Intensifying Energy Crunch Poses Further Challenges for European Paper Packaging

With recycled grades accounting for about 80% of total European containerboard production - which relies largely on purchased energy (natural gas or electricity) – an intensifying energy crunch remains a major concern for European paper packaging producers.

The exposure of a specific production site to high energy prices depends on its current energy mix, whether it has its own energy supply, whether it makes use of natural gas hedging, and the duration of possible hedge contracts. However, in general, around two-thirds of the energy used for European recycled containerboard production consists of natural gas. A significant part of this production is located in countries dependent on Russian gas.

Also, since the start of the Ukraine crisis in February 2022, in addition to skyrocketing and unpredictable energy prices, the risk of gas shortages in Europe has become more real. As a result, some paper packaging producers are seriously concerned about whether they will have enough energy at their disposal to keep their mills running. In the worst-case scenario, downstream value chains, including essential ones, could face supply disruptions and paper packaging shortages.

Energy Costs Upset Normal Supply-and-Demand Price Dynamics

The Ukraine crisis has also reversed demand dynamics. While natural gas prices continued to break records, corrugated box and, consequently, containerboard demand started to show signs of easing, due to worsening economic conditions followed by consumption declines, especially in the more industrialized economies like Germany (see Figures 1 and 2). This contrasts sharply with the situation in the last two years, when the market experienced record growth in demand for boxes as a result of the Covid-19 demand boom for certain goods, the post-Covid recovery, and e-commerce.

Weaker demand would normally lead to lower containerboard prices. However, the current energy situation disrupts this ‘normal' dynamic. Despite downward price pressure, the scale of rising energy costs is such that paper packaging players of varying size – both in recycled containerboard and boxboard segments – began announcing price increases in their press releases in August:

Next to escalating energy prices, some players in Germany (e.g. Papier- und Kartonfabrik Varel, Kunert Group) also referred to costs related to the implementation of the German national gas price surcharge. This levy was expected to add EUR 50/metric ton in extra gas costs from October.

Eventually, the German government decided to discard its planned gas levy in favor of a gas price cap, setting up a EUR 200bn “defensive shield” to support businesses and consumers.

Unsurprisingly, in September, other producers (e.g. DS Smith, Heinzel Group, Hamburger Containerboard, Schoellershammer, Kunert Group) followed Smurfit Kappa – Europe’s largest producer – and announced price hikes of EUR 100/metric ton to EUR 150/metric ton, effective October 1.

Price Hikes Help Fight Margin Pressure – But Are They Enough?

Despite previous significant price hikes (in March), sharply higher costs – now combined with weaker demand – continue to cause margin pressure for the entire European paper packaging sector, although the extent of this pressure differs per producer.

The most recent results from leading corrugated packaging producers (e.g. DS Smith, Smurfit Kappa) so far suggest that the recovery in paper and corrugated prices – in combination with long-term hedging programs – has helped them to offset energy price challenges. However, even these major players planned additional summer downtime (about 30,000 metric tons to 50,000 metric tons of capacity each), which is only a small part of announced and unannounced production cuts of 10% to 15% by paper packaging players of varying sizes (e.g. Saica, VPK Group, Hamburger Containerboard, Progroup, Papier- und Kartonfabrik Varel, Julius Schulte Trebsen, Papeterie Saint Michel). The recycled boxboard market shows similar dynamics. For instance, Solidus Solutions announced that it would reduce its solid board output by 10% from August until further notice. Remarkably, if high energy prices were a key reason for unplanned stoppages in March, it is now often also about weaker demand (and, consequently, low order intake).

There were numerous recycled containerboard production downtimes announced for September and October. According to company press releases:

Obviously, under weaker demand conditions and excessively high energy prices, where gas supply was even ‘guaranteed,’ price hikes still could not ‘guarantee’ economically viable paper packaging production for all producers. And the question remains: Will downstream demand continue to accept price increases (and to what extent), especially if gas supply disruptions drive up prices even further? One thing is certain: The current situation makes it more difficult to pass on energy cost increases through containerboard price increases, resulting in margin compression. Likely, it is even harder for small and medium-sized non-integrated mills and for those with higher sales exposure in the more industrialized countries. Therefore, on the one hand, (some) European mills may still lower their prices to secure volumes. On the other hand, depending on the supply and cost of energy, further downtimes are also possible. Reduced supply would logically result in stable or rising prices even when demand is weak.

The new and still unknown reality is forcing European producers of recycled paperboard to look beyond periodic price hikes and to come up with other measures to manage risks and energy costs in their efforts to secure their margins:

While the above measures have helped (somewhat), none of them are sufficient to ensure stable performance of the paperboard industry later this year and next. More downtimes or even closures (supply cuts) are likely, especially with energy rationing on the horizon. Most European countries are unlikely to face acute gas shortages, except for Germany and Italy, but these are countries with significant containerboard capacity. And it remains uncertain to what degree energy-intensive paper packaging production will be considered an essential service (given that it is critical to the transportation of essential health goods, pharmaceuticals, food, and other goods, operates in cross-border, interdependent supply chains, and is an industry with limited ability to switch to alternative fuels in the short term). Also it is unclear how essential but energy-intensive suppliers of the industry (like chemical producers) might be affected.

Massive uncertainties related to energy continue causing margin pressure for many recycled packaging producers and lead to price increases for paperboard. At the same time, the industry is starting to face downward pressure on paperboard prices due to weakening demand, making it more difficult to pass on cost increases in selling prices along the chain. In their efforts to manage energy costs and balance the supply and prices of paperboard, some manufacturers may choose to plan more production stops, which might logically cause high prices to persist or increase further. Also, we might see more shifts from a ’temporary’ to a kind of ‘structural’ energy price surcharge for customers and/or short-term contracts. All this, in turn, continues to create uncertainty and price pressure in the already stressed downstream supply chain.

However, the effects of higher energy costs and potential disruptions in the supply of energy and paper packaging are not limited to margin pressure. The following developments add another dimension of potential impact, not only in terms of margin but also in terms of remarkable strategic moves along the chain: