Rocky road: an improved market is being forecast to lift the North American paper industry out of its prolonged slump, but a recovery could be far from robust.

The resurgence of scrap paper prices has made many people in this industry happy. While paperstock dealers are upbeat about conditions in their market, paper and paperboard producers continue to struggle with difficult market conditions.

While there has been a glimmer of improvement in market conditions for some grades, an improved market for finished paper products is far from a sure thing.

Adding to the problem, and perhaps creating greater concern for some paper makers, is that while the domestic paper industry has been struggling to slash production and improve prices, a torrent of new capacity overseas is coming on line.

CHINESE COMPETITION. The accelerated economic growth of China has been the key reason for the surging paperstock market. During the past year, more capacity is coming on line in Asia. At the same time, domestic and Canadian mills have been shutting down machines, closing older mills and reducing production levels.

The strong demand for recovered fiber exported to China has been one of the main reasons for the sharply higher demand for many paper stock grades, providing the upbeat outlook of many paper stock dealers. For paper mills, though, this has resulted in a much tighter supply of material from their domestic scrap paper supply sources.

For many mills dependent on recovered fiber for a large percentage of their supply, the situation presents a conundrum: paying more for material to guarantee a supply, while actual demand is static at best.

While China (and a large percentage of Asia) ramps up new production, the domestic paper industry has been less able to boost its output, despite sharp reductions in inventories.

According to Bill Moore, a principal with Moore & Associates, an Atlanta-based consultant to the paper industry, the clearest example of the continued problems with the domestic paper industry has been the acceleration in the number of mill shutdowns. During the early 1990s, only a handful of mills shut down every year. However, toward the end of the 1990s, the number jumped significantly. In Fact, Moore says, a total of 21 mills permanently closed in 2001; and 19 mills closed last year.

Despite these closings and the removal of a significant amount of papermaking capacity from the market, there still doesn't appear to be much price strength for finished products. This failure to boost prices for the finished products is putting even greater pressure on domestic mills to remain fiscally solvent.

DOMESTIC DOLDRUMS. Observers have a number of opinions on how the domestic and oversells paper industries will play out.

One school of thought is that with the slowing number of mill closings, more balance is in place. This should provide some semblance of stability to the market, allowing for better pricing for many finished product grades.

In fact, some equity analysts are starting to take a much closer look at paper and paperboard companies as an investment opportunity. If, as many economists feel, the general U.S. economy is improving, a pickup in demand is likely for grades such as corrugated containers, which are often considered leading indicators of economic expansion.

However, another school of thought--one that is of greater concern for many paper companies--is the possibility that Asian mills could begin exporting more finished products to the U.S., in essence competing with domestic mills for both the raw material and the finished product market share.

Bryon Korutz, an equity analyst with Standard & Poor's, doesn't see the U.S. importing more finished paper from Asia soon. However, he cautions that if the difference in cost to make paper in the U.S. and Asia widens, the U.S. may import more product from Asia eventually.

The newsprint industry has been one of the most sharply hit sectors of the forest products industry.

During a presentation at the Global Paper & Forest Products Conference, presented by UBS, Arnold Nemirow, chairman, president and CEO of Bowater Inc., one of the largest newsprint producers in the world, noted the significant consolidation in the newsprint industry.

Fewer than 10 years ago, the top three newsprint producers controlled about one-third of the total newsprint production. Today, the top three producers control about 60 percent of the newsprint market, according to Nemirow.

Going even further, the five largest newsprint producers in North America control close to three-fourths of all the newsprint produced in the U.S.

While this is a glaring example of the consolidation in the paper business, it is not the only one. The domestic corrugated packaging business also is consolidating at a rapid pace. The top five producers of corrugated packaging in the U.S. have around 70 percent of the market.

Many companies are learning that they need to focus on a handful of grades, rather than make different products across the paper and box spectrum.

This has led Georgia-Pacific Corp., Atlanta, to pursue the consumer products sector, while jettisoning much of its paperboard business. The company now is focusing on producing tissue and paper towel products, competing against consumer products companies such as Procter & Gamble, Cincinnati.

As North American paper producers have wrestled with balancing supply and demand, offshore mills have cranked up capacity. During the past quarter alone, more than 150,000 tons of new capacity have come on line in China.

While the finished product has primarily stayed overseas, concern is growing that more could start to be shipped back to the U.S., adding even greater pressure on mills in North America.

Bill Moore, in a presentation given the annual Paper Recycling Conference & Trade Show, noted the number of paper and paperboard mills closing results in about 6.5 million tons of domestic paper capacity taken off the market during the past three years.

However, Asian paper making capacity is slated to grow at a 3.7 percent annually through 2005.

A result of the transitioning in the domestic paper industry is the decline in new capital investment in the U.S. According to a report by Ratings Direct, "The rate of capital investment in domestic plant and equipment has slowed considerably during the past few years. Significant production capacity, primarily in the U.S., has been closed or mothballed as a result of companies' adjusting investment levels to the weakened demand and attempting to reduce the structural overcapacity in many grades. These actions have been made possible through industry consolidation, which has been prompted by historically poor returns."

A SIGN OF LIFE. On another level, some segments of the North American forest products industry are showing signs of nascent stabilizing.

While there is a distinctive market imbalance for paper and paperboard, the health of this sector is linked to the overall economy. As of October, after a two-year economic slump, the economy seems to be improving. This should help firm the balance sheets for many companies that have spent the last several years making large acquisitions.

Korutz remarks that the U.S. paper industry has taken aggressive action to bring supply and demand back in balance. This action resulted in significant amount of closings of older, less efficient mills.

The cuts in production, Korutz feels, have stabilized the paper industry more than many other components of the forest products industry.

While some markets have shown modest improvements, there isn't a wholesale sign of collective improvement. Some grades, such as linerboard, are more likely to show an improvement in prices as the economy continues to gain steam.

Korutz points out that some paperboard grades are leading indicators, meaning that this sector will see the pickup long before many other economic indicators.

One grade to follow is newsprint. Bowater and Abitibi-Consolidated have worked aggressively to balance supply and demand. Having slashed production levels significantly, these newsprint-producing giants hope to push through price increases for their finished products. So far, the price increases have met a significant amount of resistance, indicating a full recovery for this segment has not yet been reached.

The coated paper market still exhibits problems, though Korutz is bearish on the short-term outlook for this grade.

Despite the expectation that paper markets should continue to improve as the overall economy improves, the possibility of significant new capacity coming on line in North America is unlikely in the short term. With hundreds of thousands of tons of new capacity coming on line offshore, domestic paper makers have little interest in spending a significant amount of money in the U.S. (or Canada) to increase capacity.

Expectations remain strong for the linerboard industry. Prices for the commodity historically trend toward a lowest pricing level of around $360 per ton. On the upside, in a much stronger market prices could climb to as high as $600 per ton.

The paper business continues to be a barometer of the overall economy. Despite modest signs of an improving market for some grades, it appears the paper industry has yet to reach the comfort level.

MULTI-NATIONAL APPROACHES

With the U.S. paper business having been sluggish for several years, some North American paper producers are turning more of their attention to Asia as an avenue for greater return on investment.

Abitibi-Consolidated, Montreal, and Bowater Inc., Greenville, S.C., two of the largest newsprint producers in the world, have both made significant investments into China and other nations in Asia.

Along with these two companies, several of the largest European paper companies, among them Norske Skog, UPM-Kymmene and Stora Enso Oyj, have all either established a significant presence in Asia or are working on developing a production presence there.

Despite these high-profile announcements, Bryon Korutz, with Standard & Poor's, feels that these moves aren't a part of an overall trend. He points out that most of the new capacity is supported exclusively by paper companies in the countries where the mills are located.

In its report, S&P forecasts that in coming years, capacity growth is expected to be highest in Latin America and Asia, where companies enjoy fast-growing, inexpensive fiber sources, low labor and energy costs and favorable prospects for demand growth.

The author is a senior editor and Internet editor with the Recycling Today Media Group. He can be contacted via e-mail at [e-mail].