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Export Regulations Volatile Paper Markets Ahead

By Bernie Lee and Adam Minter

RISI’s recycled fiber conference in Chengdu, China, examined the likely effects of Chinese environmental and import regulations that are shrinking the Chinese market for recovered paper, leaving the mixed paper picture especially uncertain.

At least 180 people representing 120 paper recyclers, traders, mills, packaging companies, and brands from 30 countries packed into a tight conference room at the JW Marriott in Chengdu, China, on Dec. 7, 2017, for the opening session of the RISI International Recycled Fiber and Containerboard Conference. Organizers from RISI (Bedford, Mass.) reported that demand was so strong—and space was so limited—they had to close registration weeks earlier. Nobody at the 2017 conference was surprised by the attendance. For months, the recycled fiber industry had been fixated on China’s announced ban on imports of certain grades of mixed paper and postconsumer plastic—and the volatility the announcement had created. Many in attendance viewed the conference, featuring analysts and market participants from China and the rest of the world, as a chance to get some clarity on the issue before the ban went into effect.

Policies force mill consolidation

The conference opened with Levi Li, managing director of RISI China (Shanghai), cautioning that “news about a policy can bring a bigger impact than the policy itself.” And if there was a consistent theme during the forum, it was that factors in addition to the import bans are contributing to the volatility in recovered paper markets.

The first factor is China’s longstanding desire to consolidate its heavy industries into large conglomerates to reduce “disorderly” competition and make the industries easier to regulate. Zhou Haichen, chief analyst for light industry and papermaking at SWS Research (Shanghai), referred to the effort as “supply-side reform,” noting that the country has made particular progress in consolidating heavy industries such as steel and mining. Accompanying this consolidation—initially, at least—are capacity reductions. In China’s papermaking industry, the closure of smaller plants eliminated roughly 30 million mt of outdated capacity during the five-year plan that ended in 2015. One policy proposal, which China is likely to have enacted before the end of 2017, would give the top 100 Chinese paper manufacturers a 40- to 50-percent market share within three years.

This consolidation process has already started, with environmental regulation being the tool of choice to achieve it. Root Li, general manager of Sichuan F. Source Paper Co. (Jinyuan, China), a large mill, described how this happens: “Environmental regulators will ask you to cut down your capacity to lower pollution,” he noted. “In Fuyang [a major eastern China papermaking city], they will restrict your output to meet energy emission targets.” Companies that can’t shoulder the cost of operating at a lower production level close, he said.

Burdens on smaller paper companies are unlikely to let up in 2018, speakers said. The policy proposal likely to have the greatest impact will restrict recovered paper import permits to papermaking companies with output capacity exceeding 300,000 mt a year. According to Tang Yanju, secretary general of the Recovered Paper Branch of the China Resource Recycling Association (Beijing), 179 companies in China can reach this threshold—a small proportion of China’s overall papermaking industry. It’s possible, she said, that the government will lower that 300,000 mt threshold, but she dismissed an audience question about lowering it to 100,000 mt—that level would allow 90 percent of Chinese papermaking companies to import, she noted.

That’s not the only policy likely to affect the number and competitiveness of China’s smaller mills. According to Zhou of SWS Research, China plans to prohibit mills that lack their own power plants from receiving a new quota to import recovered paper. In the long term, such a policy would be doing the mills a favor, he said. China’s general electricity rates are much higher than what a mill might expect to pay to generate its own electricity. “[With] no power plant, you’ll have production problems in the future,” he said.

Tang noted another policy change likely to further upend China’s recovered paper market: “If, within the last year, you’ve received a notice of infraction from the environmental authorities, you can’t import paper for a year.” That restriction has run up against a complicated reality, she said. “This year, a lot of companies received penalties because there’s been an uptick in monitoring and enforcement.” The government shows no sign of backing off, either, despite CRRA’s appeals, she added. “They say no, there’s no gray area. If you have an infraction, there’s no further negotiation, you can’t even appeal, and even if you appeal there will be no change in decision.”

Despite this inflexibility on infractions, the government remains flexible—within a limited range—on the contamination it will allow in mixed paper imported into China, Tang said. “0.3 percent, 0.5 percent could be upgraded a little,” she said, referring to proposed contamination limits. “Lots of mills are talking directly to the Ministry of the Environment. [Ministry officials] listen to mills and companies, and they’re hoping for more discussion.” She was quite clear that the goal of reducing contamination will remain because “contamination was too high.” But as a pragmatic matter, she noted, “China is short of resources, and it needs overseas ones.” How the country resolves those two imperatives remains an open question.

Chinese paper industry consolidation seems likely to continue, with impacts all the way down the supply chain. Outside the doors of the JW Marriott, scrap peddlers were busy bundling cardboard they had collected from the many shopping malls in the area. Tang made a point of declaring the end of such endeavors. “Individual street vendors will be eliminated,” she said. In their place will be professional recycling companies with recycling licenses. One benefit of this consolidated future, she said, is that companies who belong to it “can control the prices.”

By way of example, she noted that peddlers, despite stiff competition with each other, earn 1.1 to 1.2 yuan (17 to 18 cents) a kilogram for paper they collect in cities. Big recyclers, working collectively, would offer a better deal to the mills because they could drive down that price to 0.5 to 0.6 yuan (8 to 9 cents) a kilogram. “They can collectively lock onto a price and prevent the bad influence of the market,” Tang said. To further advance this development, municipal governments will establish recycler “white lists” and offer policy support to entities on the list, she said.

China’s imports likely to decline

Speakers suggested China’s new policies are likely to massively accelerate a downward trend in the country’s recovered paper imports that started about eight years ago. China’s recovered paper imports have fallen an average of 1.9 percent annually since 2009, and that parallels the decline in China’s use of recovered paper in paper production, said Echo Xu, a recovered paper analyst at UM Paper (Shanghai), now a RISI subsidiary. In 2005, China based 36 percent of its paper production on recovered fiber. At current rates of decline, recovered fiber will be less than 30 percent of its paper production by 2020. “And if policy is more strict, it drops more,” Xu added.

In part, the decline of recovered paper imports is a result of China’s growing volume of domestic fiber. Between 2004 and 2016, domestic fiber went from meeting less than 10 percent of China’s pulping needs to 30 percent. Xu is skeptical that the country can sustain that growth rate, however. China already recovers 70 percent of its paper nationwide, she said, and as much as 80 percent in the economically dynamic coastal regions. “There are no breakthroughs on the horizon that will allow greater collections,” she said. But that has not dissuaded the government from a long-term program to further restrict imports. In fact, Xu mentioned a “vague” government policy in the works that will restrict imports of all recovered paper grades that China can replace domestically. By 2020, if all imports are restricted, China will need to grow its domestic collections 60 percent annually, she pointed out, “and that’s not going to happen.” If Chinese domestic OCC prices remain high, she added, mills might have to add deinking fiber and other pulp substitutes to the mix to meet their fiber demand, especially if the estimate of 87 million mt of annual domestic containerboard consumption by 2021 is on target.

China’s policy moves leave two lingering questions: How big of a hole in supply are the import restrictions creating, and how will mills fill that hole? Xu estimates that the import restrictions will leave China in need of 5 million mt of recovered paper, and replacing that volume could actually exacerbate China’s environmental issues. “China’s domestic fiber is inferior to U.S. fiber, and strengthening it with chemical additives leads to environmental problems,” she said. That leaves Chinese mills looking to the international markets to meet their pulp and paper needs. As the mills explore these options, prices for their products are likely to rise.

Candy Chen, general manager of trading firm Vecycle (Hong Kong), said she is “concerned about the impact on the Chinese paper industry” of such policies and prices, which she believes will damage its competitiveness. But CRRA’s Tang said she believes mills will shift the higher costs of fiber onto other players in the supply chain. “Chinese companies will charge a bit more and then transfer the costs to the packaging companies and then the consumers.”

Despite these concerns about supply, consolidation, and competitiveness, the Chinese speakers agreed that the health of the Chinese paper business, and the allure of it, remain strong. Tang noted, for example, that 20 paper mills likely went bankrupt in 2017, but another 70 to 80 opened, attracted by the opportunity of historically high prices for paper and packaging and the niches that volatility offers nimble players.

Chinese policies’ global impact

China’s market influence will continue to drive the global paper industry, especially in Asia, the speakers said. Fiber costs are the lion’s share of Asian containerboard production costs, followed by labor. China’s labor costs have generally risen over the last decade, but the country still has a massive labor-cost advantage in global paper production, said Sampsa Veijalainen, RISI’s senior product manager for mill intelligence. Asia’s paper production will continue to rely primarily on recycled fiber, he pointed out. Only 20 percent of global paper production capacity uses virgin fiber, he said, and nearly half of that capacity is in North America.

While the Japanese market is more self-contained than other Asian paper markets, the South Korean market exhibits extreme price sensitivity to volatile Chinese demand. A buyer from a South Korean paper mill who attended the conference said he has seen mixed paper prices drop enough that the company is considering whether to begin importing U.S. mixed paper. At the same time, he is wary of the Chinese government reversing some of these policies, which could lead mixed paper prices to rise higher than the company’s margins can handle.

Recovered paper buyers and sellers said they worry about the lack of price stability, which they need for long-term business relationships with end-use consumers. During a panel discussion on the conference’s last morning, two Chinese end-use consumers of paper packaging indicated they’re already exploring alternative packaging materials such as wood, aluminum, and plastics. Environmental concerns have even pushed them to explore whether a circular, reusable packaging system could work to uncouple the business-to-business transportation of goods from the market volatility they’re currently experiencing. In the lobby outside the conference hall, paper packaging consumers were adamant that they are not willing to aid the paper packaging manufacturers by lobbying on their behalf.

The economic question Tang and many of the Chinese analysts, buyers, and sellers seem to be struggling with is how quickly the market will react to a new price norm. An analyst for a European broker and packaging producer remarked that since the policy environment has been filled with vague and ominous announcements, it’s all but impossible to stabilize buying patterns to maintain better pricing. The sudden spikes and drops in prices are requiring purchasing managers to focus further up and down the supply chain.

For speakers who work in regions and companies that traditionally supply China, the mood was not optimistic. Bill Moore, president of Moore & Associates (Atlanta), bluntly asserted that neither Europe or the United States is capable of meeting China’s proposed 0.3-percent contamination limit, and those recyclers would have difficulty meeting any limit below 2 percent. He expects China’s policies will lead to a “collapse” in U.S. and UK (and, to a lesser extent, EU) residential recycling programs. Eventually, he expects the low prices that are likely to result from the glut of mixed paper that previously went to China will spur U.S. mill owners to look at mixed paper as a feedstock and invest in the necessary upgrades to process it. “But we’re going to have a rocky one to two years in the mixed paper markets,” he predicted

Dan Cotter, vice president for recovered paper sales to China and other Southeast Asian countries at CellMark (Gothenberg, Sweden), a major exporter of paper to China, said mixed paper formerly bound for China is flowing to other markets “and crashing prices worldwide.” That’s been good for buyers, he explained, but not for CellMark’s suppliers. The ultimate solution, Cotter suggested, might be an allowed contamination level “that isn’t published” but which allows material to flow into China. “In the past, that’s what happened in China,” he said, admitting “it might have caused some abuses.”

Setting sights on India

In the absence of any immediate Chinese or generator-based solutions to the changing Chinese policy picture, paper recyclers and traders are looking at alternative markets for recovered paper. The Indian market is perhaps the most tantalizing. P.R. Ray of Esskay Impex (Kolkata), who has been active in the Indian paper industry for nearly a half century, outlined the scope of that opportunity in a candid speech that he opened by lamenting the poor quality of Indian industry data. Nonetheless, he was able to describe a modest but growing papermaking industry that had—as of 2016—more than 15 million mt of installed capacity and 14 million mt of production. That year it imported nearly 2 million mt of fiber, mostly newsprint, to help fulfill the large and growing demand for printed newspapers in the country. Currently 45 percent of India’s fiber use in paper production is recovered fiber, he said.

Though the Indian government reports India’s papermaking industry is growing 7.5 to 8 percent annually, Ray believes a more realistic figure is 4.5 to 5 percent, based on central bank and statistical bureau data. Under that scenario, he believes that India’s production volume should reach nearly 22 million mt by 2026. Though India’s virgin fiber mills have a steady source of domestic pulp, it will be difficult for them to grow, he said, because of India’s growing population, receding forests, and increasing demand for agricultural cash crops. As a result, he said, he believes “the road for Indian paper’s growth is through recovered paper.”

India’s leading sources of recovered paper are the United States, supplying 43 percent of its imports, and the Middle East, supplying 22 percent. The former, he noted, supplies India with high-quality fiber that simply isn’t available domestically. With 4.8- to 5-percent domestic consumption growth, he projects that India’s recovered paper needs will hit more than 14 million mt by 2026, with domestic sources providing about 9 million mt, or 62 percent of it.

Ray also said he expects recovered fiber to be the primary source of high-quality fiber for the Indian paper market. Raw material use statistics he presented show at least 33 percent of the virgin pulp used in Indian paper production consists of non-wood-based fibers. The wide diversity of languages, and the many newspapers that serve communities speaking those languages, result in a high demand for news grades and mechanically pulped fiber, he noted. But most mills consuming recovered paper use high-grade deinking bales, not the grades of recovered paper that will be seeking new markets as China’s policy changes take effect.

Bernie Lee is ISRI’s research analyst for commodities. Adam Minter is a freelance writer based in Kuala Lumpur, Malaysia. This article originally appeared in Scrap’s Jan/Feb 2018 issue. Reprinted with permission.

[SIDEBAR]

Government trade restrictions can have unexpected results, noted Bernie Lee, ISRI’s research analyst for commodities, in his presentation to the RISI China recovered paper conference in Chengdu. Lee gave a historical analysis of policies that have affected the global recycling markets in recent decades. For example, when the U.S. government decided in 1973 to impose price controls and export restrictions on steel scrap, the result was a sharp price increase—the opposite of what the rules’ proponents expected. Prices fell only after the government rescinded the rules in 1974. Lee’s presentation was a cautionary tale about the unintended consequences that can result when governments seek to protect resources and curb behaviors. —Adam Minter

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