Shrinking Supply

First off, I am going to briefly examine the outlook for supply and demand for ONP (old newspapers) in North America and then move on to how the decline in readership has affected the residential recycling stream. From there, I will dovetail into how the paper recycling business might change in the next five years, which I think is an interesting topic.

THE CHANGING BUISNESS

The author is the Houston-based supply chain manager for AbitibiBowater Recycling. He can be contacted at robert.cook@abitibibowater.com.

I think the business changed five years ago, but I also think that since that time, and particularly the fourth quarter of 2008, end users of ONP in North America got a real education and a real awakening. The volatility in the market was unprecedented, at least since 1995, and we saw some real hardships placed on end consumers in light of pricing fluctuations. So what we think could happen in the next five years is big consumers putting price ceilings in place. Big consumers may just decide that at a certain delivered price, the production facility gets closed—whether it’s temporarily or permanently—that could likely be one of the outcomes.

Rolling downtime is also another possibility. Again, I’m speaking from a newsprint manufacturing perspective, but a large company with a variety of production facilities in North America may be able to transfer production from one facility to another to try to take advantage of lower pricing, lower delivered costs into those mills.

Swing mills have the capability to use either virgin or recovered fiber or a combination thereof. These mills will likely get more astute at the cost of the head box, which is the cost of converting virgin fiber into usable pulp suitable for paper manufacturing and the cost of converting recovered fiber into suitable pulp for the purpose of paper manufacturing. Then they will compare which cost of the head box is cheaper and that is where they will place their efforts.

I think we will see that there has been a significant education over the last several years and particularly the last quarter of 2008 to make it more of a strategic decision how end users manage their incoming flow of ONP.

I also think another demand impact could be the availability of Asian countries to develop their own collection efforts. Certainly right now there are some major imports heading their way, but if those collection efforts get off the ground and start growing, we might see less of an impact on North American ONP. Having said that, North American ONP is made up of at least 60 percent virgin fiber and is very valuable commodity in places where they have no virgin fiber content in their paper.

On the supply side, we are seeing the OCC (old corrugated containers) substitution effect: As this grade becomes in higher demand, it forces producers into other grades, such as box board, to fill in the gap. That forces box board producers into mixed paper to fill in the gap, and that creates an opportunity for generators to look at the cost to produce ONP versus the cost to produce mixed paper, and compare the two revenue streams and come up with the notion that they don’t necessarily need to produce a positive-sorted ONP No. 8 to generate the same revenue. We saw this in the Southeast at the end of ’07 where mixed paper was selling for more than ONP.

Then there are newsprint exports. The other facet of this is that as demand in North America wanes, producers in North America will shift their focus to the exportation of newsprint. Once that fiber leaves North America, unlike OCC, that fiber does not come back. When OCC and other grades leave, they typically return in the form of packaging or other box board. But newsprint does not return to North America, so that could have a negative supply impact in the next several years.

I wanted to highlight the point that the overall use of ONP follows the same trend as the consumption of ONP in newsprint. However, the level of exports exceeded the ONP consumed in the manufacture of newsprint in 2003. Up until that point, the biggest customer for a generator of ONP was newsprint mills. At that point, it switched over to the export markets. What that allowed these generators to do was offset their risk, diversify their portfolios a little and change the game. In my mind, business changed back then irreversibly and I think we are going to see some significant business model changes going forward from the fourth quarter of 2008.

From 2002 to 2008, the amount of ONP comprising a typical bale of No. 8 ONP at the Abitibi-Bowater Thorold mill in St. Catherines, Ontario, which is a 100 percent recovered fiber mill consuming about 1,500 tons per day, has decreased. The makeup of the material coming into that mill is extremely important to that operation. During that period, ONP has really only slipped 10 percent, despite a 30 percent drop in the overall use of newsprint in North America during the same time. What I find really interesting is that magazines and other papers have fallen off by about 50 percent during that same time frame. So what we see is that the readership of magazines and newspapers is having an effect on the mix, and what has come in to replace these grades is inserts, uncoated and coated mechanicals that have a high brightness and high ink content. The mix of paper is changing significantly because of it, not so much on the ONP side but more in the area of magazines and other papers.

The out-throws, the browns and boxboard that has crept into the bales of ONP, has increased by 80 percent from 2002 to 2008. Now what we have got is fiber that is too dense and not bright enough for us to convert into whatever end product that the user might be looking for.

The percentage of prohibitives during the same time frame has increased 290 percent. This is the amount of tin, aluminum, plastic, wood and other things that just can’t be turned into paper. Out-throws in No. 8 ONP bales at our Thorold mill went from a low of 0.5 percent in 1994 to a high of just greater than 6 percent on average in 2008—a significant increase highlighting the impact of less ONP in a bale likely caused by lower readership in North America.

What is facing the industry are really two issues: a decline in true ONP and a decline in the quality of a bale of ONP.

Newsprint usage in the U.S. declined by 1.3 percent from 1999 to 2000. Since then, the pace of decline has been accelerating to the point where in 2007 we lost 12 percent and in 2008 we lost another 11 percent year over year. So we now are seeing double-digit declines in newsprint usage. In fact, 2009 is looking to be significantly worse than the previous years. Some estimates are that there will be a decline of between 25 percent and 30 percent in newsprint use in North America.

Uncoated mechanicals use has enjoyed moderate growth in the U.S. over the same horizon (1999 through 2007) and has remained relatively unscathed by the switch in advertising media from traditional paper forms to Internet, etc. However, it too is now suffering significant double-digit declines in 2009. The global economy has taken its turn on ad linage and other forms of use for uncoated mechanicals.

During this same time, the recovery rates for newsprint and uncoated papers improved from a low of 53 percent in 1999 to a high of 63 percent in 2003. At that point, we managed to recover 10.4 million tons of newsprint and other mechanicals in North America. But that was in 2003. Since then recovery rates have gradually improved, but the volume of newsprint recovered has fallen off significantly in light of the decline in newsprint usage in North America.

In terms of supply and demand in the short term, we see domestic demand remaining soft. Right now we are experiencing rotating downtime throughout the newsprint industry. It is not limited to any one particular company. We are seeing a significant decline in housing starts, which is reducing the need for cellulose insulation, and domestically we don’t believe that we’ll see much improvement in 2009.

We also believe that export demand will percolate depending upon the overseas producers’ abilities to reduce their finished goods inventory. Right now there is a lot of material tied up in finished goods, and as they move those goods out they will come in to buy more recovered paper. We don’t think it will be as volatile as it has been necessarily, but certainly we see an uneven demand pattern in the short term for ONP.

In the long term, we see fiber availability and quality driving the furnished mixed decisions. We see some potential changes in the industry for ONP demand in the future.

THE EFFECT OF DECLINING READERSHIP

THE SUPPLY-AND-DEMAND RELATIONSHIP