Thriving in the new Millennium
Why do we have overcapacity in the pulp market? We do not use our heads. We have myopic vision. When the market is good, we can find all sorts of reasons to contend that it is going to stay good, or get better. When the market is poor, we develop unrealistic solutions aimed at the near-term problems. To illustrate, I point to the following:
Myth No. 1: There is a world wood shortage. With plantations providing fiber, tropical rainforests, and the yet-untapped forests of Russia, we have no wood shortage.
Myth No. 2: Environmental concerns will limit capacity. Environmental concerns have not stopped the construction of new mills. Technology makes it possible to build and run our mills better and new mills are being built in areas of the world where employment is valued more than the environment.
Myth No. 3: Global demand will use up the new capacity. We have seen that new capacity has been driven by market cycles rather than by demand. We always expand when the world economic cycle is peaking because that is when prices are highest. Unfortunately new capacity tends to come onstream at the same time and just as world economies slow down. This results in overcapacity. We are just as shortsighted when the market is at the bottom of a cycle. We then conclude that the pulp business will remain poor, expansion plans are curtailed and often there are contractions in capacity (mill closings). We under expand during poor markets creating shortages when global economics recover. Fortunately these actions help control the problem of overcapacity but they also are what gives the industry its extreme volatility.
Myth No. 4: If we all took two weeks of downtime, supply and demand would come back into balance. This is the OPEC approach, but it is even less successful in our industry because of our high fixed cost structure. In addition, in recent years several new countries have entered the pulp business. These entrants have very low wood costs and unstable currencies that make this approach unfeasible. Nobody wants to be the swing producer, especially those that operate in small, isolated communities. Until we reach the cash breakeven point for a significant number of high-cost producers, there is no relief.
Myth No. 5: We are not structurally impaired, we are managerially impaired. I agree that we are managerially impaired, but I also think that this industry is structurally impaired. For example, the U.S. and other governments are subsidizing new wastepaper pulp mills in order to get the paper out of landfills rather than letting the free market work. The government of British Columbia is subsidizing the operation at Skeena. Germany is attempting to force the world to make total chlorine-free pulp which will keep some sulfite pulp mills going. The list goes on where governments continue to interfere in the marketplace, creating overcapacity.
Solutions. There has been talk that more industry concentration would better address the problems of overcapacity. This is Wall Street’s favorite solution. Concentration is not going to solve this problem. From a practical standpoint, I question whether enough concentration will ever take place, and if it does, whether it will change anything. As an example, the two largest pulp producers in the world—Georgia-Pacific and Weyerhauser—moved prices in the opposite direction this spring.
The pulp industry is going to remain a very volatile industry. The secret to success will be to increase capacity only at the right time in the cycle and to accept that there are going to be very dramatic cycles. We as an industry must discipline ourselves by these guidelines:
• Add new capacity only when the trend price of pulp is solidly above the average price needed to justify the expansion, not just when there is high peak pricing.
• If you must expand, buy capacity rather than build.
• Lobby to get governments out of the business of financing subsidies for wastepaper pulp mills.
• Further separation of timber from mills to bring more discipline to fiber costs.
• Lobby for consistency in worldwide environmental laws. Do not accept harvesting the rainforests of Southeast Asia, while the U.S. preserves old growth forest for the spotted owls.
• When we have windfall profits—and we will—distribute them to shareholders or reduce debt, but do not expand. Avoid the bias to build.
• Favor equity rather than debt on the balance sheet in order to increase rather than decrease flexibility.
Overcapacity creates low returns on capital and it also causes cyclicality. Cyclicality in turn raises the industry’s cost of capital, damages customer relationships, leads to inefficient use of resources, and makes planning and managing very difficult.
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