A recent article from the New York Times describes all too well what we in the Pulp and Paper industry have known for some time – capacity or supply-side management gone wrong is not just costly, it can be fatal to the survival of a business.

The article further describes the glut of overcapacity in the communications industry. In the past two years alone, 100 million miles of optical fiber – enough to reach the sun – were laid around the world as companies spent $35 billion to build Internet-inspired communications networks.

Only 5 percent of the capacity built is actually used or “lit”. What’s left is a staggering path of debt and losses that similarly plagues other lines of industry that built ahead of real demand.

On the road ahead to a new century of business, the question of success in many industries may lie in the refocusing of what it takes to properly manage the supply-side of the equation. Simple market theory tells us that given a competitive market environment, supply follows demand by the function of price.

We’ve been trained, however, to mainly watch the demand-side of the market, often turning a blind eye to the other side of the equation. Somehow it is easier to see the “pulling side” of the market, more exciting to talk about the next new mill or rebuild, waiting to see where new opportunity may lie. What we seem to have forgotten however, is that the risk adjusted process of matching supply with real demand– not just capacity, is the key issue, and in this process, a balanced portfolio might include market share from both far and near.

In an effort to better understand the challenges that lie ahead in international trade, my presentation will focus on the neglected supply-side issues of trade in Asia. With slack orders and downtime plaguing global industry once again, it may be more helpful to look again at the changing nature recovered paper supply by:

-         Examining the evolution of the global supply markets;

-         Highlighting the competitive factors of North American and European supply;

-         Update the supply side view of NDPI.

Evolution of Global Supply Markets

Since the early 70’s, recovered fiber supply from North American has been a staple of mills throughout the Far East. With almost 4 million tons exported by 1997, many suppliers in the United States found a developing reliance on a marketplace that had once been considered inconsistent and unpredictable.

The advent of widespread curbside collections and increased recovered fiber utilization rates energized an industry in the 90’s to supersede prior expectations about the pace at which sustainable recovery could grow, and Asia helped significantly feed this growth, slowed marginally by a financial crisis in 1997. During this “Asian flu”, many Far Eastern mills found it difficult to afford the highly priced and dollar denominated raw materials from North America due to the erosion of their currency values. The substitution of cheaper raw materials became essential.

While the U.S. economy kept chugging along, absorbing Asian imports as well as the raw materials that had previously gone export, a new global supplier emerged on the scene.

The European Union was as much a dream in the early 90’s as a reality, but certain governments, such as Germany, bolstered a common view towards environmental management. No longer was it sufficient to allow the market to find its way towards sustainable recovery, but mores, new forms of legislation came about to actively manage the lifecycle of raw materials.

Born as the Deutsche Dualles System (or DSD), Germany and other EU Countries such as France began to implement a more holistic approach to environmental resource management. More so founded on the concept of producer-subsidized collection, recovery began to grow as never before, and just in time for the ailing economies of Asia.

In the third quarter of 1997, many North American exporters of recovered fiber began to watch a phenomena of market-share attrition unfold in Asia. Spurred by sporadic mill bankruptcies and weakening conditions, many North American exporters turned inward toward domestic markets or towards more stable Asian grounds as in China.

Regardless, led by low freight costs and subsidized bulk-grade fibers, EU market share began to grow increasingly in places such as India, Indonesia, Thailand, and Taiwan. American exporters found the negotiation process to be much more of a one-way dialog as their prices were often too high and domestic orders seemed more attractive, that is, until difficulty and downtime ultimately found its way back into the business cycle in North America.

Amazingly, the tide has turned again in 2001 as market share seems to have slid back into the favor of North American bulk grades. Many Europeans decry now what was a familiar lament by their counterparts – “they’re flooding the market again.”

What is sure, as a new century dawns, is that the global nature of supply is beginning to show its potential as a river whose banks can burst and find new paths towards market share both near and far. Both North America and Europe increasingly find themselves on opposite shores of a common stream whose outlet is the gulf of industry growing in Asia, and in particular, in China.

What can be said then, about their competing access to this flow, does either one have an upper hand? Next, we’ll look at the competitive nature of the two largest global supply markets.

Competitive Factors of Supply: North America and Europe

Often times, the bottom line regarding supply is delivered cost and yield. As explained earlier, many Asian buyers were forced to buy paper based solely on delivered cost during the later 90’s, and this certainly helped the position of lower cost fiber coming from Europe at the time.

Many Asian mills learned to overcome limiting factors of European fiber – mainly the shorter fiber length and lower yields due to higher EU recovered paper utilization rates. When putting them head-to-head, several key factors must be considered when evaluating supplies from North America versus Europe:

Since the early 90’s, North America has outpaced the net volume recovered in Europe; however, one should not let this factor be misleading. The EU’s recent Declaration on Paper Recovery shows that the recovery rate in Europe has increased from roughly 39% in 1990 to 49% in 1999. The goal ahead is to reach a 56% recovery rate by the year 2005.

Clearly, the EU will continue its advances in recovery and continue to be a viable source of large supply. The market share challenge, however, is that the supply from Europe is becoming more inelastic. That is, as demand increases or decreases, supply remains relatively unchanged.

Looking at it in another way, supply responds less to the function of price than in North America. In many EU countries, such as Germany and France, strict regulation prevents supply from being landfilled at any price. The case is often that excess supply is exported to other markets.

As an example, it has been said informally that Germany must export as much as 20% of her supply to Far Eastern markets in order to avoid excess supply in her domestic markets. In other words, Germany is a dedicated exporter of recovered supply on a net basis. Increasingly, she is not alone in the EU.

As regards quality, North America still enjoys a leading edge in this category, for there is a greater amount of virgin pulp used in the paper making process. This trend, however, is diminishing as older outdated mills are scuttled, making way for a higher utilization rate of recovered fiber in North America. It may be too soon to say, but surely the American fiber of today will not look the same in 10 or 20 years. Regardless, extremely low logistical costs give the advantage to North American fiber. These rates are made ever more possible by the ongoing trade deficit in the United States, running almost $32 billion monthly.

At the current moment, the size of this flow is stronger than from Europe and therefore gives a slight edge in export freight rates from North America. What is interesting, however, is that the method of collection in Europe, where combining similar materials (OCC and MP for example), yields a higher productivity rate, so quite possibly the Europeans have an edge in managing sorting costs. It is very common to see Bohlegraaf star screen systems in the Netherlands, for example, where curbside material is positively sorted into ONP and the negative mixed paper remains (mainly cardboard, office paper, pams, and boxboard) are blended with OCC to make an “80/20 pack”. The blend is 80% OCC and 20% Mixed Papers.

Granted, the result may seem more like American mixed, but the result is a European grade of OCC that can often compete on fiber strength when used as a substitute for American MP and OCC. The value to the paper merchant is a higher productivity rate, or throughput, that maximizes the use of capital investment whilst minimizing sorting costs. These concepts grew in the U.S. from the mid 90’s but seem to have been much more absorbed in Western Europe, not just from a technology point of view, but from a consumption point of view as well.

The last supply side factor of comparison, currency, is changing on an ongoing basis. Currently, the USD is well valued against the Euro, making USD denominated orders more attractive to EU based suppliers. The strong dollar can make itself a competitive disadvantage as well, though, since North American producers may find it difficult to sell their finished product in export markets, causing domestic downtime. Of course, this downtime can cause excess North American supply to be forced onto the export market, potentially driving the price down. Advantages from cross currency exchange rates may come and go but the effects in a given market cycle are very real and powerful.

 Now that we’ve considered the evolution of the supply side of the market, its major market players, and their relative competitive advantages in competing for marketshare, we can look at supply side issues as envisioned by a mill company whose success is founded on recovered paper supply - from both supply markets: the Nine Dragons Paper Industries (NDPI) mill in Dongguan.

NDPI’s Supply Side View

First, it is helpful to update a few broad market conditions in China. In a May 21 market report, ABN AMRO’s Asian Economics and Market Strategy Division released a special article on China, which states it will be the best performing Asian economy in 2001. Furthermore, it depicts a stable economic environment in which the renminbi will not be devalued in 2001, leading further to a picture of sound sovereign credit fundamentals. With a forecasted growth rate of 7.5% for 2001, China is the best bet going in Asia. It was also recently announced that final WTO accession negotiations were completed with the EU, clearing the way for possible entry in the next few months.

So, as a new century of competition waits, the pulp and paper industry in China is poised with several millions tons of new capacity in paperboard. But this story did not begin yesterday, and it is not only focused on the demand side. For one mill, it began from a small trading company in the early 90’s.

For Nine Dragons Paper Industries, the future is a reality today. America Chung Nam formed the mill in 1996 with one machine producing 200,000 MTPY. Today, the thoroughly modern facilities at this 2-machine mill produce 650,000 MTPY of kraftliner, mottled white, and medium. A third machine is set to come online next year in order to produce over 1 million tons of containerboard: a feat matched by no other mill in a land of over 11,000 paper mills.

In order to continually move forward, however, the focus remains on access to reliable sources of supply. Building lasting supplier relationships is integral to the vision that the mill has: its supplier’s health is the mill’s own health – these two are inseparable as the mill is predicated on recovered paper as the primary raw material.

The predominant source of supply for Nine Dragons has long been, and should continue to be, from North America. To a growing extent, however, the mill has taken care to establish new sources of supply throughout the global marketplace. With increasing recovery rates and stable trade lanes into the Far East, European supplies of recovered paper are making their way into a meaningful share of supply.

Other countries such as Indonesia have had a long trading relationship with Western Europe and it has been well proven that standing in the market with “both legs” provides stability and flexibility. In preparation for a conference presentation last year, I spoke with Mr. Ming Chung Liu, Deputy Chairman and General Manager for Nine Dragons, about the supply side perspective and he had many interesting views to offer which I’d like to share with you now.

As it is with the much of the Asian paper industry, China depends heavily on three main raw material sources – wood, non-wood, and recovered paper. With a shortage of native wood-related raw materials and difficulty in establishing plantations, most of China’s mills rely on non-wood materials such as straw. The raw material of choice for the majority of new, more technically advanced containerboard mills is recovered fiber, however. Traditionally coming from sources within North America, Europe, and Asia, more emphasis is being focused on developing domestic sources of supply.

Some analysts place China’s recovery rate at around 25%,[1] compared to rates above 60% in more advanced countries such as the United States and parts of Europe. Since the whole issue of recovered paper is central in China, a key question remains: How can containerboard mills consistently source their fiber requirements? U.S. and European recovered paper suppliers, and indeed the very mills that depend upon their own domestic collections as a raw material source, are keen for insight in this issue.

Again, Mr. Liu provides his insight from the experience of establishing a major containerboard operation in China. He notes that the vast majority of older mills will rely on straw as a raw material base, whereas the relative importance of establishing global supply networks remains paramount in securing quality recovered fiber in the new competitive environment. Many containerboard mills throughout Asia have established their own local procurement agencies or offices within major countries with excess supply. Both North America and Europe are key sources of recovered paper for China and will continue to be so in the future. What he finds is that the domestic collection of recovered paper is improving, however. Focused on assisting the development of local collections, especially since they are the most inexpensive source of raw material, Mr. Liu believes a collection target of 50 – 70% of his requirements may be possible within local markets in the next few years.

Positioned with the technology to utilize recovered paper sources from around the world, the idea of managing a global recovered fiber network is crucial towards developing an optimum cost structure for producing containerboard. He notes that Chinese box makers have enjoyed competitively priced U.S. kraft linerboard imports for many years and that key expectations remain: the price of domestic containerboard must be similar to other straw-based or local recovered paper-based materials yet compete with U.S. equivalents on quality as well.

The competitive nature of these expectations demands a total commitment to the procurement process. Constant management of the cost structure in fibering the mill with raw materials from sources both local and global is crucial, but more so, establishing long-term relationships with suppliers on a local basis is the hallmark of developing sustainable procurement that is so vital to the mill’s ongoing success.

Nine Dragons Paper Industries – Current Status and Plans

Having optimized the implementation of PM2 (producing 400,000 TPY itself), Mr. Liu shared further plans for development and expansion. Recent improvements to PM1 have increased the capacity by 50,000 MT to 250,000 MTPY of kraft linerboard. Furthermore, on June 14, 2001, it was stated in a Metso Paper press release that the company will supply a linerboard machine to Nine Dragons with a capacity of 1,100 MT per day of brown kraft linerboard and it will be the largest linerboard machine in China.

The Metso delivery will compromise a three-ply fourdrinier forming section with three hydraulic headboxes, a press section with two shoe presses, a dryer section, a calender and a reel. The order will be delivered by Metso Paper’s units in Sweden, Finland and China. Startup for the machine will be some time towards the end of 2002. As stated by a company spokesman, there are no plans to use American OCC as the main fiber furnish for PM3. In fact, the exact composition of fiber furnish is undecided.

Finally, there are future plans to add a fourth production machine and 10 box plants within China. This would bring total capacity to 1.5 Million MTPY. Looking ahead even further, Nine Dragons Paper Industries has already purchased land for a new paper mill near the Shanghai area, with plans to start construction when market timing is right. Timing has always been a critical issue, but for sure, having the proper foundation in place, including supply structure, is just as essential.

Supply Side View

In the discussion of international trade, we have seen statistics time and again prove that the fastest growing paper markets are in Asia, and China in particular. This demand side approach to describe the future market place is vital, but possibly over played and misleading.

In the end, mills cannot consume more fiber than they can possibly make into salable orders. Additionally, due to the concentration of production through fewer paper manufacturing companies, orders and capacity utilization can be balanced globally and change regional market conditions in cycle times shorter than ever seen before.

Knowing the cyclicality of the market, and the fact that we are in a trough, it is crucial to consider the other side of the equation – the supply side. Suppliers must increasingly be more knowledgeable about the competitive nature of global recovered fiber supplies – and it matters not whether they are in Paris, France or Paris, Texas. Market participants would do well to consider the competitive trends that the global recovered fiber supply presents. North America is not the supply market of last resort and both European and intra-Asian supplies will certain make inroads towards higher market share. It’s almost as if we’ve been driving down the road with blinders on – not really aware of what’s going on, but listening to the same old tune.

We love our highways – in North America and Europe. Much has also been made about the information highway and we’ve even found that over-capacity can plague the “new economy” as well. What we’ve all realized, new or old, is that the economy demands a clearer view of all its aspects, not just the demand side, but the supply side as well. In the road ahead, it might be a good idea to take a pause, adjust the mirrors, read the signs around us, and be prepared to use more than just the accelerator - lest we miss the turnoff again and get stuck in the same jam. Wade Shuetzeberg. The article was originally presented during the Paper Recycling Conference held last month in Chicago. The author is America Chung Nam’s marketing manager for Europe.