Commodities to Watch: Dissolving Pulp

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www.asiapapermarkets.com February 2011 BRIEFING PAPER

The global dissolving pulp market is booming with an increasing number of pulp & paper manufacturers stepping into the textile markets to provide dissolving pulp, a pulp product used to make rayon Surging cotton prices are pushing a forgotten retro staple back onto the fashion runway: Rayon. The result of the rayon renaissance has been huge gains for dissolving pulp manufacturers, a key ingredient in rayon. Global production of dissolving pulp, which is also used in filters, screen films and diapers, has grown by roughly 25% to 5.2 million tons since 2008. Introduction
ith the demand and cost of cotton on a continual upswing, more and more pulp and paper manufacturers have been stepping into the textile markets to provide dissolving pulp, a pulp product used to make rayon. The main ingredient in rayon is a wood based substance called specialty cellulose, also known as dissolving pulp. A study released by RISI last year, shows that the global market demand for dissolving pulp is increasing the world over. World dissolving pulp demand turns upward after 30 years

(Source: RISI)

There isnt enough dissolving pulp to feed the market demand for rayon, Chadwick Wasilenkoff, CEO and Chairman of Canada-based Fortress Paper, said. Fortress Paper -- a newcomer to the pulp industry -- purchased a near-bankrupt mill in Thurso, Quebec in August last year with the intent of converting it into a highly specialized dissolving pulp producer in order to meet these market demands. The decision -- apparently -- was a wise one. The RISI study reports dissolving pulp is one of the few growth markets in the pulp and paper industry today. Key to the products success, the report continues, is a rapidly growing middle class in China and India who illustrates a high demand for rayon products and clothing. In the last five years, the rayon market has grown by 7 per cent globally, and over 10 per cent in China alone. Not surprisingly, China, Indonesia and India are leading the surge in demand for the acetate dissolving pulp from which rayon fabric is produced.

Since dissolving pulp is not an easy pulp to produce, there are fewer than a dozen market pulp mills in the world producing this grade. Today the two (very) low cost producers are both eucalyptus-based -- RGMs BahiaPulp in Brazil (350,000mt/year) and SAPPI-Saiccors mill near Durban, South Africa (830,000mt/year). In North America there are five older (softwood based) mills: Tembec at Temiscaming, Que; Neucel at Port Alice, BC; Buckeye at Foley, FL; and Rayoniers two mills at Jesup, GA and Fernandina, FL. In Europe, Bouregaard has mills in Norway and Austria. There is also some dissolving pulp being made from acacia in Indonesia (Inda Kiat). Inevitably, given the dynamics, the North American mills have been attracting the interest of
Asian buyers, who face huge demands in their own domestic markets. Four years ago the Indian company Aditya Birla purchased the former Parsons & Whittemore mill at Nakawic, NB and upgraded its 190,000mt/year to rayon grade dissolving pulp for shipment back to India.

And this month, Neucel Specialty Cellulose Ltd. was snapped up by Chinese Fulida Group Holdings Ltd.

Fulida Group Holdings Ltd has purchased Neucel Specialty Cellulose Ltd. from a consortium
of investors led by Wellspring Capital Management and GSC Group. Fulida, together with Zhejiang Fulida Ltd, which had established a minority equity position along with a strategic supply agreement with Neucel in 2010, is now assuming full ownership of the company. Jianer Qi, Chairman of Fulida Group Holdings, summed up the deal: Viscose rayon fibre competition in China has become intense. With the purchase of Neucel, Fulida gains a stable supply of dissolving pulp along with cost advantages and quality assurance which extends the value chain of our business. I strongly believe that this purchase will ensure a stable, sustainable and rapid development for Neucel, and thus help it to further achieve its unique enterprise value. ______________________________________****____________________________________

Market Dynamics
High Cotton Prices & the Rayon renaissance:
Its good news for the rayon industry! The spike in global cotton prices has boosted demand for
rayon. Cotton prices surged 91% in 2010. Writes J. Verheyden of the Financial Post (article dated January 14th, 2011): U.S. consumers wracked by a shaky economy and steep unemployment will likely think twice about buying clothes from retailers trying to pass on cotton prices that recently scaled a 150-year peak, analysts said. Americans have for years been used to cheap, cotton clothing But that will change in 2011 after cotton prices rallied to a level last seen in the 1861-1865 American Civil War.

Cotton on the ICE Futures U.S. exchange hit a record US$1.5912 per lb on Dec. 21, 2010 and analysts expect it to jump to US$2 this spring, given tight supplies. And the trend is expected to continue.

The following graph illustrates the difference between cotton linter pulp and dissolving pulp prices [in yuan / million tons vs. US$ / million tons] during the period 2009 November 2010.

(Source: CCFGroup.com)

Enter rayon or artificial silk. Rayon is making headlines as a lower cost alternative and
replacement fiber for cotton. While the cost of the most common rayon fabric has risen of late in the U.S. market, it is still relatively cheap at $2.35 per yard compared to $4 per yard for cotton shirting, Ms. Sera Coblentz, who develops clothes for New Yorks Meryl Diamond Ltd., informed the Financial Post. Its not just the U.S. Rayon commands a huge market in Asia, where an emerging middle class favors the fabric, said Rayonier CEO Lee Thomas. The synthetic has better drying capability than pure cotton, and its feel is better than polyester, that increases its appeal in hotter climates, he said.

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Rayon demand, a windfall for dissolving pulp manufacturers:

The result of the rayon renaissance has been huge gains for North American manufacturers like
Fortress Paper, Tembec Inc. and Rayonier Inc. Global production of dissolving pulp, which is also used in filters, screen films and diapers, grew by roughly 25% to 5.2 million tons since 2008, according to Tembec. And the market is not going down anytime soon. Brokerage analysts say they see more gains ahead for these companies.

For the first time in recent memory, demand for dissolving pulp has outstripped supply, and
buyers are struggling to get orders filled, said Peter Vinall, CEO of Fortresss specialty division. That reflects a corresponding move in the price of dissolving pulp (as of the first week of

January 2011) to approximately $2,350 per ton from $1,550 per ton 12 months ago, Mr. Vinall said. Fortress is spending over $120 million to refurbish a pulp mill that it says will produce 200,000 tons of dissolving pulp annually. Chinese buyers have already lined up for 156,000 tons of the production.

Tembec manufactures about 300,000 tons of the pulp annually and anticipates a $200 per ton
price increase starting January 2011, CEO James Lopez said during a November conference call. Rayon has been a welcome windfall for Tembec. The company restructured $1.2 billion in bonds in 2008, and cut debt by 200 million last year.

_____________________________________________ Are the demand & current pricing levels sustainable?

Is the turnaround in demand and price of world dissolving pulp set to continue, asks the RISI
study Outlook for Global Dissolving Pulp Market. The answer -- given the surging Asian demand and the spike in cotton prices yes! To quote from the report: After three decades of decline, dissolving pulp usage has turned upward sharply over the last decade, reaching an estimated 4.5 million tonnes in 2010. The big turnaround has been led by a jump in the viscose fiber market, where the popularity of rayon (and similar materials) has been boosted by limited supplies and surging prices of cotton. In response to this demand, Chinese viscose fiber producers have helped dissolving pulp consumption in China triple over the past 10 years. Dissolving pulp prices have appreciated with the demand, attracting producers in the Southern Hemisphere to start new lines, while in the Northern Hemisphere paper grade pulp mills are converting to dissolving pulp.

Sappi CEO Ralph Bottger, during a February 09, 2011 conference call, ruled out any
possibility of a drop in cotton prices, at least in the near future. Mr. Bottger, while affirming the role of cotton prices in driving up demand for rayon (& consequently dissolving pulp), ruled out the possibility of any oversupply situation coming up in the dissolving pulp market due to a (potential) drop in global cotton prices in turn due to a (potential) good cotton crop this year. Additionally, Sappi also expects the dissolving pulp market to remain tight, in terms of both supply and pricing, on account of the limited (and time consuming) number of capacity additions coming onstream. So, yes, current pricing levels look to be very sustainable.

Analyst Dave Hillman of Gerson Lehrman Group (GLG) confirms the above. In a report
dated October 19, 2010, Mr. Hillman wrote: China, Indonesia and India are leading the surge in demand for the acetate dissolving pulp from which rayon fabric is produced. Spot prices in the 2Q were at $1600/admt vs. a list of about $1150-1250/admt. In the 3Q, list prices were raised to $1350/admt. Now rumor has it that producers will announce a whopping $200/admt price hike on January 1st to bring the list up to $1550. He stressed on the massive demand: The former Canadian NBHK mill, Thurso, has restarted and is upgrading to dissolving pulp...and is already 75% sold.

Another major factor in keeping the market tight is, as Dave points, producing dissolving pulp is both extremely expensive and time consuming. Dissolving pulp is not an easy pulp to produce because it demands both a high Alpha cellulose content (6 carbon polymers vs. hemicelluloses 5 carbon chains which dissolve easily in caustic and are then sewered), low ash content, high purity (very low heavy metals) and very uniform degree of polymerization (dP). As such there are fewer than a dozen market pulp mills in the world producing this grade. The most costly drawback to producing dissolving pulp is the low yield. Whereas commodity papergrade pulps require 4 mt of chips to produce one mt of pulp, dissolving pulps require 5-6 mt. Given a choice, few mill managers would opt for any pulp grade requiring that much additional wood supply. In 2008/09 the lower quality dissolving pulps (i.e. borderline Alpha cellulose content) were selling for barely $200/admt more than papergrade pulps. Consequently there was little incentive to even consider spending the money to upgrade to dissolving pulps. Even under the current market circumstances, with list prices expected to reach $1600/admt on
January lst, to quote Dave, it is still more viable for existing (dissolving pulp) mills to consider major expansion programs then for the other pulp/paper mills to switch over to dissolving pulp. _____________________________________****____________________________________

Dissolving Pulp - The Great Come-Back

he life-cycle of most pulp and paper products includes the same phases that many other products have; birth, rise, peak, decline and a quiet burial. Not so with dissolving pulp i.e. viscose pulp (or, with a wider end-use spectrum, the group of high-alpha pulps). That is a grade of pulp, or rather a family of pulps with high alpha-content, which are used in a multitude of end-uses and which are also produced in a number of different ways, as illustrated below. End-uses and end-products of dissolving pulp

This is a product family which was in serious difficulties in 19970s, 1980s and 1990s but
which has made a remarkable come-back.

_____________________________________________ The Turn-around

Since the end of 1990s, dissolving and other high alpha pulps have made a good recovery and the old consumption records from early 1970s will soon be beaten, if the consumption of cotton linters pulp is added to the dissolving and other high alpha wood pulp consumption numbers, shown below from 1980 onwards, by region. The outlook for viscose and other high-alpha pulps is good, even if surrounded with some ever-present risks. World consumption of dissolving pulp decreased from 4.9MT in 1980 to 3.1MT in 2001 but has
been rising since and is likely to approach 4.5MT in 2010. Future growth is driven by China and other Asia (excluding Japan). Including cotton linters pulp would show 1980 consumption at 5.15.2MT, 2009 at similar 5.2MT and 2010 at 5.5MT, or slightly higher. Total demand has thus made a full come-back. Dissolving & other high-alpha wood pulp market development

For this turnaround, there are many reasons. However, substitution has been the most important
driver over the past few years. Dissolving and other high-alpha pulps have taken some market share from oil-based synthetic fibres but in many applications these still hold on to their share. The biggest change has been seen in the interplay between cotton and viscose. Firstly, and most importantly, the cultivation area for cotton has been reduced, e.g. in the US South, where corn and soy-bean have taken over some of the acreage earlier held by cotton. Secondly, technical development of viscose fibres has allowed a more direct replacement in some end products. Thirdly, the spinning and other techniques needed in the textile production have been developed to allow more and more blends. Most of the substitution has taken place in these blends through a gradual introduction of higher shares of viscose fibres in those applications where the special features of dissolving pulp based fibres can be utilized, especially in production with the highest speed looms.

Draughts and other weather-related problems have also limited the cotton supply. As about 25% of the dissolving pulp is produced from cotton linters, the difficulties in cotton cultivation have also impacted the cotton linters based dissolving pulp production and wood-based pulp production has benefited. The importance of the substitution impact is easily seen from the attached table revealing the use
of the different fibres in textile production (average of years 2007-2009; numbers rounded). Other natural fibres include e.g. wool and silk. Viscose volume includes cotton linters and the use of staple fibre in non-woven products. Fibre consumption in textile industry Fibre Type Synthetic Cotton Other Viscose Total

Million tonnes %

(oil) 43 57.5

23.5 31.5

natural 4.5 6.0

4 5.0

75 100.0

The low share of viscose fibre of the total fibre volume used in textiles means that if viscose replaces 1% of synthetic fibre, dissolving pulp demand goes up by nearly 11% and if viscose replaces 1% of cotton, nearly 6% more of dissolving pulp is needed. The combination of substitution of those positive drivers in the textile end-use, growing demand
in non-woven products and positive growth in some other end-uses, mainly in the specialty pulp sector, turned, as earlier said, dissolving pulp demand back up in the turn of the century, after a long decline through 1970s-1990s.

_____________________________________________ Come-Back Continues?

Opposite to most other grades of pulp, the consumption of dissolving and other high-alpha pulps
did not go down in the 2009 recession as demand leaped in China, even if a large number of textile mills were closed during the 1st half of the year. First statistics from 2010 indicate that a strong growth continues. Chinese import statistics showed the Q1 2010 dissolving pulp intake up a whopping 79% over January-March 2010 on this nowadays clearly biggest single dissolving pulp market. The price for standard grade dissolving pulp has climbed up to/near alltime record levels.

While we believe that the demand growth will continue in the foreseeable future at rates varying somewhere between 3-7%/annum, depending on success of the annual cotton crops, of oil price levels and many other issues, a word of warning is in order for those who now, seeing the high prices, plan with great enthusiasm to jump into the band-wagon, hoping to catch a wonderful ride. What about the risks? These include, among others:
Lower oil prices and better cotton crops could reverse, at least temporarily, the recent substitution trends Far more money is invested into the development of synthetic fibres than into wood pulp based fibres; new products and applications using these fibres could eat into the dissolving pulp demand Some recently positive end-use trends are likely to turn less positive or even negative. One such example is the high alpha pulp for acetate tow. So far the switch to filter cigarettes in developing countries has outpaced the reductions of smoking in the Western World. Once this switch is nearly completed, further reductions in smoking start reducing the consumption growth in this end-use considerably

The environmental message of wood-pulp based fibre, e.g. in terms of carbon footprint, is clearly better than for synthetic fibres or cotton but, dissolving pulp assets are old and continue to have environmental problems on mill sites The quality control is very strict and the acceptance of the quality from a new mill takes up to two years in some end-uses The investments into a totally new dissolving pulp line are manifold to building an equal amount of synthetic fibre capacity Conversion of existing paper pulp lines into dissolving pulp is complicated. There are some success stories but there are also complete or partial failures. All parts of the chain from the forest resource to marketing of the final products need to be taken into account in the planning process. (Source: Pyry Management Consulting Oy / 2010)

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Sources:
1. Pyry Management Consulting Oy 2. RISI 3. Seeking Alpha (http://seekingalpha.com) 4. Gerson Lehrman Group (http://www.glgroup.com) 5. Business in Vancouver (http://bivinteractive.com) 6. Tembec (www.tembec.com) 7. Fortress Paper Ltd. (www.fortresspaper.com & http://fortresspaperblog.com) 8. Fortress Specialty Cellulose (http://specialtycellulose.com/) 9. The Globe & Mail (www.theglobeandmail.com) 10. The Financial Post 11 The Wall Street Journal 12. China Textile & Apparel Online (http://www.texindex.com/)
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