Basket half full

An important question increasingly being asked in the forestry industry is whether the world is running out of recovered fiber.

Usually two main issues are raised in this regard. One is that recovery rates of scrap paper are maxing out as collectors have already tapped all easily accessible sources of supply. This is particularly true for industrialized nations, where in some cases recovery rates well exceed 90 percent.

The second, and more pressing, affair is that as the production of virgin paper diminishes over time, the quality (and quantity) of secondary fiber also is bound to decline as paper can only be recycled a finite number of times. In the absence of a fresh fiber stream, the strength and quality of the paper collected will gradually diminish.

Both these issues suggest that, in the future, supply-side shortages could arise in regions lacking secure access to virgin pulp.

This, however, is not a problem that afflicts North America. Although the U.S. and Canada register very high recovery rates, both countries have ample fiber baskets and collect significantly higher volumes of scrap paper than locally demanded. This said, short-run shortages are still possible as market conditions are still sensitive to sudden supply and demand variations.
 

The current state of affairs

Last year, recovered paper consumption in the U.S. and Canada totaled 30 million metric tons. While total usage was slightly higher than in 2012, it was almost 8 million metric tons lower than at the turn of the century. (See Graph 1, below.) Scrap paper use in North America has been declining on a trend basis, contracting in nine of the past 13 years. While exacerbated by the Great Recession, this persistent reduction in secondary fiber usage is fundamentally a consequence of the downfall of the communication paper sector in North America since the emergence of high-speed Internet.
 

At present, regional consumption of old newspapers and magazines (ONP/OMG) is 4.8 million metric tons lower than it was prior to the dot-com bubble. In fact, close to two-thirds of the overall drop in recovered fiber usage between 2000 and 2013 was accounted for by these two grades. ONP consumption has been primarily affected by falling newsprint consumption resulting from declining newspaper circulation, though substitution with virgin fiber and the closure of some recycled-based newsprint mills also have contributed to the decline.

The importance of these last two factors should not be understated. Last year, ONP consumption in the U.S. and Canada fell 12 percent compared with a 4 percent drop in newsprint production and a 0.7 percent reduction in recycled boxboard manufacturing, its two main end uses. (See Graph 2 below) The decline in ONP consumption, thus, was largely explained by a decrease in the region’s average ONP utilization rate. In the case of newsprint, ONP utilization was weighed down by the closure of Catalyst Paper’s Snowflake mill in Arizona, one of the few remaining facilities in North America running entirely on deinked pulp. For boxboard, in turn, ONP consumption was probably affected by a reduction in the use of ONP as a percentage of total pulp furnish (in detriment of mixed paper or old corrugated containers [OCC]).
 

With ONP declining sharply, why then did total recovered fiber consumption increase in 2013? Quite simply, because rising demand for OCC compensated for falling usage of ONP and mixed paper (Graph 3, above). OCC consumption in North America has been moving sideways for more than a decade, closely tracking changes in containerboard production. Between 2002 and 2012, consumption of OCC fell at an average rate of 0.3 percent per year, very much in line with total containerboard output (-0.1 percent average annual growth rate [AAGR]). Last year, however, OCC demand expanded 4.6 percent, reaching 19.8 million metric tons by year end.

At first glance, such a sudden increase in OCC deliveries might seem at odds with the North American box market. Regional box shipments edged down 0.2 percent in 2013, curtailed by lackluster growth in nondurable goods manufacturing. With consumption held back by weak corrugated shipments, containerboard demand was primarily sustained by strong inventory accumulation. Liner and medium inventories at U.S. boxplants fell sharply in 2012, prompting converters to replenish their input stocks in 2013 despite sluggish box demand. Rising domestic demand, therefore, supported containerboard production, which increased 1.1 percent.

While representing only 30 percent of overall production, recycled linerboard and medium, together accounting for two-thirds of containerboard’s OCC usage, explained 70 percent of the increase in containerboard output. In both cases, production was buoyed not only by rising demand but also by a series of startups, conversions and capacity upgrades during the spring and summer. The largest of these was the startup of Norampac’s Greenpac mill in Niagara Falls, New York, which at full ramp-up is expected to produce 490,000 metric tons of recycled linerboard. To some extent, then, growth in OCC demand in 2013 was a reflection of forward purchasing by mills with these new containerboard machines, which sought to stock up prior to the startup of commercial production.

But growth in OCC demand was not only driven by rising containerboard production. OCC deliveries exceeded the pace of growth of recycled and virgin-based containerboard. The missing piece of the puzzle was an unfavorable external environment. For the second time in 13 years, OCC shipments to China (by far the largest destination for North American OCC) declined in 2013. According to Chinese customs, OCC imports from North America edged down 5 percent versus 2012, while the U.S. Census Bureau and Statistics Canada reported a 10 percent decline (Graph 4, below).

The key here is that falling OCC imports were fundamentally a reflection of sluggish containerboard production in China as well a consequence of the much-discussed Operation Green Fence. With regard to the former, the China Paper Association (CPA) reported a 1.1 percent drop in containerboard manufacturing in 2013. Industry observers might find this surprising, considering 16 new containerboard machines were brought online during this period. Weak manufacturing activity and the closure of dozens of small and outdated mills by the Ministry of Industry and Information Technology (MIIT) were to blame. OCC imports were further curtailed by Operation Green Fence, a policy initiative by the Chinese government to clamp down on the import of illegal solid waste. The program acted as an indirect tariff barrier, blocking all recovered paper bales that did not meet minimum quality standards. As offshore shipments declined, OCC availability in North America increased, reducing input costs for recycled-fiber-based mills. Thus, despite flat growth in OCC collection, domestic OCC supply rose 4.5 percent in 2013, encouraging mill consumption.
 

The medium-term outlook

As is by now probably expected, the medium-term prospects for ONP and OCC consumption in North America are strikingly different.

Growth in ONP usage will probably continue to decline, weighed down by falling newsprint shipments. As newspaper circulation declines, the quantity of ONP collected also will drop. In fact, to the extent ONP recovery rates stay constant, the volume of ONP available for domestic consumption probably will decline faster than the quantity demanded. This is because ONP is used not only in newsprint production but also in recycled boxboard manufacturing, a segment that is not facing the same structural woes as newsprint. Thus, as disposable income rises and retail sales pick up, boxboard deliveries probably will increase. This would put upward pressure on ONP prices, prompting recycled boxboard producers to switch to OCC or to mixed paper.

In contrast to the ONP market, growth in OCC consumption throughout the next few years primarily will depend on how corrugated demand responds to future macroeconomic conditions. The U.S. economy is picking up steam after a weak start to the year. According to the Bureau of Economic Analysis (BEA), real GDP in the U.S. grew at an annualized rate of 4 percent in the second quarter of 2014, offsetting the 2.1 percent drop registered during the first three months of the year (Graph 5, below). Job creation, consumer confidence, retail spending and factory output have all been on the rise since April, paving the way for stronger corrugated demand in coming quarters. Rising box production will boost containerboard deliveries, though board demand in 2014 will grow more slowly than in 2013 owing to high box plant inventories. Importantly, most of the increase in containerboard demand throughout the next two years likely will come from the recycled segment, which also will benefit from the conversion of a former newsprint paper machine in Oregon and from the startup of a 327,000-metric-ton mill in Indiana during the second half of 2015.
 

As containerboard production expands, OCC consumption also will increase, barring a sudden drop in the utilization rate. The question, therefore, is whether enough OCC will be domestically available to meet the containerboard industry’s recovered fiber requirements. This, in turn, will depend on three main variables: the OCC recovery rate, the availability of boxes for collection and net exports of OCC.

The first of these factors offers little room for improvement. The apparent OCC recovery rate in North America (which does not take into account imports of boxed goods) has averaged 94 percent over the past two years, and short-term gains seem unlikely as they would require the introduction of innovative sorting and cleaning technologies. With flat recovery rates, OCC collection only will increase with higher potential supply. Luckily, positive growth in domestic corrugated shipments should result in higher collection levels.

But even if OCC collection rises, what will be left in the domestic market may still decline if external demand is high enough. As mentioned in the previous section, North America exports a large amount of recovered boxes to China, where imported OCC represents about one-third of containerboard furnish. If Chinese containerboard output increases substantially, mills in that country will expand their purchases of imported OCC, potentially putting pressure on North American supply. This is particularly true considering a good portion of North American OCC exported to China is shipped by traders wholly or partly owned by Chinese manufacturers. Thus, even if North American OCC requirements rise, these traders will tend to favor Chinese mills.

Throughout the next two years, we expect Chinese containerboard shipments to grow between 3 and 4 percent per year. The Chinese government is trying to engineer a transition from an export-based, investment-driven economy to one based on private consumption and a more equitable distribution of income. Such a transition, however, could cause the economy to decelerate in the short run as the government seeks to reign in credit growth, reduce industrial overcapacity and control local government debt. Note, however, that even if board demand slows down, recycled-based production still will be supported by the startup of eight new containerboard machines before the end of 2016. While government-sponsored pulp and paper closures might mitigate overall capacity growth moving forward, net capacity additions would still amount to nearly 7 million metric tons. Assuming OCC recovery rates in China remain stable between now and 2016, positive growth in Chinese containerboard production would then call for higher OCC imports from North America. Whether these shortages result will consequently depend on whether OCC collection in Canada and the U.S. is enough to satisfy both domestic and external needs.

What does this all mean? On the supply side, scrap paper collection in North America will increase modestly over time. With record high recovery rates, total collection will depend on the quantity of recoverable paper and board consumed by retailers, wholesalers, factories, offices and households. Here, rising paperboard consumption will be neutralized by falling demand for newspapers, magazines and other graphic papers.

As ONP, OMG and high-grade collection diminishes, newsprint, boxboard and tissue mills will have to look for viable alternatives. Mixed paper consumption therefore could increase in some of these sectors, as could OCC usage by noncontainerboard producers.

An adequate supply of raw material will continue to be available for recycled containerboard mills, though upward price pressures might develop if these consumers face increasing competition from China or from other segments in North America.

The author is an economic analyst primarily responsible for analyzing the containerboard and recovered fiber sectors for Montreal-based Numera Analytics. He can be contacted at jklara@numeraanalytics.com.