Thursday, March 19, 2009

Coated Paper Prices: Headed for a Crash?

If you think prices for coated paper have declined a lot recently, hang on to your hats. A bigger drop may be just around the corner.

Admittedly, the industry has done fairly well managing capacity through the current perfect storm of high inventories, economic recession, strong dollar, and the shift to digital media.

Mills have been more disciplined than in past downturns about taking downtime rather than chasing business with lower prices., limiting the declines to only $5 to $7 per hundredweight since last year's peak.

But the issue is permanent closures, not downtime, as John Maine of RISI explains in a recent analysis: “North American coated paper producers need to shut another 1.3 million tons of capacity permanently and immediately, followed by further shuts over the course of the next five years if they want to balance supply with demand,” he wrote. The continent’s coated mills can make about 9 million tons of paper annually, split about 50-50 between groundwood (mechanical) and freesheet products.

“Most of the high-cost, inefficient mills have already been closed, so the next wave of closures is going to involve larger, more efficient mills that are still generating a positive cash flow,” continues Maine.

The problem is that mills are not shut down by the industry, they are closed by individual paper companies seeking to maximize their owners’ return on investment. What paper company will volunteer to shutter cash-positive mills or machines? Not AbitibiBowater (aka AbitibiUnderwater), which is trying to stave off bankruptcy. Not Verso, North America’s #2 coated producer, which is also stuck in Penny Stock Land.

Maine points to the more “nimble” uncoated-freesheet market, where giants like Domtar and International Paper have implemented massive capacity cuts to prevent prices from crashing. What he doesn’t point out is that the big players in that industry tend to be low-cost producers, which means that smaller players trying to buck the oligopoly with a price war soon find themselves up Chapter 11 Creek without a paddle.

In the coated-groundwood market, by contrast, size doesn’t seem to matter. The best cost position these days is to be making product in Canada with machines that coat and calender in line. Medium-sized Kruger and single-machine Catalyst Paper fit that bill.

The market’s two big players, NewPage and Verso, make all of their coated groundwood in the U.S. with blade coaters and offline calenders – probably with higher costs than some single-machine companies like Domtar and Evergreen Packaging.

NewPage has demonstrated its willingness to keep the market in balance by shutting high-cost mills and machines, but how much stomach does it have for shutting even more (and more efficient) machines? Recent reports of its making uncoated freesheet and an SCB-type product on coated machines suggest its capacity-rationalization plan is complete.

The paper industry has been through down cycles before, often snapping back with rapid price increases once the economy causes demand to recover. Prices may indeed stabilize – even increase -- in a few months when the current inventory overhang is burned off and we enter the busier fall season, especially if the economy improves or energy costs rise. But that’s likely to be what Wall Street calls a “dead cat bounce” – a brief increase on the way to further declines.

“There will be some recovery in demand once the recession is over, but our best forecast indicates that demand will stay far below its pre-recession level and that demand will continue on a structural decline for the next five years,” Maine writes. Translation: Domino, Best Life, Teen People, etc. aren’t coming to life, and retailers like Circuit City and Linens 'n Things won’t magically re-emerge from bankruptcy to start printing more newspaper inserts.

There will be too many coated mills fighting over too little (and declining) demand, with European manufacturers jumping into the fray more as long as the dollar stays strong versus the euro. Even a meeting at a Chicago hotel to discuss “price leadership,” as UPM and Stora executives tried in 2002, won’t rescue this market.

Debt-laden mills will continue running as long as they are cash positive (not necessarily profitable). That will force prices down until the highest-cost machines are no longer cash positive and have to be shuttered. But continuing drops in demand will eventually force even more mills to close.

Manufacturers will try to cope by making uncoated papers on their machines, either on an ad-hoc basis or via permanent conversions. They will diversify more into bio-energy, such as wood-derived ethanol and wood-burning power generation. After all, public opinion and public policy consider it “green” to cut trees for energy (witness the new tax credit for wood-burning stoves) but un-green to cut the same trees to make pulp and paper.

Some makers of coated paper will survive, perhaps even thrive. But the industry will be transformed.

1 comment:

A.M. Mallett said...

That is a good assessment. Having worked in the industry for most of the past 20 years with most of that time in various coated publication mills, I have seen the handwriting plastered on the billboard for a long time. There used to be an old adage that "wide and white" was the mainstay philosophy for success and growth but instead we are seeing niche markets develop while the big players struggle.
A few short years ago, one of my previous employers attempted to implement a short sighted strategy of cutting costs, moving away from specialty kraft papers and continuing to focus on medium weight coated publication. Needless to say, they are no longer in business. The sad story didn't have to be that way. The specialty business had longer term potential and the location advantages of the facility were numerous. Unfortunately an old school commodity focus in the industry continues its pervasive influence and until that element is retired or removed, I am afraid the struggles will continue unabated.