Despite indications of an economic slowdown, consolidation and tighter controls on capacity will help industry weather 2001

More Discipline, Supply Management Critical to North American Stability

Also causing concern are higher oil and energy prices, and the strength of the U.S. dollar versus a weak Euro, making it harder for North American producers to increase exports and achieve dollar-based price increases. The currency imbalance has also attracted paper imports from producers in Europe and Asia.

In the wake of rising interest rates, economic growth in the U.S. slowed to an annual rate of 2.4% in the third quarter of 2000, less than half the 5.6% growth posted in the first half of the year and the lowest pace in four years. Meanwhile, the Canadian economy has been expanding at twice the rate of the U.S., growing 4.8% in the third quarter of last year. But the U.S. slowdown will have a cooling effect on the Canadian economy, which ships about 85% of its exports to the U.S.

Analysts say it is unlikely that the nation is heading towards a recession, but when economic activity begins to slow, prices come under pressure and firms begin to cut their expansion and investment plans. This may have a short-term impact on the paper industry, but most observers have a positive outlook for the year.

Analysts at Deutsche Banc. Alex Brown in New York wrote: "There are significant threats to the industry and domestic and world economies (oil prices, interest rates, strong dollar, weak Euro, high inventories, pulp prices rising faster than paper prices, etc.). However, we believe economies will remain strong enough to maintain adequate paper demand and a generally favorable environment for the industry."

The paper industry has generally shown that it is trying harder than in the past to behave in a more rational and profitable manner, mainly by managing supply. The low growth rates for industry capacity are in line with lower production volumes recorded in 2000 and low volume growth expected this year (Tables 1 and 2).

Pulp & Paper Forecaster estimates that total U.S. paper and paperboard volume will increase only 1.0% this year. This balance of supply and demand will benefit the industry in the long term, and maintain price stability in the short term.

The slower-than-normal pace is a positive sign that manufacturers do not want to be overly aggressive in adding capacity or raising prices that may benefit them in the short term but hurt prospects in the long term. Last year, prices remained fairly stable despite a slowdown in the domestic economy. Only lumber, gypsum wallboard, and structural wood panel prices dropped sharply due to overproduction and surplus capacity.

Continued consolidation of the industry also encourages market discipline. The latest news that Weyerhaeuser Co. is trying to acquire Willamette Industries Inc. represents another in a busy year of mergers and acquisitions (Table 3). More merger activity can be expected in 2001, which could lead to more efficiencies in mill operations and reduced industry volatility.

CONTAINERBOARD
Prices remain stable despite weak demand and exports

U.S. containerboard prices were en route in 2000 to end a year that amazed buyers and sellers alike because producers held prices unchanged for the longest-run in recent years--nine months, through November (Figure 1). The hold in pricing for 42-lb unbleached kraft linerboard at $470-$480/ton in the East Coast market was achieved despite a slowing economy in the third quarter, sluggish corrugated demand all of the year, and the weakest export market for U.S. linerboard since 1995.

Producers managed supply and demand by taking more than an estimated 2.47 million of market-related downtime or 7% of total capacity last year--an unusual market dynamic for the sector since prices were at their highest levels in four years. Almost one-quarter of the downtime was so-called 'slowback' of paper machines, rather than full shutdowns. Georgia-Pacific Corp. exec. Stephen Macadam outlined G-P's slowback strategy in September at the International Containerboard Conference in Miami. He said the strategy aimed at slowing a machine's output to better match demand, while also reducing costs for materials, energy, and labor. For decades, the industry has run machines almost full-out regardless of market conditions in a production-focused strategy. By year-end 2000, several companies along with G-P were using slowback, including International Paper Co., Inland Paperboard & Packaging, and Packaging Corp. of America.

FIGURE 1: Containerboard prices (delivered in eastern U.S.) US$/short ton.

The result of the containerboard supply management was a record $24.2 billion in box sales in 2000 (an estimate based on box shipments through October). U.S. box prices are pegged off linerboard prices.

The outlook on linerboard pricing heading into 2001 was one of concern because of the cooling economy; a continued strong U.S. dollar that hurts kraft linerboard exports offshore, especially in Europe; the lowest prices in almost two years for old corrugated containers (OCC); and a box sector that lost business last year to offshore box makers as the U.S. trade deficit hit a record.

The key for U.S. containerboard producers will be how they continue managing supply from November through February-typically a low-volume box shipment and inventory-building period. Over the last five years, U.S. containerboard inventory on average grew 249,000 tons from the end of October to the end of February, with the February five-year average at 3.02 million tons (Table 4). At the end of October, containerboard inventory at U.S. mills and box plants was at its highest level in five years: 2.84 million tons. Traditionally, buyers and sellers consider the market firm when the containerboard inventory settles near 2.5 million tons. However, prices for linerboard and medium increased in February/March 2000 when inventory totaled an average of 3.04 million tons.

Producers managed supply with downtime last year as well as a commitment to no new capacity, although creep capacity was expected to add an estimated 1.5% to output. Only one new containerboard machine project has been announced in the next two years in the U.S. Solvay Paperboard LLC plans a new recycled corrugated medium machine at its mill in Syracuse, N.Y., in 2002.

Anna E. Torma, an analyst with Merrill Lynch, said U.S. producers still face numerous challenges from the strong dollar on the offshore market and from the addition of new capacity offshore, especially in China, the No. 1 export market for U.S. kraft linerboard. At least seven new containerboard machines with total capacity of 1.4 million mtpy are planned in the next two years in China.

"Economic slowdown may pose further challenges," Torma explained at the Global Outlook conference in New York City in November. "Additional capacity withdrawal may be required. Structural changes and long-term trends should support longer-term stability. Markets will not reward the industry until success is proven."

RECOVERED PAPER
Weak box market, export slump sinks prices

U.S. prices for recovered paper spiked last summer near their highest levels in five years before cascading down in the second half of the year. Prices were expected to remain at year-end 2000 levels in first quarter 2001 and possibly longer, buyers and sellers said in December. The biggest fall last year on pricing was on OCC-which is the largest volume material, representing 50-55% of total recovered paper volume consumed annually by U.S. paper and board mills. The U.S. average f.o.b. seller's dock price for OCC peaked at $124/ton in May and ended the year at its lowest level in 23 months: $42/ton.

The fall in OCC was driven by sluggish U.S. corrugated demand that caused North American containerboard mills to take an estimated 2.4 million tons of downtime.

Other grades also were hit hard with price drops in the second half last year. Pulp substitute hard white envelope cuttings were down $90/ton from June to the end of the year at $310/ton. Deinking materials such as sorted office paper (SOP) and sorted (postconsumer) white ledger fell in the mid part of the year, and news grades finally softened in price at year-end. At year-end, U.S. averages were $109/ton for SOP, $69/ton for old newspapers (ONP) No. 8, $27/ton for mixed paper, and $176/ton for SWL.

Suppliers of recovered paper and mill buyers in the U.S. expect a possible turnaround in pricing and demand in late March or early April 2000 when U.S. newsprint and containerboard mills usually run their machines hard heading into the first demand-pickup period of the year. Market pulp prices also were expected to soften in the first quarter, restraining pulp substitute prices.

A key factor affecting U.S. market prices has been and continues to be export market demand. If export demand picks up significantly in early 2001, it could hoist up prices for recovered paper in the U.S. The U.S. prices were partly driven up in May and June 2000 because of strong demand from the rapidly-growing paper industry in China, as well as Canada, South Korea, and Mexico.

In 2000, the U.S. was on track to export a record 10.2 million tons of recovered paper, up 19% over 8.5 million tons in 1999. The top markets were Canada (No. 1), China (No. 2), South Korea (No. 3), and Mexico (No. 4), based on U.S. Dept. of Commerce statistics through September.

The export market, especially to China, is expected to remain a solid, growing region for U.S. tonnage. More than seven new containerboard machine projects are planned in China in the next two years, and the machines will count mainly on recovered paper for furnish.

MARKET PULP
Producers manage supply to temper rising inventories

The global pulp market is expected to weather a short-term dip in demand early this year, but could defy negative market factors and see prices rise again by the middle of 2001, according to industry watchers. Complaints about spot-market price discounts, the euro's weakness compared to the U.S. dollar, continuing sluggish demand in Asia, and reports that the U.S. economy is slowing are being countered by an unprecedented move on the part of pulp producers to cutback production before prices decline.

Also unprecedented is that list prices for benchmark northern bleached softwood kraft (NBSK) pulp remained at $710/mton from July through December, following a string of quarterly price hikes. A price hike announced by some producers in October was cancelled,yet prices held stable partly due to proactive market-related downtime by producers worldwide.

North American/Scandinavian (Norscan) market pulp inventories, drifting at or below the threshold 1.5 million mton mark since March 1999, reflects newfound discipline on the part of North American market pulp producers, who in the fourth quarter took curtailments of at least 350,000 mtons.

Reports that the worldwide economy and international trade will continue strong, if not record-breaking growth, may not solve the continuing problem with U.S.-European currencies, however. The weakness of the euro has pushed prices for North American market pulp in Europe to new heights, seriously impacting the margins of papermakers who were not able to raise their prices accordingly. While the euro rose in late 2000 to about Euro/US$.878, North American producers still complained that it had dampened the export market. In addition, the industry may be impacted by a 6.0% capacity increase in 2000 that included Willamette Industries Inc.'s re-opening of the Port Wentworth, Ga., mill that had been closed by Smurfit-Stone Container Corp. in 1998, and Mead Corp.'s conversion of a paper machine in Rumford, Maine, mill to produce market pulp.

Some producers downplay the significance of new capacity. At the Paper/Forest Products Global Outlook Conference in November, Bowater Pulp & Paper Canada president David Steuart said that despite industry concerns over capacity increases, "it is significantly less than the past 20 years average of per-annum capacity increases and a new generation of management is more willing to make changes" in managing their output.

That sentiment is backed by IP's plan to permanently cut 120,000 mtons of market pulp, about 7% of its capacity, out of its system. More significant is the willingness of producers to reduce production when trying to balance supply with demand.

However, spot tonnage, especially of hardwood pulp grades, are continuing to pressure list prices. Resource Information Systems Inc. noted this is due to "the more dire situation in the hardwood grades as compared to the softwood sector." Indonesian and Russian hardwood producers attempted throughout the year to sell their grades at any price but since they do not produce NBSK, the benchmark grade was able to maintain its relatively long-standing list. Even that may dip early in the year.

The first quarter of 2001 is considered the most susceptible time for list prices to drop, and it's uncertain whether the end-of-year prices will hold until March, when many market participants anticipate shipments to increase, bolstered by a return of Asian buyers and movement out of a slower winter.

PRINTING/WRITING PAPER
Mixed market stumbles into 2001 with higher prices

The North American printing/writing paper market saw mixed fortunes in 2000, with early price increases later eroding due to high imports to the U.S. and excessive mill and consumer inventories. Paper prices failed to rise at the rate of market pulp price hikes, squeezing the margins of printing paper mills, especially in Europe. The latter months of 2000 saw widespread downtime and an important announcement by superpower IP that it would close about 800,000 tons of U.S. uncoated free-sheet capacity.

Overall, 2000 was an improved year, with higher prices coming from a strong North American economy and increased advertising, some of it driven by internet companies. Yet the strength of the U.S. dollar continued to attract imports and hamper exports.

Slow demand growth remains a fundamental characteristic of the North American printing/writing market, but muted capacity growth and machine closures remain key to supply/demand balance in the industry, market analysts said. Incremental increases in U.S. demand will likely be fed by imports from Europe and Southeast Asia, the low cost producers of printing/writing papers.

Uncoated free-sheet. The U.S. uncoated free-sheet market fell into a downward slide in 2Q 2000, impacted by higher imports and over supply. A Sept. 1 price increase was only partially successful, but conditions were seen as favorable heading into 2001, especially with IP's plan to cut capacity.

Cut-size photocopy papers in particular have been strong, boosted by the increase in employment and the spread of home offices. Electronic media, instead of hurting paper demand, has led to higher paper consumption in some end uses. Yet the relatively mature uncoated free-sheet business has an uncertain demand outlook long-term.

Paper machine closures by IP and other producers are likely to be offset by new capacity from Willamette Industries Inc.'s planned new machine in Kingsport, Tenn., keeping capacity growth at a minimum.

Long-term pricing is expected to stay above trend levels, although a strong recovery from current levels appears unlikely (Table 5). U.S. uncoated free-sheet capacity is projected to remain essentially unchanged over the next two years, and then rise by 0.9% in 2003, with almost all the growth in that year attributed to the ramping up of Willamette's new machine, AF&PA reported. Over the 2001-03 period, uncoated free-sheet capacity is scheduled to climb at an average annual rate of 0.3%. This compares with an average annual rate of 2.0% in the previous ten-year period.

Coated papers. Coated paper markets were split in late-2000, with relative strength in coated groundwood contrasting falling prices in coated free-sheet grades. The strong advertising conditions that were benefiting the newspaper and newsprint sector also boosted magazine and coated groundwood. Meanwhile, the U.S. coated free-sheet market was hit by high inventories, strong imports, and a loss of market share to higher brightness (and favorably priced) grades of groundwood.

An expected slowdown in advertising and new capacity overseas will impact the coated paper market in early 2001, according to analysts. A U.S. postal rate increase effective in January was seen as pushing some catalog and magazine deadlines forward in 2000, leading to a small payback in 2001. Prices were expected to remain flat or increase slightly later in the year (Figure 2).

FIGURE 2: Publication paper prices (delivered in eastern U.S.) US$/short ton.

North American capacity growth is expected to be above average, with one key project being Bowater Inc.'s $182 million conversion of a 260,000 tpy newsprint machine at Catawba, S.C., to coated groundwood in two years. U.S. coated groundwood capacity over the 2001-03 period is expected to climb to 5.2 million tons, or 3.4% annually, according to AF&PA. The growth also includes the impact of Bowater's investments in U.S. coater facilities that will use newsprint as a base stock. Coated free-sheet capacity is expected to rise at an average annual pace of 1.5%, which compares with a 4.2% rate in the previous ten-year period.

NEWSPRINT
Strong 2000 market softens, but more capacity cuts loom

The year 2000 was "golden" for the newsprint business in North America, with prices climbing 16% by year-end. Yet analysts were forecasting a looser market and a slump in consumption in 2001 based on the projections for a slowing U.S. economy and downward turn in advertising lineage sales. In 2000, the newsprint market was able to recover from a precarious year in 1999, as producers successfully implemented two $50/mton price increases. Importantly, no new capacity came online in North America, and the economy remained healthy throughout the year. U.S. consumption by daily newspapers was strong through the first half of the year, but began to slip in the fourth quarter-nearly 4% on a year-over-year basis in October-reaffirming the belief that the market would slow as the year progressed.

Much of 2000 reflected strong demand and high operating rates in the North American newsprint market. Both publisher and producer inventories remained low throughout much of the year. An actual shortfall of newsprint was being predicted, and seemed imminent until the latter half of the year when consumption began to slump and publishers reported that they were able to find extra tonnage. The newsprint market slowdown did not keep major producers Abitibi-Consolidated Inc. and Bowater Inc. from announcing they planned a $50/mton, Mar. 1, 2001, price increase that would lift prices 8% from a year-end level of about $610/mton.

According to industry analysts, the key to the success of the March price increase is capacity management by producers. Abitibi-Consolidated, in particular, said it planned to cut newsprint capacity by 400,000 mtons by 2002. In addition, through conversions and permanent capacity shutdowns, analysts believe producers can offset the slump in consumption that is expected this year.

On the demand side, if publishers begin to replenish their low inventories, newsprint demand is expected to remain strong in 2001. Demand is not expected to come from high newspaper circulation numbers, which showed a slight decline as of September 2000. A drop in dot-com advertising was also expected to contribute to reduced paper demand.

Offshore markets in 2001 are expected to be strong, especially in Europe, where buyers are trying to stock up on newsprint before an expected significant price increase was established for 2001. Due to strong domestic demand in North America through most of 2000, exports to offshore markets have declined or remained flat throughout the year. The preference for the domestic North America market is expected to continue in 2001, as U.S. newspaper publishers restock low inventories, and more capacity is taken out of the market.

BOXBOARD
Little growth expected; prices under pressure

The U.S. folding carton industry has experienced a tough 2000 as shipments of folding cartons for food products, beverages, pharmaceuticals, cosmetics and other houshold goods declined about 2%, according to the Paperboard Packaging Council in Alexandria, Va. Boxboard volume for all substrates-bleached and unbleached kraft and recycled board-was weaker in the fourth quarter than earlier in the year. Weak volumes not only reduced revenues and operating efficiencies at paper mills, but also forced mills to take downtime to maintain prices (Table 6).

John Dillon, IP's chairman and CEO said the company is monitoring its paper and packaging markets very closely and is determined to keep the company's production in line with demand. He said bleached board orders had dropped in the fourth quarter, but was hopeful volumes would return to more normal levels in the first quarter of 2001.

Carton manufacturers and paperboard suppliers are bracing for another year of competitive market conditions among solid bleached sulfate (SBS), coated recycled boxboard (CRB) and coated unbleached kraft (CUK) boxboard. After several years of weak pricing, boxboard transaction prices increased about 15% over the last two years, but the last bleached board price increase was only partially successful. Fiber prices played a key role in pushing up board prices last year, but if fiber prices decline then boxboard prices will follow. The short-term outook for bleached board pricing will be heavily influenced by market pulp prices, which are due for a market correction, say many observers. Prices of OCC and ONP have already declined, putting pressure on recycled board prices.

Prices are forecast to drop slightly in the first half of 2001, based on reduced demand and lower fiber prices. At the start of the year, average SBS folding cartonboard prices were approximatley $850/ton, recycled cartonboard prices were about $600/ton, and unbleached kraft cartonboard was about $750/ton.

There is still excess capacity in most segments of the folding boxboard industry. As a result, the only major capacity expansion is in gypsum wallboard.

U.S. CAPACITY
Industry continues slow pace of capacity growth

The current slow pace of U.S. paper and paperboard capacity expansion is expected to continue during the next three years, according to the AF&PA'S 41st Annual Survey of Paper, Paperboard and Pulp Capacity and Fiber Consumption released in mid-December (Table 7). U.S. paper and paperboard capacity increased only 0.6% in 1999 and 1.3% in 2000, compared with an annual average of 2.1% during the 1991 to 2000 period.

The survey projects capacity to rise at an annual average rate of 0.7% in the next three years, specifically 0.8% in 2001, 0.9% in 2002, and 0.5% in 2003. Capacity in the report includes some machines that have already been, or soon will be, closed, but do not meet the survey criteria for removal-namely, that mills and machines must be dismantled or closed for at least a year before their capacities are removed from the survey base.

Newsprint capacity is expected to decrease from some 7.4 million tons in 2000 to less than 7.0 million tons by 2003, for an average annual decline of 2.0%. This compares with an average annual growth rate of 0.9% during the previous 10-year period.

Printing-writing paper capacity is expected to rise by about 1.3 million tons in the 2001-2003 period, or an average annual increase of 1.4%. This compares with a 1.9% average annual increase during the 1991-2000 period. Uncoated groundwood capacity is expected to rise by 5.9% per year to over 2.4 million tons in the 2001-2003 time frame. Most of the expected growth is attributable to several producers shifting capacity from newsprint to uncoated groundwood, in addition to a machine rebuild.

U.S. coated groundwood capacity over the same period is expected to climb to 5.2 million tons, or 3.4% annually. This relatively rapid growth in part reflects a conversion from newsprint beginning in 2001. The expansion also includes the impact of Bowater's investments in U.S. coater facilities that will use newsprint as a base stock.

Coated free sheet capacity is expected to rise at an average annual pace of 1.5%, which compares with a 4.2% rate in the previous 10-year period. Uncoated free sheet capacity is projected to remain essentially unchanged over the next two years, and then rise by 0.9% in 2003, with almost all the growth in that year attributed to the ramping up of a new machine. Over the three-year period, uncoated free sheet capacity is scheduled to climb at an average annual rate of 0.3%. This compares with an average annual rate of 2.0% in the previous 10-year period.

Four new machines (two of which replace old machines) were added in the U.S. tissue paper sector during 1999 and several more came online in 2000. The survey anticipates three new machines starting up in 2001 and one in 2002. As a result, tissue paper capacity growth is projected to average 2.0% during the next three years (2001-2003).

Linerboard capacity fell 4.1% in 1999, but rose 1.8% in 2000, reflecting the startup of a new machine in late 1999 plus efficiency improvements. For the 2001-2003 period, the survey shows linerboard capacity remaining virtually flat, with an average annual growth rate of 0.1%.

Boxboard capacity is expected to grow slowly in the aggregate during the next three years, with the rate of expansion averaging 0.3% (2001-2003). However, the gypsum wall board facing segment is expanding due to a new machine that came online during 2000 and the shifting of two additional machines from other grades to wall board facings, one in 2000 and the other in 2001.

There are no new U.S. machines on the horizon with respect to other boxboard grades, such as folding and milk carton and food service, but there are several cases of machines shifting among the various boxboard grades or in and out of boxboard from other sectors of the industry.

A strong pulp market over the last 18 months led to a 6% upward revision for chemical grade market pulp capacity for 2000 in this year's survey compared with the estimate in last year's survey. The sector is slated to increase 4.0% each in 2000 and 2001. Market pulp capacity then will decline fractionally in 2002 and 2003. For the 2001-2003 period as a whole, capacity is scheduled to increase at an average annual rate of 1%, according to the survey.