Southern U.S. forest products: how competitive?

In an increasingly open world economy, leading forest products manufacturers must consider global timber supplies and product markets in deciding where to develop their operations. Fiber supplies and costs, manufacturing assets and costs, and demand for final products all influence investment decisions. For example, a manufacturer may choose to locate facilities close to low cost fiber supplies or near the markets for wood products; they also may choose to invest in production overseas or focus on domestic manufacturing operations and ship their output to foreign markets. One outcome of globalization is a growing share of wood products being traded internationally, which makes all wood markets more competitive.

In 2000, between 25% and 30% of sawnwood, panels, paper, and paperboard were traded internationally. It is not surprising that the U.S. South, the most active timber market and the single largest wood products supplier in the world, faces intense competition from major wood supply regions. The South supplies 18% of the world's industrial roundwood production and 25% of wood pulp production. One of the South's big producing states, such as Georgia or Alabama, has just slightly less production than Sweden or Finland. Yet the world's leading forest products exporters are Canada, Sweden, and Finland.

Global markets also mean that the strength of the U.S. dollar may influence timber and other forest products prices and that global trade may limit price appreciation for U.S. forest products. As shown in Figure 1, the rising strength of the U.S. dollar, as measured by a trade-weighted exchange rate index, has an inverse relationship to the falling forest product balance of trade since the mid-1980s.

The United States continues to be the world's largest paper and board market, consuming more than 300 kg per person annually. Both the volume and value of this market attract suppliers from all over the world to compete with the U.S. South for a share of this market. Developed markets such as Canada and Japan use more than 200 kg per capita, while developing markets such as China use less than 40 kg. The expectation for increased consumption in the developing markets pulls new investment and production to the growing markets. Reduced consumption growth in developed economies drives curtailment and cost cutting, such as has been seen in the U.S. South. Recent declines in pulpwood consumption, in addition to structural and financial problems experienced by the industry, raise concern about how well the southern forestry sector is coping with changing markets and foreign competition.

SOUTHERN TIMBER MARKETS

Both pulp production and pulpwood consumption in the South increased steadily from the early 20th Century until about 1994. Figure 2 shows how nominal delivered prices for pulpwood in the South responded, increasing from an average of US$ 11.65 per short green ton in 1976 to about US$ 23.50 in 2004, with a spike to over US$ 32 in early 1998. Rising pulpwood prices served as incentives for producers to employ technological innovation, move manufacturing to lower-cost facilities, and substitute lower-cost fiber. Other wood use strategies included improved manufacturing techniques that allowed use of cheaper, small-diameter logs and increased yield per log. The substitution of chips and sawmill residue for roundwood as well as increased consumption of recycled fiber also shifted supply and demand.

Currently, both pine and hardwood pulpwood trade at nearly the same price. Data collected by Timber Mart-South indicate that pine pulpwood prices have remained relatively stable, when adjusted for inflation, for the last quarter of the 20th century. In Figure 3, the price range from 1976 through 2004 for real delivered pulpwood prices converges on about US$ 15 per short green ton in 1982 dollars.

Delivered conifer pulpwood prices (Fig. 4) show wood fiber costs in the U.S. South versus some of its major global competitors. Near the peak of the strong dollar period at the end of 2001, the South had lost a substantial cost advantage in world markets. Yet by the end of 2004, the weaker dollar and shifting domestic fiber markets among competitors meant that the South at US$ 73 per oven dried metric ton (ODMT) had fiber prices much closer to low-cost Brazil at US$ 65 than high-cost Scandinavian fiber at US$ 132.

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The overall timber situation in the U.S. South increasingly depends on global supply and demand, forest industry consolidation, and a major shift in forestland ownership. The future competitive advantage for the region depends on a favorable location close to active markets, terrain, climate, solid infrastructure, good management skills and governance, as well as private land and timber ownership with effectively functioning markets. Forestland taxation, urbanization, environmental regulation, and major ownership changes are still major concerns. Yet despite many challenges, the U.S. South is expected to remain the major, globally competitive wood supply region into the foreseeable future.

FOCUS ON LINERBOARD 

The United States continues to be the largest wood pulp producer in the world with 58 million short tons of output in 2002. Since 1995, U.S. pulp production has declined by 8 million short tons, while competitors, including Canada, Sweden, Finland, and Brazil, all increased output.

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The Warnell School of Forest Resources, University of Georgia, in cooperation with the Jaakko Poyry Consulting, analyzed the competitiveness of the Southern U.S. industry, focusing on Georgia's linerboard sector (1). Total linerboard capacity in the South amounts to about 16 million annual short tons (36% of global capacity), with Georgia accounting for nearly 20% of that capacity. The analysis focused on the technical level of a machine (asset quality); cash manufacturing costs (cost competitiveness) based on machine and mill parameters; and regional factors such as input prices, exchange rates, and labor productivity.

Three major linerboard grades considered in the analysis included kraft linerboard (kraftliner), testliner, and kraft-top testliner. Kraftliner is virgin fiber based linerboard which may contain some recycled fiber. This grade dominates Southern U.S. production. Testliner is 100% recycled linerboard based on lower quality recovered grades. Kraft-top testliner represents a product from Asia which has unbleached virgin pulp on the top layer. The purpose for this product is to produce testliner that can compete with imported kraftliner. Production cost estimates were based on prices for the fourth quarter of 2003. They were developed for two widely-produced linerboard commodity grades: 42 lb. for North America, and 31 lb. for the rest of the world (1000 f[t.sup.2] basis).

A total of 250 linerboard facilities across the world were examined, including 8 machines in Georgia. North American machines were found to have a higher machine capacity (338,000 annual short tons/yr) and a higher technical age (19.5 years). European and Asian producers operate younger machines (15 and 13 years, respectively); however, their average capacity (258,000 and 273,000 short tons/yr, respectively) is lower. This may be a result of the production structure, which is based on testliner produced in smaller mills. Overall, Georgia machines are average in terms of asset quality.

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Average asset quality suggests that these machines are expensive to operate. Indeed, the majority of Georgia's linerboard machines (including a testliner facility) are positioned in the third quartile and up on the global cost curve (see Figure 5). This result indicates that the mills are relatively high cost producers, with manufacturing cost approaching US$ 270 per short ton. Manufacturing costs for testliner operations were as low as US$ 200 per short ton. Wood and personnel costs were major cost drivers. While wood prices already have receded from 2003 levels, personnel costs are likely to remain high. The lowest cost producers were recycled linerboard operations in North America, Europe and Asia-Pacific.

The Southern U.S. industry's position is further eroded by changing demand and the development of cheaper alternatives to kraft linerboard by foreign competitors. As the U.S. imports more products, linerboard production has shifted to the countries of origin for imported goods, such as China. Europe and Asia are also leading the way in developing lower cost kraftliner alternatives. About two thirds of European capacity is based on recycled fiber, and Asia produces large volumes of kraft-top testliner. Southern kraftliner, while a superior quality product based on virgin fiber, is not cost competitive in some applications. Cheaper alternatives appear to do an acceptable job elsewhere, shrinking Southern U.S. market share.

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Perhaps there are lessons to be learned from our competitors that would help the industry to improve its overall performance. The first lesson to consider is an increased reliance on lighter kraftliner grades--31 lb per 1000 f[t.sup.2]--as is done in Europe and other regions. If it is possible to use lighter grades more extensively, savings could accrue in raw material usage and manufacturing costs. Additional savings could be achieved by reducing shipping costs. This process has already begun in the U.S. Such a transition could require the revision of current packaging rules and systems, as well as the cooperation of linerboard and box consumers and other parties involved in the process. While this may be challenging, good results have been achieved elsewhere.

A second lesson is the strategic use of recycled fiber, primarily old corrugated containers (OCC), in linerboard production. Recycled liner-board mills represent only 11% of Southern U.S. linerboard capacity. Also, Southern kraftliner mills use relatively limited volumes of recycled fiber; however, competitors make and use large volumes of cheaper testliner, often made at smaller mills sited closer to recycled fiber supplies on conventional industrial sites.

As shown in Figure 6, 2003 domestic recycled fiber cost (US $68 per short ton, Atlanta market) was less than half of delivered cost to Asia-Pacific (US $151 per short ton, China). While OCC markets are quite volatile, there are ways to address the volatility and let the industry take the advantage of lower cost domestic recycled fiber supplies. One option would be to produce more recycled linerboard in new, efficient facilities; another option would be to increase the use of recycled fiber in existing kraftliner mills.

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ADVANTAGES BUT GROWING PRESSURE

The U.S. South has both an abundant supply of pulpwood and a market system that has kept pulpwood stumpage prices relatively stable and low. While supply costs still concern pulp and paper manufacturers, such price stability in a major commodity can ensure the profitability of capital improvements designed to increase competitiveness. Southern U.S. pulpwood prices have been consistently lower than Scandinavia. While these prices are slightly higher than Brazil, this disadvantage is countered by Southern U.S. competitive advantages, including a location close to the market. In summary, Southern U.S. wood supplies are abundant, the market is functioning well, prices have been relatively stable and competitive for a long time and, more importantly, are expected to remain so.

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Still, the pulp and paper industry in the U.S. South (including Georgia) is under increasing pressure from global producers. Large sections of global cost curves are relatively flat, indicating that even relatively small changes in input and operational costs as well as in exchange rates may render a number of Southern U.S. machines uncompetitive and vulnerable to closure. It is also apparent that major industrial consolidation and restructuring have not yet radically improved the industry's global competitiveness. One problem seems to be the unsatisfactory state of manufacturing technology. This can be resolved with help of policies that encourage capital investment. It is also apparent that the industry needs to respond to changes in demand with investment in new technologies and products in order to maintain its leading position in the long-term.

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(1) This research was supported in part by the Georgia's Traditional Industries Program for Pulp and Paper (TI[P.sup.3])

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WHAT YOU WILL LEARN

* The position of the U.S. South in the global forest products market.

* Variations in fiber costs and how they are affected by exchange rates.

* The competitive position of Southern U.S. linerboard producers.

ADDITIONAL RESOURCES

* "SSCC Panama City Quantifies Success ... One Step at a Time," by Alan Rooks, Solutions!, October 2004. To access this article, enter the following Product Code in the search field on www.tappi.org :04OCTSO30.

* "Paper industry growth, returns and leverage--2002," by Dorothy Paun, et al, Solutions!, January 2005. Product Code: 05JANSO42.

* "Where will paper be made in the future?", by Richard B. Phillips, Solutions!, January 2003. Product Code: 03JANSO49.

ABOUT THE AUTHORS:

(Left to right) Jacek P. Siry is assistant professor of Economics and Policy at Warnell School of Forest Resources, University of Georgia, Athens, Georgia, USA. Thomas G. Harris Jr. is professor of management; and Sara Baldwin is project coordinator, Timber Mart-South, at the Warnell School, University of Georgia. David Null is principal; and Jose Gonzales is senior consultant with Jaakko Poyry Consulting, Tarrytown New York. Contact Jacek Siry by email: [e-mail].