BOSTON, MA, Dec. 4, 2008 (Viewpoint) – I just finished reading Cormac McCarthy’s latest book, The Road, so I have a very good idea about what “bleak” means. The outlook for the world pulp and paper market is not quite as bleak as life in the nuclear winter portrayed in The Road, but the next several months will be far from a happy time for the pulp and paper industry. Some solace can perhaps be taken by the fact that virtually all industrial sectors will be feeling the same sort of pain. Even formerly high-flying sectors such as metals and plastics have come down to earth with a thud, as the abrupt drop in general economic activity allows no escape; at least, for those sectors that don’t have strong political connections and can’t get a snout in the bailout trough.
The extent and the duration of the bleakness depends largely on the performance of the general economy. As usual, there are as many forecasts for the economy as there twice the number of economists. However, there don’t seem to be many “rosy scenarios” in the spectrum, such as was the case the last time we were in the middle of such a severe downturn at the beginning of the 1980s. On the other hand, there are quite a number of disaster scenarios, akin to the nuclear winter in The Road, on display. Hopefully, we have learned from past mistakes and the unrepentant doom mongers will not be able to cackle as the world economy slips into a 1930s type depression.
Our latest forecast for the world economy takes a middle of the road approach. There appears to be no doubt that the current quarter is showing a big drop in economic activity, on a worldwide basis. A considerable part of the decline is due to a massive inventory drawdown throughout the supply chain, due partially to concerns about underlying consumption and partially to lack (or high cost) of financing. The inventory reduction is transitory since the level of inventories can’t go below zero, with the extent of the damage to consumption and investment being the important consideration for 2009 outlook.
We are showing the recession in the developed world extending through the first quarter of 2009, before economic activity stabilizes in the second quarter. By that time, western Europe and Japan will have been in recession for four quarters and the USA for three quarters. Positive growth is predicted to resume in the developed world in the second half of next year, albeit at a modest pace. Massive government stimulus, both on a fiscal and monetary basis, will be the primary factor leading to the renewed expansion. China will play a major role in the government efforts to stimulate the economy by using a portion of the huge reserves built up over the past few years to leap forward on infrastructure projects.
The only silver lining in this otherwise bleak scenario for the general economy is that commodity prices will be substantially lower in 2009 than the peaks that were reached in the middle part of the current year. Already, oil prices have plunged to $55/barrel from a record level of $147/barrel less than six months ago. Other commodity prices have followed the same path and our analysis indicates that commodity prices will remain close to their current figures, on average, through the next year. Dollar prices, and even more in terms of yen, for commodities will exhibit the largest declines due to the jump in the value of these currencies.
The true commodities in the pulp and paper market, recovered paper and market pulp, are showing the same sort of pricing behavior being seen the broader world of commodities. Prices have plunged over the past three months, particularly in the case of recovered paper. Of course, recovered paper, as with other materials recovered from the waste stream, has its own set of economics compared to more traditional commodities. The most striking difference is that the cost floor for recovered products can be negative because the alternative for the waste generator is to pay to have the material landfilled. In fact, prices for some of the bulk grades of recovered paper, such as mixed paper, have gone negative. Market pulp, on the other hand, does have a positive cost floor, which is currently being severely tested.
Pricing of recovered paper and market pulp is likely to be extremely volatile over the course of 2009. Papermakers will have to rebuild their inventories of both materials sometime in the first half of next year. When this happens, prices will probably shoot up, especially for recovered paper since the supply side of this market will have been decimated by the brutal price drop in the latter part of this year. The inventory bounce in pricing will likely be short-lived, though, and another downdraft will hit both recovered paper and market pulp prices by mid-year. A more sustained upturn in recovered paper and market pulp pricing will have to await the upswing in paper and board demand which we expect to see gaining momentum by the end of 2009.
The paper and board side of the pulp and paper industry is not nearly as commodity oriented as the upstream fiber markets are, and producers are making it a priority to reinforce this proposition. Inter-regional trade constitutes a small part of world demand for paper and board, unlike in recovered paper and market pulp, making paper and board markets regional in character. Also, producers are exhibiting considerably more willingness to take downtime to match output to demand, especially in the case of products where concentration ratios have reached relatively high levels. So far, the production discipline and relative lack of trade flows have combined to keep paper and board prices from following fiber prices downward in most regions.
Our forecast shows that paper and board pricing will eventually break downward across a broad spectrum of grades in the first half of 2009. The two main factors that will cause the price decline will be the severity and duration of the demand downturn and the general slippage in production costs. Our analysis is that the extent of the demand slump will finally overwhelm the ability of suppliers to take the necessary downtime. The slide in production costs will be used as a club by end users to push prices down, just as producers used the jump in production costs this year to push prices upward. The largest price declines will be in dollar terms due to the increased value of the dollar against most world currencies. In fact, our latest forecast shows graphic paper prices rising in Europe next year, in euro terms, since they are currently well below dollar prices.
Conditions in the paper and board market should start to improve in the second half of next year, as long as our forecast for the general economy proves to be accurate. Demand will be rising, both as a result of increasing underlying consumption tied to the upswing in economic activity and due to end users rebuilding their inventories. On the supply side of the market, capacity will probably be lower for many grades due to permanent capacity closures driven by the poor demand and pricing anticipated in the first half of 2009. Therefore, operating rates will tend to rise from both the demand and supply sides of the equation. Pricing, though, will probably respond relatively slowly since production costs will still be comparatively low and operating rates, while higher than in the first half of the year, will still be modest.
There appears to be little doubt that 2009 will be a poor year for the pulp and paper industry. Demand will drop for the second consecutive year in the developed world for most paper and board grades, following the general economies downward. Producers will do their best to offset the demand weakness by proactively taking downtime and removing capacity on a permanent basis. However, they will probably not be successful in keeping prices from falling due to the severity of the slump in demand and sliding production costs. We do see some light at the end of the tunnel, though, with market conditions starting to improve in the second half of the year. Hopefully, our assessment of the general economy will prove out, instead of Cormac McCarthy turning out to be eerily prescient in his 2006 book, The Road, about an economic nuclear winter in 2009.
