In the first of two articles on market pulp, PPI highlights recent developments and reviews likely scenarios for the next five years

by Mark Lockie

Learning the lessons of a torrid 12 months

Asian economic turmoil, overproduction, weak paper demand and a strong US dollar are just some of the factors which have contributed to the poor performance of the market pulp sector over last 12 months. Producers have been badly hit by poor pulp prices throughout 1998, which managed to reach a high of just $610/ton, CIF, for the benchmark grade, northern bleached softwood kraft (NBSK). At the start of last month, NBSK prices came close to their lowest position for two years, dipping below $500/ton, CIF.

Other pulp grades have performed equally badly and it is difficult to find too many positive signs in the marketplace. But some of the more optimistic commentators predict a spate of price rise announcements for the fourth quarter backed up by a pick-up in pulp and paper demand after the traditional mid-year lull.

Understandably, most producers would rather forget the last 12 months. As one European pulp salesman said, "Constant price swings in the market have made me so weary recently that I can't even remember what has happened in the last six months." But painful as it may be, the pulp market must learn from the lessons of the past. Some analysts predict that 1999 will be a carbon copy of 1998. If this turns out to be true, then the lessons of the past 12 months will not have been heeded and the industry must expect years of unprofitable performance to come until demand catches up with supply - a situation that it is not likely to happen until early next century.

Surveying the market

According to PPI's recently published Market Pulp Survey, the industry saw market pulp capacity increase by 3.1% to 50.54 million tons in 1997. This was a fairly modest increase compared to the previous year, but did little to tighten the supply side of the sector. The producers themselves did little to help the situation either. On top of the capacity increase, market pulp producers took capacity utilization rates up and worldwide output climbed by 4.7% to 41.92 million tons.

This inability to balance supply and demand has caused the industry to falter before. In the last quarter of 1997, the imbalance cruelly exposed the sector as southeast Asia plunged into a recession more severe than most expected. At the onset of the problems, the countries most badly affected - Thailand, Malaysia, Indonesia and the Philippines - represented just 3% of global market pulp consumption. As a result, the problems were not considered a major threat to the global market pulp business. But as the ripples of discontent moved northward toward Korea, Taiwan and Japan (representing almost 20% of global market pulp consumption), the scale of the difficulties became clear, especially as many producers relied on these countries to sponge up a large proportion of their output.

In terms of timing, the Market Pulp Survey does not reflect the full effects of the Asian crisis that are being witnessed at present. The USA, for example, saw its market pulp capacity rise by 129,000 tons in 1997 (up 1.3%), while Indonesian market pulp capacity jumped 62% to 3.2 million tons (including the new 500,000 ton/yr Kiani Kertas mill). In Europe, France's capacity was given a 16% boost to 1.76 million tons last year. Much of the rise came from the new 150,000 ton Greenfield deinked pulp mill, but overall market pulp capacity in Europe rose by just 3.4%. Economic uncertainty in the former Soviet republics continued to take its toll, with production in the CIS falling 9% from 1.27 million tons in 1996 to 1.16 million tons last year. Market pulp capacity utilization was a mere 49%.

After the economic antics of 1998, a review of the industry next year will be markedly different. The Russian economy is the most recent to have faltered, but most market pulp commentators will be eyeing the statistics for market pulp consumption in Asia. There are reports that Korea is running its paper industry at around 50-60% of capacity this year. More alarming are reports that Indonesian domestic consumption of some 4.5 million tons in 1997 could nosedive to just 1.5 million tons by 1999 as the country's economic crisis unfolds.

History lesson

It all seems a far cry from the bullish mood that producers were in last September. At that time, NBSK prices stood at almost $600/ton, CIF, and producers were aiming to push through price rises to $650/ton, CIF, in October or November. Norscan stocks climbed to 1.79 million tons at the end of August, but considering that significant capacity in British Columbia lay idle, it was a higher level than expected.

By October, hopes of a price rise were dampened as the Asian crisis spread, but prices held firm. In Asia, Thailand and Indonesia were being badly affected, although larger consumers such as South Korea were starting to get sucked in by November.

Figure 1 illustrates the fall in currency values among these countries. On a positive note for Asian producers, however, the currency crash helped slash production costs, as most pulp production costs are paid in local currency. As sales are usually dollar denominated, this allowed producers to offer attractive pulp deals and boost sales.

For example, over the first six months of 1998, one of the major players in Asia, Asia Pulp & Paper (APP) reported net sales of $1,143 million, 19% up on the year-earlier period. Operating income for January-June also leapt to $425 million, an impressive 91.6% increase on the same period in 1997. But at $86.2 million, net income for the first half was 16% down on 1997. APP reported soaring sales volumes in the first half, but at lower average pulp prices of $397/ton from May-June 1998. This compares with $523/ton in the year-earlier period.

Act earlier

By the end of 1997, a combination of factors saw prices in Europe crumble. Of course, the Asian crisis was still having a major impact. But buyers were also destocking and producers could not react quickly enough and Norscan inventories rose 187,000 tons to 1.75 million tons. NBSK prices slipped to $580/ton, CIF, and by the time producer downtime registered in December's Norscan inventories (released in January), the NBSK price had slipped to $550/ton, CIF.

This fall continued through February and by March NBSK prices had fallen to a dismal $490-500/ton, CIF - although by then producers had announced a $50/ton rise for NBSK in Europe. In April, the release of the March Norscan statistics seemed to suggest that miracles had been done when the figures fell by almost 300,000 tons to 1.52 million tons. Producers duly congratulated themselves and on that evidence, the rise announced in March started taking hold. Producers promptly announced a further $50/ton rise on NBSK to take the list price back up to $600/ton in June.

This announcement now looks premature. Examining the reasons for the dramatic fall in Norscan inventories in March, it becomes clear that a significant proportion was not just due to producer downtime. Much of the inventory drop was accounted for by increased shipments, which broke the two million ton mark. Typically, China sucked up a significant amount of the pulp, entering the market to make significant purchases when the price was at its perceived low point. Much of the shipments also went into papermakers' stocks.

In May, several factors threatened to spoil the fragile upturn in prices, even though Norscan levels had fallen below the 1.5 million ton mark - normally regarded as a level below which prices start to rise. Consumer stocks had now climbed above "average" levels and, crucially, paper demand began to weaken, particularly for woodfree paper grades. The pick-up in demand that had been seen in Asia as China started buying also started to go flat.

With the traditional mid-year lull fast approaching, only the most optimistic producer believed that prices in Europe would rise to $600/ton, CIF, in June. USA producers did have slightly more success, but the rise in consumers pulp stocks and poor paper demand sent out a message to producers - take more downtime or face the consequences.

Pulp producers took downtime, but not enough to prevent NBSK prices tumbling, as they have done since. Prices first fell to $530/ton, CIF in July, then to $520/ton, CIF, in August. September saw NBSK fall below $500/ton as Norscan inventories rose above 1.8 million tons in an astonishing month-on-month rise of 310,000 tons, with operating rates up at 94%.

Currency capers

In the final analysis, producers have been a little unlucky. As soon as the Asian crisis spread north to Korea and Japan, any chance of 1998 being a good year evaporated. Producers did show they were willing to take some downtime, but in the end it proved too little, too late.

Things could have turned out better if printing/writing demand had not faltered. Over the past three years, this market has remained relatively buoyant through the traditional mid-year slowdown. As a result, pulp producers may have been lulled into a false sense of security, believing that paper demand would make a repeat performance this year. As one producer told PPI, "We just didn't believe our customers were going to have to take the amount of downtime that they have."

With August inventories on the rise, this has created added pressure on prices. It seems that the only way forward for producers is to take extensive downtime or shut capacity down completely in the hope that they can create a tighter market and achieve price rises that they so badly need to stay in business.