Weak Demand Will Mean Higher Paper Prices

Decreasing demand for publication papers in the U.S. is apparently having a counterintuitive result: higher prices. Or, at the least, higher minimum price levels during down markets.

There’s a logical explanation, and it doesn’t involve repealing the law of supply and demand. Nor does it mean that paper companies will be especially profitable in the future.

 “Newsprint will never fall below $500/tonne again, and will probably spend little time below $600/tone,” Verle Sutton wrote in the April issue of The Reel Time Report. “Average coated groundwood prices [for 40# #5] may drop below $800/ton in 2012, but will not get close to the 2009 low point of $730/ton. In fact, the current cyclical decline might be the last one in which coated groundwood pricing falls below $800/ton.”

Sutton is no optimist about the paper industry. He questions whether recently announced price increases for coated paper will stick and is especially bearish about the industry’s long-term prospects, as discussed in Why Coated Paper Prices Look Ready for a Fall.

The phenomenon Sutton describes – higher pricing “floors” for publication papers in future down markets -- is actually the result of the gloomy outlook for publication papers. It's somewhat akin to predictions that printed magazines will continue to exist for the foreseeable future, but as luxury items with much higher price points than today.

Riding the roller coaster
For decades, the prices of coated paper, newsprint and other publication grades rode a roller coaster through loose and tight markets.

Over the long haul, the roller coaster’s trend remained pretty flat: The price at one peak was generally close to the previous peak. The same was true of the troughs. It’s not a particularly unusual phenomenon: The prices of manufactured goods rarely keep up with overall inflation in the long run.

In the old days – until about, oh, 10 years ago – rising demand encouraged investments in new paper machines and in machine rebuilds. Input costs – labor, energy, fiber, chemicals – kept increasing, but the investments resulted in fewer inputs to make each ton of paper.

The result was that mills couldn’t just pass along their cost increases to customers; there was always a competitor with a shiny new machine and efficient cost structure that was happy to take on customers at a slightly lower price.

No more new machines
But no one will build another publication-paper machine in North America for the foreseeable future – if ever. With so many paper companies in or on the verge of bankruptcy, significant capital investments in existing machines are rare. The most efficient machines today are likely to remain the most efficient for years to come.

That means the industry’s efficiency gains are too meager to counter the impact of rising input costs. A coated-groundwood machine that was barely cash positive at the last market bottom in 2009 would now be shut down long before prices could drop to $730/ton again.

What’s not as clear is whether market peaks will also be higher than in the past. Price spikes occur when demand outstrips supply, which in a declining market can only happen when supply decreases. But demand has been decreasing so rapidly in recent years that, even when a machine is shut down, market tightness lasts for only a few months at most.

Another wild card is imports. New paper machines are being built in some developing countries, especially China. But tariffs, a shortage of fiber, and clumsy management have limited the Chinese mills’ impact on U.S. prices.

Perhaps if the oil market crashes, Canadian currency would weaken enough to make idle mills north of the border competitive again. The Canadian paper industry has been so devastated, however, that it’s hard to envision it rising from the ashes to cause major market disruptions in the U.S.

What seems most likely is that North American paper makers will continue to scuffle along, closing the highest-cost machines and mills when declining demand and prices force their hand. But those "cry 'uncle'" spots -- the price levels that force shutdowns and market firming -- may never be as low as they were in the past.