Mixed signals for UK producers: advertising rates appear to be moving up in the UK, but producers are under pressure from regulators and prices for energy and raw materials.

The UK is known for being a large market for paper and board products in European terms. The country boasts a comparatively healthy consumption of well over 12 million metric tons of paper and board per annum, but this year it seems that papermakers are almost more concerned with events in the energy market than their own field.

According to the main voice for the paper industry in the UK, the Confederation of Paper Industries (CPI), power prices and the impact of new energy-related regulations are having such an impact on producers that many are seriously worried about how it will impact the bottom line. According to CPI's Deputy Director Kathy Bradley, "This is the thing that is concerning us most as energy prices rose considerably over the last year or two."

Indeed, the price rises have been significant enough to attract the attention of the government. While there is as yet no "smoking gun" to indicate Enron-type market machinations, a select committee has been set up to investigate movements on the UK's energy market. The committee's report has not been completed, but the CPI believes that the market is not working the way that it should and that UK papermakers are paying the price.

The difficulties do not stop there, though. The CPI is also heavily involved in another area of energy policy--emissions trading. The UK government recently announced that it wanted higher carbon emission allocations than it initially indicated that it would ask for, putting Britain on a collision course with the European Union (EU), which is trying to set up a trading scheme that will operate across Europe to satisfy the needs of the Kyoto Protocol, which limits emissions of greenhouse gases.

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Needless to say, UK papermakers are likely to suffer if the government does not win its case for higher allocations, although here Bradley believes that the UK can mount a strong argument in its favor. The original National Allocation Plan, submitted to the EU last April, estimated the emissions from installations covered by the trading scheme would be 736 million metric tons, but this was considered something of a stretch target and was calculated on the basis of steady state conditions. As a result of economic growth since the original planning phase, the government has recalculated the country's allocations needs and is now asking for 756 million metric tons.

As yet there is little specific detail available on how the allocations will be shared among the industry sectors and the CPI is still waiting to hear more on the government's apparent intention to extend eligibility for allowances to "good quality" capacity CHP schemes. But the confederation feels that the issue is so important that it will require close attention and further lobbying in the weeks to come. "The allocations issue is ploughing its way through the EU and it looks like there's a good case, but there's just not enough detail yet for us to be able to give an informed reaction," Bradley explained.

DIFFERENT STRUCTURE

The UK industry's cautious attitude toward renewable energy contrasts with several Nordic pulp and paper companies that have been rapidly installing new power capacity at their mills. Indeed, some Nordic companies have put such investments in the high priority category in an attempt to capture new revenue streams from renewable energy--so-called green electricity--as quickly as possible. By contrast, there are just a few such investments taking place in the UK.

Bradley says there are several reasons why the approach may not be working in the UK. For one, the government seems keener to offer sticks for non-compliance than carrots in terms of financial incentives to encourage the sector to invest in renewables. In addition, the Nordic sector has a different raw material structure than the UK, relying far more heavily on fiber from other countries and recovered paper that often requires significant energy during processing.

"Some members have already been asking whether the paper industry should even be trading its emissions given some of the uncertainties," she said. "I think we assume it would be in our interests, but it's not all that certain. I guess we'll see soon, but some of our mills are very old and some are quite new so it's quite a different situation from Scandinavia."

MORE TO COME

Energy certainly seems to be the hot topic at CPI, but the organization is also dealing with a number of other "live" issues as well, such as:

* the EU's Working Time directive, which is hitting some logistics elements of the business

* the knock-on effects of January's massive storms in Sweden that blew down almost the equivalent country's annual timber cut (about 80,000 cubic meters), disrupting supplies

* continuing pressure from government, NGOs and pressure groups to boost the paper and board recovery rate

* even greater pressure from retailers such as the DIY chain, B & Q, and several publishers to utilize FSC as the only acceptable environmental certification.

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As such, CPI and its members are having to deal with challenges on several fronts. However, the industry also has to remain concentrated on trying to make deliveries and turn a profit.

Here at least there is some good news, according to UBS Warburg Analyst Harri Taittonen. "The good news is that magazines and newspapers seem to be on the up and capacity expansion in those grades appears to be quite limited for the moment," he said. "We're still missing the super catalyst that's going to really get prices moving quickly, but operating rates are getting a bit better and the first price increase announcements are out there."

In fact, the country's largest advertising group, WPP, recently reported a healthy surge in profits and suggested that newspapers and periodicals could well see some sustained demand this year. If so, that could support some of the price increases proposed for April. For now, though, UK prices are struggling slightly to maintain the gains they made at the end of 2004, so many of the producers will have their fingers crossed that positive advertising support is sustained.

The picture is somewhat less rosy for packaging producers, as Pira consultant Greg Wood explained. "If you look at that famous Ernst & Young report, it shows that the market for plastics is growing at 7-8% per year, but paper is down to between 2-4%, depending on whether you're talking about corrugating materials or containerboard or sacks and so on. The market share [for fiber-based packaging] is in a long-term decline."

According to Wood, there is still a high degree of overcapacity in the UK market and greater consolidation will be needed to turn things around. In the meantime, bigger buyers are taking advantage of the situation by using online auctions to leverage even greater competition among the suppliers. "There are just too many people and e-auctions have fuelled the downward pressure on prices," Wood explained.

Taittonen adds that new capacity coming onstream across the packaging side of the market--especially containerboard--could make the situation even worse. "I don't have the exact figures, but with Adolf Jass [in Germany] and Emin Leydier [in France] and so on, there's something like 1.2 million metric tons of capacity coming on stream in less than six months. That's got have a major impact."

EFFECT OF E-AUCTIONS

The UBS analyst also pointed out that e-auctions were not only a feature of the board sector, but increasingly the same process was pushing down prices for tissue suppliers as well. "We're seeing these auctions more and more in the UK instead of suppliers having exclusive relationships," he explained. "They can be real bullies and if at some point you want to get the business, then you have to be really aggressive, especially if you're up against the Italians, for example, who appear to have a real expertise here."

Given the latest market moves, most UK containerboard and kraftliner suppliers will probably be fairly happy if they can keep prices steady for the next few months. As one of the UK's major packaging producers, David S Smith, noted in its latest interim results, "Our UK business, St Regis, experienced extremely difficult trading conditions in its main product, CCM (corrugated case materials), with prices continuing to be depressed by sluggish total market demand, compounded by excess capacity in Europe. Margins were further squeezed by gas costs [and] the relatively high cost of our raw material, recovered paper."

The group's corrugated packaging unit also noted that UK demand climbed just 0.1% in the first nine months of 2004 and to help keep margins positive, the company will continue to seek cost cuts throughout this year.

MIXED BAG

Overall then, the UK market is a fairly mixed bag. The UK's economy is not doing particularly badly in relation to continental Europe and there are certainly some bright spots to reassure publication paper producers. However, board producers look to be in for a tougher battle and despite making noises about aiming for further price increases, over-capacity and continuing pressure from buyers look set to hamper the board segment over 2005.

WHAT YOU WILL LEARN:

* Why UK production remains flat.

* If there are positive signs for graphic grades.

* How e-auctions and overcapacity are changing the market.

ADDITIONAL RESOURCES:

* www.ppic.org.uk.

* www.davidssmith.com.

* www.m-real.com.

RELATED ARTICLE: FLAT YEAR FOR UK PRODUCTION

Despite several mill closures, the Confederation of Paper Industries' (CPI) preliminary statistics show that UK paper and board production in 2004 remained at the same level witnessed in 2003-6.2 million metric tons.

Overall consumption of paper and board did move up slightly to hit 12.7 million metric tons and the statistics indicate that graphics grades did best in this area. In addition, newsprint output reached 1.1 million metric tons for the first time since 2000. The packaging sector remained flat overall, in line with a fairly flat profile in the tissue sector.

The organization's figures also indicate that exports now account for 21% of the country's total paper and board production. Exports of graphic grades climbed by a hefty 5%, while packaging grade exports rose 4%. But the major mover was in recovered paper, where exports surged to nearly 2.5 million metric tons. Amazingly, this represents a growth of 2 million metric tons in just four years, underlining the strides the country has made in beefing up its recovery infrastructure.

UPM's Shotton mill has now switched to 100% recycled fiber, which helped to drive consumption of recovered paper up to 4.6 million metric tons--a 2% increase over the previous year. As such, recycled fiber now constitutes 68% of the fiber used for papermaking in the UK. Imported pulp now represents 25% of the raw materials as usage rose by 4% to 1.45 million metric tons, while domestic mills used less integrated, homegrown pulp directly largely as a result of the Shotton switch to recycled. In fact, the figure for domestic pulp dropped to 350,000 metric tons, or 6% of the total material used.

JIM KENNY, CONTRIBUTING EDITOR/EUROPE

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].

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