Is the Future of the Paper Recycling Industry in Futures?

The mantra made by recyclers is the concept that recovered fiber is a commodity like any other. As such, many key industry barometers, including manufacturing levels, unemployment rates, cost of living, etc., influence it.

One point that is brought up time and again is the continued impact of markets in 1995. During that year prices for most paper stock grades spiked up to record levels. Old corrugated prices topped $200 a ton, while old newspaper prices surpassed historical highs. After reaching these levels, prices crashed. The climb and the crash that followed happened in a short period of time, and created tremendous damage to an industry struggling to come into balance.

Since then, markets have moved in much softer curves. However, even without the strong jumps in prices seen several years ago there are disparities and inequalities that continue to plague the industry.

Wild swings in the price of the raw material have been one of the biggest problems, with both consumers and collectors citing these price swings as one of the reasons there is such tremendous turmoil.

A changing philosophy could be taking place. Several utility firms have been actively looking to develop over-the-counter trading for recovered fiber. Two energy-marketing groups have been moving aggressively into promoting the use of new systems to buy and sell recovered fiber. These include hedges, swaps, and the possibility of developing a futures market to move recovered fiber. The question is whether the industry is ready for a different approach to doing business.

Enron and Southern Company Energy Marketing Group have jumped into these programs with enthusiasm. Both companies are top suppliers of power. Southern, based in Atlanta,  produces more electricity than any other company in the United States.

Enron Capital, based in Houston, claims it is the largest purchaser and marketer of natural gas and the largest wholesale marketer of electricity in North America.

Mike Moulin, marketing manager for Enron, says that his firm works closely with paper companies, who are huge energy consumers. Already having an energy futures program established, moving into recovered fiber (as well as finished product) is a natural extension to the service they  provide.

More than one person in the paper recycling industry has said hedge funds and futures may seem like complicated market talk, but that the concept could be coming to the paper recycling industty fairly quickly. Presently, volatility in the paper recycling industry is creating great anxiety for both suppliers and consumers. According to Bill Moore, principal with Moore & Associates, research performed by the firm has found that despite most mills stating they pay “market price” for recovered fiber, in some cases prices for old corrugated in the same region could vary by as much as $20 a ton.

“Our price analysis finds the spread of the lowest price to the actual for OCC is as much as $20 a ton.” This price disparity highlights the inconsistencies of what is termed “market price.”

While mills dictate prices, supply and demand changes on a monthly basis. And, according to Moore, inventories continue to decline. More mills are operating with a just-in-time inventory approach. “This is causing more spot buying,” Moore adds.

FINANCIAL TOOLS

One way to alleviate this problem is through the use of financial tools such as “swaps.” Basically the way a swap works is that a party negotiates a flat price for a pre-arranged period of time. A negotiated indicator will be the barometer. If the published price moves above the contract price the buyer has to pay the difference. If the price falls below the level, the company receives a rebate for the price. Essentially, this ensures that the price a consumer pays will remain the same.

Joe Carpenter, with Global Recycling Network, an internet trading service aligned with the Chicago Board of Trades’ Recyclables Exchange, feels that it is inevitable a futures system will take place. “I see futures happening. If not, you will see a lot of companies fall out of the business,” Carpenter says.

The opportunities afforded by this move, however, create some concerns for many paper stock dealers, starting with the inability to control some of the flexibility and nuances between regions, size loads, and even quality.

Moulin says the advantage to the individual companies is that the utility firm is taking the financial risks on its shoulders, especially with contracts that carry for several years. To ensure that the proper research is done, the company is constantly vigilant about where and when the price is moving.

Moulin says that since his company has marketed this service “the response has been great.” He estimates that more than half of the top 20 paper companies in the U.S. are using the service, or are looking at using the service for some of their business.

For Enron, the service is not limited solely to buying OCC for interested mills. Some options include swaps, where the paper company could trade OCC for linerboard, place put orders, call orders, etc. This gives the company a wide range of opportunities to develop markets for the material. “Basically we have created a market that allows companies to have over-the-counter tools to hedge the commodity risks on certain types of commodities.”

Another advantage to the program is the ability of the company to make the contract agreement stretch anywhere from one year to as long as ten years. For Moulin, this gives a particular company the opportunity to set up much stronger business practices without having to concern themselves with the shifting prices

An over-the-counter market is a market without a centralized exchange or trading floor. Instead, the OTF relies upon the execution of transactions directly between counterparties.

Southern Company Energy Marketing LP has been involved in developing an OTC marketing approach for old corrugated and old news for the past several years.

Brian Dooling, manager of the division, says the company has been working on the approach over the past two years. The company is now starting to intensify their approach. “We believe there is strong potential in trading paper (including scrap paper),” Dooling says. Contract lengths the company is looking at range from 1-10 years.

While at the present time OCC and ONP are the only two paper stock grades that are being worked on by SCEM, “there has been some talk about adding DLK (double-lined kraft cuttings),” Dooling adds.

GREAT POTENTIAL

Although both Southern Co. and Enron feel there is great potential in developing a futures market for recovered fiber, presently most of the work is involved in educating both sellers and buyers on the opportunities possible with the service. “Right now we are in the early stages. We are educating people, doing presentations. Once they get past the education stage they can start taking strategic positions.”

Despite the hurdles, “The interest level is high,” Dooling says.

Jeff Mehan, director of the Pulp & Paper Division for Tradition Financial Services, New York City, an international derivatives brokerage house, notes one big advantage of a swap system is the ability of a paper company to lock into the entire spread. A paper company can establish a fixed price for both the raw material and the finished product. This would allow the company to set its margins for a more consistent income. An example would be if a recycled paperboard mill is able to purchase OCC long term and sell corrugated medium long term and lock in profitable operating cash margins.

While all three of these groups have been seeking new business, there are only a handful of deals that have been made, although one company said that between 20-30 deals have been inked so far.

According to Tradition Financial, there is currently no futures exchange that lists recovered fiber or packaging grade paper contracts. However, there are exchanges in both the United States and Europe discussing the possible introduction of a futures contract for these grades.

For paper stock dealers, there is a significant amount of apathy toward the possibilities. While far from any consensus, many dealers feel that while there are opportunities with a futures market, there are so many variables   to make the service anything more than a margin option for a handful of grades and only minimal tons.

Pete Grogan, vice president of Weyerhaeuser Recycling, Tacoma, Wash., notes that while a futures market could create a new dynamic, the market for recovered fiber already is pretty well established. Many recyclers do not perceive any need to add a third party to the equation. As an example Grogan points out the failure the CBOT has had with the cash options section of its recycling board.

Dan Bordenet, head of procurements for Inland Paper and Paperboard Packaging, feels there are both advantages and disadvantages to swaps and futures for recovered fiber. An advantage is the ability to stabilize costs, which in turns allows for better planning for the company.

However, according to Bordenet, one big disadvantage is if you miss the market, it is magnified over the length of the contract. With markets changing quickly, attempting to anticipate where the market will go over the next three months could be tricky. Extrapolating the forecasts over multiple years would be even more difficult.

 Bruce Fleming, president of Canusa Corp., a Baltimore-based paper stock operation, feels long term there could be a market for a service similar to ones being proposed. While not widely accepted today, “In the future it may be accepted.”

A large concern, according to Fleming, is that by locking into a certain price, the flow of material could dry up if prices move up sharply. “You can’t compete.”

This gets to the root of the industry. Even with all the high-tech opportunities, the industry is still down with word of mouth contracts and quick service, Fleming says. Moving to a system such as ones being offered runs counter to many of these approaches.

With prices for most paper stock grades resting in the lower levels, it is unlikely many mills will be pursuing any long-term commitment to pay more than market price for the commodity. However, any paper recycling veteran who remembers the wild ride seen in 1994-95 knows prices can climb very quickly. Setting up a flat-priced ceiling could smooth out the markets. However, do enough suppliers and consumers want to do this to smooth out the peaks and valleys?

The author is senior editor of Recycling Today and editor of Fibre Market News.

Sidebar

Definitions

Call Option – This option gives the owner the right, but not the obligation, to buy a particular commodity or market security at a predetermined strike price, at a future date.

Financial Derivative – A financial security whose value is dependent on an existing underlying asset such as a market security or commodity.

Forward Contract – A standardized forward contract traded on an organized exchange, involving the posting of margin for credit enhancement and allowing for the immediate realization of profits and losses upon closing out a position.

Futures Contract – A standardized forward contract traded on an organized exchange, involving the posting of margin for credit enhancement and allowing for the immediate realization of profits and losses upon closing out a position.

Hedge – Strategy used to offset business or investment risk. A perfect hedge is one eliminating the possibility of future gain or loss.

Master Swap Contract – A contract executed between two parties which dictates the legal credit and market disruption issues for all future, financially settled swap transactions between the parties.

Options – The right to buy or sell, for a limited time, a particular good at a specified price.

Put Option – the option giving the owner the right, but not the obligation, to sell a particular good at a predetermined strike price, at a future date.

Spot Price – The price for immediate delivery of a product.

Swap – An agreement between two parties to exchange one set of cash flows for another set of cash flows based on a different formula over a period of time.

Definitions courtesy of Southern Company