An upcycle in 1999 simmers in 2000 as paper grades face mixed markets; mergers continue

Outlook Still Favorable for North American Pulp and Paper Producers

As long as demand for printing and packaging papers remains firm, the paper industry should enjoy sustained growth over the next few years, say analysts and industry executives. Recently, the U.S. economy has shown slightly lower growth due to a rise in interest rates by the Federal Reserve. This has mainly affected the housing market and other interest-rate sensitive sectors like automobile sales. The U.S. economy should grow 3.5% to 4% during the second half of 2000, and basic demand for printing/writing papers and packaging papers should remain firm. The key to maintaining pricing stability will be to keep inventories in balance with demand, observers conclude.

In addition to the traditional sources of paper demand, the rapid expansion of the Internet has proven a boom to the printing and packaging papers sector. Dot-com advertising and marketing in newspapers and magazines has translated into demand for publishing papers. Internet sales have translated into demand for paperboard boxes and packaging materials. Dot-com public offerings and reams of related financial documents have translated into demand for printing and copying papers.

The U.S. paper industry enjoyed a good start this year, as reflected by first-quarter earnings. Richard E. Olson, chairman and CEO of Champion International Corp., reported record production of coated and uncoated papers at a number of the company’s mills in the first quarter. In addition to increased demand and higher prices for many of the company’s paper grades, Olson said a continued focus on cost reduction also contributed to the quarter’s strong earnings.

"Given the positive global economic outlook and the low announced industry capacity growth for this year, we are optimistic about the company’s earnings potential for the balance of 2000," he said.

Champion later became the highly-coveted target of a takeover battle between International Paper Co. and UPM-Kymmene Corp. of Finland. In the end,IP won the contest, offering $7.3 billion in cash and stock to acquire its rival. As part of the deal, IP also agreed to assume about $2.3 billion of Champion’s debt. The merger gives IP about 33% of the North American office papers market and 22% of the coated publication papers market. IP is now the world’s largest producer of pulp, paper and paperboard with over 20 million tons of capacity, including papermaking operations in the U.S., Canada, Brazil, Poland, and Russia.

The desire for industry consolidation spurred several other key mergers this year. In March, Consolidated Papers Inc. agreed to a merger with Stora Enso Group of Finland for $4.8 billion. The combined enterprise will be a major force in the coated papers market in both Europe and the U.S., where Consolidated Papers has long been the leading North American supplier of magazine papers. Smurfit-Stone Container Corp., which was formed by the 1998 merger of Jefferson Smurfit Corp. and Stone Container Corp., purchased St. Laurent Paperboard Inc. in May for $1.4 billion. With this acquisition, Smurfit-Stone added high-value white top linerboard grades to its product line, which is now more than 7.5 million tons of production capacity. Abitibi-Consolidated Inc. this year acquired rival Donohue Inc. for C$7.1 billion, creating the world’s dominant newsprint producer.

Paper industry executives stress cost savings and other benefits that come from mergers, but leveraging production capacity is also a major benefit. This ultimately adds stability to the market, which should benefit all producers in the long term, say analysts. Both the mergers of Smurfit-Stone Container and Abitibi-Donohue were followed by announcements of capacity rationalizations. The IP-Champion merger was widely expected by analysts to lead to further rationalization in North America’s paper sector.

STRONG MARKET SOFTENING. After three linerboard and corrugating medium price increases and one medium-only increase in the last 16 months, the U.S. containerboard industry in mid-2000 was on the verge of a possible drop in prices because of weak box volume and high inventory.

Through May, the U.S. containerboard inventory at box plants and mills totaled 3.04 million tons--471,600 tons more than the May 1999 inventory total when the market was firm and prices were rising. The inventory grew because producers made about the same amount of containerboard through the first five months this year as they did in the first five months of 1999. In addition, box volume in fourth quarter was up almost 3% over fourth-quarter 1998 box volume, and buyers stocked up containerboard in front of price increases in February-March. Box sellers also believed that second quarter box volume was hurt by a cooling economy and the growing U.S. trade deficit.

Box shipments did not grow through May compared with 1999, and linerboard exports declined 51,700 tons. U.S. exports were hampered through the first quarter by weakness in the Latin American banana business and in Europe.

Due to the slow box business, containerboard producers planned extensive downtime in June and July, totaling about 358,000 tons. In June, one-fifth of North American containerboard mills--a total of 22--planned downtime. Several representatives from companies hoped the outages would reduce supply and hold up pricing levels until mid-August when box demand seasonally takes off at its highest volume of the year through October.

Second quarter prices for 42-lb unbleached kraft linerboard were $470/ton to $480/ton in the U.S. East and prices for 26-lb semi-chemical medium were $455/ton to $465/ton. Mottled white linerboard was at $620-$630/ton in the East.

On the recovered paper side, U.S. prices for old corrugated containers (OCC) were driven up to their highest levels since 1995 because of strong demand from China and South Korea. The high OCC price in the U.S. pinched margins for 100% recycled content linerboard and medium producers, but didn’t impact the actual market prices for linerboard and medium.

The U.S. average OCC price started increasing in January, moving up to $81/ton f.o.b. seller’s dock. From there, the price jumped to $124/ton by May before falling to $113.50/ton in June. Further price erosion was occurring in July on the West Coast.

For containerboard exports, U.S. prices to Hong Kong for lightweight linerboard increased by $60/mton in first half 2000, but business slowed in June. The 125-g grade was going for $510-$520/mton (c&f) to Hong Kong. Two U.S. companies dropped their export linerboard prices to Mexico by $20/ton in May, and others dropped their prices in Europe in June. The June c.i.f. price for U.S. 175-g linerboard to Northern Europe declined $7.50/mton to $490-$510/mton. The U.S. c.i.f. price for 175-g to Northern Europe was up $25/mton since January.

Producers in North America implemented a $50/ton increase on 42-lb unbleached kraft linerboard and a $60/ton increase on 26-lb semichemical corrugating medium in two parts in February/March. The increase was implemented despite a total containerboard inventory of 3.1 million tons at the end of February.

U.S. corrugated makers implemented three box price increases since March 1999. The latest one started at the end of March and into early April and called for increases ranging from roughly 8% to 10%.

The price increases paid dividends for box makers. The value of corrugated shipments through May was up 20% over the value of shipments through May 1999, according to the Fibre Box Assn. In total, the value of the shipments through May was $9.98 billion--$1.65 billion more than the shipments value through May 1999, according to FBA.

PRICES RISING IN TIGHT MARKET. Although 1999 was a difficult year for newsprint producers in North America who watched their profits shrink as prices plummeted to five-year lows, higher newsprint consumption, and two in-place and one planned $50/mton price increases have made for a much healthier 2000.

This year the market has reflected higher consumption by U.S. dailies with lower inventories on both the buyer and producer sides. In recent months, North American producers have reported full order books—cementing two $50/mton price increases that were implemented in October 1999 and April 2000. Another $50/mton price hike was scheduled by major producers to be effective Sept. 1.

In sharp contrast to 2000, newsprint prices tumbled between December 1998 and June 1999 by $125/mton to $480/mton in the U.S. East. This was despite relatively healthy demand from U.S. daily newspapers, the largest newsprint-consuming group in the world.

Price hikes in October and April lifted mid-2000 newsprint price levels to $560/mton on both the East and West Coasts. The planned September increase is expected to raise U.S. prices to just over $600/mton, the highest level in four years.

The market turnaround was assisted by a dot-com advertising boom during the second half of 1999. Newsprint consumption in U.S. dailies started 1999 in a fairly strong fashion, and consumption continues to be strong into late summer 2000, with shipments through April up 5.1% (262,000 mtons) from the year-ago period. The strength in demand is coming from all sectors.

Also in the latter half of 1999, Asian economies began recovering and newsprint demand in the region picked up again, resulting in a decrease in imports to the U.S. In addition, strong North American demand in 2000 has decreased overseas exports from the U.S. by 19.3%, and from Canada by 11.7% from the end of May 1999, according to the Pulp and Paper Products Council (PPPC).

In the wake of its acquisition of Donohue Inc., newsprint giant Abitibi-Consolidated Inc. announced it plans to remove approximately 400,000 mtpy of high-cost newsprint capacity in North America. The figure did not include the 115,000 mtpy of newsprint lost with the conversion of the Donohue’s Lufkin, Texas, mill to specialty groundwood paper. This should further tighten an already cramped newsprint, paving the way for a smooth Sept. 1 price increase, especially since there are no new newsprint machine start-ups planned for this year.

With end-of-May operating rates in Canada at 94% and in the U.S. at 92%, producers in June were reporting no planned production downtime.

Although demand for North American newsprint remains strong into the end of June, it is expected to drop off as the year proceeds. One factor that may lead to a downshift in consumption is that the dot-com economy is showing signs of slowing down. In addition, the year-ago comparisons will be tougher later this year, as there was something of a surge in consumption late last year.

In May, North American mill inventories were at 433,000 mtons, while total demand was at 1.084 million mtons. Production remained up from last year by 1.9% at 1.294 million mtons. Publishers are reporting an inability to build inventories, which, in May, stood at about 883,000 mtons in the U.S.

With the spring price hike in place, and the market still tight, both buyer and producer sources are predicting the planned Sept. 1 price increase will go through entirely. In addition, several sources on both sides reported they expect yet another price increase during the second quarter of 2001.

PULP IN BALANCE. Market pulp emerged in 1999-2000 as perhaps the most balanced sector within the pulp, paper, and board industry. Following a significant number of mill closures in 1998-2000--many in the U.S. related to the Cluster Rule—renewed demand worldwide served to tighten markets and drive prices upward. A key barometer of the pulp market--inventory levels of North American and Scandinavian (Norscan) producers--in May 2000 hovered at a very low 1.2 million mton level. Market analysts have identified a level of 1.5 million mtons to be a threshold for Norscan supply/demand balance.

Market pulp business sources in mid-year reported an extremely tight supply situation, with many mills simply unable to build up stocks due to almost panic buying in the second quarter.

Prices for benchmark northern bleached softwood kraft (NBSK) pulp are slated to rise to $710/mton in July, up 31% from $540/mton a year earlier, according to Pulp & Paper Week. This year’s market is inevitably compared with the mid-1990s, when NBSK pulp prices rocketed to near $975/mton in 4Q 1995, leading to inventory-building and capacity expansion that caused prices to plunge to $505/mton by 2Q 1996.

Key closures of pulping lines in the U.S. related to Cluster Rule pollution regulations led in 1999 to the first reduction of pulp capacity in North America since the mid-1980s. Shutdowns included pulping operations at Belgravia Paper Co. in Pasadena, Texas, Kimberly-Clark Corp. in Mobile, Ala., and Donohue Inc. at Sheldon, Texas. U.S. market pulp supply is expected to remain tight although Mead Corp. converted a paper machine in Maine to market pulp production and Willamette Industries Inc. acquired a previously idled mill in Georgia and planned to restart it later in the year. Several other mills in North America and worldwide were adding incremental new capacity this year such as Tembec Inc. in Quebec and Slocan Forest Products Inc. in British Columbia.

Still, a "mismatch" between global capacity and global economic growth is expected to continue to push market pulp prices higher into 2001, said Pulp & Paper Forecaster. Following the Asia financial crisis in 1997, several planned pulp mill projects in Indonesia and Southeast Asia failed to receive financing. New paper machines in China and the integration of paper capacity in Indonesia have further increased Asian pulp demand. Even new large pulp mills planned in Europe and Latin America have not disturbed a positive forecast for the market.

Market pulp suppliers have won a level of customer approval for a moderate pace of price increases, with three hikes so far in 2000 all implemented in a quarterly timetable. Yet the inability of papermakers to pass on higher pulp costs continued to concern industry players and an increasing amount of printing/writing paper mills were taking production downtime worldwide in order to balance their own inventories.

UNCOATED FREE-SHEET SLIPS. The mixed fortunes of the paper industry in 2000 were reflected in the uncoated free-sheet (UCFS) paper market, where prices lagged despite higher market pulp costs and corporate consolidations that were expected to lead to producer discipline. The U.S. uncoated free-sheet market ended 1999 substantially higher than in 1998 thanks to several consecutive price increases that lifted levels to $880/ton to 900/ton for 20-lb cut size repro bond by first-quarter 2000. But markets weakened in May as demand softened, Pulp & Paper Week reported, with price levels dropping to about $860/ton at the end of the second quarter.

A strong U.S. economy, higher employment, and a reduction in white paper imports from Indonesia and Europe helped strengthen the domestic UCFS market, yet the sector in 2000 stumbled in its ability to pass on still-rising pulp, energy, transportation, and other costs. Low North American capacity growth remained a key factor, although the global market faced new machines starting up in Europe and China in 1999-2000. According to AF&PA’s latest survey, U.S. uncoated free-sheet capacity is scheduled to increase 0.6% in 2000--adding 87,000 tons of new capacity--and remain essentially unchanged through 2002 at about 15.3 million tons.

One major new capacity announcement in the U.S. was by Willamette Industries Inc., which said it acquired a paper machine previously destined for Indonesia. Willamette plans to install the new PM to produce UCFS at its Kingsport, Tenn., mill in 2002, replacing two older, smaller units. The net increase in capacity was far from impacting current markets, yet the project strengthened perceptions that UCFS is an oversupplied grade.

In defending its strategy, Willamette said North American uncoated free-sheet capacity of 17 million tpy, and a single year’s growth in demand—at a rate of 1.5%--equals 235,000 tons, approximately the net addition with the Kingsport project.

Recent corporate mergers centering around white papers, notably UCFS, include IP’s acquisition of Union Camp Corp. in 1999 and of Champion International in 2000; Weyerhaeuser Co.’s buy of the large Dryden, Ont., mill from Bowater Inc., in 1998; and Domtar Inc.’s purchase of E.B. Eddy Forest Products Ltd., also in 1998. U.S. paper industry analysts said IP-Champion should do for UCFS what Smurfit-Stone did for linerboard—rationalize excess and high-cost capacity. The newer IP will have capacity for about 5 million tpy of UCFS and a 30% market share of the sector.

Despite some weakness in mid-year, UCFS operating rates were expected to move into the 95% to 96% range in second-half 2000 and 2001, leading to conditions that will favor more price hikes, according to Pulp & Paper Forecaster. The outlook is based on a projection for demand growth of 3% in the U.S. as well as a slight net decline in capacity over the next two years.

COATED MARKETS CONTRAST. Coated paper statistics in mid-2000 did not indicate market strength yet conditions appeared to be supporting a July price increase of $40/ton on coated free-sheet grades. The price of benchmark No. 3 60-lb rolls is expected to rise to about $980/ton to $1,000/ton.

In 1999, the coated free-sheet market began to recover from a difficult 1998, when prices for some grades were at their lowest levels in more than a decade. Keeping prices depressed was excess capacity at U.S. paper mills, rising imports, and low pulp prices.

Some capacity closures, lower imports, and higher pulp prices led to a series of price increases, yet coated free-sheet shipments were markedly down in April and inventories rose. Sources in mid-year said however orders were strong and advertising, publishing, and printing conditions remained strong.

Many in the coated sector were voicing concern about a proposed 14% postal rate increase for commercial magazines that would take effect in 2001. In denouncing the proposal, the Magazine Publishers of America (MPA) told The Wall Street Journal that the hike could cost the industry $300 million.

Industry sources said the MPA likely would seek a reduction in the amount of the increase but if approved, the hike could push publishers to lighter basis weights of coated free-sheet or even to lightweight coated (LWC) groundwood papers. A source at a large magazine publisher said they likely would move from a 55-lb to a 50-lb No. 3 in the event of a postal increase. Other sources said catalog publishers might reduce the number of copies mailed or publish on the Internet.

Capital Spending Uptick. Improved pricing and profits for most major industry pulp and paper grades is leading producers to look to much needed modernization and expansion work at North American pulp and paper mills. Spending levels remain modest by historical standards, but capital spending in 2000 by North American pulp and paper companies appears headed up for the first time in over three years, according to data compiled by Pulp & Paper Project report. Capital expenditures through first-quarter 2000 show an increase of 2.6% to $7.3 billion, an increase of $187 million over the prior quarter. Data are based on current company spending estimates using a four-quarter rolling total. Expenditures in calendar year 2000 will also increase based on current data, totaling more than $8.3 billion, an increase of $1.2 billion or 16.8% over 1999. Actual spending for the year is typically less than estimates as companies adjust their spending plans during the year in response to market and financial conditions. Nevertheless, while actual spending on capital improvements in 2000 may be less, it appears probable that the downward spiral spending trend will be reversed.

Companies recently reporting higher spending levels were Georgia-Pacific Corp., and Boise Cascade Corp. Weyerhaeuser Co. was the only company to note a significant decrease in estimated spending for 2000, according to recent reports. The data are based on spending reported by 35 North American companies.