Paper Outlook 2010: Running in Place

Like many other industries in year 2009, the paper industry went into survival mode rather than seeking growth and expansion. In its just released “50th Annual Survey of Paper, Paperboard, and Pulp Capacity,” the American Forest & Paper Association (AF&PA) reported that production capacity across all product categories declined by 2.5 percent over 2009 to 93.9 million tons. Capacity is expected to decrease another 3.4 percent this year, then level off in 2011 and 2012.

“The survey also reported that 14 U.S. mills were permanently closed in 2009, shutting down 16 paper and paperboard machines, and an additional 11 machines were permanently shut down at other mills,” the organization said. “Furthermore, several mills and machines have been indefinitely idled in response to weak market conditions, but have not been removed from the survey base because they may be restarted at some future date.”

The permanent production shut-downs and indefinite idling represent a type of holding pattern in response to uncertain national and global economic conditions. For example, in International Paper’s year-end report, Chairman and CEO John Faraci noted, “Our focus on reducing overhead costs, matching our supply with our customer demand, and realizing Industrial Packaging synergies gave us the ability to generate record free cash flow and pay down a significant amount of debt while positioning ourselves for 2010.” IP ended the year with a modest profit of $663 million, compared to a loss of about $1.3 billion for 2008.

Similarly, Domtar saw sales decline from approximately $6.4 billion in 2008 to $5.5 billion in 2009, yet earnings rose to $310 million in 2009, compared to a loss of $57.3 million the year before. “While we faced a high level of lack-of-order downtime and a steep decline in pulp prices in the first half of the year, we benefitted from stable prices in papers and kept our inventories low. Meanwhile, our efforts to reduce working capital and lower fixed costs proved to be a catalyst for the second half of 2009,” said John D. Williams, Domtar president and CEO.

Briefly stated, instead of producing paper no one wanted to buy, the mills idled capacity to save production costs and prevent piling up inventory. The larger mills generally finished the year in sound financial condition, ready for whatever 2010 might bring.

Black Liquor
Another boon to the paper industry was the black liquor tax credit loophole. Black liquor is a tar-like by-product of the paper production process, and for decades it has been used to fire paper mills. The provisions of a highway bill passed by Congress in 2005 encouraged the use of alternative fuels, such as ethanol, by granting a 50-cent tax credit for every gallon consumed of a traditional fossil fuel mixed with an alternative fuel. In 2007, this tax credit was extended to industries outside transportation. Those paper mills that were able mixed some measure of diesel fuel with the black liquor they were already using in order to qualify for the tax credit.

In total, the federal government gave out more than $6 billion in these alternative fuel tax credits to dozens of companies in the paper industry in 2009, and this went a long way toward supporting their bottom lines. However, the issue has raised many objections and cries of foul play, and 2009 was the last year the mills could take advantage of the program.

Interesting to note, the impact of the tax credit program has been not entirely positive and even a little bizarre. For example, although the alternative fuel tax program for paper mills expired at the end of 2009, some congressional legislators submitted proposals to redistribute the alternative fuel tax credit dollars to include them as part of the funding for federal health care proposals. These legislators determined that by re-directing the $6 billion per year from alternative fuel credits over the next four years, they could count that money as another $24 billion available for federal health care reform, even though the tax credit program has expired.