Growing economy and low capacity growth open path for recovery; some caution for year 2000, but 2001 could be a strong year

North American Industry Outlook Bright Over Next Two Years

Growth rates in Europe, Asia, and Latin America will be better than in North America, which will give a boost to paper demand throughout the world, said Philip Suttle, director of global economic analysis at J.P. Morgan Inc. This pickup in growth outside North America is important because together these regions represent approximately 67% of world paper and paperboard consumption vs 33% for North America.

FIGURE 1: 1999 recovery year.

Production capacity of pulp, paper, and paperboard will not increase as fast as global economic growth. New capacity additions in 1999 were at their lowest level in the past 10 years. This will mean steady improvement in paper mill operating rates and gradually rising prices.

"Global capacity in paper and paperboard is slated by us to grow at only 1.6% in 2000 and 1.7% in 2001," reports Salomon Smith Barney. As a result, industry operating rates are forecast to rise from 91.0% in 1999 to 91.9% in 2000 and 93.0% in 2001, according to the firm.

AF&PA's capacity report, released in December, projected U.S. capacity to grow just 0.7% over the next three years. U.S. capacity declined 0.5% in 1999, the first decline on record, reflecting numerous shutdowns totalling 2.5 million tons in 1999.

FIGURE 2: Strong second-half 1999 boosted output.

Packaging strong. Manufacturing activity was stronger in packaging papers than in printing/writing papers during the second half of 1999. U.S. containerboard mills, for example, operated at 95% of available capacity in October, and bleached paperboard mills operated at 97%. In contrast, coated free-sheet mills operated at just 85% and uncoated groundwood mills operated at 90%. Operating rates are forecast to improve in 2000, and this will set the stage for continued pricing recovery.

"For 2000, we project price increases for all grades," analysts at Deutsche Bank Securities Inc. wrote last October. "Generally, we have assumed two increases in the year, which is the norm for the industry in an upcycle. While containerboard and pulp are again expected to show the largest growth in 2000, all other grades except bleached board (which outperformed in 1999) are forecast to achieve double-digit percentage growth." The range of price forecasts include linerboard (+19%), corrugating medium (+20%), newsprint (+14%), uncoated free-sheet (+13%), and bleached board (+6%). The benchmark price for northern bleached softwood kraft (NBSK) pulp is forecast to increase 19% to reach $700/mton by the end of this year, according to Deutsche Bank Securities.

FIGURE 3: Improvements seen ahead.

The bank does warn that its forecasts are subject to continued global economic expansion. "We do caution that among all grades, uncoated free-sheet, pulp and coated free-sheet are experiencing the largest capacity increases in the rest of the world, and if the overseas economies weaken, our forecasts for these grades could be the most at risk."

The bank's global markets research team said they hoped any price increases would be implemented slowly and that producers would find price increases "difficult to attain." If industry pricing rose rapidly, producers could become "cocky and over optimistic about business conditions." This would lead them to build new capacity or engage in other actions adverse to the interests of stockholders.

"The worst scenario would be a replay of 1994-95, when prices rose so fast that it encouraged significant capacity additions and inventory accumulation, setting the groundwork for the weak pricing environment since that time," said Deutsche Bank's research team.

Linda Lieberman, a paper analyst at Bear Stearns & Co., also said that the traditional thinking in the paper industry that presaged an unprecedented capacity expansion in previous years has been replaced by a more pragmatic approach to business. "The mindsets of managements have begun to change as they focus more on capital and returns," she said. These new managers, some with no previous paper industry experience, or bias, are making tough decisions such as shutting down production lines to trim inventories and closing old or inefficient mills, said Lieberman.

The possibility of more mergers and takeovers in the industry also encourages industry watchers. Opinions vary, but containerboard and coated papers are the most mentioned as sectors where more consolidation may occur. The $2.5 billion merger of Jefferson Smurfit Corp. and Stone Container Corp. in late 1998 opened the way for major capacity rationalization in the containerboard sector. Smurfit-Stone Container Corp.'s aggressive actions to shut surplus mill capacity led to improved pricing and profitability for the entire containerboard segment.

FIGURE 4: Imports level off.

The merger trend continued in 1999. International Paper Co.'s (IP) $6.6 billion acquisition of Union Camp Corp. was completed in May. The stock transaction valued Union Camp at $71/share. The transaction represented a substantial consolidation in two large segments of the paper industry: containerboard and uncoated free-sheet paper. IP said it expects to realize annual cost savings of $300 million from the two companies' combined business and manufacturing operations.

Also in May, Georgia-Pacific Corp. acquired paper and office supply distributor Unisource Worldwide Inc. for $1.24 billion. Unisource is G-P's biggest customer, and the transaction was a defensive move to block a takeover by UGI Corp., a Pennsylvania utility company.

In another strategic transaction, Fort James Corp. sold its folding carton packaging business and a recycled paperboard mill in Kalamazoo, Mich., to Graphic Packaging Corp. for $830 million in cash. Fort James said it wanted to focus resources on building its consumer products and tissue business.

In November, Weyerhaeuser Co. acquired MacMillan Bloedel Ltd., Canada's largest paper and forestry company, in a stock transaction valued at $2.45 billion. The transaction strengthened Weyerhaeuser's leading market position as the world's largest producer of softwood lumber and market pulp. It also moved Weyerhaeuser up to the No. 3 spot for U.S. producers of containerboard and corrugated packaging.

Market Pulp

Long-anticipated market pulp upswing could last for as long as two more years

FIGURE 5: Forecast for 2000 bright

Norscan inventories have been at 1.5 million mtons or lower since March 1999. The October North American/Nordic (Norscan) chemical pulp producer inventories sank to 1.14 million mtons, or 19 days' supply, the lowest figure since June 1995 and the lowest for an October since the 1989 level of 1.06 million mtons. The market balance tends to tip in favor of producers when Norscan inventories drop below 1.5 million mtons, and pricing tends to increase when stocks are lower than 1.3 million mtons.

Prices began moving upward in second-quarter 1999, increasing from the low of $460/mton in Europe in fourth-quarter 1998 to $480/mton in May 1999.

In the first six months of 1999, world chemical market pulp demand was up by 1.2 million mtons, or 8%, compared to 1998, yet market pulp consumer and supplier inventories were estimated to be at normal levels for the first time since 1994, the Canadian Pulp and Paper Assn. (CPPA) reported. Supplies continued to tighten worldwide throughout the year, and by the end of 1999, many pulp customers were on allocation and there was very little spot tonnage to be had.

FIGURE 6: Positive forecast for pulp

Pricing reached $600/mton by November. With most NBSK producers needing about $500/mton to be profitable, the new prices are helping the industry recover from a nearly four-year downturn that saw market- and environmentally-related chemical pulp mill closures and company consolidations, along with massive production outages aimed at balancing supply and demand.

In the U.S. alone, 820,000 mtons of integrated pulp capacity have been shuttered since 1998 (with another 190,000 mtons scheduled for 2000), largely due to the implementation of the Cluster Rule, the CPPA said. In addition, since 1998 North America has seen the market-related closure of more than 1 million mtons of market pulp capacity, with most of the tonnage expected to be permanently removed from production.

With fewer market pulp producers now and more producers who focus on pulp as a core product, the industry is expected to show more discipline in maintaining announced price levels and balanced inventories. Underscoring this, noted Canadian pulp consultant Fraser Evans, are changes on the world level in currency values, wood costs, and mill efficiencies that have served to reduce pulp production cash costs. He said these changes have brought the costs of the lowest- and highest- cost regions to within just over $200/mton of each other.

Fraser Evans President, F. Evans Associates

Positive forecasts. Equity Research Associates (ERA) expects prices in Europe to average $680/mton in 2000, up from $520/mton in 1999. The market momentum has caused several analysts to revise earlier, more pessimistic price forecasts. Salomon Smith Barney analyst Chip Dillon said in November that his group was reviewing its global NBSK price forecast of $610/mton for 2000 because, given recent trends, it was probably too conservative. In mid-October Morgan Stanley Dean Witter revised its 2000 forecast to $636/mton from $598/mton.

ERA expects the price to peak in 2001 at $800/mton from April through July before beginning a drop that leaves it at $600/mton in November.

Speaking at the Paper/Forest Products Outlook Conference in New York in November, Evans said, market pulp demand growth through 2002 "will not be stellar" in North America and that it will be moderate in Europe. However, he said other regions, especially Asia, will exceed their demand of the past five years. Evans pointed out that although consumption was slowed by the Asian financial and economic crises that started in mid-1997, pulp shipments to Asia from 1995 to 1999 grew by an average annual rate of 3.9%; in 1998, non-Japan Asia accounted for 20% of world printing paper consumption, compared with only 7% in 1980. Meanwhile, this year China alone will purchase over 2 million mtons of market pulp, and its buying was consistent during 1999.

"So the pulp market looks good," Evans said. He said the industry could help insure its well-being with dedication to a strong marketing process and by focusing on profitability in order to enhance its value.

Also supporting market strength, Evans said, is that the current ratio of the price of NBSK to lightweight coated paper is not even 60%, compared with 90% in the 1989 upcycle, and 80% in the 1995 upcycle.

Looking at 1995 to 1999-1995 marks the last upcycle-Evans said the amounts of new pulp and paper capacity would at first appear to be complementary. He noted that world printing/writing and tissue paper capacity grew by nearly 20%, softwood kraft capacity by 1 million mtons, and hardwood capacity-not factoring in closures-by more than 2 million mtons. However, he pointed out, the pace of those grades' paper production in the past four years did not show a commensurate increase in the consumption of market pulp, which increased by just 1% annually.

Evans added that new paper machine integration has also siphoned off consumption of market pulp.

WASTEPAPER

Wastepaper markets to improve slightly, despite short-lived setbacks in first half

"North American consumption of recovered paper will show a gain of only 2.0% in 2000 after rising an average of 4.8% per year in 1999," according to David Clapp, economist with the Resource Information Systems Inc. (RISI) consultancy.

U.S. wastepaper demand will be bolstered by an increase in recycled capacity, particularly for newsprint, according to Bill Moore, president, Moore & Associates. He expects that the first of several newsprint deinking projects slated to come online-at Donohue Inc.'s Sheldon, Tex., mill-will begin to raise old newspaper (ONP) demand by early in the New Year. Two other recycled newsprint projects slated for completion in 2000 are from Bowater Pulp and Paper Canada Inc. at Thunder Bay, Ont., and Inland Empire Paper Co. at Spokane, Wash.

No panic in OCC. The containerboard business is forecast to remain relatively healthy in 2000, though not as robust as in late 1999. Thus, demand for old corrugated containers (OCC) should be relatively stable. OCC prices could fall a bit early in the year, but are likely to rise again in the second half as containerboard production improves.

Demand from the tissue sector is expected to be strong but relatively flat in 2000 compared to 1999. However, expansions set for completion starting in 2001 will boost consumption for such grades as coated book stock and sorted office papers.

In the pulp substitutes, the price run-up of 1999 will come to an end by early spring due to a projected downturn in pulp, according to Clapp. However, he projects higher prices for high-grade deinking and pulp substitutes later in 2000, "with notable increases occurring over the next three years."

David Clapp Manager, World Recovered Paper RISI

The expected closure of kraft pulp mills early in the new millennium is likely to cause buyers of market pulp to switch some of their consumption to pulp substitutes, according to Sue Andersen, manager of strategic services, Thompson Analytic International Inc. (TAII). "Many mills are turning to recovered paper to fill the fiber gap that has been created," she said.

Suppliers asleep. Most major grades of recovered paper are expected to be tight this year because recovery rates are already high and collections have been lagging, according to Moore. "The supply community is somewhat asleep," he noted, referring not only to municipal programs, but also to the upheaval in the solid waste business.

TAII, too, stated concern about consolidations both in the solid waste and paper industries-including paperstock processors. M. Pike Hamlin, director of operations for TAII, said he was surprised that these changes had not yet had an effect.

U.S. exports of wastepaper should improve in 2000. Moore expects that the U.S. will be exporting more to Asia as Europe exports less and consumes more of its own recovered paper. This is especially true for ONP because there is a trend to increase the recycled content in European newsprint, he said.

With exports expected to be stronger this year than last, there will be more pressure on domestic U.S. markets, particularly later in the year as U.S. mills' operating rates improve. Clapp expects overall U.S. wastepaper demand to be somewhat weaker in the first half than in the second half. He projects paper and paperboard production will slow though mid-year as inventories-built up late in 1999 due to Y2K concerns-are worked off. "However, global economic conditions should be picking up enough later in the year to generate a sustainable recovery in both the domestic and overseas markets for recovered paper," said Clapp.

PRINTING/WRITING PAPER

Strong economy, little new capacity bode well for market in 2000

This is based on several developments that occurred in 1999 which most forecasters expect to bode well for the year ahead. U.S. mill inventories generally moved toward more balanced levels, and the economy continued to show surprising strength. The latter, despite the explosive growth of e-commerce, has had a positive effect on all forms of print advertising in catalogs, magazines, and direct mail. There was little capacity growth at North American printing/writing paper mills in 1999, and expansion is expected to remain minimal in 2000 in most grades.

FIGURE 7: Newsprint, groundwood prices up.

In December 1999, the U.S. capacity report from the American Forest & Paper Assn. of December 1998, printing/writing paper should show growth on average of 0.7%/year (2000 to 2002); for the 10 years 1988 to 1998, growth averaged 2.3% year. Total capacity for printing/writing grades was about 29 million tons in 1999.

Coated. A key development in the coated grades during second-half 1999 was that producers appeared to have gotten mill inventories back under control, especially in the coated groundwood market. U.S. coated groundwood mill inventories stood at about 135,000 tons in September, compared to 188,500 in June. That enabled producers to raise prices twice in 1999.

However, a factor that cannot be overlooked is that of paper imports to the U.S. from overseas. While some slowdown in the rate of growth of imports took place last year, new capacity continues to come online in Asia and Europe. One key question to be resolved is: Will the new European coated groundwood capacity affect U.S. markets? RISI predicts a rise in coated groundwood imports from Europe after the 400,000 mtpy Haindl machine starts in 2000. No further price rises are forecast until after first quarter 2000, sources say.

The coated free-sheet market experienced some tightness in second-half 1999 as inventory levels stabilized. As of November, No. 3 60-lb rolls were transacting at $860/ton to $880/ton, up from $830/ton in the first half of 1999. But imports from Asia continue up and will probably reach close to 200,000 tons (final figures not available at press time); overall imports are expected to continue rising, but at a slower pace in 2000 and 2001, according to RISI. Global coated free-sheet capacity continues to expand fairly rapidly, but a pulp price increase may help producers raise prices in second half 2000, according to Pulp & Paper Forecaster.

FIGURE 8: Trend upward in commodity grades.

SC additions. In the uncoated groundwood market, where prices remained flat for most of 1999, another key question is whether capacity growth due to conversions from newsprint and new machines will drive prices down further. Donohue Inc. is adding 250,000 tons of SC-B at the Lufkin, Texas, mill in 2000, and Stora Enso North America expects to reach full capacity of 385,000 tpy of SC-A at its Port Hawkesbury, N.S., mill in 2000. Alliance Forest Products Inc. will add 62,000 mpty of capacity after a startup of a new machine and shutdown of other machines at its Donnaconna, Que. mill in 2000. In Europe, Gebruder Lang Papierfabrik brought a new 280,000 mtpy machine online that will make mainly SC at its Ettrigen mill in Germany. Although SC demand is growing, operating rates will be kept low by large capacity expansions, RISI says, and prices will remain flat through 2000.

As in the coated grades, uncoated free-sheet mill stocks in the U.S. came under control in 1999, and along with rising pulp prices, that contributed to some price firming. Prices went up in September about $50/ton. Imports continued to be a factor however, but RISI predicts with the recovery in Asia and growing world demand-2% a year-for uncoated free-sheet, the future is bright for this market.

Newsprint

Prices will be higher in 2000; consolidation should continue

Paper and forest products industry analyst Ross Hay-Roe of Equity Research Associates in Sechelt, B.C., says the higher prices will continue in 2000, even though the market may soften during the first quarter, typically the slowest consumption period of the year for U.S. daily newspapers. Pulp & Paper Forecaster expects newsprint prices to average $545/mton in 2000, up almost 7% from an average of about $510/mton in 1999. Other paper and forest products analysts are forecasting higher average prices in 2000, in a range of $535-$580/mton.

The market. Newsprint consumption in 2000 is expected to be flat with 1999's strong levels of 14.4 million mtons, according to Pulp & Paper Forecaster. Consumption by the dailies-the largest newsprint-consuming group in the world-will be affected by the continued conversion by publishers to the slimmer 50-in. web width, according to Mark Kennedy, a paper and forest products analyst with TD Securities Inc. in Toronto. He said he believes the web-width reductions-which can save a newspaper up to 8% on its newsprint costs-will cut annual consumption by about 1% for the next three years.

At the same time, newsprint production capacity is coming out of the pipeline with very little new capacity coming online. Producers plan to shut or convert an estimated 335,000 mtons of newsprint capacity in 2000, in addition to the 360,000 mtons permanently retired in 1999.

Canadian newsprint capacity is expected to rise slightly (0.6%) to 9.93 million mtons in 2000 from 9.87 million mtons in 1999, according to the Canadian Pulp and Paper Assn. (CPPA). The CPPA keeps capacity on its books for 12 months unless the machine has been dismantled. U.S. newsprint production capacity is projected to decrease slightly (0.2%) to 7.39 million mtons from 7.41 million mtons in 1999, according to the American Forest & Paper Assn. (AF&PA).

Only one new newsprint machine is on tap for North America at Inland Empire Paper Co. of Spokane, Wash. The company said the 205,000 mtpy machine-which will replace an existing 90,000 mtpy machine-is expected to come online by October 2000.

Trends. Finally, industry observers said they expect to see consolidation continue, either through mergers among large newsprint producers or through large producers acquiring smaller operators or stand-alone mills. For example, Smurfit-Stone Container Corp. is still seeking buyers for its two remaining newsprint mills in Oregon City, Ore., and Pomona, Calif. The Newberg, Ore., mill was sold in November to the former Southeast Paper Manufacturing Co.-now SP Newsprint Co.-of Dublin, Ga. The top five producers control just over 60% of North American newsprint capacity, compared with about 44%t 10 years ago.

CONTAINERBOARD

Shutdowns help stabilize market in 1999; prices could continue to rise in 2000

The turnaround put prices at their highest level by yearend 1999 since January/February 1996. The average kraft linerboard price for 1999 was en route to hit $390-$400/ton, just above the five-year average price of $395/ton.

The market firmed because of the reduced supply line and steady demand for corrugated boxes in the U.S. By October, U.S. box shipments were up 1.3% over 1998 levels, according to the Fibre Box Assn. By November, U.S. integrated producers implemented about 11% to 13% increases for their boxes during the year, based on reports from public companies. Two box increases were implemented starting in the spring and in August.

Prices for kraft linerboard and semichemical medium remained unchanged for five months, from July through November, and were expected to be unchanged heading into 2000. The last time prices were unchanged for six straight months was in 1995.

The stability in the U.S. market coupled with a weak market for U.S. exported kraft linerboard in Asia and Europe throughout most of the year. U.S. producers implemented one price increase in Asia and one increase in Europe last year. However, U.S. linerboard export shipments hit their lowest level in more than three years last October: 204,500 tons. Usually, the U.S. exports about 300,000 tons/month offshore. However, the weak export market didn't impact the domestic U.S. market since box demand was steady and the economy was growing at an annual rate of more than 3% through October.

This stability in the U.S. market was a goal of SSCC, which shut four mills with capacity of 1.075 million tons at the end of 1998. Two more mills and two machines were shut indefinitely by International Paper Co. (one mill and one machine), Packaging Corp. of America (one machine), and a joint venture SSCC-Four M mill in Florida. In total, 2.2 million tons of U.S. containerboard capacity was permanently or indefinitely shutdown.

Spring increase? Heading into 2000, producers were concerned about a 2% increase in inventory in September and October, months when inventory usually declines. Three majors (SSCC, Georgia-Pacific Corp., and Norampac Inc.) planned to take 100,000 tons of market-related downtime in November and December. Producers also were divided on whether there would be a subtle increase in demand for boxes because of possible Y2K stockpiling or if inventories might grow. In September and October, U.S. containerboard/box plant inventory increased by 2.5% or 65,000 tons to 2.66 million tons at the end of October. Producers were uncertain if a yearend push for consumer products and boxes would alleviate the buildup.

FIGURE 9: Prices rose 25% in liner.

In late 1999, Matthew K. Berler, an analyst with Morgan Stanley Dean Witter in San Francisco said containerboard prices "should remain on a recovery track" possibly through 2001 as long as inventories were controlled below trendlines. He said the market also would benefit from minimal new containerboard capacity in the U.S. and continued improvement in global economic growth in 2000.

Several producers alerted customers to the possibility of a price increase on kraft linerboard and semichemical medium sometime from March through May 2000. If an increase was proposed and implemented in first-half 2000, it would be the third combination increase in 16 months. Some majors even talked about holding off on an increase until second half because of the uncertainties involving inventory and Y2K.

Some box buyers were concerned about the quick rise in board prices and discussed possibly looking at alternatives to corrugated or going after long-term guaranteed prices with suppliers. Others talked of hedging as a way to even out costs.

BOXBOARD

Little growth expected this year; folding carton market in transition

"Companies continue to struggle with competitive conditions in many packaging and converting markets," said Mark Wilde at Deutsche Bank Alex Brown.

The U.S. folding carton industry, in particular, has been experiencing some tough times recently, said Wilde. Through the first 10 months of 1999, the cumulative dollar value of folding carton shipments was down 0.2% although tons shipped were up 1.2%, according to the Paperboard Packaging Council.

Carton producers and their paperboard suppliers are confronting more aggressive purchasing trends from North America's largest consumer products and food distribution companies. Many of these customers have forced price concessions, which has reduced profitability in the folding carton industry and opened the way for consolidation and rationalization.

Last year, for example, Graphic Packaging Corp. acquired the folding carton and recycled paperboard mill operations of Fort James Corp. Graphic Packaging has emerged as the folding carton industry's largest player. Also, Westvaco Corp. purchased the Inland Eastex bleached paperboard mill in Texas for $625 million and acquired Mebane Packaging Group, a leading independent supplier of folding cartons to the pharmaceutical industry.

Grade shifts. Carton manufacturers and paperboard suppliers are bracing for another year of competitive pricing among solid bleached sulfate (SBS), coated recycled boxboard (CRB) and coated unbleached kraft (CUK) boxboard. In recent years there has been a shift away from premium priced SBS to recycled and unbleached kraft grades. Since 1987, SBS has seen its share of the folding carton market decline from 38% to 31%.

Figure 10: CUK prices to rise in January.

Market pricing for folding boxboard is driven both by fiber costs and paper mill capacity and production trends. After two years of weak pricing, boxboard producers pushed through a series of price increases in the third and fourth quarter of 1999. Most coated recycled board prices increased about $50/ton, moving transaction levels to about $540-$580/ton. SBS prices increased about $70/ton, moving to $820-$840/ton. Prices of bleached cup stock jumped more than $100/ton, rising to about $850-$900/ton for polycoated grades. Producers of coated unbleached kraft board planned to implement a $40/ton price increase by Jan. 1, which would raise transaction prices to about $710-$720/ton. Prices are forecast to remain stable in 2000 because little growth is expected in consumer products and food packaging markets.

Because there is still excess mill capacity in most segments of the boxboard industry, the only major capacity expansion is in the gypsum wallboard area, which has benefited from the recent boom in housing construction and remodeling. Republic Group Inc. will commission a new 220,000 tpy recycled paperboard mill at Lawton, Okla., to produce gypsum paper in the first quarter of this year. Also, Inland Paperboard and Packaging Inc. and Caraustar Industries Inc. have formed a joint venture to convert Inland's Newport, Ind., containerboard mill to lightweight gypsum papers. The capacity of the modified paper machine will be approximately 250,000-300,000 tpy and will be operational in the third quarter.