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Editor’s note: The following article is an edited transcript of the presentation James Armstrong of Armstrong Investment Research gave at the 2017 Paper & Plastics Recycling Conference in mid-October.

Year-to-date demand for containerboard—whether you look at it on an average-days-of-supply or actual basis—is up somewhere between 2.8 percent and 3.5 percent. That is double what even the most optimistic people thought containerboard demand would be even as early as last year. Two things are happening.

First, outsourcing is declining. The amount of jobs and the amount of manufacturing that are going over to China are declining. Now, that doesn’t sound like a big deal; it just means you don’t lose anything. But there is an underlying factor: As outsourcing stabilizes and manufacturing stabilizes, the underlying demand for nondurable goods, especially food products, has continued to grow for decades. The growth in nondurable goods has offset the decline in durable goods almost exactly until recently. That is why you saw zero percent demand growth for the last decade in containerboard. But once you lose it, you can’t lose it twice. So even if manufacturing just stabilizes, you’ve got underlying demand growth.

Now, add e-commerce to that. According to current estimates, e-commerce accounts for about 1 percent of containerboard demand growth. E-commerce is only 8.5 percent of the overall retail market, but it is growing at a rate of 18 percent to 20 percent per year, and it is likely to accelerate. That could mean that you see strong e-commerce growth for years to come.

E-commerce and containerboard demand

In addition, e-commerce is affecting the retail space. From 2000 to 2010, everybody had an e-commerce strategy, but most sales were still brick and mortar retail. Malls grew; retail was big. Now you can’t pick up a newspaper without hearing about mall closures or this or that store going out of business. More sales will go online in the future.

Overall containerboard demand could grow by 3 percent to 4 percent until 2030. If that happens, North American containerboard demand would need to grow by 60 percent in the next 13 years.

What happens if e-commerce grows to 30 percent of retail by 2030? It could completely change how we buy stuff in the U.S. and eventually the globe. Bottom line: We’ve reached a tipping point.

If that happens, e-commerce could add from 1 percent to 2 percent to containerboard demand per year, and that is above underlying demand growth. That means overall containerboard demand could grow by 3 percent to 4 percent until 2030. If that happens, North American containerboard demand would need to grow by 60 percent in the next 13 years. The containerboard industry has not grown in almost two decades and suddenly would need to almost double capacity.

Containerboard supply sources

Where in the world is all the supply going to come from?

U.S. containerboard producers are producing above 95 percent already. You are talking about 97 percent some months. That is absolutely unsustainable. You need more downtime. You can’t get much more out of the current system.

There is also the opportunity for conversions, and containerboard conversions are going to happen: International Paper (IP) has one out on the market, Domtar has been threatening one, and Packaging Corp. also is doing conversions. These are going to come online, but that still is not a huge amount of capacity. Two line—not even two full mills but two line—conversions will eat up one year of additional demand. All existing printing and writing paper capacity in North America would need to convert to containerboard to meet expected demand.

Could there be new virgin capacity? Well, a new virgin mill has not been built since 1994 anywhere in the globe. To get a virgin mill built in the U.S., it would take seven to 10 years to get the permits through.

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The other potential source of supply is recycled capacity. We will need recycled capacity, and recycled capacity will be added. However, the global old corrugated container (OCC) supply chain is maxed out. We have to mix in mixed paper and other lower-quality materials to make the containerboard we’re already using.

You are out of OCC, unless somehow you can get collection rates much higher, and I am actually hearing collection rates are going down with e-commerce. You are going to have a global OCC problem. This is going to help push OCC prices up over the long term.

More and more boxes

Now, one of the things that people worry about is will e-commerce cannibalize current demand. If I’ve got 125 shirts in a 5-foot-by-5-foot box that is shipped to a retailer, that one box uses 150 square feet of board. Let’s assume that all 125 units go into individual 1-foot-by-1-foot boxes. The boxes still hold 125 units, but it takes 750 square feet of board to make those boxes. That’s a lot more board to ship the same amount of product. This will continue as e-commerce becomes more prevalent.

There also are other reasons there will be little cannibalization. First, most people don’t direct ship yet. I know I don’t quite get all of my products from China, even though everything has “Made in China” stickers on it. Products come in a big box to an Amazon distribution center, and they get unpacked and repacked in small boxes. Well, that is just added boxes to the supply chain—adding more demand.

In addition, individual boxes are not packed efficiently. How many people have ordered a package of pencils from Amazon, for example, and it comes in a large box. That could add a huge amount of square footage to containerboard demand and huge amounts of OCC demand.

Another thing that everybody talks about: lightweighting. Everybody says, “Look, we’re going to use a whole lot less board going forward; it’s just going to happen.” We still haven’t quite seen that.

Let’s assume that basis weights are going down 0.3 percent per year, as data from Boston-based global forest products industry information provider RISI illustrates. Demand will massively overwhelm any basis weight declines, so you are still going to need the extra fiber.

Adapting to e-commerce

The world needs to adapt to this different environment. More virgin capacity will be needed; we know that. Unlike aluminum and some other materials, you can only recycle a box so many times—you lose fiber even if you get a perfect collection rate; it’s just how the physics works.

The mills must be more flexible. That means they need to take uptime and downtime better. They need to have better fiber supply. They need to be able to take different types of fiber, such as mixed paper.

E-commerce is only 8.5 percent of the overall retail market, but it is growing at a rate of 18 percent to 20 percent per year, and it is likely to accelerate.

In addition, collection of OCC will change. There are solutions, but you have to make a fundamental assumption: Consumers, especially U.S. consumers, are lazy. Education has been proven to be ineffective in many areas and is not necessarily the key to improving collection.

Containerboard producers are demanding higher quality. You’ve heard about China and its 0.3 percent level for “carried waste,” which is probably a little hard to get to, but every containerboard producer is complaining about the quality of recovered fiber they are getting. You must improve collection methods. You must figure out how to sort along the system.

E-commerce is going to drive a lot of change. More containerboard capacity will be needed; that means more recycled materials. The mix of containerboard production must be rebalanced. All capacity brought online globally, or most of it since 1994, has been recycled based. That is nearing the end and needs to balance out.

Where and how OCC will be collected needs to change as well. If retailers at one time were generating 90 percent to 95 percent of the OCC collected per year, and retailers are going out of business, how does that change your model? You need to figure out what to do about it.

James Armstrong is CEO of Armstrong Investment Research (AIR), Las Vegas. He has more than 10 years of experience covering the global paper and packaging and building materials industries. He can be contacted by email at james.armstrong@armstrong investmentresearch.com.