The Global Paper Game
Rocked by the recession and a drop in demand over the last few years, mills changed their business model. Instead of running machines at virtually any price, mills have taken a far more disciplined approach, controlling supply to meet the dwindling demand.
Pricing didn't drop, though. Mills had to raise prices just to stay afloat. The numerous increases that mills have imposed upon publishers over the last couple of years have been dictated by the mills' health, and not by demand. That's not likely to change.
Mills continue to take downtime, shut down machines, and in some cases, get out of the industry altogether. Last summer, International Paper Co., the largest producer in North America of coated groundwood, announced it was getting out of the business and planned to sell every one of its coated paper and supercalendered mills. Those mills will likely be acquired by another paper maker or an investor, said Gerald Chisholm, vice president of sales for Gould Paper Corp., a Manhattan-based paper broker.
At the moment, though, all eyes are on Canada. The UPM-Kymmene mill in Miramichi, New Brunswick, which produces about 500,000 tons per year of coated groundwood, struggled through a nine-month labor strike and lockout last year that ended in the fall. About 85 percent of that mill's production goes to the North American market and that mill provides for about 8 percent of the North American supply, according to Resource Information Systems Inc. (RISI).
Now, it's idle again. The mill announced a 90-day closure in February 2006 due to lack of profitability. It is slated to reopen in May.
"Profitability improvement in UPM's magazine paper business requires cost savings and active capacity management," said Jyrki Ovaska, President of UPM's magazine paper division, in a statement. "The Miramichi mill has high operating costs, and the strong Canadian dollar makes the mill's exports to the U.S. unprofitable. That's why we have decided to temporarily cease operations at Miramichi during the slowest season of the year."
If the mill doesn't come back online, publishers can brace themselves for another price increase in the summer, and maybe a tightened supply, said John Maine, vice president of graphic papers for RISI. Maine gave a presentation recently at the Primex Conference in St. Petersburg, Florida, detailing how global influences would drive the paper market. The strong Canadian dollar, the increase in wood cost in Eastern Canada and the rising cost of energy are contributing to the significant capacity closures in Canada, Maine said. Other paper manufacturers are also feeling the squeeze. Domtar Inc. announced last year that it would shut down two paper machines and put its Vancouver mill up for sale. If the Canadian dollar doesn't come back down;or continues to appreciate;there could be further capacity closures there, he added. Only this time, the imports may not be able to come to the rescue.
During the strike and lockout last year, UPM, which is based in Helsinki, Finland, was able to meet its customers' demands by importing its European paper. Overall, the North American market has become more dependent on imports, as it slashes its paper-making business. For a while, Europe and Asia had been pushing the industry forward with better quality paper and better efficiency, and filled in the gaps as the North American supply shrank.
Now those foreign mills will get to dictate pricing. "They're not going to build a new machine in Wisconsin, but in Asia or Scandinavia," Chisholm said. "That's the problem that we face. That's where the investments are being made and that's where the new capacity is. Those are the people who will dictate the prices."
A Silver Lining
That's not necessarily a bad thing for U.S. publishers, because mills can no longer charge a higher price for paper that's manufactured in North America. "Global influences keep prices down. That trend will continue," Chisholm said. "But the biggest peril is to Canadian paper mills. There aren't a lot of coated producers that can come into the U.S. because of high costs." Also, production that's taken offline here is not likely to come back.
Last year in North America, there were more than 5 million tons of paper cut out of the capacity, due to downsizing, rightsizing and closures, he adds. "The reason that's happening is that people aren't buying the paper. That's highly unusual. It's a whole new trend in our business. I don't think that will ever come back online." Outside of Kruger starting up a new paper machine two years ago in Canada, there really hasn't been a new coated paper machine built in the last 20 years here, he said.
At the moment, the dependency on imports doesn't pose a real problem to publishers. But demand is starting to pick up in Europe, even as that market faces its own troubles. UPM announced recently that it would eliminate 3,600 jobs;11 percent of its workforce. It plans to completely shut down its mills at Voikkaa, Finland, that produce 410,000 metric tons of magazine-grade paper. This is again, due to lack of demand and profitability. UPM will also convert one of its coated paper mills in Central Finland to label paper production next year. The closures will cut UPM's European coated magazine paper capacity by 17 percent.
Supply and Demand
Demand is expected to be modest this year, after a surge of about 5 percent in January, Maine says. North America is expected to see a 1 percent increase, compared to a 3 percent increase in demand for both Western Europe and Asia, and a 4 percent increase projected for the rest of the world, according to RISI.
"When increases in demand are combined with recent capacity closures, the market has gotten fairly tight," Maine adds. "A number of producers have had to go on allocation and prices have started to increase, for some as early as February."
What's more likely is that mills are unofficially allocating paper to their customers. Mills know how much paper their customers tend to use per issue and they make sure that amount is available.
"I didn't commit to a certain volume, but the mills know how much we use and it's always there for us," says Jerry Britt, executive vice president and COO of DuPont Publishing Inc., who buys paper through a paper merchant for its roster of magazines with a circulation of 250,000. "I have yet to have any trouble getting what I need, primarily due to our relationship with our mill and the relationship with all of the people in the buying process."
Mills announced a 5 percent increase, $2.50/hundred weight or around $50/ton, on mostly coated freesheet grades in February. The increase is not expected to be fully implemented before April.
Some in the industry anticipate a coated groundwood increase by July. A lot is riding on the Miramichi mill. "If UPM starts up the Miramichi mill May 1, they'll need 40,000 tons of business a month to run the mill. They won't see that if they announce a price increase for July 1," Chisholm said.
Still, that's a better scenario than last year's numerous price increases which drove paper prices up anywhere between 14 and 20 percent, depending on contracts and relationships with mills. And, publishers are already dealing with a 5.4 percent postal increase that was implemented in January.
Publishers may not have the luxury of making paper-grade changes to absorb the increases, such as a switch to a supercalendered grade. "The supercalendered market is very tight because of the situation in Canada," Maine said. Supercalendered grades are also expected to be hit with an increase this month. "There's a desire to move to supercalendered paper but right now publishers can't do that because it's not available."
Looking for Alternatives
Some believe the one-two paper/postal punch is enough to drive publishers to the Internet, and away from the printed page. "I am very curious to see how this tight market and run-up in prices in coated paper affect the shift to the Internet," Maine said.
Ironically, as publishers embrace the Internet to cut costs with paper and postage, that affects the supply and demand ratio for paper, said DuPont's Britt.
The catalog industry also bears watching. As retailers cut back on catalog production, that affects supply and demand and the market for the magazine papers, too. For example, the Walt Disney Co. has decided to discontinue its catalog operations this year, instead funneling all of its money earmarked for catalog production into its Internet marketing efforts.
Catalogs also have the luxury of switching paper grades more seamlessly than magazines. "If the paper prices get too high, I can't switch paper from month to month with a high-end magazine," Britt said. "If you're a catalog, no one remembers what you printed on last year."
Brace for At Least
One Price Hike Looking forward through the end of the year, publishers should expect at least one price increase across all grades this year and a continued tightening of supply. "Our best-case forecast: The Canadian dollar comes back down to 83 cents by the end of the year, energy costs start to abate with oil costs dropping," Maine says. "If those assumptions are wrong, we'll see more capacity shutdowns."