Q4 Paper Outlook — Cuts in Capacity

Paper prices and production drop as a slow U.S. economy continues to plague suppliers.

BY CAROLINE MILLER

A flagging U.S. economy, an increase in offshore paper and the never-ending merger and acquisition dance among paper producers is continuing to keep the price of paper low, reports NAPL Chief Economist Andrew Paparozzi. In his latest survey of printers, 72.5 percent of those polled responded that paper prices are stable.

However, what is more interesting is the growing number of printers that are reporting falling paper prices. In June 2001, 18.5 percent indicated prices were falling. That number has increased progressively from last summer when less than 1 percent of Paparozzi's sample said prices were falling. But by January of 2001, 3 percent of those surveyed noted prices were declining and, by March 2001, just over 6 percent said prices were dropping.

"Although it is still a minority, it is a growing minority. There is a very, very clear trend toward declining prices," explains Paparozzi.

It's a trend that Craig Brodock, president of Brodock Press in Utica, NY, has also noticed in recent months. "Over the past year, Brodock has found the coated sheetfed paper market to be fairly stable. Recently, we have incurred a slight price decrease in premium and No. 1 sheets," he reports.

Soft Economy, Demand
The dropping paper prices are a result of the soft demand from a struggling U.S. economy, reveals Robert Smith III, vice president of purchasing for Mechanicsburg, PA-based Fry Communications.

"The midpoint of 2000 marked the high water mark for coated paper pricing. The 12 months since have seen a steady deterioration in the perception of global economic vitality. It almost seems that many are stunned at how quickly things got so terrible."

And Paparozzi does not expect to see any major changes in pricing while the economy remains mired. Still, when the much anticipated economic turnaround will arrive remains unclear.

"The economy remains the dominant issue. We still don't have any definite authoritative signs that the economy has indeed begun to turn around. No one knows when it is going to change. There is a huge difference of opinion as to how strong of a recovery we will see.

"It is very likely that it will be a somewhat muted recovery. It will stop well short of the growth that we enjoyed in the mid-1996 to mid-2000 years. The idea that we were going to have a robust, second half recovery is obviously not going to happen," he says.

Paparozzi does note that he has begun to see printer confidence rise in NAPL's printing business index. "In our surveys, we are starting to see that printer confidence is beginning to rise. Our printing business index has leveled off after it peaked last August. However, it is important to recognize that the rising optimism is based on the expectation that the economy is going to respond to the tax and interest rate cuts by year's end," Paparozzi reveals.

Interest Rate Cuts
While key indicators appear to have stabilized for now, the economy's next move will depend on how well it responds to the stimulus that the U.S. Treasury and the federal government have applied.

The result of this current economic uncertainty is serving to fuel the merger fever that the paper producers have been caught up in this past year. "The market is extremely competitive and, given a stumbling economy, this could negatively impact the smaller mills and merchants, as they will not be able to survive the down cycle. We forecast more acquisitions and consolidation," states Brodock.

The slowing economy has also forced paper mills and merchants to look for ways to hang onto their existing business base by being more willing to negotiate prices than they would be in a more prosperous cycle, he claims.

"Opaque, as well as text and cover, mills are far more willing to negotiate than the coated mills. They are generally smaller and the economic slowdown has had a more direct impact on them," according to Brodock.

While not currently impacting printers, numerous consolidations followed by several mill closings could hurt paper availability, according to Roy Grossman, president of Sandy Alexander, in Clifton, NJ.

"Uncertainty is the key word here. With Sappi's withdrawal from the U.S uncoated paper and converting paper segments, we see a lack of stability in the short term. Availability, until recently, has not been an issue. However, due to production cutbacks, it is beginning to tighten."

And printers can expect to see even more cuts in paper capacity. "As expected, consolidation has removed some of the capacity. The larger economic force of the marketplace will remove still more. If not for the capacity withdrawals and mill closings over the last 12 months, prices would be much more volatile," Smith reports.

Although production cutbacks will have some impact on availability, Paparozzi is not worried about a possible paper shortage. "Eighty percent of the printers that we surveyed reported that paper is as available as always. We really haven't seen a change in paper availability. It remains very stable."

While the economy continues to take center stage, it is not the lone factor in lower paper prices. Further impacting pricing and availability in the U.S. paper market is the increase in imports from the European, Canadian and Asian markets. The year 2000 saw a 15 percent rise in imported coated paper, while U.S. production of coated paper fell by 1.5 percent.

"Our sources in the paper market have expressed concern with both foreign competition and the slowdown in our economy as they negatively affect the market overall," notes Brodock. He suspects that the domestic text and cover mills will be the most impacted by the growth of foreign grades in the American market.

Long-term View
Still, paper prices will remain stable and may drop even further with a struggling economy. Printers should not expect paper prices to remain low for long, warns Brodock.

"We suspect that once the demand increases, the mills will try to recover their past losses, as well as their increased production costs due to fuel prices being higher, which equates to an overall price increase. If the market demands weren't so weak, prices would have increased already."