Demand for graphic papers keeps dropping, usually faster than the industry can reduce capacity. Struggling paper mills are often playing a giant game of chicken, scuffling along on thin margins (or negative margins) in hopes that a competitor will shut down a machine to balance the market.
So why are paper companies suddenly announcing price increases for coated paper, and why is the biggest printer in the U.S. worried about possible paper shortages?
SAPPI surprised nearly everyone late last week by announcing a $40/ton price increase on coated freesheet (CFS) in the U.S. Then Verso delivered an even bigger shock this week with $40 hike not only on CFS but also on coated groundwood (CGW), which is in even greater oversupply than CFS.
But, first, let’s look at the rather cryptic statement from a recent R.R. Donnelley filing with the Securities and Exchange Commission:
“Management believes that the paper supply is consolidating, and there may be shortfalls in the future in supplies necessary to meet the demands of the entire marketplace. Higher paper prices and tight paper supplies may have an impact on customers’ demand for printed products,” the document said. “Contractual arrangements and industry practice should support the Company’s continued ability to pass on any future paper price increases, but there is no assurance that market conditions will continue to enable the Company to successfully do so.”
What does Donnelley know that the rest of us don’t? With or without consolidation, how do you run out of something when demand for it is declining?
Donnelley seems to be worried about the proposed merger of Verso and NewPage, North America’s two largest makers of coated paper.
“NewVerso" would control half the continent’s capacity for coated paper, which could stifle Donnelley’s legendary ability to negotiate very huge and very sweet deals.
The paper giant could play the “Our way or the highway card,” as NewPage has often tried to do (usually more to its own detriment than that of its customers). And it may be in a position to balance markets by aggressively idling or shutting capacity.
If the merged company is successful, smaller competitors might give up on certain parts of the market. Then a single NewVerso miscalculation – about demand or imports, for example – could quickly lead to shortages.
And if the highly leveraged company isn’t successful, Donnelley’s (and everyone else’) ability to secure coated paper could depend upon the mercurial moods of a bond market that cares nothing about the health of the paper, printing, or publishing industries.
Or maybe Donnelley is saying, “We really don’t know what consolidation of the paper industry will mean to us, but it could be a big deal. So our lawyers told us we’d better cover our donkeys in case a few know-it-all private-equity boys screw everything up.”
As for the nearer term, market participants say SAPPI’s move is a bit early and aggressive, but there is some hope that capacity reductions, the strong euro, a decent economy, and this year’s election will bring the CFS market into balance later this year. SAPPI is trying to set the table for a July 1, or maybe an Oct. 1, price hike for contract customers who have quarterly price protection.
“They’ll need others to follow and for demand to pick up for it to succeed,” one paper broker commented.
But Verso’s move on CGW seems to be more a matter of wishful thinking by a money-losing supplier. And so far it’s been met with silence by competitors.
CGW faces two challenges that CFS doesn't: 1) High-quality supercalendered (SC) paper, which increasingly competes with CGW for some applications, but at a lower price. 2) The weak loonie (Canadian dollar), which means Canadian CGW and SC makers are happy to grab market share in the U.S. by pricing more aggressively than their American counterparts.
Here’s how one paper-market veteran summed up the pricing announcements: “Watch everyone announce, then [watch] the guessing game of who actually went up and who maneuvered for market share. All in all, they probably each have some bottom business they can raise, and that's who it [the price hike] will be applied to.”