This second article on the fortunes of the market pulp sector looks at likely supply/demand patterns over the next five years

by Richard Cockram

What future for the market pulp sector?

Buyers and sellers of market pulp have been concerned for decades about the cyclical nature of pulp prices. Both sides agree that more stable pricing would benefit all players, but as demand for market pulp has increased in most of the past 25 years, producers must claim most of the responsibility for this cyclical performance.

Since 1995, northern bleached softwood kraft (NBSK) prices have fluctuated between $500/ton, CIF, and $600/ton, CIF, before discounts, with spot prices often nearer to $400/ton. But the manufacturing cost of producing NBSK, even before financial charges and delivery costs, is between $400/ton and $450/ton for many producers in Canada and the Nordic countries. Most mills need prices to average at around $650/ton in order to generate an acceptable long-term return on capital.

Hardwood pulp producers in the Norscan region (USA, Canada, Sweden, Finland and Norway) are similarly affected, but they have the added problem of facing up to increasing competition from very low cost pulp being produced in Asia. This has already led to several significant pulp mill closures during 1998 (Table 2).

Future folly?

The good news is that most of the Asian greenfield mills which could have come on stream during 1999 and 2000 have been postponed as a direct result of the region's financial crisis.

Debottlenecking projects continue at pulp mills across the world, but it is estimated that less than one million tons of net additional bleached pulp capacity will start up between 1998-2001. This compares with almost four million tons (including integrated pulp) coming on line at mills in 1997 alone.

The bad news is, of course, the Asian crisis. This has clearly spread from the smaller countries in the region to Japan, and now threatens China. Short-term demand for pulp has been drastically curtailed, but at least some renewed purchasing is expected during the fourth quarter this year. Inevitably, however, these sales will be made at rock bottom prices.

Curiously, Norscan market pulp producers reacted to the widely anticipated drop in demand by operating at a 94% capacity utilization rate in July. The average operating rate for Norscan producers over the past 20 years has been just below 90%. The result has been catastrophic with inventories being forced up by over 300,000 tons - a record July increase. Why the industry ran at these high levels in such a tough market is not clear. Recent closures will help reduce the industry's average operating rate, but more substantial closures are necessary before the remaining producers can expect to run at high levels without building inventory.

Eventually renewed growth in demand and low capacity growth is expected to restore market balance. This will happen sooner if the new Japanese prime minister succeeds in turning his country's economic fortunes around by restructuring banks, increasing public expenditure and opening up Japan's markets to competition. This will happen later if China is forced to devalue its currency in order to regain competitiveness. If this nightmare scenario becomes reality, China's Asian trading partners will be plunged further into recession. The Russian crisis does not help muster optimism with regard to short-term world economic growth.

Pulp pushers

Even looking at the most optimistic demand scenario, market pulp will still be in significant oversupply until well into 2000 unless the producers themselves take positive corrective action. Georgia-Pacific has recently taken a leading role by voluntarily withdrawing substantial volumes of pulp from the market, suffering, as it does, from the strong US dollar and very low cost competition in Indonesia and Thailand. Other major producers must see that they face at least two more years of mediocre prices unless more capacity is taken out of the system.

In the "good old days", excess pulp capacity could be dumped on Asian markets with minimal impact on western prices. This simply does not work any more. Asia (excluding Japan) is now the third largest importing region in the world, accounting for over 12% of bleached kraft market pulp deliveries in 1997, compared with 21% in the USA. Not only that, but Nordic and North American pulp and paper companies now have substantial investments in Asian mills, which should stimulate beneficial changes in behavior between the continents. The only way to deal with excess capacity today is to cut back production to the level of shipments. Those with a financial interest in the sector will have their fingers crossed that this much-repeated message is finally getting through.

Tight years

Provided Asian economies get back on track within the next two to three years, the supply outlook dictates that a tight market for pulp should develop around 2002. Borrowing for new pulp mills will be extremely difficult during the next two years, leaving companies time to concentrate on regrouping, restructuring, improving efficiency and reducing environmental impact, instead of building more and more production capacity. New pulp mills will be needed as the next decade progresses, but planners must ensure that such mills come on stream in sequence rather than in the huge bursts of the 1980s and early 1990s.

The rapid trend toward consolidation in the industry gives the sector hope that strong leadership will become a key feature of the market pulp business in the medium to long term. Short term, the business remains in the hands of a large number of relatively uninfluential companies.

This article is based on "Pulp Price Trends" published three times each year by NLK Consultants Ltd. For details phone +44.1932.564.966, fax +44.1932.569.223 or email nlkuk@compuserve.com