Going global: both the demand for and the supply of recovered paper will push a trend toward more cross-border trading.

The following text is an edited version of remarks made by Bill Moore at the opening of the keynote session of the 2004 Paper Recycling Conference & Trade Show, which took place in Atlanta in late June.

The paper recovery business continues to go more global. Looking at global investments in recycled papermaking capacity throughout the next four years, we see North America may actually have 1.8 million tons less capacity. And as we lose capacity in North America, Japan also will lose a couple of hundred thousand tons of capacity during that time frame.

Europe is on the other side of the equation. Some people think of Europe as a mature paper industry market, but our forecasts certainly don't show that. More than 5 million tons of new recycled papermaking capacity will come online in Europe by 2007.

The biggest factor in the global picture, as everyone knows, is the Asia/Pacific region. This region will be adding more than 11 million tons of recycled capacity in the next four years. And lead among that is China, accounting for the lion's share of that capacity increase. Looking at the statistics for Chinese imports of recovered paper, it is apparent through the first half of 2004 that the trend toward more imports continues, with the month of February 2004 showing a record amount.

This trend is likely to accelerate during the next two years. China is worth talking about some more; attendees of this conference heard it last year and we heard it the previous year, but the numbers do speak loudly. We are right on the edge of a significant number of new paper machine project startups.

SUPPLY-SIDE ECONOMICS. Where is their secondary fiber coming from? Japan was not a supplier to China in any meaningful way until 2000, but recently they have grown. The Japanese paper industry has been sluggish like North America's, and thus paper stock dealers have become exporters to China.

The volume from European nations, which have a fair amount of supply going to China, has really kind of flattened out. We expect Europe will continue to export recovered paper to China, but we don't expect to see a dramatic increase.

Who does that leave? That leaves the North American market. The export total jumped up in 2003, and in 2004 the figure is going to be even higher. Given the extent of Chinese demand, that nation's mills are now looking to the United States for almost two-thirds of their overseas supply. Can the North American/United States market produce that?

A first glance reveals that the pressure will be on North America producers to do that. When we look at exports from Europe, Germany, which was a significant exporter for many years and grew throughout the 1990s as an exporter, has actually been declining in its export levels. As there is more recycled papermaking capacity coming online in Germany's domestic mills, this will further inhibit its ability to export to China.

Luckily for Chinese buyers, supplies in Italy, Spain and the U.K. are growing. The United Kingdom truly has become a significant player in the world recovered paper market.

Japan was on the rise as an exporter in 2001, its exports decreased in late 2002 and then its export rate increased again in early 2003 before flattening. We don't see a lot of tonnage coming out of Japan in terms of an increase in the three-to-five year near-term future. We think Japan will continue to be an exporter, but its domestic business is picking up a little bit, and its recovery levels are already, so high that few new recovery opportunities remain.

RECOVERY RATES. As must of us know, the current recovery rate of old corrugated containers (OCC) in the United States is pushing 75 percent. The American Forest & Paper Association (AF&PA), Washington, has announced future recovery goals for the industry.

But an important aspect of this effort is what the cost to collect and process the last ton of OCC will be. When we were at 30 [percent] or 40 percent, the collection cost was relatively low. Therefore, the market price to produce a recoverable ton at a profit was much lower. When you get to the mid-70s in recovery percentages, we're talking an average of $60 in collection and processing costs to get that last ton out (excluding fiber acquisition cost). The curve starts to move exponentially upward to increase the recovery rate.

To go from 70 [percent] to 75 [percent] to 85 percent, which is where we have to go to by 2010, we add $35 per ton to the cost basis. The market price has to rise that much just to cover costs, which does not include any potential rise in the fiber acquisition cost.

Companies appear willing to enter the North American market. Ekman & Co. is a well-known Swedish company with a U.S. office. It entered the U.S. trading market in the last year and had a significant acquisition with KC International.

Over the past two years, International Forest Products (IFP)--somewhat similar to Ekman in that it is a large finished products trader--saw the trends in recovered paper, including the lack of export of board and newsprint grades, and established its own recovered paper business and has acquired some paperstock plants.

RecycleAmerica Alliance (RAA), the subsidiary of Waste Management Inc., is stepping up its export activities. RAA was not a strong player in direct exports three or five years ago, but is becoming a player.

Elof Hansson has entered the U.S. brokerage business. With the exception of IFP and RAA, these are pure brokers. To some extent, they are looking for the same recovered tons baled by someone else. Brokerage itself is not the answer.

No one over a long period of time is going to go out and collect recovered paper if they cannot make a profit on it. That, to me, is the tremendous challenge that paper industry faces throughout the next five or six years.

In old newspapers (ONP), the AF&PA statistical methodology produces a current recovery rate of almost 73 percent. By 2008, given the world demand, the recovery rate must increase to 87 percent. It's not doable, in my mind. The supply is going to have to come from somewhere else.

If you look at the market pricing of ONP during the last three years, it's not been a demand-driven market. It's been a lack-of-supply-driven market. We've got a lot of supply work ahead. Is it possible?

I think the U.S. system will rev up to produce more material, but we can't do it all. Europe will increase recovered paper rates also. We may sec some places that we don't think of as exporters, such as large Latin American cities, contributing. Domestic collection in Asia will grow to provide part of it. It's a global answer. Just like the buying side is global, the supply side also is increasingly global.

OCC AND JIT DON'T MIX

A new report available from Moore & Associates, Atlanta, finds a correlation between paper mill inventory practices and average prices paid for their fiber. "We have developed a strong correlation proving what we have suspected through the years--the mills that hold longer inventories pay lower prices for recovered paper," says Bill Moore, co-author of the new study. "The converse of this hypothesis is also true; that mills holding the shortest inventories typically pay higher prices for their recovered paper."

The report, titled "An Analysis of Recovered Paper Inventory Practices," uses the Moore & Associates ForeSight[SM] price database and statistical analysis to verify the correlation between OCC (old corrugated containers) and ONP (old newspapers) purchase prices and inventory levels.

According to Moore, the supply on hand of OCC/ONP at mills has declined markedly from the early 1990s, as the mills adopted JIT or "Just-In-Time" inventory practices, following suit with other manufacturers.

"While for most manufactured raw materials, holding less inventory saves a company working capital and thus improves its bottom line, for recovered paper, the JIT principal does not hold up," says Moore.

As an example, Moore cites weather conditions and other unexpected events causing quick upturns in price. Mills with adequate inventory could wait for prices to subside but JIT mills had to stay in the market, causing their average purchase price to escalate.

"Armed with this report, a company can perform an analysis of the value of the working capital for inventory vs. the savings that could accrue based on the buying flexibility longer inventories give," says Moore.

Those seeking more information on the study can contact Moore & Associates at [phone] or visit its Web site at www.MARecycle.com.

The author is president of an international consulting firm providing strategic services to the paper and paper recycling industries. He can be contacted through the company's e-mail address at MARecycle@aol. com.