Pulp has proved to be the driving force for the Chilean pulp and paper sector, but the next round of expansion could prove to be the last

Chile faces up to financial and forest challenges

As industry has marched on this smooth path to progress, Chilean producers have cleverly carved themselves a niche market in the radiata pine pulp business, based on cheap and plentiful wood supply. Today, 36% of global radiata pine supplies are produced in Chile, according to CMPC Forestal.

Radiata is considered to be a higher quality raw material than southern pines and normally sells at a premium of about $30/ton - in good times, that is. But Chilean pulp producers fear that the easy times might be over. Chile's major commercial advantage - cheap wood - is threatened by a lack of suitable land and the rising cost of creating forest plantations.

New environmental protection laws are adding to the investment cost of projects and Chilean producers fear that their competitors have also become leaner and meaner. The widespread effects of the pulp price crisis in recent years have forced other softwood producers to seriously tackle production costs, making them a much more potent competitive force.

Pulp focus

Although paper production has a part to play, it is pulp that Chile is known for in the forest products sector and there are quite a few expansion schemes in the pipeline. Arauco, for instance, has plans for two new greenfield pulp mills. The long-awaited Valdivia mill has finally received an environmental permit, while a second proposal to build a mill close to the Itata river in Chile's VIIIth region (north of Concepcion) is making good progress. Both mills would be based on eucalyptus and radiata pine, with a capacity of 500,000-550,000 ton/yr. The price tag is estimated at $1.3 billion per mill.

According to Arauco, the Valdivia project will go ahead "as soon as market conditions improve". An outline plan for the Itata project was presented to the authorities earlier this year and an environmental impact study is being carried out. Arauco wants to have everything in place for the moment when the market turns, according to Arauco's sales manager, Ubaldo Salvestrini.

CMPC also has big plans for the pulp sector. The group wants to add another 500,000 ton/yr eucalyptus line at its Santa Fe mill for startup in 2005. Another softwood line could eventually follow at its Pacifico mill.

Although the level of activity in new projects would appear to indicate otherwise, pulp producers are not as confident about the market as the proposed investments might suggest. Pulp expansions are mainly driven by the availability of wood and the need to maximize assets. While wood is in somewhat short supply for the moment, plantations will mature in the early years of the next century and wood availability will explode.

CMPC reckons that the annual sustainable felling rate for radiata pine will reach 25 million m by 2010, while the figure for eucalyptus will top 8 million m. About 45% of the radiata pine will go to the pulp industry in addition to around three-quarters of the eucalyptus supply.

A lack of suitable land for new plantations is hindering growth

Clear favorite

Chile has very clear advantages in the radiata pine market, including faster growth rates than other pines, a well-established reputation and more often than not, better sale prices. In contrast, the benefits of moving into eucalyptus are not immediately apparent. After all, Chile would have to compete with the likes of Brazil and Indonesia in the hardwood sector. Both countries have better growth rates than Chile and the collapse in the value of their respective currencies make them a formidable competitive force.

But within Chile, radiata pine is increasingly used for more added-value products, such as timber, and any expansions in the pulp sector may well have to rely on eucalyptus fiber. The eucalyptus species in widest use is globulus. This is the same type as is used on the Iberian peninsula, but it is different from the grandis species planted in Brazil. Globulus growth rates are lower than grandis, but globulus has a better density and the wood yield is higher, according to the business development manager of CMPC Celulosa, Luis Llanos.

As plantation areas within Chile have become scarcer and more expensive, planting costs have risen considerably. The best sites have already been utilized and growth rates for new plantations are likely to be slower. As a result, wood costs have already increased significantly - the wood cost per ton of pulp is now $154/ton in Chile, compared to $144/ton in the US south, CMPC has calculated. In 1991, Chile was $120/ton and the US south was $130/ton. As if to rub salt into the wound, the industry's cost problem has been compounded by a series of forest fires that plagued the industry earlier this year. It is widely believed that the fires were arson attacks and it remains to be seen whether this will be an ongoing problem for producers.

With little land left for plantations, the latest round of pulp expansion plans could well be Chile's last. Both Arauco and CMPC are looking toward Argentina for further growth. As evidence of this, Arauco bought Argentina's only softwood kraft mill, Alto Parana, in 1996. The company has already invested $40 million in the plant to expand capacity from 270,000 tons/yr to 310,000 tons/yr. Arauco is also adding to its plantations in Misiones state and is in the process of building a new 200,000 m/yr sawmill. Another pulp line will eventually follow, according to the company.

CMPC is concentrating on Corrientes state. The group also intends to add a pulp mill eventually. As CMPC points out, soil and climate conditions are similar to those in Brazil and wood costs should be equally low.

But even for these two major players, marketing the extra pulp output will be a challenge.

On paper

Chile's forest industry has come a long way since CMPC started up its Laja mill in the 1950s. The country now has a capacity of around two million tons of chemical pulp, almost all for export. Paper capacity remains modest in comparison at around 650,000 tons/yr. With a population of just 14 million, Chile has a small domestic paper market. Newsprint consumption, for instance, is just 65,000 tons/yr and the two main producers of the grade, Bio Bio and CMPC's Inforsa, already have to export a large part of their output. Inforsa recently increased capacity through a major rebuild on one of its machines, while Bio Bio is in the process of upgrading a unit at its mill.

CMPC dominates the paper sector in Chile. The company's Laja mill is Chile's only producer of printing/writing papers, but the operation also produces sack kraft. CMPC produces paper at the Maule mill as well, where a new 150,000 ton/yr boxboard machine started up recently and the company has plans to build a linerboard "mini-mill" close to Santiago.

CMPC has been most active in the tissue sector though. The group's Puente Alto mill has a 60,000 tons/yr tissue capacity, while a greenfield mill at Talagante started up in 1997 with a capacity of 30,000 tons/yr. CMPC has not limited its operations to just Chile though, and now has tissue capacity in Peru, Argentina and Uruguay.

Compañia Papelera del Pacifico is one of the few other groups on the paper expansion trail. The company has plans to install a second-hand linerboard machine with a capacity of around 150,000 tons/yr. Startup has been penciled in for the second half of this year.

Neither CMPC nor Arauco feel that integrating pulp and paper production is a solution - at least for the moment. Both companies mention the poor return on investment of woodfree producers and feel they have nothing new to bring to this particular market. As Llanos points out, "We will pursue investment in areas where we have advantages."

Salvestrini also adds that with such a small domestic market, almost all of the output would have to be exported. As a result, Chilean companies would face considerable competition from low-cost producers in Brazil and Indonesia, for example.

Facing the challenge

Chile's pulp producers have weathered the Asian financial crisis relatively well up to this point. Although Asia accounts for one third of the country's exports, Chile did manage to shift output to alternative markets (including China) when demand from countries such as Korea, Taiwan and Thailand dropped dramatically.

The Arauco mill has kept up with the pace on environmental issues

Prices left something to be desired though. The full fallout from the Brazilian crisis is not yet known, but there are distinct fears that Brazil could start flooding export markets with paper as demand drops off at home. As Salvestrini explains, "Even it we do not compete directly with Brazil, our customers do. If paper production is down in Europe, pulp imports drop off too."

But Brazil is not fully geared up for paper exports, Llanos comments, and producers would find it difficult to suddenly switch output to export markets. Apart from anything else, Llanos points out that Brazil lacks the ports that would be needed to make such a dramatic change.

On the other hand, there is widespread optimism that the length of the current downswing in the pulp market is forcing Chile's competitors to shut down high-cost operations, especially in North America. But there is also fear that the downcycle is forcing the competition to look more closely at costs, especially in Europe, turning rivals into a much more formidable force.

As Salvestrini comments, another worry is increased integration among European papermakers. Europe accounts for about one third of Chile's pulp sales and Arauco, for example, had targeted non-integrated papermakers in the region to build up long term relationships based on trust, reliability and service. The trend toward integration has meant that there are fewer non-integrated papermakers left and the business climate has changed considerably.

Chilean pulp producers are not overly worried though. Salvestrini feels that Chile still has a good product in terms of its radiata pine pulp. And as European papermakers feel the pinch from cheap imports from Indonesia and Brazil, radiata pine might provide a good alternative to the more expensive northern bleached softwood kraft pulp. "It's a matter of money," says Salvestrini. "Papermakers can produce paper with any fiber. They are also happy to drive a Rolls Royce, but can they pay for it? A Volkswagen or Honda gets you there too. It's the same with paper. The world is learning how to use cheaper fibers of different origins. They have to. The competition is too strong."

Nevertheless, producers are not being complacent and companies are working hard to optimize, reduce costs and look for new business opportunities.

Buying capacity could prove an attractive option for Chilean producers. And at least one of Chile's forest companies is keeping an eye on the privatization plans of Portucel in Portugal and the tribulations of Fletcher Challenge in New Zealand.

Low-cost freight rates are one of the advantages of producing in Chile

Chile: an economic safe haven hit by a global crisis

Chile has long been an island of stability among the turmoil of Latin America. The country began to prosper after the management of the economy was taken out of direct political control and Chilean business was ruthlessly modernized. Over the course of its recent history, the country's economic performance has been managed by technocrats, largely without political interference.

Following the principles of global competitiveness and survival of the fittest, Chile's economic managers opened up the country's previously well protected domestic market and industry was forced to compete worldwide on a level playing field. The change from military dictatorship to a democratically elected government also passed relatively smoothly, and Chile witnessed average annual growth rates of over 7%.

Lately though, the economy has faltered. The Brazilian currency crisis is the latest problem to hit home, but the Chilean economy had already been battered as exports to Asia - one of Chile's most important markets - dropped off dramatically. Businessmen are keeping a wary eye on developments in Brazil, but so far the fallout from the Brazilian crisis has been comparatively limited.

Opinions differ on whether Chile has felt the full impact of the crisis as yet. Some feel that like a giant tsunami wave, the crisis will engulf the whole of Latin America, including Chile. But many others believe
that nothing quite so dramatic is about to happen and any consequences will be indirect, such as a further increase in interest rates.

As several commentators have pointed out, Chile's economy was already slowing before the latest fiscal crisis in Brazil. Growth rates had already dropped to 2-3% and observers point out that the weakening peso had more to do with the all-time low in copper prices than with any attacks on the country's currency. (Copper still accounts for 50% of Chilean exports, although this is well down on the 90% levels witnessed a couple of decades ago.)

Although it was widely felt that the Chilean peso had been overvalued for some time, the devaluation from Peso 453 to the US dollar a year ago to Peso 499 at the beginning of March has hit almost every market sector. And the fiscal problems have come at the same time as Chileans are facing the prospect of reopening old wounds in the wake of the arrest of General Pinochet in the UK.