Top 5 must-win fights for the paper industry CEOs and Management
The Russian-Ukraine war is causing big turbulence in our lives and the world economy. We have already seen a rapid increase in energy pricing and there will be most probably a shift in the sourcing of oil and gas for many European countries. The green shift and finding new sources of supplies is not happening without a cost and Germany and Italy are at the core of this challenge as the biggest paper-producing countries in Europe. The roles of currencies e.g. in the oil trade have been challenged by Russia. This with the rising interest rates can cause big fluctuations in the values of different currencies.
On top of this already over 4 M people have been forced to leave Ukraine as refugees and we might be facing food shortages in the future due to this war. The long period of globalization is taking a step back and we could see the change in trade flows of goods and the rise of protectionism and self-sufficiency.
Although the paper markets have bounced back from the heavy decline caused by the pandemic the industry is facing suddenly many new challenges. One of the major issues is the high inflation and increasing financial costs due to rising interest rates. These changes alone are causing high pressure on product pricing and increasing investment costs. Global supply chains have suffered due to a lack of components and challenges in the shipping of goods. Printers and publishers have experienced a shortage of paper due to the relatively good market situation, the above-mentioned problems, and the long-lasting strike in Finland. Quite recently Stora-Enso announced the plan to divest its non-strategic paper assets. Are the markets ready for final consolidation where the last men standing in the business are formed from the exited assets of traditional paper companies? Which companies could follow Stora-Enso’s example?
In this article, we dive deeper into these issues and summarize in the end the 5 key fights the industry leaders are facing shortly.
Market development
European graphic paper demand 2017–2021.
It looks like the paper market is having breathing time from the heavy market decline trend. It is most likely that this is temporary and market decline will continue but with a slower phase in the future. Are we close to reaching the bottom/turning point in market size? This is difficult to predict but newsprint, magazines, and catalogs could still be declining at some rate also in the near future due to the substitution trend by digital publishing.
A related article published in August 2020:
Paper and Board production 2000–2021.
Paper production
The production trend and the number of paper machines are well reflecting the market development. The 6 % increase in production during 2021 has happened in all major segments due to the market recovery after the peak year of the pandemic.
The average capacity in 2021 was 81 000 t/a calculated with 90 % OR. This means that there is still a large number of small machines in the markets. These machines serve the specialty paper markets. The trend toward higher speeds and widths is happening in all segments but in specialties, the cap in production output to paper and packaging lines, is still big on average.
We know that most of the small assets in graphic paper markets have already been closed or converted into specialties. This market is growing but the only real “commodity” specialties that can swallow the output of those machines left in graphic papers are C1S and glassine markets. In these businesses, the largest machine has already a capacity of 300 000 t/a but most of the rebuilds have lately had a capacity close to 100 000 t/a. This means that the main option for conversions from graphic papers is the large packaging paper markets.
In the graphic paper market and packaging paper market, the capacities for state-of-the-art machines and rebuilds can be as high as 300–600 000 t/a.If we calculate the number of machines needed for the current total production level with cost-efficient future production line capacity, we can see the potential for general efficiency improvement in the industry. E.g. if we select an average capacity of 400 000 t/a. The 90 Mt yearly production with OR 90 % could be achieved with only 250 production lines. This would mean in theory closures of 989 machines in the future. This would include also a large number of the small specialty paper lines but we estimate that there is still potential in each segment to improve efficiency with the economics of scale.
A related article published in February 2021
A related article published in September 2020
Russia and Ukraine conflict and strike in Finland
Pulp
Russia invaded Ukraine on 24. February 2022. This conflict is causing many effects on the international markets. It has also a direct impact on the pulp and paper markets. Russia is a net exporter of market pulp. Roughly 10 Mt of BSK and 0,3 Mt of BHK are exported from the country mainly to China. This will most probably continue and trade will increase with China. Smaller volumes are exported to European markets and this is having a minor effect on paper markets directly but exports to China will in the short term reduce export volumes to China for European producers.
Paper
500 000 tons of UKP is exported to Europe from Russia mainly to Germany. This has a bigger impact on European markets. This will create opportunities for the local producers of packaging materials.
Wood
Finland has been importing 10 Mt of wood yearly for pulp production from Russia and 500,000 t of mainly sawn products from Russia but these supplies can be compensated with local supplies. Wood consumption has been forecasted to increase to record levels due to stopping Russian wood imports, startups of new pulp mills, and a big sawmill investment in Finland. EU regulations on sustainable forest management and carbon storage can lead to restrictions on harvesting wood and to tighter supplies thus increasing the wood prices in Finnish and EU markets. This can also limit the possibilities for further investments in this segment.
Competing end-uses for wood are also a threat and wood supplies. The construction industry can store carbon for a long time in the wooden building structures and the packaging industry has a better position to purchase wood due to higher product prices and margins compared to the paper markets.
Sourcing of wood/pulp will be a critical factor in the paper and packaging industry also because the decreasing paper market is feeding less and less recycled fibers to the European market every year.
Energy trade and currencies
The biggest effect coming in due course might be the energy trade changes. Russia has tied now the ruble to the gold standard and is demanding purchases to be made in rubles. The main currency for oil trade has been the US dollar. EU has announced that it will decrease supplies from Russia in the long term but has significant challenges to cutting back supplies in the short term because there is no real alternative for this in Germany and Italy. Stopping supplies from Russia could lead to mass unemployment and unrest in Europe. In the worst-case scenario, this is not our choice but Russia will end up canceling supplies by itself.
On the other hand, if Russia is successful in forcing also EU to buy Russian oil and gas in ruble and some Russian allies and partners will do this it can have a major effect on the role of the US dollar and its value. Furthermore, Russia has increased pricing and is accepting payments also with cryptocurrencies.
In the short term, this development would have a major cost impact because alternative energy sources need big investments and short-term supplies are most likely higher in cost compared to Russian supplies. We have already seen a significant energy price increase and this will most probably continue and cause high pressure on product pricing also for paper producers.
Inflation
The long pandemic, excess money supplies in the form of financial support packages from Central Banks, and lately the Russia-Ukraine conflict have contributed to the fast rise of high inflation. E.g. in Finland, we have recorded already monthly inflation of 7 %, and petrol prices at the pump have increased by> 40 %. This will cause demands for higher wages in Europe and the US. This will lead to the government spending money on subsidies to compensate for the high energy prices for consumers and companies.
US FED has increased the interest rates already many times during the past 12 months. The European Central Bank is following but with a delay. Increasing interest rates is causing challenges in Europe as some countries have a very high-risk position on national debts and can not bear high-interest rate for their loans without EU support. This has formerly been handled with EU-level compensation packages. During the COVID crisis, the EU decided to take common loans for the vast support packages, and now cutting Russian energy supplies, high inflation, and increasing interest rates have raised this issue again. If there is a big interest rate difference between the US dollar and the Euro it could also lead to the weakening of the European currency. On the other hand, how will the US dollar value develop if part of the oil trade is fading to other currencies?
What effect the cost inflation will have on paper prices? Can printers and publishers push the increased prices on their products without losing big junks of business to their online publications? Most of the publishers have both businesses and this is an opportunity internally but can also lead to a loss of revenue for these companies. On top of this, in the short term, the paper producers must be able to correct supply shortages to their customers.
Euro-area inflation 2017–2022.
Globalization
The current war is most probably affecting the historical blocks in global trade. It could be that Russia, China, India, Africa, and maybe Brazil will form a stronger partnership in the future. The US, EU, Japan, and Britain would form the core of the counterblock. The US-China trade has a major role in defining if this development will happen and in which format.
The positive side of the recent conflict has been the unity of the Western world in actions sanctioning and isolating Russia and decisions to accelerate the shift to green non-fossil energy resources. On the other hand, if Europe is the leader in this development due to the high share of imported energy it can weaken the EU’s competitive position in the short term because most probably the Russian and Middle East gas and oil will find new customers in ASIA and Africa. For NA this is not a major issue as they can be self-sufficient in energy and also use fossil energy. On top, they will benefit from exporting oil and gas to Europe at least in the short term.
Grain and fertilizers
Ukraine and Russia are also sources of many other key raw materials. One key product is grain and it has been predicted that the war and shortage of the fertilizers produced in these countries will cause a shortage in the global markets. This will lead to a food price increase that has been already noticed in the European and US markets. The main export countries from Ukraine have been African countries. If these countries will experience food shortages it can cause a major refugee flow to Europe.
Refugee challenge and rebuilding of Ukraine
It has been reported that 8 million people have been forced to leave their homes in Ukraine. More than 4 million people have left Ukraine for neighboring countries. Housing and feeding a large number of refugees will also increase base costs for European countries in the short term. When these people move back and start building Ukraine’s destroyed infrastructure one of the key questions is how the funding of rebuilding of Ukraine will be financed. Who will pay the cost of this war?
Shortage of paper
Printers and publishers have been reporting a shortage of paper supplies. This has been caused by several factors: the long-term effect of closing non-competitive paper assets, recovery of markets and relatively high economic growth, global logistic problems, and the UPM paper mill strike in Finland. The strike has continued for over 3 months, and the effect has been on top of the tight market situation. The total graphic paper capacity in the strike has been 1,875 Mt, which could cause a supply cap of roughly 300,000 t this year if the strike ends by the 31st of April. Total pulp capacity is 2,4 Mt/a, which is causing a lack of supplies of roughly 0,8 Mt this year with the same logic. On top, the specialty paper mill in Finland on strike has a capacity of 300,000 t/a glassine and specialties.
Some examples of the latest conversions
The key to success in graphic paper asset exit/sales success is the time frame the current market will give these mills for positive cash flow and thus time to develop a new strategic path for the new owners.
The asset competitiveness in current markets and conditions, location, raw material base, cash flow level, and conversion investment needs are the key issues as a base for successful conversions.
In the short term, because of the current crisis, the projects are challenged by the general cost inflation and sustainable cost-efficient energy sourcing.
P&W machine conversions into packaging business
ND Paper, the US subsidiary of Nine Dragons Paper (Holdings) Limited a leading North American producer of pulp, paper, and paper-based packaging, is implementing a series of transformations at its Rumford Division to further expand into packaging grades.
- Rumford Division.Conversion of its R15 paper machine from P&W papers into a lightweight, high-strength kraft liner board products
- Rumford Division.Expansion of R12 paper machine capability to include unbleached recycled bags and converting papers, in addition to its current offering of bleached and unbleached papers
- At ND Paper’s Biron, Wisconsin mill, the company will be converting its B26 paper machine at the end of 2022 from coated mechanical papers to lightweight, high-strength recycled packaging products.B26 machine produces approximately 260,000 short tons annually of lightweight coated mechanical (CM) papers for end uses like catalogs, magazines, and retail inserts.
BillerudKorsnäs has entered a merger agreement to acquire Verso Corporation, a leading producer of coated papers in North America, for a purchase price of approximately USD$ 825 million in cash, with the transaction expected to close in the second quarter of 2022.
BillerudKorsnäs says that it intends to build a cost-effective and sustainable paperboard platform in North America by converting some of Verso’s assets into paperboard machines with an estimated CAPEX of up to SEK 9 billion while maintaining its position as “quality and cost leader” in specialty and coated woodfree paper.
P&W paper machine conversions into specialties:
The challenge of the current graphic paper assets left is that most of them are almost too big for servicing the specialty paper markets and there is limited room for conversions in these segments.
In 2018, UPM announced the conversion of Paper Machine 2 in Nordland, Germany, from fine paper to specialty grades. The machine is producing a wide range of products, such as glassine, kraft, and barrier papers. The annual designed capacity of Nordland PM2 is 110,000 tonnes. The project investment was 110 million euros.
Lecta is in the process of a transformation, from being a graphic paper manufacturer to manufacturing a diverse product portfolio of specialty papers for labeling, flexible packaging, and other high-value-added segments. Condat mill in France has transformed a large paper machine (Line 8) from coated woodfree paper to release liner manufacturing. The project investment was 80 million euros.
Exit plans
The large graphic paper companies were formed largely by consolidation and since the financial crisis, the development has been mainly reversed. Is there a possibility to make one or two companies that will focus only on graphic papers and will outperform the rest? Which companies will be the last men standing and which machines have the competitiveness to stay in the business? In many other market segments outside of the paper industry, 1 or 2 cost-efficient producers are left at the end of market consolidation. Smaller producers have escaped to niche segments.
Out of the 2 big ones Stora-Enso has already announced to withdraw from the paper business. Stora-Enso will concentrate on its core growth businesses and will sell out all paper-related assets: Hylte (News, TPM-based) and Nymolla (Advertising, Pulp integrated WFU) in Sweden, Maxau SC (Magazine, recovered fibers) mill in Germany, and Anjala (books, groundwood) in Finland.
In recent years UPM has been closing machines but also sold paper lines to companies that have been converting the mills into packaging business. These examples include the Shotton Newsprint mill in the UK, and the Chapelle and Stracel Newsprint mills in France. What could happen next? Is UPM following the same strategy as SE related to graphic assets? The company will in a few years also face a major management change as the current COB and CEO are reaching retirement age. The new management must decide the future of the paper business as one of the first tasks.
One key issue that could impact the financing of investments in this sector, is the new EU Taxonomy Compass, which aims to make the contents of the EU Taxonomy easier to access for a variety of users. It enables investors to check which activities are included in the EU Taxonomy, to which objectives they substantially contribute, and what criteria they have to meet.
Conclusion
Below we summarize the key issues that the graphic paper industry is facing in current markets due to the challenges described in this article:
- Handle general cost inflation and sourcing of key raw materials
- Cost-efficient supply of sustainable energy
- Sustainable and cost-efficient sourcing of pulp, recycled fibers, and wood
- Avoiding high increase in relative workforce cost
- Pricing of products supporting the margins
2. Navigate through setbacks in globalism
- Optimizing customer and supply base
- Managing trade barriers
- Hedging currency risks
3. Secure a high level of customer service
- How to consistently secure supplies and good service to customers
4. Keeping assets competitive
- Managing investments and conversions
- Selling or closing of current uncompetitive assets
5. Make strategic renewal and exit
- Defining an exit strategy
- Selling of non-strategic assets
- Managing exit from the business
- Finding buyers for the production lines and mills
Time to renew your strategy
Currently, the industry is experiencing is a third turning point in history since 2008 affecting on a large scale the pulp, paper, and packaging markets.
Our Services
Co-writers of this article
Riitta Salo, Founder & CEO, RES-Consulting
Contact: riittasalo@icloud.com, +358 40 543 2156
Heikki Hyvärinen, Founder & Partner, H&H Advisors
Contact: heikki.hyvarinen@hhadvisors.fi,+358 40 9695455
