U.S. and Canadian pulp and paper producers face a difficult road ahead, and weakness in global markets could delay full recovery this year
	North American Paper Industry Hopes For Clearer Sailing after Fiscal Storm
	By Pulp & Paper Week editors GREG RUDDER, NOEL DEKING, BRYAN SMITH, KATHRYN MACKENZIE, BRUNO NAVARRO, and RAE ANN ROCKHILL

The continued lackluster performance of the global ecomony in general and the U.S. economy in particular have caused North American paper companies to batten down the hatches and weather what have been particularly turbulent times. Consolidations, closures, capital constraint, and cost cutting are just some of the methods used by producers to secure themselves while hoping for a brighter future. Now, statistical indicators have producers expecting an upturn as economics seemingly turn in their favor, prices begin a slight rebound, and production of paper and paperboard begins to climb slightly (Tables 1 and 2).

TABLE 1. U.S. paper/board production is expected to rise 1.4% in 2003.

TABLE 2. Canadian paper/board capacity is predicted to increase 0.7% in 2003.

The U.S. economy began to lose momentum in the fourth quarter of last year after advancing at a very solid 3.1% annual rate in the third quarter. Economists cut their estimates of fourth-quarter growth to 1.3% from earlier projections of 2.6%. This raised concerns that the economy was headed for a "soft patch" that could undermine consumer confidence and push the economy back into recession.

The Philadelphia Federal Reserve Bank survey of economists in November predicted total gross domestic product would grow 2.6% this year, down from the previous estimate of 3.0%.

"The U.S. economy is on a knife's edge, and the near-term risks are decidedly negative," said RISI economist Brendan Lowney.

If the economy avoids a "double-dip" recession early this year, demand for all paper grades should pick up steadily for the remainder of the year. Business inventory levels remain low, so there is a high potential for inventory restocking when a stable, sustained recovery takes hold.

Total paper and paperboard exports are forecast to remain relatively flat this year, even though the U.S. dollar is forecast to continue its downward correction. The overvalued U.S. dollar had a major impact on trade flows in recent years. The American Forest and Paper Association (AF&PA) said the overvalued dollar imposed a de facto 25% to 30% tariff on U.S. paper producers selling into overseas markets and allowed foreign producers in Europe and Asia to take domestic market share from U.S. paper manufacturers.

The AF&PA reported that U.S. consumption of paper and paperboard grew by 3.5 million tons during the past five years, but imports captured more than 90% of that growth. Printing and writing papers coming from Europe, Asia, and South America increased as much as 60% during the period. Meanwhile, exports of kraft linerboard-once the largest U.S. export grade-declined about 35%, falling from 4.5 million tons in 1997 to about 2.7 million tons last year.

This reversal of historical trade flows displaced many domestic producers and forced many U.S. paper mills to permanently shut down. The U.S. paper industry has actually decreased in size in the past two years. Industry capacity declined by approximately 2.3% in 2001 and 1.0% last year. This was the first net decline in industry history, and additional capacity contractions are expected in 2003-2004 as companies shut down older, high-cost mills and paper machines. At the same time, a tremendous amount of new capacity is scheduled to start up in other parts of the world, which will further erode U.S. export demand.

MARKET PULP

Producers hope for bounce back from tough 2002

Although North American market pulp producers implemented some price increases during 2002, helped domestically by lowered inventory levels and abroad by a sustained drop in the U.S. dollar, the year was a low point for the industry.

Benchmark northern bleached softwood kraft (NBSK) list prices inched upward from an eight-year low of $465/tonne in March to $510/tonne, where it remained for the third quarter (Table 3). But pressures from offshore and a drop in U.S. demand during the fourth quarter toppled the year's earlier gains, and by December, it appeared that prices could approach a cyclical floor again. During the fourth quarter, several analysts covering the paper/forest products sector revised downward their price estimates for market pulp through 2004 and beyond.

TABLE 3. Pulp operating rates and prices were up in 2002.

At year's end, signs showed that prices and demand would remain low until the second quarter of this year. North American/Scandinavian producers saw inventories begin to rise in October last year to 1.658 million tonnes, above the 1.5-million tonne level many industry participants believe represents a balanced market. Sources expected a continued jump in stocks, which was likely until March this year when seasonal demand for pulp could reverse an inventory bulge.

Through late last year, there were few signs that producers in the U.S and Canada would take significant downtime to reverse a rise in stocks that they had fought to achieve in 2001. As a result, poor demand coupled with overproduction would likely bring down prices of NBSK during the first quarter of 2003.

That could be reversed during the second quarter this year, as a seasonal uptick in demand in the U.S. combines with renewed buying activity from Asian markets as they restock supplies after the slow lunar new year period in early February. Producer stocks have historically dropped by 109,000 tonnes during March, and if available inventories avoid rising much above 2.0 million tonnes, the producers could be poised for a sustained recovery. In addition, there were improved signs down the supply chain, including a rise in advertising revenues and some paper price increase proposals.

Contacts pointed to positive developments in Asian markets, such as China, Taiwan, and South Korea, where growing economies contributed to higher-end paper and board product consumption levels. There was also hope that the U.S. dollar would weaken as it had through much of last year, making U.S. exports cheaper for foreign buyers. In addition, several pulp mill shutdowns from International Paper Co. (IP), NorskeCanada, and Georgia-Pacific Corp. in the past two years could have a lasting impact on supply and demand in North America.

A Pulp & Paper Week poll of five analysts covering the paper/forest products sector showed an average forecast price for NBSK list prices at $520/tonne this year. That would represent modestly higher levels (up 6%) than last year, when prices averaged about $490/tonne. However, several of the same analysts had significantly revised downward their projections for this year during the fourth quarter when inventories rose and prices declined.

RECOVERED PAPER

U.S. consumption dips again, exports grow

U.S. consumption of recovered paper was on track to decline year-over-year for the third consecutive year in 2002. Overall, through September last year, U.S. mill consumption of recovered paper was off 1% and on track to total an estimated 35.2 million tons.

The largest consumers of recovered paper-U.S. containerboard and newsprint mills-curtailed production throughout the year. The newsprint and containerboard sectors were operating at rates of 82% and 90%, respectively, through November last year due to significant machine downtime.

U.S. exports continued rising last year and were expected to increase 4.4% over the 2000 level and total 11.0 million tons, according to the AF&PA.

With slightly less demand on the U.S. domestic market last year, mills closely watched their recovered paper inventory. In September, total U.S. mill inventory of recovered paper totaled 989,500 tons-down 5.6% compared with the total in September 2001.

The slightly lower U.S. consumption of recovered paper last year, combined with aggressive buying from China at certain points, drove up overall average pricing in 2002 vs. 2001. Based on a Pulp & Paper Week average, pricing of six major volume materials was up 31% last year, compared with 2001. Old corrugated containers (OCC) increased from a U.S. average at the f.o.b. seller's dock of $40/ton in 2001 to $66/ton last year.

How the slow-recovering U.S. economy unwinds, as well as how China manages its U.S. OCC supply, are key indicators for pricing and demand this year. For example, U.S. box demand was strongest in July and August last year. During that time, U.S. average OCC prices were $111/ton and peaked last year at $124.50/ton in July, just as U.S. box demand and Chinese buying peaked.

For other grades, such as old newspapers (ONP) and sorted office paper, the key issue will be managing reduced recovered paper supply against the possibility of increased output from mills.

Last year, ONP No. 8 rose 76% in average pricing from $43.50/ton in January to $76.50/ton in November. Mixed paper increased 84% from $19/ton in January to $35/ton in November. China increased orders of mixed paper significantly last year, on average taking about 125,000 to 140,000 tonnes/month from the U.S. And U.S. ONP exports also increased last year compared with 2001. The price for sorted office paper also increased 63% last year from $76/ton in January to $124/ton in November.

There remains adequate supply of U.S. recovered paper to serve the demand of domestic newsprint, containerboard, tissue, and recycled paperboard mills, according to Edward Tucciarone of Smurfit-Stone Container Corp. (SSCC), who spoke at the 10th Paper/Forest Products Global Outlook Conference in New York City in November.

Tucciarone, vice president of eastern sales for SSCC, said that the increase in use of U.S. mixed paper will continue because of U.S. curbside pickup programs that call for mixing papers and board and since mixed paper can be used to supplement OCC. Tucciarone said he expected mixed paper to play a larger fiber role in the future, with North American mill technology improving to run the lower-grade mixed paper.

Tucciarone said the recent closure of Inland Paperboard & Packaging's 450,000-tpy recycled linerboard machine in Antioch, Calif., will move more than 400,000 tpy of OCC from the domestic market to the export market. Bowater Inc.'s Calhoun, Tenn., newsprint mill also has temporarily stopped using ONP No. 8, he said.

At the same time, there have been conversions to using more recovered paper at Abitibi-Consolidated Inc.'s (ACI's) Thorold, Ont., newsprint mill; Bowater's Coosa Pines, Ala., newsprint mill; and Weyerhaeuser Co.'s Valliant, Okla., linerboard mill.

NEWSPRINT

For rebound, focus remains on ad linage

The second half of 2001 and most of 2002 were difficult for the North American newsprint industry. North American newsprint prices began dropping in July 2001 and dropped for 12 consecutive months from $625/tonne to $445/tonne, for a total decline of $180/tonne (Figure 1). Toward the end of June 2002, several of the largest newsprint producers, including ACI and Bowater, announced that they planned to implement a $50/tonne price increase on Aug. 1. As of mid-November, $35/tonne of that increase had been implemented, bringing newsprint transaction prices to $480/tonne, with no further increases expected for the rest of the year.

FIGURE 2. North American newsprint operating rates are expected to continue hovering under 90% during the first quarter of 2003.

Last year, the industry continued to be plagued with weak newsprint consumption and flimsy advertising linage. Mid-year, many large U.S. daily newspaper companies reported a slight rebound in ad linage in some sectors. According to a survey of major newspapers, ad linage increased five consecutive months from June through October. But help-wanted advertising, a key indicator in economic recovery, had not rebounded as of November from the record lows it experienced in 2001.

Industry sources said they had expected the newsprint market to rebound by the fourth quarter last year. But midway through the fourth quarter, the rebound had not occurred. With the Aug. 1 increase stalled at $35/tonne, there was even some talk about the possibility of rebates for those smaller publishers who had paid the full $50/tonne.

As of late November, the holiday season had not proven to be a boost for consumption. And heading into the first quarter of 2003, many industry sources were expecting a difficult first half of the year. As with last year, newsprint producers are looking for a sustained rebound in the U.S. economy, increased corporate spending, and a return to advertising spending (and linage) levels of 2000.

With mill operating rates hovering at 90% or just below last year (Figure 2), ACI, Bowater, and NorskeCanada announced approximately 1.6 million tonnes of total market-related downtime in an effort to control inventories. These production cuts pushed North American operating rates to approximately 87% in 2002, compared with 91% in 2001.

FIGURE 1. North American newsprint prices stayed weak into 2003.

Industry sources say that for mill and consumer inventories to remain at their current low levels, producers will have to continue to operate at below 90% during the seasonally soft first quarter of 2003.

Newsprint prices are not expected to rise in the first quarter of this year. Both producer and daily newspaper company sources report they expect to see flat pricing through at least the end of the first quarter, and it could be well into mid-year 2003 before producers try to implement another price increase for standard 30-lb newsprint, sources said.

An uncertain economy has led newsprint publishers to remain cautiously optimistic about the prospect of improved ad linage this year.

"Consumption has bottomed out (and) we saw a temporary pick up in demand. I think we've seen the worst of it, but I don't think we're completely out of the woods," said a contact at a large U.S. daily publishing company at the end of November.

Consumption by U.S. dailies was off 2% year-to-date through October to approximately 6.9 million tonnes. According to RISI, overall U.S. newsprint consumption is expected to increase 3.9% from 10.2 million tonnes this year to 10.6 million tonnes in 2003.

Printing and Writing Papers

Inventory control helps free-sheet grades

North American producers of printing and writing papers last year continued to cut costs, remove inefficiencies, and tighten supplies in an attempt to reverse falling prices and demand that marked much of the previous year (Table 4).

TABLE 4. U.S. printing/writing paper shipments fell 2% in 2002.

Producers announced $40/ton ($2/cwt) price increases for uncoated and coated papers that began to push prices up in October, though not by the full amount. Dwindling mill inventories and reduced capacities led coated free-sheet manufacturers to propose another $40/ton increase for Jan. 1, 2003.

The end of last year began to see an upturn in pricing that approached, and in some cases, surpassed year-ago levels. But downward pressure was still present from a slow-recovering U.S. economy, less-than-robust advertising demand, and a postal rate increase in June. Also, the lingering effects of the Sept. 11, 2001, attacks and subsequent mail-bound anthrax scare continued to hurt direct mail.

Uncoated papers. The U.S. uncoated free-sheet market, which remained weak through much of last year, began to show steady signs of recovery in 2002 primarily due to inventory reductions. Most grades of uncoated free-sheet posted price increases through the latter half of last year, even as demand remained relatively soft (Figure 3).

FIGURE 3. Uncoated free-sheet prices are expected to continue trending upward in 2003.

Office papers remained strong, boosted by the growing popularity of home-based offices. Prices for 20-lb OCR laser bond rose 3.1% year-over-year in November, and 20-lb repro bond posted gains of 1.3%. Prices for 50-lb offset rolls and 50-lb trade book stood at 3.6% and 3.4% in November, respectively, from year-ago levels.

Meanwhile, mill inventories fell steadily from 1.23 million tons in January 2001 to 1.0 million tons in September last year. Excluding cover and text grades, uncoated free-sheet fell from 1.13 million tons in January 2001 to 940,800 tons in September last year.

Uncoated free-sheet demand through the next decade is expected to grow by an average of 2%/yr, reversing a three-year downward trend in shipments. U.S. demand is expected to grow more than 3%, compared with last year's demand.

Coated papers. Coated paper markets also bore the brunt of a weak economy as magazine advertising largely dried up in 2001 and was slow to return last year. The lagging ad market prompted publishers to shut down several well-known titles that were struggling to make a profit, such as SmartMoney, published by Time Inc., and Mutual Funds magazine.

Year-to-date shipments of coated paper at the end of September 2002 were slightly more than 6.43 million tons, down 3.1% from the same period in 2001.

Coated groundwood saw several months of flat demand in 2002, posting year-to-date shipments of 3.28 million tons in September last year, down 1.4% from the same period in 2001. Coated free-sheet fared worse, with year-to-date shipments at 3.15 million tons or 4.9% below last year's level.

A force affecting the market has been the ability of producers to regulate supply in the face of sluggish demand. Since 1999, North American producers have shut 105 paper machines, removing capacity of 2.8 million tons of uncoated free-sheet and specialty paper, 1.3 million tons of coated free-sheet, 670,000 tons of uncoated groundwood, and 200,000 tons of coated groundwood, according to RISI.

The slow return of demand and diminishing inventories could lead to growth rates in 2003 and 2004 of 2% to 3%/yr for uncoated free-sheet, 3% to 4%/yr for coated free-sheet, 5%/yr for coated groundwood, and 3% to 4%/yr for uncoated groundwood.

BOXBOARD

No significant movement for cartonboard

U.S. economic growth and consumer nondurable spending are the key drivers of folding boxboard demand. Both of these indicators are forecast to trend upward this year, but boxboard market growth tends to be low because food and beverage packaging accounts for nearly 60% of end-use demand. These are mature and low-growth markets, even as hundreds of new food products are introduced every year. But competitive materials like plastic pouches, foil, and flexible packaging have gradually replaced paper for many packaged goods.

Domestic folding boxboard volume remained flat last year at approximately 8.5 million tons, down from 8.8 million tons in 2000. The decline in domestic demand was partially offset by an increase in export shipments. Exports rose about 5% to 1.83 million tons from 1.7 million tons in 2001.

RISI forecasts continued weakness in the domestic sector through the first quarter of this year since consumer nondurable spending and consumer confidence have only recently begun to show improvement. October was the first month since last July that consumer spending, which accounts for about two-thirds of U.S. economic activity, outpaced personal income growth. In addition, high levels of unemployment remain in many sectors of the economy, creating a drag on consumer confidence.

Domestic boxboard demand could remain flat as long as the first six months of the year. End users will keep inventories low until a solid, sustained economic recovery takes hold. Once warehouses begin to empty, inventory restocking will occur and boxboard production will gradually pick up. But last year's round of price increases for all folding boxboard grades will further increase substitution of alternative packaging solutions and limit future boxboard growth.

Total folding boxboard exports this year are expected to remain close to last year's level because new paper machine startups in Europe and Asia will displace imports. Foreign producers are adding new capacity in key export markets like liquid packaging board and folding cartons. Also, a greater preference for recycled paperboard grades like white-lined chipboard in overseas markets will lead to displacement of solid bleached sulfate paperboard.

The boxboard price forecast for this year remains unchanged, and producers will struggle to maintain current price levels for all cartonboard grades. The year-end 2002 benchmark price for 16-pt. solid bleached sulfate was $860-$880/ton. The potential for lower fiber costs for both bleached pulp and recovered wastepaper will put downward pressure on boxboard prices. However, producers will limit supply to keep markets in balance.

CONTAINERBOARD

Linerboard prices rise, but box demand still soft

TABLE 5. Containerboard inventory rose in 2002.

U.S. containerboard producers look to 2003 with their eyes on benefiting from four years of aggressive consolidation and continued supply-side restraint in trying to match supply and demand (Table 5).

Executives with the major North American producers believe those two issues should help them generate less-volatile pricing for the benchmark 42-lb unbleached kraft linerboard. If so, that also means less-volatile pricing for corrugated boxes.

Producers implemented three consecutive price increases from 1999 through the spring of 2000, generating a net increase of $130/ton for 42-lb kraft linerboard (Figure 4). Prices began falling in early 2001 through first-quarter 2002, a net decline of $60/ton, or nearly 13%.

Containerboard producers were able to avoid a complete price collapse through the downcycle by taking enormous market-related downtime and running at an average operating rate of 86%.

FIGURE 4. Containerboard prices (delivered in eastern U.S.) showed improvement going into 2003.

At the same time, the U.S. box business lost a lot of ground, with actual shipments down two years in a row in 2000 and 2001. The year-over-year decline was the first two-year falloff in 26 years. In the two-year period, actual U.S. box shipments declined a total of 6%. A growing U.S. trade deficit that attracted more foreign imports and the continued loss of U.S. manufacturing bases offshore to Mexico and China contributed to the decline in the U.S. box business.

Last year, U.S. box shipments, through November, were on track to total 377.7 billion ft2. This marked an unprecedented third year in a row of declining U.S. box shipments. The three-year decline would represent a loss of 28 billion ft2 of shipments compared with 1999 actual shipments.

Still, with supply-side reductions and a modest increase in box shipments in June and July last year, North American producers implemented their first combination containerboard increase in nearly two years-despite the overall soft box market conditions in North America. The kraft linerboard increase was proposed for mid-June but was implemented in July at $20/ton. This fell short of the proposed $30-$40/ton price increases. Another $5/ton linerboard increase was added in September, but pricing declined $5/ton in November because of lower spot prices and additional discounting.

As of November 2002, the 42-lb contract price for kraft linerboard in the East was $430-$440/ton. The 26-lb semichemical corrugating medium price was $390-$400/ton.

Along with the containerboard increase in 2002, box makers moved on a price increase in August, gaining by November between 3% and 6%. The $20/ton kraft linerboard increase was almost 5%.

The key issue at year-end 2002 was holding onto the linerboard price hikes because board demand was expected to decline sharply in December, January, and into early February. As a result, various major producers planned market-related downtime as high as 500,000 tons for November and December.

Consolidation in the past four years has put more capacity in the hands of a few major integrated producers. For example, the top five producers manage 69% of North American containerboard capacity.

Illustrating that the downtime and consolidation might have aided the bottom line of North American integrated producers, the average 42-lb kraft linerboard price in the East from 1999-2001 was $430/ton-$30/ton more than the average price for the product in the four years before that period (1995-1998).

The major consolidation deals in 2002 in the sector involved Weyerhaeuser's $7.8-billion acquisition of Willamette Industries Inc., Mead Corp. and Westvaco Corp. merging in a $3-billion deal, Temple-Inland Inc. acquiring Gaylord Container Corp. for $868 million, and SSCC acquiring MeadWestvaco's 850,000-tpy corrugating medium mill in Stevenson, Ala., for $375 million.

In total, Weyerhaeuser, SSCC, and Temple-Inland's subsidiary Inland Paperboard and Packaging permanently shut 1.4 million tpy of containerboard capacity in 2002 or 3.5% of total capacity.

Even with the supply constraint by North American producers, a Chinese containerboard producer planned-for the first time-to export testliner to the U.S. West Coast this year. This move, if it continued growing in terms of board from China, would be competitive against North American containerboard in North America. China is the fastest-growing containerboard market in the world and has become the second-largest containerboard-producing country in the world behind the U.S.

For box business to improve, U.S. executives with major integrated companies wait on a consistently growing U.S. economy to spur nondurable product manufacturing along with solid consumer spending, possibly by the second half of this year. However, in August through October 2002, U.S. nondurable output declined month-over-month in each of the three months, even though that time is typically the busiest box shipment period of the year in the U.S.

U.S. CAPACITY

TABLE 6. Pulp capacity is down 1.2 million tons since 2000.

U.S. paper/board capacity to rise 0.5%, pulp flat

After two years of massive rollbacks in production capacity, U.S. paper and paperboard capacity is set to increase approximately 0.5% this year. Total wood pulp capacity (Table 6) is forecast to remain relatively unchanged as paper mills look to use more recovered paper for their fiber requirements.

Capacity of primary paper (printing/writing papers, newsprint, packaging papers, and sanitary tissue products) is expected to total 48.8 million tons this year, an increase of 0.5% from 48.6 million tons last year. Paperboard capacity (Table 7) is expected to total 52.3 million tons, up 0.6% from 52.0 million tons. Overall U.S. industry capacity is projected at 101.1 million tons this year. The final figure at year-end could be slightly lower if companies continue closing older, high-cost facilities.

During 2001-2002, approximately 74 paper mills and machines were closed in the U.S., eliminating an estimated 9.4 million tons of total production capacity and marking the largest contraction in industry history. Some of this lost production capacity was replaced by newer, more efficient machines, and the net capacity decrease was about 3.5 million tons.

Since January 1995, more than 83,000 workers lost jobs in the pulp, paper, and allied products industry, according to the U.S. Bureau of Labor Statistics. Total employment in the paper and allied products industry has dipped to about 615,00 workers. The industry employed more than 700,000 people in 1995.

TABLE 7. Paperboard capacity is down 2.0 million tons since 2000.

Some of the largest capacity shutdowns appeared in the containerboard sector, which lost more than 4 million tons of capacity since the beginning of 1999. SSCC shut down six containerboard mills during this period and sold three recycled paperboard mills, removing 1.7 million tons. Inland shut down one recycled linerboard mill and two linerboard machines it gained from the Gaylord Container Corp. acquisition and sold a third kraft paper mill last year.

The printing/writing papers sector also saw significant capacity cuts as market pressures forced older facilities to permanently close. IP, for example, closed the Hudson River mill in Corinth, N.Y., and a second mill in Erie, Pa. Both mills were built in the late 19th century. Many mills dating from the 1940s and 1950s were also closed during the past two years.

New capacity was limited to only five paper mills last year. Among the larger projects, Weyerhaeuser ramped up a new 432,000-tpy uncoated free-sheet paper machine at Kingsport, Tenn., in October and will reach full production later this year. At the same time, Weyerhaeuser is closing an older 170,000-tpy unit at the mill, which was formerly a Willamette mill.

Bowater has nearly completed the conversion of a newsprint machine at Catawba, S.C., to produce lightweight coated groundwood papers for newspaper inserts. The converted machine will have an estimated 330,000 tpy of capacity.

In containerboard, Solvay Paperboard LLC started up a new 180,000-tpy recycled corrugated medium machine in June at its Syracuse, N.Y., mill. The addition of a third paper machine will raise total output to more than 1,500 tpd or 535,000 tpy.