Fine doing fine but uncoated looks exposed.

In the United States, the coated fine paper sector is doing, well, fine, while the uncoated fine sector is lagging behind somewhat. In Europe, the situation is certainly similar, but there are enough market variations to make some tangible differences across the grades. Just as importantly, the fluctuations in the U.S. dollar/Euro exchange rate appear to be playing their part as well.

According to Morgan Stanley Analyst Chuck Spencer, producers in the United States are feeling confident that they will just about manage to make their third increase in a year stick for April, but there are still some regional differences impacting Europe. "If you look at the changes in the Euro against the dollar since last summer, you'll see that it's moved about 12% and that reasonably well matches the price increases that have gone through in the United States," he says.

However, if United States producers manage to set that third increase in concrete it should, in theory, then help Europeans argue for higher prices. The problem for European producers is that the market is still running operating rates that are just a bit too low to keep the supply/demand balance tight.

As another UK-based analyst pointed out, "The problem is that you're starting from a lower base on operating rates. Last year, we saw some impressive volume growth rates. Coated fine paper was up something like 11% on shipments and 8% on demand, so it was one of the strongest grades. But operating rates were still just hitting the 90% mark, so the proposed increases in September/October failed. And even though some companies like M-real are still hoping their January increases will stick I don't really think the market is tight enough yet."

On the plus side, there is a widespread consensus that advertising is on the up and the momentum remains strong, which will undoubtedly help coated fine paper grades and uncoated grades to a lesser degree. With any luck, a sustained ad recovery in 2005 will allow price increases in Europe after the summer, but for the moment several analysts feel that producers don't quite have the pricing power they require as yet. As Spencer explained, "It seems to have taken a little longer than we thought [for prices to move], but the underlying fundamentals do appear to be going in the right direction."

[ILLUSTRATION OMITTED]

Another fly in the ointment is to be found in the latest figures released by Cepifine--Europe's fine paper producers association (see Figure 1). While no one seems to be questioning that market fundamentals are strengthening, the latest figures clearly illustrate that consistent double-digit growth is not reasonable to expect and the market has to pause for breath sometimes.

Indeed, as the table clearly shows, Western European demand for both coated and uncoated woodfree papers took a breather in February, dipping by around 3% compared to the same period last year.

According to Credit Suisse Analyst Lars Kjellberg, the figures should not be misinterpreted as market weakness. "This, I think, is more of a hangover effect," he said. "Compared with the very strong situation we had at the end of last year, it's to be expected. There's been a degree of psychological warfare as well with buyers stocking ahead of price negotiations, and that seems to have lowered the resolve of the companies to push through prices."

That said, the coated paper segment seems to have weathered the storm reasonably well even if prices only stayed stable, but there's no doubt that uncoated fine paper grades have suffered if the latest figures from FOEX are to be believed (See Figure 2).

The FOEX indices chime fairly well with the comments coming from various market commentators. As one analyst noted, "With figures like these coming out, I think you'd have to say that second quarter increases look a little problematic. There is still talk of companies such as Sappi going for an increase before the summer, but for me it looks as if it's no longer going to happen. I'd certainly agree though, that the underlying demand expectations for advertising and direct mail look reasonably healthy, so maybe in September we'll see something more positive then."

However, Kjellberg believes that securing that famous third increase in the United States just could provide the momentum needed to spring a coated paper increase before the market traditionally weakens over the summer. Stora Enso is believed to be among those watching the United States closely before it makes its play, but as Kjellberg argues, the producers appear to be lacking the courage of their convictions for the moment. As he said, "Demand continues to rise, but there's not a lot of confidence being shown and it seems like when one group weakens the rest follow."

WRONG DIRECTION

The situation is less positive for uncoated grades, though. The consensus here seems to be that although the underlying demand profile is essentially stable, external factors are impacting on prices across Europe. There are different effects combining to depress prices, but as far as at least one commentator is concerned, one of the main causes of this current decline can be traced to Eastern Europe where improving quality and a strong euro have served to make Western Europe an increasingly attractive target.

Kjellberg cautioned against exaggerating the effects of new capacity from Eastern Europe, but he does believe that uncoated fine paper grades are witnessing the negative impact of low-cost competition from the east.

"The strong euro has attracted imports and the industry is now talking about Eastern Europeans making inroads into the market," he said. "Uncoated copy paper from countries such as Poland, Slovakia and Russia is accounting for [a greater percentage of the market], along with spot lots from places like Indonesia and Brazil. I don't necessarily believe that they're having a huge impact on trade flows, but in terms of affecting the marginal price, they probably are. After all, if you're based in the Slovak Republic or Russia and you want to build market share in Europe, the obvious way to do that is through price, taking advantage of your low costs."

If lower-priced imports are indeed setting the tone in the marketplace, then it's fair to say that the main challenge for uncoated fine paper producers at the moment is to stabilize prices. For the moment, that seems achievable if current demand trends remains robust, but there is little doubt that increased competition from imports will continue to hamper upward price movements at the margin.

LACKING CONFIDENCE

For the paper producers themselves, the mood seems to be one of caution. On the one hand, they know that market trends are running in their favor, but there is still some wariness in terms of operating rates and competition. On top of that, energy and chemical prices are proving troublesome in terms of profitability, although these factors could actually help create some "push" pressure for future prices increases.

Stora Enso is fairly typical in its view that, "Demand for fine paper is expected to remain good in Europe throughout the first quarter [though] the indirect effect of the weak dollar may disturb the supply and demand balance. Coated fine paper prices should stay stable during the first quarter, but prices for some uncoated grades are still under pressure."

According to Sappi, there is also reason to be cautiously optimistic--in some areas at least. The company recently quoted forecasts indicating that annual global demand growth for coated woodfree would rise by an average of 4.4% until 2008. This makes it one of the fastest growing segments in the business, according to the company. However, for uncoated fine paper producers, the same report showed that annual global demand growth would be just 2.3% over the same period, indicating further weakness in the market.

Europe's coated fine paper producers cannot afford to be complacent, though, as Sappi points out, since exports to the United States are likely to meet ever more competition from sources in Asia. Indeed, Asia and Eastern Europe could well continue to negatively influence prices if a strong euro proves to be attractive over the longer term.

Comments from the likes of UPM, M-Real and IP all tell similar stories. All in all, it seems that there is some good news for Europe's fine paper producers. It's not great news, but it could be worse.

Coated fine paper looks set to see continued strong demand that could even produce a price upturn before the summer, although the fall may be a better bet. Less encouragingly, uncoated fine paper producers are set to feel the pinch for a while yet.

However, as long as the region's economy keeps some sort of momentum going and the euro doesn't strengthen too much, there is some optimism that levels could stabilize. And for both coated and uncoated fine paper grades, possibly the best news is that there appear to be almost no significant capacity additions in the pipeline--within Europe at least.

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This year could yet prove to be a positive one for the region's producers, but it seems unlikely the champagne corks will be popping.

Figure 1: Western European fine paper statistics

Tonnes ('000)                   February          Year-to-date

                           2005  2004       %  2005  2004       %
                                       change              change

CWF Total deliveries        726   730   -0.5%  1462  1453    0.6%
  - to W.E.                 539   553   -2.5%  1087  1110   -2.1%
  - to outside W.E.         187   177    5.6%   375   343    9.3%
  W.E. demand (estimated)   553   569   -2.8%  1114  1142   -2.5%

UWF Total deliveries        612   626   -2.2%  1257  1248    0.7%
  - to W.E.                 517   541   -4.4%  1059  1078   -1.8%
  - to outside W.E.          95    85   11.8%   198   170   16.5%
W.E. demand (estimated)     629   650   -3.2%  1277  1285   -0.6%

* UWF
Uncoated woodfree grades are printing and writing papers made of
chemical pulp.
* CWF
Coated woodfree grades are UWF printing and writing papers, where
on each side a mineral coating is added.

Source: Cepifine

Figure 2: FOEX price indices.

               LWC 60    Ctd WF  A4 B-copy
                 g/m2  100 g/m2    80 g/m2
               offset     reels     sheets
                reels

Date              EUR       EUR        EUR

  29-Mar-05    691.87    717.24     785.30

  22-Mar-05    692.14    717.59     785.51

  15-Mar-05    690.18    714.62     786.67

   8-Mar-05    690.93    718.51     793.54

   1-Mar-05    690.38    717.91     797.42

  22-Feb-05    690.88    719.13     803.54

  15-Feb-05    688.88    717.03     803.40

   8-Feb-05    687.33    717.57     803.73

   1-Feb-05    682.72    717.00     802.20

  25-Jan-05    678.92    713.59     802.89

First index
 values

  03-Aug-99    762.58    727.93     818.01

Source: FOEX

RELATED ARTICLE

WHAT YOU WILL LEARN:

* How Europe's fine market is developing.

* How prices have weakened for uncoated producers.

* How a surge in advertising spending is aiding producers.

ADDITIONAL RESOURCES:

* www.sappi.com.

* www.foex.fi.

* www.cepifine.org.

* www.storaenso.com.

* www.m-real.com.

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].