Dips and plateaus

The U.S. old corrugated containers (OCC) market has been on a roller coaster ride over the last two years because of significant swings in Chinese demand. In early 2017, U.S. prices surged to decade highs following a surge of exports to China, but prices crashed to decade lows in late 2017 and in 2018 as China began severely restricting imports of recovered paper and announced its intention to ban all “solid waste” imports by 2020.

More recently, demand for finished paper products in China has significantly slowed because of the weakening economy (further reducing Chinese demand for recovered paper). Additionally, the country enacted a 25 percent tariff on U.S. recovered paper imports effective Jan. 1.

While the OCC market will undoubtedly remain volatile, our base case assumption is that Chinese imports of U.S. OCC will stabilize near where they were in 2018 given China’s presumed continued need for externally sourced fiber to supply its domestic paper industry.

At the same time, we expect domestic OCC demand to be flattish to slightly down in the months to come as U.S. containerboard mill operating rates decline because of flattening domestic box demand and declining export containerboard demand. As a result, we expect U.S. OCC prices to be somewhat flat for the foreseeable future, bearing in mind that they’re already sitting at lows not seen since May 2009.

Looking back at 2017 and 2018

U.S. OCC prices crashed in late 2017 and into 2018 because of China’s restrictions on recovered paper imports. China’s recovered paper imports plummeted from 28.5 million metric tons in 2016 to an estimated 17 million metric tons in 2018 as the country began restricting contamination levels in imported OCC through a program called National Sword and later announced its intention to eventually eliminate “solid waste” imports.

According to pricing data tracked by Boston-based Fastmarkets RISI, OCC export pricing from the U.S. to China fell by $38 per ton out of the ports in New York and San Francisco and by $40 per ton out of the ports in Chicago and Los Angeles for the September 2017 buying period. Mixed paper shipments to China declined by $25 to $31 per ton out of every U.S. port during that same month.

A West Coast-based exporter is quoted in Recycling Today’s October 2017 issue as saying, “When you take the largest export-buying country and shake it upside down, this is what happens. If China walked in tomorrow and said, ‘Ha-ha, just kidding,’ the market would go through the ceiling. It’d go up $50 in one night.”

While OCC prices inched upward later in 2017, prices for shipments to China fell by $30 per ton in February 2018.

Following drastic price declines for recovered paper in the first quarter of 2018, China’s May 4, 2018, announcement that it was suspending U.S. operations of China Certification and Inspection Group North America (CCIC NA) for one month further disrupted the recovered paper market, as inspections of outgoing shipments to China were unable to occur.

An exporter of secondary fiber off the West Coast told Recycling Today at that time that shipping anything to China was a “bit of a gamble” and not worth the risk. “Who would have thought [China] would ban imports of recyclables for one month anyway? So, who wouldn’t think that they could stretch it to two months? Who wants to take that gamble?”

China reduces OCC imports

The obvious question is whether China can continue to import so much less OCC than it has historically (or continue to cut imports further) given that its supply of domestic recovered fiber is insufficient to feed its substantial paper and board capacity.

Chinese containerboard producers recently have invested in foreign countries (the U.S., Laos and Vietnam) to supply their domestic mills with containerboard. Through these investments, Chinese companies appear to have found sufficient sources of fiber to replace the lost OCC tons; there’s no indication of any shortage in China despite its severe curtailment of recovered paper imports over the past two years.

For all we know, China could find a way to replace yet more of the recovered paper it used to import. However, we suspect a substantial chunk of the reduced imports over the past two years was the elimination of trash, and we believe China isn’t importing more of it.

The price reporting and market analysis provider for the forest products sector, Fastmarkets RISI, recently noted that its contacts expected China to permit just 60 percent of the global recovered paper tonnage imported in 2018 to be imported this year, meaning a 40 percent decline in imports. In addition, the firm estimated U.S. OCC shipments to China will cease by 2021. If that were to occur, how would China be able to replace those lost tons?

Fastmarkets RISI attempted to address this issue at its International Containerboard Conference Nov. 12-14, 2018, in Chicago, with one of its analysts saying that in such a scenario, Chinese producers would have to acquire yet more pulp and paper mills outside of China. The country also would need to improve its domestic collection through a combination of government and private investment. (According to Fastmarkets RISI, there is limited room to do so given already high recovery rates.)

Meeting China’s standards

U.S. recyclers have had difficulty meeting the 0.5 percent contaminant level on imported OCC required by the Chinese government largely because of the limits of recycling infrastructure in the U.S. For context, Fastmarkets RISI reported that before the Chinese government announced a ban on mixed paper imports at the beginning of 2018, Chinese mills noted that 30 percent of their imported recovered paper was contaminated with plastic bottles, cans and other nonpaper material.

The reason for such high contamination is largely the result of the expansion of single-stream recycling systems in the U.S. As a result of this process, recyclable paper has become commingled with recyclables, such as plastic bottles and aluminum cans, and with garbage that can’t be recycled, and material recovery facilities (MRFs) can have difficulty separating these materials, leading to higher contaminant levels in bales of recovered paper.

The obvious question is whether U.S. recycling systems can improve to meet the low contaminant levels required for Chinese imports and whether such an event would result in increased demand for U.S. OCC in China. While some mill sources and recyclers quoted by Fastmarkets RISI believe the solution is a switch toward dual-stream recycling in which paper is isolated from other recyclables, other sources think a dual-stream system would be too expensive to be feasible from a hauling and sorting perspective. Those sources say they think a more immediate solution is to improve single-stream recycling through consumer education on what can be recycled to reduce the level of garbage and other contaminants that end up at MRFs.

Contacts also told Fastmarkets RISI that fixing recycling in the U.S. will take “education, collaboration, comprehensive communication, investments and leadership.” Put simply, industry sources agree that fixing U.S. recycling will be no easy task, given that significant cooperation and investment undoubtedly will be required. Yet industry sources differ in opinions on the best way to solve the problem.

To the extent U.S. recyclers are successful in improving OCC quality (within the Chinese 0.5 percent contaminant level requirements), we would expect China to import more OCC given the country’s need for externally sourced fiber, but this is likely a longer term trend.

Where are prices headed?

Given the uncertainty surrounding the future of Chinese OCC demand, OCC prices are understandably hard to predict. We think stable prices are the most sensible expectation, particularly given our expectation of stable Chinese import levels and flat to slightly declining domestic OCC demand.

Sonoco Products, Hartsville, South Carolina, said at an investor conference in December 2018 that it expected OCC prices to be flat from current levels in 2019, and prices already have fallen since then. If China somehow manages to eliminate recovered paper imports, a temporary supply glut would arise in the U.S., and prices would fall. However, in such a scenario, recyclers would cut back on collection, and prices likely would stabilize, albeit at a lower level.

In fact, statistics from the American Forest & Paper Association (AF&PA), Washington, show the U.S. recovery rate for OCC/ unbleached kraft paper fell from 92.7 percent in 2016 to 88.8 percent in 2017. AF&PA says the decline was attributable to a 10.1 percent decrease in net exports of OCC. While the 2018 recovery rate has not been calculated as of mid-February, we assume a similar trend.

The author is a director, equity research analyst with Cleveland-based KeyBanc Capital Markets Inc. He is focused on the packaging sector and can be reached at ajosephson@keybanc.com.