Study the paper market and the lectures you heard in Economics 101 will come rushing back to you. While simplifying the paper market and all its complexities is a difficult task, looking at the past few years in this context is quite helpful in trying to understand what is to come. Here is a quick review of the coated paper market, definitions of grade levels, and some of the important indicators to watch.

The paper market can be divided into five segments: coated, uncoated, packaging, household, and recovered. The focus of this article is the coated paper segment that is further divided into grades commonly referred to as freesheet (Premium, #1, #2, and #3 woodfree) or groundwood (#4, and #5 lightweight mechanical) stocks.  Freesheet stock is made of pulp that is converted from wood using a chemical process that breaks apart the fibers and dissolves impurities, creating a “woodfree” paper.   Groundwood stock is created from pulp that uses a mechanical process to convert the wood into fiber.

Availability and pricing of coated freesheet and groundwood papers has been a hot topic for publishers over the past year.  The coated paper market has been tight and the prices increases have occurred several times. The market has clearly been in disequilibrium. Let’s look at some basic economic principles to understand what is at work here.

The laws of supply and demand drive the paper market. The law of demand states that buyers are more willing to pay for a quality item at a lower price. The law of supply states that producers will seek the lowest production costs and higher prices to sell their items. The market mediates any conflict by determining the equilibrium price for the goods or services. The equilibrium is the point at which there is no surplus or shortage and the price is “just right.”  How does this influence your paper price, availability, and lead-time for your paper?

Supply

On the supply side of the paper market there are indicators that tell us supply is not going to grow in the coated paper sector. One indicator is capacity—the amount of paper the mills can produce. It is estimated that capacity will only grow at a very gradual and low rate. The American Forest and Paper Association (AF&PA) estimates that coated freesheet paper capacity will grow by 315,000 tons or 4.1% for a total capacity of 5.3 million tons by ’06. This growth in capacity will come from mill conversions that are slated to stop producing groundwood and start producing freesheet grades. The AF&PA reports that coated groundwood capacity has grown from 4.8 million tons in 2000 to 5 million tons in 2004 and predicts that capacity will remain steady through 2007.

Another supply indicator is investment into new mills and manufacturing capability. Since 2002, 29 mills have been shut down. There is only one new paper machine scheduled to come online before 2007. Depressed paper prices have limited the available cash for investment into capital improvements and expanded capacity.

Demand

Demand for coated papers was mildly positive from 1990 – 2003, increasing at a rate of 1.4% according to statistics from the Pulp and Paper Products Council (PPPC).  In general, the demand for coated stock showed some growth in 2004, up 7.4% over 2003 for groundwood, and up more than 7% for freesheet. An increase consumption of 2.5 – 3% in 2005 is expected for groundwood, and 2% increase for freesheet.  This increase may not come to pass. In January and February of this year, shipments declined and the mills shipped at 87% of capacity.

When you look at demand broken down by grade levels, it is interesting that overall, 75% of publications are printed on coated groundwood, 20% are printed on coated freesheet, and 5% on uncoated groundwood. While overall demand may level out, the demand for  #5 groundwood is expected to increase in 2005 as publishers look for ways to combat rising paper costs and postal increases. Meeting the demand for groundwood is complicated by the strike at the UPM Miramichi plant that produced approximately 8% of the North American groundwood supply.

Is there unused capacity in the market? Is the demand for coated paper cooling? I believe the answer to these questions is yes and that as a result, we are moving as close to an equilibrium price as we have seen for many years. Let’s see what happens with the next round of increases.