An unstable global environment demands an understanding of past and current market conditions.

part 1

Containerboard historically has been one of the fastest-growing grades. It is the largest grade area in the global paper and forest products industry, accounting for almost one-third of total global paper and paperboard capacity (if one includes the small "swing" grade of unbleached kraft paper). Specifically, as shown in Chart A, the containerboard segment-including kraft paper-accounts for just more than 100 million metric tons, or about 30% of the world's total paper and board capacity.

Over the past 18 years, global consumption of containerboard has compounded at 4%, above the overall global paper and board consumption growth rate of about 3% per year over this period, which is also above the global real gross domestic product (GDP) growth rate.

Paper/forest products is one of the world's most fragmented industries. The global paper and forest products industry is highly fragmented relative to most industries-a problem we see as contributing to the industry's relatively poor profit performance over the past decade. The top 10 producers of all grades hold only about 25% of global paper and board capacity. Furthermore, the ownership of capacity is still rather fragmented within regions. As Chart B depicts, the top 10 producers control 55% or less capacity within each major region except Japan. Even after the dramatic Stora-Enso and Smurfit-Stone Container mergers (creating the two largest paper and forest products companies in the world), these two will each control no more than a mere 4% of global capacity.

Containerboard is the globe's most fragmented paper grade. Many in the United States consider the containerboard industry to be fairly highly integrated. The new Smurfit-Stone Container will hold close to 20% of U.S. containerboard capacity. However, looking at producer concentration by grade, containerboard is actually the least concentrated grade in the world, when looking at how much capacity the top 10 producers control. Even in market pulp and fine paper (coated and uncoated free sheet combined), there is more concentration than found in the containerboard sector. The level of concentration in bleached board, coated groundwood and supercalendered paper is the most healthy in the paper and forest products industry-the top 10 players in these grades control more than 70% of global capacity.

Newsprint, in which the top 10 producers now control about 60% of global capacity, has also seen rapid improvement. Finally, the tissue market has become much healthier in North America and Europe through the Kimberly-Clark/Scott Paper and Fort Howard/James River mergers. Pricing stability, which benefits customers, and profitability, which benefits producers, have clearly been more enhanced in these grades than in the balance of the industry.

The U.S. and North American containerboard industry is less fragmented than the global industry. Aided by the Stone Container-Jefferson Smurfit merger and reflecting its relatively heavy kraft (or virgin) board orientation, the U.S. industry has its top 10 producers in control of almost 84% of the capacity in the country. Specifically, the top 10 U.S. producers own or control 26.8 million of the country's 31.95 million metric tons of containerboard capacity. Again, globally however, the top 10 producers of all containerboard grades control only 36% of the capacity, as evidenced in Chart C.

We believe that the industry outside of the United States tends to be more fragmented as it is much more recycled based, and recycled-based containerboard machines tend to be cheaper to build. Also, smaller countries have indigenous containerboard systems that involve smaller mills servicing domestic markets.

Nevertheless, the containerboard industry is highly globalized with substantial trade flows, particularly emanating from North America. As such, the high degree of global fragmentation-notwithstanding the United States' concentration-continues to make containerboard one of the most volatile businesses in the world. Only the development of a truly two-tiered market between kraft- or virgin-based board and recycled-based board would free the U.S. containerboard industry from the globe's fragmentation.

The United States is increasingly relying on global demand growth. In 1997, nearly 4.5 million tons of kraft linerboard was exported, with Asia accounting for nearly one-third of the total. Including recycled linerboard along with kraft linerboard, we calculated that the United States exported 4.6 million short tons (almost 4.2 million metric tons) of kraft and recycled linerboard. Just 10 years earlier, only 2.2 million tons of linerboard were sent offshore, meaning that exports grew at a compounded rate of 7.7%. Linerboard exports are not expected to get back to the 1997 record level anytime soon.

By contrast, according to the Fibre Box Association, domestic consumption of containerboard grew to 29.4 million tons in 1997 from 22.4 million tons in 1987-or at just a 2.8% annual clip. Put differently, in 1997, the United States exported nearly 1.6 tons of linerboard for every 10 tons of containerboard consumed, while in 1987 the ratio was just 1-to-10. From a different angle, for every three tons of U.S. containerboard consumption growth during this decade, there was one ton increase in exports.

One issue on the domestic front centers around the misconception that the United States is shipping more square footage per ton. However, the tons-per-square-feet ratio has not changed significantly since 1970 (after having dropped sharply from 1940-1970). We believe that demand for heavier weight boards in some applications has offset increases in lighter-weight demand in other applications.

The issue of exports is critical. One can argue that much of the capacity decisions made in 1994 and 1995-which have not even begun to generate a decent return-were predicated on a continuation of strong export growth. In 1998, continued export growth has "hit the wall," as seen in Chart D. In other words, we will see what will be the first decline in exports since 1993.

In January and February, we saw increases in exports. This was followed by modest year-to-year declines in March and April. In May and June, exports fell by nearly one-fourth, or almost 100,000 tons each, from the same months in 1997. For the full-year 1998, we expect linerboard (both virgin and recycled) exports to fall by nearly 400,000 tons, or 8.7%, to 4.23 million tons from 1997's 4.6 million tons.

Again, we do not expect U.S. containerboard exports to exceed 1997's records for many years to come. Regardless of this view, we believe that it would be imprudent to build new capacity in the United States with part of the decision being based on quick resumption of the high single-digit export growth rates seen in the 1987-97 period.

Chip Dillon presented this information in a speech that he delivered at the Eighth International Containerboard Conference, which took place September 17-18 in New Orleans. For information on Dillon, see page 4, BCI's new Contributors page.

*Next month, discover near- and long-term challenges at work in the global containerboard market.