China's consumption draws ravenous interest: China is the hottest ticket in town for the world's paper industry and it looks like this show is going to run and run.

As Finland's airline, Finnair, announces that it is starting three flights a week to Shanghai in addition to its normal services to Beijing, it is difficult to avoid thinking that the paper industry is playing a major part in the carrier's growth plans. With executives from UPM-Kymmene, Stora Enso, and Metso Paper all trekking out to the Orient on a regular basis, it seems like Shanghai represents a sure bet for the country's main airline.

[ILLUSTRATION OMITTED]

Of course, China's rapid economic expansion is creating opportunities--and challenges--for everyone involved in the global marketplace, whether they happen to be from Finland, Germany, the United States, India, or wherever. But the pulp and paper industry seems especially keen on exploiting opportunities in the Middle Kingdom.

And no wonder. Economists regularly predict GDP growth of between 7% and 9% for China. Jaakko Poyry recently estimated that the country's paper and board consumption would rise by more than 4.6% per year against a global average of 2.1%. Observing that China already consumes about 34 million metric tons of paper and board each year, you begin to see why both producers and machine builders are racking up the air miles in pursuit of new business.

As the president of UPM-Kymmene's fine and specialty paper division, Jyrki Ovaska points out, "China's paper and board consumption is growing rapidly. New technology is pushing it and the scale of foreign direct investment is creating demand, especially in grades that require modern machines. There's huge demand growth taking place."

LARGE ORDER

A mere glance at some of the projects on Metso's order book or Voith's startup list (Table 1) underlines the unprecedented scale of the activity taking place across China's paper industry. Literally millions of metric tons of new capacity are being added to the country's production capabilities every year and forecast consumption growth seems likely to feed the frenzy for years to come.

According to Markus Wild, the general manager for Voith sales in Asia, "I think the growth in capacity will continue for some time yet, but perhaps the nature of the products will change. So far, the newsprint market has been busy so it could switch to the copy paper market if newsprint is saturated. But whatever happens, we are chasing a lot of active projects at the moment."

A recent Voith machine startup provides a good example of the type of project Wild is referring to. In July, Shandong Huatai Paper started up PM 10 in Dawang, some two hours drive from Tsingtao in Shandong Province. The Voith machine is designed to produce 3.1-m wide newsprint rolls. By August the machine was producing more than 650 metric tons/day of 48 g/[m.sup.2] newsprint at production speeds of up to 1655 m/min. Deinking, stock and chemical preparation, automation, and a finishing line all formed part of the project.

Huatai's president, Jianhao Li, reckons that this startup makes Huatai Paper the largest producer of newsprint in China. The group has a long-term goal of taking paper capacity at this location to 1 million metric tons/year.

That is just one machine among many, though. On the board side, Voith has started up the world's largest machine for white lined chipboard from recycled furnish. Board Machine 1 at Shandong Bohui has a design speed of 600 m/min and a wire width of 6.23 m. The machine boosts the Group's total production capacity to 300,000 metric tons/year of graphic paper and board and the company is aiming to reach 1 million metric tons/year by 2008 in an attempt to become a "global player."

SUPPLIER'S PARADISE?

China's paper industry is expanding so fast that Voith Paper's colleagues at Metso Paper are enjoying the boom just as much. According to the Finnish supplier, newsprint demand in China has risen from 1.15 million metric tons in 1998 to nearly 1.8 million metric tons in 2002 and the outlook is for annual growth of close to 8% until 2010. As a result, there is a lot of business to go round. On top of its other orders and startups, Metso received an order for a 330,000 metric tons/year newsprint line from the Hebei PanAsia Long Teng Paper Company to be installed at a greenfield mill in Hebei Province.

That particular line, announced in September, took the combined value of Metso's equipment orders from China in 2003 to approximately EUR 550 million. One of the supplier's largest single deals though, is Metso's EUR 100 million paper machine for UPM-Kymmene's Changshu mill. Unlike the overseas/Chinese joint venture ownership model accommodated within the Hebei PanAsia Long Teng Paper Company, UPM-Kymmene is going on its own with its new 450,000 metric tons/year fine paper machine near Shanghai.

The total project cost for the uncoated copy and offset paper line will be around EUR 470 million once automated reel storage, sheeting plant expansion, and coating equipment is included. The Changsu plant already produces 350,000 metric tons/year of woodfree uncoated and matt coated fine papers on line and the idea is that this machine will be rebuilt to produce glossy lightweight coated fine papers.

MARKET SCRUTINY

One of the most interesting elements of this investment is that UPM-Kymmene has expended a lot of time and effort in selling Changsu to its shareholders. UPM-Kymmene knows as well as anyone from its previous joint venture experience with APRIL (Asia Pacific Resources International) that Asia can be a difficult place to operate. Perhaps as a result, the Group has made a great show of explaining exactly why it is investing massive sums in China.

As Ali Malassu, associate principal at Jaakko Poyry in Singapore, explained, "Whatever happens in China, there is going to be a cut-throat pricing situation that could prove very difficult for overseas companies especially. For example, companies like UPM must work hard to justify projects because in order for management to get the green light to invest from their shareholders and the market they must show that the financial returns are there."

In fact, UPM-Kymmene produced a 28-page presentation to make its case for the Changsu investment to the financial community. In it, management points out--among other things--that they are getting much better production flexibility at the mill for a capacity cost of just EUR 1045/metric ton. In return, they are getting access to one of the fastest growing printing paper markets in the world, where advertising expenditure growth for printed media is forecast at 15% per annum until 2008.

"The market is not established yet," said Ovaska. "It's far from being mature and it's evolving rapidly and that's why we've published a lot of information about the market. We felt that in this case with the new machine our shareholders should know as much as possible."

OVER DONE

On the face of it, UPM-Kymmene has made a very strong case for the investment. But until the new line gets going in 2005 it will be impossible to know. In the meantime, the prospect of attractive sales growth in a dynamic Chinese market is certainly going to attract international and domestic rivals. So the next question to be answered is whether overcapacity could prove a fatal flaw, even in such a rapidly expanding market.

Wild at Voith says, "My guess is that we could have as many as three white paper machines being built each year and that would be great news for us. Of course, we wouldn't be able to do all of these, but we would have our share."

While Malassu at Jaakko Poyry thinks three fine paper machines a year might be overdoing it, there is certainly a high level of awareness that overcapacity could prove a real danger across a broad range of grades. However, it is also incredibly difficult to ascertain the true state of play with regard to capacity expansions in China as the head of Stora Enso's Asian operations, Seppo Hietanen, points out. "In some grades yes, it is a possibility," he says. "The problem is that we don't really know which proposals are genuine plans and decisions to go ahead and which are just people trying to place a marker. But the risk is there."

That view is echoed by UPM-Kymmene's Ovaska. "The Chinese market is quite strange in that sense," he explained. "There are a lot of rumors and lots of announcements, but a lot less actual building. I think a lot of it is signalization in fact, and in reality the capacity growth will be pretty much in balance with the market."

IN DEFAULT

Calculating consumption growth and overcapacity risk in a country as large, diverse, and dynamic as China would be difficult at the best of times. But the waters are muddied even more than usual with the presence of Asia Pulp & Paper (APP) in the mix. APP was responsible for the world's largest corporate emerging market debt default when it stopped repayments on more than US$ 13 billion.

In the middle of September, APP was still in talks with various creditors regarding that default, but that fact did not stop the company's owners from letting it be known that they planned to build a pulp mill and four new paper machines in China--anything between US$ 3-5 billion of new investment, depending on what figures you use.

For many in the West, talk of new investment on such a scale might be dismissed out of hand considering APP's current difficulties. But in Asia, the plans have enough credence for many industry watchers to discuss what will happen should the projects actually go ahead--including rampant overcapacity.

As one local commentator noted, "They seem to have their ways of getting finance and they are going to get it whether or not the international financial markets in the West think they should or not. I really think that the financing will come and it will come from Chinese sources."

Of course, with China developing so fast, overcapacity need not be the problem that some predict. And given the nature of Chinese industrial policy, it is even possible to envisage a scenario where the state itself dictates how much is too much.

Hietanen explained, "Of course, the Chinese authorities have a very good vehicle for making sure that [overcapacity] doesn't become a major problem. For every investment of this nature, you need approval from Beijing, so it would be possible for them to control that aspect of the business if the vehicle was used in the correct way. The question is whether they would welcome as much foreign direct investment as possible, which means we could perhaps see a green light given to too many projects, or whether they're only going to give a green light only to those projects that have a chance to become profitable."

MORE CONFUSION

Despite extensive feasibility studies and a widespread belief in the industry that Stora Enso will eventually expand in China, the company has yet to announce any formal plans. Making that decision, though, is unlikely to be straightforward.

Like any paper or board company interested in taking on the Chinese market, they face the challenge of a huge geographical spread, a rapidly changing demand situation, bureaucracy, the prospect of massive step-changes on the supply side, and any number of unreliable statistics.

Yet there is still another unknown that could be even harder to predict--the rate of decline among the older, smaller mills that supply much of the Chinese market today.

"I think we have a reasonably good picture of the market, but there is one part of the equation which is rather difficult to assess and that is the speed of the disappearing capacity in China," says Hietanen. "There will be a lot of old, obsolete mills that will disappear from the picture, which means that a lot of capacity will go, but we just can't say how long they will hold on for."

According to free market economics, such small, inefficient mills would disappear rapidly. But there is ample evidence to suggest that the authorities will be loathe to let all such businesses simply disappear overnight, given the potentially unsettling economic and social consequences.

With this in mind, the government has already made some attempts to create paper and board companies that will be able to compete in a more competitive environment, such as the creation of Shandong Chenming. Even so, many small mills remain. "Quite often, these old mills are the only place using local materials and employing the local population, so it might actually be quite difficult to close them down," Malassu pointed out. "I'm sure they will be wiped out eventually, but they may not be dying off all that quickly. They are often owned by the government and they are often supplying government printers that are supplying government publishers. Plus, it's not as if their business is all that attractive for anyone else as the standard payment terms are often half a year or more."

IMPORT CUTS

One thing that is certain is that all this new capacity will have a major impact on the China's paper and board import balance. Most industry watchers predict a rapid decrease in imports as the tap opens on domestic output, although there are some who forecast a slower decline in import levels as the Chinese economy roars forward, soaking up the new output. Either way, imports of many grades are likely to drop.

The new capacity is producing some interesting effects in other ways too, according to Malassu. Chinese machines designed to produce boxes using testliner with a kraftliner outer layer are responsible for a sharp drop in kraftliner imports from the USA, he believes. "You get a nice shade and the printability you need on the surface, but you're not paying for the quality in the middle," he argues. "Those people are then selling that product as a competitive substitute for kraftliner and that's already caused a dramatic drop in the volume of kraftliner being imported from the United States. IP and others are being forced to sell their kraftliner at prices near where domestic producers are selling kraft top testliner."

As Malassu points out, there will always be a market for true kraftliner (electronics goods, for example), but overseas producers of every grade will have to be wary of Chinese preferences. "The Chinese have a concept of 'good enough' quality," he noted. "For cut-size, yes, you're going to want high brightness and whiteness and strength to run in the copiers and so on. But for other uses, such as uncoated flyers, it might be enough to have 30%-40% of nonwood in the furnish."

[ILLUSTRATION OMITTED]

BOLD CHALLENGES

Paper and board producers operating in China--whether domestic or international--are set to face quite a number of obstacles as the market grows ever larger. Product managers may well have to react to "good enough" issues, while rapid growth and import substitution will challenge management and investors to make a judgement on how much capacity is enough and what might constitute too much. All of this must also be achieved in a market where transparency is not the most frequently traded commodity.

The challenges and the risks are certainly there, but the rewards for the companies that manage to succeed look to be substantial. It will certainly be a game worth watching.

[ILLUSTRATION OMITTED]

METSO: - MAJOR ORDERS TO CHINA

1999 Orders
   Black Dragon Group, Qiqihar,             Newsprint
   Heilongjiang

   Dong Guan Nine Dragons Paper, Guangdong  Linerboard

2000 Orders
   Shandong Chenming, Shouguang, Shandong   LWC

   Jilin Shixian, Tumen, Jilin              Offset newsprint

   Hanyang Chenming, Wuhan, Hubei           Unctd Woodfree

   Gold East Jiangsu (APP), Dagang,         Complete finishing line              Jiangsu                                  for double-coated                                                             fine paper

   Sun Paper, Shandong                      Folding boxboard

2001 Orders
   Dong Guang Nine Dragons Paper,           Linerboard
   Guangdong

   Jilin Paper, Jilin                       LWC

   Yueyang Paper, Yueyang, Hunan            LWC

2002 Orders
   Sun Paper, Shandong                      Board

   Dongguan Jinzhou, Guangdong              Corrugating medium

   Dongguan Jinzhou, Guangdong              Corrugating medium

   Dongguan Jianhui, Guangdong              Board

   Dong Guang Nine Dragons Paper,           Board
   Guangdong

2003 Orders
   Sun Paper, Yanzhou, Shandong             Paper machine

   Ning Shing Development, Ningbo,          Boardmaking line
   Zheziang

   Jiangxi Chenming Paper, Nanchang,        LWC
   Jiangxi

   UPM-Kymmene, Changshu, Jiangsu           Unctd Woodfree

   Hebei PanAsia Long-Teng, Shijiazhuang,   Newsprint
   Hebei

Source: Metso

Note: Several orders not included

VOITH: - MAJOR STARTUPS IN CHINA

1999 Startup
   Zhuhai Hongta Rhenheng, Zhuhai  Folding Boxboard/LPB

2001 Startup
   Mingfeng Special Paper          Cigarette Paper
   Shandong Rizhao, Rizhao         Folding Boxboard/LPB

2002 Startup
   Nanping Paper (PM3)             Newsprint (Rebuild)
   Nanping Paper (PM4)             Newsprint (Rebuild)
   Lee & Man Paper                 Testliner/Corr Medium

2003 Startup
   Zibo Bohui Paper, Shandong      Board
   Jinfeng Spike Paper             Cigarette Paper
   Mudangjiang Hengfeng Paper      Cigarette Paper
   CNTIC Trading, Huatai           Newsprint
   Mingfeng Special Paper          Ctd Woodfree

2004 Startup
   Chung Loong, Shanghai           Testliner/Corr Medium

Source: Voith

Note: Several projects not included

TOTAL P&B PRODUCTION, IMPORTS AND APPARENT CONSUMPTION (1000 metric tons)

Year                         2001    2002         **2010

Production                 32,000  37,800  50,000-60,000
Imports                     5,587   6,346         10,000
Apparent Consumption       37,587  44,146  60,000-70,000
Per Capita (kg/person/yr)      28      33          43-50
**Goal Set

MARKET PULP, WASTEPAPER AND WOOD CHIP IMPORTS (1000 metric tons)
Year          2001    2002

Market Pulp  6,419   6,873
Wastepaper   4,904   5,265
Wood Chip           900(e)

Note: Market pulp and wastepaper imports are expected to continue to increase at a comparatively high rate over the coming years.

Source: CTAPI

ADDITIONAL RESOURCES:

* "China needs vast recovered fiber imports," Jaakko Poyry Management Consulting, Solutions!, March 2003, p. 12.

* "China's paper industry: Entering the WTO era," Hannu Oinonen and Nie Xiaorong, Solutions!, March 2003, pp. 28-32.

* "The promise of paper in China," Martin Koepenick, Solutions!, Sept 2001, pp. 48-51.

* Note: All of these articles are available online at www.tappi.org. TAPPI and PIMA members can download them for free.

RELATED ARTICLE: IN THIS ARTICLE YOU WILL LEARN:

* Why most of the world's new machine projects are in China.

* If there is a threat of overcapacity in China.

* Why APP's plans may unsettle the Chinese market.

JIM KENNY, Contributing Editor

About the author: Jim Kenny is contributing editor/Europe, for Solutions! magazine, and is based in Brussels, Belgium. He is the former vice president of editorial for Paperloop and today heads his own company, DSI. Contact him by phone at [phone], or by email at [e-mail].