LIVING IN INTERESTING TIMES / 6 May 2019
Living in interesting times: How China is speeding up fiber market transition
Chinese actions to curb imports of recycled fiber have caused confusion in the recycled fiber markets. A significant drop in imports of recycled fibers could even be followed by a total ban of imports. What challenges and opportunities does the industry face going forwards?
China’s changes in their import policy regarding recycled fibers have been significant, creating both winners and losers. So far, the situation has created challenges for Chinese mills, as supply of recycled fiber has become limited and the price of domestically collected fiber has skyrocketed. In the US and Europe, on the other hand, paper and board producers are enjoying unusually low fiber cost.
In 2016, China imported close to 29 million tons of recycled fiber, and 2017 imports dropped to approximately 26 million tons. Imports during 2018 landed on 17 million tons. Currently many Chinese producers expect imports for 2019 could be lower than 12 million tons. The situation may very well become even worse for Chinese producers. The government has indicated that it may ban all imports of recycled fiber altogether by the end of 2020.
China to remain fiber importer, one way or another
Chinese forest resources are nowhere near enough to enable the country to be self-sufficient with domestic pulp to be able to replace current fiber imports. So far, recycled fiber seems to be the furnish of choice in many grades. Total consumption of paper and board is estimated to grow some 20 million tons by 2025, which is nearly half of the estimated global demand growth. In containerboard alone, where almost all production is recycled fiber based, demand is expected to grow slightly more than 10 million tons by 2025. Basically, all announced new Chinese containerboard capacity, so far, is planned to use recycled fiber as furnish. Is this possible or are there other options that are more viable?
Fiber supply solutions
Using the containerboard market is a good example to illustrate the challenge; in 2017 Chinese containerboard production reached 45 million tons, almost all of it recycled fiber based. 15 million tons of OCC was imported, making up approximately 1/3 of total furnish. Between 2019 and 2021 it has been decided that approximately 10 million tons of new capacity will be built, all intending to use recycled fiber as furnish. On top of that there are projects exceeding 8 million tons of capacity, planned but not yet confirmed. One conclusion seems to be that China, if all projects are built, strives to largely remain self-sufficient in containerboard supply.
If a total ban on solid waste imports will be implemented, approximately 15 million tons of current production needs to find new ways to source fiber, or close down. So what alternatives are at hand?
Alleviate current import restrictions
This option would include no ban on recycled fiber. It could also mean that current contamination restrictions of 0.5% could be changed to 1%, more in line with what the industry currently considers realistic to comply with given current equipment and collection practices. Still, this option seems to go against current efforts to stem the environmental challenges China is facing. So far, the contamination rules have, as intended, led to a change in the quality of imports. More volumes of DLK #13 and double sorted OCC #12 have been sourced from the US instead of the lower qualities traditionally imported. However, there are indications that large Chinese producers, and thus significant importers of recycled fibers, find a total ban unrealistic and now plea for continued imports beyond 2020.
Increase domestic recycled fiber collections
The second option is to try to replace current imports and supply new capacity with domestically collected fiber. As the Chinese containerboard producers serve the Chinese manufacturing industry, a significant share of the corrugated boxes will leave the country through exports and will be recovered overseas. Our estimates, when adjusting for export flows, indicate total recovery rates exceeding 60%, close to adjusted levels seen in Europe and the US. Recovery rates for OCC are likely higher, just like in the US and Europe. The potential to significantly increase recovery of OCC within China is low and far from 15 million tons. (see graph 1)
Graph 1 - Recovered rates - Statistical vs. Actual
Increase containerboard imports
The third option is already to some extent being addressed. During 2018, imports of e.g. kraftliner, increased. There are also expansion plans in neighbouring countries, e.g. Vietnam and Laos, announced by Chinese producers with the clear intention to export to China. There are also examples of Chinese producers buying mills in the US, which will be converted to containerboard for exports to China. However, to replace 15 million tons requires significant investments on projects that will be more or less entirely dedicated for exports. The volumes equal 30-40 machines and the effort will take quite some time to undertake.
Import new sources of fiber
The fourth option is therefore maybe more likely; new ways to supply Chinese mills with pulp. The most obvious one would be to increase the imports of unbleached kraft pulp, UKP. This is likely to happen, particularly as quality issues will become more important over time. However, current global market pulp capacity dedicated to UKP is very small, approximately 4 million tons. But capacity is about to change. One large Chinese containerboard producer bought a closed pulp mill in the US in 2018. Following some investments, the capacity of UKP at the mill is expected to reach 275.000 tons. One reason why current UKP projects are limited is the product’s relative unattractiveness compared to recycled fibers which are far cheaper. (see graph 2)
Graph 2 - Fiber prices in China and US
This leaves us with a potentially highly interesting opportunity that is not yet to any large degree being exploited; recycled pulp. This could be a significant opportunity as the Chinese government considers it to be a product in its own right, and may be imported. So far this is a small product. During 2018 approximately 300,000 tons of recycled fiber was imported, usually from sources around China and with a widely varying quality. Current production is not likely to be sustainable. In e.g. Vietnam, Indonesia but also Taiwan, authorities are increasingly concerned for the same reasons as China; they see a growing problem with increasing imports of material that subsequently lead to issues with waste water and solid waste.
A significant opportunity could emerge in the geographies where most of the recycled fiber is generated, i.e. North America and Europe. It is conceivable that recycled fiber pulp mills could emerge close to export ports or in areas with large populations where there are huge flows of fiber, like US West Coast, Rotterdam or Antwerp.
Chinese backwards integration creates captive markets
Many Chinese containerboard producers already have significant recycled fiber sourcing organisations in these markets and it would be another way to integrate backwards. Leading Chinese paper and board producers have a fairly long history of integrating backwards to ensure fiber supply, including acquiring pulp mills abroad. From a Chinese perspective, the case for recycled pulp is, arguably, based on economics. The price difference between domestically collected OCC and buying OCC in the US is currently approximately $330/ton. The question is if the price difference can justify greenfield investments. It is also a question of how long this price difference can remain. However, an analogy could be Chinese pulp mills that are willing to import very expensive woodchips to keep their mills running.
As it happens, one of China’s leading containerboard producer, Nine Dragons, is already on its way to building capacity in the US, exceeding 1 million tons of recycled pulp for exports to China. Lee & Man has announced to build greenfield capacity in Asia.
Fiber strategy remains key to success
In our opinion, current Chinese actions are only spurring existing trends to develop faster than previously expected. The two main trends are tighter recycled fiber markets, as well as increasing concern over deteriorating quality of recycled fiber. If China continues on its current track and allows recycled fiber imports although limited but with highest quality requirements, earlier exported low quality fibers will remain in the US and Europe. Understanding the changing dynamics in the fiber markets is of strategic importance.
It is clear that most paper and board producers need to reconsider their fiber sourcing strategies to address the changing structure of supply. Today it is unclear how far the Chinese companies are willing or able to take their backward integrations strategies, and to what extent the Chinese market becomes captive.
There are also commercial aspects to consider as the performance of a mill’s paper products may change due to changing quality of furnish. As paper performance changes, so does suitability to various end applications and the value to customers.
Finally, a new field of recycled pulp products is emerging. To capture these opportunities, brand new strategies need to be developed from scratch. Winners will devise fiber sourcing strategies and define the most suitable use for these new products.