen Atkinson]

Oh, absolutely.

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

So do you think the Americans are finished with us?

[Stephen Atkinson]

Absolutely not. I was reading the comments from the senators from Oregon and Idaho right after the announcement of the agreement on April 27 and 28. To paraphrase, basically they're saying—well, Oregon was, and I'm trying to get the words right—something to the effect that tens of thousands of jobs were lost in Oregon because of the practices of the Canadian government. So obviously it's starting up again.

As you know, 69% or 69 senators voted for the duties in the first place. Clearly it's coming back.

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

Okay. How would you view company C, which has stood up to the judgments they've received and has lost half a million dollars? Would you view it a little differently?

[Stephen Atkinson]

If a company lost half a million dollars by standing up...?

[Lui Temelkovski, Liberal, Oak Ridges—Markham, ON]

By standing up for the judgment they've received through the courts of law, as opposed to not standing up.

[Stephen Atkinson]

I see what you're saying. If we take the presumption that no money will be returned, are you better off to take what you can? Yes. It depends where you set your yardstick. Good point.