Conversions: Tsunami or Trickle?

 REBUILDS & CONVERSIONS

MARKO SUMMANEN, FISHER INTERNATIONAL

When a dam breaks, there can be a catastrophic release of stored up water that rushes downstream doing great damage to the inhabitants below. Is that about to happen with conversions? The industry has a big reservoir of newsprint and printing and writing machines; meanwhile, demand—the reason for them to keep making their grades—is crumbling. Everyone “knows” that you can convert a communication papers machine to containerboard, consumer packaging, or, in some cases, specialty paper, and everyone “knows” that there is growth in those grades. Is the dam about to break?

THE RESERVOIR

There are 1,310 machines worldwide making 121 million metric tons of newsprint (NP) or printing and writing (PW) grades. Altogether, they represent 27 percent of the world’s papermaking capacity. A single percent of average global communication papers demand decline would release capacity equal to three or four average-sized packaging machines. In containerboard (CB), that represents about 0.7 percent of global capacity; in consumer packaging, 3.5 percent. A global demand decline in communications papers accompanied by conversions of closing capacity could clearly have a disruptive impact on packaging markets. This article examines the likelihood of this outcome and what would have to happen for it to occur.

A bird’s eye view of the marketplace gives an inkling of the dynamics at play with growing and shrinking grades. Globally, the paper industry is still growing. In the past 10 years, it added about 100 million tons of new capacity. However, there are striking differences in the performance of different grades (Fig. 1).

In packaging grades, e-commerce is driving continued growth. From 2012 to 2017, business-to-consumer global sales are expected to double to more than US$2.1 trillion, and this trend can be expected to continue. Growing demand in packaging has allowed even old, small, and slow paper machines in those grades to survive. In Asia, many of them are already swing machines between major grades. Conversions from larger communications machines could put them at risk, further increasing the potentially disruptive impact of conversions.

Printing and writing has seen a steady decline over the past decade worldwide. Newsprint has been in freefall for some time now and the plunge continues.

WHAT TO DO WITH AGING ASSETS

North American assets are the oldest in technical age, while Asia’s assets are the youngest (Fig. 2). In North America, there has been very little new capacity investment in the 21st century—only a little in corrugating medium, linerboard, and tissue and towel. Overall assets are very old; roughly one-third of machines date back 50 years or more. Some are beyond updating and the rest still require capital to keep running (Fig. 3).

Either way, the rest of the world will put competitive pressure on them—despite the latter’s low costs for raw materials—further motivating conversions. This reality is reflected in North America’s rising imports of paper and board. Historically, a strong US dollar also triggers overseas investments and imports into North America.

Additionally, there may be regional reasons holding America back from making new greenfield investments. Project costs are more expensive in North America than in other regions. Permits may be harder to get and engineering and construction resources with experience in greenfield paper mill construction may be harder to find after decades of disuse.

WHAT’S NEXT?

So, it looks like conversions should be the way to go. Converting a brownfield mill to another product is far cheaper than building greenfield, and plenty of such capacity is available. In Europe, there is also another motivator: mill closures are so expensive that assets are changing hands at reasonable cost just to mitigate the expense of shutdowns for companies operating in declining paper grades.

But this is only half the picture. We haven’t seen much of asset repurposing happen yet and there are numerous reasons why. To be successful with a conversion, a mill must be in the right place for both raw materials and markets. Some mills that are technically suitable for conversion (e.g., from newsprint to liner) fail to qualify because they are in the wrong location. On top of this, a conversion candidate must trim efficiently, given the corrugators it will serve (Fig. 4).

We have seen machine conversion projects look good when compared to new machines in terms of investment cost per annual ton. However, other parts of the mill can require so much work that investment in a conversion doesn’t pay off. Consider the problem of aging recovery boilers, many of which are approaching the end of their useful lives. Does it make sense to invest in papermaking when the pulp mill may not survive long enough to pay back the investment?

A machine’s size and configuration also determine its suitability for conversion. Newsprint machines are more attractive for conversion to liner if they already have a shoe press. Even more attractive can be PW paper machines equipped with a shoe press, size press, and dilution control headboxes (Fig. 5). Conversions are even more attractive if the mill already uses recycled fiber and has good access to such fiber in volume.

Integrated mills may enjoy competitive power production even if paper production costs are high. For them, conversion to packaging may be a viable option. A low-risk pulp mill with high-risk paper machines also could be a good candidate (Fig. 6).

There are other serious obstacles to conversion besides the machine’s location and its technology. Jumbo rolls of packaging need to be converted and sold to end-user customers. For containerboard in North America, the largest potential market for conversions, most converting capacity is owned by the industry’s current liner and medium producers. By definition, they are unlikely to buy the output of new entrants. New entrants must fight for acceptance for the remaining 15 percent or so of the industry’s consumption that is served by independent converters. And worse, any given converted machine has access to only a portion of that 15 percent, since independent converters are located all across the expansive North American landscape. Furthermore, a new machine will have a basis weight preference, even further limiting the independent volume for which it can compete. So, a large conversion could require an extremely high share of the truly available independent market. It is a daunting task unless the machine has a significant competitive advantage.

Another complicating consideration is that introducing new capacity can itself affect the market’s supply-demand balance. A surfeit of new conversion capacity could affect the attractiveness of the market, creating a feedback loop that every investor must be aware of. We model such interactions with System Dynamics mathematics to help us understand how much new capacity each market can absorb. Our models make it clear that there are strict limitations to what markets can absorb without changing the behavior of the market.

TSUNAMI OR TRICKLE?

We at Fisher conclude that a wave of conversions is neither an obvious, unavoidable outcome nor a false promise. There are certainly cases where the stars align: an owner has box plants to sell the paper through, finds a machine with the right size and configuration in a good location with access to fiber and other resources, and converts it at less cost than building new. Alsip, Deridder, SPFT, SAS Blue Paper and others all had drivers making conversions feasible and attractive.

Clearly, each conversion case must be evaluated in two ways: there are so many individual characteristics that it first must be evaluated on its own merits. Also, there are enough market factors—such as how competitors and customers will respond—that conversions must take into account the impact of the potential investment on the market’s own dynamics.

Powerful industry trends in the form of diverging growth rates between communication papers and packaging grades motivate conversions. Still, they require significant investment and many factors must align before that investment is justified.

Marko Summanen is VP business development for Fisher International, a consulting firm that supports the global pulp and paper industry with business intelligence and data-driven strategy consulting. The information and analyses for this article are drawn from FisherSolve, the industry’s premier market intelligence database and analytics resource. Learn more at www.fisheri.com. Summanen can be reached at [email protected]

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