Newsprint: positives in a difficult market.

There may be plenty of mixed messages bouncing around the newsprint sector, but one thing that seems certain is that 2006 will see prices climb higher in most markets. Champagne corks are unlikely to be popping wildly however. In fact, there are plenty of reasons why newsprint producers might be left feeling rather flat at the current market situation, especially given sharp increases in energy costs and falling circulation figures recorded among a host of publishers.

On the other hand, there is also evidence that a long battle against oversupply in western Europe and North America may finally be paying some dividends, while at the same time higher input costs mean that price increases are slightly easier to push through. Indeed, hikes going into 2006 are almost inevitable as producers struggle against low and ever tightening margins.

Sticking with the positive, it's fairly clear that most Europeans sellers are looking for higher prices for their newsprint as each of the big players made announcements in the run-up to the vital year-end negotiating period. European volumes are generally based on longer term contracts, so this is always a crucial period in the calendar for buyers and sellers alike.

Stora Enso was fairly typical when it indicated that January 1st would see rate hikes. A release in December noted that, "In Western Europe, demand is improving but prices will be stable until the end of the year, forecast to increase in 2006."

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UPM followed suit, noting that demand for standard and improved newsprint was higher and prices for standard newsprint averaged 4% higher in Europe in 2005. Again though, there were mixed messages as UPM said that energy prices were significantly higher, although recycled paper prices were slightly lower than those seen in 2004. Norske Skog noted that prices for newsprint in Europe were "substantially" below other markets at the end of 2005, while Holmen commented that market conditions for newsprint had improved over 2005.

All in all, the global newsprint market is fairly solid. As one analyst explained, "2006 is definitely going to produce higher newsprint prices. The only question is how much. Lots of figures have been suggested, but personally I still believe that the increase will come out in the mid-single digits, somewhere around 5-6%. Some announcements have been a lot higher than that, but there's also a range of evidence that the increase will be lower in the Nordic region and that could bring the increases down a bit. They've benefited from currency movements and when you consider that something like a fifth of Europe's newsprint capacity is in Sweden, then they might not stick firm on the 10% announced."

Certainly, the FOEX index for newsprint showed that prices were showing solid signs of progress in both Europe and North America (See Figure 1). In fact, mid-December showed a 5.1% increase on European prices from the beginning of 2005--before many of the higher contract rates for 2006 were even agreed.

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As the FOEX analysts pointed out, "The newsprint market remains firm. Most of the key producers have announced price increases in the range of 5-10% [for January 1st], depending on the producer and on the market."

As always, there are currency effects to be taken into account, but one of the positive elements reinforcing the calls for price rises was a general increase in demand across Western Europe in 2005, albeit a modest 1.4%.

UPWARD PRESSURE

For some financial groups such as Handels-banken Capital Markets, the positive news was enough to prompt a buy signal as the group forecast a European price increase of some 6% in 2006. Consequently, Norske Skog and Holmen were placed as some of the best short-term picks in the Nordic pulp and paper sector.

Meanwhile, Morgan Stanley predicted a rough ride for publishers when it noted, "We now factoring a 7% increase in newsprint prices in 2006. Publishers will find it hard to improve margins."

Indeed, Morgan Stanley's team went so far as to predict further rises in 2007. "Our sense is that the balance of power lies unusually strongly with suppliers due to higher energy prices and capacity utilization rates," reported the analysts. "Market conditions are further being tightened by Norske Skog's decision to idle PM 2 at its Follum mill. Price increases will also receive support from the closure of Norske Skog's Union mill in the first quarter of 2006 and the withdrawal of 130,000 metric tons/yr of capacity at Stora Enso's Kvarnsveden's mill at the end of 2005. These closures will partly offset the start of the Holmen machine in Spain at the beginning of 2006, allowing operating rates to near full capacity in 2007."

On top of that, there is still the prospect that Stora Enso could consider closing its newsprint capacity at Summa as the group already has the mill "on watch" as part of its profit enhancement program.

Overall though, Norske Skog's comments on the market situation were typical as the CEO, Jan Oksum noted, "For 2006, we expect a reasonably tight market for newsprint and price increases in most countries and regions."

DECLINING CONSUMPTION

Given the structural differences between the North American and European market, most indices show that newsprint prices crept along around the EUR 500/metric ton mark for most of 2005 in Europe, while US prices showed a steadier improvement, reaching as high $620/metric ton in some places later in the year

The range of movement reflects the differences in the trading patterns and exchange rates, but again there is little argument that prices are heading north in the United States as well, even if some of the fundamentals are less than positive.

As the team at FOEX commented recently, "In the U.S. newsprint market, the battle between the negative impact on the pricing from the poor demand statistics and the upward pressure from costs and capacity cuts continues. The producers continue to try to get through the announced price increases and/or energy or freight surcharges. [As a result] our price benchmark has moved back and forth in the recent weeks."

In fact, newsprint demand in North America has been poor, not to put too fine a point on it. Toward the end of 2005, the Pulp and Paper Products Council reported that shipments were down 3.9% on the previous year. However, producers look to have been robust in their response as production dropped 4.4% over the same period, cutting capacity utilization to 95% from 96% in 2004.

As a result, prices have moved up on the basis of higher energy costs and capacity tightening among the players, but several commentators have wondered whether the industry can keep up its discipline as demand contracts. "Producers may be able to push pricing for a while, but I wonder if they can keep it up, especially if consumption falls in the U.S.," one said. "We're forecasting an increase in ad spend, but I suspect that there's only going to be a small portion of that that will go into newsprint with the increase in web advertising we're seeing."

In fact, ad spend is reported to fairly robust in most of the main global markets, although Europe is attracting a few more pessimistic comments going into 2006 (see Figure 2). The problem is that a lot of marketers are finding the Internet increasingly attractive, especially in the more industrialized economies. It may not be a major structural problem yet, but newsprint is likely to benefit less from increased ad spend than in previous cycles.

LOOKING UP

Despite the obvious problems, the North American majors are showing some determination to go after the price increases they need to ward off the ill effects of rising energy, transportation, chemical and other costs.

At a recent conference, the CEO of Abitibi-Consolidated, John Weaver, said that a newsprint price increase is to be "expected" in 2006 as the sector now has a better grasp of the supply and demand levers. Given the slowdown in consumption in the United States in particular, the ability to exert some influence on the market has cost the industry dearly in terms of jobs, shutdowns, and PM product conversions.

"It's not great news. Two of the biggest North American newsprint companies--Bowater and Abitibi-Consolidated--have said that they think standard newsprint consumption will continue to decline," said one analyst. "Basically, there are fewer dailies around, plus publishers are switching to lighter paper or producing smaller editions. In fact, I recently read somewhere that 3 million tons of newsprint capacity has been shut down in North America in the past 5 years."

Most recently, Abitibi-Consolidated announced the permanent closure of two newsprint mills in December as the Stephenville plant in Newfoundland/Labrador and the Kenora unit in Ontario were shuttered. "We could not find a viable long-term solution to return the two mills to profitability," said Weaver. "These decisions are difficult but essential to achieve our objectives. We recognize the hard work of many committed people, but after much effort, we simply could not overcome the inherent challenges facing these operations."

The closures will cost around US$ 200 million in asset write-downs and closure costs and will remove 344,000 metric tons/yr of capacity from the market, the company said.

The fact is, though, that such moves are necessary. The most recent PPPC inventories showed drops even as shipments and consumption dipped. And as Weaver noted, "North American inventories are significantly lower for newsprint", and this has certainly helped keep prices buoyant.

That is a view echoed by Bowater's chairman and CEO, Arnold Nemirow. "Bowater's product pricing improved throughout [2005]. However, we have experienced significant cost pressures, especially energy, chemicals and distribution costs, and the strong Canadian dollar. We do expect market fundamentals to continue to support Bowater's improved fourth quarter pricing."

Here again though, Bowater reported operating losses in 2005 and is yet another group looking to implement cost-cutting programs. They will be needed as the company's third quarter results showed that unit manufacturing costs were up 9% in newsprint.

Needless to say, the group is looking at alternatives. Indeed, Bowater plans to convert approximately 200,000 metric tons of annual newsprint production at its Calhoun mill to higher-margin specialty grades, for example, and similar conversions have been penciled in for Thunder Bay.

GLOBAL VIEW

Newsprint consumption may be declining in North America, but there are at least positive signs across the emerging markets. Among the more recent developments, upgrades and capacity expansions have been announced in Chile and Argentina. But the biggest expansion is taking place, inevitably, in China.

Prices for newsprint imports rose in several Asian countries recently. Again, the hikes were largely in response to higher costs for raw materials, energy, and transportation. Significant increases in consumption are also evident in China, for example, but as one commentator cautioned, "As always in Asia, there's always the fear that capacity expansion will outpace consumption growth and I think we're seeing a bit of that now. Also newsprint demand in China is up 3-4% and lots more in India, but Korea and Taiwan are actually quite weak for the moment, so it's not all one-way traffic."

Certainly, new capacity continues to come on stream. Among several recent expansions is a new machine started up by Hebei Pan Asia Long-Teng Paper Co--an 80%/20% joint venture between PanAsia Paper and Hebei Longteng Paper Corp.

The group opened its greenfield mill in the Hebei province of China at the end of 2005, but the event was somewhat overshadowed by the news that Norske Skog had snapped up 50% of the shares in Pan Asia from Abitibi, propelling the Norwegian based group to becoming the biggest newsprint producer in the world.

The news was apparently welcomed on the stock markets as Norske Skog's share price showed strong upward impetus, even in the face of a ratings downgrade from Moody's. One analyst close to the deal said, "I think the increase seen since the move is just because it's a really good strategic fit."

The management team certainly seems to agree. CEO Jan Oksum said, "Sole ownership of PanAsia will give us full access to the largest and fastest-growing market for newsprint in the world. We have gradually increased our holding in PanAsia over the last seven years and we will be taking over a modern and competitive company. Although our collaboration with Abitibi has worked well, we see considerable advantages in being the sole owner."

The acquisition totals 1.8 million metric tons/yr and means that 30% of Norske Skog's newsprint capacity is located in Asia, making it the largest newsprint manufacturer in Asia, with leading market positions in China, Korea and Thailand.

Norske Skog paid US$ 600 million for Abitibi's shares, consolidating some US$ 275 million of net interest-bearing debt as part of the deal. In tonnage terms, the acquisition comes in at US$ 1008 per metric ton of capacity, financed largely by US$ 615 million rights issue that was underwritten by Deutsche Bank and Nordea.

As Norske Skog noted, "This continent already consumes more newsprint than either Europe or North America, and growth, particularly in China, is expected to remain substantial in coming years."

Norske Skog PanAsia as the new company will be known is now the sole owner of two newsprint mills in Korea and has a majority holding in two mills in China and one in Thailand. However, the deal also means that--somewhat understandably--other projects were put on ice. As the company said, "Norske Skog has carried out a main study on a possible new paper machine at the Pisa mill in Brazil. The study concludes that such an investment will be positive for the company, but certain aspects relating to the general operating conditions remain to be resolved. The Board of Norske Skog has therefore decided that further consideration of this project will be postponed until further notice."

POSITIVE OUTLOOK

All in all, newsprint faces some tough challenges. It is still unclear whether producers--many of whom are not creating shareholder value--will be able to claw back increases in energy, chemicals and transportation costs in 2006.

Consumption, too, remains an issue (see Figures 3 and 4). Overall demand is declining in some markets, but there are more positives than negatives in global terms. Added to that, there is some recognition that overcapacity is something that needs close attention. In the near term, prices can only go up. The big question still remains, can profitability follow suit?

ABOUT THE AUTHOR

Jim Kenny is international editor 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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JIM KENNY, INTERNATIONAL EDITOR

WHAT YOU WILL LEARN:

* How the global newsprint markets are developing.

* How price increases are being compromised by rising costs.

ADDITIONAL RESOURCES:

* "Inside the Numbers: U.S. Newsprint Bounces Back, But Challenges Remain," by Jaakko Poyry Consulting, Solutions!, February 2005. To access this article, type in the following product code in the search field on www.tappi.org: 05FEBSO52. Or call TAPPI Member Connection at 1 800 332-8686 (US); 1 800 446-9431 (Canada); [phone] (International).

* Canada: singing the blues?, by Alan Rooks, Solutions!, January 2005. Product Code: 05JANSO64.

* "Newsprint: declining high technology," by Jim Thompson, Solutions!, January 2004. Product Code: 04JANSO67.

* "Newsprint Trends: No news is not good news," by Alan Rooks, Solutions!, January 2005. Product Code: 05JANSO69.

* "Newsprint in the headlines for all the wrong reasons," by Jim Kenny, Solutions!, September 2003. Product Code: 03SEPSO40.

PIX Benchmark       on Dec 13   Prev Week  Beginning 2005

PIX Euro Newsprint  EUR 490.43  EUR +0.51  EUR +24.92
PIX US Newsprint    USD 609.68  USD -0.42  USD +58.90

Figure 1: European and U.S. Newsprint Prices. Source: FOEX

(1,000 tonnes)

                          October            Year-to-Date
                     2005  2004  % change  2005  2004  % change

NEWSPRINT
Total Shipments      792   826    -4.2%    7570  7725   -2.0%
  to Western Europe  686   705    -2.7%    6490  6505   -0.2%
  to Outside W.E.    105   121   -12.8%    1080  1220  -11.5%
W.E. Demand          782   792    -1.2%    7462  7356    1.4%

Figure 3: Western European newsprint statistics. Source: Cepiprint.

                           September          Year-to-date
                    2005   2004   Change  2005   2004   Change

NORTH AMERICA
Production          1009   1052    -4.1%  9520   9956    -4.4%
Operating Rate        94%    96%            95%    96%
Total Shipments     1057   1084    -2.5%  9543   9928    -3.9%
  to Canada           92     89     3.6%   799    805    -0.8%
  to United States   741    789    -6.1%  6822   7301    -6.6%
  to Other Markets   224    206     8.6%  1922   1821     5.5%

                                                 Change from
                    SEP    AUG    JUL     SEP    month  year
                    2005   2005   2005    2004   ago    ago

INVENTORIES
North American
Producers            306    354   346      325    -48   -19

Figure 4: North American newsprint industry statistics. Source PPPC.