As previously reported on PIworld.com, D. Edward Tree wrote on Dead Tree Edition
that coated paper prices were set for a collapse,
citing falling demand. Paper Guru replied
that paper prices would be determined by supply and demand, not by demand alone, and suggested that the mills would balance supply and demand. D. Edward Tree responded
that the coated mills were in bad shape financially and could not afford to idle mills, and thus would not be able to balance supply and demand.
First, this has been a good discussion, and the above synopsis does not do it justice. If you have not read the previous posts, I recommend that you do.
I would not presume to predict what NewPage, Verso, Sappi or any papermaker would do about idling mills, nor am I here to tell them how to run their businesses. Rather, I’m trying to point out some market dynamics that may be not be fully understood by all.
Paper consumption in North America is declining. This is a structural decline, and not just a cyclical decline. That means we can’t expect paper demand to “return to normal” when the economy recovers. This is the new “normal.” That point is not in debate, though experts do differ on the rate of decline.
This was not always the case, and there was a time when it seemed to make sense to take short-term measures to maintain cash flow until demand came back—cut prices to get orders, build inventory and, worst-case, take temporary downtime. Note that I said “seemed to.” Faced with the choice of lower prices or downtime, the better choice is downtime (I’ll get back to this).
In reality, the (perceived) choice was often lower prices and downtime, or just lower prices, and the mills opted for “just lower prices.” This led to more than a decade of negative returns.
Printers are very familiar with these choices, and the results.
We talked about uncoated freesheet and the rationalization and strong prices that market has seen. D. Edward Tree argues that coated is different: uncoated freesheet is dominated by two strong players with strong financial positions; whereas in the coated paper segment, the leaders are financially weak and cannot afford to idle mills.
International Paper (IP) and Domtar have a combined market share in uncoated freesheet of close to 60 percent. The combined share of NewPage and Verso in coated mechanical is similar, so that’s not the issue. It is argued that IP and Domtar can afford to reduce capacity because their financial position is strong. But one might argue the converse—because they have balanced supply and demand, they have maintained prices. As a result, they have been profitable and, therefore, are financially strong. An oversimplification, perhaps, but certainly there is some truth there.
It is important to note out that, if a mill cannot afford to reduce capacity, it cannot afford to reduce prices, either. I remember when I was selling uncoated freesheet in the days before consolidation. Prices were very competitive, and sales people were under constant pressure to meet competitive prices at $2-$3/cwt. ($40 to $60 per ton.) below official “transaction” prices. At one of our sales meetings, I asked the team, “Which is worse, dropping our price by $2/cwt. or taking all of our mills down for two weeks?”
Meeting lower prices was almost routine, while two weeks of downtime was a disaster. But in reality, at the time a $2/cwt. price reduction was a reduction in revenue of about 6 percent, and that went right to the bottom line.
However, two weeks is only 4 percent of a year’s output, and that does not all go to the bottom line. True, if the price cut was just for that order, or even just for a month, that would be better than taking the downtime, but that was the fallacy. As long as supply exceeded demand, the price reduction was permanent, and as the industry now well recognizes, the demand decline is structural, not cyclical—i.e., not temporary.
As the Dead Tree Edition
blog pointed out, industry analyst Verle Sutton recently predicted that coated prices will decrease next year until losses force some companies to idle their machines. That much is simply Economics 101: if supply exceeds demand, prices will fall. No debate there.