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Q1 PAPER OUTLOOK -- The Price Is Right

January 2002

It's a good news/bad news situation. The good news: Printing paper prices are very favorable and popular grades are readily available. The bad news: When prices are low and paper is readily available it generally means that the demand for printing is soft, as well.

And that is exactly what the trend in the paper market has been for the past year. In late October and early November, just 2.5 percent of those who responded to the National Association for Printing Leadership's (NAPL's) national monthly paper survey indicated that paper prices were rising in that period. "It's the lowest we've ever seen that number. That is down from 42.5 percent a year earlier," states NAPL Chief Economist and Vice President Andrew Paparozzi.

The majority of the respondents, or 80 percent, agreed that prices were stable, while 17.5 percent felt paper prices were falling. While 80 percent of NAPL's survey responded that prices were stable, most in the industry contend that prices are continuing to fall, especially in the coated paper markets.

"The coated paper market is in the doldrums. It's about as soft as it's ever been," contends Roy Grossman, president of Sandy Alexander. "Pricing is extremely low and availability is high. As soft as last year was, this is significantly more so."

And the trend towards lower prices and high availability is only going to continue as the economy continues to flag. "In 2001, the paper industry was expecting a rebound later in the year, But, for 2002, there is a general feeling that paper suppliers are headed for a tough year with little relief in sight," explains Addis T. Hilliker, vice president of supply chain management at Banta Corp.

However, coated stocks aren't the only category of the market that is reporting weak demand. The paperboard market also experienced a difficult year, according to Marc Tannenbaum, vice president of marketing for Westvaco Packaging Resources Group.

Soft Market Continues

"In terms of general market conditions, they are pretty soft. Demand is slack, at best. It has been a pretty tough couple of months since September 11. We are really anticipating a market that is going to continue to be challenging with soft demand and readily available supply," he adds.

The third and fourth quarters of 2001 saw a continued drop in paper prices, across the board, in response to an economy clearly in recession and as a result of the September 11 tragedies.

"Pre-September 11, there were lots of layoffs, the economy wasn't doing well and consumer confidence was low," continues Tannenbaum. "September 11 was a seismic event that made all those conditions all that much worse. All the uncertainty that people already had was highlighted by the terrorist attacks."

And the terrorist attacks seemed to only delay what appeared to be the beginning of an economic recovery. Paparozzi reports that prior to September 11, NAPL surveys showed there were some early signs that the economy might be beginning to stabilize.

"A lot of our indicators were beginning to stabilize. They were even beginning to climb in August 2001. Our Printing Business Index Activity Indicator had actually risen from a record low of 38.5 percent back in May, all the way up to 48.9 percent in August. In August—for the first time in almost a year—more of the printers that we surveyed reported that business was picking up rather than slowing down."

Tannenbaum agrees. "We were predicting that things might come back in late March and early April of 2002. We had seen some encouraging signs." But any hopes of an economic recovery were dashed on on September 11.

It should be noted, however, that while September 11 certainly had an impact on the economy, it was not the event that sent the economy into recession.

"September 11 certainly delayed the recovery and it deepened the downturn, but our feeling was that economy was well into a recession before September 11," reveals the NAPL economist. "The numbers were very very weak well before the 11th. This may well be the worst downturn in the industry since the 1981-1982 recession. The numbers are far worse than what we saw during 1990-1991 downturn."

Still, there may be some signs that paper market activity may be beginning to get back on track. October 2001 saw a 2.3 percent increase in lightweight coated paper shipments over the same month in 2000—rising 31,000 tons over September shipments, according to the American Forest & Paper Association (AF&PA). Uncoated freesheet also saw an increase with 89,000 tons shipped in October 2001 in comparison to September; however, it still fell by 121,800 tons compared with October 2000.

While the October numbers are encouraging, it is still much too early to tell when the recovery will come in 2002. There are several factors that will impact paper markets and printers, including advertising, a proposed USPS increase, the Enron bankruptcy and intense industry consolidation.

Especially hard hit by the sagging economy and the terrorist attacks has been the advertising industry, which is undergoing one of the longest slumps in recent memory. This slump has caused a significant drop in the demand for coated stocks, which is expected to continue well into 2002 as advertising makes a slow rebound.

The proposed postal rate hike, which will most likely go into effect in the fourth quarter of next year, will also impact paper demand. Publishers are expected to counter the increased postal costs by lowering catalog and magazine page counts, by choosing cheaper and lighter basis weight grades, as well as smaller product trim sizes. Many catalog publishers are also planning to refocus their sales efforts on existing clients, and lessen their efforts to recruit new customers through bulk mailings.

The Enron Effect

Also playing a role in the health of the paper market is the impact of the Enron Corp. bankruptcy. Enron's forest products unit has assets in three newsprint mills, and also trades in white papers, packaging grades, pulp and recovered papers. Many in the paper industry are concerned about what will happen if that paper inventory is moved onto the market at below-market prices in an effort to generate quick cash flow.

The fear is that the inventory will flood the market causing prices to drop even more. In addition, Enron is involved in long-term hedging contracts with paper, pulp and paperboard producers and major buyers. With Enron's financial position compromised, these contracts now hang in the balance. It remains too early to tell what the final impact of Enron's fiscal troubles will have on the paper market.

The paper company consolidation trend also appears that it will continue in 2002. The hostile takeover attempt of Willamette by Weyerhaeuser continues to unfold, as well as the $10 billion merger of Westvaco and Mead Papers. In the short term, it appears that the mergers have only served to reduce the number of grades available to printers.

While there has been a greater effort on the part of the large mills to balance supply of paper to demand, to date, the industry has been unsuccessful in achieving a balanced market, contends Banta's Hilliker. "The merger activity has resulted in numerous efforts to eliminate non-standard grades, but this often results in the elimination of product differentiation that could help to create niche markets for mills that are in dire need of maintaining market share."

For Tannenbaum, the outlook for 2002 remains somewhat glum. "For 2002, we are planning for a flat if not a down year. We really are anticipating another tough 12 months."

Paparozzi, of the NAPL, agrees. He says the slumping economy will continue to impact print sales throughout the first and second quarter.

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