A Scrappy Supply Chain

- Since China changed its import policy again in 2018, the US old-corrugated-containers (OCC) market has seen oversupply and significantly lower domestic prices. Current soft domestic OCC demand is increasing pressure on US domestic OCC prices, which have plunged further.

- Low OCC prices also complicate the US kraftliner market, which suffers already from softer domestic and global demand. At the same time, US-China trade tensions bring extra challenges to the US OCC and kraftliner markets.

- Dealing with a structural oversupply of domestic recovered paper (RCP) requires the entire supply chain to start working together on domestic recycling challenges. We are starting to see developments in technology, industry partnerships, consolidation, and foreign capital flowing into the US, but more efforts are still needed. Efforts from a regulatory perspective might also be needed to stimulate a systematic change.

Market conditions were rattled after China introduced its harsh regulation of RCP imports in the beginning of 2018. The average price of US domestic OCC 11 briefly stabilized at around USD 60/mt for 2H 2018 before tanking another 50% in 2019 (see Figure 1). We expect soft OCC prices to persist in the US in the coming one to two years, as we see Chinese OCC imports continue to diminish due to weaker domestic containerboard demand and to China’s move towards zero RCP imports.

Total US OCC exports in 2018 climbed by 26.5%, or 2.3mmt, as Southeast Asian regions stocked up on low-priced, low-quality OCC 11 (see Figure 2). However, the surge did not sustain, and OCC trade flow is yet to find its balance. Total US OCC exports remained flat year-over-year through May 2019, with major importing countries such as China and Mexico seeing big dips (down 20% each). US OCC exports were first disrupted in 2017 by China’s significant import quota cuts, driving down volume by 8.8%, or 870,000 mt. The excessive volume created then contributed to OCC oversupply and was further stimulated by China’s dramatic shift from OCC 11 to the cleaner OCC 12 (double-sorted OCC) in 2018, due to the 0.5% contamination rule. In the long run, we do not expect new Asian markets to absorb all of the tonnages that would have been exported to China.

Adding to weak exports, domestic OCC demand is also showing signs of softness. Logically, the growing production of recycled containerboard in the US (now 30% of the total US market) would require additional volumes of OCC. However, total US OCC consumption decreased 3.7% year-to-date through April 2019, according to the American Paper & Forest Association, due to a soft containerboard market and downtime at multiple major US containerboard mills. This, in combination with low export OCC prices, increased the pressure on US domestic OCC prices, which plunged further.

In the case of an expected complete OCC import ban by China by the end of 2020, an additional 5.5mmt of US OCC exports (based on 2017 and 2018 average volume) would need to find a new home. Three million metric tons of additional recycled capacity from announced projects and capacity creep could potentially consume 2.4mmt of those 5.5mmt of OCC. This would still leave over 3mmt of OCC in oversupply – or 12% of total OCC produced domestically.

The US-China trade war poses an additional challenge to US OCC and containerboard pricing. Pulp and paper products comprised USD 3.7b worth of the USD 100b goods that were targeted for raised tariffs in 2018. With the recent additional tariff increase on June 1, 2019, some of these products will be taxed at significantly higher rates of up to 25% (see Table 1). Last November, China lowered its tariffs for the same products from Most-Favored-Nations within the rest of the WTO. This not only translates to an overall economic impact of over USD 350m in pulp and containerboard products’ tariffs, but also curbs the competitive advantage of US products. US OCC and kraftliner prices have become less attractive due to the tariffs, encouraging Chinese buyers to turn to imports from other countries.

As one of China’s most important trade partners, the US’s trade policies could hinder the strong growth of China’s export-driven economy. This would negatively affect US containerboard export demand and limit opportunities for US exports of kraftliner. Though not a direct factor in US kraftliner demand, the ongoing US-China trade dispute could have a much more profound impact over the long term than is seen now.

Domestically, US kraftliner prices – which had experienced continuous hikes since 2009, with the exception of a minor price adjustment in 2016 – have declined by 4% since March 2019 (see Figure 3). Kraftliner producers are taking downtime in reaction to the softer demand resulting from decelerating global economic growth, total US containerboard-capacity additions outpacing demand (3% annually until 2021), and oversupply in the global markets. The pain is partly offset by lower pulp and OCC prices. The oversupplied domestic RCP market gives recycled containerboard producers a competitive advantage in sourcing raw materials, allowing them to lower the cost of recycled containerboard production. This puts additional pressure on kraftliner prices and margins, and we are starting to see a trend of US producers incorporating a higher percentage of OCC in kraftliner as a response.

Conversely, we expect imported containerboard will continue to cover the OCC gap in China in the short term, providing extra export opportunities for US kraftliner. US virgin containerboard exports grew in 2018 by 5.5% YOY, or 254,000mt (see Figure 4). However, US kraftliner needs to compete with recycled containerboard from Europe and Southeast Asia, especially where producers also benefit from low OCC prices and transport proximity. This, along with the trade war, adds to the challenges of US kraftliner exports.

OCC and mixed paper have suffered the most from China’s RCP import policy changes. To respond to the subsequent supply-demand imbalance, the US urgently needs to update its waste management system and to produce cleaner RCP. There have been a series of reactions throughout the supply chain aimed at systematically addressing the current lack of RCP waste management infrastructure:

- Technology innovation: Companies are developing patented technology to sort and process waste like never before, extracting value out of scrap efficiently, and producing cleaner RCP as a result. Examples include: the Max-AI AQC robotic sorter by Bulk Handling Systems; Alpine Waste & Recycling’s investments to improve sorting speed by 33%; and WestRock accepting mixed-paper bales containing foodservice packaging for its recycled containerboard mills in the US.

- Recycler consolidation: We are beginning to see consolidation among recyclers, as large packaging and consumer-packaged-goods companies demand a greater supply of recycled content in their packaging. For instance, Integrity Fiber Supply acquired Marck Trading to better supply Midwest Paper Group, who just completed a 400mmt/year recovered containerboard expansion.

- Foreign capital: In addition to foreign capital flowing into the pulp and paperboard space, we are starting to see the participation of foreign capital in the scrap recycling front. Though most investments focus on plastic scrap, there has been one investment in the RCP recycling space – Ecomelida’s investment in carton recycling in South Carolina.

- Industry partnerships: Consumer-packaged-goods (CPG) companies, retail companies, non-profit organizations, and municipalities are coming together to generate solutions. For example, the Foodservice Packaging Institute partners with municipalities to extract high-quality fiber from foodservice packaging. Closed Loop Fund is collaborating with major CPG and retail companies to develop scrap collection and processing infrastructure in the US and to create value out of RCP products. Their efforts include supplying single-stream recycling carts to municipalities to produce cleaner RCP bale, and investing in companies like CleanFiber to create cellulose insulation from OCC and old newspaper.

Despite these efforts, the US is still faced with greater challenges. High scrap collection and processing costs continue to squeeze the profitability of recyclers, driving smaller independent operators out of business. In order to be profitable, some companies are changing their earnings model by charging for RCP pick-up, as an example. Given limited growth opportunities in new domestic and export markets, we believe that regulatory mandates, such as those in Europe and Canada, could play a crucial role in stimulating investments in better waste management solutions. Yet such policy changes, both at state and at national levels, would be difficult to achieve. Drafting and adopting legislation is a long process, and an economically viable solution is yet to be found.