The financial meltdown is having several effects on the paper and print industries in Canada. The economic slowdown means less demand, but exchange rates and energy costs are also having a significant impact.
The Canadian dollar hit a high of $1.09 against the U.S. dollar on Nov. 8, 2007. Although it receded from that level, it remained close to parity through much of this year and stood at $.97 as recently as Sept. 29. In exactly 30 days, the loonie plunged to $.77, a decline of 23%.
But this is not about the loonie; this is really about the U.S. dollar. If we consider gold to be the “gold standard” we see that during that period the price of gold in U.S. dollars fell 16%, while the price of gold in Canadian dollars rose 6%. So most of what we see is really a strengthening of the U.S. dollar, rather than a weakening of the Canadian dollar.
It may seem odd that the greenback is strengthening as financial markets collapse because of a crisis that started in the U.S. The explanation is oil. The price of oil in U.S. dollars fell from $106.89 on September 26 to $64.15 on October 24, a decline of 40% in just about a month. As the economic downturn deepened, demand for oil fell, as did the price.
Impact on paper markets
Printers and merchants report that the summer was dead, and that September did not bring the normal seasonal recovery. PPPC data supports this: North American printing and writing paper demand was down 6.4% through the first nine months of the year. However, we have seen major consolidation in the industry, and capacity reductions have kept supply and demand in balance. Operating rates were at 92% which is close to the full practical sustainable maximum. As a result, paper prices have been rising in the face of declining demand.
However, paper price increases were barely sufficient to offset cost increases as fiber and energy costs moved up sharply. As a result, the pressure on mills to maintain or increase prices was unabated. Canadian mills especially were under cost pressures as the loonie moved up toward and finally over $1.00. While many of the leading mills in the U.S. and Canada were profitable, profits as a percent of sales were generally under 5% and leading companies did not earn their cost of capital. Domtar’s return on shareholder’s equity is tracking at less than 5%, while Abitibi Bowater lost $108 million in the third quarter. In the U.S., IP is tracking at around 8% return on shareholder’s equity, and Verso, despite a strong third quarter remains negative year to date.
It appeared that given the combination of consolidation and cost pressures, prices would continue to rise despite weak market conditions, but everything has changed. Energy costs are coming down, and the U.S. dollar has strengthened, attracting imports to North America once again. As cost pressures on mills ease, demand declines, and pressure from imports increases. It is reasonable to expect prices to ease somewhat. So far, at least, prices for most grades are holding up, though there are reports of push back from publishers on newsprint grades and coated mechanical.
Impact on Canadian merchants and printers
In most sectors, printers buy their paper from merchants. For uncoated woodfree and coated woodfree grades, merchants in Canada are often buying from mills in the U.S. such as Verso, New Page and IP. Domtar sells to Canadian merchants in Canadian dollars, but typically the American mills sell to Canadian merchants in U.S. dollars. This means that when the value of the Canadian dollar fell by 23% in 30 days, Canadian printers got a 23% price increase unless the merchants absorbed the loss. In many cases, that is exactly what happened: a merchant who bought paper on September 29 in U.S. dollars with 30 day terms, and sold it to a printer on that date in Canadian dollars, would have paid 23% more for that paper when he wrote the check 30 days later.
While merchants may have absorbed some of the currency loss, it is working its way through the system and printers are surely feeling it now. One merchant reported that on uncoated free sheet, IP held the price firm in U.S. dollars, while Domtar adjusted the Canadian dollar price upward to maintain parity. Even as U.S. prices ease somewhat, the prices in Canadian dollars may continue to drift upward, or at best, follow the U.S. prices down with a lag.
Looking ahead
We can’t control the price of oil or the value of the loonie. However, there are things printers can do to weather the storm. First, minimize risk. Watch your credit, receivables turnover and days outstanding. Don’t make long term price commitments. While there are signs that price pressures will ease, short term currency fluctuations can wipe out or reverse the benefit of U.S. price drops. Finally, printers should also stay extra close to their mills, merchants and customers.
Jack Miller is senior consultant, North America, for Pira International, a leading supplier of strategic, marketing and technical consulting in paper, print and packaging. jack.miller@pira-international.com
