Pulp & Paper Forecaster report predicts that strong demand growth and capacity restraint will lead to strong markets, but some ups and downs are likely

Five-year Paper Industry Outlook Bright If Capacity Growth Remains Restrained

Pulp & Paper: Markets are strengthening right now and are the best the industry has seen in some time. Will this continue in the short term?

Schaefer: I continue to see conditions coming into place that will fuel a strong recovery in operating rates and product prices during the next two to three years. Worldwide, the combination of limited capacity growth and a rebounding world economy will push operating rates and prices higher, especially in 2001. The U.S. dollar is expected to weaken, which will also pull up dollar-denominated prices.

The world economy will continue to gain momentum going forward. Just as important to the forecast—and subject to less risk—is the very positive capacity outlook for the next two years. For these reasons, the likelihood of a sustained rally in pulp and paper prices appears better now than since the 1994-1995 boom.

Since 1980, the underlying trend in growth rate of demand for paper and paperboard has been approximately 3.3%/yr. Given the improving conditions in overseas economies, growth in demand is likely to be somewhat higher than this 3.3% figure in both 2000 and 2001. Thus, we see the worldwide operating rate moving up to a strong 93.5% by 2001.

P&P: What are some of the key factors affecting the longer term outlook?

Schaefer: A key issue will be how producers respond to the rising operating rates and prices. Will they be less willing to add new capacity than in the past? It is my view that they will.

However, much of the capacity idled in recent years has not been dismantled, and so it remains available to be re-started when market conditions improve. The assumption is that this will occur in a number of cases, but generally not until 2001 or 2002. Thus, I expect capacity growth for paper and paperboard in the U.S. to be limited to 1.1% in 2000, and operating rates will remain relatively high during the next five years.

Another major issue is the effect the Internet will have on paper consumption in North America. I believe the effect will continue to be mixed and that consumption of communications papers will continue to trend upward in the next five years, but at a slower pace, setting the stage for further improvements in 2000.

Printing and writing imports will continue to gain market share, and the overall growth of exports will not be as strong as in the past.

P&P: What are the major risks to a sustained recovery?

Schaefer: The forecast described above depends on the general economic outlook for the U.S. and Canada. The outlook for both economies remains positive, but the risks on the downside are substantial. Inflation is a growing risk but should remain more subdued than would otherwise be the case considering the strength in the economy. With interest rates moving upward but not dramatically so, it’s expected that the U.S. economy will decelerate but not move toward a recession, making this a “soft landing” scenario.

Economic strength overseas should boost exports, thus strengthening the overall manufacturing sector as well in 2000 and 2001. The business investment outlook is also positive. The current wave of innovations in computing and telecommunications has sparked a massive and sustained bout of investment in new capital goods by businesses. Given the huge expansion of interest in e-commerce recently, this wave of investment is assumed to carry forward for at least the next two years. A sharper downturn in the U.S. economy is expected to occur in 2002.

FIGURE 1: Over the next five years, U.S. paper and board production and demand will expand modestly.

A key projection is that the U.S. dollar will drop significantly in value relative to other key currencies, especially the Euro and the Canadian dollar. The unwinding of strength in the U.S. currency will be a solid, positive factor for dollar-denominated prices.

P&P: Will costs rise for producers?

Schaefer: Contributing to higher product prices will be higher fiber prices. Market pulp prices are heading higher, propelled by economic recoveries overseas and many capacity withdrawals. Recovered paper prices will also move higher as paper and paperboard operating rates pick up here and overseas, particularly in Asia.

P&P: What does the trade picture look like for the next five years?

Schaefer: I sense a shift underway in how some producers view the long-term appeal of producing for export markets. In terms of consumption of paper and paperboard, the North American market is clearly mature, with growth rates slowly trending downward for many grades. Thus in some grades, such as linerboard, the likely strength of the export market will be an important consideration in justifying a new project. The problem is that in recent years, the export market has been less favorable for North American producers than many expected, which may be causing perceptions to change.

In the case of kraft linerboard, for example, exports to Asia dropped sharply after the Asian economic crisis began, as U.S. producers were undercut in price by local, low-quality testliner. Until this happened, it was widely believed that the undisputed quality advantage that U.S. linerboard has over Asian linerboard would support export levels and prices. Following this experience, it is reasonable to question the degree to which foreign consumers value higher quality product, especially during troubled economic times. This suggests that from the perspective of North American producers, export markets may be riskier and less lucrative over the long term than had previously been believed.

P&P: Newsprint demand has recovered recently. Will this continue?

Schaefer: Newsprint consumption has been healthy during the past two years, but this is not surprising in light of the exceptionally strong performance of the U.S. economy. However, newspapers continue to face two key, long-term problems: slipping readership and threats from online advertising. In the U.S., circulation will continue to decline, pulling down newsprint consumption during the next five years. Consumption is projected to drop slightly in 2000.

The threat to the “cash cow” that is newspaper classified advertising is quite real. The early signs of this effect can already be seen in the quarterly classified advertising revenue data for 1999. Despite a booming economy, both the recruitment and real estate categories showed surprisingly low growth on a year-over-year comparison.

The projection continues to be that once the economy returns to more normal conditions, newsprint consumption will resume it’s downward trend. Thus, I look for more capacity closures or conversions, especially in Canada.

P&P: Will printing and writing grades continue to prosper or will the Internet slow or stop growth?

Schaefer: The outlook is favorable for stronger markets through both the short term and the entire five-year forecast horizon, despite the rapid developments on the Internet and in other electronic media. I view the current upturn in the printing and writing market to be in the early stage of a two- to three-year cyclical upswing. The current recovery is being fueled by a global economic recovery combined with a marked tapering off of capacity expansion worldwide. The chances are good that global printing and writing operating rates, as well as prices for these grades, will rise through the next two years, as has been projected for some time.

Printing and writing paper demand will rise in all major grades in the U.S. during the next five years, but the rate of growth will generally slow. The Internet and related developments clearly pose a substitution threat for publication-grade papers. This is likely to show up as further slippage in end-use factors, as indicated in the amount of paper consumed per billion dollars of GDP. At the same time, however, my view is that the Internet will continue to have positive effects on the overall economy and that this will provide an indirect boost to paper consumption.

The Internet and the e-commerce movement it is fostering are leading to substantial productivity gains in the economy, which allows for a greater rate of sustained economic growth than would otherwise be the case. My view is that solid growth in living standards will continue to translate into rising paper consumption in the U.S. during the next five years, despite the slippage in end use factors.

For coated papers, the long-term growth outlook in the U.S. remains positive but is certainly more muted than in the past. Despite the spreading of the Internet revolution, I am projecting that there will not be abrupt and dramatic declines or changes in coated paper consumption during the next five years. Instead, I anticipate the continuation of the two major long-term trends in coated paper demand.

First, coated paper demand in the U.S. has been trending upward, but decelerating as key end use markets mature. Second, coated free-sheet is commanding a growing share of the coated market, and this is also expected to continue. For example, coated groundwood has been steadily losing market share to coated free-sheet.

For uncoated free-sheet, the consensus view has long held that the demand for uncoated free-sheet, especially cut-size paper, is not threatened by developments in electronic media. This has been and remains my view as well, and the projections include an upward trend in uncoated free-sheet consumption in the U.S. during the next five years. Still, uncoated free-sheet demand in the U.S. is showing clear signs of maturing. The projected growth rate for uncoated free-sheet demand in the U.S. during the next five years, using apparent consumption, is 2.3%/yr.

For the next five years, my assumption is that little, new uncoated free-sheet capacity will be added in either the U.S. or in Canada. This largely reflects the pre-emptive effect of massive investments in uncoated free-sheet capacity in Asia.

Uncoated groundwood demand has grown quite rapidly during the past two decades, but in the 1990s, there has been a marked downturn in demand as key markets, such as inserts, matured. Most of the recent growth in demand has been for supercalendered paper, which is making inroads in catalog and magazine applications. Overall, demand should grow at a moderate rate of 2.3%/yr. during the next five years. Most of this incremental tonnage will be supplied by North American producers as newsprint machines continue to be converted to higher-quality uncoated groundwood production.

FIGURE 2: Total U.S. paper and board exports will slowly expand, while the surge of imports eases overall.

P&P: Advertising revenue is crucial to many print products. What impact will the Internet have on print-based advertising?

Schaefer: Advertising of all sorts, including print media, will be strong throughout 2000. The Internet is creating new buyers as well as sellers. The good news for print media is that the development of e-commerce means advertising will be stronger overall in the next five years. The bad news is that the Internet will put downward pressure on print media’s market share. As noted, newspapers face the most immediate threat, while direct mail and magazines should be less affected.

However, in the latter part of the forecast period, the risk of displacement will grow, notably for products such as catalogs and direct mail. For example, online shopping will certainly continue to explode in the future. Currently, consumers use print catalogs and online catalogs as complimentary products to order goods. The threat is that it’s likely people will increasingly use only electronic catalogs and cease to use paper-based catalogs at all.

P&P: Will traditionally steady growth in tissue continue, and what impact will there be from all the current new capacity?

Schaefer: Consumption will continue to trend upward in North America, but accelerating capacity growth will lead to some slippage in operating rates. Overall, I’m projecting a rise in U.S. tissue new supply (a proxy for demand) of about 1.9%/yr. during the forecast period.

To produce this additional output, the industry will have to add a considerable amount of capacity in the next five years. This means that tissue will continue to be the one paper grade in the U.S. that is active in terms of adding new paper machines.

I anticipate that the market environment will not be quite as favorable to producers going forward as it has been in the past five years. The last three years have seen a significant acceleration of capacity expansion.

P&P: The recent rapid economic growth has benefited containerboard grades. Is this expected to continue?

Schaefer: The long term outlook remains bright for corrugated shipments, meaning strong gains in containerboard consumption. Box shipments have trended rather steadily upward, with growth averaging about 2.7%/yr. since 1970.

Key factors affecting this part of the market include a healthy economic outlook in the U.S. and a number of product related issues, such as increased displacement of folding cartons by mini-flute corrugated boxes; substitution of plastics for paperboard boxes; and the coming rebound in overseas economies. And finally, the Internet will boost demand for packaging.

Export demand for U.S. linerboard is also on a longer-term upward course, so there will be competing demands for tonnage. The containerboard market will become extraordinarily tight in the later years of this forecast unless new domestic capacity is added. The incentives to add new machines will be very strong.

P&P: What is the outlook for folding boxboard grades?

Schaefer: Boxboard is a growing market, but its underlying trend rate of growth is modest. In the past several decades, demand has trended upward at a rate of slightly more than 1%/yr. The slow rate of growth is largely due to the maturity of the end-use markets that it serves and pressures from competing packaging materials.

Slow capacity growth points to higher prices during the next several years. In addition, the longer-term outlook for boxboard includes rising prices in both nominal and inflation-adjusted terms, with a key driver being low capacity growth.

In the folding carton market, I anticipate a marked slowdown in domestic demand during the next five years, with the average annual growth rate dropping to below 1%. Contributing to the longer-term downshift in folding carton demand is the fact that consumer spending in the next five years will not match the performance seen in the past five years. Finally, I expect that competing packaging materials will continue to weaken folding carton demand.

P&P: Market pulp prices have staged a remarkable recovery in the past year. What is the outlook?

Schaefer: The long-anticipated market pulp upswing finally occurred during 1999, due to a combination of factors. The issue of capacity has been critical, since not only did capacity growth slow, but actual net capacity withdrawals occurred in North America.

Against this backdrop, the current five-year forecast for market pulp is generally quite positive for producers. Capacity is expected to be relatively tight, and, coupled with expected long term gains in demand globally, should mean that producers will hold the upper hand.

Of course, a key variable is the future of idled capacity in North America. My forecast takes a middle of the road approach, assuming that some of this capacity will come back online given the strong price forecast, but that a considerable amount of the shutdowns are permanent.