HAWKINS WRIGHT

Pulp market outlook: short-term cycles & long-term trendsAIAC meeting, Milan, 8th June 2017

HAWKINS WRIGHT

• Price differential restored, both softwood and hardwood trade close to “marginal cost”….

Limited downside for prices

• But strong capacity growth & slowing of China’s economy

Sustained recovery seemed unlikely in the absence of permanent capacity shuts

Pulp markets troughed in 2016…

400

450

500

550

600

650

700

750

800

Jan-14 Jan-15 Jan-16 Jan-17

US

$/t

deli

vere

d

ChinaNet NBSK prices vs. NET BEKP prices

China NBSK China BEKP

Source: Hawkins Wright

?

?

HAWKINS WRIGHT

• In the event, net BHKP prices in China have rocketed by $150/t from $480 in October to $630 in

May.

• NBSK prices rose from $570 to $670.

• Prices in Europe and N America lagged China significantly and a significant discount in net

prices emerged, which only started to narrow in April.

…With little warning of the imminent rally to come

No mill closures

since late 2015

400

450

500

550

600

650

700

750

800

Jan-14 Jan-15 Jan-16 Jan-17

US

$/t

deli

vere

d

ChinaNet NBSK prices vs. NET BEKP prices

China NBSK China BEKP

Source: Hawkins Wright

Guaiba

PUMA

OKI

PL2

OKI

PL1

HAWKINS WRIGHT

• But in short, Chinese demand has been exceptionally strong and

production much weaker than expected.

• Let’s start with demand…

What happened ??

50

70

90

110

130

150

170

190

210

Jan-14 Jan-15 Jan-16 Jan-17

Ind

ex

, 2

00

5=

10

0

Pulp prices versus other commodities (index)

Economist commodity-price index

IMF commodity price index

NBSK price (CIF Europe) index

BEKP price (CIF Europe) index

DWP price (CIF China) index

Source: Hawkins Wright, IMF, The Economist

Pulp prices v commodity indices

Once again, pulp prices lag

the commodity cycle by

several months

HAWKINS WRIGHT

World-20 BCP shipments to ChinaY-o-y growth

• Over six months from October to March, Chinese pulp demand increased by

1.6 million tonnes = 3.2 million tonnes annualised (left chart).

“Trend” growth is 1.2 million tpa

Chinese demand boomed from October to March

(1,000)

(500)

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

-100

-50

0

50

100

150

200

250

300

350

400a

nn

ua

lize

d g

row

th, 0

00

s to

nn

es

y-o

-y m

on

thly

dif

fere

nc

e, 0

00

s t

on

nes

y-o-y change (LHS)

annualized (RHS)

This was never

sustainable, and indeed

PPPC estimates growth

slowed dramatically in

April.

Source: PPPC

HAWKINS WRIGHT

China buying cycle is a macro-economic phenomenon

• China reversed a 3 year deflationary cycle through a combination of weaker currency,

supply side reforms, and monetary and fiscal stimulus in Q1 2016.

• Producer price inflation (PPI) hit 8 percent in February, encouraging inventory build.

• Paper prices are no exception, rising by $100-250/t depending on the grade. Larger

Chinese paper mills run full for the first time in many years, higher profitability.

90

92

94

96

98

100

102

104

106

108

110

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

Chinese PPI (Producer Price Index) (January 2016=100)

Producer price indexfor industrial products

Paper and paperproducts

Source: National Bureau of Stats

Any value less than

100 = deflation

HAWKINS WRIGHT

Chinese paper prices

Coated paper prices, by region

Uncoated paper prices, by region

• Price hikes have been achieved in

absence of acceleration in underlying

demand – graphic paper sector is

restructuring and consolidating.

• Similar price rallies were experienced by

packaging board grades (both recycled

and virgin based).

• Tissue prices have increased more

modestly, with jumbo rolls rising around

$70/t. As a result, higher pulp prices

(which have increased by $140 since

September) have eaten into margins, and

operating rates are estimated at 80-90%.

• However, underlying tissue demand

continues to grow strongly, and will

remain the main driver of imported wood

pulp in the years to come.

85

90

95

100

105

110

115

120

January

2015=

100

China

North America

West Europe

85

90

95

100

105

110

115

120

125

130

January

2015=

100

China

N America

Europe

HAWKINS WRIGHT

The inflationary cycle is starting to reverse, gradually

Chinese economy remains strong in Q2, but many indicators suggest the China

cycle is maturing…

Government is tightening monetary conditions and investment is slowing. Equity

and commodity prices falling on lower expectations for second half. PPI started to

fall in March and April, Caixin-Markit PMI <50 in May.

Corrections in related sectors (dissolving pulp and viscose, recycled fibre and

containerboard).

Fine paper sector starting to weaken, as summer approaches and exported

volumes are being pulled back.

Pulp demand cooling, local rmb prices now well below the US dollar price.

Softwood markets more fragile than hardwood

Inventories not excessive in Chinese ports or paper mills, but inventories are

often measured based on recent demand rather than future…

HAWKINS WRIGHT

Pulp demand in other regions is fairly weak

A severe pull-back in China could quickly spell trouble…

-3.7%

-0.7%

11.9%

3.2%

4.5%

1.1%

7.6%

17.7%

4.9%

-400 -200 0 200 400 600 800

West Europe

Latin America

Oceania

Japan

East Europe

North America

Other Asia/Africa

China

TOTAL

(thousand tonnes)

Bleached chemical demand growth, 2017 v 2016 (Jan-Apr)thousand tonnes and y-o-y%

Source: PPPC

HAWKINS WRIGHT

• Producers are struggling to catch up with the unexpected surge in demand. Many are well

sold into the summer, hardwood stocks close to record lows.

Partly seasonal

Meanwhile, pulp supply remains very tight…

15

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30

35

40

45

50

55

Wo

rld

-20 p

rod

ucer

sto

cks

BSKP BHKP

Source: PPPC, Pulpwatch

World-20 Producer inventories, days of supply

Source: PPPC

HAWKINS WRIGHT

• Within the reporting sample, production weaker than expected as new capacities take time to

ramp up and other mills face specific mechanical problems.

• There is a lot going on outside the sample, in China and Indonesia. We estimate APRIL has

withdrawn around 0.8 million tonnes of BHKP through integration and conversion to

dissolving.

• Meanwhile, APP has yet to increase sales following the start of line 2 in mid-December. Line

1 has recently started tests, but group surplus may not become apparent until August.

Production

1.5

1.6

1.7

1.8

1.9

2.0

2.1

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17

mill

ion

to

nn

es

(3 month moving average)

BSKP

BHKP

World-20 bleached chemical pulp production

Source: PPPC

HAWKINS WRIGHT12

APP OKI project update

Wood chips mills

Pulp mills

APP Group

APRIL Group

Others

Perawang

Kerinci

Jambi

Dumai

Musi

Kutai

OKI

PT

Toba

Korindo

(Oji)

Kiani

Kertas

Samarinda

Assumptions

• Line 2 to start in June

• Regular sales to commence in July, at first 65kt/month rising to 100kt a month by year end.

• APP talks about “value based growth”, but difficult to know the full picture.

Indonesian fibre challenges:

• Pest and disease

• Peat land’s subsidence

• Regular and catastrophic fire

• Declining yields?

HAWKINS WRIGHT

• Further hardwood price hikes in China have been proposed, but

resistance is mounting.

narrowing differential with BSKP should not be ignored based on

recent experience.

• In contrast, net prices in Europe are still playing catch-up. Prices may

continue to rise in June particularly if the euro strengthens further.

• Most acknowledge a slow-down in the second half, but much depends

on an increasingly unpredictable supply-side.

New capacities of Fibria (BEKP) and Metsa Fibre (NBSK) are due

by Q4 but will not have much impact this year.

However, a number of recent additions have yet to reach their

potential.

Short-term summary

HAWKINS WRIGHT

• Despite the maturity of the global paper industry, structural changes will

continue to promote market pulp demand

Tissue and hygiene sectors are fairly immune to aging population and

technological change.

Renewable packaging demand remains positive.

Declining graphic paper consumption removes a key feedstock for certain

non-integrated paper (tissue and packaging) mills.

Viscose demand, whilst still relative small, is gaining in momentum.

Longer-term trends - demand

HAWKINS WRIGHT

Demand - reliance on China is increasing….

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mill

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to

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es

Total market pulp demand, by region

China

Other emerging

Latam

East Europe

Japan & Oceania

North America

Europe-3,000

-2,000

-1,000

1,000

2,000

3,000

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Thousand to

nnes

Year on year growth in market pulp demand, China v ROW

China

Rest of world

China, average: 1.2Mt/yr

ROW, average: -0.2Mt/yr

• Recent acceleration in Chinese demand is encouraging in light of slower GDP.

• Economy transitioning to consumption

• Increasingly strict environmental regulations are also accelerating the process of

substitution of non-wood and recycled fibres from smaller Chinese enterprises.

However, these are “one-off” gains, not to be repeated.

HAWKINS WRIGHT

…for all fibre suppliers

• China’s wood deficit has increased by

around 115 million m3 over the past

ten years

• Since 2006 China accounts for

235% growth in global P&B

production

115% growth in global market

pulp demand

107% growth in HW chip demand

91% growth in dissolving pulp

demand

0

20

40

60

80

100

120

140

160

180

200

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016e

mill

ion

cu

bic

me

tre

s, R

WE

China's wood imports

Logs Lumber Chips Pulp

HAWKINS WRIGHT17

China scenarios

0

5

10

15

20

25

30

35

40

trill

ion U

S$

GDP, PPP adjusted, current US$

China USA Japan India

?

Source: IMF database, April 2017Source: Martin Wolf in the FT, 12th April 2017

Any long term projections are therefore heavily dependent on assumptions regarding the

development of the Chinese economy.

China has overtaken USA as the leading global economy in PPP adjusted terms, but in doing

so has accumulated debt of over 255% of GDP. At current trajectory (with GDP target of 6%

pa), debt is expected to reach 300% by 2019. This model of growth is not sustainable,

however, there are divergent views regarding the next stage in China’s economic development.

HAWKINS WRIGHT

• The wave of investment in new capacity has yet to reach its potential, implying

some challenges in 2018.

• However, beyond 2019 there are few confirmed projects.

• Furthermore, major question marks hang over hardwood chip supplies to China

and Japan from 2020 and beyond.

Longer-term trends

HAWKINS WRIGHT

Market pulp capacity set to experience 4 years above trend, regardless of OKI assumption (ours is

highlighted in red below)

Capacity growth of 2016 has yet to be fully realised, meaning production may surge higher

over the second half of 2017 and 2018. A number of unconfirmed projects exist, but without

firm schedules. Arauco’s MAPA has recently received approval from Chilean Supreme

Court, now awaiting board approval

Market pulp capacity growth to peak in 2018

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An

nu

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ng

e in

cap

acity

(millio

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nn

es)

To

tal

cap

acit

y (

mil

lio

n t

on

nes)

Annual change in BCP capacity

BSKP

BHKP

Supply growth based on current plans

Source: Hawkins Wright

10 year ave =1.3Mt

OKI

OKI

Market pulp capacity growth: BSKP and BHKP, net of any conversions/integration

?

HAWKINS WRIGHT

China accounts for all growth in Asian hardwood chip demand

• Lack of affordable pulp wood in China forces growth in pulp production to rely on imported

chips

• China has surpassed Japan as the leading wood chip consumer, but the model is different

• Chinese companies are developing supply chains and reducing dependence on Vietnam.

They are following Japan towards total integration.

0.0

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25.0

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mill

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bd

mt

Japan Korea Taiwan China India

Asian hardwood chip imports

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mil

lio

n b

dm

t

Chinese chip imports, by origin

Other

Indonesia

Thailand

Australia

Vietnam

Source: Customs data

Chinese hardwood chip imports, by origin

HAWKINS WRIGHT

Woodchip suppliers to Pacific Rim, 2005-2016

• Indonesia & OKI

• Vietnamese supply peaked and may shrink due to 2% export tax and over-cutting last year (as farmers

tried to avoid some tax), and possibly declining chip prices. Government encourages plywood, MDF,

furniture & pulp (Vietracimex)

• Some Australian plantation leases are not being renewed as land is repurposed.

• Chilean supply unlikely to rise much further (especially if MAPA is approved), and is vulnerable to

rising freight costs. Brazil & Uruguay more focussed towards Europe.

Conclusion: lower availability of woodchips threatens competitive position of Asian pulp mills, and may

promote demand for market pulp in the longer term

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

mill

ion b

dm

t

Australia South Africa Latam

Thailand Vietnam Indonesia

0.0

5.0

10.0

15.0

20.0

25.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

mill

ion b

dm

t

Australia South Africa Latam Thailand Vietnam Indonesia Other