FNR-148

Cooperative Extension Service
Purdue University
West Lafayette, IN

Predicting Black Walnut Log Prices

William L. Hoover. Professor of Forest Economics
Forest scientists have been gathering for
over 30 years the information needed to manage
black walnut plantations for timber and nut
production. This information has led to great
interest in black walnut plantation establishment
and management for financial returns. Black
walnut is one of the fastest growing and highest
valued hardwood species, but the long time
periods required for hardwood trees to mature
limit potential financial returns.

Evaluation of long-term investments in black
walnut plantations. depends on tree growth
rates, log quality, and costs incurred, as well as
the expected price for logs when the trees are
big enough to sell. This publication reviews price
changes over the last 40 years and discusses two
basic ways to predict future prices using historical
price trends. Particular attention is paid to the
folly of predicting prices based on a portion of a
cycle in prices and of using compound rates of
increase to project prices with the effects of
inflation removed.

Walnut price data collected for Indiana show
that the dramatic price increases of the 1970's
and early 80's have yielded to a period of decline
followed by renewed increases at a much lower
rate. The sawmills and veneer mills processing
black walnut apparently realized that the dramatic
higher prices paid in the 1970's and early
1980's couldn't be passed on to buyers of
lumber and veneer. In addition, the supply of
black walnut timber was so scarce that higher
prices could do little to make more timber
available for harvest.

Based on these observations, it's suggested
that the most appropriate way to predict future
walnut prices is to use a long-term average trend-
line price. The approach is recommended for
estimating the financial returns from investments
in plantations, not for timber marketing decisions.
Marketing decisions should take into
account current market conditions. Most owners
of timber have the option of waiting out a
decline in price levels.

Source of Price Data

The price data were collected by the Department
of Forestry and Natural Resources, Purdue
University. It is prices paid by mills in Indiana for
delivered logs. The delivered prices include the
price received by the timber owner-stumpage,
plus the cost of logging and transportation of the
logs to mills. Prices are reported for four grades
of sawlogs and two grades of veneer logs of
seven different sizes. Data for the current year is
published in the "Indiana Forest Products Price
Report and Trend Analysis" sold by the Ag
Communications Service Media Distribution
Center, 301 South 2nd Street. Lafayette, IN
47901-1232.

The market for walnut logs in Indiana is
highly developed and based on over a century of
fine hardwood processing. Logs are shipped to
Indiana mills from many other states. Thus, the
Indiana price data reflect regional market conditions.
However, the amount actually paid to
landowners for stumpage varies greatly across
the region. Thus. you should seek information
from consulting foresters and others familiar with
your local market conditions to determine the
relationship between the reported prices and
prices in your area.

Analysis of Current Market
Conditions

The changes in the actual price of sawlogs
and veneer logs are shown in Figures 1 and 5
respectively. In addition to the year-to-year
variation, prices tend to follow cycles covering
four years or more. The cycles frequently differ
among the grades and sizes of logs. As an
example, compare prices between 1993 and
1994. The size of differences in prices in the
spring of 1994 compared to 1993 were mixed.
Prime and No. 1 sawlog prices were up by 15
percent and 2.4 percent respectively (Table 1).
The price of No. 2 and No. 3's were down by
1.7 percent and 20.4 percent respectively.

These changes were apparently due to log
supply conditions and not increased demand for
lumber. Walnut lumber prices change very little
(Table 2). The amount of change in a specific
size and grade of log is also due in part to sampling
error.

Veneer log prices generally declined from the
spring of 1993 to 1994 (Table 3). The only
exception was for larger lower grade (select) logs.
Improvements in processing technology, especially
veneer drying, have increased the value of
these logs. The upper grade logs (prime) were
down from 4 to 16 percent. The larger select
logs were up 17 percent to over 50 percent.
Smaller select logs were down 6 to 9 percent.

What's a Realistic Price Trend?

Analysis of investments with a pay-back
period of 40 to 60 years or more are obviously
risky. An investor needs to believe in the basic
human values associated with the warmth and
beauty of ~real wood" to even consider this
option. Social scientists generally agree that
basic human values are much less subject to
change than technology and how this technology
is used to satisfy our wants and needs. To the
extent that real wood meets some basic emotional need,
it has an enduring place in our lives.
What the last 15 years has taught us, however, is
that no matter how primal the need, the reality
of cost constraints affects how needs are met. In
terms of value provided, the market place
through the pricing mechanism constantly places
goods and services in relative balance.

The price increases observed for walnut in
the late 1970's and early 1980's with the affect
of inflation removed, i.e. real prices, couldn't
continue. To illustrate, consider the relative value
of a board foot of walnut and a new car 40 years
from now. Say the walnut is veneer quality
timber now worth $5.00 a foot and the car is
worth $20,000. both in terms of what a dollar
will buy in 1994. The car is equivalent in value to
4,000 board feet (MBF) of walnut veneer logs.
Now assume that walnut prices increase 8
percent per year in terms of 1994 dollars for
40 years and the price of the car stays the same.
The walnut price goes to $109 per board foot.
The car is then equivalent in value to 184 board
feet of walnut. In general, however the relative
values for the mix of goods and services consumers
desire don't change that dramatically. By the
way, car prices have increased primarily because
of inflation and additional features, not because
the real cost of basic labor and material inputs
have increased.

Let's next consider walnut price trends and
discuss whether or not they are sustainable at
current levels.

Sawlog Price Trends

Actual sawlog prices since 1957 have increased
significantly (Figure 1 and Table 6). The
trend lines (straight lines) shown in Figure 1
represent an average increase over the entire
38-year period. Because we are used to discussing
price increases in terms of a compound rate
of interest, I'll present the equivalent annual
compound rate of increase. This is the interest
rate which if compounded over the entire period
(1957 to 1994) provides the same value in 1994
as the trend line, as illustrated in Figure 2. These
compound rates should not be used to project
prices into the future, as discussed above. Compounding
gives price increases which aren't
realistic. The equivalent compound rates for
sawlogs were 5.1, 6.1, 6.9, and 5.6 percent for
Prime, No. 1', No. 2, and No. 3 grade log
respectively.

Investments should be judged in terms of the
actual increase in purchasing power of the
money invested. Therefore, we need to look at
the price increase in terms of constant (real)
dollars. The producer price index for finished
goods is used as the indicator of inflation (Figure
3). Consumer prices follow the same pattern as
producer prices over the long run. The trend line
for inflation is equivalent to a 6.3 percent compound
interest rate. To protect the purchasing
power of the amount invested. the timber should
increase in unit price at least at this rate. It's the
total real rate of return, however, that should
ultimately be used to decide on whether or not to
make the investment.

The degree to which the increase in price
has kept up with inflation is judged by "deflating"
log prices. This is done by dividing the actual
price by the producer price index. The resulting
"real price" series can be used to evaluate the
real price increase.

The real price of prime sawlogs increased
dramatically, although in cycles, from 1957 to
1971 (Figure 4). After 1971 the real prices for
prime sawlogs have not kept up with inflation.
The trend line reflects a 0.2 percent decline. The
real price of the lower grade logs has just barely
kept up with inflation. The real increases for the
1957 to 1994 period were 0.2. 0.6, and 0.4
percent for No. 1, No. 2. and No. 3 sawlogs
respectively.

Veneer Log Price Trends

The actual prices of prime and select veneer
logs in seven size classes are shown in Figures 5
and 6, respectively, and Table 7. The pattern is
similar to that of sawlogs. After advancing slowly
from 1957 to the early 1970's, prices moved up
sharply until the early 1980's. Prices during the
1980's were highly variable, but by the end of
the decade were trending upward again. Note,
also the differences in the patterns between the
prime and select grades. In particular selects, the
lower grade logs, have increased more than the
prime grade in the last several years.

The deflated (real) prices and trend lines for
the seven size classes of prime and select veneer
logs are shown in Figures 7 to 10. The long-term
trend lines show a pattern similar to sawlogs.
The trend lines don't, however, reflect prices
during the 1970's and overestimate price levels
in the 1957 to late 1960's, and again from the
late 1980's to the early 1990's. High prices in
the 1970's "pulled up" the trend line, placing it
well below the exceptionally high prices of the
1970's. The unsustainably high prices of the
1970's caused projections based on the 1957
to the early 1980's data to yield grossly exaggerated
estimates of increases.

Applying the concept of an average compound
rate of increase for the trend lines for
veneer logs, as discussed for sawlogs, gives
higher rates of increase than for sawlogs. The
trend line increases for veneer logs are given
in Table 4. The largest increases are for small,
high-quality veneer logs. This is inconsistent
with pricing patterns over the last several years.
Comparisons between the two smallest classes
and the other size classes must be made with
caution. Prices for 12 to 15 inch logs weren't
collected until 1984. This was several years
after markets for small veneer logs were well
established.

Making Price Projections

A review of the figures showing the real
prices of walnut logs, plus the discussion above,
should convince you that prices don't increase
exponentially, i.e. at a compound rate. In reference
to Figure 2, projections should be made
using the straight trend line. However, this is not
the normal practice. Investment analyses are
often simplified by compounding prices using the
interest rates given in Table 4. This would mean
projecting forward using the curved line in Figure
2. You can clearly see that the projected prices
are going to be dramatically different with the
two methods.

Investors also frequently use current prices to
make investment analyses. Since walnut log
prices are cyclical, this could give an unreasonably
high or low level. An alternative is to use the
current price from the trend line. If you believe
that prices will continue to increase based on
historical patterns, then use the equation for a
straight line to project the price. The equation is,

P = a + b T,

where, "a" is the intercept and "b" is the slope.
These values are given in Table 5. "T" ranges
from 1 to 38 for years 1957 to 1994 for
sawlogs and the five largest veneer logs sizes.
"T" ranges from 1 to 11 for years 1984 to 1994
for the two smallest veneer log sizes. To project
the price of a given type of log, substitute into
the equation the value of T for the number of
additional years of interest. For example. the
1982 base year trend line price for one thousand
board feet (MBF) of 16-17 select veneer logs in
the year 2039 (45 year projection), would be,

Price = 969.18 + 25.731 x (83) = $3,105 per MBF

Note that if the exponential method was used the
projected price would be,

Price 1947 x (1.01783)^ 4/5 = $4,313 per MBF

In this equation $1,947 is the trend line price in
1994 and 1.01783 is (1 + i), where i is the
interest rate from Table 4. The exponent, 45, is
the number of years the price is compounded at
1.783 percent per year.

Summary

Planting trees provides many rewards If,
however, your primary focus is financial return
and you have an area of fertile, deep, well-
drained soil, you might consider establishing a
black walnut plantation. Establishing and maintaining
a plantation result in many expenses and
a great amount of work by you or paid labor.
The decision to make this investment should be
based on realistic expectations, especially regarding
the future value of walnut timber. Using the
equations for straight trend lines statistically
estimated for the entire time period for which
data is available is recommend. The equations
for these lines is updated annually and reported
in the Indiana "Forest Products Price Report and
Trend Analysis" for the current year.

New 3/95
Cooperative Extension Work in Agriculture and Home Econom-
ics, State of Indiana, Purdue University and U.S. Department
of Agriculture Cooperating. H.A. Wadsworth, Director, West
Lafayette, IN. Issued in furtherance of the Acts of May 8
and June 30, 1914. It is the policy of the Cooperative
Extension Service of Purdue University that all persons
shall have equal opportunity and access to our programs and
facilities.