Intensifying Energy Crunch Poses Further Challenges for European Paper Packaging

Massive uncertainties related to energy – now combined with uncertainties related to demand – continue causing margin pressure for many recycled paper packaging producers. Although recent price hikes, combined with other measures, have (somewhat) helped, none are sufficient to ensure stable performance of the paperboard industry later this year and next. More closures (due to supply cuts) are likely to be seen, especially with potential energy rationing on the horizon, which might cause high prices to persist or increase further. All this, in turn, continues to create uncertainties and price pressure in the already strained downstream supply chain.

Energy Remains the Biggest Uncertainty

With recycled grades accounting for about 80% of total European containerboard production - which relies largely on purchased energy (natural gas or electricity) – an intensifying energy crunch remains a major concern for European paper packaging producers.

The exposure of a specific production site to high energy prices depends on its current energy mix, whether it has its own energy supply, whether it makes use of natural gas hedging, and the duration of possible hedge contracts. However, in general, around two-thirds of the energy used for European recycled containerboard production consists of natural gas. A significant part of this production is located in countries dependent on Russian gas.

Also, since the start of the Ukraine crisis in February 2022, in addition to skyrocketing and unpredictable energy prices, the risk of gas shortages in Europe has become more real. As a result, some paper packaging producers are seriously concerned about whether they will have enough energy at their disposal to keep their mills running. In the worst-case scenario, downstream value chains, including essential ones, could face supply disruptions and paper packaging shortages.

Energy Costs Upset Normal Supply-and-Demand Price Dynamics

The Ukraine crisis has also reversed demand dynamics. While natural gas prices continued to break records, corrugated box and, consequently, containerboard demand started to show signs of easing, due to worsening economic conditions followed by consumption declines, especially in the more industrialized economies like Germany (see Figures 1 and 2). This contrasts sharply with the situation in the last two years, when the market experienced record growth in demand for boxes as a result of the Covid-19 demand boom for certain goods, the post-Covid recovery, and e-commerce.

Weaker demand would normally lead to lower containerboard prices. However, the current energy situation disrupts this ‘normal' dynamic.  Despite downward price pressure, the scale of rising energy costs is such that paper packaging players of varying size – both in recycled containerboard and boxboard segments – began announcing price increases in their press releases in August:

  • - Recycled containerboard grades: Germany’s LEIPA – a EUR 60/metric ton price rise from September 1; Germany’s Papier- und Kartonfabrik Varel – a EUR 100/metric ton price rise from October 1; Smurfit Kappa – a EUR 130/metric ton price rise from September 19.
  • - Recycled cartonboard grades: Dutch solid board manufacturer Solidus Solutions – an 8% to 10% surcharge for solid board from August 15; Austrian MM Board & Paper – a EUR 100/metric ton price rise for cartonboard from September 1; Sweden’s Fiskeby – a not-yet-determined amount from November 1.

Next to escalating energy prices, some players in Germany (e.g. Papier- und Kartonfabrik Varel, Kunert Group) also referred to costs related to the implementation of the German national gas price surcharge. This levy was expected to add EUR 50/metric ton in extra gas costs from October. 

Eventually, the German government decided to discard its planned gas levy in favor of a gas price cap, setting up a EUR 200bn “defensive shield” to support businesses and consumers.

Unsurprisingly, in September, other producers (e.g. DS Smith, Heinzel Group, Hamburger Containerboard, Schoellershammer, Kunert Group) followed Smurfit Kappa – Europe’s largest producer – and announced price hikes of EUR 100/metric ton to EUR 150/metric ton, effective October 1.

Price Hikes Help Fight Margin Pressure – But Are They Enough?

Despite previous significant price hikes (in March), sharply higher costs – now combined with weaker demand – continue to cause margin pressure for the entire European paper packaging sector, although the extent of this pressure differs per producer.

The most recent results from leading corrugated packaging producers (e.g. DS Smith, Smurfit Kappa) so far suggest that the recovery in paper and corrugated prices – in combination with long-term hedging programs – has helped them to offset energy price challenges.  However, even these major players planned additional summer downtime (about 30,000 metric tons to 50,000 metric tons of capacity each), which is only a small part of announced and unannounced production cuts of 10% to 15% by paper packaging players of varying sizes (e.g. Saica, VPK Group, Hamburger Containerboard, Progroup, Papier- und Kartonfabrik Varel, Julius Schulte Trebsen, Papeterie Saint Michel). The recycled boxboard market shows similar dynamics. For instance, Solidus Solutions announced that it would reduce its solid board output by 10% from August until further notice. Remarkably, if high energy prices were a key reason for unplanned stoppages in March, it is now often also about weaker demand (and, consequently, low order intake).

There were numerous recycled containerboard production downtimes announced for September and October. According to company press releases:

  • - German producer Julius Schulte Trebsen announced plans for another production shutdown for a total of 12 days (about 250,000 metric tons of capacity). In addition, daily production output will be limited to 80%. Both measures will lead to an estimated production reduction of about 45%.
  • - Hamburger Containerboard (part of the Austrian Prinzhorn Holding) announced plans to reduce production again in September and October by a total of 70,000 metric tons.
  • - The containerboard mill of Italian producer Pro-Gest Group in Mantua remained idle after the maintenance shutdown in the summer but was restarted on September 26.
  • - German producer Delkeskamp Verpackungswerke again announced a permanent closure of its Nortrup site (about 135,000 metric tons of capacity).

Obviously, under weaker demand conditions and excessively high energy prices, where gas supply was even ‘guaranteed,’ price hikes still could not ‘guarantee’ economically viable paper packaging production for all producers. And the question remains: Will downstream demand continue to accept price increases (and to what extent), especially if gas supply disruptions drive up prices even further? One thing is certain: The current situation makes it more difficult to pass on energy cost increases through containerboard price increases, resulting in margin compression. Likely, it is even harder for small and medium-sized non-integrated mills and for those with higher sales exposure in the more industrialized countries. Therefore, on the one hand, (some) European mills may still lower their prices to secure volumes. On the other hand, depending on the supply and cost of energy, further downtimes are also possible. Reduced supply would logically result in stable or rising prices even when demand is weak.

Trying Different Strategies

The new and still unknown reality is forcing European producers of recycled paperboard to look beyond periodic price hikes and to come up with other measures to manage risks and energy costs in their efforts to secure their margins:

  • - Hedging is being considered more often these days, including by recycled containerboard mills. However, even for those who timely resorted to hedging, current long-term gas contracts (at the pre-increase price) are about to run out, and choosing options for a new hedging strategy might be challenging in this unknown reality. For example, hedging energy on a rolling basis could gradually increase energy costs if forward prices continue showing an upward trend. And not all producers have the capability to hedge. Furthermore, hedging contracts could be at risk if contingency plans, including price capping, are imposed.
  • - Energy surcharge is another ‘temporary’ mechanism. In March, Pro-Gest Group adjusted its sales policy to the energy costs trend, gradually passing on the cost increases to its customers. In August, Solidus Solutions said it would continue to work with a temporary energy surcharge – updated on a monthly basis – based on the Dutch natural gas index TTF.
  • - Temporary machine stoppage would normally be a last resort due to the high fixed costs involved. However, for a number of mills today, ‘temporarily’ stopping production is more economical than continuing. This is sometimes the case even for mills that are mostly hedged in terms of energy prices, such as the above example of Papeterie Saint Michel. Some mills opted to sell their current natural gas hedges for spot price, enabling them to generate some margin, although this option might become less attractive with new hedging contracts. At the same time, as mentioned above, recycled paperboard producers more often opt to ‘temporarily’ cease production to balance supply with easing demand, which could also help maintain current paper prices or even introduce price hikes.
  • - Building safety stocks of recycled paperboard is a common choice of many producers in response to potential energy disruptions and paperboard shortages, especially when the risk of an energy deficit has become more real and demand is showing signs of decline. Interestingly, some companies have also considered building ‘gas stocks’ by renting gas storage.
  • - Self-supply of energy (cogeneration plants) would generally reduce a production site’s use of fossil energy and its vulnerability to high energy prices. That is why sustainable solutions for self-supply energy are already a part of industry short- and medium-term energy transition efforts. Remarkably, for some mills that (partially) have their own energy supply, external sales of (excess) energy have now become an additional attractive short-term option to mitigate the impact of high energy prices.
  • - Natural gas alternatives are also a part of the paperboard industry’s long-term energy transition agenda, which advocates for renewable alternatives to natural gas. In contingency plans for a potential gas shortage, some paperboard producers have started to switch to alternative – but not necessarily renewable – energy sources, when feasible. For example, Mayr-Melnhof Group is investing in oil refining and investigating the partial use of fuel oil at most of its production sites. However, these measures will have no short-term effect.

While the above measures have helped (somewhat), none of them are sufficient to ensure stable performance of the paperboard industry later this year and next. More downtimes or even closures (supply cuts) are likely, especially with energy rationing on the horizon. Most European countries are unlikely to face acute gas shortages, except for Germany and Italy, but these are countries with significant containerboard capacity. And it remains uncertain to what degree energy-intensive paper packaging production will be considered an essential service (given that it is critical to the transportation of essential health goods, pharmaceuticals, food, and other goods, operates in cross-border, interdependent supply chains, and is an industry with limited ability to switch to alternative fuels in the short term). Also it is unclear how essential but energy-intensive suppliers of the industry (like chemical producers) might be affected.

Full Impact of Energy Crisis Yet To Be Seen

Massive uncertainties related to energy continue causing margin pressure for many recycled packaging producers and lead to price increases for paperboard. At the same time, the industry is starting to face downward pressure on paperboard prices due to weakening demand, making it more difficult to pass on cost increases in selling prices along the chain. In their efforts to manage energy costs and balance the supply and prices of paperboard, some manufacturers may choose to plan more production stops, which might logically cause high prices to persist or increase further. Also, we might see more shifts from a ’temporary’ to a kind of ‘structural’ energy price surcharge for customers and/or short-term contracts. All this, in turn, continues to create uncertainty and price pressure in the already stressed downstream supply chain.

However, the effects of higher energy costs and potential disruptions in the supply of energy and paper packaging are not limited to margin pressure. The following developments add another dimension of potential impact, not only in terms of margin but also in terms of remarkable strategic moves along the chain:

  • Loss of competitiveness: Further increases of recycled paperboard prices could cause European mills to lose competitiveness relative to other regions, while global export markets and prices become even more competitive amid weaker demand. Initially, higher prices would reduce the competitiveness of European containerboard exports. At some point, the price level of European recycled containerboard grades may even reach the level of imported virgin containerboard grades – for example, from the US or Brazil. This would provide additional export opportunities for other regions.
  • Investments in sustainability and the energy transition: As the energy crunch puts even greater pressure on the industry to accelerate its energy transition efforts, there are growing concerns about whether there will be sufficient capital available for all the plans that are still in the pipeline. Furthermore, as some European paperboard producers try to find a way to survive, we might see potential delays, fewer new projects in general, and fewer investments in sustainability and the energy transition in particular.
  • A new level of vertical integration: Schwarz Produktion, the owner of grocery store Lidl and department store Kaufland, has acquired a paper mill from Stora Enso that is “almost energy-independent.” According to the retail company, the idea behind this acquisition is to secure uninterrupted paper and packaging supplies amid a perfect storm of soaring energy costs, rising raw material prices, and strikes at major paper mills. This might just be the beginning of a new trend.