EPA-230/3-76-014
ECONOMIC IMPACTS OF PULP AND
PAPER INDUSTRY COMPLIANCE WITH
ENVIRONMENTAL REGULATIONS
VOLUME I
Summary and Aggregate Industry Impact Analyses
\
o
f
MAY 1977
U. S. ENVIRONMENTAL PROTECTION AGENCY
Office of Planning and Evaluation
Washington, D. C. 02460
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ECONOMIC IMPACTS OF PULP AND
PAPER INDUSTRY COMPLIANCE WITH
ENVIRONMENTAL REGULATIONS
VOLUME I
SUMMARY AND AGGREGATE INDUSTRY IMPACT ANALYSES
Prepared by:
Claire R. Canty
Louise M. Firth
Fred D. lannazzi
Nelson R. Lipshutz
Henry R. Martin
Peter L. Oliver, Project Leader
of
Arthur D. Little, Inc.
Report for
Office of Planning and Evaluation
U.S. Environmental Protection Agency
June 1977
EPA-230/3-76-014
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PREFACE
This report is the result of a major program of study sponsored by the Environmental
Protection Agency as part of its continuing effort to assess the economic impacts of its regulatory
programs. Unlike many of EPA's other industry economic studies, where the focus is on the
impact of a particular regulation, this study examined the combined effect of water, air, and noise
regulations on the pulp and paper industry.
It was not possible, of course, to take every environmental regulation into account. In some
cases, cost data was lacking, as were some final regulations. It was possible, however, to focus
quantitatively on the most significant programs now in effect.
In addition to providing an assessment of the combined impact of major environmental
programs, a key objective of this study was to improve the methods used in previous studies and
thereby provide more accurate conclusions as well as a better foundation for future studies. In
many cases, this objective was realized through the use of more recent or previously unused data
in areas such as industry production cost and pollution control cost. However, the basic analytical
methods also were improved.
In sponsoring this study, the EPA wanted an independent assessment of the pulp and paper
industry. Although the overall conclusions are endorsed by the Agency, there may be instances in
which technical judgments of the contractor differ from those of the EPA. Similarly, assumptions
that concern policy should not be construed as an indication of EPA policy intentions.
This report was prepared for EPA by Arthur D. Little, Inc., Cambridge, Massachusetts,
under contract number 68-01-2841. Additional copies are available through the National Techni-
cal Information Service, Springfield, Virginia 22151. Further information concerning this and
other economic studies conducted by EPA can be obtained through the Office of Planning and
Evaluation, U.S. Environmental Protection Agency. ^
EPA and Arthur D. Little gratefully acknowledge the important data inputs to this study
provided by: The American Paper Institute (production, capacity, OSHA noise cost data),
National Council of the Paper Industry for Air and Stream Improvement (water and air effluent
control costs), U.S. Department of Commerce (OSHA noise and state air regulation costs) and a
cross section of pulp and paper companies (historical selling prices, and mill closure factors and
probabilities).
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TABLE OF CONTENTS
Page
List of Tables ix
List of Figures xv
I. EXECUTIVE SUMMARY 1
A. PURPOSE AND SCOPE 1
B. KEY BASES OF ANALYSIS 2
C. CONCLUSIONS 3
D. KEY COST AND ECONOMIC IMPACT FINDINGS 6
E. ANALYTICAL APPROACH AND LIMITATIONS 13
II. INDUSTRY DESCRIPTION 19
A. CHARACTERISTICS OF THE PAPER AND ALLIED
PRODUCTS INDUSTRY 19
B. DEFINITION OF INDUSTRY SECTORS TO BE ANALYZED 21
C. HISTORICAL REGIONAL DEVELOPMENT 26
D. TECHNOLOGY AND PRODUCTIVITY TRENDS 26
E. ECONOMIC CHARACTERISTICS 30
F. FINANCIAL STRUCTURE AND PERFORMANCE 41
III. COST OF COMPLIANCE 49
A. SUMMARY 49
B. GENERAL METHODOLOGY 54
C. COSTS FOR EXISTING INDUSTRY 57
D. COSTS FOR NEW MILL SOURCES 68
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TABLE OF CONTENTS (Continued)
Page
III. COST OF COMPLIANCE (Continued) J
E. RELATIONSHIP OF CONTROL COSTS TO TOTAL MILL
INVESTMENT AND OPERATING COSTS 74
F. DISCUSSION OF ANALYSIS 77
IV. PRICE AND SECONDARY IMPACTS 89
A. OVERVIEW 89
B. FINDINGS 89
C. PRICE INCREASE REQUIRED TO RECOVER EXISTING
INDUSTRY'S INCREMENTAL COMPLIANCE COSTS 92
D. METHODOLOGY 107
E. LIMITATIONS AND SENSITIVITY ANALYSIS 117
V. MILL CLOSURES AND EMPLOYMENT IMPACTS 123
A. SUMMARY 123
B. METHODOLOGY 125
C. CLOSURE IMPACT FINDINGS 131
VI. CAPITAL IMPACTS 157
A. INTRODUCTION 157
B. METHODOLOGY AND FINDINGS 159
C. SENSITIVITY ANALYSIS 169
D. LIMITATIONS OF ANALYSIS 186
VI
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TABLE OF CONTENTS (Continued)
Page
VII. BALANCE OF TRADE IMPACTS 189
A. INTRODUCTION 189
B. CONCLUSIONS 190
C. METHODOLOGY AND COMPUTATION DETAILS 198
D. LIMITATIONS OF ANALYSIS 203
Vll
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LIST OF TABLES
Table No. Page
1-1 Studied Product Sector Shares of U.S. Primary Pulp, Paper,
and Paperboard Capacity, 1974 3
I-2 Product Sectors with Economic Impact(s) Above the
Paper Industry Average 5
I-3 Estimated Capital Costs for Compliance 7
I-4 Incremental Operating Costs for Existing Industry Compliance 8
I-5 Costs for Typical New Mills to Comply with Studied Regulations 9
I-6 Effect of Mill Size and Pulping Process on BAT Water Effluent
Control Costs 10
11-1 Sales to Assets Ratios for Paper and Other Manufacturing
Industries, 1975 20
11-2 Magnitude of All Pulp, Paper and Paperboard Sectors - 1972 22
II-3 Paper Industry Process Sector Subdivisions for Effluent
Guidelines Analysis 23
II-4 Process/Product Relationships Woodpulp Consumed by
Type, 1973 25
II-5 Pulp and Paper Industry Product Sectors 27
II-6 Regional Distribution of U.S. Pulp and Paper Mills--1975 29
II-7 Capital Expenditures and Capacity Expansions for All Pulp, Paper
and Paperboard Mills, 1965-1976 33
II-8 Kraft Linerboard Mill Capital Requirements in 1964 and 1974 35
II-9 Bleached Kraft Pulp Mill Investment Decision Made in 1964 and 1974 36
11-10 Changes in Paper and Allied Products Industry Capital Structure,
1970-1975 47
IX
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LIST OF TABLES (Continued)
Table No. Page
11-11 Relative Profitability of Selected Product Sectors 48
111-1 Summary of Incremental Costs of Compliance for Existing
Industry Through 1977 50
III-2 Summary of Incremental Costs of Compliance for Existing
Industry 1977-1983 51
111-3 Unit Cost of Compliance with Federal Standards for New
Mill Sources 53
111-4 Cost of Compliance Relative to Total Fixed Capital and Operating
Costs for New Mills 55
111-5 Product Sectors Included in Studied Process Categories 56
111-6 Summary of Air Emission Control Costs for Existing Industry 60
111-7 Summary of Incremental Air Control Cost to Existing Industry
(SIP Standards) by Major Process Category 62
111-8 Summary of Incremental Air Control Cost to Existing Industry
(SIP Standards) by Product Sector 63
111-9 Summary of Water Effluent Control Cost for the Existing
Industry by Process Category 65
111-10 Summary of Water Effluent Control Cost for the Existing
Industry by Product Sector 66
111-11 Summary of Water Effluent Control Cost for the Existing
Industry by Product Sector 67
111-12 Summary of Incremental OSHA Noise Control Cost to Existing
Industry by Major Process Category 69
111-13 Summary of Incremental OSHA Noise Control Cost to Existing
Industry by Product Sector 70
111-14 Unit Cost of Compliance with Federal Air Emissions Standards
New Mill Sources 73
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LIST OF TABLES (Continued)
Table No.
111-15 Unit Cost of Compliance with Federal Water Effluent Standards
New Mill Sources 75
111-16 Unit Cost of Compliance with Federal OSHA Standards -
New Mill Sources 76
111-17 Relationship of Selected Products to Product Sectors 79
111-18 Summary of Capital and Operating Costs for the Manufacture of
Unbleached Kraft Linerboard 80
111-19 Relationship Between Manufacturing Costs and Environmental
Control Costs in 1975 Dollars 81
IV-1 Long-Run Price Impact of Major Environmental Regulations
Imposed Upon the Pulp and Paper Industry 90
IV-2 Price Increase to Cover Cost of Environmental Regulations to
the Existing Industry 93
IV-3 Average Paper Industry Price Increases Resulting from Major
Environmental Regulations, 1976-1983 96
IV-4 Price Elasticity of Demand Pulp, Paper and Paperboard Products 110
IV-5 Product Sector Rate of Annual Growth in Capacity Historic,
Planned and Forecast 112
IV-6 Chase Econometrics Forecast Compared to 1976 Actual and
1977 Forecast 113
IV-7 Sensitivity of Price Impact Estimation to Variations in Cost
of Capital and Payback 119
IV-8 Capital Recovery Factors for Various Payback Periods and
Capital Costs 120
IV-9 Sensitivity of Existing Mill Price Effects of Environmental
Regulations to Cost Estimates 121
XI
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LIST OF TABLES (Continued)
Table No. Page
IV-10 Sensitivity of Long-Run Price Effects of NSPS Water and Air
Regulations, SIPS Air Regulations and the OSHA Noise
Standard to Cost Estimates and the Cost of Capital 122
V-1 Results of Closure Screening Analysis 132
V-2 Potential Closure Impact of 1977 Guidelines by Process Sector 133
V-3 Potential Closure Impact of 1977 Guidelines by Product Sector 134
V-4 Incremental Closure Impact of 1983 Guidelines by
Process Sector 135
V-5 Incremental Closure Impact of 1983 Guidelines by Product Sector 136
V-6 Profile of Large Dissolving Sulfite Mill Closure Model 138
V-7 Profile of Small Paper Grade Sulfite Mill Closure Model 139
V-8 Financial Comparison of Closure Alternatives for Large
Dissolving Sulfite Pulp Mill Model 140
V-9 Financial Comparison of Closure Alternatives for Paper Grade
Sulfite Pulp Mill Model 142
V-10 Profile of Groundwood Paper Mill Closure Model 143
V-11 Financial Comparison of Closure Alternatives for Small
Groundwood Pulp Mill Model 145
V-12 Profile of Deinking Mill Closure Model 146
V-13 Financial Comparison of Closure Alternatives for Small
Deinked Pulp Mill Model 147
V-14 Profile of IMonintegrated Tissue Mill Closure Model 148
V-15 Financial Comparison of Closure Alternatives for Nonintegrated
Tissue Mill Model 149
XII
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LIST OF TABLES (Continued)
Table No. Page
V-16 Profile of Recycled Paperboard Mill Closure Models 151
V-17 Financial Comparison of Closure Alternatives for Recycled
Paperboard Mill Model 152
V-18 Regional Employment Impacts Associated with 1977 (BPT)
Mill Closures 154
V-19 Incremental Regional Employment Impacts Associated with
1983 (BAT) Mill Closures 155
VI-1 Summary of Projected Financial Performance of the U.S. Pulp,
Paper and Paperboard Industry 1976-1983 160
VI-2 Sensitivity of Projection to Variations in Assumptions 172
VI1-1 U.S. Imports and Exports of Pulp and Paper, 1974 191
VII-2 Kraft Linerboard Cost Differentials Landed in Germany from
Southeast U.S. and Sweden 193
VII-3 Bleached Softwood Kraft Pulp Cost Differentials Landed in Germany
from Southeast U.S. and Sweden 195
VII-4 Sulfite Dissolving Pulp Cost Differentials Landed in Germany from
Southeast U.S. and Sweden 196
VII-5 Newsprint Cost Differentials in U.S. Midwest from Southeast and
Western Canada 197
VII-6 Bleached Softwood Kraft Pulp Cost Differentials in U.S. Midwest
from Southwest U.S. and Western Canada 199
VII-7 Inter-Country Comparison of Water and Air Pollution Control
Expenditures, 1970 and 1975 201
VII-8 Assumed Inter-Country Pollution Control Cost Differentials, 1983 202
VI1-9 Wood Usage and Costs - By Region and Product, 1975 204
Xlll
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LIST OF FIGURES
Figure No. Page
1-1 Procedural Framework for Estimating Economic Impacts 14
11-1 Year-End Capacities for Virgin Pulp and Papermaking, By
Region - 1975 28
11-2 Paper & Paperboard Wholesale Price Index (WPI) and All
Commodity Price Index 38
11-3 Paper & Paperboard Wholesale Price Index and Utilization of
Capacity 39
11-4 Percent Net Profit After Tax to Net Sales 42
11-5 Percent Net Profit After Tax to Net Worth 43
11-6 Percent Net Worth to Total Capital for Paper Versus All Industries 45
111-1 Methodology for Calculating Cost of Compliance Existing Mills 58
111-2 Methodology for Calculating Cost of Compliance New Mills 71
III-3 Interrelationship of Cost of Compliance and Direct Manufacturing
Costs 78
IV-1 Long-Run Price Increase Resulting from Environmental Regulations
in the Pulp and Paper Industry 91
IV-2 Price Increases Necessary for Existing Industry to Cover the Cost
of Environmental Regulations 94
IV-3 Impact on Operating Rates of Studied Regulations 97
IV-4 Annual Growth in Demand Paper and Paperboard Products
1977-1983 99
IV-5 Projected Total U.S. Pulp and Paper Demand and Capacity
Utilization 100
IV-6 Peak Capacity Utilization Rate Paper and Paperboard Sectors
1977-1983 102
xv
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LIST OF FIGURES (Continued)
Figure No. Page
IV-7 Overall Methodology - Price Impact 108
IV-8 Chase Econometrics CEQ Economic Scenario, May 17, 1976 114
V-1 Procedure for the Mill Closure Analysis 124
VI-1 Capital Requirements Analysis Methodology 158
VI-2 Capital Investment Requirements of the U.S. Pulp, Paper and
Paperboard Industry 1976-1983 162
VI-3 Funds Flow Model Impact on Operating Rates of Studied
Regulations 166
VI-4 External Financing Requirements of the U.S. Pulp and Paper
Industry Historic and Projected (Midrange Forecast) 168
VI-5 External Corporate Financing in the U.S. Economy Historic and
Projected (CEQ Forecasts) 170
VI-6 External Financing Requirements of the U.S. Pulp and Paper
Industry as a Percent of All Corporate External Financing Historic
and Projected (Midrange Forecast) 171
VI-7 Sensitivity of Capital Investment Requirements to Assumed
Capacity Growth 173
VI-8 Sensitivity of External Financing Requirements to Assumed
Capacity Growth and Demand Growth 175
VI-9 Sensitivity of External Financing Requirements as Percent of All
Corporate External Financing to Assumed Capacity Growth 176
VI-10 Sensitivity of Capital Investment Requirements to Uncertainties
in Cost of Compliance 178
VI-11 Sensitivity of External Financing Requirements to Uncertainties
in Cost of Compliance 179
VI-12 Sensitivity of External Financing Requirements as Percent of All
Corporate External Financing to Uncertainties in Cost of Compliance 180
xvi
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LIST OF FIGURES (Continued)
Figure No. Page
VI-13 Pro-Forma Book Rates of Return on Equity for the U.S. Pulp,
Paper and Paperboard Industry for the Period 1966-1975 182
VI-14 Sensitivity of External Financing Requirements to Assumed Cost
of Equity Capital 183
VI-15 Sensitivity of External Financing Requirements as Percent of All
Corporate External Financing to Assumed Cost of Equity Capital 184
VI-16 Capital Investment Requirements of the U.S. Pulp, Paper, and
Paperboard Industry Under Alternative Compliance Schedules
1976-1983 185
VI-17 Sensitivity of External Financing Requirements to Assumed
Compliance Schedule 187
VI-18 Sensitivity of External Financing Requirements as Percent of All
Corporate Financing to Assumed Compliance Schedules 188
VI1-1 Procedure for Estimating Balance of Trade Effects 192
xvii
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CHAPTER I
EXECUTIVE SUMMARY
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I. EXECUTIVE SUMMARY
A. PURPOSE AND SCOPE
To assist various government agencies in making decisions about environmental regulations
for the U.S. paper industry, the EPA retained Arthur D. Little, Inc., to undertake a com-
prehensive study aimed at measuring the potential economic impacts that would result from the
industry's total cost to comply with the following existing or proposed regulations:
Water Regulationsthose issued by EPA for existing and new capacity. Two levels
of control for the existing industry are assessedthat for compliance with BPT
("best practicable control technology currently available") which is required for
1977, and that for BAT ("best available technology economically achievable")
which is required for 1983. New-capacity control costs are based on the New Source
Performance Standards (NSPS) currently in effect. These regulations do not affect
existing pretreatment standards or other costs associated with use of municipal
treatment facilities.
Air Regulationsthose issued by states (State Air Quality Implementation
PlansSIP) for the existing industry, and those issued by EPA as they apply to
new capacity.
Noise Regulationsthose issued by the Occupational Safety and Health Adminis-
tration (OSHA) for compliance with a 90-dBA noise level using engineering and/or
administrative controls to achieve compliance. Noise regulations apply equally to
both existing and new capacity.
Four types of existing or proposed environmental regulations were excluded from these economic
impact analyses:
All regulations that affect woodland management (e.g., use of herbicides and
pesticides), harvesting practices, and alternative timberland uses.
Regulations that mandate fuel switching or require S02 removal. (This study
assumes the use of low-sulfur fuel.)
"Nonsignificant deterioration" regulations under consideration by Congress that
would tighten current air emission limitations for new or expanded pulp and paper
mills.
Priority pollutants regulations that are being studied by the EPA for possible
inclusion in the 1983 water effluent guidelines.
The study analyzes cost-recovery impacts of the above water, air, and noise regulations on
the pulp, paper, and paperboard product sectors of the total paper and allied products industry.
Thus, the analysis does not include costs or impacts associated with timberlands, or pa-
per/paperboard converting operations (except where converting is done at the paper mill). The
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study also excludes specialty paper products, for which Federal water effluent guidelines have not
yet been proposed. Table 1-1 shows that the studied product sectors accounted for about 99% of
1974 U.S. primary pulp, paper and paperboard capacity.
In 1975, the studied product sectors accounted for about 45% of the sales of the paper and
allied products industry, 55% of its assets and 42% of its employment.
The report assesses the industry's incremental costs to meet the environmental regulations
defined above. Then it estimates the following economic impacts of these costs on the product
segments they affect directly and on the industry and economy as a whole:
Price and Demand Effects
Short-Term Capacity Constraints
Secondary Impacts on Suppliers
Closure and Employment Effects
External Financing Requirements
Balance of Trade Effects
B. KEY BASES OF ANALYSIS
The results of this analysis should be interpreted in the light of the following key assump-
tions and study parameters:
1. The base case assumed that: regulatory timetables and national effluent standards
will be achieved. It is evident that this assumption does not hold for EPA's BPT
water guidelines, which required effective treatment systems to be operating by
July 1977. A number of mills reported in 1976 that they would be unable to meet
this deadline. Moreover, some mills received five-year permits prior to the pro-
mulgated national standards. Consequently, the effluent limitations in many per-
mits may differ from the national standards. A sensitivity analysis was preformed
to test the capital effects of extending the BPT expenditures beyond 1977 to
January 1980.
2. Starting dates for the Arthur D. Little forecasts were: January 1976 for the
industry's capital and financing requirements; January 1975 for environmental
control and operating costs (including capital recovery). The earlier date was used
for operating costs because the 1975 recession prevented most paper companies
from raising prices in 1975 and 1976; thus the incremental costs incurred since
January 1975 generally are not reflected in 1976 prices.
3. Product quality will not change significantly through 1983. There has been much
industry discussion about employing lower-brightness, higher-yield pulp in its
products, and thereby reducing pollution loadings as well as costs. As yet, however,
there is no evidence that this trend has begun; therefore, it would be very specula-
tive to predict its timing and effects.
4. Competitive pricing is assumed in all price, demand, and capacity forecasts. To the
extent that Federal price controls or guidelines are imposed and sustained, the
capacity and capital requirement forecasts in this report would be altered.
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TABLE 1-1
STUDIED PRODUCT SECTOR SHARES OF U.S. PRIMARY PULP, PAPER,
AND PAPERBOARD CAPACITY, 1974
Sector % of 1974 U.S. Capacity
Unbleached Kraft Paper 7.1
Unbleached Kraft Paperboard 22.6
NSSC Corrugating Medium 7.2
Recycled Paperboard 14.0
Construction Paper 3.5
Bleached Market Pulp 7.8'
Dissolving Pulp 3.8'
Printing/Writing Paper 18.8
Bleached Board and Bristols 8.3
Tissue 7.0
Newsprint and Uncoated Groundwood 8.1
Bleached Packaging Paper 2.1
Total (Excludes Specialty Papers) 98.7
1. Based on total pulp.
Source: American Paper Institute.
5. Cost models and dollar projections employ constant 1975 dollars, unless otherwise noted. This
assumes no "real" inflation relative to the general GNP deflator. If the paper industry
experiences real cost inflation, its price, capital, and financing requirements will be higher
than projected here. However, the studied regulations would not change the relative increase
in its cost-recovery price.
6. Chase Econometric's, May 17, 1976, Economic Growth Forecasts for the Council on Environ-
mental Quality were used as the bases for the demand and capacity forecasts. The industrial
production index and GNP series in the Chase forecasts reflect a mild recession in 1978-1979.
followed by four years of sustained growth to 1983. Chase Econometrics predicted average
annual growth rates of 4.3cr for GNP and 6.5rr for industrial production, 1976-1983. The
forecast of real GNP was very close to the 1976 actual and is also close to the Administration's
prediction for 1977 made in early 1977.
C. CONCLUSIONS
1. The analysis indicates that on balance, the economic impacts of the studied regulations on the
paper industry and on the economy as a whole are relatively small.
By 1983 the average paper price at the mill level will be about 6'V higher than the
1975 price ($292 per ton) as a result of the regulations. Relative price increases at
the consumer level will be less than the base paper price increases except for tissue
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which will equal the paper price increase of about 4.1%. As a result of the
regulations, consumers will pay about $10.50 more per capita annually for paper
products by 1983.
In the long run as a result of the studied requirements for new capacity, average
prices will be 8% higher than if the regulations were not in effect. This corresponds
to about $15 per capita at the consumer level.
A few products are likely to experience supply shortages through 1980, as is now the
case with coated printing papers. However, beyond 1980, if the current slow rate of
growth in capacity continues, and if the economy grows at the high end of the
predicted likely range, supply shortages may become more prevalent. Neither
current nor long-range shortages, however, can be directly attributable to the
studied regulations.
The demand for certain raw materials will continue to decline because of pulping
chemical changes to reduce air pollution loadings and costs; the impact on sup-
pliers of those materials will be mitigated, however, because most suppliers are
aware of this trend and are likely to cultivate other markets to offset declining sales
to the paper industry.
If all paper companies were to achieve BPT by 1977, the industry's external
financing requirements would reach a peak somewhat exceeding the industry's
previous share of total U.S. corporate financing. However, an effective stretch-out
of BPT expenditures to about 1980 (evidenced by the industry's reported and
planned expenditures) indicates that this peak will not occur. Moreover, assuming
the industry will space its capital expenditures evenly from 1978 to meet 1983
guidelines, its external financing requirements should not be difficult to obtain
since it will be well below the industry's historic share of total corporate financing.
However, the comparative difficulty particularly for small- to medium-sized firms
in raising expansion capital on top of meeting pollution control regulations will
contribute to the increasing concentration of larger firms in this industry.
Projected mill closures during the forecast period are about one-third of the
industry's normal attrition rate. In the near term, about 10 mills could close
because of 1977 water regulations. (Many closure situations are under judicial or
EPA review so the firms have not made a final decision to close.) The primary
employment associated with these mills is about 2,600 people or 1% of the current
employment of all studied sectors. The mills have a total capacity of 1,400 tons per
day or 0.7% of 1974 U.S. capacity.
After the 1977 deadline, an additional 17 mills could be financially unable to meet
1983 water standards. This impact is much less certain. First, the time horizon is
longer. Second, the analysis did not attempt to predict the effect of Section 301 (c)
of the 1972 Federal Water Pollution Control Act, which provides that if plants can
demonstrate serious financial hardship, they may be granted a variance from the
1983 water regulations. Primary unemployment could amount to 3,500 jobs or
about 1.6% of current employment for all studied product sectors. These 17 mills
have a total capacity of about 1,700 tons per day or 0.9% of 1974 U.S. capacity.
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The U.S. balance of trade is not likely to be affected significantly. U.S. mills
engaging in international trade generally have a large total cost advantage over
their foreign competitors and their relative costs for environmental controls will
increase only modestly through 1983. Thus, their total cost advantage will not be
reduced significantly.
2. The studied compliance costs and their impacts vary widely by process/product sector, size of
mill (economies of scale) and age (retrofitting problems). Table 1-2 indicates the prod-
uct/process sectors that as a result of higher costs or financing problems are likely to expe-
rience and/or cause economic impacts greater than the industry average in one or more
categories:
TABLE 1-2
PRODUCT SECTORS WITH ECONOMIC IMPACT(S)
ABOVE THE PAPER INDUSTRY AVERAGE
Product/Sector
Long-Run
Environmental
Price Effect1
Environmental
Closures
(% of 1974
Capacity)
Unusual
Financing
Problems
NSSC Corrugating Medium
Kraft Bag Paper
Kraft Linerboard
Bleached Board
Printing/Writing Paper
Tissue
16
10
10
8
6
Poor profit
prospects
nonintegrated
Poor profit
prospects
nonintegrated
Construction Paper
Bleached Paper Pulp
NE
NE
Age/obsolescence
of sulfite
process mills
Recycled Paperboard
Low profit
and growth
prospects
1. Prices are expected to be higher by these amounts (derived from new mill costs) than they would have been without
the studied regulations. They do not represent the incremental effect of going from the 1975 control levels to New
Source Performance Standards.
NE Not estimated.
Source: Arthur D. Little, Inc., estimates.
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D. KEY COST AND ECONOMIC IMPACT FINDINGS
In reaching the above conclusions,Arthur D. Little, Inc., considered the following facts and
analytical findings to be most relevant:
1. Costs of Compliance
By 1975, the paper industry had made substantial progress toward complying with existing
environmental regulations, but it still faces large capital expenditures to meet the studied
regulations from 1975 through 1983 (Table 1-3). Water effluent control will account for about 76c,c
of total direct capital costs for the studied regulations and thus will impose the heaviest financial
burden. Taken individually, average incremental costs to comply with air and OSHA regulations
are relatively small. Incremental capital costs to meet 1977 timetables are about 55c/c of total
direct costs.
The industry's recent and planned direct water and air emission control investments
reported by the National Council of the Paper Industry for Air and Stream Improvement
(NCASI) are lower than the annual rates implied by the Arthur D. Little, Inc, cost estimates.
This variance is caused by several factors:
Some effluent permits were based on interim guidance that was different from the
promulgated standards; affected firms are not required to "catch up" until after
their permit expires.
Certain mills may have found less costly ways to achieve 1977 standards than the
technology assumed for the compliance cost estimates.
Some mills plan to meet EPA requirements by tying into new municipal treatment
systems whose construction has been delayed beyond the July 1977 deadline.
A number of mills have not yet initiated treatment plant construction, which
makes it impossible for them to meet the 1977 deadline.
Water effluent expenditures for the industry represent about 80% of the total incremental
operating costs for the studied regulations. The incremental costs projected to 1977 will represent
65cr of the total increment, as demonstrated in Table 1-4.
For new mills, the capital component of compliance costs varies between $7 million and $27
million depending upon the mill's pulping process and its size (Table 1-5). On the basis of
projected industry capacity represented by each of the product sector cost models, the weighted
average cost of compliance is about 15% of the total capital cost for new industry capacity. New-
mill operating costs also vary widely, from $12 to $28 per ton.
New-mill costs of compliance (both capital and operating) are higher than existing mill
costs primarily because the latter reflect partial compliance by January 1975, the starting point
for this study. The new-mill regulations also generally are more stringent than those for existing
mill 1977 standards, but less, demanding than proposed 1983 guidelines (primarily because color
removal is excluded).
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TABLE I- 3
ESTIMATED CAPITAL COSTS FOR COMPLIANCE
($Million)
1975- 1977- Total
1977 1983 1975-1983
Direct Cost (Internal and
External Treatment)
Existing Capacity
Air 690 170 860
Water 2250 1410 3660
OSHA 320 80 400
New Capacity
Total Existing 3260 1660 4920
(2)
Air 30 120 150
Water 240 960 1200
OSHA 30 120 150
(1)
Total New 300 1200 1500
Existing and New Capacity
Air 720 290 1010
Water 2490 2370 4860
OSHA 350 200 550
Total Direct Cost 3560 2860 6420
Indirect Cost
(3)
Replacement of capacity retirements induced by effluent
control 623
Capitalized maintenance for equipment used in
environmental control 2014
Total Indirect 2637
TOTAL 9057 '
Notes: (1) To relate to the capital impact analysis ADL estimates that
1975 expenditures were $L/340 million; therefore, the direct
and total capital cost from 1976 to 1983 is $4,780 million
and $7,417 million respectively.
(2) Estimated on the basis of: a) mid-range capacity growth rate
(Ref Vol III, Table H-6B) which results in about 20 million
tons of capacity growth 1975-1983; and b)a 1975 average cost
for environmental control at 15% of the average capital require-
ment for replacement capacity ($500/annual ton).
(3) ADL estimates about 1.25 million tons of capacity retirements
primarily caused by the water regulations.
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TABLE 1-4
INCREMENTAL OPERATING COSTS FOR
EXISTING INDUSTRY COMPLIANCE1
(1975 Dollars per Ton)
Total EPA Water SIP Air OSHA Noise
1975-1977 11.10 8.40 1.80 .30
1978-1983 6.10 5.40 .40 1.20
Total 17.20 13.80 2.20 1.50
(1975 Average base price: $292 per ton.)
1. Includes capital recovery.
Source: Arthur D. Little, Inc., estimates.
Compliance costs vary widely among alternative pulping processes and different sizes of
existing and new mills. In tissue production, for example, compliance costs for a small mill
integrated to sulfite pulp are about three times those of a large mill integrated to kraft pulp
(Table 1-6).
Similar cost differences among other pulp and paper industry sectors account for most of the
variability in economic impacts, particularly price increases, mill closures and the ability to
obtain financing.
2. Price and Secondary Impacts
The long-term effect on the average paper price, 8%, is based on the impact of the studied
regulations on new mills. The studied water guidelines will account for 6% and the air and OSHA
noise regulations for the remaining 2%. The product sector averages vary from 4% to 16% with a
clustering in the 6-10% range. Note that the price effects cited above represent the total long-term
impact of the studied environmental regulations and not the incremental effect of going from the
1975 effluent level to NSPS.
The existing industry will require a smaller price increase (6%) to recover the incremental
cost of the studied regulations, because it is already in substantial compliance with the environ-
mental requirements for 1977. Long-term paper prices will increase about 12% without additional
environmental costs (assuming the industry maintains a 13% return on equity) because of the
higher costs of current new mills compared with those of typical existing mills.
Demand for paper products is relatively price inelastic; thus, the projected 8% long-run
environmental price increment will reduce potential consumption by 5%. This loss is equivalent
to one or two years of normal growth potential spread over at least the next six years.
Tight capacity is possible in 1977-1978 for printing/writing paper and could develop in 1982-
1983 for bleached board, printing/writing paper, NSSC medium, and kraft linerboard, if the
industry maintains its current rate of capacity expansion, and if the Chase growth forecast and
8
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TABLE 1-5
COSTS FOR TYPICAL NEW MILLS TO COMPLY WITH STUDIED REGULATIONS
Product Sector
Kraft Linerboard
Kraft Bag Paper
NSSC Corrugating Medium
Recycled Boxboard
Bleached Board
Bond Paper
Tissue (from Kraft)
Newsprint (Kraft/GW)
Newsprint (Deinked)
Bleached Market Pulp
(1975 Dollars)
Typical
Total Compliance Costs
Mill Capital
Capacity $MM %of Mill
(tons/day)
1000
230
ium 450
400
500
300
163
550
330
800
24.9
7.6
17.7
8.1
20.2
11.7
7.4
12.0
14.1
26.4
17
12
26
14
14
12
10
10
25
14
Opei
$/Ton
14.60
18.90
25.90
12.50
24.00
22.50
23.40
17.90
27.50
19.60
rating
% of Mfg
9
7
13
5
7
6
4
5
12
8
Includes capital recovery
SOURCE: Arthur D. Little, Inc., estimates
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TABLE I- 6
EFFECT OF MILL SIZE AND PULPING PROCESS
ON BAT WATER EFFLUENT CONTROL COSTS
( 1975 Dollars)
Bleached
Sulfite Bleached Kraft
Mill Size (tons/day)lOO 100 250 500
Capital Costs
$ (Million) 15.8 10.5 18.0 28.5
$/Annual Ton 158 105 72 57
Operating Costs ($/Ton) 2'
Operational 17.60 9.80 7.50 6.20
Capital-Related 19.10 12.70 8.20 6.90
Total 36.70 22.50 15.70 12.10
1
The cost increments are the additional costs beyond the industry's
average control costs at the end of 1974.
2
Includes capital recovery.
SOURCE: Arthur D. Little, Inc. , estimates,,
10
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the upper boundary of demand both materialize. If these shortages occur, they will not be caused
by plant closures since environmentally related closures represent only 1.2% of the industry's
1982 capacity. Nor will they be caused by the capital requirements of the studied regulations per
se because the industry's ability to expand capacity does not appear to be constrained by its
external financing requirements to comply with the studied regulations. During their formula-
tion, the regulations probably heightened management uncertainties, but historically there has
been no correlation between pollution control expenditures and increases in capacity.
With the exception of tissue, prices for consumer paper products and packaging will
increase by a lower percentage than will intermediate paper products. By 1983, however, the
average consumer will pay about $10.50 more per year for paper because of price increases
resulting from the studied regulations. Beyond 1983, when new mill costs will strongly influence
price, the per capita cost increment will rise to about $15 per year.
Saltcake suppliers to the paper industry are likely to experience the greatest secondary
impacts as their product continues to be replaced by caustic soda and sulfur in the interest of
reducing kraft mill sulfur emissions. The saltcake producers are certainly aware of this trend and
have successfully increased sales to other markets to offset losses in the paper industry market;
the impact hinges on their continued success in finding offsetting growth opportunities.
3. Mill Closures and Employment Impacts
Of 556 U.S. pulp and paper mills studied, 27 may close because of difficulties in meeting
pollution control requirements.1
Ten mills could close because of 1977 pollution control requirements. The resulting loss of
capacity, about 1,400 tons per day, would reduce the capacity for bleached paper grade market
pulp by 3%, printing/writing paper by 2.4%, tissue by less than 1%, construction paper by 1.5%,
and recycled paperboard by 1.1%. About 2,600 jobs, or slightly more than 1% of total current
employment of all studied product sectors would be lost. Total unemployment (primary plus
secondary) is estimated at 3,700 jobs.
If proposed, 1983 water effluent guidelines are adopted, an additional 17 mills, representing
1,700 tons per day of capacity, may also close. This impact would reduce the nonintegrated
printing/writing paper capacity by 2.6%, nonintegrated tissue by 3.39o, corrugating medium by
1.8%, construction paper by 1.5%, recycled paperboard by 1.1%, and newsprint by less than I'.V.
About 3,500 additional jobs would be lost, or about 1.6% of total current employment of all
studied sectors. Primary plus secondary unemployment from these closures is estimated to be
7,100 jobs.
Air pollution control requirements were considered in the mill screening phase and discussed in the industry
interviews, but water effluent regulations proved to be the most serious problem for the mills judged to be in
jeopardy of closure. No closures related to emission control are projected for kraft process mills, which face the
largest air pollution control expenditures. Also no mills were judged likely to close primarily as a result of the OSHA
noise regulations.
11
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4. External Financing Requirements
The flow of funds analysis indicates that over the eight-year period 1975-1982, the pulp,
paper, and paperboard sectors (exclusive of woodlands and converting operations) of the industry
will invest about $21.3 billion in 1975 dollars) in total capital equipment. Of this, about $7.4
billion represents direct compliance costs (by existing and new mills) plus replacement of
pollution-related closures; almost $6 billion is attributable to water effluent controls while the
balance is split between air and noise regulations.
To finance its investment requirements, the paper industry will need to raise about $4.5
billion in the capital markets, of which about $3.5 billion is attributable to the studied regu-
lations. About 77% of the external financing would have been required during 1976 and 1977 if the
EPA's original July 1977 water effluent deadline were to have been met using the compliance
costs employed in this study. The stretch-out of BPT expenditures to about 1980, which appears
to be taking place, will reduce the industry's high financing requirements in 1976 and 1977.
This level of external financing, compared to aggregate financing in the economy, does not
differ significantly from the share of total corporate financing successfully obtained by the pulp
and paper industry in the past. Therefore, there is no reason to expect that the industry's demand
for capital funds to comply with the studied regulations will divert capital away from capacity
expansion or place an insurmountable barrier in the way of compliance. While reasonable
variations in the major assumptions of the analysis would have a substantial impact on the total
amount of external financing over the period, they would not alter the qualitative conclusion that
compliance is financially feasible.
Although the projected financing requirements appear to be manageable for the industry as
a whole, certain firms undoubtedly will experience difficulties. In particular, small and medium
companies (especially the marginally profitable ones) are finding it difficult to meet the large
capital requirements for plant and woodlands that are necessary for even minimum expansion
increments on top of smaller, but continuing, pollution control expenditures. Thus, in com-
bination with plant and woodland cost inflation, capital requirements for pollution control are
diminishing the smaller firms' opportunities to expand, and hence, are helping to increase the
concentration of the large paper companies.
5. Balance of Trade Impacts
Increases in current U.S. environmental cost disadvantages versus Canada and Sweden (the
two largest world trade competitors) are projected through 1982; however, they are relatively
small and are offset by much larger U.S. cost advantages in wood, transportation, and tariff
protection. Thus, the studied regulations are not'likely to cause significant changes in the current
relative cost advantage of the average U.S. mill that exports unbleached kraft linerboard,
bleached kraft market pulp, and dissolving pulp the three largest-volume pulp and paper
products exported by the United States. Nor are U.S. imports of newsprint and bleached kraft
paper pulp (which account for nearly 80% of U.S. pulp and paper imports) likely to increase as a
result of environmental cost differences.
The analysis, therefore, indicates that there will be no significant impacts on the U.S. trade
balance as a result of the pulp and paper industry's compliance with the studied regulations.
12
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E. ANALYTICAL APPROACH AND LIMITATIONS
1. Industry Segmentation and Procedural Framework
The first major task was to disaggregate the paper industry into relevant process and
product sectors. Arthur D. Little then applied the compliance costs developed for 12 process-
related sectors to each of the industry's 13 major product groups. Of these, the 10 most important
sectors were selected for analyses of price and output effects, whereas all sectors were included in
the closure and capital sufficiency analyses.
Figure 1-1 shows the procedural framework used for estimating the various economic
impacts. It indicates the sources and uses of data drawn from outside the study, and the
interrelationships of the various inputs and analyses designed to assure consistency of results
throughout the study.
2. Process Economics Analysis
A process economics cost analysis was the foundation for all of the subsequent economic
impact analyses. Here, Arthur D. Little drew upon many sources of compliance costs data, e.g.,
the National Council of the Paper Industry for Air and Stream Improvement (NCASI), the
American Paper Insitute (API), the U.S. Department of Commerce (USDC), the EPA and their
consultants. Arthur D. Little modified the basic cost data to put it in a comparable timeframe
and to include consistent cost elements, and then applied the costs to the various product sectors
for use throughout the analysis. It also employed its data files and industry experience to develop
models of new and existing mills and used these to estimate price effects and capital requirements
for capacity expansion, and to ascertain the closure potential of selected groups of marginal mills.
The likelihood that new technology may reduce the compliance cost estimates was not
quantified. To this extent, therefore, the costs may be overstated. The accuracy of the aggregate
compliance costs, summed for each product sector, is: Air and Water Regulations +25%, -109o;
OSHA Noise Regulations +25%, -50%. The foregoing cost variability is within the accuracy of
other key inputs (e.g., projections of GNP, capacity, and cost of capital) used in the economic
impact analysis.
3. Price and Output Effects
An economic analysis provided price, output, and capacity projections for the aggregate
industry and each of its major product sectors. Process economics cost models for new mills were
employed to analyze compliance cost impacts using a discounted cash flow technique to arrive at
estimates of the long-run equilibrium price effects. These price effects were traced through
distribution channels for selected products to obtain representative consumer price impacts.
In addition to estimating long-run price effects, Arthur D. Little calculated for each product
sector and in aggregate the price increase necessary for existing mills to recover their increase in
average total cost resulting from compliance with the studied regulations. The flow of funds
analysis generated an estimate of the average price impact likely between 1976 and 1983 for the
projected mix of new and existing industry capacity.
Econometric models (i.e., demand and supply equations) for the industry and its key
product sectors were generated from historic price, production, and capacity data. The resulting
demand equations were used with Chase Econometric's May 1976, macro-economic forecasts to
13
-------
FIGURE I- 1
PROCEDURAL FRAMEWORK FOR
ESTIMATING ECONOMIC IMPACTS
STUDIED
REGULATIONS
COSTS
OF
COMPLIANCE
ANALYSIS OF PRICE
AND OUTPUT EFFECTS
- Econometrics
- DCF Models
- Cost Analysis
HISTORIC
PRICE, OUTPUT,
CAPACITY
CAPACITY
EXPANSION
COMMITMENTS
PRICE,
OUTPUT,
CAPACITIES AND
SECONDARY IMPACTS
- Screening
- DCF Models
ECONOMIC
FORECASTS
(CHASE)
LOSURE
AND
EMPLOY-
MENT EFFECTS
CAPITAL SUFFICIENCY
ANALYSIS
- Project
Requirements
- Funds Flow
Model
CHARACTERISTICS
EXTERNAL
FINANCING
REQUIREMENTS
COMPANY
FINANCIAL
STATEMENTS
IMPORT/EXPORT
IMPACT
ANALYSIS
BALANCE
OF
TRADE EFFECTS
PRODUCTION/
ISTRIBUTION COS
IN COMPETING
COUNTRIES
POLLLUTION
CONTROL COSTS
IN COMPETING
COUNTRIES
C j Exogenous to Study
Analysis
Result
-------
project demand to 1983. The paper industry's announced commitments for new capacity through
1979, and Arthur D. Little's estimates of capacity expansion from 1979 to 1983 (both adjusted by
the results of the mill closure analysis) were linked with the demand projections to arrive at
capacity utilization forecasts. The forecasts from the aggregate industry model were then used in
the capital financing analysis.
The long-run equilibrium price effects of the studied regulations were based upon a 10% cost
of total capital to the pulp and paper industry. Sensitivity analysis on this variable indicates that
the relative impact of the studied regulations is not sensitive over the cost of capital range of 7.5-
12.5%. The relationship between the long-run baseline price (assuming none of the studied
regulations existed) and the 1975 market price is more sensitive. The baseline price ranged from
2% to 22% over the range of 7.5 to 12.5% in cost of total capital.
The demand forecasts are subject to several uncertainties: historic relationships between
paper consumption and price could change; product substitution technology may change; Chase
Econometric's economic forecasts may not materialize; and the demand equations themselves
have an uncertainty range. Since only the last two sources of uncertainty can be quantified, only
they were included in the sensitivity analysis.
4. Mill Closures and Employment Effects
In the mill closure analysis, a number of estimating problems had to be addressed: dis-
tinguishing environmental causes from other factors that could lead to future closures; different
decision criteria for various types of owners; and wide variations among the mills themselves. To
address these complexities, Arthur D. Little developed a method that involved: (1) screening
each mill in the studied product/process sectors to identify mills that may have difficulty in
complying with environmental regulations; (2) interviewing the management of 143 questionable
mills to gain perspective on their closure potential; and (3) financial analysis of selected cate-
gories of mills identified as having closure potential. This approach led to estimates of the
number of mills, the amount of capacity and the employment that are likely to be impacted by
the studied regulations.
Since closure methodology was designed to estimate overall paper industry closure impacts,
each mill within the studied product/process sectors was not specifically analyzed in sufficient
depth to predict whether it in particular is likely to close. However, the results provide an
estimate of overall impact for each sector. Also, the majority of mills that were found most likely
to be severely impacted by environmental regulations already are marginally profitable; thus, it
was difficult to clearly distinguish environmentally related closures from closures that would
have occurred in any event.
5. External Financing Requirements
The external financing analysis was based on a flow-of-funds model of the pulp, paper, and
paperboard sectors of the industry developed by Arthur D. Little. The model does not independ-
ently forecast sales margins; instead it assumes that over the period 1976-1983, the industry will
continue to pursue its traditional financial policies and to price its products consistent with the
demand schedule it faces to achieve its required rate of return (i.e., cost of equity capital). Major
inputs were the projected costs of equity capital, composite financial statements for 32 major
companies whose business activities are highly concentrated in primary pulp and paper produc-
tion, announced industry commitments for future capacity expansion through 1979, Chase
15
-------
Econometric macro-economic forecasts, demand forecasts from the econometric models, esti-
mates of the level of capital investment for capacity expansions and projections of the capital
costs for compliance with the studied regulations. The model balanced the industry's capital
requirements against its cash flow and estimated the timing and magnitude of the residual
external financing requirements. To lend perspective, the analysis compared the paper industry's
projected share of all corporate external financing with the historic trends.
The fact that the model does not reflect the financing requirements of the entire paper and
allied products industry in no way invalidates the results, since comparisons of projected require-
ments with historical experience also excluded converting and woodlands investment.
Industry operating rates projected in the analysis were somewhat lower (80-90%) than those
which obtained (85-95%) until recently. To the extent that the industry expects to run at higher
operating rates than those projected, its rate of capacity expansion will decline and its demands
for investment funds will be lower than those projected here.
The analysis employs the usual equilibrium assumption in both product and capital mar-
kets, which in a dynamic economy is an objective sought but never exactly achieved. Therefore, it
is to be expected that over the years the paper industry's actual performance will fluctuate about
the forecast values.
6. Balance Of Trade
The import/export impact analysis compared projected environmental costs in the United
States with those of major countries competing in pulp and paper trade. Then it evaluated what
changes the cost differences are likely to cause in current intercountry production/distribution
cost structures. At present, U.S. mills have cost advantages in marketing the major import/export
products. Thus, if environmental costs were to change this cost advantage significantly, the U.S.
balance of trade also would be affected.
The study analyzed major products which in 1974 accounted for 799c of U.S. imports and
45rr of U.S. exports of pulp and paper products. Small-volume products were excluded since they
typically face relatively high tariff barriers and therefore are less sensitive to environmental cost
differentials. Moreover, if some of these products were to be affected, the tonnage involved would
have little effect on the U.S. trade balance.
Intercountry production/distribution cost differentials included only items whose cost dif-
ferences most significantly affect total delivered costs: wood, transportation, and duties. To the
extent that aggregate costs for other factors of production also vary, estimates of U.S. competitive
advantages could change; rapidly rising labor costs in other countries currently are increasing the
competitive advantage of U.S. mills.
The analysis assumes that U.S. mills will maintain their approximate current six-year lead
time (in implementing water, air, and noise controls) over their counterparts in key competing
countries; the projected environmental cost differentials would change to the extent that this lead
time changes or the proposed 1983 water effluent guidelines change.
16
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7. Other Studies Examined
Arthur D. Little reviewed the following studies related to future costs and economic impacts
of the paper industry's compliance with various environmental regulations to familiarize its
project members with the analytical techniques employed and conclusions reached:
"Economic Impacts on the American Paper Industry of Pollution Control Costs,"
by URS Research Company to the American Paper Institute, September 1975.
"Capabilities and Cost of Technology Associated with the Achievement of the
Requirements and Goals of the Federal Water Pollution Act Amendments of 1972
for the Pulp and Paper Industry," by Hazen and Sayer, Inc., to National Commis-
sion on Water Quality, March 1975.
"A Pilot Study on Measuring the Economic Impact of Water Pollution Abatement,
Pulp, Paper, and Paperboard Mills, SIC 2611, 2621, 2631" by National Bureau of
Economics Research to the National Commission on Water Quality, June 1975.
"Capacity Creation in the Basic Materials Industry, Preliminary Draft by Barry
Bosworth, Brookings Institution, August 1976.
"Price Increases and Capacity Expansion in the Paper Industry," Council on Wage
and Price Stability, December 1976.
"The Environmental Regulation Impact Study on the Pulp and Paper Industry,"
draft report by U.S. Department of Commerce, December 1976.
17
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CHAPTER II
INDUSTRY DESCRIPTION
-------
II. INDUSTRY DESCRIPTION
This chapter describes the economic and financial characteristics of the pulp and paper
industry that were considered relevant in the economic impact analyses which follow.
A. CHARACTERISTICS OF THE PAPER AND ALLIED PRODUCTS INDUSTRY
The pulp, paper and paperboard product sectors that are the subjects of this analysis are the
primary product production components of the paper and allied products industry, which also
encompasses timber sales and paper/paperboard conversion to end products.
With sales of about $32 billion in 1975, the total industry ranked tenth among the 15 major
U.S. manufacturing industries and accounted for about 4% of the total shipment value of U.S.
manufacturing output. This industry includes the manufacture of pulp (from wood and other
fibrous raw materials), and paper and paperboard (from pulp and wastepaper), and conversion of
the latter into end products such as boxes, stationery, and sanitary tissue. In 1975, the industry
employed 643,000 people or 0.8% of the total U.S. working force (3.7% of manufacturing industry
employment) and had total assets at book value of $28 billion.
The industry generates about 45% of its own heat and power requirements. Nevertheless, it
is the third largest purchaser of electricity and fuels among all U.S. industries and in 1974
accounted for about 10% of total industrial energy purchases.
The industry was the fourth largest user of water according to the latest available data (1972
Census), accounting for roughly 17% of the water consumed by manufacturing establishments
that year. Most of the paper industry's water use is for processing of wood pulp and as the
medium for carrying the pulp to produce paper and paperboard. In contrast, most water use in
other manufacturing industries is for cooling and boiler feed where the water is not intermingled
with the product and the pollution problems are therefore mitigated.
The paper industry employs a relatively high ratio of capital per dollar of sales. With its
sales-to-assets (book) ratio of 1.14 in 1975, the paper industry is the fifth most capital intensive
among the 15 U.S. industries (Table II-l). This measurement, however, understates the true
asset size of the paper industry. Many companies carry substantial timberland properties on their
books at original purchase prices, which are well below present market value.
Vertical integration is the prevalent corporate structure in this industry. About 72% of
current U.S. pulp, paper, and paperboard production comes from mills that are integrated in
three tiers: 1) control of a portion of the woodlands required for their wood supply, 2) pulping,
and 3) paper and paperboard production operations. Paper and paperboard mills which are not
integrated to pulp or woodlands operations supply the remaining 28% of industry production.
However, many of these, as well as most of the integrated mills are forward integrated to paper or
paperboard converting operations such as stationery, tissue and boxes. Thus the typical paper
company is integrated to three or four levels.
Considering its capital intensiveness and the apparent advantages of vertical integration,
this industry is relatively fragmented in terms of the number of companies and number of plants
that operate within it. In 1974, approximately 410 companies operated 718 pulp, paper,
paperboard and building paper mills or mill complexes. The converting sectors of the industry are
even more fragmented. The degree of concentration varies considerably among the industry's
primary product sectors, as described in Volume II. There has been no pronounced historic trend
toward increasing concentration for the aggregate production of pulp, paper, and paperboard.
19
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TABLE II-l
SALES TO ASSETS RATIOS FOR PAPER AND OTHER MANUFACTURING INDUSTRIES. 1975
Sales/Assets
Petroleum and Coal Products 1.00
Primary Metals 1.02
Instruments and Related 1.07
Chemicals and Allied Products 1.10
Paper and Allied Products 1.14
Machinery Except Electrical 1.16
Stone, Clay and Glass Products 1.24
Printing and Publishing 1.26
Rubber and Miscellaneous Plastics Products 1.31
Electrical and Electric Equipment 1.32
Transportation Equipment 1.40
Textile Mill Products 1.50
Fabricated Metal Products 1.56
Food and Kindred Products 2.12
Tobacco 2.54
Ratios are based on data for the fourth quarter of 1975, assets are at
book value.
SOURCE: Federal Trade Commission, Quarterly Financial Report for
Corporations.
20
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In 1975, the United States accounted for about 35% of the world's production and 37% of
total world consumption of paper and paperboard products. Thus, while the country is a large
exporter (mainly pulp and kraft linerboard), on balance it is a net importer, primarily because of
the large amounts of newsprint and pulp it imports from Canada.
B. DEFINITION OF INDUSTRY SECTORS TO BE ANALYZED
1. Aggregate Industry Subdivisions
This analysis focuses on certain sectors of the paper industry that involve the production of
pulp and primary paper and paperboard products. The processes employed generate substantial
amounts of water and air pollutants; to meet the requirements of Federal and state environmen-
tal regulations the companies already have invested large amounts of capital for control facilities.
Converting operations are included in the price and closure analyses only to the extent that
some converting (predominantly tissue) is usually done at the paper mill site; in these cases, the
employment and value added for converting are integral to the mill's paper production. All other
converting operations that are generally separated from the paper mills (such as containers,
boxes, and bags) were excluded. Converting operations generally have relatively minimal pollu-
tion problems and will be subject to a different set of effluent guidelines and regulations than the
paper and paperboard sectors.
Table II-2 provides an overview of all primary sectors of the pulp and paper industry in
terms of the latest available U.S. Department of Commerce data (1972). A total of 787 estab-
lishments with gross fixed assets of about $14 billion employed about 220,000 people to produce
products worth about $12 billion in 1972.' Thus, the value of shipments for the primary processing
sectors amounted to about half of the industry's total and the sectors accounted for about 30% of
the industry's employment.
The largest primary SIC subdivisions are paper mills and paperboard mills. Most of the
production in both these sectors comes from mills integrated to on-site pulp production. However,
many mills, particularly in the paper sector, are included that rely on purchased "market" pulp
and wastepaper for their fiber raw material.
The so-called "market" pulp mills specialize in either paper grade pulp, dissolving pulp, or
a combination of both. Paper grade pulp, an intermediate product, is sold primarily to non-
integrated or partially integrated paper mills. A substantial amount of market pulp also is sold by
pulp producers that are integrated to paper or paperboard.
In 1972, the total value of pulp shipped by all market pulp producers was $1.1 billion. Of
this, $658 million, or 58%, was shipped by plants in the pulp mills sector (SIC 2611) while the
remaining $442 million (42%) was shipped by mills classified as paper mills (SIC 2621) or
paperboard mills (SIC 2631).
1. These figures include 25 building board mills which are not considered as part of the paper industry in this study.
The USDC mill count is also higher than that used by Arthur D. Little, Inc., because of finer separation of
establishments in multimill complexes.
21
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TABLE H-2
MAGNITUDE OF ALL PULP. PAPER AND PAPERBOARD SECTORS - 1972
SIC Number of Number of Value of Gross Value3 Shipments/
Code Sector Establishments Employees Shipments Fixed Assets Assets/Ratio
($ million) ($ million)
2621 Paper Mills 358 130,000 6,400 7,600 0.84
2631 Paperboard Mills 276 68,000 4,100 4,400 0.93
2661 Building Paper 95 12,000 470 400 1.18
and Board Mills
2611 "Market" Pulp 58 11,000 690 1,600 0.43
Mills
TOTAL 787 221,000 11,600 14,000 0.83
a!971 data; 1972 data not yet available.
SOURCE: 1972 Preliminary Census of Manufactures U.S. Department of Commerce.
2. Process/Product Sectors Studied
For this impact analysis the primary pulp, paper and paperboard segments were subdivided
into the 12 process and product sectors shown in Table II-3. These process-oriented subcategories
were employed in EPA's water effluent guidelines study of this industry; they were chosen on the
basis of similar production and pollution loading characteristics. The 12 sectors include about 162
fewer mills than the total industry because the Guidelines and Impact studies exclude building
board and specialty paper mills. Following are summaries of the studied process/product sectors
which are amplified in Appendix A (Volume III):
The unbleached kraft process is employed almost exclusively to produce unbleached kraft
paperboard (primarily linerboard, the facing material for corrugated containers) and unbleached
bag, sack, and coarse papers. It produces high strength, relatively low cost packaging products.
NSSC corrugating medium is the inner fluting material used for corrugated containers. It
employs a high-yield, low-cost but weak pulp suitable for its role as a partition between two layers
of linerboard. This product is often made adjacent to a linerboard mill to minimize water effluent
costs by using a joint chemical recovery system.
Recycled paperboard is a product group consisting of paperboard made predominantly from
coarse recycled paper (e.g., newsprint, corrugated containers, cartons) that is not deinked or
bleached. Major products include folding boxboard, corrugating medium, linerboard, gypsum
wallboard facing, cardboard and specialty boards.
22
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TABLE II-3
PAPER INDUSTRY PROCESS SECTOR SUBDIVISIONS FOR EFFLUENT GUIDELINES ANALYSIS
Process Sectors
Unbleached Kraft
NSSC2
Unbleached Kraft and NSSC
Recycled Paperboard
Construction Paper
Bleached Kraft
Sulfite
Soda
3
Mechanical
De inked
Nonintegrated Tissue
Nonintegrated Printing /Writing
TOTAL
Number of Mills
End of 1975
29
18
10
160
70
80
28
3
22
35
59
42
556
Total Product
Capacity-19741
(1000 tons)
9,100
2,900
5,400
9,100
2,300
26.0002
4,300
300
2,500
2,300
1,700
2,400
68,300
4
Average
Mill Size
(tons/day)
900
460
1,540
165
95
925
440
285
325
190
80
160
Includes all products produced at mills.
"Includes one mill producing printing/writing paper; rest produce corrugating medium.
Includes chemi-mechanical mills.
r
Based on total mill products.
SOURCES: Lockwood's Directory of the Paper and Allied Trades-1976.
Arthur D. Little, Inc., estimates.
23
-------
Construction paper is produced mainly from coarse wastepaper although significant
amounts are also made from groundwood pulp. Its primary applications are roofing felt, under-
layment paper, and asphalt shingles.
The bleached kraft process is used to produce both dissolving pulp and paper grade pulp.
The latter is employed primarily in bleached paperboard, bleached packaging papers, newsprint
and groundwood specialty papers, tissue and printing/writing papers.
The sulfite process competes directly with kraft in the dissolving and paper pulp markets
and also in producing newsprint, groundwood specialty papers, tissue and printing/writing
papers. Sulfite is being displaced gradually by kraft.
A third chemical pulping process, soda, has been displaced almost completely by kraft.
Only three U.S. printing/writing paper mills now employ this process.
Several groundwood or mechanical pulping processes are used primarily to produce news-
print and both coated and uncoated groundwood papers. A minor application, molded pulp, has
been excluded from the analysis because water effluent guidelines have not been issued for this
sector.
Deinking of printed wastepaper is finding increasing use in producing recycled newsprint,
tissue and printing/writing papers. It is often the only feasible means for nonintegrated mills to
become at least partially integrated to pulping and thus reduce their fiber costs.
Nonintegrated paper consists of two product sectors: tissue and printing/writing papers that
are made primarily from purchased pulps. Nonintegrated mills which make coarse papers such as
bag and special industrial papers were excluded because water effluent guidelines have not as yet
been finalized for this sector.
Sixteen cotton [inter mills that produce pulp from cotton were also excluded from the
analysis because applicable water effluent guidelines have not been issued. Cotton linter or rag
pulp finds it major use in printing/writing and special industrial papers.
In sum, the analyzed process sectors include 78^'o of the industry's mills, and 93'ci of its
primary product production and employ about 267,000 people including workers associated with
converting tissue and printing/writing paper at the mill site.
3. Studied Product Sectors and Relationship to Process Sectors
While pollution control technology and costs vary with each pulping and papermaking
process, the impacts of the costs are primarily a function of the market characteristics of the
industry's products. The paper industry is made up of a number of subindustries built around
major product categories. For this analysis, the numerous product categories were aggregated into
10 paper/paperboard and two market pulp sectors. These were selected on the basis of: (1) having
common applications or markets, or (2) combining products customarily produced within a single
mill. Many of the product sectors use a variety of pulping processes. Table II-4 indicates the
relationships of the 10 paper/paperboard product groups to the pulping processes employed by
showing pulp consumption by type.
24
-------
TABLE II ~ 4
PROCESS/PRODUCT RELATIONSHIPS - WOODPULP CONSUMED BY TYPE, 1973
Pulp Type
Bleached Kraft
Unbleached Kraft
Bleached Sulfite
Unbleached Sulfite
Groundwood
Semi-Chemical
Dissolving
Soda and Other Woodpulp
Wastepaper
Other Fibers
TOTAL *
(Type of Pulp Consumed Divided
Newsprint & Un
Coated Groundwood
17.5%
Small
Small
5.1
66.3
Small
-
lulp Small
11.3
Small
Printing &
Writing Paper
54.6%
2.7
8.9
Small
6.3
3.2
Small
6.2
8.2
Small
Tissue
Paper
40.0%
5.5
20.8
1.5
3.9
2.3
Small
1.6
29.2
1,0
Bleached Board
And Bristols
100.5%
2,3
1.4
Small
Small
Small
-
Small
-
Small
by U.S. Product Production)
Packaging, Papers
Unbleached Bleached
7.8% 86.2%
94.6 7.7
7.4
1.8
Small
Small Small
Small
Small Small
2.3 Small
Small
Unbl. Kraft NSSC Recycled Const.
Paperboard Paperboard Paperboard Paper**
5.2% -% 3.9% -%
94.0 7.0 1.7
Small - Small
Small - Small
Small 1.1 3.0
69.1 Small Small
Small
1.1 - Small 33-; 0
2.9 23.5 107.3 72.0
Small 2.0
Specialty
Papers
51.2%
19.9
12.1
Snail
1.6
Small
2.7
1.8
28.2
22.3
103.8%
92. OZ
105.8%
106.9%
105.6%
105.6% 103.4%
100.4%
115.8%
110.0%
141.4%
*Excess over 100% primarily reflects fiber losses, while figure below 100% is due to coatings and other additives.
**Arthur D. Little, Inc., estimates.
SOURCE: American Paper Institute restructured data.
-------
The processes used to make the various pulp and paper products are directly related to the
types of pulp that best fit the desired product properties. Certain products are synonymous with a
particular process: e.g., unbleached kraft paper and paperboard, NSSC (neutral sulfite semi-
chemical paperboard and bleached kraft) board and bristols. The remaining product groups are
made by a variety of processes, and usually with a blend of different pulps.
Since process characteristics and costs vary considerably, this factor causes differences in
the cost competitiveness of various producers as well as in their costs for pollution abatement.
Table II-5 shows the 1974 U.S. capacity for the 12 product groups included in the analysis
and points up the leading positions of the unbleached kraft paperboard and printing/writing
paper sectors. Each sector is discussed separately in Volume II to illustrate its de-
mand/supply/price characteristics, export/import trends, price impacts, output effects and likeli-
hood that supply shortages will occur as a result of the studied environmental regulations.
C. HISTORICAL REGIONAL DEVELOPMENT
The U.S. pulp and paper industry began in New England in the 1880's with the devel-
opment of groundwood pulping, sulfite pulping, and papermaking to supply the growing paper
needs of the Northeast. The proximity of the expanding population centers to water and high-
quality softwood pulpwood resources in northern New England and New York State were key
contributors to this early development.
Gradually, however, the need for substantial wood supplies for pulping (as well as for
lumber and plywood) outstripped the resources of the Northeast. Many of the mills, particularly
those nearest the population centers, closed their pulping facilities and turned to purchased pulp,
or, in some cases, deinked wastepaper for their fiber requirements. The pulp and paper industry
moved its production base to the North Central States, then to the Pacific Northwest and finally
to the South as the population spread from the eastern seaboard.
The movement to the South in the late 1930's was prompted by the commercialization of the
kraft process, which enabled mills to use the resinous wood that grows there. The industry
flourished in that region because of the availability of low-cost wood, favorable timberland
acquisitions from defunct lumber companies during the depression, plentiful fossil fuel, and a
lower cost area for new industrial construction than in the Northeast. About 64% of the industry's
pulping capacity and 49% of its papermaking capacity are now located in the South (Figure II-l).
Because of this pattern of development, the older, smaller, nonintegrated and generally less
productive mills tend to be located in the Northeastern and North Central States, while the
newer, larger, and integrated mills are located in the South and Pacific Northwest. Table II-6
shows this regional distribution.
D. TECHNOLOGY AND PRODUCTIVITY TRENDS
Pulp and papermaking technology has been refined over many years of development.
Recent technology advances in this industry have been almost exclusively evolutionary refine-
ments (rather than breakthroughs), or adaptations of outside technology (e.g., computerized
process control) to the paper industry. Nevertheless, the refinements have significantly improved
pulp and papermaking technology and productivity. For example, theremo-mechanical pulp
provides quality advantages and cost savings over the conventional stone or refiner groundwood
26
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TABLE I1-5
PULP AND PAPER INDUSTRY PRODUCT SECTORS
Sector
NSSC Medium
Recyled Paperboard
Construction Paper
Bleached Market
Dissolving Pulp
Tissue
Groundwood2
TOTAL PULP
Number of U.S.
Suppliers
:t Paper
:t Paperboard
>ard
iper
: Pulp
I
iting
and Bristols
fncoated
2
;ing Paper
ling pulp)
tnd Paperboard
^20
30
30
^90
19
^25
8
74
21
51
^20
VL9
i
1974
000 Tons
4,389
13,965
4,430
8,680
2,165
3,711
1,824
11,613
5,155
4,322
5,002
1,291
61,012
61,881
47,540
Capacity
% Total
7.1
22.6
7.2
14.0
3.5
7.81
3.81
18.8
8.3
7.0
8.1
2.1
98.7
100.0
100.0
Based on total pulp.
2
Uncoated groundwood and bleached packaging papers were not included in
the econometric analysis.
3
Excludes insulating and hard-pressed board.
4
Excludes defibrated/exploded and screenings since products not
applicable for this.
SOURCES: American Paper Institute
Arthur D. Little, Inc., estimates.
27
-------
30
25
c
o
^ 20
c
o
C 15
o
10
Virgin Pulping Capacity
Papermaking Capacity
\ ^\
/-'v
\~ ^ \
V-
-
\ /
/\
Northeast North Central South Pacific Northwest
Source: "Paper/Paperboard/Wood Pulp Capacity," API - 1975-1978
All grades of paper and paperboard.
FIGURE II- 1 YEAR-END CAPACITIES FOR VIRGIN PULP
AND PAPERMAKING, BY REGION - 1975
28
-------
TABLE II-6
REGIONAL DISTRIBUTION OF U.S. PULP AND PAPER MILLS - 1975
(numbers of mills)
Sector
Unbleached Kraft
NSSC
Unbleached Kraft and NSSC
Recycled Paperboard
Construction Paper
Bleached Kraft
Sulfite
Soda
Ground wood
De inked
2
Nonintegrated Printing, etc.
Nonintegrated Tissue
TOTAL
Northeast
0
2
0
60
16
11
4
1
10
14
19
33
170
North Central
1
10
0
53
16
7
11
0
7
15
19
11
150
South
25
5
7
28
29
47
1
2
1
1
2
12
160
West
3
1
3
19
9
15
12
0
4
5
2
3
76
Total
29
18
10
160
70
80
28
3
22
35
42
59
556
Includes Chemi-Mechanical mills.
?
Excludes cotton fiber mills.
SOURCES: Lockwood's Directory of Paper and Allied Trades -1975. Industry Sources.
-------
processes. Almost every major paper machine component (particularly the headbox, and wire)
has been improved recently. In addition, a number of chemical pulping processes are also under
development which offer potentially higher pulp yields or lower pollution loadings than the
conventional kraft and semi-chemical processes.
Most mills reinvest or periodically "rebuild" components of their pulping and papermaking
equipment. In these rebuilds, the bottlenecks to higher production rates are replaced with more
productive equipment. Thus a typical mill usually continues to improve productivity until the
mill is too obsolete to warrant further investment.
Technical developments, coupled with rebuild programs and increasing scale of operations
for new and expanded mills and closures of less efficient facilities, have improved paper industry
productivity at a relatively steady rate. According to Bureau of Labor Statistics, the industry
average productivity increased about 4.5% per year between 1960 and 1969 and 3.9% per year
between 1969 and 1974 (reflecting growth between years with comparable capacity utilization
rates).2 The industry's rate of productivity improvement will probably continue to decline
because of slower demand and capacity growth and a peaking of new mill sizes. However,
continued technology refinements and perhaps some future breakthroughs should improve pro-
ductivity at least at a modest rate.
The paper industry on average spends about 0.8% of its sales revenues on research and
development, split about equally between product research and process development. In addi-
tion, paper companies obtain important R&D support from suppliers of process equipment and
chemicals.
The industry's process research is heavily oriented toward projects that are directed primar-
ily at reducing air and water effluents (and hence control costs) from pulping and papermaking
processes. Often these research projects also reduce production costs. For example, 14 of the 17
recent significant process developments reviewed in Appendix C (Volume III) are aimed primar-
ily at reducing air or water effluents.
E. ECONOMIC CHARACTERISTICS
This section addresses the salient characteristics of demand, supply, prices, and general
competitive characteristics of the pulp and paper industry that were considered in the economic
impact analysis.
Demand
As a whole, pulp and paper is a mature industry. Total demand for its products has grown at
only about the same rate as the GNP in real terms. In fact, only a few product sectors are growing
faster than GNP. The industry's growth appears to be gradually declining below the GNP rate
because prices have increased rapidly of late, the full per-capita consumption potential has
almost been attained and some competing products have substituted. At the same time, entry to
the industry and expansion of capacity are becoming more difficult. Thus its capacity expansion
rate is more likely to also be slower and paper prices more likely to rise at least as fast as the
general inflation rate.
2. Labor costs, however, represent only about 15% of the total costs of the pulp, paper and paperboard industry
segments.
30
-------
U.S. per capita consumption of paper and paperboard products is significantly higher than
that of any other country. In 1975, for example, U.S. annual per capita consumption was 524
pounds: the next closest country was Sweden at 490 pounds and Canada was third at 350 pounds.
Per capita consumption in the underdeveloped regions is well under 100 pounds.
Few substitute materials compete directly with paper and paperboard products. The excep-
tional products primarily affected are tissue, bleached paperboard and both unbleached and
bleached packaging papers. Tissue products have displaced reusable cloth towels, napkins and
handkerchiefs, in achieving their relatively high rate of growth in the 1950's and 1960's. The
growth rate of bleached paperboard has diminished primarily because of substitution by plastic
packages for milk and other dairy products and in disposable plates, cups, and trays. Unbleached
and bleached packaging papers have been growing very slowly, primarily because of substitution
by polyethylene and other plastic films.
On the raw materials side, bleached market pulp competes with the cleaner "pulp sub-
stitute" grades of wastepaper, primarily in the production of printing and writing papers and
tissue. It also competes to a limited degree with cotton fibers in certain high-quality writing
papers. There are no direct substitutes for dissolving pulp, but 70% of its output is consumed in
cellulosic fibers and cellophane, which compete strongly with fibers and films derived from
petroleum products.
Historically, paper prices actually declined relative to the wholesale price and GNP deflator
indices during 1960-72. This decline probably stimulated demand and the consumption correla-
tion with GNP might not have held had real paper prices risen. However, this stable price pattern
changed dramatically in 1973. The 18-month period from mid-1973 through year end 1974 saw an
average increase (in current dollars) of 37% for pulp and paper products compared with 27% for
the wholesale price index. Prices of a number of individual pulp and paper products increased by
well over 100%.
It is generally believed that demand for most of the industry's products is relatively
insensitive to price changes. Key supporting factors are that few substitute products compete
directly with paper and that direct or indirect expenditures on paper products represent a small
portion of the consumer's total disposable income.
The econometric analysis in this study confirmed that the demand for paper is price
inelastic. The average percent reduction in demand due to a price increase is about two-thirds of
the percent price increase relative to the GNP deflator. This estimate is based upon price,
demand, and U.S. economic trends from 1968 through 1975. It is possible that the effects of the
unprecedented rapid price increases that occurred in 1973-74 have not yet been reflected fully in
the subsequent consumption data and that the long-term price elasticity of demand will be higher
than the present estimate.
Supply
Short-term supply potential in this industry can be measured by annual published capacity
data for each major product group and for nearly every pulp and paper mill. The product group
data are derived by the American Paper Institute (API) through annual surveys of current
capacity and planned expansions of all pulp and paper manufacturers. These surveys provide
reasonably accurate capacity projections for the next three years. Thus, the data can be com-
pared with the industry's current and projected production data to indicate average mill oper-
ating rates in each sector.
31
-------
The API defines "practical maximum capacity" as the tonnage of paper, paperboard, or
pulp of normal commercial quality that could be produced with full use of equipment and
adequate supplies of raw materials and labor, assuming full demand. No allowance is made for
losses due to unscheduled shutdowns, strikes, temporary lack of power, etc., which decrease
actual production, but not production capacity. The capacity of paper machines which produce
more than one grade is apportioned in accordance with actual production patterns and plans for
future operation.
As a result of the unscheduled production losses noted above, few product sectors can
operate at full capacity over a full year. For most sectors, full annual operation means a 95-96%
operating rate. Chief exceptions are dissolving pulp and bleached board, where the producers
report capacity more conservatively and thus have attained 100% annual operating rates.
The short-term supply curves in this industry are nearly horizontal and then rise very
steeply as production costs increase when the mills are run continually at higher operating rates.
To increase production some mills can simplify their product line and emphasize heavier weight
products, but there are few other opportunities. Pulp and paper mills are run on a three-shift
basis because of the time and costs associated with mill shut-downs and start-ups. For the same
reason, most mills run on a seven-day-per-week basis, although some of the smaller mills
(typically those that are not integrated to pulp) run on a five-day-per-week schedule.
Paper machines and pulp mills require a certain amount of maintenance down-time. This
time is scheduled throughout the year and factored into the capacity rating for each mill. When
the industry is straining to meet demand, a certain amount of maintenance down-time can be
foregone, temporarily, but this leads to machine breakdowns that cause production losses and
require the use of overtime maintenance labor.
There are essentially three methods for increasing capacity over the longer term: in-
cremental expansion of existing mills, installation of new paper machines, or construction of new
mills. An incremental expansion is usually less than 50% of the original plant capacity and takes
one to two years to complete once plans have been laid. This expansion route typically costs about
half of a new mill's investment per ton of capacity because most support facilities are already in
place. Construction of new mills typically takes three to four years once financing has been
arranged and the necessary environmental clearances obtained. New-mill lead times, after
preliminary planning, are typically 3-6 years. In the 1960's, the lead time was 2-4 years. The
longer time has increased the uncertainty in planning for and investing in new mills and thus had
an inhibiting effect on capacity expansions. New-mill costs recently have been rising at 10-20%
per year and in 1975 typically were $150,000-200,000 per daily ton of capacity.
Table II-7 compares pulp, paper and paperboard mill capital expenditures with their net
annual capacity expansions since 1965. The comparison indicates that since 1965 the industry has
been able to increase capacity an average of 3.3% per year while its net plant expenditures
(excluding pollution control equipment) have declined by about 2% per year (in current dollars)
despite a high capital goods inflation rate. This apparent anomaly was caused by a dramatic shift
to capacity expansions via additions to existing mills. In 1968, for example, new mills contributed
49% of the net capacity increment compared with only 7% of the expansions committed for 1976-
1978.
32
-------
TABLE II-7
CAPITAL EXPENDITURES AND CAPACITY EXPANSIONS FOR
ALL PULP, PAPER AND PAPERBOARD MILLS, 1965-1976
(Current Dollars)
Total Capital Pollution Control Net Plant Net Paper & Paperboard Capacity
Expenditures^ Component^ Expenditures Increase Over Preceding Year^
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
Avg. Annual
Growth (%)
$ MM
827
961
1122
766
878
882
755
841
998
NR
NR
2.2
$ MM
50
65
76
93
128
187
203
339
351
523
645
621
25.7
% of Total
6.0
6.8
6.8
12.1
14.6
21.2
26.9
40.3
35.5
~
$ MM
111
896
1046
673
750
695
552
502
637
-2.1
M Tons
1,823
3,337
2,569
2,262
2,131
580*
1,750*
2,861
1,785
1,305
1,006
1,371
% of Total
3.9
6.9
5.0
4.2
3.8
1.0
3.0
4.7
2.8
2.0
1.5
2.0
3.3
*
Unusually large number of mill closings significantly reduced net expansions in 1970
and 1971.
NR - Not yet released.
SOURCES: "TJ.S. Department of Commerce, Annual Survey of Manufacturers.
2
National Council of the Paper Industry for Air and Stream Improvement, Inc.,
Special Report No. 76-05.
3
American Paper Institute - Paper, Paperboard, Wood Pulp Capacity.
33
-------
The table also shows the very rapid increase in expenditures for pollution control facilities
that occurred as the industry made substantial efforts to comply with existing state and Federal
requirements. Some capacity was expanded and chemical and energy saved by these expendi-
tures, but such economic benefits were generally small and incidental to their primary purpose of
reducing air and water effluents. While the industry's net plant expenditures declined as pollu-
tion expenditures rose, this does not necessarily imply a direct trade-off. Many other factors
exerted an influence in reducing plant investment over this period.
Other factors that have contributed to the slowdown in net plant expenditures, particularly
since 1967, include a growing scarcity of new or expandable mill sites that have an economic
supply of wood, price controls, and management uncertainty over future economic cycles, govern-
mental regulations, energy supply and cost inflation. As a result of these factors, fewer and fewer
firms have available mill sites and the financial and woodland resources needed to make major
capacity expansions.
The rising capital requirements for new mills coupled with the practical difficulties of
finding enough suitable supporting woodlands to acquire or lease has limited the number of firms
that are now able to finance major capacity expansions. Most major expansions are now being
made by the large, well-capitalized firms that have already obtained substantial woodland
ownership or control at prices considerably below today's market values.
Tables II-8 and H-9 show how capital requirements changed between 1965 and 1974, using
as examples linerboard and bleached kraft pulp mills, the most capital intensive of the industry's
product sectors. Over this period, the minimum economic mill size has nearly doubled and the
investment per annual ton of capacity has more than doubled. Selling prices also have more than
doubled so the mill investment-to-sales ratio increased only modestly. However, when the
investment required to provide what is considered a minimum level of woodlands ownership
coverage is added, one finds that both the total capital requirements and the investment per
dollar of sales have escalated significantly.
Capacity expansion via mills that are not integrated to pulp is now virtually nonexistent,
primarily because of low profitability. The present producers are caught in a squeeze between
paper prices established by integrated producers and the costs for bleached market pulp, the
price of which has escalated more rapidly than that of all other paper industry products.
The above trends also reduced the entry of new firms into the pulp and paper industry. The
primary entry route for companies outside this industry is by acquisition of existing pulp and
paper companies rather than by grassroots investment.
All of the above factors point to a slower rate of capacity expansion in the paper industry
and increasing market concentration among the largest firms that have the resources to make
major expansions. Pollution control regulations probably contribute to the increasing concentra-
tion trend because the larger firms generally will have greater financial ability, both to retrofit
their existing mills to meet pollution regulations and to make large capacity expansions.
Prices
Comparison of the wholesale price indices (current dollars) for paper/paperboard and for all
commodities since 1963 reveals that, until 1973, the paper price indices demonstrated a general
34
-------
TABLE II-8
KRAFT LINERBOARD MILL CAPITAL REQUIREMENTS
IN 1964 AND 1974
(Current Dollars)
1964
1974
Sales
Size of Mill
Price (End of Year)
Annual Sales
700 TPD/238,000 TPY
$110/Ton
$26 MM
1,000 TPD/340,000 TPY
$195/Ton
$66 MM
Mill Investment
Investment per Annual Ton
$ Investment per $ Sale
$40 MM
$168
1.5
$135 MM
$397
2.1
Land Investment
Acres Required for
100% Coverage1
Acres Required for
20% Ownership
Cost of Land per Acre
Total Land Investment
420,000
84,000
$200
$17 M
510,000
102,000
$1,000
$102 M
Total Investment for Mill & Land $57 MM
$ Investment per $ Sales 2.2
$237 MM
3.6
1-1/2 Cord per. Annual Ton; 1.2 acres per cord in 1964.
1-1/2 Cord per Annual Ton; 1 acre per cord in 1974.
Source: Arthur D. Little, Inc. estimates
35
-------
--J.y.i'JI. ;:'..< \ <\ L' ' -
Size of Mill
Price (End of Year)
Annual Sales
450 TPD/150,000 TPY 800 TPD/27 O.C'OO TPY
S14.r;/Ton $335/Ton
$22 MM $90 MM
HLil lnves_tjrnent;
1 iwestmerit per Annual T.-.II
v Investnoiit t-'er $ Sal.o
$40 >FM
1.8
$170 MM
$630
1.9
!'.:ind_ 1 iivosti.ient.
\crcs Required for
li)0% Ccverage-'-
A;:rc.s Rei|u.i rnd for
20% Ownership
Cost: of Land per A-.:re
i'ot:ii Land IIIVPUtir.ctir.
$200
$ 1 r> MM
540,000
108,000
$1,000
$ 108 MJ!
Total Investment inr Mill c, I.an.l G5' MM
$ .Investment per $ Sales
$278 MM
3.1
J.
2 Cords per Annual Ton; 0,8 rords per acre in 1964.
2 Cords per Annual Ton; 1 cord per acre in 1974.
\r t.h;i r I;. :. i i ! i t , I ii: . , r-s ! i 1:1:11 t-
36
-------
pattern of stability and rose more slowly than the all-commodity index (Figure II-2). In deflated
dollars, paper/paperboard prices declined by 19% and all commodities by 14% between 1960 and
1972. Between 1973 and 1975, however, both indices, but especially the paper/paperboard index,
rose faster than the general inflation rate.
The relative stability and modest increases in nominal pulp and paper prices in the 1960's
and early 1970's can be explained by a combination of factors. The slow rate of increase can be
attributed to the fact that capacity was rapidly expanded, causing several cycles of oversupply,
and prices were held down as producers tried to expand their market share, increase volume and
more fully utilize their woodlands, large acreages of which had been acquired recently. Also,
primarily as a result of economies of scale, the addition of new capacity and the improvement or
replacement of old facilities, the industry was able to improve productivity by about 4.5% per
year, which helped to stabilize costs. Finally, the industry experienced only a modest rate of cost
inflation for raw materials and energy because both were in ample supply in the 1960's.
Just the opposite set of conditions led to the very rapid price increases in 1973 and 1974.
First, the industry's rate of productivity increase dropped to 3.9% per year in the early 1970's as
its rate of capacity expansion decreased sharply and as new-mill economies of scale reached
practical limits. Second, raw material, energy and labor costs began to inflate at a much faster
rate than in the past, but could not be passed on through price increases in the weak markets and
low mill operating rates of 1970-1972. When most pulp and paper markets rebounded strongly in
1973, prices started to climb, but the increases were held in check by Federal price controls. Then
as demand continued to grow and approached the industry's practical maximum capacity in
1974, price controls were lifted partially in March and fully in July. This, coupled with capacity
constraints, caused the industry's prices to surge, not only absorbing the cost inflation the
industry had been unable to pass on since 1969, but also bringing profit margins to a post-World
War II high.
Figure II-3 shows that the relationship between average paper industry prices and capacity
utilization rates (a surrogate for supply/demand equilibrium) is imperfect. This imprecision is
caused partially by the fact that the paper/paperboard price index employs list prices for a
number of large commodities which do not reflect the full amplitude of true market price swings.
The econometric analysis in this study utilizes actual market prices for the major product sectors.
However, even these prices do not track closely with capacity utilization. This indicates that the
industry is not perfectly competitive and/or that the other causal factors discussed earlier mask
the price/capacity utilization relationship.
Price leadership has been noticeable in several of the more concentrated product sectors.
The North American newsprint industry exhibited the most clear pattern of price leadership. The
dominance and concentration of the Canadian industry has had an important influence since
Canada supplies about two-thirds of U.S. demand. John Guthrie3 has documented the newsprint
price changes that have occurred between 1950 and 1970. His data indicates that price changes in
this period were initiated by six Canadian and U.S. companies.
3. John A. Guthrie, An Economic Analysis of the Pulp and Paper Industry, Washington State University Press, 1972.
37
-------
190
170
OJ
oo
Q 150
(O
T3
C
o.
-------
100
c
o
Paper & Paperboard
tion
90
80
70
1965
1967
1969
1971
1973
1975
1977
Paper & Paperboard WPI
170
150
o
Q
X
0)
T3
130
110
90
1965
1967
1969
1971
1973
1975
1977
FIGURE 11-3 PAPER & PAPERBOARD WHOLESALE PRICE INDEX AND
UTILIZATION OF CAPACITY
39
-------
Like newsprint, paper grade pulp supply is relatively concentrated, and Canadian produc-
ers currently supply about 60% of U.S. requirements. The dissolving pulp market has the
characteristics of a bilateral oligopoly (few suppliers sell to a small group of buyers) and
transactions are made through long-term contracts which tend to stabilize prices. List prices for
paper grade pulp also appear stable, but actual prices are more volatile than dissolving pulp's
since there usually is considerable discounting under list prices during weak markets and a
greater incidence of premium spot prices during tight markets. During the U.S. price controls of
1973-1974 and continuing through the weak markets of 1975-1976, Canadian producers were able
to price considerably above most U.S. mill prices because of their generally better pulp quality
and their large share of the market.
With the possible exception of bleached paperboard and kraft linerboard, price leadership
patterns are not evident in the other product sectors. Most other sectors have many competitors
and are less capital intensive. Their prices have changed more frequently, and generally prices
have increased at faster rates than prices of newsprint, bleached paperboard or linerboard, but
more slowly than prices of dissolving and paper grade pulps.
Trend Toward Increasing Market Concentration
Volume II discusses the current competitive structure of each major product sector. In
general, they fall within the spectrum from oligopolistic (e.g., dissolving pulp with eight com-
petitors), to something approaching perfect competition (e.g., recycled paperboard with about 90
competitors). International competition is important in only a few sectors: newsprint where the
United States is a substantial importer, linerboard where it is an important exporter, and pulp
where it is both a significant importer and exporter. Thus, with these exceptions, the United
States is essentially a self-contained market for other paper and paperboard products.
Although market share concentration in the paper industry's product sectors changed very
little through 1972 (according to the latest U.S. Department of Commerce statistics) recent
developments indicate concentration will increase. The primary causes are the mounting barriers
to entry discussed previously. Relatively slow growth in demand for the industry's products,
coupled with increasing capital intensiveness as mill sizes, woodlands requirements, and plant
costs rise in this industry have discouraged most smaller firms from making major expansions.
Few, if any, firms from other industries have entered over the past ten years other than by
acquisition of existing facilities.
At present, most capacity expansion is being undertaken by the larger, more profitable
firms that have the necessary capital resources to make major expansions as well as the sub-
stantial control over the woodlands needed to assure a continuing supply of wood raw materials.
Thus small to medium companies are likely to lose market share.
An accelerated rate of closures of marginal mills by both large and small paper companies in
the early 1970's has also contributed to increasing concentration." Closure rates have been
primarily a function of the paper industry's economic cycles the most rapid closure rates since
World War II occurred in the 1970-71 recession. Closure rates will probably also increase around
the water effluent control implementation deadlines in 1977 and 1983 as some mills are unable to
take on the required new capital burden. Ironically, pollution control regulations could also have
4. Appendix A-12, Mill Closure Trends, discusses historical mill closures by product sector.
40
-------
the effect of extending the life of certain mills. To justify making a major investment in pollution-
control equipment, some mills will be modernized to assure that they will remain sufficiently
competitive to recoup the new investment. The pollution regulations will also increase the cost for
new mills through 1983 and thus will temporarily reduce their cost competitiveness with the older
mills that now are close to compliance with 1977 standards.
One factor which tends to stabilize market concentration in the paper industry is that no
major technological change appears to be in the offing which would obsolete the existing pulping
and papermaking process. All the technological changes that have occurred in the recent past or
are now on the drawing boards involve incremental improvements to the existing technology, and
when their merits are proven, they can be readily adopted by most existing mills. Appendix C
(Volume III) describes the most significant current technology changes taking place or under
pilot evaluation in the pulp, paper, and paperboard sectors.
F. FINANCIAL STRUCTURE AND PERFORMANCE
Very few publicly-held companies in the paper industry produce a single product line or
employ a single process. Thus, no composite data are publicly available on the profitability of
individual product or process sectors. Financial models of typical new mills (discussed later in
this section) indicate that, in general, product sector profitability clusters fairly closely around
the industry average. The industry's aggregate profitability, on the other hand, is well docu-
mented and illustrates the financial consequences of the supply, demand, and price trends just
discussed.
Both the Federal Trade Commission (FTC) and the Internal Revenue Service (IRS) publish
composite data which provide the primary profitability indicators for the total paper and allied
products industry. The IRS also accumulates a composite for firms that produce primarily pulp,
paper, or paperboard (as opposed to converted products); however, this data is not as useful for
current analyses since it is not published until several years after the fact.
1. Total Industry Averages
Figures II-4 and II-5 compare trends in the paper industry's after-tax return on sales and net
worth with those of all manufacturing industries. The FTC data indicates higher profitability
than the IRS data. This difference can be explained by the fact that the FTC uses a sampling of
paper companies which is heavily weighted toward large companies. The IRS, on the other hand,
employs a composite of all companies submitting income tax returns that also include a balance
sheet, and its data is more representative of the entire industry. The chief implication from the
differences in these two data series is that the smaller or less capital intensive (e.g., paper
converting) companies generally are less profitable than the larger firms and tend to bring down
the industry's profitability.
Throughout most of the 1960's, the paper industry's return on sales and net worth was below
the all-industry average as it increased capacity rapidly and suffered through several cycles of
excess capacity as a result. As discussed earlier, a number of reasons contributed to the over-
supply cycles the competition for the dwindling number of mill sites and backup woodlands,
the vying for market share in markets that were beginning to mature, and the extremely low
prices for market pulp mainly because of capacity overexpansion in Canada. However, coincident
with the profitability plunge in 1970 and 1971, the industry's historical rate of capacity expansion
fell and stayed well below historic trends despite the up-turn in profitability in 1973 and 1974.
41
-------
7.0%
6.0%
5.0%
o
CL
4.0%
3.0%
A
/\
f t
I 1
( )
( 1
/ »
/ I FTC Data:
/ A Paper &
Allied Products
FTC Data:
All Mfg.
Industries
IRS Data:
Paper &
Allied Products
2.0%
1.0%
1960
1965
1970
1975
1980
FIGURE 11-4 PERCENT NET PROFIT AFTER TAX TO NET SALES
42
-------
20%
15.0%
o
ct
10.0%
5.0%
\
\.
IRS Data:
Paper & Allied
Products
FTC Data:
Paper & Allied
Products
FTC Data:
All Mfg.
Industries
1.0%
1960
1965
1970
1975 1976
FIGURE 11-5 PERCENT NET PROFIT AFTER TAX TO
NET WORTH
43
-------
In 1970 and 1971, the paper industry's after-tax return (both on sales and capital) fell to its
lowest point since World War II. The period of overcapacity and weak prices in the 1960's laid the
foundation. Demand for paper declined slightly as a result of the 1970 recession and the industry's
capacity expansions brought its capacity utilization to around 90%.5
Demand recovery in 1972 led to improved mill operating rates and higher prices throughout
the paper industry which in turn caused a dramatic up-turn in profitability. Profits continued to
rise through 1973 and particularly in the first and second quarters of 1974 after price controls were
partially lifted for this industry in March of that year and fully lifted in June. The up-turn in the
industry's earnings also caused shareholder's equity to regain a larger proportion of the total
capital structure.
In 1974, the industry's return on sales and net worth reached its highest point since World
War II and climbed well above the all-manufacturing-industry average after holding well below
this average in the 1960's. This rapid up-turn in profitability and ranking was caused by high mill
operating rates and particularly by the very large price increases that the industry obtained after
price controls were lifted. The industry's operating rates approached, and in some cases exceeded,
maximum sustainable levels for such items as bleached market pulp, newsprint, linerboard,
printing papers, and tissue. This tight supply condition enabled the producers to simplify their
product lines and thus achieve longer runs and more production from their mills. However, the
fundamental reason for the tight supply itself was that the industry began to slow its rate of
capacity expansion starting in 1970. This slowdown in turn caused the industry's capacity to be
stretched by the up-turn in demand which took place from 1972 through mid-1974.
The recession which began in the second half of 1974 again caused a decline in paper
industry profitability starting in the fourth quarter and continuing through the third quarter of
1975. The principal factor behind the profitability decline was low mill operating rates as paper
demand declined faster than GNP. Average capacity utilization dropped to around 85%; how-
ever, there was very little price deterioration. Therefore, while profitability declined, it held up
surprisingly well compared with previous serious recessions. With their newly won price increases
in 1973 and 1974, producers chose to curtail production rather than risk price reductions which
might be difficult to recoup when the economy recovers. The industry's higher profitability
reduced its breakeven capacity utilization rate (historically around 85%), making it easier to
decide in favor of production cutbacks rather than price discounts. And, of course, there was
widespread concern that price controls would be re-established and industry managers were
reluctant to get caught with their prices and profits down as they did in 1972.
Figure II-6 shows that between 1963 and 1971, the capital structure of the paper and the all-
manufacturing industry composites saw the rapid displacement of net worth by long-term debt.
However, the paper industry's debt proportion increased faster than that of the all-industry
composite. With an average debt-to-total-capital ratio of 33% and a low profitability in 1970-
1971, many firms exhausted their borrowing power. The combination of low profits and debt
limitations contributed importantly to the subsequent slower rate of capacity expansion. Even as
profitability rose in 1972-1974, relatively high debt levels along with capital goods inflation
prevented many companies from using debt to finance major expansions.
5. Although 90% is not a particularly low operating rate, the market was sufficiently weak to preclude any opportunities
for the companies to increase prices to cover the accumulating cost inflation they experienced during 1967-1971.
Conversely, prices were held low to keep demand and capacity utilization as high as possible.
44
-------
85%
80%
o
75%
70%
FTC Data:
All Manufacturing
Industries
IRS Data:
Paper & Allied Products
A
\
N
FTC Data:
Paper & Allied
Products
65%
1960
1965
1970
1975
FIGURE M-6 PERCENT NET WORTH TO TOTAL CAPITAL
FOR PAPER VERSUS ALL INDUSTRIES
45
-------
Table H-10 shows annual changes in the paper industry's sources of capital since 1960. It
indicates that equity financing has not been an attractive alternative to debt. The only signifi-
cant net revenues from stock sales took place in 1961, 1969, and 1971. More frequently, large
amounts of stock were repurchased, reflecting prevailing low stock prices. As a result, all of the
industry's increases in net worth have come from retained earnings. This is not to imply that
retained earnings and long-term debt will continue to be the primary financing modes for the
paper industry. In 1975 and 1976, equity financing became attractive for a number of paper
companies that successfully sold new issues by taking advantage of their recent profit improve-
ment trend and a period of stock market recovery.
2. Profitability Variations by Product Sector
Table II-9 indicates that in 1975, bleached paper pulp was the most profitable and NSSC
corrugating medium the least profitable of the industry's major product sectors. Note that the
purpose of the analysis is to show relative and not absolute differences between product sectors. It
employs mid-1975 prices and estimated costs for minimum economic-sized mills assuming that
they were brought fully on-stream in 1975 and had a capacity utilization of 90%. The analysis
does not attempt to reflect the actual costs of existing mills and it is of course a snapshot of one
point in time under prescribed conditions. Appendix F (Volume III) provides the supporting
data used in this comparison.
Bleached paper grade pulp is clearly the most profitable product sector at present. It
achieved this position primarily because of very large price increases in 1973 and 1974 when the
world supply/demand balance reached shortage proportions. Bleached pulp is the most capital
and wood intensive of the paper industry's products and this has limited recent capacity
expansions.
Printing/writing paper's profitability index is deceptively high in that the sector's mid-1975
capacity utilization rate was around 75% rather than the 90% rate employed for the comparative
analysis. With its operating rate about 10 points below the industry average of about 85% in 1975,
this sector's profitability was close to the paper industry's average.
The comparisons do not reflect the profitability of the nonintegrated printing/writing and
tissue paper companies, whose average profitability is probably below that of the least profitable
sector in Table 11-11. These firms are currently caught in a profit squeeze between high market
pulp prices and relatively low paper prices that are held down by integrated producers seeking
better capacity utilization. New mill models were not developed for the nonintegrated sectors
because it is unlikely that new mills will be built until the margin between market pulp and paper
prices widens appreciably. There is no evidence that this will happen in the foreseeable future.
Volume II describes the major product sectors and analyzes the economic and competitive
characteristics which affect their profitability and growth.
46
-------
TABLE II-10
CHANGES IN PAPER AND ALLIED PRODUCTS INDUSTRY CAPITAL STRUCTURE. 1970-1975
(millions of dollars)
Net Change in Equity
Retained Earnings
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
TOTALS
% of Total
275
255
288
286
378
461
539
405
493
569
289
94
564
1,025
1,668
1,158
8,747
Capital
Net Stock Sales Total I
39
401
(134)
(171)
40
(93)
6
(104)
(201)
340
(196)
253
(275)
(104)
124
118
43
314
656
154
115
418
368
545
301
292
909
93
347
289
921
1,792
1,276
8,790
65%
Net Change
n Long-Term Debt
110
97
234
9
3
472
657
632
463
68
555
417
(164)
100
411
736
4,800
35%
Net profit retained in business.
SOURCE: FTC Quarterly Financial Report for Manufacturing Corporations.
47
-------
TABLE H-11
RELATIVE PROFITABILITY OF SELECTED PRODUCT SECTORS
00
Product Category
Kraft Linerboard
Kraft Bag Paper
NSSC Corrugating Medium
Recycled Paperboard
Bleached Paper Pulp
Dissolving Pulp (Sulfite)
Bleached Paperboard
Printing & Writing (Bond & Book)
Newsprint
Newsprint (De-inked)
Tissue
Tissue (De-inked)
(Basis: New Mills
Capacity
(tpd)
1,000
230
450
380
800
550
500
300
550
330
163
76
Or- Stream in
Production
(1000 tpy)
313
72
141
119
250
172
157
94
172
103
51
24
1975)
Costs Including
Effluent Control
2) 3)
Capital Operating
($millions) ($/tor>)
159 119
68 155
74 143
55 169
196 181
173 230
154 220
103 281
128 169
61 176
78 . 528
32 611
Selling Profitability
Price Index4)
($/ton) (% )
195
250
193
215
335
385
350
480
260
260
736
736
9.2
4.3
3.7
4.2
13.8
9.6
7.5
12.4
6.4
8.4
7.8
3.6
1) Annual production at 90% operating rate;
2) Capital costs include air control, effluent control, OSHA requirements, and working capital;
3) Operating costs indicated exclude depreciation; they include air, effluent, and OSHA requirements;
4) Profitability index is pre-tax profit (margin minus depreciation) divided by total capital;
depreciation calculated at 5.8% of total capital, equal to 6.25% of fixed capital.
5) Reflects weighted average for clay coated boxboard, recycled liner and medium and gypsum linerboard.
SOURCE: Arthur D. Little, Inc., estimates.
-------
CHAPTER III
COST OF COMPLIANCE
-------
III. COST OF COMPLIANCE
A. SUMMARY
1. Introduction
The principal aim of this chapter is to portray for each major sector of the paper industry the
total costs of complying with existing and proposed air, water, and noise regulations.
The costs are not meant to apply to any one mill. The estimates, and the methodology
through which they were derived, are meant to provide a basis for measuring the economic impact
of the studied regulations on the industry as a whole. A different method was used to assess the
potential impact of pollution controls on possible closure candidates. (See Chapter V.)
The estimated costs of compliance are based primarily upon published data. These data
were primarily the EPA Development Documents for air emissions control and water effluent
control. See Volume III, Appendices E-l and E-2 for the specific references. Arthur D. Little was
not retained to develop cost estimates for any of the three types of regulations; Arthur D. Little
did, however, update and supplement the basic data for the sake of consistency and
comparability.
Separate cost estimates were prepared for the existing industry and for new capacity. Since
the capacity of the existing industry is clearly defined, total costs for compliance are reported as
well as cost per unit of capacity. However, the capacity of mills not yet built will be influenced by
the potential impact of control costs. In this chapter, therefore, only the unit cost of compliance of
these future mills are derived. Total costs are estimated in Chapter VI, which deals with capital
impacts.1
2. Findings Related to the Existing Industry
The capital costs for the existing paper industry to comply with regulations on air, water,
and noise from 1974 to 1977 total $3.2 billion (Table III-l):
$690 million to achieve compliance with SIP air regulations.
$2.2 billion for compliance with BPT water regulations.
$320 million for the proposed 90-dBA noise control level.
The weighted average operating cost, including charges for capital recovery (@ 12.1'^c),'2 is
$11. I/ton for the situations analyzed. Note that the capacity decline shown in Table III-l is based
on economic as well as environmental reasons.
The estimates also indicate that between 1977 and 1983 the existing industry will be
required to spend $1.7 billion for compliance with the studied regulations (Table III-2): $170
million to comply with SIP air regulations, $1.4 billion for compliance with BPT water regu-
lations and $80 million for the proposed 90-dBA noise control level. Again, the decline in capacity
is based on economic as well as environmental regulations. Note that control costs for new
replacement or expansion capacity constructed during this period are not included here.
1. Note that all investment and operating costs are reported in mid 1975 dollars, and thus do not reflect future cost
inflations.
2. See Chapter IV for derivation of this value.
49
-------
TABLE j.11-1
SUMMARY OF INCREMENTAL COSTS OF COMPLIANCE FOR EXISTING INDUSTRY THROUGH 1Q77
(1975 Dollars)
Product Sector
Unbleached Kraft Paperboard
Unbleached Kraft Paper
NSSC Corrugating Medium
Recycled Paperboard
Construction Paper
Bleached Board & Bristols
Printing & Writing Paper
Tissue
Newsprint
Bleached Pkg. & Ind. Conv.
Uncoated Groundwood Paper
Dissolving Pulp
TOTAL3
Year-End
Capacity Base
(000 toi
1974
13,970
4,390
4,430
8,680
2,160
5,160
11,600
4.320
3,720
1,290
is/yr)
1977
13,970
4,390
4,240
8,440
2,160
5,160
11,270
4,210
3,650
1,290
1,280 1,190
1,820 1,820
62,820 61,790
i
SIP Air
Emission Control
Capital
($KM)
186
, 61
22
27
7
82
154
54
43
17
16
18
690
Total
Oper. d
($/ton)
1.9
2.0
1.0
0.7
0.7
2.2
2.2
2.1
1.8
2.0
2.0
1.5
1.8
Federal Water
Effluent Control
Capital
($MM)
373
122
112
187
34
174
595
268
162
54
62
102
2,250
Total
Oper.d
($/ton)
5.8
6.3
5.0
5.1
3.5
8.1
12.8
15.3
10.7
10.2
11.9
13.9
8.4
Federal OSHA
Requirements
Capital
($MM)
40
12
24
44
19
15
81
38
23
5
12
7
320
Total
Oper.d
($/ton)
0.5
0.5
1.0
1.0
1.8
0.5
1.3
1.7
1.1
0.7
1.8
0.7
0.9
TOTAL0
Capital
($MM)
599
195
158
258
60
271
830
360
228
76
90
127
3,260
Total
Oper . d
(0/ton)
8.3
8.8
7.0
6.8
6.0
10.8
16.2
19.0
13.6
12.8
15.7
16.1
11.1
a. Incremental costs to 1977 are estimated at 80% of total SIP regulations after deducting estimates
expenditures through 1974. Incremental costs to 1983 are the remaining 20% of costs to reach SIP
standards.
b. Incremental costs to 1977 are costs for BPT less estimated expenditures through 1974. Incremental
costs to 1983 are the total increment from 1977 to 1983.
c. Totals may not add because of rounding.
d. Operating costs include capital recovery at 12.1%.
SOURCE: Arthur D. Little, Inc., estimates.
-------
TABLE III-2
SUMMARY OF INCREMENTAL COSTS OF COMPLIANCE FOR EXISTING INDUSTRY 1977-1983
(1975 Dollars)
Product Sector
Unbleached Kraft Paperboard
Unbleached Kraft Paper
NSSC Corrugating Medium
Recycled Paperboard
Construction Paper
Bleached Board & Bristols
Printing & Writing Paper
Tissue
Newsprint
Bleached Pkg. & Ind. Conv.
Uncoated Groundwood Paper
Dissolving Pulp
TOTAL
Year-end
Capacity Base
(000 tons/pr.)
1983
13,970
4,390
4,090
8,070
2,060
5,160
10,950
4,050
3,440
1,290
800
1,710
59,980
SIP Air
Emission Control3
Capital
($MM)
46
15
6
7
2
20
39
14
11
4
4
4
170
Total
Oper.d
($/ton)
0.5
0.5
0.2
0.2
0.2
0.6
0.5
0.5
0.5
0.5
0.5
0.4
0.4
Federal Water
Effluent Control*3
Total
Capital ' Oper.
($MM) ! ($/ton)
258 ; 4.7
90
108
54
24
141
363
155
91
36
41
52
1,410
5.0
4.3
1.6
2.:5
6.1
7.5
8.8
6.0
6.3
10.8
9.7
5.4
Federal OSHA
Requirements
Capital
($NM)
10
3
6
11
4
4
20
10
6
1
2
2
80
Total
Operd
($/ton)
0.1
0.1
0.3
0.3
0.5
0.1
0.3
0.4
0.3
0.2
0.4
0.2
0.3
TOTAL c
Capital
($MM)
314
108
120
72
30
165
422
179
108
41
41
58
1,660
Total
Oper.d
($/ton)
5.3
5.6
4.8
2.1
3.0
6.8
8.3
9.7
6.7
6.9
11.7
10.3
6.1
a. Incremental costs to iy7/ are estimated at »G7<, of total for SIP regulations after deducting estimated expenditures
through 1974. Incremental costs to 1983 are the remaining 20% of costs to reach SIP standards.
b. Incremental costs to 1977 are costs for BPT less estimated expenditures through 1974. Incremental costs to
1983 are the total increment from 1977 to 1983.
c. Totals may not add because of rounding.
d. Operating costs include capital recovery at 12.IS.
SOURCE: Arthur D. Little, Inc., estimates.
-------
All states will not have the same SIP regulation level through 1977; hence, the incremental
cost of $170 million in 1977-1983 represents the cost to the industry if all states impose regulations
as stringent as the current Oregon standards used in the cost calculations. If states impose more
stringent regulations than those used here, the estimates would have to be revised.
An estimated capital cost of $1.4 billion will be needed to bring the existing industry from
the water effluent level required by 1977 to the more stringent 1983 level.
The 1977-1983 capital cost for OSHA noise control, like the estimate for compliance with
SIP regulations, reflects broader compliance with the present regulations rather than imposition
of more stringent regulations.
3. Findings Related to New Capacity
Compliance costs for a new-mill may vary from $4.4 million to $31.6 million (Table III-3),
depending on the type of facility as well as its size.
In this section, cost of compliance estimates are given on a unit basis. These unit costs are
subsequently used to develop capital requirements for the postulated capacity increases through
1983. (See Chapter VI.)
Note that the cost of compliance with air and water effluent regulations is computed on a
process basis; thus the estimated costs of compliance for the same product made by different
processes can be significantly dissimilar. Since economic impacts were measured on a product
basis, it was necessary to estimate product/process combinations for future mills. The relation-
ship between manufacturing processes and products is described in Section III-B.
Note also that in some instances pulp mill size is disproportionately larger than paper mill
size. The difference, however, simply reflects the different economic unit sizes of the respective
operations. For example, it would be economical to build a 1,000-tpd unbleached pulp mill and
support it with a 1,000-tpd liner board mill. However, it would not be economical to build a 300-
tpd printing and writing paper mill and support it with a 300-tpd bleached kraft pulp mill; about
an 800-tpd pulp mill would be necessary to achieve economic operation. Therefore, the balance of
the pulp mill capacity not utilized in the studied product sector (printing and writing paper) is
assumed to be utilized on site for other grades. Accordingly, the investment for the pulp mill is
apportioned to the study products on the basis of its corresponding capacities. Compliance with
NSPS water effluent regulations is by far the single most important cost. Generally, these
regulations are about equivalent to the BAT levels that apply to existing mills. The only
significant difference between the two applies to the bleached kraft process category: color
removal is not required under NSPS but is specified in the BAT regulations. The addition of color
removal to the NSPS regulation would add $3 to $5 million capital cost to the bleached kraft
process examples (bleached board, printing and writing papeps, tissue, newsprint, and market
pulp).
The investment and operating costs for air emission control are measured from an "eco-
nomic level" of control and clearly do not reflect total industry expenditures for air emission
control equipment. The "economic level" is site specific and changes with the value of the by-
product. Thus, the derived cost of compliance would change if a different percentage of recovery
were considered "economic." For purposes of this analysis, Arthur D. Little used the 97.5'r
economic recovery level employed in EPA's control cost estimate.
52
-------
TABLE III-3
UNIT COST OF COMPLIANCE WITH
FEDERAL STANDARDS FOR NEW MILL
SOURCES
(1975 Dollars)
Mr Emission
KSPS Water .New Source
Mil] Cap.(tpd) Effluent Stds. Standards
Product Sector and
Specific Pro'li.ict .'" Process Catur.nrv
UnMoarhcd Krait Paperboard:
Kraft Lipi.-rboard Unbleached Kraft
U.ihleirhcd Kraft i'aper :
Kraft. ::-i;'. P/ipcr Unbleached Kraft
NSSC Corriicat inp Medium:
CorruiviL'rii.-. "...vlium NSSC Pulping
F.i/cyc KU Pap-.'i''.>C'cjrd :
K,->cyrU>d "ox'-'.-.ird Recycled Paperboard
Jute Lir..'.-rhr-51-d " "
HI'-.-.MK M^.-!;i:r " "
£'Yj>.?'.- '. I. iiv.-;'':v>ard " "
Court ruction P-.»per:
Nun" Construction Paper
lilcaclr'd R'-arci i Bristols :
Bloarhed I'.ip-rboard (S3S) RCT Kraft
Prin''in~ .', i.'rltiti!*. Paper:
i'-.'n'i I'.ip-jr Fine Kraft
li.i.'K Paper Fine Kraft
TJSSMO Taper UCT Kraft
Tissue Pap'.'r Nonint. from Waste
Paper
N.-.;sprinr Fine Kraft/CW
N':w;.,:i-ii.t Deinkinp,
?-.. 4. In;!. Converting:
N OIK.' -
Uncnatud Grounclwood Papers :
None -
fiissi-.'K'lR? Pulp:
Jisf.-ilv-;-i;'. Fulp Dissolving Siilfite
i' !'.:>' !". ci " 'ri;c.'t ?n] p :
r.-'f: rj.irker. '/'nip Kr;.ift ^fKt. Pulp
Pulp
1000
800
450
400
" 330
330
400
-
800
800
800
800
-
1240
-
-
-
550
800
Paper
1000
230
450
400
330
330
400
-
500
300
300
163
76
550
330
-
-
550
800
Total Total
Capital Oper.3 Capital Oper.a
(SNM) ($/rpn) ($MM) (S/ ton)
19.
4.
13.
6.
6.
6.
6.
-
16.
8.
8.
4.
3.
9.
12.
-
-
27.
20.
0
8
6
8
1
1
8
1
5
5
8
4
2
9
5
3
11
13
21
10
11
11
10
19
17
17
18
28
10
25
33
15
.7 2.9
.3 0.8
.3 l.l
.3 0.3
.2 0.8
.2 0.2
.3 0.3
...
.7 2.1
.3 1.2
.3 1.3
.0 0.6
0 0.1
2 0.8
.2 0.2
-
.6 l.l
.8 3.1
1.6
2.0
1.6
0.8
0.8
0.6
0.8
-
2.4
2.4
2.5
2.5
0.9
0.9
0.6
-
-
1.3
2.1
OSHA
Requirements
Total
Capital Oper. a
($MM) ($/ton)
3.0
2.0
3.0
1.0
1.0
1.0
1.0
-
2.0
2.0
2.0
2.0
1.0
2.0
1.0
-
-
3.0
3.0
1.3
3.6
3.0
1.4
1.7
1.7
1.4
-
1.9
2.8
2.8
4.9
7.7
1.8
1.7
-
-
2.4
1.7
Total Unit
Cost of
Compliance
total
Capital Oper. a
(SMM) ($/ton)
24.9
7.6
17.7
8.1
7.4
7.3
8.1
-
20.2
11.7
11.8
7.4
4.5
12.0
14.1
-
-
31.6
26.4
14.6
18.9
25.9
12.5
13.5
1J.3
12.5
-
24.0
22.5
22.6
25.4
36.6
12.9
27.5
-
-
37.3
19.6
a. Operating costs includes capital recovery at 12.1%.
SOURCE: Arthur D. Little, Inc., estimates.
-------
The capital investment for noise control for new mills is significantly greater than that
reported for existing mills. The apparent discrepancy reflects the fact that, presented with the
option of using either administrative controls or building sufficient "engineering control," into a
new mill to comply with noise regulations, most producers will elect to take the latter route.
Although administrative control reduces capital costs, it is subject to subsequent modification by
OSHA in the event the mill is found to be in violation. Rather than risk being faced with the high
costs of mill modification, most producers would choose to design in "engineering controls" for
new capacity. The variation in operating costs from about $12 to $37 per ton of production for the
studied product sectors is caused by a number of factors, for example, size, type of manufacturing
process, etc. For a new mill the capital cost for the studied regulations varies from 10% to 26% of
the total capital requirement and operating costs vary from 4% to 14% of the total manufacturing
cost of the selected products (Table III-4).
B. GENERAL METHODOLOGY
This section describes in general terms the methodology used in developing the cost of
complying with the studied regulations. A more detailed explanation is contained in the analysis
of the three types of regulations (Appendix E) and in the supporting data for the mill cost models
(Appendix F).
1. Process-to-Product Transformation
Although the economic impact of compliance is measured by the associated cost for an
individual product or product sector, the studied regulations apply to the manufacturing proc-
esses, not the products. Moreover, a given product often can be made by more than one process or
combination of processes, and the cost of compliance for these alternative methods may vary
significantly.
Unfortunately, data are not available to transform current industry capacity, typically
reported on a product basis, to a process basis. Hence, the percentages of the process costs
allocated to the individual product sectors are based on the considered opinions of a number of
individuals knowledgeable about the industry.
On the basis of this knowledge of industry practice, Arthur D. Little constructed a matrix
(Table III-5) showing the process categories to which the EPA water effluent control regulations
apply and the related product sectors used in the economic impact analysis. The matrix indicates
how costs of compliance should be apportioned. Table III-5 shows for example, that regulations
(and their associated costs) for the unbleached kraft process category would apply to the
unbleached kraft paperboard and the unbleached kraft paper product sectors. Accordingly, cost
of compliance derived for the existing industry related to the unbleached kraft process category
must be apportioned to these two product sectors. The costs derived from the remaining process
categories identified in this table were similarly apportioned to their corresponding products.
In the cost calculations, all mills that make a combination of products are included in those
process categories with the higher costs for compliance.
A similar problem occurs in estimating costs for new increments of industry capacity.
Therefore, in projecting costs for compliance out to 1983, Arthur D. Little assumed one or more
currently favored processes would be employed for each of the studied product sectors.
54
-------
TABLE II1-4
COST OF COMPLIANCE RELATIVE TO TOTAL FIXED CAPITAL AND OPERATING COSTS FOR NEW MILLS
(1975 Dollars)
Mill Total Delivered
Capacity (tpd) Manufacturing Cost
Product Sector
and Specific Products
Unbleached Kraft Paperboard:
Kraft Linerboard
Unbleached Kraft Paper:
Kraft Bag Paper
NSSC Corrugating Medium:
Corrugating Medium
Recycled Paperboard:
Recycled Boxboard
Jute Linerboard
Bogus Medium
Gypsum Linerboard
Process
Category
Unbleached Kraft
Unbleached Kraft
NSSC Pulping
Recyc. Paperbd.
Pulp
1000
800
450
400
330
330
400
Paper
1000
230
450
400
330
330
400
Capital
($MM)
148.7
65.3
67.7
57.8
39.1
32.1
49.8
Total
Operating
($/ton)
170.9
258.7
196.1
238.4
198.9
178.9
203.0
Total Cost of
Conpliance
Capital
($MM)
24.9
7.6
17.7
8.1
7.4
7.3
8.1
Total
Operating
($/ton)
14.6
18.9
25.9
12.5
13.5
13.3
12.5
Cost of Compliance
(Percent of Total Mfg.)
Capital
17
12
26
14
19
23
16
Total
Operating
9
7
13
5
7-
7
6
Bleached Board & Bristols:
Bleached Paperboard (SBS)
BCT Kraft
800
500
144.8
326.0
20.2
24.0
14
Bond Paper
Book Paper
Tissue:
Tissue Paper
Tissue Paper
Newsprint :
Newsprint
Newsprint
Dissolving Pulp:
Dissolving Pulp
Bleached Paper Pulp:
Bleached Market Pulp
Fine Kraft
Fine Kraft
BCT Kraft
Nonint. from Waste
Paper
Fine Kraft/GW
Deinking
Diss Sulf ite
Kraft Mkt. Pulp
800
800
800
-
1,240
550
800
300
300
163
76
550
330
550
800
96.7
94.8
70.9
28.4
120.5
55.9
161.6
184.0
389.1
403.6
687.9
748.2
246.7
237.1
332.5
261.3
11.7
11.8
7.4
4.5
12.0
14.. 1
31.6
26.4
22.5
22.6
25.4
36.6
12.9
27.5
37.3
19.6
12
12
10
16
10
25
20
14
6
6
4
5
5
12
11
8
SOURCE: Arthur D. Little, Inc., estimates.
-------
TABLE III-5
PRODUCT SECTORS INCLUDED IN STUDIED PROCESS CATEGORIES *
Unbl. Bl. Pkg Bl.
Product Kraft Unbl. NSSC Recyc. Bleached Print. & Ind. Unc. Kraft
Paper- Kraft Corr. Paper- Const. Board & & News Conv. GW Mkt. Dis.
.Process ^^~~-~^board Paper Med.' board Paper Bristols Writ. Tissue print Paper Paper Pulp Pulp
Unbleached Kraft - - - - - ______
NSSC _ _ ^ _ _ _ _ ______
Unbl. Kraft/NSSC -- - - ______
Recycled Paperbd. _ _ _ ^ _ _ _ ______
Const. Paper _ _ _ _ ^ _ _ ______
Bleached Kraft **- - -
Sulfite _____ _ e ^ ^ 0 _ _ _
Dissolv. Sulfite _____ _ _ _ _ _ _ _ 0
Soda - -- - -- 9 ___ _ __
De-inked _____ _ 9 9 9 _ _ _ _
Groundwood _____ _ 9 _0_^__
N/I Tissue _____ _ _ ^ _ _ _ _ _
N/I Fine _____ _ 9 ______
* See Table E-l, Appendix E for specific value.
** Note that the bleached Kraft process is used to make unbleached Kraft products. This apparent anomaly is not
an error; several mills produce both bleached and unbleached products.
-------
When industry capacity is reported by process category, 1974 bleached kraft market pulp
capacity is included at some 6.1 million tons, but when industry capacity is reported on a product
basis, that tonnage and its associated control cost appears to be excluded. In fact, however, its
associated investment and operating cost of compliance is apportioned to those product sec-
tors principally printing and writing, tissue and uncoated groundwood papers that use it as
a raw material.
The cost of compliance for market pulp was handled in this manner because of the
methodology used for the economic impact analysis. In that analysis, market pulp was considered
an intermediate product; hence, its cost of compliance is passed on to the user the non-
integrated paper mill. Accordingly, the investment and operating cost estimates for those product
sectors which use market pulp include both costs of compliance actually experienced on-site, and
those associated with market pulp.
2. Engineering Cost Estimates
The original engineering cost estimates used to derive costs of compliance come from
sources other than Arthur D. Little. Arthur D. Little's role was to modify the basic cost data to
put it in a comparable time framework with consistent cost elements for us throughout the
economic impact analysis.
C. COSTS FOR EXISTING INDUSTRY
1. Approach
Figure III-l illustrates the applicable regulations and the principal sources used to estimate
compliance costs for the existing industry. The costs of compliance are estimated separately for
the existing and new segments of industry capacity, because: (a) most regulations differ for the
two segments, (b) existing industry costs are incremental from year-end 1974, whereas NSPS
costs reflect total costs for new mills, and (c) the capacity of the new segment is unknown; hence
its cost for compliance cannot be aggregated on a total industry basis.
The separate consideration of existing and new capacity is a logical approach for analytical
cost analysis, but it is not the usual way in which industry exports expenditures for pollution
abatement; more typically, published capital expenditures combine costs for modifications to
existing facilities with those associated with new capacity. Accordingly, in those instances where
Arthur D. Little used industry cost data, appropriate adjustments were made to exclude that
portion (or estimated portion) associated with new or incremental capacity. Conversely, to
estimate the total industry expenditure say for 1977 Arthur D. Little combined the
estimate derived in this section to that associated with new capacity added in that year
(Section D).
To project the capacity of the existing industry through 1983, Arthur D. Little employed the
industry's year-end 1974 capacity and assumed normal retirement rates through the ten-year
studied period. The retirements, estimated at some 3 million tons out of a total of some 68 million
tons of capacity, are for all purposes and not as the result of pollution considerations alone.
Closures attributed to environmental regulations are estimated and discussed separately. There-
fore, cost of compliance for the retired tonnage is reflected not in the estimates derived in this
section but in the discussion of the capital required to replace the retired tonnage.
57
-------
00
Studied
Regulations
Cost
Analysis
Data Sources:
EPA, Dept. of
Commerce, NCASI,
ADL
Federal
Water
Regulations
Data Sources:
EPA (Dev.Docs.),
NCASI, ADL
Federa]
Noise
Regulations
Data Sources:
API, ADL
Resultant Cost of.
Compliance for Total
Existing Industry
Process/Product
Transformation
Capacity
Survey-
Data
(API)
'Allocation of \
industry Capacity ]
to Process Cate- I
gories (ADL) J
To
Economic
Impact
Analysis
SIP regulation for Oregon used as the basis for calculating cost of compliance
FIGURE III-l, METHODOLOGY FOR CALCULATING COST OF COMPLIANCE - EXISTING MILLS
-------
All costs of compliance are first shown on-a process basis (as they are derived) and are
subsequently apportioned to the appropriate product sectors. Note that when presented on a
process basis, the annualized operating cost does not include capital recovery charges.
2. Air Emissions Control
Existing mills are not directly subject to Federal air regulations, but they must comply with
State Air Quality Implementation Plans (SIPs); accordingly, the latter were used as the basis for
calculating cost of compliance. Appendix E-l (Volume III) lists the SIP standards for several
states, illustrating that the requirements differ somewhat from state to state.
In this analysis, Arthur D. Little selected the most stringent current state standards,
typified by Oregon's 99.0% particulate removal in kraft recovery boilers.
Implicit in the use of a single set of standards for SIP are two key assumptions:
All states will ultimately impose regulations consistent with the most stringent
current state regulations.
Progressively more stringent state regulations will not apply over the period cov-
ered by this study.
The total cost to the existing industry to meet SIP standards was estimated in three broad
areas: controls for kraft pulp mills, controls for power boilers, and early retirement of existing
kraft recovery boilers. From the total derived cost of $1,284 million, $428 million was deducted as
the reported cost incurred through 1974. The net some $860 million is the additional
capital requirement for the existing industry to meet SIP standards (Table III-6), the details of
which are explained as follows:
(1) Kraft process controls (including power boilers): This is a straightforward application
of unit cost estimates for the kraft process subcategory. Power boiler standards and costs are not
well defined for SIP standards. To determine the cost for SIP standards, Arthur D. Little
employed EPA's well-defined power boiler cost for proposed federal standards and used the same
cost ratio as for recovery boiler particulate removal.
(2) Power boiler controls for other categories: This item was not estimated on an engineer-
ing basis, which would require a mill-by-mill survey to determine applicable standards and
approximate costs. The total industry cost estimates include only a reasonable allowance based
on applying kraft category unit costs for power boiler particulate controls to the production
generated in other process categories.
(3) Retirement of recovery boilers in kraft categories: Historically, kraft recovery boilers
were operated above their rated capacity, but stringent SIP standards for removal of particulates
and TRS usually cannot be met under these conditions. Thus, the imposition of SIP standards
generally requires the addition of incremental recovery boiler capacity, or the replacement of
existing capacity with a larger unit, so that boilers may be operated near their nominal capacity
without loss of pulping capacity in the mill. Arthur D. Little did not attempt mill-by-mill
engineering estimates for this item. Its total industry cost estimates include a capital allotment
for premature recovery boiler replacement based on total capacity, to acknowledge that this is a
legitimate and significant factor in the total cost of compliance with SIP regulations.
59
-------
TABLE II1-6
SUMMARY OF AIR EMISSION CONTROL COSTS FOR EXISTING INDUSTRY
(1975 Dollars)
Capital
Costs
($raillions)
Operating
Costs a
($millions/yr)
1. Kraft categories process controls
Economic Recovery Level
Additional costs to SIP level
Sub-total
2. Power boiler controls for other
categories
3. Retirement of recovery boilers
in kraft categories
298
319
617
107
560
(115.0)
28.8
(86.2)
10.7
Total Industry Costs for SIP Standards 1,284
(75.5)
4- Less Expenditures through 1974,
one-third of total
Net Industry Costs for SIP Standards
from 1974
( 428)
860
(103.3)
28
Excludes capital recovery.
Rounded
SOURCE: Arthur D. Little, Inc., estimates,
(4) Expenditures through 1974: This item was estimated on the basis of industry reports
that about one-third of the industry was in compliance. This was interpreted as meaning that
one-third of the total capital investment for compliance with SIP standards (including the
economic recovery level) had been made by 1974. Arthur D. Little distributed capital and
operating costs by assuming that all mills had achieved the economic recovery level, and that
60
-------
additional expenditures were proportional to capacity throughout the kraft categories. This
approximation is adequate for estimating total industry costs, costs by major process and product
sectors, and costs for the total industry to achieve compliance with SIP standards.
The detailed development of unit cost estimates and their application to appropriate
process subcategories and size ranges are explained in Appendix E-l, (Volume III).
Arthur D. Little further assumed that 80% of the incremental cost of compliance will be met
in the period from 1975 to 1977 and 20% beyond 1977. It is apparent that uniform compliance with
SIP standards will not be achieved by 1977. However, the compliance distribution over the
studied period is not precise.
Cost of compliance with SIP standards are aggregated by major process category in
Table III-7. The operating costs indicated are for operation and maintenance only (excluding
capital recovery), as required for the impact analysis methodology. The process-to-product
transformation discussed previously was applied to establish the cost of compliance by product
sector (Table III-8). The variation among product sectors simply reflects the fact that the costs for
kraft pulping controls, power boiler controls, and replacement of recovery boilers would not apply
equally to all sectors. Product sectors that do not employ the kraft process such as NSSC
corrugating medium, recycled paperboard, and construction paper incur only the cost associ-
ated with air emissions controls for the power boiler.
3. Water Effluent Control
Federal water effluent regulations for existing pulp and paper mills call for compliance with
the BPT level by 1977 and the BAT level by 1983. The specific requirements and the derivation of
the costs for compliance are described in Appendix E-2. The general methodology is similar to
that used for deriving the costs for air emission control namely, to develop models for various
size mills in each of the process categories and multiply the unit cost for each model by the
corresponding number of plants in the industry. From the resultant derived total cost, the
expenditures reported by the industry through 1974 are deducted; the net is apportioned to the
studied product sectors via the product transformation process.
Unit costs from the process models in the EPA Development Documents were used to derive
the industry's cost of compliance.3 Arthur D. Little estimated the number of mills corresponding
to the models and adjusted the unit costs and incremental cost calculations contained in the
Development Documents by:
3. The "Development Documents" referred to Include the following:
"Development Document for Advanced Notice of Proposed or Promulgated Rule Making for Effluent Limitations
Guidelines and New Source Performance Standards for the Bleached Kraft, Groundwood, Sulfite, Soda, Deink, and
Nonintegrated Paper Mills Segment of the Pulp, Paper, and Paperboard Point Source Category," EPA 440/1-
75/047, August 1975.
Development Document for Interim Final and Proposed Effluent Guidelines and Proposed New Source Perform-
ance Standards for the Bleached Kraft, Groundwood, Sulfite, Soda, Deink, and Nonintegrated Paper Mills Segment
of the Pulp, Paper, and Paperboard Point Source Category," Vol. 1, EPA 440/1-76/047-a, January 1976.
"Development Document for Effluent Limitations Guidelines and Standards of Performance: Pulp, Paper, and
Paperboard Industry," draft report to EPA by Wapora, Inc., June 1973.
"Development Document for Effluent Limitations Guidelines and Standards of Performance: Builders' Paper and
Board Industry," draft report to EPA by Wapora, Inc., June 1973.
Arthur D. Little meetings and correspondence with E.C. Jordan, Company, EPA contractor for compliance cost
estimates in August 1975, and January 1976, Development Documents.
61
-------
TABLE III-7
SUMMARY OF INCREMENTAL AIR CONTROL COST TO EXISTING INDUSTRY (SIP STANDARDS)
BY MAJOR PROCESS CATEGORY
Total Category
Year-end Capacity
Major Process
Category
Unbleached Kraft
NSSC Medium
Bleached Kraft /NSSC
Recycled Paperboard
Construction Paper
Bleached Kraft
Sulfite
Dissolving Sulfite
Soda
De- inked
Groundwood
N/I Tissue
N/I Fine
1974
8,760
3,270
4,960
8,670
2,160
26,460
3,200
910
290
2,420
2,850
1,670
2,380
(000 tons/yr)
1977
8,760
3,080
4,960
8,430
2,160
26,420
2,990
910
190
2,390
2,740
1,650
2,290
1983
8,760
2,930
4,960
8,060
2,060
26,290
2,830
800
190
2,220
2,300
1,580
2,180
Capital
Costs
($1975)
143
12
80
34
9
526
12
4
1
10
11
7
9
b
Operating
Costs
.($. 1975)
3.5
1.2
1.9
3.4
0.9
11.7
1.2
0.4
0.1
1.0
1.1
0.7
0.9
68,000 66,970 65,160 860
Declines reflect total closures in process category.
TOTAL
a.
Excludes capital recovery.
Rounded.
SOURCE: Arthur D. Little, Inc., estimates.
62
28.0
-------
TABLE III-8
Os
OJ
SUMMARY OF INCREMENTAL AIR CONTROL COST TO EXISTING INDUSTRY (SIP STANDARDS)
BY PRODUCT SECTOR
Product Sector
Unbleached Kraft Paperboard
Unbleached Kraft Paper
NSSC Corrugating Medium
Recycled Paperboard
Construction Paper
Bleached Board & Bristols
Printing & Writing Paper
Tissue
Newsprint
Bleached Packaging & Ind.
Conv. Paper
Uncoated Groundwood Paper
Dissolving Pulp
TOTAL
1974
13,970
A, 390
4,430
8,680
2,160
5,160
11,600
4,320
3,720
1,290
1,280
1,820
62,820
Sector /ear-End
Capacity Base
(000 tons/yr)
1977
13,970
4,390
4,240
8,440
2,160
5,160
11,270
4,210
3,650
1,290
1,190
1,820
61,790
a
1983
13,970
4,390
4,090
8,070
2,060
5,160
10,950
4,050
3,440
1,290
800
1,710
59,980
b
Operating Costs
Capital
Costs
($/millions)
232
76
28
34
9
102
193
68
54
21
20
22
860 C
Oper. & Maint.
($/ton)
0.4
0.4
0.4
0.4
0.4
0.4
0.6
0.6
0.5
0.5
0.6
0.4
0.5
Capital
Recovery
($/ton)
2.0
2.1
0.8
0.5
0.5
2.4
2.1
2.0
1.8
2.0
1.9
1.5
1.7
TOTAL
($/ton)
2.4
2.5
1.2
0.9
0.9
2.8
2.7
2.6
2.3
2.5
2.5
1.9
2.2
Declines reflect total closures in product sector.
Unit costs based on 1977 capacities.
Rounded.
SOURCE: Arthur D. Little, Inc., estimates.
-------
Updating from 1974 to mid-1975 dollars;
Adding about 5% to the reported operating cost for operating and maintenance
supplies; and
Revising the assumptions about "in-place" treatment facilities for certain process
categories.
The Development Documents presented a rough estimate of the amount of land required for
effluent treatment but not its cost. Arthur D. Little believes the cost would be only about $25
million, or less than 1% of the total capital requirements for water effluent treatment. Land
availability, therefore, was considered significant only for estimating closure probabilities for
specific mills and land was excluded from the cost estimates.
To use EPA's unit cost estimates, Arthur D. Little categorized industry capacity to agree as
closely as possible with the rationale for industry categorization in the Development Documents.
The capacities were assigned by subcategory and mill size, and corrected for mills known to use
municipal treatment. Arthur D. Little assumed there will be no capacity retirement in mills that
use municipal treatment.
Table III-9 summarizes the investment and operating cost for the existing industry to meet
1977 and 1983 Federal water effluent regulations. Note that these costs are incremental to
expenditures made prior to 1975 and that the operating costs exclude capital recovery. The
estimated $2.2 billion through 1977 for BPT and the additional $1.4 billion through 1983 for BAT
excludes any capital investment for replacement capacity or net new additional capacity that
may be built during the studied period.
Tables III-10 and III-11 present the cost of compliance on a product basis the former for
the 1974 to 1977 period and the latter for the 1978 to 1983 period.
The indicated operating costs are weighted averages over the total capacity of each product
sector. The range of these costs has been calculated on the basis of the highest- and lowest-cost
subcategory and mill size range for each product. Note that the weighted averages for recycled
paperboard and construction papers are lower than the indicated minimums. This reflects the
fact that many mills use municipal treatment in these product sectors, causing the effective range
for the weighted average to have a minimum cost of zero. However, the reported range applies
only to mills that have on-site effluent treatment and therefore must invest in their own
treatment systems.
As described previously, the treatment costs associated with market pulp are handled in a
special way in the process-to-product transformation. Market pulp capacity is included in the
process summaries as a part of bleached kraft capacity. When costs are transformed to the
product sectors, those associated with market pulp production are added to the costs incurred at
the point where it is consumed i.e., in nonintegrated or partially integrated mills. For
example, the cost component associated with nonintegrated printing and writing paper produc-
tion includes not only the direct cost of treating mill effluent but also the treatment cost
associated with the market pulp used as raw material by the mill.
64
-------
TABLE III-9
SUMMARY OF WATER EFFLUENT CONTROL COST FOR THE EXISTING INDUSTRY BY PROCESS CATEGORY
(1975 Dol
Total Category
Year-End Capacity
(000 tons/yr)
Major Process Category
Unbleached Kraft
NSSC Medium
Unbleached Kraft /NSSC
Recycled Paperboard
Construction Paper
Bleached Kraft
Sulfite
Dissolving Sulfite
Soda
Deinked
Groundwood
N/I Tissue
N/I Fine
TOTAL
1974
8,760
3,270
4,960
8,670
2,160
26,460
3,200
910
290
2,420
2,850
1,670
2,380
68,000
1977
8,760
3,080
4,960
8,430
2,160
26,420
2,990
910
190
2,390
2,740
1,650
2,290
66,970
1983
8,760
2,930
4,960
8,060
2,060
26,290
2,830
800
190
2,220
2,300
1,580
2,180
65,160
lars)
Effluent Control Costs
Capital Cost
($millions)
BPT
237
91
106
187
34
904
216
71
10
144
110
78
66
2,250b
BAT
153
95
67
54
24
733
92
27
8
26
44
44
47
l,410b
Operating
($mlllions/yr)
BPT
20.3
5.6
9.5
19.9
3.4
106.8
27.8
9.3
1.2
20.5
10.8
8.3
6.8
250
BAT
23.2
2.4
10.8
6.1
2.3
75.0
9.3
3.4
0.7
4.1
4.5
5.7
5.5
153
Cost3
(.avg. $/ton cap'
BPT
2.3
1.8
1.9
2.4
1.6
4.0
9.3
10.2
6.5
8.6
3.9
5.0
3.0
3.7
BAT
2.6
0.8
2.2
0.8
1.1
2.9
3.3
4.2
3.7
1.8
2.0
3.6
2.5
2.3
Excludes depreciation and cost of capital
Rounded
SOURCE: Arthur D. Little, Inc., estimates.
-------
TABLE 111-10
SUMMARY OF WATER EFFLUENT CONTROL COST FOR THE EXISTING INDUSTRY BY PRODUCT SECTOR
(1975 Dollars to
Year-End Capacity Base
(000 tons/yr)
Product Sector
Unbleached Kraft Paperboard
Unbleached Kraft Paper
NSSC Corrugating Medium
Recycled Paperboard
Construction Paper
Bleached Board & Bristols
Printing & Writing Paper
ON Tissue
Newsprint
Bleached Packaging & Industrial
Converting Paper
Uncoated Groundwood Paper
Dissolving Pulp
13
4
4
8
2
5
11
4
3
1
1
1
62
1974
,970
,390
,430
,680
,160
,160
,600
,320
,720
,290
,280
,820
,820
1977
13,
4,
4,
8,
2,
5,
11,
4,
3,
1,
1,
1,
61,
970
390
240
440
160
160
270
210
650
290
190
820
790
Meet BPT Regulations)
Operating Costs3'
Capital
Costs
($ millions) O&M
373
122
112
187
34
174
595
268
162
54
62
102
2,250C
2
2
1
2
1
4
6
7
5
5
5
7
4
.6
.9
.8
.4
.6
.0
.4
.6
.3
.1
.6
.1
.0
Capita]
Recover}
3.2
3.4
3.2
2.7
1.9
4.1
6.4
7.7
5.4
5.1
6.3
6.8
4.4
r Avg.
5.8
.6.3
5.0
5.1
3.5
8.1
12.8
15.3
10.7
10.2
11.9
13.9
8.4
b ($/ton)
Total
Range
5.3
5.6
4.5
4.6
3.1
7.3
11.5
13.8
9.6
9.1
10.7
12.5
7.6
- 6.9
- 7.4
- 6.0
- 6.0
- 4.1
- 9.5
- 11.7 .
- 18.0
- 12.5
- 11.9
- 14.0
- 16.3
- 9.9
a. Operating costs include capital recovery at 12.1%
b. Based on 1977 capacities
c. Rounded
SOURCE: Arthur D. Little, Inc., estimates.
-------
TABLE III-ll
SUMMARY OF WATER EFFLUENT CONTROL
COST FOR THE EXISTING INDUSTRY BY PRODUCT SECTOR
(1975 Dollar Increment from
Year-end Capacity Base Capital
(000 tons/yr) Costs
Product Sector
Unbleached Kraft Paperboard
Unbleached Kraft Paper
NSSC Corrugating Medium
Recycled Paperboard
Construction Paper
Bleached Board & Bristols
Printing & Writing Paper
Tissue
Newsprint
Bleached Pkg. & Ind.
Converting Paper
Uncoated Groundwood Paper
Dissolving Pulp
TOTAL
1983
13,970
4,390
4,090
8,070
2,060
5,160
10,950
4,050
3,440
1,290
800
1,710
59,980
($raillions)
258
90
108
54
24
141
363
155
91
36
41
52
1,410C
BPT to BAT Regulations)^
Operating Costs ($/ton)a'
O&M
2.5
2.5
1.1
0.8
1.1
2.8
3.5
4.2
2.8
2.9
4.6
3.5
2.6
Capital
Recovery
2.2
2.5
3.2
0.8
1.4
3.3
4.0
4.6
3.2
3.4
6.2
6.2
2.8
Total
Avg.
4.7
5.0
4.3
1.6
2.5
6.1
7.5
8.8
6.0
6.3
10.8
9.7
5.4
Range
4.3 -
475 -
3.9 -
1.4 -
2.3 -
5.5 -
6.8 -
7.9 -
5.4 -
5.6 -
9.7 -
8.7 -
4.9 -
5.5
5.8
5.2
1-9
3.0
7.2
8.9
10.4
7.1
6.6^
12.8
11.6
6.4
a. Operating costs include capital recovery at 12.1%
b. Based on 1983 capacities
c. Rounded
SOURCE: Arthur D. Little, Inc., estimates.
-------
4. Noise Control
Noise regulations proposed by the Occupational Safety and Health Administration (OSHA)
for compliance with a 90-dBA noise level apply to both existing and new industry capacity. A
more detailed description of the regulation is given in Appendix E-3 (Volume III). Because of the
scarcity of published information on this subject, Arthur D. Little drew almost entirely upon
estimates of noise control costs developed by the American Paper Institute, the best current data
source.
API recently conducted a company survey and estimated that the existing industry would
have to invest some $516 million to comply with the proposed 90-dBA regulation. This figure,
which does not include the cost of facilities already in place, applies to all sectors within the 2600
SIC code pulp, paper and board manufacturing and converting.
Since the Arthur D. Little study did not include converting or the manufacture of certain
types of building products (e.g., hardboard and particleboard) the full $516 million did not apply.
The excluded sectors have fewer than the average number of workers and process steps per mill,
so it was assumed that they would incur only 25% of the total investment. The remainder, about
$400 million, was applicable to the studied sectors.
Arthur D. Little allocated this incremental $400 million into various process categories,
taking the position that the capital costs for compliance are more closely related to type and
number of installations than to the number of production workers. The costs were then trans-
formed into the product sectors used in the economic impact analysis. A more detailed descrip-
tion on the cost allocation is contained in Appendix E-3.
API has estimated operating costs at $25-68 and $20-40 per worker for monitoring and
audiometric testing, respectively. Arthur D. Little used the low end of the range $25 per
production worker for monitoring and $20 per production worker for audiometric testing. In
addition to these charges, Arthur D. Little assumed 5% of capital investment for maintenance
labor and supplies and 12.1% for capital recovery.
Tables 111-12 and 111-13 summarize the cost by process category and product sector, respec-
tively. Again, capital recovery was not included in the operating costs for OSHA noise control by
process category but was included in the tabulation by product sector.
Arthur D. Little assumed that 80% of these expenditures would be required through 1977
and the remainder between 1977 and 1983. As with the studied air and water regulations, costs
associated with new mills were handled separately.
D. COSTS FOR NEW MILL SOURCES
1. Approach
Figure III-2 illustrates the regulations and methodology used for estimating the cost of
compliance for new industry capacity. Costs of compliance for new mill sources are based entirely
on federally promulgated or proposed regulations. In general, the regulations are somewhat more
stringent than those that apply to existing mills.
68
-------
TABLE III- 12
SUMMARY OF INCREMENTAL OSHA NOISE CONTROL COST TO EXISTING INDUSTRY
BY MAJOR PROCESS CATEGORY
Major Process
Category
Unbleached Kraft
NSSC Medium
Bleached Kraft /NSSC
Recycled Paperboard
Construction Paper
Bleached Kraft
Sulfite
Dissolving Sulfite
Soda
De-inked
Groundwood
N/I Tissue
N/I Fine
TOTAL
(1975 Dollars)
Total Category
Year-end Capacity (000 tons/y:
1974
8,760
3,270
4,960
8,670
2,160
26,460
3,200
910
290
2,420
2,850
1,670
2,380
68,000
1977
8,760
3,080
4,960
8,430
2,160
26,460
2,990
910
190
2,390
2,740
1,650
2,290
66,970
1983
8,760
2,930
4,960
8,060
2,060
26,290
2,830
800
190
2,220
2,300
1,580
2,180
65,160
Capital
- Costs
($MM)
36
27
12
55
23
99
27
6
4
40
31
20
14
400
Q
Operating
Costs
($MM/yr)
1.9
1-5
0.7
3.9
2.0
5.4
1.5
0.3
0.2
2.5
1.7
1.4
1.0
24.0
Excludes capital recovery
SOURCE: Arthur D. Little, Inc., estimates,
69
-------
TABLE 111-13
SUMMARY OF INCREMENTAL OSHA NOISE CONTROL COST TO EXISTING INDUSTRY BY
(1975 Dollars)
Sector Year-End
Capacity Base
(000 tons/yr)
Product Sector
Unbleached Kraft Paperboard
Unbleached Kraft Paper
NSSC Corrugating Medium
Recycled Paperboard
Construction Paper
Bleached Board and Bristols
Printing & Writing Paper
Tissue
Newsprint
Bleached Pkg. & Ind. Conv. Paper
Uncoated Groundwood Paper
Dissolving Pulp
TOTAL
1974
13,970
4,390
4,430
8,680
2,160
5,160
11,600
4,320
3,720
1,290
1,280
1,820
62,820
1977
13,970
4,390
4,240
8,440
2,160
5,160
11,270
4,210
3,650
1,290
1,190
1,820
61,790
1983
13,970
4,390
4,090
8,070
2,060
5,160
10,950
4,050
3,440
1,290
800
1,710
59,980
Capital
Costs
($/millions)
50
15
30
55
23
19
101
48
29
6
15
9
400
PRODUCT SECTOR
f\
Operating Costs
Oper. & Maint.
($/ton)
0.2
0.2
0.4
0.5
1.0
0.2
0.5
0.7
0.4
0.3
0.7
0.3
0.4
Capital
Recovery
($/ton)
0.4
0.4
0.9
0.8
1.3
0.4
1.1
1.4
1.0
0.6
1.5
0.6
0. 8
Total
($/ton)
0.6
0.6
1.3
1.3
2.3
p. 6
1.6
2.1
1.4
0.9
2.2
0.9
1.2
Unit costs based on 1977 capacities
SOURCE: Arthur D. Little, Inc., estimates.
-------
Studied
Regulations
Cost
Analysis
Data Sources:
EPA
Dept. of Commerce
ADL, NCASI
Resultant
Cost of Compliance
for new mills
(Cost per mill)
ederal
Water
Regulations
Data Sources:
EPA, ADL,
NCASI
Federal
Noise
Regulations
(OSHA)
Data Sources:
API, ADL
Product/
Process
Examples
(ADL)
Process/Product
T ran s f orma t i on
To
Economic
Impact
Analysis
FIGURE III-2. METHODOLOGY FOR CALCULATING COST OF COMPLIANCE - NEW MILLS
-------
As noted earlier, environmental regulations are based upon type of manufacturing process,
while their economic impact is measured on a product basis. An analysis of the cost of compliance
for new sources therefore tends to be speculative: since more than one type of process may be used
in the manufacture of a single product, one must decide which process is most likely to be used in
the construction of new capacity to meet future demands. This decision will affect the cost of
compliance because of the differences between the various manufacturing processes. Fortunately,
clear process preferences have developed for most paper products. Arthur D. Little discussed this
issue with numerous industry representatives and then exercised its judgment as to what this
future "process mix" will be.
Costs for new mill sources are presented on a unit basis, using cost models of specific
processes and corresponding products. Accordingly, a process/product transformation is not
necessary, because it is implicit in the cost models.
Each cost model indicates the mill capacity used in developing the cost estimates. As shown
in the supporting data contained in Appendix E (Volume III), costs of compliance are not linearly
related to size; the comparatively large mills used in the models have lower unit costs than do
existing facilities, which in general tend to be smaller than new econonic-size mills.
2. Air Emission Controls
The proposed Federal air control regulation calling for 99.7% particulate recovery from the
kraft recovery and combination boilers was used as the basis for deriving the cost of compliance
with air emission controls. The specific requirements of the proposed regulation are contained in
Table E-3, Appendix E-l. The investment and operating cost estimates for compliance are those
incremental from an "economic recovery level," assumed in this analysis to be 97.5% removal of
particulate matter. Obviously, the incremental cost for compliance would change if the "eco-
nomic level" were altered.
Table 111-14 illustrates the investment and operating cost for the increment from 97.5% to
99.7% particulate recovery for selected products. The mill sizes chosen in these examples typify
new economic-size manufacturing facilities, which are generally larger than the average existing
facility. The relationship between size and cost is discussed in Appendix E-l.
3. Water Effluent Control
The proposed Federal New Source Performance Standards were used as the basis for
deriving costs of compliance. These regulations are essentially the same as the BAT regulations
proposed for existing mills, except that color removal for the bleached kraft sectors is not
specified in the NSPS.
Arthur D. Little used the NSPS cost estimates for an aerated stabilization basin in all new-
mill models. New mills are not required to meet more stringent effluent control standards for 10
years after their initial permits are issued; therefore, costs for new mills to reach BAT have not
been included. The specific requirements for each of the studied process (and corresponding
product) categories are contained in Tables E-17 to E-19, of Appendix E-2 (Volume III).
The effluent control capital and operating costs were obtained from the Development
Document base (detailed in Appendix E-2) in two steps. First, the applicable process subcategory
costs for typical sizes were adjusted to pulp mill capacity where applicable, or to paper machine
72
-------
TABLE III-14
UNIT COST OF
Product Sector
and Specific Products
Unbleached Kraft Paperboard:
Kraft Linerboard
Unbleached Kraft Paper:
Kraft Bag Paper
NSSC Corrugating Mediu~:
Corrugating Medium
Recycled Paperboard:
Recycled Boxboard
Jute Linerboard
Bogus Medium
Gypsum Linerboard
Construction Paper:
None
Bleached Board & Rristols:
Bleached Paperboard (SBS)
Printing £ Writing Paper;
Bond Paper
Book Paper
Tissue :
Tissue Paper
Tissue. Paper
Newsprint:
Newsprint
Newsprint
Bleached Pkg. & Ind.Conv.:
None
Uncoated Groundwood Papers:
None
Dissolving Pulp:
Dissolving Pulp
Bleached Paper Pi'lp:
Blear V-d Y.-rr.er F-jlr1
COMPLIANCE WITH FEDERAL AIR EMISSIONS STANDARDS - NEW MILL SOURCES
(1975 Dollar Increment
Process
Categorv
Unbleached Kraft
Unbleached- Kraft
NSSC Pulping
Recyc. Paperbd.
K n
Construction Paper
3CT Kraft
Fine Kraft
Fine Kraft
3CT Kraft
Nonint. fron W-aste
Eaper
Fine Kraft /GW
Deinking
_
_
Diss. Sulfite
!'r.-;ft :-nct. Pulp
from Economic Recovery Level)
Mill Capacity (tpd)
Pulp
1000
800
450
400
330
330
400
_
800
800
800
800
1,240
_
_
550
900
Paper
1000
230
450
400
330
330
400
_
500
300
300
163
76
550
330
_
_
550
P. 00
Capital
Costs
($mtllions)
2.9
0.8
1.1
0.3
0.3
0.2
0.3
_
2.1
1.2
1-3
0.6
0.1
0.8
0.2
_
__ i
1.1
3.]
Opepatipg Costs
O&M
0.6
0.7
0.7
0.5
0.5
0.4
0.5
_
0.8
0.9
0.9
1.2
0.4
0.4
0.4
_
_
0.6
0.8
Capital
Recovery
1.0
1.3
0.9
0.3
0.3
0.2
0.3
_
1.6
1.5
1.6
1.3
0.5
0.5
0.2
_
_
0.7
1.3
($/ton)
Total
1.6
2.0
1.6
0.8
0.8
0.6
0.8
_
2.4
2.4
2.5
2.5
0.9
0.9
0,6
_
_
1.3
2.1
-------
capacity for nonintegrated examples. Second, for examples integrated to bleached kraft, the
portion of total effluent control cost applicable only to paper capacity was calculated by direct
proportion.
The effluent control costs are the allocated total for pulp and paper effluent based on paper
capacity, but the level of cost takes into account the scale economies of integration to a larger
pulp mill.
The complex pulp mill associated with integrated newsprint production was handled as a
1240-tpd fine kraft mill for purposes of estimating effluent control costs. The BOD, TSS, and
hydraulic load for groundwood are all lower than for bleached kraft; thus, the estimating
procedure slightly overstates total cost. However, there is no clear method for determining
standards or applying the "pure" process data to complex pulp and paper mills.
Table 111-15 summarizes the investment and operating costs of selected examples, for
compliance with NSPS. Note that whereas the costs to the existing mill (for both BPT and BAT)
were incremental to treatment facilities already in place, the costs for NSPS cover the entire
"battery limits" of the treatment facilities. Since there are no deductions for in-place facilities,
the new mill models indicate the total cost for water effluent treatment rather than simply the
increment beyond that assumed to be in place in 1974. The relationship of investment and
operating costs for compliance to total mill investment and operating costs for the selected
examples is discussed in Section E of this chapter.
4. Noise Control
Table 111-16 presents the investment and operating costs for noise control at the 90-dBA
level for the studied product/process examples. The capital costs ($1-3 million per plant) are
order of magnitude only.
These estimates are significantly greater than those reported for existing mills. The differ-
ence reflects Arthur D. Little's opinion that, presented with the option of using either adminis-
trative controls or building sufficient "engineering control" into a new mill to comply with noise
regulations, a producer would elect to take the latter route. Although administrative control is a
much less capital-intensive method of compliance, it is subject to subsequent modification by
OSHA if the mill is found to be in violation. Rather than risk being faced with the high costs of
mill modification, most producers would choose to equip their new mills with adequate "engi-
neering controls" initially. A more detailed discussion is contained in Appendix E-3 (Volume III).
E. RELATIONSHIP OF CONTROL COSTS TO TOTAL MILL
INVESTMENT AND OPERATING COSTS
1. Approach
To add perspective to these estimates of the costs of compliance for the existing industry
and for selected examples of new mills, Arthur D. Little prepared total investment and operating
cost (I&O) schedules for the manufacture of selected products in new mills. Figure III-3 illustrates
how these costs were analyzed and cost models developed.
74
-------
TABLE 111-15
UNIT COST OF COMPLIANCE WITH FEDERAL WATER EFFLUENT STANDARDS - NEW MILL
SOURCES
(1975 Dollars)
Product Sector
and Specific Products
Unbleached Kraft Paperboard:
Kraft Linerboard
Unbleached Kraft Paper:
Kraft Bag Paper
NSSC Corrugating Medium:
Corrugating Medium
Recycled Paperboard:
Recycled Boxboard
Jute Linerboard
Bogus Medium
Gypsum Linerboard
Construction Paper:
None
Bleached Board & Bristols:
Bleached Paperboard (SBS)
Printing & Writing Paper:
Bond Paper
Book Paper
Tissue :
Tissue Paper
Tissue Paper
Newsprint :
Newsprint
Newsprint
Bleached Pkg. & Ind. Conv:
None
Uncoated Groundwood Papers :
None
Dissolving Pulp:
Dissoliving Pulp
Bleached Paper Pulp:
Mill Capacity (tpd)
Process
Catec-orv
Unbleached Kraft
Unbleached Kraft
NSSC Pulping
Recyc. Paperbd.
11 it
11 11
M 11
Construction Paper
BCT Kraft
Fine Kraft
Fine Kraft
BCT Kraft
Nonint. from waste-
paper
Fine Kraft/GW
Deinking
Diss.Sulfite
Pulp
1000
800
450
400
330
330
400
_
800
800
800
800
1,240
-
550
800
Paper
1000
230
450
400
330
330
400
_
500
300
300
163
76
550
330
550
800
Capital
Costs
($millions)
19.0
4.8
, 13.6
6.8
6.1
6.1
6.8
_
16.1
8.5
8.5
4.8
3.4
9.2
12.9
27.5
20.3
Operating Costs
O&M
5.0
5.7
10.7
4.1
4.4
4.4
4.1
_
7.9
7.0
7.0
7.2
11.6
4.2
11.3
, ~
16.1
6.9
Capital
Recovery
6.7
7.6
10.6
6.2
6.8
6.8
6.2
11.8
10.3
10.3
10.8
16.4
6.0
13.9
~"
~
17.5
8.9
($/ton)
Total
11.7
13.3
21.3
10.3
11.2
11.2
10.3
19.7
17.3
17.3
18.0
28.0
10.2
25.2
~"
~
33. fc
15.8
Bleached Market Pulp
Kraft Mkt. Pulp
-------
TABLE 111-16
UNIT COST OF COMPLIANCE WITH
FEDERAL OSHA STANDARDS - NEW MILL
(1975 Dollars)
Mill Capacity f*~j\
Product Sector
and Specific Products
Unbleached Kraft Paperboard:
Kraft Linerboard
Unbleached Kraft Paper:
Kraft Bag Paper
NSSC Corrugating Medium:
Corrugating Medium
Recycled Paperboard:
Recycled Boxboard
Jute Linerboard
Bogus Medium
Gypsum Linerboard
Construction Paper :
None
Bleached Board & Bristols :
Bleached Paperboard (SBS)
Printing & Writing Paper :
Bond Paper
Book Paper
Tissue:
Tissue Paper
Tissue Paper
Newsprint :
Newsprint
Newsprint
Bleached Pkg. & Ind.Conv ;
None
Process
Category
Unbleached Kraft
Unbleached Kraft
NSSC Pulping
Recycled Paperboard
it it
n ii
it M
Construction Paper
BCT Kraft
Fine Kraft
Fine Kraft
BCT Kraft
Nonint . from Waste
Paper
Fine Kraft /GW
Deinking
-
Pulp
1000
800
450
400
330
330
400
-
800
800
800
800
-
1,240
-
-
Paper
1000
230
450
400
330
330
400
-
500
300
300
163
76
550
330
-
Capital
Costs
($millions)
3,0
2.0
3.0
1.0
1.0
1.0
1.0
-
2.0
2.0
2.0
2.0
1.0
2.0
1.0
-
SOURCES
Operating Costs
O&M .
0.3
0.4
0.6
0.5
0.6
0.6
0.5
-
0.4
0.4
0.4
0.4
2.8
0.5
0.6
-
Capital
Recovery
1.0
3.2
2,4
0.9
1.1
1.1
0.9
~
1.5
2.4
2.4
4.5
4.9
1.3
1.1
($/ton)
Total
1.3
3.6
3.0
1.4
1.7.
1.7
1,4
1.9
2.8
2.8
4,9
7.7
1.8
1.7
Uncoated Groundwood Papers ;
None
Dissolving Pulp
Dissolving Pulp
Bleached Paper Pulp:
Bleached Market Pulp
Dissolving Sulfite
Kraft Market Pulp
550
800
550
800
3.0
3.0
0.5
0.4
1.9
1.3
2.4
1.7
SOURCE: Arthur D. Little, Inc., estimates.
-------
An example of an existing mill would not be particularly informative, because site- and
mill-specific conditions would limit its applicability to the more generalized objective of this
analysis, namely, to generate costs for the subsequent economic impact analysis.4 Accordingly,
new mill models were used to illustrate the relationship of costs of compliance to total I&O.
As noted, all the previously listed cost of compliance estimates were adapted from published
sources. Arthur D. Little updated and modified them, but they are essentially those developed in
the cited reference material. On the other hand, the figures for investment and operating cost for
direct manufacture are Arthur D. Little estimates. Arthur D. Little has assessed their reason-
ableness and ascertained that they are well within the precision of pre-engineering cost estimates
(±25%).
The number of examples selected to characterize the industry (and hence assess the impact
of cost of compliance) is, of course, arbitrary. In choosing specific examples, Arthur D. Little was
guided by the diversity of specific products within each product sector. Table 111-17 lists the
studied product sectors and the specific examples selected to characterize them. The table also
indicates the importance of the selected product with respect to its share of the total capacity in
the related product sector. Obviously, there are significant variations of any given product, hence,
the sample calculations are intended simply to provide some perspective of the relationship
between manufacturing costs and costs for compliance.
2. Sample Cost Model
Table III-18 is a sample of the investment and operating cost schedule developed for one of
the previously listed product examples; similar schedules for the other products are contained in
Appendix F (Volume III). Note that the operating costs exclude charges for capital recovery;
these charges were intentionally excluded to facilitate the use of the models in the econometric
analysis, where they are handled in the typical manner for cash flow analysis.5 However, to
provide a complete picture of costs, they have been included in Table III-19 at their weighted
average value over the life of the sample mill. This table summarizes the total investment and
operating costs and the relationship of cost of compliance for the selected examples. The capital
requirements for compliance with the studied regulations comprise from 10% to 26% of the total
fixed capital and constitute from 4% to 13% of the total mill operating cost.
F. DISCUSSION OF ANALYSIS
1. Application and Limitations
The methodology used in this section was designed to develop capital and operating costs
for compliance with the studied regulations for major product sectors of the industry; a different
methodology, more appropriate for showing the possible cost to a single mill, was used in the
Closure Analysis (Chapter V).
Both the water effluent and air emission cost models are based upon current industry
manufacturing practices and control technology. The likelihood that new technology may reduce
costs has not been examined in the analysis; this exclusion is appropriate, since any effort to
4. Site- and mill-specific conditions are postulated for selected closure candidates. These examples are discussed
separately in Chapter V.
5. That is, depreciation charges change from year to year.
77
-------
oo
Cost of Compliance
with Air, Water and
Noise Regulations
(See Figure III-2)
Investment and Oper-
ating Costs for
Selected Process/
Product Examples
(ADI)
Compliance
vs. Direct
Mfg. Costs
To
Economic
Impact
Analysis
FIGURE III-3. INTERRELATIONSHIP OF COST OF COMPLIANCE AND DIRECT MANUFACTURING COSTS
-------
TABLE 111-17
RELATIONSHIP OF SELECTED PRODUCTS TO PRODUCT SECTORS
1974 Yr-end Capacity Percentage of Sector
Product Sector
Unbleached Kraft Paperboard
Unbleached Kraft Paper
NSSC Corrugating Medium
Recycled Paperboard
Construction Paper
Bleached Board & Bristols
Printing & Writing Paper
Tissue
Newsprint
Bleached Pkg. & Ind . Conv.
Uncoated Groundwood Papers
Dissolving Pulp
Bleached Paper Pulp
Selected Product
Kraft Linerboard
Kraft Bag Paper
Corrugating Medium
Recycled Boxboard
Jute Linerboard
Bogus Medium
Gypsum Linerboard
-
Bleached Paperboard (SBS)
Bond Paper)
Book Paper;
Tissue Paper (virgin)
(recycled)
Newsprint (virgin)
" (recycled)
-
-
Dissolving Pulp
Bleached Market Pulp
(million
Sector
13.97
4.39
4.43
8.68
-
2.16
5.16
11.60
4.32
3.72
1.29
1.28
1.82
6.15 -
tons) Represented by
Product Selected Product
12.90
2.303
4.43
2.67
0.43
1.36
1.10
3.92
7.05
3.22
1.10
3.31
0.41
-
-
. 1.82
6.15
99.5
52.4
100.0
30.8
6.0
15.7
12.7
-
76.0
60.0
74.5
25.5
89.0
11.0
-
-
100.0
100.0
Estimated from 1974 production
Source: "Paper, Paperboard, Wood Pulp Capacity, Fiber Consumption, 1974-1977," API, October, 1975
-------
TABLE 111-18
SUMMARY OF CAPITAL AND OPERATING COSTS FOR THE MANUFACTURE OF
UNBLEACHED KRAFT LINERBOARD
BASIS: Process: Continuous Kraft Pulping
Production: 1000 tons/day; 345,000 tons/year
Mill Location: Southeast
Capital Requirements ($millions)
1. Excluding Environmental Regulations
Direct Manufacturing Process
OSHA Regulations
Total Fixed Capital
Total Working Capital (3 months delivered cost)
2. Plus Effluent
Water Control
Air Control
Operating
Control Cost
- Internal
- External
- Economic Level
- Environmental Level
Total Fixed
Total Working
Cost Item
Fiber Cost
Other Raw Materials
Hourly Labor
Supplies
Energy
Factory Overhead
Capital-related (less capital recovery)
Sub-total, Factory Cost
GS&A
Freight Out
OSHA Regulations
Total Delivered Cost, Direct Mfg.
Total Delivered Cost, excluding
Federal Environmental Regulations
Water Control Regulations
Air Control Regulations - Economic Recovery
Environmental Control
Total Delivered Cost,
excluding capital recovery
121
3
124
10
6.3
12.7
2.8
2.9
Capital 148.7
Capital 10
$/Ton $000/Year
41.9 14,460
4.5 1,550
11.4 3,930
9.9 3,410
6.9 2,380
4.8 1,660
7.9 2 , 720
87.3 30,110
7.3 2,520
20.9 7,210
115.5 39,840
0.3 100
115.8 39,940
5.0 1,740
(2.7) (930)
0.6 220
118. 7a 40,970
a Capital recovery charges add $52.2/ton to this cost, giving a total of $170.9/ton.
Source: Arthur D. Little, Inc., estimates.
80
-------
TABLE 111-19
RELATIONSHIP BETWEEN MANUFACTURING COSTS
AND ENVIRONMENTAL CONTROL COSTS JH 1975
00
. ' Environmental
Product Sector
and Specific Products
Unbleached Kraft Paperboard:
Kraft Linerboard
Unbleached Kraft Paper:
Kraft Bag Paper
NSSC Corrugating Medium:
Corrugating Medium
Recycled Boxboard
Jute Linerboard
Bogus Medium
Gypsum Linerboard
Construction Paper:
None
Bleached Board & Brlstols:
Bleached Paperbd. (SBS)
Printing & Writing Paper'.
Bond Paper
Bock Paper
Tissue:
Tissue- Paper
Tissue Paper
Newsprint ;
Newsprint
Newsprint
Bleaching, Pkg. & Ind. Conv:
None
Uncoated Groundwood Paper:
None
Dissolving Pulp:
Dissolving Pulp
Bleached Paper Pulp:
Bleached Market Pulp
Process
Category
Unbleached Kraft
Unbleached Kraft
NSSC Pulping
Recycled Paperbd.
ii n
ii n
ii n
Construction Paper
BCT Kraft
Fine Kraft
Fine Kraft
BCT Kraft
Nonint. from waste
paper
Fine Kraft/GW
De-inking
-
-
Dissolving Sulflte
Kraft Market Pulp
Mill C
Pulp
1000
800
450
400
330
330
400
-
800
800
800
800
'
1,240
-
-
-
550
800
Total Delivered
Capacity (tpd) Mfg. Costs
Total
Capital Oper.
Paper ""'" "
1000
230
450
400
330
330
400
-
500
300
300
163
76
550
330
-
-
550
800
UPU1J
148.
65.
67.
57.
39.
32.
49.
-
144.
96.
94.
70.
28.
120.
55.
.-
-
161.
184.
7
3
7
8
1
1
8
8
7
8
9
4
5
9
6
0
IW ton)
170.9
258.7
196.1
238.4
198.9
178.9
203.0
-
326.0
389.1
403.6
687.9
748.2
246.7
237.1
332.5
261.3
NSPS
Effluent
Capital
T5W
19.
4.
13.
6.
6.
6.
6.
-
16.
8.
8.
4.
3.
9.
12.
-
-
27.
20.
u
0
8
6
8
1
1
8
1
5
5
8
4
2
9
5
3
Water
Standa
i-Hc
Total
Oper.
(S/to '
11.
13.
21,
10.
11.
11.
10.
-
19.
17.
17.
18.
28.
10.
25.
-
33.
15.
n)
7
3
3
3
2
2
3
7
3
3
0
0
2
2
6
8
Control Costs
Air Emissions
New
Source ^l"«nH ST-^Q
Capital
(SMM)
2.9
0.8
1.1
0.3
0.3
0.2
0.3
-
2.1
1.2
1.3
0.6
0.1
0.8
0.2
-
-
1.1
3.1
Total
Oper.
($/ ton)
1.6
2.0
1.6
0.8
0.8
0.6
0.8
-
2.4
2.4
2.5
2.5
0.9
0.9
0.6
-
1.3
2.1
OSHA Requirements
Capital
($.T
3
2
3
1
1
1
1
2
2
2
2
1
2
1
3
3
IM)
.0
.0
.0
.0
.0
.0
.0
.0
.0
.0
.0
.0
.0
.0
.0
.0
Total
Oper.
($/ ton)
1.3
3.6
3.0
1.4
1.7
1.7
1.4
-
1.9
2.8
2.8
4.9
7.7
1.8
1.7
2.4
1.7
Total Cost of
Compliance
Cap
($MM
24.
7.
17.
8.
7.
7.
8.
-
20.
11.
11.
7.
4.
12.
14.
-
31.
26.
Ital
)
9
6
7
1
4
3
1
2
7
8
4
5
0
1
6
4
Total
Oper.
(5/ton)
14.6
18.9
25.9
12.5
13.5
13.3
12.5
-
24.0
22.5
22.6
25.4
36.6
17.9
27.5
-
37.3
19.6
Cost of
Capital
17
12
26
14
19
23
-
14
12
12
10
16
10
25
-
20
14
Compliance
Operating
Costs
9
7
13
5
7
7
6
-
7
6
6
4
5
5
12
*"
11
8
SOURCE:
= Arthur D. Little, Inc., estimates.
-------
project the significance of savings and the rate of implementation of new technology is specula-
tive at best. Nevertheless, it must at least be acknowledged that new or modified pulping and
bleaching processes could be developed whose effluent streams would be less costly to control.
Cost reductions could result from less polluting manufacturing processes, water effluent or air
emission treatment, or a combination of both. While the timing and impact of such technological
developments are clearly unpredictable, it would be short-sighted not to recognize the continuous
evolution of technology and its possible resultant impact upon both the capital requirements of
the industry and the costs of compliance. Control regulations have, in fact, stimulated the
development of less polluting processes and more economical treatment technology.
Another major assumption of the analysis is that product quality will not change during the
studied period. Product specifications sometimes change without adversely affecting utility in
the final application: during the past five years, for example, the basic weight of newsprint has
been reduced from 32 to 30 pounds per ream, and a solid unbleached kraft board is capturing
markets once served by solid bleached board and recycled board. Although more such changes
could admittedly occur, they are a subject of considerable complexity and controversy, and
Arthur D. Little considers it inappropriate to speculate on the products that might be affected.
Effluent- or emission-control cost models were used to estimate aggregate costs to a product
sector. However, the resultant "average" costs obviously understate the cost to some mills and
overstate the costs to others. Thus, while some mills report their cost of compliance to be
significantly greater than those presented in the Development Documents, others report that they
are now or soon will be in compliance with the BPT guidelines through the application of control
technology that is simpler and less costly than that specified in the effluent-control cost models.
The accuracy or reasonableness of the estimated cost of compliance is, of course, an
important issue in subsequently assessing the economic impact of the studied regulations.
Considerable work has been done by EPA and others in assessing the costs of compliance with air
and water regulations; the cost estimates for noise reduction are, in Arthur D. Little's opinion, an
order of magnitude less accurate. Pre-engineering cost estimates generally have a possible
variability of plus 25% and minus 10%. Arthur D. Little believes that these percentages would
apply to estimates of aggregate costs for air and water control for a given product sector.
(Obviously, as stated earlier, the variation for any one mill can be significantly greater than this
range.) On the other hand, the variation in cost estimates for noise reduction is estimated at plus
25% and minus 50%. The large variability in the negative direction reflects that the cost estimates
used in this analysis were based on achieving compliance via "engineering in the pathway";
reportedly, significant capital cost reductions could be achieved by substituting administrative
control for some of this engineering. However, since the permissible level of administrative
control is speculative, costs of compliance are more appropriately based on the more costly
method of compliance. Clearly, however, additional work is required to raise the quality of the
OSHA noise reduction cost estimates to the level of the air and water control cost estimates.
Overall, while there is significant variability in the cost of compliance estimates, it is well
within the accuracy of other factors (growth in GNP, cost of capital, etc.) used in assessing the
economic impact of the studied variations.
82
-------
2. Causes of Cost Escalation
Table 111-19 summarized the total capital investments for new plants and their relationship
to the capital costs for compliance. Depending on the type and size of the plant used in each cost
model, the capital cost associated with the studied regulations ranges from 10% to 26% of the
total capital requirements. In relation to the industry capacity represented by each of the cost
models, the weighted average cost of compliance is about 15% of the capital cost of additional
industry capacity.
While the contribution of capital requirements for compliance with environmental regu-
lations is substantial, it is not the only cause of cost escalation in new construction. Other factors
include inflation and the tendency to build more capital-intensive facilities to reduce operating
costs.
Inflation of course, has been a significant factor in the rising cost of new construction,
particularly from the third quarter of 1973 through mid-1976. Its influence can be seen in
numerous equipment cost and plant construction cost indices. However, a comparison of plant
investment estimates presented in this report with one obtained by simply escalating say, a 1965
plant investment estimate via these indices, shows that the reported capital requirements are
substantially higher. Clearly, costs for new plant construction have risen much faster than
inflation plus the 15% increment associated with the cost of compliance.
The reason is that pulp and paper mills are simply becoming more capital-intensive; this
reflects an effort by producers to slow the rate of increase in costs of raw materials, energy, and
labor. They are turning to more sophisticated (and more costly) processes to reduce cost in these
areas and to facilitate the external water effluent and air emission control treatments.
The use of fiber reclamation in modern pulp and paper mills is an example of greater plant
investment to achieve savings in raw materials. Not many years ago, "knots" (wood chips and
actual wood knots that failed to break up in the digester), screening/cleaning rejects, and some of
the paper machine "white water" were discharged without further treatment. Today, reclamation
of the "knots" and screening/cleaning rejects is an accepted industry practice. The equipment
used for this purpose is costly, but it saves enough high-cost fiber to make the additional
investment economically attractive.
In a similar manner, fiber traditionally has been recovered from water discharged at various
points in the pulping and papermaking operation where the concentration of fiber per volume of
water is high, but recovery has not been economical where concentration is low. The latter is no
longer true, not only because of the increased cost of fiber but also because any fiber not recovered
and reused internally in the manufacturing operation must now be recovered and disposed of in
an external effluent treatment process.
To the extent possible, the Development Documents attempted to apportion the additional
investment for fiber recovery between that due to economic recovery and that prompted by
effluent control. Clearly, however, this apportionment of capital dollars is a complex and arbi-
trary process. The point is that a greater investment is being made today in fiber reclamation for
economic reasons than some ten or even five years ago, when fiber costs were significantly lower.
83
-------
Additional large investments are being made in new plants for more efficient use of energy.
Higher pressure boilers that cost more but are more efficient are being included in new plant
designs; additional or larger heat "economizers" are being installed, and new or additional on-site
power generating equipment is being included. These and other process changes are being made
to reduce energy consumption. However, they are not new or emerging technical developments;
they have been available for years, but have become economically justifiable as energy costs have
tripled.
Similarly, more automation has been designed into new plants. The additional investment
dollars can be justified in terms of fiber and energy savings and labor cost reductions, but it has
contributed significantly to the capital cost for building new production facilities.
Thus, while Arthur D. Little cannot quantify the relative importance of the various factors
contributing to the escalating cost of new capacity, the causes clearly include others besides
inflation and the cost of compliance with environmental regulations.
3.Comparison of Cost Estimates with Other Published Estimates
For purposes of this discussion, the costs of compliance with the studied regulations are
divided into two discrete areas: those for proposed regulations or guidelines pertaining to air and
water, and those proposed for noise reduction. A detailed analysis and comparison of the Arthur
D. Little cost estimates with paper industry surveys and other published estimates are contained
in Appendix E-4 (Volume III). This section is a summary of that information.
a. Control Costs for Water and Air
Estimates of industry's costs for compliance with the studied water and air regulations have
been developed by the following:
Hazen and Sawyer, Inc. 1977 and 1983 water effluent control for existing industry.
National Council for SIP air costs for existing industry, and Federal
Air and Stream Improvement water and air regulations for new capacity.
The results were summarized and used as the cost basis of a study6 prepared for the
American Paper Institute by the URS Research Company. The total costs were estimated at $8.2
billion (in 1974 dollars) for the period 1974 to 1983 exclusive.
To be on the same time basis as that used in this report, the above figure must be converted
to mid-1975 dollars and reduced by the amount of reported expenditures through 1974; the result
is $8.7 billion. (See Table E-22, Appendix E-4). Implicit in this estimate is that industry capacity
would increase from some 73 million tons at the end of 1977 to some 89 million tons by 1984. In
comparison, Arthur D. Little estimates the cost of compliance at some $6.6 billion, based on the
assumption that industry capacity will increase to only 86 million tons.7 Accordingly, one of the
6. "Economic Impacts on the American Paper Industry of Pollution Control Costs," report by URS Research Company
to the American Paper Institute, September 1975.
7. Other industry growth scenarios are also postulated, with correspondingly different costs of compliance.
84
-------
first and most obvious sources of variance between the two estimates is the difference in the
capacity base. Simply correcting for the 3-million-ton difference in capacity would reduce the
variation from $2.1 billion to $1.8 billion. The latter figure is about 21% higher than the Arthur D.
Little estimate; it is also developed against a more stringent set of assumptions with regard to the
required level of environmental control.
In view of the uncertainty and changing characteristics of the proposed regulations and/or
guidelines, the two independent estimates are remarkably close and certainly within the precision
of other key factors (growth in GNP, cost of capital, new technology, new products, etc.) that
influence the economic impact of these estimated costs. Thus, while Arthur D. Little believes the
estimates are well within the accuracy of the overall impact analysis, it appears appropriate to
discuss them here in somewhat more detail.
(I) Water. Both URS (Hazen & Sawyer) and Arthur D. Little estimate that compliance
with water regulations would cost the existing industry $2.2 billion. This apparent agreement is
somewhat misleading, however; the URS estimate includes a higher unit cost for compliance, a
more stringent set of regulations, and a higher level of in-place treatment facilities than were
assumed in the EPA Development Documents, upon which Arthur D. Little's figures are based.
The higher unit cost for the more stringent regulations and level of in-place treatment facilities
coincidentally offset each other, so the net incremental capital requirement is the same as that
estimated by Arthur D. Little.
A detailed comparison of these two estimates is given in Appendix E-4.
(2) Air. Arthur D. Little and URS disagree significantly on the cost for compliance with air
regulations, particularly to the existing industry for the 1978-1983 period. Since the URS report
contains no information to support the estimates or to explain the methodology used in deriving
them, Arthur D. Little cannot be sure of the reasons for the variances. They appear to be the
assumptions (hence related costs) associated with:
the required level of control for the existing industry,
the level of economic recovery (existing and new industry capacity), and
capitalized maintenance and replacement of capacity.
Level of Control: State Air Quality Implementation Plan (SIP) standards apply to
the existing industry; Federal regulations do not. Furthermore, SIP requirements
vary significantly from state to state; hence, a given type and size of mill can have
greatly different costs of compliance, depending on its location.
Even though many states presently do not have regulations as stringent as those of Oregon
(which require 99% particulate recovery), Arthur D. Little used that state's current SIP standards
to calculate the existing industry's cost of compliance. Arthur D. Little postulated that the
current Oregon regulations would be more broadly applied to those states that presently have less
stringent regulations.
The URS (NCASI) estimates did not specify what regulations were used in deriving the cost
estimates or whether more stringent controls beyond those assumed through 1977 would
85
-------
apply in the 1978 and 1983 period. Judging from its magnitude, however, one would suspect that
the estimate for the existing industry's expenditures from 1978 to 1983 includes provision for the
application of more stringent regulations.
Capitalized Maintenance/Replacement Cost: Major capital expenditures are oc-
casionally budgeted entirely for environmental controls. More frequently, how-
ever, they are primarily for the building of grassroots facilities, replacement of
existing capacity (capitalized maintenance), or incremental expansion of existing
mills and only a portion of the investment goes into environmental control. Unfor-
tunately, it is difficult to generalize on the amount that is necessary for compliance
with environmental regulations in relation to the expenditures for enlarging capac-
ity or increasing the efficiency of the process.
For cost estimating purposes, Arthur D. Little has shown separately the capital investment
associated with:
capitalized maintenance to maintain the existing industry at rated capacity and
investment requirements for new capacity, whether that new capacity is to replace
existing capacity or add net additional capacity.
Hence, by deriving the cost of compliance empirically, Arthur D. Little has attempted to avoid
the inappropriate allocation of industry expenditures.
Table III-6 summarized the derived capital cost for air emission control for the existing
industry using the current Oregon SIP standards. The estimate of $1.3 billion includes costs for:
(a) those mills using the kraft process, (b) power boiler controls for other process categories, and
(c) earlier retirement of recovery boilers in the kraft process categories.
Deducting the reported industry expenditure of some $0.4 billion from the derived estimate
results in an incremental cost of $0.9 billion in additional capital for the existing industry to
achieve the 99.0% particulate recovery required by the Oregon standards.8
By way of comparison, the incremental air emission control cost reported by NCASI for the
existing industry amounts to some $2.4 billion (mid-1975 dollars). On the assumption that
perhaps 85% ($2.0 billion) of this total is associated with the kraft process, each of the 127 existing
kraft mills in the industry would have to spend about $16 million to control air pollution. This
figure appears to be much too high for the incremental cost of compliance; it must include
provision for other capital requirements, such as incremental new capacity or capitalized mainte-
nance items, which are shown separately in the Arthur D. Little cost analysis.
b. OSHA Noice Control Costs
Two sources of information deal with the costs of noise reduction to meet the proposed
OSHA noise regulations The American Paper Institute and Bolt Beranek & Newman, Inc.
(BBN). Arthur D. Little used the American Paper Institute (API) data, estimated a $516 million
for all sectors in SIC 26. Arthur D. Little modified this data, to reflect the fact that API had
included certain SIC codes that were omitted from the Arthur D. Little analysis, and arrived at
an estimated incremental capital cost to the existing industry of $400 million.
8. This estimate does not include capital expenditures for fuel conversion. The conversion of power boilers from oil to
coal or from natural gas to oil or coal would add significantly to the derived cost.
86
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The BBN study appears to extrapolate very limited data. Using the estimated costs of noise
reduction in two mills (whose type, size, number of machines, etc., were not indicated), BBN
divided these figures by the number of production workers in each plant and then extrapolated
the cost per worker to the cost for the entire industry.
Arthur D. Little believes that the costs of noise reduction are more closely associated with
the type and number of pulp and paper mills and the number of paper- or board-making
machines. Accordingly, it relied on the API estimate, which takes these factors into
consideration.
87
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CHAPTER IV
PRICE AND SECONDARY IMPACTS
-------
IV. PRICE AND SECONDARY IMPACTS
A. OVERVIEW
This chapter details the price increases that are likely to occur from the cost to the pulp and
paper industry to meet the studied air, water, and noise regulations. The projected price increases
provided the basis for calculating demand reductions, supply/demand imbalances, and effects on
suppliers.
The price impacts of the environmental regulations can be summarized as follows:
Average paper prices will increase a total of 8% over the general inflation in the
long run as a result of new mill costs to comply with the water, air, and OSHA
noise regulations. Paper prices will increase an additional 12% because of recent
substantial increases in new mill costs not related to environmental regulations.
Consumer product price increases in relative terms will be less than the price
increase of the paper, except for tissue which should experience the same increase
(about 4.1%).
Demand for paper products is relatively price inelastic. The projected 8% average
price increase will cause a 5% lower level of potential paper demand, equivalent to
about 1- '/2 years of "normal" growth.
The existing industry requires a lower price increase (6%) to recover incremental
costs of environmental regulations, since it has already made substantial in-
vestments and progress toward meeting 1977 requirements.
With the possible exception of saltcake suppliers, paper industry suppliers face
minimal impacts as a result of the price increases and demand reductions caused
by the studied environmental regulations.
B. FINDINGS
1. Price Impacts
a. Introduction
The price increases that will result from the studied environmental regulations were
analyzed in three different ways:
1. The long-run price effects (beyond 1983) based upon studied environmental regu-
lations on new mills.
2. The price increase necessary for existing mills to recover their total incremental
costs of compliance with the studied regulations.
3. The average aggregate price level likely to prevail from 1976 to 1983 (in 1975 dollars)
if the industry's return on total capital averages 10%.
The first two analyses were applied to estimate price impacts for the individual product
sectors and the total industry. The third analysis is a by-product of the funds-flow analysis
discussed in Chapter VI.
89
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b. Long-run Price Effects
Prices will be $24 per ton, or about 8% higher, than they would otherwise have been in the
long-run as a result of costs associated with the studied environmental regulations. EPA New
Source Performance Standards (NSPS) for water effluent will have the greatest impact at $19 per
ton or 6% of the long-run price without regulations ($327). OSHA noise regulations will add about
a 1% price increase and EPA NSPS air regulations combined with State Implementation Plan
and air regulations contribute an additional 1% (Table IV-.1).
It should be noted that the price increase figures cited above represent the total long-run
impact of the studied environmental regulations and not the incremental effect of going from the
1975 effluent level to NSPS. The long-run baseline "without regulation" average price of $327 per
ton represents the price necessary to earn the industry's historic rate of return1 on a new mill
excluding any equipment that is not justified on economic grounds.
TABLE IV-1
LONG-RUN PRICE IMPACT OF MAJOR ENVIRONMENTAL REGULATIONS
IMPOSED UPON THE PULP AND PAPER INDUSTRY
1975$/Ton % Change
1975 Market Price 292
New Mill Inflation Effect 35
Without Regulation
Subtotal 327
Incremental Price Increases Due To:
EPA NSPS Water 19 6
OSHA Noise 3 1
EPA NSPS and SIP Air 2 1
TOTAL PULP AND PAPER 351 8
Source: Arthur D. Little, Inc., estimates.
Prices will also increase in the long-run because the cost of new plant construction and
equipment replacement has increased so rapidly in recent years. The average 1975 price for a ton
of paper was $292, but the long-run average price based upon the construction and operating costs
of new mills without any environmental controls will be $327 per ton. This represents a 12f;o
increase in price a greater impact than that of all the studied regulations. The magnitude of
the price inflation impact is sensitive to the cost of capital and the potential variability in
operating costs. (See Section D.2, Sensitivity Analysis.)
The impact of environmental regulations varies by product sector (Figure IV-1). The price
increase for tissue, $35 per ton, is higher than for any other product. However, since tissue is the
highest priced paper product, $769 per ton in 1975, the $35 represents an increase of only 4.1%,
the smallest percentage increase that will be experienced by any product sector. A price increase
for NSSC (neutral sulfite semi-chemical) corrugating medium of $32 per ton, is equivalent to a
price increase of 15.7%, the highest relative price increase, because the price of NSSC is at the
lower end of the spectrum for paper products ($193 per ton in 1975).
1. The long-run price impacts were estimated based upon a 10% cost of total capital (13% on equity capital). Although
the price levels change with different costs of capital, the relative impact is insensitive to variability in the cost of
capital. (See Section D.2, Sensitivity Analysis.)
90
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FIGURE IV-1
Industry Aggregate
Bleached Board (SBS)
Newsprint
NSSC Corrugating
Medium
LONG-RUN PRICE INCREASE
RESULTING FROM ENVIRONMENTAL REGULATIONS
IN THE PULP AND PAPER INDUSTRY"1
$/Ton Without
Environmental Regulations
$327
362
280
198
LL
a
7.3%
Printing & Writing
Bond Paper
Book Paper
Recycled
Recycled Boxboard
Gypsum Linerboard
Tissue
Tissue
Deinked Tissue
Unbleached Kraft
Linerboard
Unbleached Kraft
Bag Paper
"Excluding woodland regulations.
436
449
260
219
782
185
297
jm
6.4%
6.2%
i
5.3%
Hl6-3%
H
NSPS WaterP I
OSHA Noise
NSPS Air
& SIP
E
mm 10.3%
+
iiiiiiiii-
100.0 105.0 110.0 115.0
Relative Price Increase Necessary
(100.0 = Price without Environmental Controls)
H 1-
-------
C. PRICE INCREASE REQUIRED TO RECOVER EXISTING
INDUSTRY'S INCREMENTAL COMPLIANCE COSTS
The price impacts discussed thus far are those that will prevail in the long run when the
industry is dominated by plants that must comply with new source performance standards. Over
the next several years, however, the price increases will be those required by existing mills to
recover the costs of the following:
EPA 1977 Water Effluent Guidelines
EPA 1983 Water Effluent Guidelines
OSHA Noise Standard
SIP Air Emission Standards
The aggregate price increases necessary to recover the cost of these regulations to the
existing industry are shown in Table IV-2. The 1977 and 1983 water effluent regulations require
an average price increase of $8 and $6 per ton, respectively, to cover the incremental cost of
compliance. Most of the incremental cost associated with OSHA noise and SIP air regulations
will be borne by 1977, with a lesser amount incurred by 1983.2 The price increases required to
cover the incremental compliance costs amount to $11 per ton (3.8% of the average 1975 price) by
1977 and a total of $17 per ton (5.8%) by 1983.
The incremental cost of environmental regulations to the existing pulp and paper industry
and the price increase needed to cover these costs vary by product sector (Figure IV-2). Tissue
producers require the smallest percentage increase in price, 3.7%, to cover the cost of pulp and
paper industry regulations. The greatest relative impact, 7.9%, will be on the price for uncoated
ground wood.
Although the uncoated groundwood product creates less air and water pollution than tissue,
its treatment costs are higher than average per ton because the mills are small. The higher than
average treatment cost combines with the low per-ton price to yield a high relative impact. Thus,
the potential relative price increase is related to the product's base price as well as its cost for
environmental control.
The SIP air regulations vary considerably from state to state in both the emission level
allowed and the timing required. As discussed in Section III-C.2, estimates for SIP costs were
based on the assumption that all mills would meet current Oregon standards, the most stringent
in existence. The Oregon standards are becoming progressively tighter, but most other states are
far enough behind to permit the estimated price impact of these standards to be taken as an
upper bound of the probable impact unless more stringent standards are imposed nationally.
Among the product groups studied, the price increase necessary to recover the SIP costs ranges
from a low of 0.3% of the 1975 price for tissue to a high of 1.2% for kraft paper.
In estimating the cost of the OSHA noise standard, Arthur D. Little assumed that com-
pliance activity would occur over the period 1975-1983. (See Chapter III.) In total, the existing
industry can recover the cost of the proposed OSHA Noise with just a small price increase,
ranging from 0.1% of the 1975 price for bleached board, to 0.7% for NSSC corrugating medium.
2. See Chapter III, Section D for a more complete discussion.
92
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TABLE IV-2
PRICE INCREASE
TO COVER COST OF ENVIRONMENTAL REGULATIONS
TO THE EXISTING INDUSTRY *
(1975 Dollars per Ton)
By By
1977 1983 Total % Change
Average Price, 1975 292
Type of Regulation
EPA 1977 Water 8 8 2.9
EPA 1983 Water 6 6 1.8
SIP Air 2 0** 2 '0-./7
OSHA Noise _1_ Qftft _i 0.4
Total Pulp & Paper 11 6 17 5.8
*Incremental cost of going from 1975 level to requirement.
**Less than 0.5%.
SOURCE: Arthur D. Little, Inc., estimates.
Environmental regulations will have a greater impact on increasing production costs for new
mills than for existing mills. Compliance cost estimates for the existing industry represent the
incremental expenditure from the various effluent (or noise) levels of 1975 to compliance with
each of the regulations. For new mills these compliance costs are the incremental costs from the
economically justified effluent control level to compliance with regulations for new sources. Other
factors also make costs of compliance higher for new mills.3 For example, new machinery runs at
higher speeds than old machinery and is therefore noisier, which increases the cost of compliance
with OSHA noise regulations. As a result, price increases related to environmental costs are
generally lower for existing mills than the long-run price increases indicated in Table IV-1. The
exception to this rule is newsprint, in which existing industry requires a 7.5% increase (Figure IV-
2) to recover the cost of environmental regulations whereas the long-run price increase based on
new sources is only 5.7% (Figure IV-1). However, the long-run price (without environmental
regulations) for new sources will be $280 per ton compared to the 1975 price of $265 per ton, or a
total price with regulations of $296 compared to $286 for the existing industry. Therefore, the
total price level required for the existing industry to recover compliance costs is less than the long-
run price that will prevail as a result of environmental regulations.
3. See Chapter III for the details of cost of compliance differences.
93
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FIGURE IV-2
Industry Aggregate
Bleached Board
& Bristols
Dissolving Pulp
Newsprint
NSSC Corrugating
Medium
Printing & Writing
Papers
Recycled
Paperboard
Tissue
Unbleached Kraft Paper
Unbleached Kraft
Linerboard
Uncoated
Groundwood
PRICE INCREASES NECESSARY
FOR EXISTING INDUSTRY
TO COVER THE COST OF ENVIRONMENTAL REGULATIONS
(Percent Change) .
Ave. 1975
Price
$292 M f^y \ -
353 f | |^^ J!
398 M [^
265 J | ^=0^
193 ^ r \~P/-'\ n
591 \ \ f^PI'HI 1 L
215 M mm }\*
769 \ | IP^I i -f ii3-7^
2A2 ) | 1^;^ 1 i i
) \ I
335 ) | fefe
.i;iii;y5'9%
|| 1 5.0%
li.;| .i [[ \ 6-57°.
\ HI in mi ?-7%
Ijllllllll ]]| 6.2%
+-2^ EPA 1977 Water | |
1% SIP ^
OSHA Npise ^^
I II 1 5'9% EPA 1983 Water |||||||
rF"n 7.0%
i! |il|! illjllilijllMll 7.9%
1 1 1 1 1 1 1 1 1 1 1 1 1
100.0 105.0 110.0
Relative Effect on Price (100.0 = 1975 Price)
-------
d. Average Paper Price Increase 1976 to 1983
From 1976 to 1983, the cost structure of existing mills in the pulp and paper industry will
predominate. However, new capacity will come on-stream and some existing equipment will be
replaced. Consequently, the price impacts of environmental regulations occurring over the next
few years will be a result of the costs of environmental regulations to both the existing industry
and new sources. The real price increases that occur will be the result of economic conditions,
cash flow and Federal tax effects.
The aggregate price impact of the studied regulations over the period 1976-1983 was forecast
using the industry flow of funds model described below, in Chapter VI and Appendix H. Table IV-
3 sets forth the aggregate price impacts to be expected if the industry takes full account both of its
immediate and its prospective cost of capital, investment requirements, achievable output levels,
and operating costs in its current pricing decisions. Costs to the existing industry play the
dominant role in establishing the price increases that will result from the studied regulations
between 1976 and 1983. The net effect on the industry of the interplay between tax effects, output
adjustments, and miscellaneous other factors results in an estimate of the impact of compliance
beyond 1975 levels of $17 per ton which is coincidentally equal to the price increase necessary for
existing industry to recover the cost of the studied regulations.4 However, Table IV-3 also
indicates that the aggregate price level over the 1976-1983 period will be increased further by
about $13/ton over 1975 prices to compensate for inflationary increases in the basic cost of
construction of new capacity and in the costs of environmental control equipment already
installed by the existing industry.
2. Outlook for Demand and Capacity Utilization
The outlook for aggregate paper industry demand and capacity utilization was analyzed by
two different methods.
(1) Demand adjusted for the 1976-1983 average paper price increase occurring in 1976
and the resulting capacity utilization rates in the funds flow model. (See Chapter
VI.)
(2) Demand forecast adjusted to reflect price increases equal to average environmen-
tal cost increases to the existing industry.
The second method of projecting average industry demand and capacity utilization consists of
forecasting aggregate paper demand (from the demand equation and the Chase Econometrics
forecast without a 1978 recession) and adjusting for the price increase necessary for the existing
industry to recover its compliance costs. This view of potential capacity shortage is more
conservative because it projects a higher demand.
The demand forecast and upper and lower boundaries around the forecast are shown in
Figure IV-3, along with the estimated capacity utilization rate. The announced capacity expan-
sion plans of industry were combined with the expected demand level (without a 1978 recession)
to arrive at an estimate of the industry capacity utilization rate through 1979. In addition,
aggregate capacity growth rates were estimated for the years 1980 through 1983 and operating
rates were projected for these years.
4.The similarity of these numbers is coincidental because the funds flow model assumed method of the incremental
cost of compliance from December 1974 to July 1, 1977 was incurred in 1975. The analysis of costs to the existing
industry included the total incremental cost from December 1974 to July 1977. The discounted cost of environmental
regulations for new sources that will come on-stream from 1976 to 1983 is coincidentally equal to one-third of the
cost of compliance for the existing industry.
-------
TABLE IV-3
AVERAGE PAPER INDUSTRY PRICE INCREASES RESULTING FROM
MAJOR ENVIRONMENTAL REGULATIONS, 1976-1983
1975
$7Ton % Change
1975 Price 292
Aggregate Price Without Regulations 305 4.4%
Type of Regulation
EPA 1977, 1983, and
NSPS Water 14 4.8
OSHA Noise 1 0.3
EPA NSPS and SIP Air 2 0.7
SubtotalRegulations 17 5.8%
Total Pulp and Paper 322 10.2%
SOURCE: Arthur D. Little, Inc., estimates based upon Chase Econometric's
midrange economic scenario, with average annual growth of 4.6%,
for GNP 6.5%,for industrial production and increased government
spending to ameliorate the forecast 1978 recession.
96
-------
FIGURE IV -3
IMPACT ON OPERATING RATES OF STUDIED REGULATIONS
95
A. Mtdrange Growth Rates
90
a.
to
85
80
75
76 77 78 79 80 81 82 83
1975 Price
Economic Price
Excluding Studied
Regulations
Economic Price
Including Studied
Regulations
B. High Demand and Low Capacity Growth Rates
c
o
H
JJ
to
N
O
tO :
a
nj i
95
90
85
80
75
76 77 78 79 80 81 82 83
97
-------
This method indicates that capacity may be tight in the 1980's if the boundary of Chase
Econometric's forecast and the upper boundary of demand materializes. Otherwise, no short-
term price pressure is foreseen as a result of high operating rates. The cause of the tight capacity
and resulting price pressure, if it materializes, will stem from demand growing at a greater rate
than capacity and not mill closures from environmental regulations. Mill shutdowns induced by
environmental regulations have a very small impact, representing 1,000,000 tons/year or 1.2'V of
1983 paper and paperboard capacity.
For the individual product sectors, demand for paper and paperboard total demand for each
sector was forecast using the demand equation and the Chase Econometric's Forecast (see
Section C.4). Price increases to cover the incremental cost of environmental regulations to the
existing industry were assumed to occur for 1977 requirements by 1977 and for 1983 requirements,
by 1980. Demand levels were adjusted to reflect price elasticity.
The projected growth in demand varies by product sector, as seen in Figure IV-4. Higher
than average growth rates in demand are forecast for unbleached kraft paperboard, NSSC
corrugating medium and for printing and writing papers. Tissue and unbleached kraft paper are
forecast to grow slower than the average, as well as U.S. production and consumption of
newsprint. On the whole, the growth in paper demand will keep pace with the growth in the GNP
driven by a much higher growth forecast for industrial production. Based upon the Chase
Econometric forecast used in this study, the GNP will grow at an annual rate of 4.2c/o from 1975 to
1983. Paper and paperboard demand, under the same economic scenario, will grow at an annual
rate of 4.6'"c,5 spurred by an IIP growth forecast of 6.3% per year.
It was noted above that, under average conditions, an additional price increase of $13/ton
will be needed to cover the cost inflation for new capacity and the enviornmental control
equipment already in place, if the industry is to earn its required cost of capital. Figure IV-3
presents average industry operating rates obtaining under these conditions, and indicates that
peak operating rates would not rise above 85%. These operating rates are the result of adjusting
the demand forecast from the demand equation and the Chase Econometrics scenario for 1976-
1983 price increases.
Variations in demand and capacity growth could lead to higher operating rates. Under the
most unfavorable conditions from the point of view of capacity pressure, i.e., high demand growth
and low capacity growth (cf. Chapter VI), the expected average prices are $298/ton without and
$314/ton with the studied regulations, compared to the 1975 average price of $292/ton. These
lower price increases compared to those expected under mid-range conditions reflect the lower
level of capital investment which must be supported by operating margins and the lower unit
fixed costs corresponding to higher output levels. Figure IV-5 shows the corresponding operating
rates and indicates that while demand is less retarded by price than under mid-range conditions,
peak operating rates are not realized until 1982-1983.
5. When comparing 1983 to 1975 to obtain a growth rate for the period, a business cycle peak year (1983) is compared
to a business cycle through (1975). The corresponding average annual growth rates from 1974 to 1983 are 3.5% for
GNP and 2.3% for paper.
98
-------
FIGURE IV-4
o
o
Industry Aggregate
Bleached Board
& Bristols
Dissolving Pulp
Newsprint
NSSC Corrugating
Printing & Writing
Papers
Recycled
Paperboard
Tissue
Unbleached Kraft
Paper
Unbleached Kraft
PapeLboard
SOURCE: ADL Estimates.
ANNUAL GROWTH IN DEMAND
PAPER AHD PAPERBOARD PRODUCTS
1977 - 1983
4.6%
i2.6%
6.6%
3.3%
1.7%
1.0%
6.2%
1.0
2.0
3.0
4.0
GNP
5.0
-f--
Growth Rate
6.0 IIP 7.0
Growth
Rate
8.0
-------
FIGURE IV-5
PROJECTED TOTAL U.S. PULP AND PAPER DEMAND AND CAPACITY
UTILIZATION
80,000 . .
70,000 .
000
TONS
60,000 .
50,000.
% CAPACITY
UTILIZATION
100
90
DEMAND^ WITH NO RECESSION
(High Growth Scenario)
75 76 77 78 79
CAPACITY UTILIZATION
80 81 82 83
1
Low Growth in Capacity
Midrange Growth in Capacity
A High Growth in Capacity
| | | j.
75 76 77 78 79
..) j. j |_
80 81 82 83
LCapacity Utilization = U.S. Capacity.
100
-------
The likelihood of high capacity utilization rates differs by product sector, as illustrated in
Figure IV-6. Recycled board, a product traditionally with excess capacity, is forecast to remain
that way. Bleached board and bristol, a sector historically operating at very high rates,6 will
continue to do so, and may experience real price increases as a result, despite the fact that price
increases were not as large for this sector as others in the capacity crunch of 1973-74. If the Chase
Econometric's Forecast materializes, printing and writing papers, NSSC corrugating medium
and unbleached kraft board also could experience price pressure from high operating rates.
3. Consumer Price Increases
Because the demand for pulp and paper products is relatively price inelastic (0.57), it will be
in the industry's economic interest to raise prices to recover all costs for environmental pro-
tection. Since the price elasticity of demand for pulp and paper is less than one, the producers will
gain more revenue if they raise prices to cover costs, in spite of the resulting demand reduction.
However, since demand elasticity is greater than zero, the pulp and paper industry will pay some
of the "cost" of environmental controls through lower levels of long-run demand. The estimated
loss of potential demand caused by the price effect of the studied regulations ranges from 2.3% to
8.9' r for the major product sectors, with the industry average about 4.2%. This demand loss is
equivalent to about one year of average paper industry growth, but the impact will be spread over
at least seven years (1976-1983).
What will compliance with the studied regulations cost the consumer? In Table IV-3, a $17
per ton price increase at the paper mill level was projected for 1983, resulting from the paper
industry's incremental costs for meeting EPA water effluent, SIP air and OSHA noise regu-
lations. In practice, this mill price will be increased substantially by the time the paper reaches
the consumer as a result of converter and wholesale/retail profit margins or commissions. Based
on the 1967 (latest available) U.S. Department of Commerce Input-Output Table and industry
data, the following average markups apply to the major paper products purchased by consumers:
Converter pretax profit on sales 10%
Wholesale and retail trade markups 70
rr . , 80%
Total
The above average markups on the cost of goods sold, particularly for wholesale and retail
trade, will probably remain relatively stable through 1983. The direction and magnitude of yearly
change is mainly dependent on whether labor costs at the wholesale/retail level increase faster or
slower than purchased goods costs. Markups are also likely to decline when consumer demand is
weak and increase when it is strong. For this analysis, however, it was assumed that on average,
1967 markups will approximate the markups on consumer paper products between 1975 and 1983.
This means that the $17 per ton price increase by 1983 (ex-mill) due to the studied regulations
will inflate to about $31 per ton at the consumer level.
Thus by 1983, the average consumer will pay about $10.50 a year more for paper products
(1975 purchasing power) as a result of the studied regulations. Arthur D. Little estimated this
impact, by applying the $31 per ton price increase to an average per capita consumption of about
6. Capacity utilization rates for this sector are not strictly comparable to others due to a difference in the way capacity
is defined. In general, the capacity is understated (operating rate is higher) compared to other products.
101
-------
FIGURE IV-6
PEAK CAPACITY UTILIZATION RATE
PAPER AND PAPERBOARD SECTORS
1977 - 1983
Industry Aggregate
Bleached Boards
& Bristols
Dissolving Pulp
Newsprint
NSSC Corrugating
Printing &
Writing Papers
Recycled
Paperboard
Tissue
Unbleached Kraft
Paper
Unbleached Kraft
Paperboard
94.7
78.4
91.3
1983
95.0
79.0
1983
92.0
85.9
1983
94.0
1983
101.0
1983
1982
104.0
1983
1S83
70.0
SOURCE: ADL Estimate based upon
Medium Growth Scenario
80.0
90.0
1983
100.0
94.0
Capacity Utilization Rate
110.0
-------
685 pounds (projecting from 1975 levels with annual growth rates of 4.6% for paper and 0.9% for
population). In the long run (when mills constructed since 1975 become dominant in establishing
market prices), the projected $24 per ton price increase at the mill will correspond to about $15
per capita increase for the average consumer.
As for relative effect on consumer product prices, the greatest impact will be felt on lOO'.V
paper products such as tissue, writing paper, newspapers and magazines. They not only use the
most paper per unit, but also have relatively low product values. The estimated long-run price
increase for tissue will be 4.1% of the consumer price. Somewhat lower relative increases will
occur for the other listed examples because paper's share of their cost is diluted by converting,
publishing, and printing costs.
The price impact for products packaged in paper is diluted even further, since the paper is
usually a very small portion of both the weight and the value of the product. Typical long-run
price markups on food packaged in folding cartons and corrugated containers will be less than I'.V.
A number of examples will illustrate the range of price increases the consumer faces from
paper industry compliance with the studied environmental regulations. The examples are divided
into two categories: (1) paper products consumed directly (sanitary tissue, newspapers and
magazines), and (2) packaging products (folding cartons and corrugated containers). In every
case, paper products that are comsumed directly have a much larger consumer effect per unit
than packaging consumed in conjunction with other consumer products. In general, paper
products that are consumed directly contain much more paper per unit and thus have a much
lower product value than consumer products packaged in paper or paperboard. Therefore,
environmental regulation costs for primary pulp and paper production will cause a higher
percentage price increase for consumer paper products than for products in paper or paperboard
packages.
Sanitary tissue is the only consumer product where the consumer and primary product price
increases are identical. The reason for the idential increase is that tissue converting (i.e., to small
rolls) was included in the primary production cost and price. Since distribution markups apply
equally to the basic paper price and to the environmental-control price increase, the relative price
increase is the same at the retail level.
Note that as the value added for the consumer paper product increases, there is a corre-
sponding decline in the percent price increase resulting from environmental controls. For most
other consumer products such as stationery, school and art supplies, the consumer price
increases fall between those of tissue and magazines. The price increases for higher-value
products such as books and decorative laminates fall below this range.
Because of the variety of products that are packaged in paper materials, the relative
consumer price increase caused by environmental costs varies widely for packaging material.
Therefore, absolute price increases per package were calculated for several popular consumer
items (milk, cereal, and canned goods) and the resulting percent markup for typical products was
calculated. These data indicate that the studied environmental regulation costs will cause
relatively small increases for consumer products packaged in paper or paperboard.
103
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4. Impacts on Supplier Industries
a. General Reduction in Potential Growth
Price increases related to the studied environmental regulations will have several effects on
suppliers to the paper industry, but the most obvious impact will be a reduction in potential
paper industry demand. As discussed previously, the estimated reduction in the paper industry's
demand potential between 1976 and 1983 will be 3.3% of its 1975 demand. This is equivalent to
about one year of average paper industry growth. However, the full effect will be spread over at
least seven years and probably longer.
The supplier industries will experience lower rates of demand growth than they would have
otherwise experienced. It is possible that the slower rate of growth in demand for paper supplies
will be offset by growth in other products, because the paper industry is not the dominant market
for most of its suppliers. Even its primary raw material, wood, derives about half of its demand
from lumber and plywood applications. The paper market represents an even smaller portion of
the total market for many of its chemical raw materials, for example, chlorine (20%), caustic soda
(17%), soda ash (6.5%) and sulfur (3%). Thus, it is quite possible that offsetting growth in other
applications for these raw materials will compensate for the lower rate of growth in their potential
paper industry demand. Shifts in end use growth rates are to be expected and for the most part
are anticipated and planned for by the industry's suppliers. The lower rate of growth in paper
demand per se will not have any appreciable impact upon suppliers.
Of potentially greater consequence than the average loss of potential growth in the paper
industry are the raw material substitutions that are taking place as the industry attempts to
reduce its air and water emissions and costs. Appendix C (Volume III) describes a variety of
substitution trends under way to replace or reduce:
sulfur in NSSC and sulfite pulping;
saltcake in kraft pulping; and
chlorine in pulp bleaching.
The impacts of these substitutions are described below.
b. Elemental Sulfur Use
The paper industry's consumption of elemental sulfur has declined more significantly than
that of any of its other raw materials; it dropped 26%, from 450 to 335 long tons, between 1969 and
1974 because of the combined effects of sulfite and NSSC mill closures, tightening up of the sulfur
requirements of the remaining mills in these sectors, and shifts to green liquor and nonsulfur
semi-chemical pulping. All of the above trends are likely to continue and are likely to be joined by
the installation of oxygen pulp mills in the United States, which would add to the rate of
elemental sulfur decline in the paper industry. On the other hand, the paper industry accounts for
only 3% of sulfur's total demand; so even if elemental sulfur were to be replaced entirely in
pulping, even modest growth in other markets would readily replace the loss. Thus, the impact on
the sulfur industry will be negligible.
104
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c. Saltcake Use
A trend with a potentially higher impact replacing saltcake with caustic soda in kraft
pulping has begun. Saltcake consumption by the paper industry was about the same in 1974
as in 1968 after having dropped to about 74% of its 1968 level during the 1971 recession. In
comparison, U.S. kraft pulp production grew 9% between 1968 and 1971 and 19% between 1968
and 1974. Thus, saltcake lost about 19% of its paper industry growth potential during 1968-1974.
Furthermore, this loss is probably understated in that saltcake demand was given a boost in 1974
because there was a shortage of caustic soda and many mills also operated over their rated
capacity, which increased sodium and sulfur losses. Caustic soda consumption by the paper
industry on the other hand increased by about 45% between 1970 and 1974. This substitution
trend is all the more serious because the paper industry currently accounts for about 75% of
saltcake's total demand.
The main reason for saltcake's demise in kraft pulping (where it is used as a make-up for
sodium and sulfur lost in the chemical recovery furnace and lime kiln) is that it provides more
sulfur than the pulping reaction requires. Excess sulfur is the prime contributor to the sulfur
compound air emissions of the kraft industry. Caustic soda enables sodium and sulfur in the
process to be kept in closer balance and thereby reduces the excess sulfur problem. For many
mills, this emission reduction benefit justifies caustic soda's price premium over saltcake.
Another factor behind saltcake's decline in kraft pulping is the increasing use of sulfur-
containing by-products from the kraft mill tall oil recovery system and chlorine dioxide gener-
ators, and purchased oil refineries' caustic wash which contains sulfides. These low-cost sources
of sulfur compound the excess sulfur problem thus making it more desirable to use caustic soda to
balance the system and less desirable to use saltcake.
Arthur D. Little estimates that the kraft industry's purchased saltcake consumption will
decline to 50% of 1974 levels and possibly less by 1983. This translates to a drop in demand from
1,220,000 short tons in 1973 to about 600,000 short tons in 1983. On the other hand, other
applications for saltcake (primarily detergent and glass production) have increased their aggre-
gate saltcake consumption at an average 5% per year since 1965. If this rate of growth continues,
saltcake consumption in non-pulp applications will increase by about 400,000 short tons to a level
of about 1,100,000 short tons in 1983, and substantially offset the consumption loss in the kraft
pulp industry.
If these offsetting growth trends continue, total saltcake consumption would decline at an
average rate of only 1% per year for the period 1973-1983. However, even such a modest net
decline is likely to be accompanied by more drastic shifts among the various saltcake supply
sources; imports and the Manheim Furnace process are likely to decline rapidly while production
volumes of by-product, dichromate process, and natural (mined) saltcake are likely to remain
close to their present levels. None of these trends, however, indicates any drastic unforeseen
changes that the suppliers cannot compensate for to avoid significant reductions in profitability
or employment. Most saltcake suppliers are already well aware that total demand for their
product is leveling off and is likely to decline. Therefore, while the economic impact on this
industry from the decline in paper industry consumption will require major adjustments, it is
being anticipated and thus is unlikely to have serious net financial and employment
consequences.
105
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d. Chlorine Use
Substitution of chlorine by clorine dioxide and to a much lesser extent by oxygen pulp-
ing/bleaching and high consistency bleaching of kraft pulp mill will reduce chlorine's growth
potential in this application. However, the paper industry's consumption of chlorine is still
growing faster than its bleached pulp production; it averaged 4.4% per year between 1969 and
1974 compared with a 3.7% average growth in bleached kraft pulp production. Chlorine's growth
in the paper industry has been bolstered by increasing use for intake water purification (e.g., for
slime control), wastewater treatment and the achievement of higher pulp brightness levels. Pulp
brightness levels appear to have reached their practical limit and probably will be lowered
somewhat to help reduce water effluent loadings. However, it appears unlikely that chlorine
consumption in the paper industry will see an absolute decline from the combined effect of the
above trends. Also any growth-reduction effects will be mitigated since the paper industry
represents only 20% of total chlorine demand. Therefore, it is unlikely that the chlorine producers
will be faced with serious hardships as a result of these predictable trends in their paper industry
market.
The chlorine substitution trend offers significant reductions in the water effluents from pulp
bleaching operations. Chlorine dioxide has a much greater oxidizing power per chlorine atom
than chlorine; moreover, chlorine dioxide's action does not produce chlorinated organics to the
same degree that chlorine does. Of course, oxygen bleaching produces no chlorinated organics at
all. Thus, the effluents from chlorine dioxide or oxygen bleaching stages are much less offensive
than those from a chlorination stage.
e. Raw Materials Benefiting from Studied Environmental Regulations
Two of the paper industry's important raw materials, caustic soda and sodium chlorate, will
benefit as a result of product substitutions caused by the studied air and water pollution
regulations.
Caustic soda usage in the paper industry increased to a 10% average annual growth rate
between 1970 and 1974, largely because of caustic's displacement of saltcake. (In fact, this
stimulated demand was partly responsible for caustic soda shortages in 1973 and 1974.) Also
because of the disparate growth in consumption of chlorine (5% per year) and caustic soda (10%
per year) in the paper industry, the industry is moving toward a more balanced consumption of
these chemicals approaching the proportion in which they are produced as co-products in the
electrolytic process (i.e., 1/1.1 chlorine/caustic vs. the paper industry's current use ratio of 1/0.8).
This trend in turn will provide the chlor-alkali producers more flexibility in serving this market,
although it will also facilitate captive chlor-alkali production by pulp producers.
Increased use of sodium chlorate in the paper industry has also become apparent. Sodium
chlorate is the raw material from which chlorine dioxide is generated at the pulp mill; hence it is
the beneficiary of chlorine dioxide's displacement of chlorine in pulp bleaching. Between 1970
and 1974, the paper industry's use of sodium chlorate grew at a rate of 4.7% per year while
bleached pulp production increased at a rate of 3.7% per year.
The chlorine displacement trend is just beginning; therefore, sodium chlorate's paper
industry growth rate is likely to rise even higher through 1983. This increase will be particularly
beneficial for the chlorate industry since the paper industry already represents about 78% of total
sodium chlorate demand. Therefore, the higher growth will not be diluted appreciably by slower
growth applications.
106
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D. METHODOLOGY
Figure IV-7 displays the interrelationships of data and analytic techniques employed in the
price impact analysis.
To estimate price and output effects, Arthur D. Little used information generated in the
description of the industry and product sectors (Chaper II and Volume II), the cost of compliance
with environmental regulations (Chapter III), and the mill closure analysis (Chapter V). The
sequence was as follows: Compliance costs for new mills were analyzed with new mill models to
arrive at estimates of the long-run equilibrium price effects. These price effects were traced
through distribution channels for selected paper products to obtain representative consumer
price impacts. Econometric models for the industry and the individual product sector sup-
ply/demand relationships were generated based upon the characteristics of each product sector,
transaction prices, production and capacity. The econometric demand and supply equations were
used with Chase Econometric macro-economic forecasts (prepared for the Council of Environ-
mental Quality), to arrive at a forecast of demand. The paper industry's announced com-
mitments for new capacity through 1979 and Arthur D. Little estimates of capacity from 1979 to
1983 were combined with demand forecasts to arrive at capacity utilization forecasts. The
findings of the mill closure analysis also were incorporated into the estimate of capacity. These
forecasts from the aggregate paper and paperboard model were then used in the capital require-
ments analysis described in Chapter VI.
1. Demand and Supply Relationships
Demand and supply relationships for various product sectors of the paper industry were
modelled through the use of econometric equations describing the demand and short-run supply
functions. Historic market price and consumption, and prices of factor inputs (labor, wood,
energy) formed the basis for estimating the demand and supply equations. The objectives of
formulating these models were to estimate the price elasticity of demand for the various products
and to provide a vehicle for identifying price pressure caused by short-term capacity problems for
the product sectors.
Product demand was defined as U.S. consumption (U.S. production plus imports minus
exports). Imports were a factor for the aggregate of paper and paperboard and for newsprint.
Exports were significant for linerboard and dissolving pulp. When the demand models were
applied to produce a forecast, it was assumed that import market share and export market share
remained constant throughout the period. (This is consistent with the balance of trade impact
analysis which concluded that no change in the United States balance of pulp and paper trade
would result from the studied regulations.)
The industry was divided^ into groupings based on similarity of product characteristics or
end uses. Most of the paper products studied are intermediate goods; that is, they are converted
or combined with another product before reaching the end user. As a result, demand for these
paper products is derived from the demand for the complementary goods. Since paper and
paperboard end products are used throughout the economy, the demand for paper itself was
expected to fluctuate with general economic conditions. Furthermore, specific economic in-
dicators were expected to relate to each individual product sector. Sectors with heavy industrial
use were found to be more closely related to indicators of industrial activity, such as the index of
industrial production, than to GNP, which encompasses the service sector.
107
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FIGURE IV-7
OVERALL METHODOLOGY- -PRICE IMPACT
O Exogenous Factors
Results of Analyses
( Analytic Process
From
Process
Economics
Cost
Analysis
o
00
Long-run
EquilibriumPrice
Cost/Price
Analysis
Existin
Industry
Cost of
Compliance
Consumer
Product
I Impact I
Consumer
/ Price
/ Impact
Price
Effects
New
Mill
Models
Cost of
Compliance
Output
Effects
Econometric
Models
Product >
./Characteristics -
Forecast
1977 -
1983
Historic
Transaction
Prices, Produc-
tion and Capacity
Capacity
Utilization
Chase
Econo-
metric i
lanne
& Esti-
mated
Capacity
rowth
Mill
Closures
To Capital
^ Availability
Analyses
-------
In some cases, paper products have substitutes, the chief of which are plastic films and con-
tainers. The two product sectors that historically have competed with plastics are bleached board
and unbleached kraft bag and sack paper. In these cases, the relative price ratio of the major
product competing with the paper product was incorporated in the demand equation. However,
this empirical analysis yielded demand relationships in which the price of a substitute product
relative to the price of the paper product correlated inversely with the demand for the paper
product. This relationship is simply not credible in explaining movements in paper demand,
because it means that as the price of a substitute product increases relative to the paper product,
demand for the paper product decreases. One reason for these anomalous results may be that the
significant displacement of these products by plastics has already occurred (see Volume II,
Chapter II, Sections B and C) and that the recent prices of substitute products have increased at
least as fast as paper product prices. This is not to say that there is no cross-elasticity of demand,
but rather that the substitution effect and cross-elasticity cannot be measured econometrically
over the 1968-1975 time span.
The demand for paper products is inelastic, as expected. When demand for a product is
inelastic, it means that the relative decline in quantity demanded will be less than the relative
increase in price. In the case of paper, an 8% increase in price is estimated to result in a 5%
decline in quantity demanded. If demand were elastic, an increase in price would be offset by a
greater relative decline in quantity demanded. For example, a 1% increase in price would be
offset by a decline in quantity demanded greater than 1%.
When demand is inelastic, any price increase results in an increase in total revenue. If
demand is elastic, a price increase results in a decline in total revenue. Conversely, when demand
is inelastic, a reduction in price results in a reduction in total revenue. This explains the large
profit erosions suffered by the paper industry in the past during weak markets when competitive
price cutting to improve individual mill operating rates led to a general price decline.
The price elasticities of demand derived from the demand equations are shown on Table IV-
4. Two demand equations were estimated for the aggregate of all paper products: one was based
upon a weighted average price of the product sectors modelled, and another was based upon the
wholesale price index (WPI) for all paper and paperboard. Neither series was completely satisfac-
tory. The wholesale price index reflects list prices, and has not accurately reflected short-term
changes in transaction prices until 1973. On the other hand, the weighted average of the sector
transaction prices is higher than the aggregate prices in the industry and diverges from the
general trend movement of the WPI for paper, particularly in recent years. Of the two equations,
that based upon the WPI, had a higher estimated elasticity of demand (.59 versus .37). On
balance, Arthur D. Little felt the WPI-based equation was more realistic to use in the aggregate
demand forecasts and in capital availability analysis.
Supply relationships were utilized to identify price increases induced by supply bottlenecks.
Results of the supply function analysis were not nearly as good as the analysis of the demand
relationship for the paper products studied. The prices of factor inputs (labor, wood, energy, etc.)
used in the production process do not solely explain price movements over the period studied and
therefore a substantial amount of price variation is not explained by the supply function. Price
increases in labor and materials do not completely account for the large price increases that
109
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. I
TABLE IV-4
PRICE ELASTICITY OF DEMAND
PULP, PAPER AND PAPERBOARD PRODUCTS
Estimated 95% Confidence
Product Elasticity Interval
Bleached Board
& Bristols .18 + .18
Bleached Market Pulp .46 + .35
Dissolving Pulp .63 + .32
Newsprint* .70 + . 36
NSSC Corrugating
Medium ** .35 + .09
Newsprint** .74 + .36
Printing & Writing
Paper .26 + .14
Recycled Paperboard** .46 + .35
Tissue .45 + .18
Unbleached Kraft
Linerboard** .50 + .27
Unbleached Kraft
Paper** .90 + .26
All Paper & Board
Eq. 1: Weighted
Sector Prices** .37 + .08
Eq. 2: WPI ** .57 + .27
Equation for Arc elasticity of demand:
AQ _ AP
e " (Q! + Q2)/2 v (P-L + P2)/2
Source: Derived from econometric models estimated by ADL.
Estimates for Sectors designated * were based on data through 1976; those
with ** used data through 1975; all others were based on data through 1974.
110
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occurred in 1973-74. This is consistent with findings of other research.7 For some product sectors,
however, it was possible to relate the paper product price to the sector's capacity utilization rate;
this relationship provides a basis for estimating future effects of high rates of capacity utilization
upon prices.
2. Product Sector Capacity Growth Assumptions
It is necessary to have an estimate of what the aggregate growth in capacity will be in order
to evaluate capital availability and financing in the paper industry (Chapter VI). It was also
desirable to have estimates of capacity for the individual product sectors in order to identify any
short-term capacity problems which might cause price increases.
Econometric models were developed with a third equation, which modelled the change in
capacity by product sector over time. In the modelling process, Arthur D. Little considered:
timing of the investment decisions that brings new capacity on-stream, cost of capital during the
life of the construction period, an approximation of what the industry might have foreseen for
economic growth, and capacity utilization rates in the year in which the investment decision was
made. The results of this empirical analysis produced function relationships that either were not
statistically significant, had the wrong sign, or had standard errors in excess of 30%. Therefore,
Arthur D. Little sought a more reliable projection method.
The alternative method chosen was based on the industry's own estimates of capacity
scheduled to come on-stream through 1979, published by the API in September 1976. Therefore,
this approach entailed projecting capacity growth rates for the four-year period 1979-1983. These
were estimated by Arthur D. Little product sector experts after analyzing product market and
profitability trends, historic capacity growth rates which prevailed from 1960 to 1975, planned
growth rates for 1976 through 1979, and the Chase general economic forecast through 1983.
Table IV-5 contains the historic capacity growth rates, industry planned growth rate
through 1979, and the rate estimated by Arthur D. Little for 1980 through 1983.8 The aggregate
growth rate in capacity of 3.2% per year is less than the aggregate growth rate in demand (4.2%)
leading to the relatively high capacity utilization rates forecast for 1983. In general, products with
high rates of growth in demand are also the most profitable, and these are the sectors whose
capacity is forecast to grow at a higher than average rate. Dissolving pulp capacity is estimated to
remain stable throughout the period with no net additions foreseen through 1983.
3. Mill Closure Effects on Price
The results of the mill closure analysis were incorporated into the capacity estimate for the
period 1977 through 1983. As indicated in Chapter V, closures due to water pollution control
regulations were assumed to occur in the years when compliance is mandated; that is, closures
resulting from the promulgated 1977 water regulations were assumed to occur in 1977, while mill
closures resulting from the 1983 proposed water regulations were assumed to occur in 1983. Mill
closures are probable in three product sectors: printing and writing papers, tissue paper, and
recycled boxboard, for a total of 1,000,000 tons of capacity by 1983.9
7. See Barry Bosworth, "Capacity Creation in the Basic Materials Industries," The Brookings Institution, August 1976.
8. The relationship Arthur D. Little sought to model was capacity growth in terms of tonnage as opposed to investment
dollars. Investment expenditures cannot be extrapolated from historic relationships for a variety of reasons,
explained more fully in Chapter V.
9. See Chapter V and Volume II for product sector details.
Ill
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TABLE IV-5
PRODUCT SECTOR RATE OF ANNUAL GROWTH IN CAPACITY
HISTORIC, PLANNED AND FORECAST
Historic Growth Rates
Planned
Estimated Range 1979 - 833
Product Sector 1961 - 65
Bleached Boards
& Bristols
Dissolving Pulp
Newsprint
NSSC Corrugating
Printing & Writing
Recycled Paperboard
Tissue
Unbleached Kraft
Paper
Unbleached Kraft
Paperboard
All Other
2.4%
1.9
O.O4
7.0
5.6
NA
5.5
4.3
8.7
1966 - 70
4.7%
3.3
8.3
5.2
4.7
O.O4
5.3
1.5
7.9
1971 - 75
2.4%
0.7
1.0
3.4
4.4
0.4
0.6
1.8
4.1
1976 - 79
2.8%
0.1
1.8
2.7
2.8
1.4
1.8
0.3
5.2
2.8
Low
2.0%
0.0
1.5
4.5
3.0
1.2
1.5
1.0
2.9
Average
3.0%
0.0
2.0
5.9
4.0
1.7
1.6
1.4
4.0
High
4.0%
0.0
2.5
7.5
5.0
2.2
2.1
1.8
5-1
Aggregate Paper
& Paperboard
3.1
4.2
2.7
2.8
2.3
3.2
4.1
Based upon year-end capacity figures, Paper, Paperboard & Woodpulp Capacity Reports, API, various years.
"Industry announced commitments, 1975-1978 Capacity, Paper, Paperboard, Wood Pulp Fiber Consumption, Sent. 1.076, APT,
Arthur D. Little, Inc., estimates.
Small decline in capacity.
-------
4. Chase Econometric Model
As mentioned above, the forecasts for demand and capacity growth for the individual
product sectors are based upon the Chase Econometric Forecast provided for the Council on
Environmental Quality as of May 17, 1976. This forecast projects a mild recession in 1978-79, and
n strong recovery with four successive years of sustained growth in the period 1980 through 1983.
(A version of the forecast without recession or eight years of sustained economic growth also was
used.)
Figure IV-8 depicts the Chase forecast in terms of industrial production and GNP for the
years 1976 through 1983 and also the percent change in the level of the economy each year from
the preceding year. Chase feels that this forecast is conservative and that the forecast for the
198()'s is consistent with conditions that prevailed from 1962-1969.
As seen in Table IV-6, the Chase real GNP forecast was very close to the 1976 actual and is
close to the administration's early 1977 published prediction for 1977.
TABLE IV-6
CHASE ECONOMETRICS FORECAST
COMPARED TO 1976 ACTUAL AND 1977"FORECAST
(Real GNP in 1972$)
1976
1977
1978
Chase Econometrics Forecast
for CEG (5/76)
"No Recession"
Actual 1976
Current Administration
1977 Forecast
1,267.0 1,320.2 1,320.A
1,267.0 1,320.2 1,390.0
1,265.0
1,328.2 1,394.6
Derived from 5% growth in real GNP for 1977 and 1978.
The administration forecast calls for a real growth in GNP during 1977 of 5'<. The levels of
real GNP that will result from a 5rr growth in 1977 and 1978 will be .&'/< higher than the Chase
Econometrics CEG forecast in 1977 and .3'7 higher than the "no recession" forecast for 1978.
The Chase forecast calls for five consecutive years of expansion from 1979 to 1983. The six
economic expansions since World War II have averaged 48 months in duration. If the Korean
War and the Vietnam War expansion periods are excluded, the average expansion was 34
months.10 Continuation of this trend would point to a downturn in 1978-79 followed by another
downturn during 1982 or 1983. Viewed in this light, the "no recession" version of the Chase
forecast and the continuous growth in the early 1980's in the baseline forecast appear to be
optimistic.
10. Wall Street -Journal, March 14, 1977, p. 1.
113
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FIGURE IV- 8
CHASE ECONOMETRICS
CEQ ECONOMIC SCENARIO, MAY 17, 1976
GROWTH IN THE ECONOMY
2000
1800 '
GNP
1600
($ Billions
1972)
IIP
/XGNP
/ /'
/x'
1400 f S
\ AZ---^^
1200 f:"~~*~^//
' ,--v
; S '' /
1000 -j-
IIP
- 180
- 160
140
- 120
100
70 72 74 76 78 80 82 84 86 88
% CHANGE IN ECONOMIC ACTIVITY
10.0
% Change
0.0
-10.0
i i
70 72 74 76 78 80 82 84 86
114
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The product sector forecast and the aggregate paper demand forecast are likely to be high if
the Chase Econometric forecast is optimistic. If so, the forecast will overstate the capacity
shortages and the industry's future capital requirements in the 1980's. Conversely, if economic
growth is higher than indicated in the "no recession" version, near-term capacity pressure will be
understated.
5. Estimation of Price Impacts
The long-run equilibrium price impacts for the various environmental regulations were
based on new mill models for product sectors, using the discounted cash flow model that was used
in the funds flow analysis and is described in detail in Appendix H (Volume III). The process
economics cost estimates of the construction and operation of a new mill were simulated over the
life cycle of that mill, with and without environmental regulation costs for water, air, and OSHA
noise regulations. The financial parameters were different for the estimation of long-run price
effects as compared with the funds flow analysis. The analysis was done separately for each new
mill as follows:
The initial balance sheet for each new mill was obtained from the process economic
models (Appendix F).
The working capital requirement was specified for each at 3 months delivered cost.
Divided payment was 50rr of earnings.
The corporate tax rate was taken as 48^-.
Buildings were depreciated over 33 years and equipment over 16 years by the
double declining balance method.
The investment tax credit option for pollution control equipment allowing a tax
credit of 10'r of the investment was issued.
The baseline cost of total capital was 10f/r with a sensitivity analysis using plus 2.5'r. In addition
a sensitivity analysis was performed on costs for the new mills. (±10^r for operating costs; +25'7,
-10'c for investment).
In the long-run, prices in a competitive industry will cover all costs, including a normal rate
of return to the industry. The Arthur D. Little analysis estimates long-run price effects, assuming
a 10'V cost of capital to the industry, which represents the normal return to the paper industry
estimated in a recent EPA study."
A different method was used to estimate price increases necessary for the existing industry,
which will dominate the base capacity for the period 1977 through 1983 because the wide
variability among mills precludes simple modelling of the existing industry. Given the current
market price and an annualized value for the incremental cost of compliance to the existing
industry for the various environmental regulations, a price increase was estimated that would
fullv recover these costs.
11. Gerald A. Pogue, Estimation of the Cost of Capital for Major United States Industries. The 10% cost of total capital
is a weighted average of the reuturn on equity (13%) and debt cost.
115
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The annualized value of capital expenditures and operating costs required by environmen-
tal regulations was calculated by the level annual recovery method. Total capital cost to the
existing pulp and paper industry, including a normal rate of return on capital was annualized by
amortizing capital costs over 18.4 years, the average book depreciation life of pollution control
investment, with a 10'Y> cost of capital.12
Rate of return on capital can be expressed as the total return to providers of capital divided
by capital:
Profit + Interest
Rate of Return = Total Capita,
It can also be expressed as the margin on sales multiplied by turnover:
Rate of Return = Margin x Turnover
Profit + Interest Sales
x
Sales Total Capital
where: Sales = Price x Quantity.
When compliance with environmental regulations causes increases only in operating cost,
the total change in cost will be equal to the change in operating cost and the change in price will
be equal to the change in operating cost. Since an increase in investment is not required, the total
return (profit plus interest) stays the same. In the more typical case, where industries must invest
in capital equipment to comply with environmental regulations, they must earn a risk-com-
mensurate return on this capital or the total rate of return to that industry will fall. Here, the
annual capital recovery is given by the formula:
D = -^ J-
(1 +r)n- 1
where
D = the annual capital recovery
r = cost of capital (risk-commensurate rate of return)
11'. Ibid.
116
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I = initial investment
n = useful (book) life of capital investment.
The change in cost representing the return to capital is equivalent to:
n
I D-
This method of annualizing investment or other capitalized expenditures plus the change in
operating costs yields the change in total cost resulting from compliance with an environmental
regulation.
The aggregate price impacts for 1976 to 1983 were a by-product of the funds flow analysis,
described in Chapter VI. The financial parameters used and computational details are contained
in Appendix H (Volume III).
E. LIMITATIONS AND SENSITIVITY ANALYSIS
1. Limitations of Models
The usefulness of any model lies in its appropriateness as an approximation of the real
world. Because a model is an approximation rather than a mirror of the real world, it depends
upon the structure or interrelationships that existed in the recent past. It serves essentially as an
analytic tool which provides insight to probable effects and order-of-magnitude estimates.
The price impacts were estimated on the premise that the pulp and paper industry is
competitive, and therefore, that long-run price increases resulting from environmental controls
will be determined by new mills earning the normal (risk-commensurate) rate of return for the
industry. While the paper industry is comprised of many firms and for the most part behaves in a
competitive manner, certain product sectors are characterized by a few producers (bleached
board) or dominant firms (newsprint). Nonetheless, competitive models were used for these two
sectors because they provide a reasonable indication of price increases. The levels of demand
estimated and the elasticities of demand may be misestimated if changes in price are caused for
reasons other than cost increases. The possibility of errors in the calculation of price elasticity
occurs because price may not equal marginal cost in a non-competitive industry, and the supply
function parameters cannot be estimated accurately.
As discussed previously, the attempt to measure substitution effects was not successful,
which may affect the estimates of parameters for the bleached board and unbleached kraft bag
paper sectors, where substitution is likely. The impact is a tendency to overestimate the demand
level for the study period if the relative price of substitute products does not increase as much as
those paper products.
117
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2. Sensitivity Analysis
Arthur D. Little examined the sensitivities of the price impact results to:
variations in cost of capital,
the depreciation period assumed for the pollution control equipment, and
variations in the cost of compliance estimates.
Table IV-7 displays the sensitivity of the price increase estimated for existing industry to
variations in the cost of capital and payback period for the industry in aggregate. The price
estimation procedures for the existing industry utilized a level annual return concept. As the
payback period for the pollution control investment is shortened or the cost of capital increases,
the necessary price to recover costs increases. The effect of going from a 10% cost of total capital
to 12.5% cost of capital is approximately a 10% difference in the estimated price effect. The
impact of going from 18.4 years combined depreciation period for land, plant and equipment to 10
years accounts for a 17-20% increase in the estimated cost-recovery price necessary for the
existing industry.
Table IV-8 demonstrates the variability that occurs as one modifies the payback period and
after-tax rate of return. Factors shown in this table are the values which are multiplied times the
original investment to produce annualized values for capital recovery.
Table IV-9 shows the sensitivity of existing mill price impacts to cost estimates. For a
product sector, operating costs could vary by as much as 10% in either direction, and capital costs
might vary as much as 10% lower or 25% higher than the expected values.
The sensitivity analysis for new sources was similar. Discounted cash flow analyses were
done for the new mill models with both the upper and lower boundary cost estimates, and with
the cost of total capital at 10% and 12.5%. As in the existing industry case, a range of ±10% was
estimated for operating costs while the variability in capital costs (including the cost of construc-
tion of the basic mill) was estimated at +25%, -10%. For each cost of capital, there is a material
difference in the baseline and projected prices, ranging from 10% on the low side to 15% on the
high side over the range of cost estimates. If the cost of capital to new mills is 12.5%, the relative
price effect of environment regulations is slightly lower than at the 10% cost of capital because the
baseline price is raised by approximately 9% (Table IV-10).
118
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TABLE IV-7
SENSITIVITY OF PRICE IMPACT ESTIMATION TO
VARIATIONS IN COST OF CAPITAL AND PAYBACK
Environmental 18.5yrs. 15 yrs. 10 yrs. 18.5 yrs. 15 yrs. 10 yrs.
Regulation 10% 10% ___ 10% __ 12.5% ___ 12.5% 12.5%
EPA--1977
Water Effluent
OSHA Noise*
SIPS
2.9
0.4
0.7
3.0
0.4
0.8
3.4
0.5
1.0
3.2
0.4
0.8
3.3
0.5
0.9
3.7
0.5
1.0
EPA--1983
Water Effluent 1.8 1.9 2.1 3.0 2.0 2.3
Total 5.8 6.1 7.0 6.4 6.7 7.5
Source: Arthur D. Little, Inc., estimates.
-------
TABLE IV-8 .
CAPITAL RECOVERY FACTORS
FOR VARIOUS PAYBACK PERIODS
AND CAPITAL COSTS
to
o
Achieved After-Tax
Return
7.5
10.0
12.5
10 Years
.14569
.16275
.18062
12 Years
.12928
.14676
.16519
15 Years
.11329
.13147
.15076
17.5
Years
.10447
.12325
.14323
18.4
Years
.10194
.12094
.14116
20 Years
.09809
.11746
.13810
r (1 + r)
n
Annual Recovery _
Initial Investment (1 + r)n - 1
where r = achieved return on investment
n = payback period
-------
TABLE IV-.9
SENSITIVITY OF EXISTING MILL PRICE EFFECTS
OF ENVIRONMENTAL REGULATIONS
TO COST ESTIMATES
Product Sector
Bleached Boards
& Bristols
Bleached Pkg. &
Ind. Conv.
Construction Paper
Dissolving Pulp
Newsprint
NSSC Corrugating
Printing & Writing
Recycled Paperboard
Tissue
Unbleached Kraft Paper
Unbleached Kraft Paperboard
Uncoated Groundwood
All Paper & Paperboard
1975
Price
$353
Expected Effect
398
260
193
591
215
769
242
195
335
292
Price
$371
424
280
205
616
224
798
256
206
362
% A
5.0%
6.5
7.1
6.2
4.2
4.1
3.7
5.9
5.6
7.9
Lower Bound
Upper Bound
309
5.8
Price
$369
421
278
204
6.3
223
795
255
207
259
307
% A
4.5%
5.8
6.3
5.7
3.7
3.7
3.4
5.3
6.1
7.1
5.2
Price
$374
429
284
207
617
225
803
259
211
367
% A
5.9.'
7.8
9.2
7.2
4.3
4.7
4.4
7.0
8.2
9.6
-------
TABLE IV-10
SENSITIVITY OF LONG-RUN PRICE EFFECTS
OF NSPS WATER AND AIR REGULATIONS, SIPS AIR REGULATIONS AND THE OSHA NOISE STANDARD
TO COST ESTIMATES AND THE COST OF CAPITAL
Expected Price
A. Cost of Capital = 10% After Tax
Lower Bound
Upper Bound
Baseline
Product Price
Aggregate Paper
Bleached Board
Newsprint
NSSC Corr. Medium
Printing & Writing
Bond Paper
Book Paper
Recycled
Recycled
Boxboard
Gypsum Liner-
board
Tissue
Tissue
Deinked Tissue
$327
362
280
198
436
449
260
219
754
782
After
Reg.
$351
391
296
229
464
477
275
234
785
826
% A
7%
8
6
16
6
6
6
7
4
5
Baseline
Price
$294
326
252
178
392
404
234
196
679
704
After
Reg.
$316
352
266
206
418
429
248
210
707
743
% A
7%
8
6
16
6
6
6
7
4
5
Baseline
Price
$376
419
324
227
517
504
296
250
862
887
After
Reg.
401
449
340
258
546
532
312
264
895
932
% A
7%
7
5
14
6
6
6
6
4
5
Unbleached Kraft
Linerboard 185 203 10
Unbleached Kraft
Bag Paper 297 327 10
167
267
183
294
10
10
214
348
232
380
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CHAPTER V
MILL CLOSURES AND EMPLOYMENT IMPACTS
-------
V. MILL CLOSURES AND EMPLOYMENT IMPACTS
A. SUMMARY
1. Methodology
The identification of mill closures and employment impacts related to environmental
control is a complex and imprecise analysis for at least three reasons. First, mill closures are
caused by a variety of factors in addition to environmental control such as technical/economic
obsolescence of product and/or manufacturing process, mill profitability, and general economic
conditions.
Second, the decision-making frame of reference is subject to substantial variability; for
example, the decision-making context for a private owner of a small mill may be quite different
from that for an analysis of a major corporation or financial institution. Third, the various mills in
the process/product sector categories considered in this study vary considerably in size, product
mix, average prices, cost structures, etc.
Accordingly, a methodology was developed which considers each of these factors and
attempted to identify those closures which are influenced primarily by the investment and
operating costs associated with environmental control.
The potential capacity lost because of mill closures was estimated through a multistage
screening process (Figure V-l). First, all mills studied were characterized and put through an
internal screening analysis to identify an initial list of mills vulnerable to closure. Managers of
these mills were then contacted to assess further the extent to which their mill complies with
pollution regulations, management intentions, and mill conditions that might affect a possible
closure decision. On the basis of this information, the number of mills requiring financial analysis
was further reduced. Finally, a discounted cash flow analysis was used to determine whether the
net present value of expected cash flows characteristic of groups of selected vulnerable mills was
less than the net present value of closing and salvaging the mill in 1976, with and without
additional water pollution control expenditures to meet EPA's 1977 and 1983 guidelines (BPT
and BAT). This analysis provided a further adjustment to the list of plants that might close.
The estimated reduction in capacity from mill closures was used as an input to the
econometric analysis to assess potential impact upon price. Employment losses provided the
basis for the community impact analyses in specific regions where closures were predicted.
2. Findings
Of 566 U.S. pulp and paper mills studied, 27 mills, corresponding to about one million tons
of capacity are projected to have difficulty complying with the studied pollution control require-
ments.' An additional two million tons of capacity is projected to be lost through normal attrition
over the studied period. The timing of the projected environmental related closures follows.
1. Air pollution control requirements were addressed in the industry interviews but water effluent regulations were a
far more serious problem for the selected mills. No effluent-related closures are projected for the kraft process mills
which also face the largest air pollution control expenditure.
123
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FIGURE V-l
PROCEDURE FOR THE MILL CLOSURE ANALYSIS
Screening
Analysis
Exogenous
Input
Mill
Manager
Interviews
Co
Compliance
Most
Vulnerable
Mills
Vulnerabl
Mill Models
Business and
Financial (..CF)
Cost of
Capital
From _
ENGINEERING
COST ANALYSIS
From
MICRO-ECONOMIC
ANALYSIS
Input to MICRO-
ECONOMIC ANALYSIS
-------
a. 1977 Closures
Ten mills could close because of 1977 pollution control requirements, with a resulting loss of
about 1400 TPD of product capacity. These capacity removals have an impact on the bleached
market pulp (paper grade), printing/writing papers, tissue, construction papers and recycled
paperboard product sectors. Primary unemployment associated with these mills represents about
2600 jobs or slightly more than 1% of total current pulp and paper industry employment. Total
unemployment (primary plus secondary) is estimated to be about 3700 jobs.
b. 1983 Closures
An additional 17 mills, representing about 1700 TPD of capacity removals, could close if
proposed 1983 water effluent guidelines are adopted. The impact will be greatest on the non-
integrated printing/writing, and tissue paper sectors. These 1983 projections, however, are much
less certain than the corresponding estimates for the 1977 guidelines. Estimated primary unem-
ployment resulting from these additional closures is 3500 jobs, or about 1.6% of total current
industry employment. Total employment from these closures is estimated to be 7100 jobs.
3. Limitations
Each mill within the studied product/process sectors was not specifically analyzed in
sufficient depth to enable prediction of individual closure candidates. Instead, groupings of
potentially vulnerable mills were used as the basis of the estimates for each industry sector. The
conclusions on 1983-related closures are based more heavily on Arthur D. Little's financial
analysis instead of inputs from the individual mill managements; these conclusions are more
limited by the uncertainties of the long-term financial projections that are required for such an
analysis. Finally, the analysis did not attempt to estimate the effect of Section 301(c) of the
Water Pollution Control Act of 1972 which provides that if a plant can demonstrate individual
hardship, it may obtain a variance from the guidelines.
B. METHODOLOGY
1. Introduction
Because of the complexities of disassociating mill closures influenced by environmental
regulations from those attributed to other technical/economic factors, a methodology was devel-
oped that focused on estimating the number of mills and amount of capacity and employment
affected by environmentally-related mill closures. This methodology involves (1) screening each
mill in the studied product/process sectors to identify mills that may have difficulty complying
with EPA pollution control standards; (2) interviewing mill management to gain additional
perspective on relevant mill characteristics; and (3) financial analysis of selected categories
ofmills identified as having closure potential.
2. Screening Analysis
The screening analysis began with the collection and organization of published information
on each mill, including data on mill capacity, major products produced, and external treatment
in place. Based on these inputs, a panel of Arthur D. Little industry specialists met to review the
closure possibilities for each mill. Marginal and questionable mills were segregated for further
review. In the screening process, the judgment of Arthur D. Little industry experts was applied in
evaluating mill production parameters and in-place treatment facilities. In addition the screen-
ing panel applied its knowledge of the process/product sectors and of many of the individual mills
themselves.
125
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a. Mill Production Capacity
In many cases, the larger mills enjoy a more favorable cost position. Most larger mills have
economies of scale that allow them to more easily absorb pollution control costs; in addition they
usually are newer and more efficient. Thus, mill size is an appropriate criterion for this screening
analysis. Therefore, while size criteria were applied to each process sector on an individual basis,
mills in the lower size quartile in each process sector received special scrutiny.
6. Treatment Train Facilities In-Place
It is reasonable to assume that mills that (1) currently comply with 1977 effluent standards,
(2) have announced definite plans to comply, or (3) are so close to compliance that the mill's
management has (at least implicitly) demonstrated a commitment to the mill, are less likely to
close for environmental reasons. Therefore, mills that do not have in-place the following pollution
control equipment were assessed more comprehensively in the screening analysis:
Secondary treatment
Chemical recovery or incineration (sulfite and NSSC mills)
Municipal treatment facility tie-in (recycled paperboard mills)
Inputs for this part of the analysis included:
(1) National Council of the Paper Industry for Air and Stream Improvements, Inc.,
mill listings of the extent and type of effluent treatment processes in-place;
(2) EPA mill effluent load data;
(3) Other publicly available information sources; (e.g., trade directories and period-
icals); and
(4) Arthur D. Little's familiarity with many of the mills under consideration. The
above sources were also cross-checked wherever possible to assure their accuracy.
With this information, a reasonably accurate data base was developed concerning
a given mill's proximity to compliance with 1977 pollution control standards (as
well as capacity and product mix).
c. Process/Product Sectors
The industry sectors under consideration have varying average prices, product mixes, cost
structures, and effluent load characteristics. Pollution control requirements have had and will
have varying impact on these process sectors. Process sectors which have had more severe closure
impacts in the past (e.g., sulfite and recycled paperboard sectors) were assessed more com-
prehensively in the screening analysis.
d. Knowledge of Specific Mills
As noted above, the screening panel was familiar with many of the mills that were exam-
ined. In certain instances, this familiarity provided the opportunity to gain relevant additional
perspective on specific mills.
126
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3. Direct Industry Contact
The interview process was designed to validate and update published information, and to
develop a more accurate understanding of the position of mills identified in the initial screening
as requiring further review. In addition, a number of multi-mill companies were interviewed to
review all their mills. This made it possible to validate the adequacy of the screening process by
determining whether any potential closures could be identified that had not been identified in the
initial screening phase. Issues involving mill economics, pricing, pollution control expenditure
requirements, and perspectives and future plans of mill management were addressed in these
interviews. (A copy of the guide used in these interviews is presented in Volume III, Appendix G.)
On the basis of the additional information developed via industry interviews, marginal and
questionable mills from the first screening were screened again using the criteria described
earlier. (Table V-l shows the number of mills requiring further review that were identified in each
of the screening phases.)
4. Financial (DCF) Analysis
As a result of the initial screening and follow-up interviews, a number of mills were
identified as being vulnerable to closure. A discounted cash flow analysis was used to evaluate
further the likelihood that these mills would close. Selected mills were grouped into homogeneous
categories according to process sector, product mix and size.2 On the basis of a "typical," mill(s)
in each mill grouping, financial models were developed. The financial models were developed to
be representative of typical vulnerable mills within a given mill category, but they are not meant
to be representative of any individual mill situation. Based on these financial models, a dis-
counted cash flow analysis (in constant 1975 dollars) was performed. (The basis of the DCF model
utilized is discussed in Volume III, Appendix H.) Three scenarios were tested via DCF analysis.
a. Operation To 1983 (No Incremental Pollution Control Expenditures)
If the net present value (NPV) of expected cash flows generated by the mill model in
question is less than the NPV of salvaging the mill in 1976, it is reasonable to assume that the mill
would close, even in the absence of additional pollution control requirements. Such a mill closure
should not be considered to be environmentally related.
6. Operation to 1983 (Compliance with BPT)
If the NPV of expected cash flows under this scenario is less than the NPV of salvaging the
mill in 1976 (and Scenario A indicates that the mill is economically viable), it is reasonable to
assume that closure resulting from BPT could be expected.
c. Operation to 1993 (Compliance with BPT and BAT)
If the NPV of expected cash flows under this scenario is less than the NPV of salvaging the
mill in 1976 (and Scenarios A and B indicate that the mill would continue to operate), it is
reasonable to assume that closure would result from the combined effects of BPT and BAT. A
comparison of the results under Scenarios B and C indicates the relative contribution of BPT and
BAT to the resulting closure impact.
2. However, because of the unique characteristics of individual mills within a particular grouping, no category could be
considered completely homogeneous.
127
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The judgment of Arthur D. Little industry experts was used to extend findings resulting
from these "typical" existing mill models to actions that may be expected in specific mill
situations.
In essence the results of the DCF analysis were used as an additional method for verifying
potential mill closures identified in the screening analysis and industry interviews.
5. Cost/Price/Inputs Used in Financial Analysis
Estimates of economic parameters for mill models of closure candidates (e.g., operating
costs, pollution control costs, salvage value, working capital, maintenance/upkeep requirements)
are based on process economics analyses of existing mills. (Summaries of the existing mill models
are included in Section C. The methodology and assumptions used to develop these models are
discussed in Volume III, Appendix F.)
Prices under cases with no controls are based on current transaction prices for the specific
paper grades being modelled. Price increases under cases with pollution controls are based on the
econometric model (Chapter IV) and are phased in over the periods 1976-1977 (BPT) and 1980-
1983 (BAT).
The financial analysis employs 1975 dollars.
6. Sensitivity Analysis
The mills under consideration in the mill closure analysis vary greatly in terms of market
characteristics, profitability and investment requirements. Moreover, projections of the above
factors required in the financial analysis phase of the closure methodology are subject to a great
deal of uncertainty. As a result, the impact of several key variables (including cost of capital,
operating rate, and margin) on closure findings was tested. This sensitivity work was done for
each mill model, since the degree of uncertainty/variability varied in each case. The sensitivity
impact was quantitatively assessed only where a reasonable change in a given variable had the
potential to reverse the findings of the financial model. (For example, if the financial model
indicated a closure even at a 95% operating rate, an analysis using a lower operating rate
assumption was not necessary.) For a more detailed discussion of the sensitivity work done in
each process sector, refer to the specific financial conclusions in the closure analysis findings.
7. Community Employment Impact Analysis
a. Introduction
The total employment impact of a mill closure on a local economy consists of a primary and
secondary impact. The primary impact is the immediate loss of jobs at the mill and is essentially
a function of the size of the mill. The secondary (multiplier) impact is the additional reduction in
employment incurred elsewhere in the economy as a result of an aggregate reduction in con-
sumption. The magnitude of the secondary impact depands primarily on:
The relationship between basic and non-basic employment in the region and;
The capacity of the region to re-employ displaced workers.
128
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b. Definition of Economic Region
An analysis of employment impacts in a local economy requires a geographic definition of
the region. The boundaries of the local economy must be carefully delineated because the
absorptive employment capacity depends strongly upon the economic size and composition of the
region.
This analysis is based primarily on Standard Metropolitan Statistical Areas (SMSA) or
counties surrounding the mill site.8 As a first approximation, a 25-mile radius was used to define
the area within the local economy. Counties or major towns which were substantially within this
25-mile radius were included. Additional counties were also included within the local economy if
a relatively large city was within a 40-mile radius of the mill site and good access roads existed.4
c. Impact Estimation
The primary impact was estimated by surveying closure candidates for employment data.
For pulp mills that were integrated back to woodlands operations, the employment data included
both mill workers and loggers. The inclusion of woods workers in the primary impact is appropri-
ate because their jobs are directly dependent upon the operation of the mill.
The secondary economic impact was assessed on the basis of Economic Base Theory from
which regional employment multipliers are derived. Base theory asserts that in a given region a
stable relationship exists between basic and non-basic employment. Basic employment in a
region consists of employment oriented to markets outside the region. Non-basic employment
provides support to basic employment and serves local needs. For most communities, agricul-
tural, mining, manufacturing, and tourist-related employment are considered basic. All other
economic activities are assumed to be non-basic.
The employment multiplier used to estimate secondary employment impacts was derived
by dividing total employment (basic and non-basic) by basic employment. For example, if a local
economy had 200 total jobs and 100 jobs in the basic sector, the multiplier would be 2.0. That is, a
decrease of one basic job would result in a decrease of two jobs in the local economy.
Re-employment opportunities for mill workers and loggers in the area were also evaluated,
since these opportunities reduce the secondary employment impact. Two criteria were used to
measure these opportunities. The first deals specifically with the proximity of other paper mills in
the area. It was assumed that some of the displaced workers would be able to obtain employment
at these mills. The second criterion reflects the potential opportunities available in other manu-
facturing industries. Some of the skills acquired in a paper mill are transferable to other
manufacturing sectors. However, if unemployment in a locality is high after a mill closure, re-
employment will be more difficult. Based on past work, Arthur D. Little assumed that the
displaced workers will be able to obtain up to 0.59c of total local manufacturing employment in a
reasonable time (six months) under conditions of low unemployment (less than 5%). Under
conditions of high unemployment, re-employment could conceivably be less than 0.19c. Note that
re-employment does not reduce primary impact job losses, since those jobs are assumed to be lost
forever with respect to the local economy. However, re-employment does reduce the base upon
which secondary job losses are estimated.
3. A standard Metropolitan Statistical Area (SMSA) Is an Integrated regional economy (with a minimum of 500,000
people) which Is served by and Influenced by Its central city.
4. Most of the rural towns had populations of less than 10,000. Towns of over 30,000 were considered large enough to
exert an influence on the smaller rural towns.
129
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8. Limitations
a. Mill Size and Diversity
The scope of this study included 556 pulp and paper mills. These mills vary by size, product
mix, average price, cost structure, and existing pollution control equipment. However, since an
analysis of every mill in the industry was beyond the scope of this study, an approach was
developed to screen a large number of mills on the basis of generalized criteria, and then focus in
greater detail on a smaller number of endangered mills. This methodology made it possible to
estimate overall closure impact (i.e., the number of mills, amount of capacity, and employment
affected by mill closures) in specified product/process sectors. Although the sensitivity analysis
considered some of this mill-to-mill variability and uncertainty, the approach was not designed to
predict and identify individual mill closure probabilities. A significant amount of additional
analysis of individual mills would be required to achieve the latter objective.
b. Variability of the Decision-Making Frame of Reference
Many types of decision makers may have a role in mill closure decisions. (For example, a
private mill owner may have a very different decision-making frame of reference, compared to an
analyst for a major paper company or financial institution.) Judgments and analysis in the
closure study were made from the standpoint of a financially-oriented decision maker using
objective profit maximizing criteria.
c. Environmentally Related Closures Versus
Closures for Other Reasons
The problem of separating environmentally related closures from closures that would have
occurred regardless of pollution control requirements complicates the predictions. Previous work
in this area indicates that many impacted mills would have difficulty surviving because of
various economic and competitive factors. Thus, future changes in economic conditions (both in
the overall economy and in specific market sectors) are also important to the closure impact
results reflected in this report. These factors could increase or decrease the future closure level
from this study's projections.
d. 1983 Guideline Impact
In general, the longer-term (1983) findings resulting from this study are less certain than
those shorter-term (1977) findings described earlier. The managements of many mills that were
contacted expect 1983 guidelines to be revised and, thus, are not sure what the ultimate
parameters of these 1983 guidelines will be. For this reason, as well as the long lead time, the
managements of many mills view 1983 pollution control cost requirements with much uncer-
tainty, and were unwilling to speculate on their future actions. Hence, to a greater degree than in
the short-run analysis, conclusions on 1983-related closures are based more heavily on financial
analysis. Therefore, 1983 closure conclusions are limited by the uncertainties of the long-run
financial projections that are required for such an analysis.
e. Section 301 (c)
The analysis did not attempt to estimate the effect of Section 301(c) of the Water Pollution
Control Act which provides that if a plant can demonstrate individual hardship, it may obtain a
variance from the water effluent regulations.
130
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C. CLOSURE IMPACT FINDINGS
1. General Findings
Table V-l shows that of 556 U.S. pulp and paper mills 27 have a high closure potential,
resulting from the burden of meeting 1977 or 1983 EPA water effluent guidelines. In general, most
mills studied have either: (1) complied with 1977 effluent guidelines; (2) planned actions that will
enable them to comply; or (3) already closed.
This section provides an overview of the closure findings resulting from this analysis.
Section C.2 describes in greater detail the higher impact process sectors identified in the study.
a. Impact from 1977 Guidelines
Table V-2 shows that 10 mills, accounting for 1390 tons per day of finished product capacity,
will be affected by 1977 water effluent guidelines. The sulfite process sector is subject to the
heaviest impact with three closures accounting for 580 tons/day of finished product capacity.
Table V-3 indicates the capacity removal effect from a product point of view. Bleached market
pulp (paper grade) and printing/writing papers, with 39r and 2.4% of 1975 capacity removed,
respectively, are the most seriously affected.
b. Incremental Impact from 1983 Guidelines
Table V-4 indicates that 17 additional mills representing 1715 tons/day of finished product
capacity are projected to close as a result of 1983 water effluent guidelines. This impact is
incremental and excludes closures resulting from the 1977 guidelines. The groundwood, sulfite,
deinked, and non-integrated tissue process sectors are most heavily affected.
Table V-5 subdivides the impacts of the 1983 closures by product. The printing/writing
papers and tissue sectors with 2.6Tc and 3.39c of 1975 capacity removed, respectively, are the most
heavily affected.
In general, the study's findings concerning longer-term closure impacts are less certain than
the shorter-term findings previously described. The managements of many mills that were
contacted expect the proposed 1983 guidelines to be eased before they are promulgated and are
not sure what the ultimate parameters of these guidelines will be. Industry interviews also
indicate that mills that have invested recently in.pollution control equipment to comply with
1977 guidelines may not necessarily meet the proposed 1983 guidelines. Thus, the 1983 findings
rely more heavily on the financial analysis phase of the screening and are limited by the
uncertainties inherent in this analysis. As a result, these findings should be interpreted within the
context of the relatively broadly-ranged confidence intervals shown in Table V-5, which reflect
the above uncertainties.
2. Discussion of High Closure Impact Process Sectors
a. Sulfite Sector Closure
(1) Characteristics of Mills Vulnerable to Closure. Sulfite pulp/paper was identified as
subject to the highest closure impact among the studied process sectors. Three mills, representing
about 5rr of total sulfite sector capacity, do not expect to comply with the 1977 guidelines. One of
these has no chemical recovery facilities in place. The other two mills have partial recovery
131
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TABLE V-l
to
RESULTS OF CLOSURE SCREENING ANALYSIS
Product /Process Sector
Bleached Kraft
Groundwood
Sulfite
Soda
De inked
Tissue - NI
Printing & Writing Papers-NI
Unbleached Kraft
NSSC
Combined Unbleached Kraft /NSSC
Construction Papers
Recycled Paperboard
Total
Number
of Mills
Examined
(Year-end
1975)
80
23
27
3
35
59
42
29
18
10
70
160
556
Number
of
Direct
Discharges
77
19
26
3
30
39
29
28
14
10
13
37
325
Mills
Remaining
After
Initial
Screening
6
11
11
1
14
31
13
4
6
1
8
35
141
Mills
Remaining
After
Industry
Interviews
0
4
14
1
5
5
3
0
0
0
2
2
36
Mills
Remaining
After
Financial 1
Analysis
0
4
5
1
5
5
3
0
0
0
2
2
27
That is, potential closures resulting from primarily from 1977 plus 1983 water effluent guidelines.
Source: Arthur D. Little, Inc., estimates.
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TABLE V-2
POTENTIAL CLOSURE IMPACT OF 1977 GUIDELINES BY PROCESS SECTOR
OJ
OJ
Process Category
Groundwood
Sulfite
Soda
Deinked
Tissue - NI
P&W Papers - NI
Construction Papers
Recycled Paperboard - NI
Number of Closures
1
3
1
1
1
1
1
1
Productive Capacity Removed
(tons/day)
75 (P&W papers)
320 (market pulp)
260 (P&W papers)
300 (P&W papers)
25 (Tissue)
10
200
100
100
10
1390
SOURCE: Arthur D. Little, Inc., estimates.
-------
OJ
TABLE V-3
POTENTIAL CLOSURE IMPACT OF 1977 GUIDELINES BY PRODUCT SECTOR
Bleached Market Paper Grade Pulp
Printing & Writing Papers
Tissue
Construction Papers
Recycled Paper Board
Productive
Capacity
Removed
(tons/day)
320
835
35
100
100
1390
Productive 1975
Capacity
Removed
(%)
3.0
2.4
*
1.5
1.1
* Less than 1%
Source: Arthur D. Little, Inc., estimates
-------
TABLE V-4
INCREMENTAL CLOSURE IMPACT OF 1983 GUIDELINES
BY PROCESS SECTOR
Incremental
Number of Added Productive
Process Category Closures Capacity Removed
(tons/day)
Groundwood 3 700 (P&W papers)
90 (newsprint)
Sulfite 2 300 (special indus=-
trial papers)
80 Medium
Deinked 4 260 Tissue
60 (P&W papers)
Tissue - NI 4 175
P&W papers- NI 2 150
Construction Papers 1 100
Recycled Paperboard - NI _!_ 100
17 1715
Special Industrial Papers sector not included within this
study's scope. Thus, this capacity not included in total
estimates
Source: Arthur D. Little, Inc., estimates.
135
-------
TABLE V-5
OJ
o\
INCREMENTAL CLOSURE
Market Category
Newsprint
Printing & Writing Papers
Tissue
Corrugating Medium
Construction Papers
Recycled Paperboard
IMPACT OF 1983 GUIDELINES
Productive Capacity
Removed
(tons/day)
90
910
435
80
100
100
1715
BY PRODUCT SECTOR
Productive 1975
Capacity Removed
(%)
*
2.6
3.3
1.8
1.5
1.1
Confidence ,
Intervals
(%)
25
30
30
30
25
30
*Less than
Source: Arthur D. Little, Inc., Estimates
-------
systems in-place and produce lignin by-products from the unrecovered liquor. None of the mills
has secondary treatment. All three closure candidates have less than 200 tons/day of pulp
capacity, which places them in the lowest quartile of U.S. sulfite mills ranked by size. Two
additional sulfite mills are likely to close if 1983 guidelines are enacted. These are also small mills
(less than 150 tons/day of pulp capacity). The managements of both these mills believe they
comply, or will be able to comply with 1977 guidelines.
(2) Analysis of Results. Of the 27 U.S. sulfite mills examined, 11 were identified in the
initial screening as requiring further information to clarify their closure potentials. After inter-
viewing the managements of these mills either by telephone or in person, we judged two of these
mills to be safe from pollution-related closure through 1983. These interviews also resulted in the
identification of five additional mills that were originally eliminated in the first screen, but
required further analysis based on company feedback.
To evaluate the 14 mills remaining after the second screen, Arthur D. Little developed two
generalized financial models of the identified mills. (See Tables V-6 and V-7.) A large dissolving
pulp mill model was chosen because there were several questionable mills (located both in Alaska
and in the lower 48 states) that approximate the parameters of this model. A small paper-grade
pulp mill model was chosen because four vulnerable mills identified in the second screening phase
approximate the parameters of this model.
Because the 14 questionable mills differ significantly in size, product mix, average prices
and costs, profitability, and cost of compliance, it was impossible for the two models to be
representative of all 14 situations. Consequently, extrapolations were required to evaluate the
closure likelihood of those mills not precisely represented by the models.
Table V-8 shows the results of the DCF analysis of the large dissolving pulp mill. The results
indicate that the model can absorb both 1977 and 1983 pollution control expenditures from the
standpoint of both net present value (NPV) and internal rate of return (IRR). This model requires
external financing totaling $14 million. A maximum of $8 million in external financing is required
in 1977. Internal cash flows generated by this model allow all external funds to be repaid by 1979.
In view of the model's high initial profitability, it should be possible to raise the external
capital required, subject to the possibility of a very tight supply situation in the capital market.
Varying the operating rates from 95% to 85% and the cost of capital from 10% to 20% did not
change the findings. Therefore, it was concluded that large dissolving pulp mills which have
financial characteristics similar to this model generally have significant cash-flow generating
capability and are unlikely to be vulnerable to closure because of 1977 and 1983 effluent control
requirements.
Since the above analysis was completed, Arthur D. Little has made an intensive study of the
Ketchikan Pulp Company (KPC) Mill in Alaska because of the Company's request for a hearing
under Section 507(e) of the Federal Water Pollution Control Act. The latter study indicated that
the KPC mill is also unlikely to close for pollution control reasons, but since this mill was not as
strong financially as the generalized model shown here it is closer to the point where a closure
could be forced for financial reasons. The reasons for this difference in financial performance
involved site and mill specific factors (particularly with respect to projected logging costs) that
only an in-depth analysis of a specific mill could reveal.
137
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TABLE V-6
PROFILE OF LARGE PI SSOLVING SULFITE MILL CLOSURE MODEL
BASIS; Product: Viscose Grade Dissolving Market Pulp
Process: Mg Base sulfite pulping with MgO recovery
Production: 600 tpd; 200,000 tpy (95% of capacity)
Location: Pacific Northwest
Fiber Furnish: 100% Whitewood (chips)
Power: On-site generation
Effluent Treatment: Primary clarification
Average Selling Price: (end of 1975): $396/ton
CAPITAL PARAMETERS;
Book Value: $30 million (assumed)
Working Capital: $14 million
Additional Capital Requirements:
a. Federal Water Regulations for 1977 BPT - $28 million
for 1983 BAT - $15 million
b. Upkeep $2 million/year
Salvage Value: $6 million (assumed)
OPERATING COSTS; $/ton
Total Delivered Cost, (without controls) 287
Additional operating cost for:
Federal Water Regulations 1977 9
Federal Water Regulations 1983 5
Total Projected Delivered Cost 301
(with Federal Water Regulations)
Excluding depreciation and interest
Source: Mill Survey and Arthur D. Little, Inc., estimates
138
-------
TABLE V-7
PROFILE OF SMALL PAPER GRADE SULFITE MILL CLOSURE MODEL
BASIS: Product: Bond paper, in rolls
Process: Mg base sulfite pulping with MgO recovery
Production: 150 tpd; 50,000 tpy (95% capacity)
Location: North Central
Fiber Furnish: 100% chips from roundwood (50/50 SW & HW)
Power: On-site generation plus purchased
Effluent treatment: Primary clarification
Average selling price: (end of 1975): $495/ton
CAPITAL PARAMETERS;
Book Value: $24 million (assumed)
Working Capital: $4 million
Additional Capital Requirements:
a. Federal Water Regulations for 1977 BPT - $6.1 million
for 1983 BAT - $3.7 million
b. Upkeep $0.5 million/year
Salvage Value: $5 million (assumed)
OPERATING COSTS; $/ton
Total Delivered Cost (without controls) 341
Additional Operating Cost for:
Federal Water Regulations 1977 12
Federal Water Regulations 1983 5
Total Projected Delivered Cost 358
(with Federal Water Regulations)
Excluding depreciation and interest
Source: Mill Survey and Arthur D. Little, Inc., estimates
139
-------
TABLE V-8
FINANCIAL COMPARISON OF CLOSURE ALTERNATIVES FOR
LARGE DISSOLVING SULFITE PULP MILL MODEL
Net Present Value
Over Salvaging Mill
Now; 10% cost of
Capital
Implicit Internal
Rate of Return-*-
Total External
Financing
Maximum External
Financing in any
One Year
Year of Maximum
External Financing
Load
Year Debt Retired
No Controls -
Operate Until 1983
$54 Million
55%
Meet 1977 Standards
and Operate Until
1983
$40 Million
32%
$14 Million
$ 8 Million
1977
1979
Meet 1983 Standards
and Operate Until 1993
$65 Million
32%
$14 Million
$ 8 Million
1977
1979
IRR is relative to salvage value, which is defined as scrap value plus working capital: in
this case $20 MM.
SOURCE: Arthur D. Little, Inc., estimates.
-------
This finding underscores the fact that while the generalized mill model approach employed
here can be used to estimate overall closure and employment impacts, much more specific
analysis is needed to predict closures of individual mills.
Table V-9 shows the results of the DCF analysis resulting from the small paper-grade sulfite
mill model. The results indicate that this model can also absorb 1977 and 1983 pollution control
expenditures in terms of both NPV and IRR indices. This means that small paper-grade sulfite
mills which produce high-quality printing and writing papers and otherwise fit the model's
parameters should not be vulnerable to mill closure as a result of the studied effluent control
levels.
However, several small mills judged to be marginal or questionable in the industry screening
phase of the analysis do not fit parameters of the small sulfite mill model. In particular it was
evident that their profitability is below that of the model. Factors (or a combination thereof)
leading to this conclusion include:
Greater capital expenditure requirements to achieve 1977 or 1983 guidelines be-
cause of site-specific conditions;
Smaller mill size (up to half as large as the mill model) resulting in higher
operating costs and lower profit margins;
Lower average prices resulting from a lower-value product mix. (For example, one
small paper-grade sulfite mill had an average price of $200/ton for its packaging
product less than half of the writing paper price used in the model.)
Thus, despite the healthy financial position reflected by the paper-grade sulfite mill model, a
qualitative assessment of the aforementioned factors led Arthur D. Little to conclude that five
sulfite mills perform less well than the model by a large enough margin to be considered
vulnerable to closure.
It should also be noted that the closure impacts identified for the sulfite sector are conserva-
tive to the extent that they do not reflect three sulfite mills scheduled for closure and replacement
by additional kraft pulp capacity at nearby sites. Since this tonnage removed will be replaced by
kraft pulp, the resulting capacity and employment impacts were not considered significant.
b. Groundwood Sector Closures
(1) Characteristics of Closure Candidates. One groundwood sector closure is expected as a
result of 1977 effluent guidelines. This mill is old, inefficient, and small, with a capacity of 75
tons/day. Three additional closures are expected as a result of 1983 effluent guidelines. Two of
these mills are small (less than 100 tons/day of pulp capacity) and the third has a pulp capacity of
225-275 tons/day.
(2) Description of Analysis. In the initial screening analysis, 23 mechanical pulp mills
(groundwood, thermo-mechanical and chemi-mechanical) were examined and 11 were identified
as requiring company contacts. Updated information from these interviews indicated that seven
of these mills were sufficiently viable to be invulnerable to closure because of pollution regu-
lations. One model was developed for the financial analysis of the remaining four mills (Table V-
10).
141
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TABLE V-9
FINANCIAL COMPARISON OF CLOSURE ALTERNATIVES FOR
PAPER GRADE SULFITE PULP MILL MODEL
to
Net Present Value
Over Salvaging Mill
Now ; 10% Cost of
Capital
Implicit Internal
Rate of Return
<.
Total External
Financing
Maximum External
Financing in any
One Year
Year of Maximum
External Financing
Load
Year Debt Repaid
No Controls -
Operate Until 1083
$22 Million
52%
Meet 1977 Standards
and Operate Until
1983
$19 Million
40%
Meet 1983 Standards
and Goer-ate Until 19«3
$27 Million
40%
IRR is relative to salvage value, which is defined as scrap value plus working capital.
SOURCE: Arthur D. Little, Inc., estimates.
-------
TABLE V-10
PROFILE OF GROUNDWOOD PAPER MILL CLOSURE MODEL
BASIS; Product: Uncoated Groundwood paper, in rolls
Process: Stone Groundwood (bleached SW)
Production: 150 tpd; 50,000 tpy (95% of capacity)
Location: North East
Fiber Furnish: 70% Groundwood; 20% Waste paper; 10% Market Pulp
Power: 50% of grinder power requirement from hydro; balance
purchased electric power
Effluent Treatment: Primary Clarification
Average Selling Price: (end 1975): $320/ton
CAPITAL PARAMETERS;
Book Value : $10 million (assumed)
Working Capital: $4 million
Additional Capital Requirements:
a. Federal Water Regulations for 1977 BPT - $3.2 million
for 1983 BAT - $1.5 million
b. Upkeep $0.5 million/year
Salvage Value: $2.0 million (assumed)
OPERATING COSTS
Total Del'vd Cost (without controls) 300
Additional Operating Cost for:
Federal Water Regulations 1977 6
Federal Water Regulations 1983 j 3_
Total projected Delivered Cost 309
with Federal Water Regulations
Excluding depreciation and interest
Source: Mill Survey and Arthur D. Little, Inc., estimates
143
-------
Table V-ll shows that the DCF analysis of this model indicates that with an internal rate of
return of 10% the mill is marginally viable in the absence of pollution control investment
requirements. Under both 1977 and 1983 guidelines, the NPV is negative. The model's cost of
capital would have to be an unrealistically low, 5-6% (in constant dollars), in order for the mill to
continue to operate. Note, also, that this DCF analysis was based on a 95% operating rate, the
most optimistic condition that could be postulated in this industry sector. These results tend to
verify the closure indications revealed in the industry screening and interviewing phases.
c. Deinking Sector Closures
(1) Characteristics of Closure Candidates. One deinking mill closure is anticipated be-
cause of 1977 effluent guidelines. This mill is very small (less than 50 tons/day). Its existing
treatment consists of primary clarification. The mill does not anticipate being able to tie into a
municipal treatment system. Four additional closures are expected as a result of 1983 effluent
guidelines. Three of these mills are also in the 50-tons/day range. The fourth is 200-300 tons/day.
These four mills anticipate that they will be able to comply with 1977 effluent guidelines.
(2) Description of Analysis. In the initial screening analysis, 35 deinking mills were
examined and 14 were identified as requiring company contacts. Industry interviews indicated
that nine of these mills were not vulnerable to closure for pollution-related reasons. One mill
model was developed for the purposes of analyzing the five remaining mills (Table V-12).
Table V-13 shows the results of the DCF analysis generated by this model. These results
indicate that while the mill is viable in the absence of further pollution control investment
requirements, it cannot absorb 1977 or 1983 guideline-related investments. In both cases, the net
present value of expected cash flows is less than current salvage value and the internal rate of
return is 6% and 8%, respectively. Again, these results tend to confirm the signs of high closure
probabilities observed via mill screening and industry interviews.
d. Nonintegrated Tissue Sector Closures
(1) Characteristics of Closure Candidates. One nonintegrated tissue mill closure is antici-
pated because of 1977 guidelines. This mill is very small (10 tons/day). Four additional closures
are expected from the impact of 1983 guidelines. These mills are in the 25 to 75-ton/day range.
(2) Description of Analysis. In the initial screening process, 59 tissue mills were examined
and 31 were identified as requiring further review. Industry interviews indicated that 26 of these
mills were not in jeopardy of closure as a result of the effluent guidelines. One "typical" mill
model was developed for the financial analysis of the remaining five candidates (Table V-14).
Table V-15 shows the results of the DCF analysis generated by this model. It indicates that
the mill is marginally viable in the absence of pollution control expenditures and is not viable
when impacted by 1977 or 1983 guideline capital requirements. The mill model has an IRR of 8%
under these scenarios. Total external financing requirements are estimated to be $0.8 million
with maximum financing of $0.6 million in 1977. This model also confirms descriptions of low
profitability and high closure potential received during the company interviews.
144
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TABLE V-ll
Net Present Value
Over Salvaging Mill
Now; 10% Cost of
Capital
Implicit Internal
Rate of Return^-
Total External
Financing
Maximum External
Financing in any
One year
Year of Maximum
External Financing
Load
Year Debt Retired
FINANCIAL COMPARISON OF CLOSURE ALTERNATIVES FOR
SMALL GROUNDWOOD PULP MILL MODEL
Meet 1977 Standards
No Controls - and Operate Until Meet 1983 Standards
Operate Until 1983 1983 and Operate Until 1993
10%
($2.0 Million)
5%
$1.5 Million
$1 .0 Million
1977
1980
($2-3 Million)
6%
$1.5 Million
$1.0 Million
1977
1980
Not TH i1S;elatl1Ve t0 S3lvaSe value' "hich is defined as scrap value plus working capital.
Note. The additional decimal place in the dollar figures was added to indicate differences, if any,
between 1977 and 1983; it does not reflect any additional precision.
SOURCE:
Arthur D. Little, Inc., estimates.
-------
TABLE V-12
PROFILE OF DEINKING MILL CLOSURE MODEL
BASIS; Product: Sanitary Tissue; 50% toilet, 40% towel, 10% napkins
Private Label & institutional grades
Process: Wastepaper deinking
Production: 76 tpd; 25,000 tpy (95% capacity) on 3 Machines
Location: Northeast
Fiber Furnish: 100% Waste Paper
Power: Purchased
Effluent Treatment: Primary Clarification
Weighted Average Selling Price (end of 1975): $650/ton
CAPITAL CONSIDERATIONS;
Book Value: $4 million (assumed)
Working Capital: $4 million
Additional Capital Requirements:
a. Federal Water Regulations for 1977 BPT - $5.0 million
for 1983 BAT-- $0.6 million
b. Upkeep $0.4 million/year
Salvage Value $1.0 million (assumed)
OPERATING COSTS
1 582
Total Delivered Cost (without controls)
Additional Operating Cost for:
Federal Water Regulations 1977 18
Federal Water Regulations 1983 4_
Total Projected Delivered Cost 604
(with Federal Water Regulations)
Excluding depreciation and interest
Source: Mill Survey and Arthur D. Little, Inc., estimates.
146
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TABLE V-13
FINANCIAL COMPARISON OF CLOSURE ALTERNATIVES FOR
SMALL DEINKED PULP MILL MODEL
Meet 1977 Standards
No Controls - and Operate Until Meet 1983 Standards
Operate Until 1983 1983 and Operate Until 1993
Net Present Value
Over Salvaging Mill
Now; 10% Cost of
Capital
Implicit Internal Rate of
Return 1
Total External
Financing
$ 2.1 Million
17 %
(S 1.4 Million)
6 %
$ 3.6 Million
($ 0.9 Million)
$ 3.6 Million
Maximum External
Financing in any
One Year
Year of Maximum
External Financing
Load
Yeai debt retired
$1.8 Million
1977
1982
$ 1.8 Million
1977
1983
IRR is relative to salvage value, which is defined as scrap value plus working "capital.
NOTK: The additional decimal place in the dollar figures was added to indicate differences, if any,
between 1977 and 1983; it does not reflect any additional precision.
SOURCE: Arthur D. Little, Inc., estimates.
-------
TABLE V-14
PROFILE OF NONINTEGRATED TISSUE MILL CLOSURE MODEL
BASIS; Product: Sanitary Tissue; 50% toilet, 40% towels, 10% napkins
Private Label Grades
Process: Non-integrated papermaking
Production: 76 tpd; 25,000 tpy (95% capacity) on 3 Machines
Location: Northeast
Fiber Furnish: 70% Purchased Market Pulp; 30% Waste Paper (Pulp
substitute Grade)
Power: Purchased
Effluent Treatment: None
Weighted Average Selling Price (end 1975): $800/ton
CAPITAL CONSIDERATIONS:
Book Value: $4 million (assumed)
Working Capital Requirements: $5 million
Additional Capital Requirements:
a. Federal Water Regulations for 1977 BPT - $2.1 million
for 1983 BAT - $0.9 million
b. Upkeep $0.4 million/year
Salvage Value: $1.0 million (assumed)
OPERATING COSTS;
Total Delivered Cost (without controls) 748
Additional Operating Cost for:
Federal Water Regulations 1977 8
Federal Water Regulations 1983 5
Total Projected Delivered Cost 761
(with Federal Water Regulations)
Excluding Depreciation and Interest
Source: Mill Survey and Arthur D. Little, Inc., estimates.
148
-------
TABLE V-15
FINANCIAL COMPARISON OF CLOSURE ALTERNATIVES FOR
NONINTEGRATED TISSUE MILL MODEL
Meet 1977 Standards
No Controls - and Operate Until Meet 1983 Standards
Operate Until 1983 1983 and Operate Until 1993
Net Present Value
Over Salvaging Mill . /f. n -, ,*-,
Now 10% Cost of °'3 - ($ °'7 Million) ($ 0.7 Million)
Capital
Implicit Internal Rate of g ^
Return 1 U ''
Total External
Financing - $ 0.8 Million $ 0.8 Million
Maximum External
Financing in any - $ 0.6 Million $ Q.6 Million
One year
Year of Maximum
External Financing - 1977 1977
Load
Year. Debt Retired - 1979 1979
"'"IRR is relative to salvage value, which is defined as scrap value plus working capital.
NOTE: The additional decimal place in the dollar figures was added to indicate differences, if any,
between 1977 and 1983; it does not reflect any additional precision.
SOURCE: Arthur D. Little, Inc., estimates.
-------
e. Recycled Paperboard Sector Closures
(1) Characteristics of Closure Candidates. Two recycled paperboard mill closures are
anticipated as a result of pollution control guidelines. Both mills are small (less than 75
tons/day), do not have access to municipal treatment facilities, and cannot afford the required
secondary treatment to meet 1977 water effluent regulations.
(2) Description of Analysis. In the initial screening process, 160 mills were examined and
35 were identified as requiring further review. Industry interviews indicated that most of these
mills have or will tie into municipal treatment facilities. Thus, only two mills could be considered
to be jeopardized by pollution control requirements. One "typical" closure model was developed
for the financial analysis (Table V-16).
Table V-17 shows the results of the DCF-analysis performed on this model. It indicates that
with a 10% internal rate of return the model is marginally viable in the absence of pollution
control expenditures. However, the IRRof the model drops well below 10% when 1977 or 1977 plus
1983 guideline cost impacts are factored in. Thus, this model is not economically viable under
either effluent guideline regulation.
When relating the poor financial performance of the recycled paperboard mill closure model
to the fact that only two closures out of 160 mills were projected, it is important to consider the
following:
By far, the greatest number of paper industry closures during the period January
1965 to June 1975 took place in the recycled paperboard sector (34 mills closed,
accounting for 1.2 million tons of capacity). These historic closures have acted to
"weed out" many of the less economically viable mills.
Of the 160 mills studied in this sector, 123 have complied with effluent guidelines
via low-cost approaches:
94 mills have tied into municipal treatment facilities.
25 mills have closed up or internalized their processes.
4 mills utilize spray irrigation systems.
Financial analysis indicates that if it were not for the capability of many mills in this sector
to take advantage of these lower-cost compliance approaches, the closure impact in the sector
would be significantly higher. It also follows that if future regulations create incremental cost
impacts for recycled paperboard mills (such as pretreatment as a prerequisite for municipal
treatment tie-in), this sector should be carefully evaluated as a potentially high impact sector.
/. NSSC Sector Closures
In the initial screening process, 18 mills were examined and six were identified as requiring
further review. Industry interviews indicated that:
Three of these mills recently have changed their product mix. Two are now
producing recycled paperboard and one is producing construction papers. These
product mix changes had a negligible impact on capacity and employment.
One millhas tied in to a municipal treatment plant.
Two mills are installing secondary treatment facilities on-site.
150
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TABLE V-16
PROFILE OF RECYCLED PAPERBOARD MILL CLOSURE MODELS
BASIS: Product: 60% Boxboard; 40% Chipboard
Process: Secondary Fiber Pulping; all production in sheets
Production: 100 tpd; 33,000 tpy.
Location: North Central Metropolitan
Fiber Furnish: Recycled Fiber
Effluent Treatment: Primary Clarification
Weighted Average Selling Price (Mid 1976): $265/ton
CAPITAL CONSIDERATIONS;
Book value: $6 million (assumed)
Working Capital Requirements: $2 million
Additional Capital Requirements:
a. Federal Water Regulations for 1977 BPT $2.3 million
for 1983 BAT $0.7 million
b. Upkeep $0.3 million/yr.
Salvage Value: $1.5 million (assumed)
OPERATING COSTS ($/ton)
Total Delivered Cost (without controls) 243
Additional Operating Cost for:
Federal Water Regulations 1977 7
Federal Water Regulations 1983 2
Total Projected Delivered Cost 252
(with Federal Water Regulations)
Excluding depreciation and interest.
Source: Mill Survey and Arthur D. Little, Inc., estimates.
151
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TABLE V-17
FINANCIAL COMPARISON OF CLOSURE ALTERNATIVES FOR
RECYCLED PAPERBOARD MILL MODEL
Net Present Value
Over Salvaging Mill
Now 10% Cost of Capital
Implicit Internal Rate
of Return1
Total External
Financing
Maximum External
Financing in Any
One Year
Year of Maximum
External Financing
Load
Year Debt Retired
Meet 1977 Standards
No Controls - and Operate Until Meet 1983 Standards
Operate Until 1983 1983 and Operate Until 1993
$1.1 Million
15%
($0.3 Million)
$0.8 Million
$0.5 Million
1977
1979
($0.9 Million)
$0.8 Million
$0.5 Million
1977
1979
IRR is relative to salvage value,which is defined as scrap value plus working capital.
SOURCE: Arthur D. Little, Inc., estimates.
-------
Thus, while no mills were identified in the analysis as being closure candidates, three mills
shut down their NSSC pulping processes to comply with effluent guidelines. To this extent,
closure impacts in the NSSC process sector may be understated from a capacity standpoint
although the product mix changes have reduced employment relatively little.
3. Community Employment Impacts
a. 1977 Guidelines
Ten mills in three geographic regions of the country are projected to close because of 1977
effluent guidelines. Total employment impact is estimated to be 2635 primary losses plus 1105
secondary losses, distributed as shown in Table V-18.
The heaviest loss of jobs will be in the Northeast, North Central, and Northwest regions.
However, because many of these mills are in urban regions where the primary unemployment
impact constitutes a very small percentage of total basic employment, re-employment opportu-
nities are likely to limit the total employment impact to the primary impact.
b. 1983 Guidelines
Seventeen mills in four geographic regions of the country are projected to close because of
1983 effluent guidelines with a total employment impact of about 7125 jobs distributed regionally
as shown in Table V-19. Again, the most seriously affected regions will be the Northeast (eight
closures, 3000 jobs), in the North Central region (five closures, 3350 jobs), and the Northwest (two
closures, 560 jobs). One closure in the North Central region a large deinking mill is in an
area with little re-employment opportunities and has a relatively high secondary employment
multiplier. This closure represents about two-thirds of the total employment impact in the North
Central region.
153
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TABLE V-18
REGIONAL EMPLOYMENT IMPACTS ASSOCIATED WITH
Region and
Mill Type
Northwest
Sulfite
North Central
Sulfite
Sulfite
Groundwood
Construction Papers
Northeast
Deinked
Tissue - NI
Printing & Writing
Soda
Recycled Paperboard
1977 (BPT)
Primary
Impact
175
220
450
210
100
980
100
50
660
600
NI 70
1480
MILL CLOSURES
Secondary Impact
2
Re-employment Multiplier
40 2.1
>220 1.4
15 0.8
15 1.9
45 1.8
> 100
> 50
> 660
> 600
> 70
Secondary
Impact
285
0
350
370
100
820
0
0
0
0
0
0
Total
Impact
460
220
800
580
200
1800
100
50
660
600
70
1480
TOTAL
2635
1105
3740
Secondary Impact = (Primary Impact - Re-employment) X multiplier
Multiplier = (Total Employment/Basic Employment) - 1
SOURCE: Arthur D. Little, Inc., estimates.
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TABLE V-19
INCREMENTAL REGIONAL EMPLOYMENT IMPACTS ASSOCIATED WITH
Region and
Mill Type
Northwest
Sulfite
Groundwood
North Central
Sulfite
Deinked
Deinked
Deinked
Northeast
Groundwood
Groundwood
Tissue - NI
Tissue - NI
Tissue - NI
Tissue - NI
South
1983 (BAT)
MILL CLOSURES
Secondary Impact
Primary
Impact
150
150
300
200
750
150
120
ing - NI 75
1295
250
600
160
100
220
50
ing - NI 300
oard - NI 50
1730
125
ipers 50
175
3500
Re-employment
130
40
15
0
85
15
> 75
0
75
> 160
55
140
> 50
> 300
> 50
65
> 50
2
Multiplier
2.1
2.0
2.1
2.0
1.1
0.9
1.4
1.4
1.3
2.3
1.4
2.2
2.0
2.3
1.3
0.6
2.0
1
Secondary
Impact
40
220
260
390
1500
70
95
0
2055
350
685
0
65
175
0
0
0
1275
35
0
35
3625
Deinked
Construction Papers
TOTAL
2Secondary Impact = (Primary Impact - Reemployment) X multiplier
Multiplier = (Total Employment/Basic Employment) - 1
SOURCE: Arthur D. Little, Inc., estimates.
Total
Impact
190
370
560
590
2250
220
215
75
3350
600
1285
160
165
395
50
300
50
3005
160
5JO
210
7125
-------
CHAPTER VI
CAPITAL IMPACTS
-------
VI. CAPITAL IMPACTS
A. INTRODUCTION
In assessing the economic impact of the studied environmental regulations, it is necessary to
place the regulatory burden into the context of the industry's total projected operating and
capital costs and to inquire whether these demands can be met within the constraints imposed by
the discipline of the capital markets. This study does not attempt to estimate the impact of large
new financing demands on the paper industry's cost of capital; rather, it attempts to assess the
size and timing of the industry's external financing requirements to comply with the studied
water, air, and noise regulations, and to place the magnitude of this burden into perspective.
1. Approach
The overall structure of the analysis is presented in Figure VI-1. The central analytical tool
was a flow-of-funds model of the U.S. pulp and paper industry developed by Arthur D. Little. It
differs from the other funds flow model recently applied to this problem in that it does not
attempt to independently project sales, margins, etc.1 Instead, it recognizes the importance of
equilibrium conditions in both product and capital markets; hence, it assumes that over the
period 1976-1983 the industry will continue to pursue its customary financial policies and to price
its product and set its output level consistent with the demamd schedule which it faces to achieve
the required rate of return. Key elements of the methodology are discussed in Section B and
supporting details are presented in Volume III, Appendix H.
After experimenting with several approaches Arthur D. Little found that the most reliable
method of forecasting the investment requirements of the paper industry was to work with the
API's most recent survey of its members' planned capacity changes. These data provided a
reasonably reliable forecast for each major grade to 1979. Arthur D. Little then projected this data
to 1983 by taking into account the capacity growth trend since 1970 and the relative profitability
of the various grades. Then two curves reflecting the upper and lower bounds of capacity
expansion between 1979 and 1983 were selected for the sensitivity analysis. Finally Arthur D.
Little's process economics models were used to convert the tonnage capacity projections to dollars
of capital requirements. Thus the approach took full account of capacity expansions already
committed and minimized the uncertainties of making long range projections.
2. Summary of Findings
The analysis indicates that over the eight-year period 1976-1983, the U.S. pulp, paper and
paperboard industry (exclusive of woodlands and converting operations) will invest approx-
imately $21.3 billion (in 1975 dollars) in capital equipment, of which some $7.4 billion will be the
direct result of compliance with the studied regulations. Of this $7.4 billion, almost $6 billion is
attributable to water effluent controls, with air and noise regulations making up the balance.
To finance its investment requirements, the industry will need to raise substantial funds in
the capital markets. Assuming average business conditions, a moderate level of capacity growth,
and pricing policies which fully reflect the marginal cost of capital funds and the relative
inelasticity of final demand for pulp, paper and paperboard, external financing requirements will
amount to about $4.5 billion, of which about $3.5 billion is attributable to environmental
1. URS Research Company, The Economic Impacts of Effluent Guidelines Compliance by the American Paper Industry.
American Paper Institute, 1975.
157
-------
FIGURE VI-1
CAPITAL REQUIREMENTS ANALYSIS METHODOLOGY
Industry
Announcements
Growth
Scenario
Structure
of
Future
Capacity
Capacity
Analysis
Sectoral
Capacity
Forecast
New Mill
Capital
Costs
Sectoral
Capacity
Retirement
Forecasts
Investment
Analysis
Capitalized
Maintenance
Levels
Existing
Capacity
nvestment i
Incremental
and Replacement
Capacity
Investment in
Major Maintenance
Expansion
Mode
Distribu-
tion
New Mill
Operating
Costs
Flow of Funds
Analysis
Forecast
Operating
Costs
Existing
Industry
Capital Costs
of Compliance
Existinq
Industry
perating Cost
of Coreliance
Historic
Financial
Statements of
Sample Firms
Cost of
Equity
Capital
Forecast
Aggregate
Demand
Existing
Industry
Operating Costs
Other
Industries
Financial
Data
Econometric
Modelling
Equilibrium Price
Historic
Operating
Rate
Pro-Forma
Financial Statement
of Pure Pulp and
Paper Sector
Macro-
economic
Scenario
External
Financing
Requirements
Financial Structure
of Industry
158
-------
regulations.2 The bulk of these funds (about 77%) would have been required during 1976 and 1977
if EPA's original 1977 water effluent deadline were to have been met using the assumed
technology.
This level of external financing, compared to aggregate financing in the economy, does not
differ significantly from the share of available funds successfully obtained by the pulp and paper
industry in the past. Therefore, it is difficult to assert that the demand for capital funds produced
by compliance with the studied regulations will divert an inexpansible capital supply away from
capacity expansion, or place an insurmountable barrier in the way of compliance. Table VI-1
presents a summary of the financial projections underlying these conclusions.
The analysis has also considered the impact on these conclusions over the range of uncer-
tainty in the major assumptions. While reasonable variations in the assumptions have a sub-
stantial impact on the total amount of external financing over the period, they do not alter the
qualitative conclusion that compliance is financially feasible. However, the analysis does indicate
that the industry's actual rate of compliance to be expected given the industry's current and
announced pattern of future compliance expenditures, will result in reduced financial pressure on
the industry prior to 1978.
B. METHODOLOGY AND FINDINGS
1. Capital Investment Requirements
a. Methodology
Annual capital investment requirements for the pulp, paper, and paperboard sector of the
industry were projected for each of the major components:
Incremental expansion of the total capacity of the industry;
Replacement of capacity retired either through normal obsolescence or because of
inability to comply with the studied regulations;
Major (capitalizable) maintenance of capacity in place; and
Upgrading of existing capacity to comply with the studied regulations.
(1) Expansion of Capacity. In estimating the investment requirements for capacity expan-
sion, Arthur D. Little used industry commitments for capacity expansion through 1979 and
projected three different series of total year-end capacity for each of the years 1980 through 1983
for 15 product sectors. The capital cost for expansion in each product sector was based on the
process economics new mill models, described in Chapter III, Section E, modified to reflect the
fact that much of the expansion will be carried out either through rebuilding existing machines or
installing new machines at an existing mill rather than by developing new "grassroots" sites. The
time pattern for these capital expenditures was 40% in the year of completion, 40% in the first
preceding year, and 20% in the second preceding year, which is the typical pattern in this
industry once the capital has been committed.
2. Note that only part of the external financing requirements of the industry is attributable to the studied controls,
despite the fact that pollution control investment exceeds total external financing, because the average price
charged by the industry, its level of production, and its consequent internal cash flow are quite different in the two
cases corresponding to presence and absence of the studied regulations.
159
-------
TABLE VI-1
SUMMARY OF PROJECTED FINANCIAL PERFORMANCE OF THE
U.S. PULP, PAPER AND PAPERBOARD INDUSTRY
1976-1983
( 1975 Dollars )
Eight-Year Totals and Averages
Operations
Price/ton ($/ton)
Total Production thousand tons)
Sales Revenue ($ Millions)
General, Selling and Administrative
Expenses
Cost of Goods Sold - excluding
compliance costs
- compliance costs
Interest on debt
Depreciation (book)
Income taxes (book)
Net Income
Net Income/Sales (book.)
Net Income/Equity (book)
Investment ($ Millions)
Replacement and ,>
Expansion - excluding compliance costs
- compliance costs
Major maintenance
Compliance costs for existing capacity
Total Investment
Investment cost/ton of capacity -
greenfield site
Investment cost/ton of capacity -
average of greenfields, new machines,
and improvements
External Financing ($ Millions)
Gross Equity Raised
Gross Debt Raised
Total
Excluding All
Studied Regulations
305
500,142
152,476
16,463
101,447
2,499
11,758
8,627
11,683
7.66%
12.11%
$ 6,934
6,993
13,927
579
Including All
Studied Regulations
322
487.849
157,146
16,889
99,569
2,365
4,191
13,460
8,216
12,457
7.93%
11.66%
$ 7,744
1,391
8,372
3,834
21,341
675
363
$ 143
751
894
458
$ 1,006
3,444
4,450
$810 million difference between columns 1&2 reflects cost to replace
mills closed as a result of the studied regulations.
160
-------
(2) Replacement of Retired Capacity. The investment requirements for replacement of
retired capacity were based on historic mill closure rates in each of 15 product sectors projected
through the period 1976-1983. Estimated mill closures resulting from water effluent regulations
were also included in these projections, and were assumed to occur in 1977 and 1983, the
deadlines for meeting EPA's water effluent guidelines. However, such closures were excluded
from the analyses of cases that assumed water effluent guidelines were not in force. The methods
of estimating capital cost levels and expenditure patterns described above under "Expansion of
Capacity" were also used here.
(3) Major Maintenance. As is described in Vol. Ill, Appendix F, pulp and paper mills
require large maintenance expenditures approximately one-third of the way through their useful
life as well as at subsequent times. Detailed information on the age of equipment in place is not
available. Therefore, these expenditures were approximated as an annual equivalent of 29o of
capacity in place valued at new mill (replacement) cost, including the appropriate level of
environmental control. This approach implicitly recognizes the need for maintenance of environ-
mental control equipment as well as of productive equipment.
(4) Upgrading of Existing Capacity. The investment requirements for bringing existing
capacity into compliance with Federal regulations were based on the data presented in Chapter
III, "Cost of Compliance." These costs were originally estimated as increments over a 1974
baseline. Since the funds flow model starts in 1976, Arthur D. Little reduced these costs by one-
third of the investment scheduled over the period 1975-1977, which is tantamount to the assump-
tion that the industry is proceeding with compliance with proposed 1977 standards on schedule.
Further, water effluent control and OSHA noise control costs have been increased for the cases
which assume no water effluent regulations to be in effect to reflect the cost of compliance for
capacity which would not be retired under these circumstances.
6. Results
Figure VI-2, which summarizes the analysis, indicates that compliance with the studied
regulations will require more than double the industry's capital investment in comparison with
the investment which would be needed in the absence of these regulations during 1976 and 1977,
and will require an increase of 35-50% during the period 1978-1983. The marked deviation of the
curve that includes water effluent control requirements from parallelism with those that include
only noise and air regulations is caused by the additional investment required to replace the
capacity of plants projected to close because of their inability to comply with water effluent
control regulations.
2. External Financing Requirements
The need for external financing in an intrinsically profitable enterprise arises from the
inevitable lag between the time when expenditures on physical plant must be made and the time
when gross profits produced by sales of the plant's output are available to defer the investment
costs. In an ongoing enterprise, the magnitude of the external financing necessary to support
further investment is usually less than the total investment level because of the availability of
internally generated funds produced by the existing business. Further, the roles played by
internally and externally generated funds are conditioned by the price and output relationships
extant in the market faced by the enterprise.
161
-------
FIGURE VI-2
CAPITAL INVESTMENT REQUIREMENTS OF THE
U.S. PULP, PAPER AND PAPERBOARD INDUSTRY
1976 - 1983
Annual
Capital
Investment
(Billions
of
1975 $)
i EXCLUDING
| STUDIED
REGULATIONS
77 78 79 80 81 82 83
76
'. I '. '. '.
: 1 .' J
i . . -
,;-:|;;;;;;;
.....
; I
: : ].:
.
:::
162
-------
a. Methodology
Arthur D. Little developed a financial model of the U.S. pulp and paper industry (excluding
woodlands and converting operations) which incorporates the above considerations. The model
operates through the creation of consistent annual sets of balance sheets, income statements, and
flow-of-funds statements. The model provides for both equity and debt financing, but raises
equity only when a specified debt/equity limit is exceeded. Numerous industry spokesmen and
financial analysts have indicated that the paper industry is currently as highly leveraged as
possible; therefore, the model set the debt/equity limit at the actual 1975 level. All analyses
employed constant 1975 dollars.
The model utilizes five major types of data to determine the level of external financing
required when the industry achieves equilibrium price and output levels:
the financial parameters of the industry as it existed at the end of 1975;
forecast investment requirements;
forecast operating parameters of the industry;
forecast price/quantity relationships; and
required rate of return on equity.
The general procedures used to develop these data are described below.
(1) Financial Parameters of the Existing Industry The starting point for the analysis was a
composite of the financial statements for the period 1966-1975 of the 32 major pulp and paper
producers whose business activities are highly concentrated in primary pulp and paper produc-
tion. These financial statements were then adjusted to eliminate woodlands operations, con-
verting operations (except for tissue), merchant sales (jobbing), and other businesses unrelated to
pulp and paper manufacturing. The adjustments were performed using financial ratios available
from the FTC/SEC Quarterly Reports for Manufacturing Companies, Dun and Bradstreet Re-
ports, annual financial reports, and Arthur D. Little industry expertise. The resulting "clean"
financial statements for the composite were then scaled up by the ratio of total U.S. primary pulp
and paper sales to the sales of the 32 company composite to produce pro-forma financial
statements for the total U.S. primary pulp and paper sector. These pro-forma statements were
then used:
To establish an initial balance sheet for the industry which defined:
The initial equity base against which rates of return were measured;
The initial level of assets and the appropriate depreciation schedule; and
The initial level, maturity structure, and embedded interest cost of long-term
debt.
To determine the financial policies reflected in the balance sheet which should be
used as ongoing constraints, including:
The debt/equity ratio of the industry; and
The relationships of the working capital accounts (including cash, receiv-
ables, inventories, and accounts payable) to the level of activity of the
industry.
163
-------
To ascertain the cash operating costs of the existing industry, including:
Manufacturing cost; and
General, sales, and administrative expense.
To establish the reinvestment behavior of the industry as reflected in its dividend
payout policy.
(2) Forecast Investment Requirements. Capital investment requirements were developed
as described above. In addition, incremental working capital requirements were forecast using the
relationships determined by analysis of the historic financial statements.
(3) Future Operating Parameters of the Industry. In estimating the operating parameters
of the industry in the forecast period, Arthur D. Little took into account changes in operating
costs attendant upon the introduction of new equipment. Future manufacturing costs were
computed as the weighted average of the costs corresponding to the existing industry and the
costs developed in the new mill models. Because insufficient data were available to construct unit
manufacturing costs for the existing industry on a product sector basis, all sectors were treated
collectively for the existing industry, and the existing industry's unit cost was weighted in each
year in proportion to the amount of 1975 capacity still in place. The unit operating costs for new
mills were weighted sector by sector in proportion to the amount of new capacity installed on a
replacement or incremental expansion basis.3 The absolute level of costs was established sepa-
rately for fixed and variable cost components. Fixed costs were determined by multiplying unit
fixed cost by capacity in place; variable costs were determined by multiplying unit variable cost
by tonnage produced.4
(4) Forecast Price/Quantity Relationships. An econometric model of aggregate U.S. demand for
pulp and paper products was used to project sales volumes (described in Chapter IV). Final
production tonnage and product price were estimated using an iterative process with the follow-
ing steps:
1. Industry production tonnage was forecasted on the basis of average 1975 prices.
2. The industry's financial performance was forecasted using product price as a
parameter which was varied until the internal rate of return on equity achieved its
target value. (See below.)
3. A new forecast of industry tonnage at the forecast price was carried out, and steps 2.
and 3. were repeated until the price projected using the rate-of-return criterion
equalled the price assumed in the production tonnage forecast. This price increase
was assumed to occur in 1976. '
3. This weighting procedure is tantamount to assuming uniform operating rates in all product sectors, which is an
adequate approximation for present purposes.
4. Because of recent shifts in the real levels of operating costs and changes in the scale of production in the industry,
the use of regression methods to extract fixed and variable cost components from the historic time series appeared
unreliable. Hence, the split between fixed and variable cash manufacturing costs for the existing industry was
assumed to be the same as the capacity-weighted average split corresponding to the new mill models, and existing
industry costs were based solely on 1975 results.
164
-------
The aggregate funds flow model estimate of the price that will prevail over 1976-1983 reflects
the cost for new capacity. This additional increase in price brings with it an additional decline in
the quantity demanded.
Under average conditions, an additional price increase of $13/ton will be needed to cover the
cost inflation for new capacity and the environmental control equipment already in place, if the
industry is to earn its required cost of capital. Figure VI-3 presents average industry operating
rates obtained under these conditions, and indicates that peak operating rates would not rise
above 85'r. These operating rates are the result of adjusting the demand forecast from the
demand equation and the Chase Econometrics scenario for 1976-1983 price increases, assuming
the price increases occur in 1976.
Variations in demand and capacity growth will lead to higher operating rates. Under the
most unfavorable conditions from the point of view of capacity pressure, i.e., high demand growth
and low capacity growth, the expected average prices are $298/ton without and $314/ton with the
studied regulations, compared to the 1975 average price of $292/ton. These lower price increases
compared to those expected under mid-range conditions reflect the lower level of capital in-
vestment which must be supported by operating margins and the lower unit fixed costs corre-
sponding to higher output levels. Figure VI-3 shows the corresponding operating rates and
indicates that while demand is less retarded by price than under mid-range conditions, peak
operating rates are not realized until 1982-1983.
(5) Required Rate of Return/Cost of Capital Assumption. The determination of the rate of
return required by the pulp and paper industry is extremely difficult. To assure standard
methodology, EPA provided an estimate of the cost of equity capital to the industry developed by
Professor Gerald Pogue5 based on the capital asset pricing model. While Professor Pogue's
projections incorporate annual variations in the cost of capital, Arthur D. Little's analysis was
performed using the average value of about 13% which prevailed both during the historic and
forecast periods in Dr. Pogue's analysis.
This simplification was made for two reasons. First, most of the annual variation in the
equity cost forecasts was produced by fluctuations in risk-free rate assumptions caused in turn by
assumed variations in inflation rates which are excluded from the Arthur D. Little model.
Second, the remaining variation was produced by assumptions concerning the rate of return on
the market portfolio, which are of questionable reliability.
Arthur D. Little believes that use of a constant cost of equity capital had no material impact
on its ultimate conclusions. However, three other issues must also be addressed to understand
Arthur D. Little's use of Professor Pogue's estimates.
The first is the question of book vs. market values. Professor Pogue's analysis was quite
properly based on the market value of the industry's equity, whereas Arthur D. Little's analysis is
based on an estimate of the book value of equity. Arthur D. Little did not adjust its equity
5. Dr. Gerald A. Pogue, Estimation of the Cost of Capital for Major United States Industries, 1975.
165
-------
FIGURE VI-3.
FUNDS FLOW MODEL
IMPACT ON OPERATING RATES OF STUDIED REGULATIONS
A. Midrange Growth Rates
^1 -| --- -^--* - J-
/, j".7..^.yt .'i_i_.T--ii ; yir."?zr!~'"'i !"T.i.r.j'.'. ~
1975 Price
Economic Price
Excluding Studied
Regulations
Economic Price
Including Studied
Regulations
B. High Demand and Low Capacity Growth Rates 2i;;;.i
f-
:i: i
79 80 81 82
-------
estimate because the market value of the industry's equity has fluctuated both above and below
book value, and Arthur D. Little was unable to identify any criterion to select one market value as
most appropriate to a long-run analysis. Further, Arthur D. Little's experience in working with
management in numerous industries suggests that management decisions on pricing, investment,
and related matters are frequently based on book rather than market values, and are not altered
directly as a result of fluctuations in the market price of the firm's securities.
The second issue is the impact of Arthur D. Little's constant dollar assumptions. Economic
theory teaches that the cost of capital can be represented as the sum of three terms: the pure time
value of money, which measures the investor's preference for present consumption over future
consumption; the inflation premium, which measures the investor's requirements for mainte-
nance of the purchasing power of future returns; and the volatility premium, which measures the
investor's price for assuming the risk of an uncertain future return. The sum of the first two terms
constitutes the so-called "risk-free rate," which can be measured directly by the yield on short-
term government securities or indirectly by the intercept of the capital asset pricing model
regression equation. But it is not possible to measure the two components of the risk-free rate
separately, and an attempt to simply subtract the realized rate of inflation from the risk-free rate
to estimate the pure time value of money during the 1970's leads to negative values, which
contradict both economic theory and common sense. Since no valid theoretical guide to per-
forming a more sophisticated adjustment exists, Arthur D. Little made no adjustment for the
elimination of inflation from its forecasts.
The third and most important issue is the questionable validity of using the results of the
capital asset pricing model to establish a rate of return target for internal investment decisions by
the firm or industry. This threshold issue is very much an open question in the finance and
economics literature. The capital asset pricing model focuses only on the non-diversifiable risk of
a stock market investment, and completely ignores the intrinsic or diversifiable risk. While this
position may be reasonable for the holder of a fully diversifiable portfolio, it is difficult to assert
that a prudent business entity should ignore any major element of business risk in deciding upon
its own investments. Further, estimating the parameters of the capital asset pricing model from
historic data implicitly assumes that the business environment has not recently changed enough
to change the investor's risk expectations. Despite these and similar limitations, Arthur D. Little
used the same return on equity as indicated by the capital asset pricing model results because it is
consistent with the historic rates of return realized by the industry. Also Arthur D. Little did a
sensitivity analysis of the capital and financing requirements using both higher (18'/(> and 15'V)
and lower (9' c) costs of capital to the industry.
b. Results
Figure VI-4, which presents the historic and projected annual external financing require-
ments of the industry in constant 1975 dollars over the period 1966-1983, indicates that the
external financing requirements of the industry will be substantially increased in absolute terms
by compliance with the studied environmental regulations. During 1976 and 1977, external
financing will greatly exceed the annual levels required by the industry during any of the past ten
years. However, the figure also indicates that very high requirements for external financing do not
persist beyond 1977; in fact, annual external financing requirements during the period 1978-1983
should be significantly below their historic level. This conclusion flows from the assumption that
the industry's realized rate of return will be equal to its required target rate of return. To the
extent that capital market considerations are not fully reflected in the industry's pricing deci-
sions, this conclusion could, of course, be altered.
167
-------
FIGURE VI-4
3 1.6
en ,
e 1.4
o
5; e1-2
00
o 1.0
0)
.8
cfl
C
w
EXTERNAL FINANCING REQUIREMENTS OF THE
U.S. PULP AND PAPER INDUSTRY
HISTORIC AND PROJECTED (MIDRANGE FORECAST)
2.4 ,
Excluding Studied
Regulations
Including All Studied
Regulations
9 n - ' _- - i : _
£. \J i 1~
1.8 ilL -;
. 4 - --
.2
1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979
1 ' i
1980 1981 1982 1983
-------
Despite the fact that the near-term external financing requirements of the industry are
higher than their historical levels in absolute terms, they are not particularly high in the context
of the overall rate of external financing in the private sector of the economy. Figure VI-5 presents
the value of total annual corporate financing in the U.S. economy over the period 1966-1983 in
constant 1975 dollars,6 and Figure VI-6 presents the ratio of pulp and paper industry annual
external financing to the U.S. corporate total for the same period. Figure VI-6 indicates that even
when all environmental controls are included, the share of all corporate financing represented by
pulp and paper industry financing is only about 3.8% in the year of highest demand (1976), which
is not much higher than the industry's share of 3.2% achieved in 1966. Further, in 1977, the pulp
and paper share drops to about 1.8%, and in the period 1978-1983 never exceeds 0.5%. The
problems of raising large amounts of capital funds can be substantial, and vary from company to
company. However, the analysis indicates that, in the aggregate and assuming free market
pricing, the imposition of environmental controls will not require the industry to place relative
demands on the capital markets significantly greater than it has in the past.
C. SENSITIVITY ANALYSIS
The results discussed in the preceding sections of this chapter have been based on central
estimates of the rates of capacity and demand growth, the cost of equity capital, the cost of
compliance with environmental regulations, and the actual compliance schedule. None of these
quantities is known with absolute certainty. Therefore, Arthur D. Little carried out additional
analyses to ascertain whether reasonable variations in any of these quantities would lead to
significantly different conclusions.
Because of the complexity of the interactions among the various assumptions, it was not
possible to consider all possible assumption combinations. Therefore, the analyses were per-
formed by varying one class of assumptions at a time, holding all other quantities at their central
values. Table VI-2 summarizes the impacts of variations in the assumptions on projected product
prices, investment levels, and external financing requirements.
1. Sensitivity to Growth Rate Assumptions
Because in Arthur D. Little's model, the rate of capacity growth is an exogenous variable,
the level of capital investment is insensitive to the assumed rate of growth of demand. In contrast,
the level of external financing requirements depends jointly on both the capacity and demand
growth rates because of the dependence of internal funds generation on price achieved and
quantity sold.
Figure VI-7 sets forth the ranges of annual capital investment requirements of the industry
corresponding to the capacity growth assumptions set forth in Chapter IV, Table IV-17. (Note
that the capital investment requirements of the industry during the period 1977-1978 depend on
variations in growth rates beyond 1979 because of the lead time for construction expenditures.)
6. The values for the historic period 1966-1975 are based on Standard and Poors Corporate statistics, adjusted by the
GNP implicit price deflator. The values for the period 1976-1983 are based on a regression model described in
Appendix I and on the Chase Econometrics CEQ forecasts of interest rates, corporate profits, and gross private
fixed non-residential investment.
169
-------
FIGURE VI-5
EXTERNAL CORPORATE FINANCING IN THE U.S. ECONOMY
HISTORIC AND PROJECTED (CEQ FORECASTS)"
1
CTi
14-1
O
CO
ti
O
pq
60
a
H
O
-J a
O C
(3
)-i
0)
~f 1 "t T 1 i
130 -
120
110
100
90
80
70
60
50
40
30 -
20
10
67 68 69 70 71 72 73 74 75 76 77 78 79 80 81
82 83
-------
FIGURE VI-6
EXTERNAL FINANCING REQUIREMENTS OF THE U.S. PULP AND PAPER INDUSTRY
AS A PERCENT OF ALL CORPORATE EXTERNAL FINANCING
HISTORIC AND PROJECTED (MIDRANGE FORECAST)
^Including all Studied Regulations)
g
u
1-1
0)
66
67 68 69 70 71
72 73
74
75 76 77 78 79 80 81 82 83
-------
TABLE VI-2
SENSITIVITY OF
PROJECTION
TO VARIATIONS IN ASSUMPTIONS
(1975 Dollars)
CENTRAL VALUES
Without Studied Regulations
With noise regulations only
With noise and air emissions
regulations
With all studied regulations
RANGES (With all studied regulations)
Cost of Compliance: High
Low
Demand Growth/Capacity Growth:
High / High
High / Low
Low / High
Low / Low
Cost of Equity Capital
18%
15.5%
9%
Compliance Schedule
Price/ton
$305
306
308
322
327
320
317
314
324
321
353
337
301
Total Investment
1976-1983
($ Millions)
$13,927
14,604
15,517
21,343
22,938
20,426
23,370
19,239
23,370
19,239
21,343
21,343
21,343
Total
External
Financing
($ Millions)
894
1,065
1,543
4,450
5,416
3,947
6,318
3,545
6,317
3,422
2,694
3,358
6,893
1977 expenditures extended to 1980 320
21,931
5,381
172
-------
FIGURE VI-7
SENSITIVITY OF CAPITAL INVESTMENT REQUIREMENTS TO
ASSUMED CAPACITY GROWTH
ON
en
a
o
H
M
g
6
u
co
a)
CJ
1
Excluding Studied Regulations
Midrange Scenario
___ t Excluding Studied Regulations
High and Low Growth Scenarios
Including All Studied Regulations
Midrange Scenario
Including All Studied Regulations
High and Low Growth Scenarios
76
83
-------
The figure indicates that:
Under high growth rate assumptions, total industry capital expenditures over the
eight-year forecast period would be about $23.4 billion (compared to the midrange
estimate of $21.3 billion), of which about $7.7 billion (compared to the midrange
estimate of $7.4 billion) would be attributable to environmental controls.
Under low growth rate assumptions, total industry capital expenditures over the
forecast period would be about $19.2 billion, of which about $7.1 billion would be
attributable to environmental controls.
The consequences of these possible variations in investment requirements under various
demand growth assumptions7 are set forth in Figure VI-8 which indicates that:
Under high capacity growth rate assumptions, the external financing requirements
of the industry over the eight-year forecast period, including compliance with all
environmental regulations, would be about $6.3 billion (compared to the midrange
estimate of $4.5 billion), irrespective of the assumed rate of growth in demand.
Under low capacity growth rate assumptions, the external financing requirements
of the industry would be about $3.5 billion assuming a high rate of growth in
demand, and about $3.4 billion assuming a low rate of growth in demand.8
The range of total external financing requirements over the forecast period under the
alternative growth scenarios is quite large in absolute terms. However, note that differences in
growth rate assumptions have almost no impact on financing requirements during the period of
highest relative financing demand (1976-1977), but have a significant impact in the period 1978-
1983 during which the external financing load is relatively small.
Figure VI-9 presents the ranges of the share of all corporate external financing represented
by pulp and paper financing. The level of all corporate financing is based on the Chase CEQ
forecast, and so slightly underestimates total corporate financing under more expansive condi-
tions; hence, the shares presented are conservative estimates, and would likely be somewhat
lower in actuality. The figure indicates that, even assuming a high rate of capacity growth and
compliance with all studied environmental controls, the annual level of external financing over
the forecast period still does not indicate an unprecedented demand for funds.
2. Sensitivity to Cost of Compliance Estimates
As Chapter III points out, estimates of both capital and operating costs for compliance with
the studied environmental control regulations are subject to the uncertainty inherent in all pre-
engineering cost analyses. Arthur D. Little therefore analyzed the impact of the range of uncer-
tainty discussed in Chapter III on investment and external financing demands. The limits used
for both capital and operating costs both for the existing industry and new mills were:
7. The midrange demand growth estimates presented previously were based on a modification of the Chase Econo-
metrics CEQ forecast developed by Chase assuming Federal action to mitigate the effects of a 1978 recession. The
low demand growth scenario used in the analysis corresponds to the Chase CEQ macroeconomic forecast without
the assumption of governmental intervention; the high demand growth scenario corresponds to a modified forecast
developed by Chase assuming no recession in 1978.
8. This apparently paradoxical result is produced by the need to finance an increase in working capital to support
higher sales levels under high demand growth assumptions.
174
-------
FIGURE VI-8
SENSITIVITY OF EXTERNAL FINANCING REQUIREMENTS
TO ASSUMED CAPACITY GROWTH AND DEMAND GROWTH
High Demand Growth Scenario Low Demand Growth Scenario
iiiLi2: L:ri:;ju. :.i;i;,:.;:...:.. ;|-,a4TluninT-i:ai]:;ir::rn::n:-^ ' ^''
_^ Including All Studied Regulations
""" High Capacity Growth Scenario
Including All Studied Regulations 2'2
Low Capacity Growth Scenario
Including All Studied Regulations 2 Q
Midrange Capacity Growth and Demand
Growth Scenarios
;^::^-:'j.:^: j ;T:i.| riij+^, \r -::i 4^ .; i^'P 1. 8
1.4 4
FliK F^-!T:±|_ :S]:K±EIi:E5±E
75 76 77 78 80
76 77 78 79 81 81 82 83
-------
FIGURE VI-9
SENSITIVITY OF EXTERNAL FINANCING REQUIREMENTS
AS PERCENT OF ALL CORPORATE EXTERNAL FINANCING TO ASSUMED CAPACITY GROWTH
o\
Midrange Forecast
High Capacity . Growth
Low Demand Growth Scenario
Low Capacity Growth Scenario
High Demand Growth Scenario
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
82
83
-------
A high-side variation of 25% for OSHA noise regulations, SIP air emission control,
and EPA water effluent guidelines; and
A low-side variation of 10% for air and water effluent control, and of 50% for OSHA
noise regulations.
Figure VI-10 presents the range of capital investment requirements corresponding to these
limits, and indicates that:
The total capital investment requirements of the industry over the eight-year
forecast period, assuming midrange growth rates for capacity and demand, could
vary between $20.4 billion and $22.9 billion (compared to the midrange estimate of
$21.3 billion) depending on the realized level of compliance costs.
Figure VI-11, which sets forth the range of external financing requirements corresponding to
the uncertainty in the cost of compliance, and Figure VI-12, which compares these requirements
to the level of all U.S. corporate financing, indicate that:
The total external financing requirements of the industry over the forecast period,
assuming midrange growth rates for demand and capacity, could vary between
$3.9 billion and $5.4 billion (compared to the midrange estimate of about $4.5
billion) depending on the realized level of compliance costs;
The greatest impact of variations in compliance costs occurs during the period
1976-1977, as would be expected because of the large expenditures necessary
during this period to bring the existing industry capacity into compliance with
1977 standards.
The relative share of all corporate financing required by the industry could rise as
high as about 4.3% (compared to a historic high of 3.2% and the midrange estimate
of 3.8%) during the year of greatest financing demand.
3. Sensitivity to Cost of Capital Assumptions
As has been mentioned before, Arthur D. Little's analysis treated capacity growth as an
exogenous variable, so the levels of capital investment requirements used are insensitive to the
assumed cost of equity capital. However, the level of external financing needed by the industry
does depend on capital cost, since the required rate of return influences pricing policy and thus
the internal generation of funds.
The discussion of the cost of capital presented above describes the difficulty of estimating
and deducting the inflationary expectations premium from the cost of equity capital. This
implies that the cost of capital estimate used may be high when applied to an analysis which
excludes general price inflation. However, a likely increase in investors' and industry partici-
pants' perceptions of the future riskiness of the industry more than offsets any tendency to
overestimate the cost of capital.
In the context of Arthur D. Little's analysis, which abstracts from uncertainties about
future changes in the real prices of the factors of production, there are two important new sources
of perceived risk. In its external environment, the industry faces substantial uncertainties about
the degree of direct and indirect governmental regulation and associated costs which will be
177
-------
FIGURE VI-10
SENSITIVITY OF CAPITAL INVESTMENT REQUIREMENTS
TO UNCERTAINTIES IN COST OF COMPLIANCE
CO-
IT)
Ol
rH
M-J
O
CO
O
I
4J
CO
I
ct)
(X
at
u
. Excluding Studied Regulations
Including All Studied Regulations
Uppcir and Lower Limits on Cost of
Compliance for All Studied Regulations
178
-------
FIGURE VI-11
SENSITIVITY OF EXTERNAL FINANCING REQUIREMENTS TO
UNCERTAINTIES IN COST OF COMPLIANCE
2.6
2.4
ON
CO
C
o
H
pq
x^
00
a
H 1
:££_j Excluding Studied Regulations
Including All Studied Regulations
Upper and Lower Limits on Cost of
Compliance for All Studied Regulations
8
cu
79 80 81 82 83
179
-------
FIGURE VI-12
SENSITIVITY OF EXTERNAL FINANCING REQUIREMENTS AS PERCENT '
OF ALL CORPORATE EXTERNAL FINANCING TO UNCERTAINTIES IN COST OF COMPLIANCE
00
o
4 t
Midrange Forecast
High and Low Limits of
Compliance Cost Estimates
66
67
68
69'
70
71
72
73 74
82
83
-------
imposed on it. In its internal environment, the industry is rapidly adopting a much larger scale of
production than heretofore, which carries with it increased operating leverage risk and increased
lead time to situate and install new capacity. In Arthur D. Little's judgment, these factors more
than outweigh the inflationary expectations premium effect. Therefore sensitivity tests were
made for upward variations in the cost of equity capital, assuming equity costs of 15.5% and 18%
(compared to the standard estimate of 13%).
Despite the fact that the industry's cost of equity capital is likely to be higher in the future
than in the past, the time frame in which the discipline of the capital markets will become
effective on pricing policy is difficult to predict. Therefore, Arthur D. Little also considered the
possibility that the rate of return on equity realized by the industry may be below its indicated
target level. In order to determine a reasonable lower bound for such a realized return, the historic
book return on equity for the pulp, paper, and paperboard sector of the industry was examined.
Figure VI-13 presents the realized level of return on equity for the period 1966-1975, and indicates
that the ten-year weighted average return was 8.8%. While the time series is extraordinarily
volatile, the historic average level constitutes a floor on the average realized return that can
reasonably be expected over the period 1976-1983. Accordingly, a sensitivity test was performed
assuming an equity cost of 9%.
Figure VI-14 sets forth the results of these analyses, and indicates that:
« As the cost of equity capital increases, the external financing requirements of the
industry decrease substantially, falling from about $6.9 billion at 9% to $4.5 billion
at 13%, to $3.4 billion at 15.5% and to $2.7 billion at 18%. However, the absolute
differences in required external financing levels are spread uniformly over the
entire period, and are most pronounced on a relative basis in the period 1978-1983
during which external financing requirements are low in absolute terms.
Figure VI-15 compares these external financing requirements to total U.S. corporate financ-
ing, and indicates that:
« Irrespective of the assumed cost of equity capital, the peak levels of external
financing as a percentage of all corporate financing slightly exceed the historic
high. However, the average level of financing over the entire period 1976-1983
compared to all corporate financing is lower than the historic average.
4. Sensitivity to Compliance Schedule Assumptions
All the analyses described thus far in this chapter have assumed strict adherence to the
promulgated 1977 and proposed 1983 water regulation deadlines. However, as has been noted
elsewhere in this report, industry contacts indicate that the 1977 deadline will not be met by some
firms. Therefore, Arthur D. Little has examined the impact of shifting BPT expenditures forward
to 1980. In performing this analysis, Arthur D. Little has adjusted the incremental capital cost for
bringing the existing industry into compliance based on its actual 1975 and planned 1976-1977
expenditures, and has delayed all closures induced by 1977 water effluent standards to 1980.
Figure VI-16 compares the capital investment requirements of the industry under the modified
and original compliance schedules, and indicates that:
181
-------
FIGURE VI-13
PRO-FORMA BOOK RATES OF RETURN ON EQUITY
FOR THE U.S. PULP. PAPER AND PAPERBOARD INDUSTRY
FOR THE PERIOD 1966 - 1975
1-
67
68
69
70
71
72
73
74
75
182
-------
FIGURE VI-14
SENSITIVITY OF EXTERNAL FINANCING REQUIREMENTS
TO ASSUMED COST OF EQUITY CAPITAL
Includes all studied regulations
183
-------
FIGURE VI-15
SENSITIVITY OF EXTERNAL FINANCING REQUIREMENTS AS PERCENT OF
ALL CORPORATE EXTERNAL FINANCING TO ASSUMED COST OF EQUITY CAPITAL
oo
~-15.5% Required Rate of Return
18% Required Rate of Return
Includes all Studied Regulations
9% Required Rate of return
13% Required Rate of Return
66
67
79
80
81 82
83
-------
FIGURE VI-16
CAPITAL INVESTMENT REQUIREMENTS OF THE
U.S. PULP. PAPER. AND PAPERBOAKD INDUSTRY UNDER
1-
ALTERNATIVE COMPLIANCE SCHEDULES
1976 - 1983
Original
Compliance Schedule
Delay of 1977
Standard Deadline
to 1980
76
77
78
79 80
185
81
82
83
-------
The incremental investment requirements to comply with all studied standards is
about $8.0 billion (compared to the midrange estimates of $7.4 billion) because of
the lower amount of 1975 compliance investment reported by the industry.
Deferring implementation of the promulgated 1977 standards to 1980 would sub-
stantially reduce investment requirements during 1976 and 1977.
The external financing implications of altering the compliance schedule are set forth in
Figures VI-17 and VI-18. These indicate that deferring implementation of the promulgated 1977
regulations to 1980 would reduce the annual external financing requirements of the industry to
levels well below their historic high when compared to total corporate financing in the economy.
D. LIMITATIONS OF ANALYSIS
The Arthur D. Little analysis was restricted to the pulp, paper and paperboard sector of the
total paper and allied products industry, and so did not consider capital investment demands
attendant on woodlands acquisition or downstream converting. Such demands would be in
addition to those considered here. Because all comparisons of projected financing requirements
with historical experience have been made on a consistent basis, this restriction in no way
invalidates the results. However, the financing requirements of the entire paper and allied
products industry would be greater than those presented here for the pulp, paper and paperboard
sector.
The analysis assumes free market pricing behavior of the industry. To the extent that such
behavior is restricted, for example, by the imposition of Federal price controls or guidelines, the
conclusions of this report could be altered.
The analysis was performed in dollars of 1975 purchasing power and has assumed no real
inflation (i.e., inflation relative to the increase in the general price level) in the prices of capital
goods, labor, wood, or other factors of production. To the extent that real inflation occurs, the
investment and external financing requirements of the industry will be increased over the level
reported here.
The analysis was based on a range of estimates of capacity expansion rates based on
industry announcements, historic behavior, and Arthur D. Little expert judgment, but these
growth rates were not adjusted dynamically to reflect emergent operating rates. The projected
operating rates are somewhat lower than those realized historically until recent years. To the
extent that the industry returns to high operating rate targets, its rate of capacity expansion will
decline and its demands for investment funds will decrease below those projected here.
The analysis is based on the usual assumption of equilibrium in product and capital
markets. In a dynamically changing economy, equilibrium is an objective sought but never
exactly achieved. Therefore, it is to be expected that while the results presented here provide a
reliable indication of the general effects which will occur, the actual performance of the pulp and
paper industry will fluctuate over the years around the projections presented.
186
-------
FIGURE VI-17
SENSITIVITY OF EXTERNAL FINANCING REQUIREMENTS
TO ASSUMED COMPLIANCE SCHEDULE
Original Compliance
fit Schedule
Delay of 1977
Standard Deadline
:E:! to i960
76
187
-------
FIGURE VI-18
SENSITIVITY OF EXTERNAL FINANCING REQUIREMENTS AS PERCENT OF
ALL CORPORATE FINANCING TO ASSUMED COMPLIANCE SCHEDULES
oo
oo
2-
1-
-------
CHAPTER VII
BALANCE OF TRADE IMPACTS
-------
VII. BALANCE OF TRADE IMPACTS
A. INTRODUCTION
1. Current Competitive Status of U.S. Pulp and Paper Industry
World production of pulp and paper products is centered in three major regions: United
States, Canada, and Scandinavia. These regions account for 49% of world paper and paperboard
capacity. They owe their dominance primarily to the fact that they were the first regions to
develop a pulp and paper industry to utilize their large timber reserves, which amount to about
36% of the world's softwood and 10% of its hardwood growing stock. Russia is the only other
country with large softwood inventories (54% of world), while Latin America has the largest
hardwood inventories (52% of world). However, most of their wood is in remote regions which
offsets their low stumpage and harvesting costs; in any case, their pulp and paper industries are
in an early stage of development and have not begun to export in any significant amounts.
The U.S. pulp and paper industry generally has maintained a favorable cost position to all
foreign competition, mainly because of economies of scale realized in its extremely large mills,
coupled with relatively low-cost pulpwood delivered to the mill sites. In the early 1970's, U.S.
pulpwood prices began to rise much faster than previously as competition for the essentially fixed
supply of wood intensified. Most foreign wood prices, however, have risen at least as fast, so the
U.S. has not begun to lose its chief competitive advantage in world pulp and paper markets.
Pulpwood costs in Scandinavia are two to three times those in the southern United States
because the demand for Scandinavian wood now exceeds the timber growth rate in that region.
Because of its high wood costs, Scandinavia's pulp and paper sales are now confined largely to
Europe.
In eastern Canada, production centers heavily on newsprint, a substantial quantity of which
is produced in comparatively old mills. In addition, pulpwood costs in eastern Canada tend to be
higher than those in the southern and western United States because of the difficulties of
harvesting and transporting the wood in Canada. Western Canada, on the other hand, supports
large market pulp mills and integrated pulp and paper complexes with relatively low manufac-
turing costs that are similar to those of U.S. Pacific Northwest mills, but somewhat higher than
those in the southern United States. Therefore, the southern U.S. kraft mills are generally the
world's most profitable.
Despite its general cost competitiveness, the United States for some time has been a net
importer of pulp and paper products. In 1974, it had a net trade deficit of about $400 million. This
deficit has been caused primarily by large imports of newsprint and bleached pulp from Canada
which has concentrated its production on these products while the U.S. industry sought other
product opportunities; thus, the United States lacks the capacity to be fully self-sufficient.
Other parts of the world, such as Russia, South America, and Africa, have relatively low-
cost wood reserves but do not yet have the plant capacity to be significant producers in the world
market. In most cases, moreover, pulp/paper mills in these regions will incur significant transpor-
tation costs that will at least partially offset any production cost advantages.
189
-------
The purpose of this analysis is to estimate the degree to which the cost advantage enjoyed by
U.S. pulp and paper mills in the world market for certain commodities will be adversely affected
by any production cost differences caused by the studied water, air and noise regulations among
the major competing regions. The study also seeks to estimate whether decreases, if any, in the
cost advantage of the U.S. mills will increase imports and decrease exports, and thereby reduce
the U.S. balance of trade.
2. Scope of Analysis
The major pulp and paper items imported to or exported from the United States are
unbleached kraft linerboard, bleached kraft pulp, dissolving pulp, and newsprint (Table VII-1).
In total tonnage, these accounted for 79% of U.S. imports and 459b of U.S. exports of pulp and
paper products in 1974. The analysis focuses on these major products since they are likely to be
most sensitive to changes in relative costs between countries.
The remaining imports and exports are distributed over a large number of products. Trade
volumes for these products are small because they typically face high tariff barriers which have
already created high inter-country cost differentials and rendered them less sensitive to differen-
ces in environmental costs.
3. Overall Approach
The basic approach used to analyze balance of trade impacts was to estimate current
production and distribution cost differentials among the major competing countries, project
environmental costs among these countries and evaluate the changes they would cause in the
relative cost differentials. Thus, foreign trade would be affected if environmental costs were to
significantly change the relative cost advantage for U.S. mills in the studied products.
To simplify the basic production cost analysis without unduly sacrificing accuracy, Arthur
D. Little concentrated on factors whose cost differences most significantly affect total delivered
costs: wood cost at the mill, transportation costs and duties. Regional labor, chemicals, energy,
and other manufacturing costs are generally comparable in aggregate and were assumed to
remain so among the major competing regions. It was also assumed that long-term inflation rates
for all the above cost items would be about the same, or that currency exchange rates would offset
any inflation differentials between competing regions. Figure VII-1 illustrates the total data flow
ari'd^analytical process.
B. CONCLUSIONS
1. Impact on Exports
The analysis indicates that water, air, and noise regulations through 1983, are unlikely to
reduce significantly U.S. exports of unbleached kraft linerboard, bleached kraft paper pulp, and
dissolving pulp the three largest volume pulp and paper products exported by the United
States. The basic reason for this conclusion is that projected environmental cost differences are
unlikely to change the current relative cost advantage of U.S. exporters.
The environmental cost disadvantage of U.S. kraft linerboard mills relative to Swedish
mills is expected to remain at about $6 per ton through 1983 (Table VII-2). Therefore, the studied
environmental controls, per se, should not change the present U.S. total cost advantage. Present
190
-------
TABLE VII-1
U.S. IMPORTS AND EXPORTS OF PULP AND PAPER, 1974
Imports Exports
Product $MM % $MM /
SOURCE: U.S. Department of Commerce.
Unbleached Kraft Linerboard 2 - 404 16
Bleached Kraft Pulp 756 26 432 17
Dissolving Pulp 63 2 260 10
Newsprint 1,484 51 53 2
All Other 515 21 1,378 55
TOTAL 2,920 100 2,527 100
191
-------
FIGURE VII-1
PROCEDURE FOR ESTIMATING BALANCE OF TRADE EFFECTS
Pollution
Control
Costs in Other
Countries
U.S. Increase
in Pollution
Control Costs
Production
and Distribu-
tion Costs in
Other
Countries
Balance of Trade
/naJ ysis
Change in
Comparative Cost
Advantage
U.S.
Production and
Distribution
Costs
Estimation of
Balance of
Trade Effects
Exogenous
Result
j Analysis
-------
TABLE VII-2
KRAFT, LINERBOARD COST DIFFERENTIALS LANDED IN GERMANY FROM SOUTHEAST U.S.
AND SWEDEN
(1975 dollars per short ton)
Basis: Assume costs other than wood, transportation, duties and water/air/
noise controls are the same in both producing locations. Control
costs are based on reported OECD averages (1975) and ADL estimates
(1983).
Southeast U.S. Cost Advantage
1975 Differential Items U.S. Sweden (Disadvantage)
Wood 40 108 68
Transportation 33 17 ( 16)
Duties* 17 17 0
Environmental Controls See Table VII-7 ( 6)
Net Differential 46
1983 Differential Items
Wood and Transportation 73 125 52
Duties 17 11 ( 6)
Environmental Controls See Table VII-8 ( 6)
Net Differential 40
*Reflects planned tariff reductions for Scandinavian countries from 12%
in 1972 to 0% in 1984.
SOURCE: Arthur D. Little, Inc., estimates.
193
-------
Common Market tariff regulations, however, call for elimination of duties on Swedish imports by
1984, which obviously would improve Sweden's cost position relative to U.S. mills. However, the
gap may not narrow, since the API is working hard to minimize or eliminate the projected
differential in duties.
Environmental cost differentials also should not affect significantly the current U.S. cost
advantage in bleached softwood kraft pulp through 1983 (Table VII-3). The present environmen-
tal cost differential itself is not likely to change appreciably and the southern U.S. mills should at
least maintain their substantial wood cost advantage over Swedish producers. Thus, U.S. mills
should retain their absolute and relative cost advantages.
A similar analysis (Table VII-4) for sulfite dissolving pulp indicates that a projected
increase in the environmental cost differential between U.S. and Swedish mills will moderately
reduce the large cost advantage now enjoyed by the southern U.S. mills. The total projected
reduction of the U.S. cost advantage is about 11% ($9 per ton). Since the estimated southern U.S.
cost advantage is very large (about $78 per ton), the projected $9 per ton reduction is com-
paratively modest. Thus, any resulting decline in dissolving pulp export volumes is likely to be
too small to quantify.
2. Impact on Imports
The analyses of newsprint and bleached kraft paper pulp (which accounted for 77?c of U.S.
pulp and paper imports in 1974) indicate that imports will not increase appreciably as a result of
environmental cost differences. Although increases in the U.S. environmental cost disadvantage
versus Canada are projected through 1983, they are either small or offset by increasing U.S. cost
advantages in other elements of production.
Western Canadian newsprint producers will apparently improve their present cost position,
vis-a-vis southern U.S. mills, by virtue of the latter's increasing relative cost for environmental
control. The indicated lowering of the U.S. mills' cost advantage from $22 to $14 per ton by 1983
(Table VII-5), might be expected to discourage expansion of U.S. newsprint mills and increase
Canadian imports. However, these cost changes must be examined in the light of other cost
changes not reflected in the analyses. Of prime importance is the fact that eastern Canada (the
source of most U.S. newsprint imports) has many old, high-cost plants that include small sulfite
mills. These mills face closure because they cannot economically justify the chemical recovery
systems now required for water effluent control. Therefore, many eastern Canadian producers
ultimately will have to rely on purchased market pulp for their chemical pulp requirements. The
purchased pulp will make them even higher-cost producers and give them a strong incentive to
support high newsprint prices in the United States, their major market. Also labor costs through-
out Canada are rising much more than in the United States, so the assumption of parity in all
costs other than those for wood, transportation, and environmental controls may not hold in this
case. Furthermore, as noted earlier, the U.S. water pollution control estimates for newsprint may
be somewhat overstated in that costs for the highest polluting process employed (i.e., sulfite or
kraft) were applied to both the chemical and groundwood pulp production volumes. Finally, an
increasing number of U.S. newsprint producers have found it advantageous to expand their
capacity via deinked newsprint, and in so doing, to stop or reduce further market share gains by
Canadian suppliers. Because of the above factors, Arthur D. Little believes that U.S. newsprint
producers will actually increase their share of the U.S. market by as much as 5% (i.e., from 339B to
38^r) by 1983, in spite of their higher cost burden for environmental controls.
194
-------
TABLE VII-3
BLEACHED SOFTWOOD KRAFT PULP.COST DIFFERENTIALS LANDED IN GERMANY FROM
SOUTHEAST U.S. AND SWEDEN
(1975 dollars per short ton)
Basis: Assume costs other than wood, transportation, duties and water/
air/noise controls are the same in both producing locations.
Control costs are based on reported OECD averages (1975) and
ADL estimates (1983).
Southeast U.S. Cost Advantage
1975 Differential Items U.S. Sweden (Disadvantage)
Wood 53 130 77
Transportation 32 12 (20)
Environmental Controls See Table VII-7 . ( 6)
Net Differential 51
1983 Differential Items
Wood and Transportati"r 85 . 142 57
Environmental Controls See Table VII-8 ( 6)
Net Differential 51
SOURCE: Arthur D. Little, Inc., estimates
195
-------
TABLE VI1-4
SULFITE DISSOLVING PULP COST DIFFERENTIALS LANDED IN GERMANY FROM SOUTHEAST
U.S. AND SWEDEN
(1975 dollars per short ton)
Basis: Assume costs other than wood, transportation, duties and water/air/
noise controls are the same in both producing locations. Control
costs are based on reported OECD averages (1975) and ADL estimates
(1983).
Southeast U.S. Cost Advantage
1975 Differential Items U.S. Sweden (Disadvantage)
Wood 61 161 100
Transportation 32 12 ( 20)
Environmental Controls See Table VII-7 ( 2)
Net Differential 78
1983 Differential Items
Wood and Transportation 93 173 80
Environmental Controls See Table VII-8 (11)
Net Differential 69
SOURCE: Arthur D. Little, Inc., estimates.
196
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TABLE VI1-5
NEWSPRINT COST DIFFERENTIALS IN U.S. MIDWEST FROM SOUTHEAST AND WESTERN
CANADA
(1975 dollars per short ton)
Basis: Assume costs other than wood, transportation, duties and water/air/
noise controls are the same in both producing locations. Control
costs are based on reported OECD averages (1975) and ADL estimates
(1983).
Southeast Western U.S. Cost Advantage
1975 Differential Items U.S. Canada (Disadvantage)
Wood '34 43 9
Transportation 24 37 13
Environmental Controls See Table VII-7 -
Net Differential 22
1983 Differential Items
Wood and Transportation 58 80 22
Environmental Controls See Table VII-8 ( 8)
Net Differential 14
SOURCE: Arthur D. Little, Inc., estimates.
197
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Environmental control costs will not appreciably change the current cost advantage that
bleached softwood kraft pulp mills in the southern United States now enjoy over their counter-
parts in western Canada (Table VII-6). The projected increase in the environmental cost dis-
advantage for U.S. mills is small in comparison with the significant wood cost advantage now
held by the southern U.S. mills. Therefore, no significant change in bleached softwood kraft pulp
imports can be associated with the projected environmental control costs.
C. METHODOLOGY AND COMPUTATION DETAILS
1. Rationale for Selection of Major Export/Import Regions
West Germany was selected as the export destination because of its central location within
the European Common Market, which consumes about 49% of U.S. exports of kraft linerboard,
35% of its bleached kraft pulp export, and 50% of its dissolving pulp exports. Sweden was chosen
as the key competing export country for cost comparisons because it is a major producer of the
above products and has the major share of the European market. Moreover, if Swedish producers,
with their high wood costs, can obtain a competitive advantage in the Common Market by virtue
of their lower environmental costs, Canadian producers, who have a large share of world bleached
and dissolving pulp markets, also would improve their cost position relative to that of the United
States both in Europe and in other export markets.
The major U.S. pulp and paper imports are newsprint and bleached kraft paper pulp, both
of which are supplied almost entirely from Canada. Southern U.S. mills generally have a
pulpwood cost advantage in producing these products. Therefore, if the studied environmental
regulations were to significantly reduce the cost advantage of the southern U.S. mills, imports
would increase for these products as well as for other pulp and paper products that are imported
in lesser amounts. Western Canada was selected as the most likely source of future imports
because it has Canada's lowest cost wood supply and most recent capacity expansion has taken
place there. Note, however, that most U.S. newsprint imports currently come from eastern
Canada.
2. Assessment of National Differences in
Pollution Control Requirements and Costs
The degree to which environmental control requirements will affect the U.S. balance of
payments will be determined by the differences in enforcement objectives and timetables in the
major competing export regions. A review of reports concerning current progress of the objectives
for paper industry environmental controls in Canada and Scandinavia shows that:
The current focus of water effluent control is on standards that can be met by
intensive internal control measures plus primary treatment of the remaining
effluent. There are exceptions to this, such as British Columbia, a growing number
of other Canadian provinces, and most inland areas of Sweden and Norway where
the regulations require primary plus secondary water treatment by the late 1970's.
As of 1975, however, virtually all U.S. mills had installed primary water treatment
and many mills had also installed some degree of secondary treatment as they
pointed toward meeting the 1977 standards.
All of the studied countries are attempting to control air pollution through limita-
tions on particulate emissions and most have begun or are planning to implement,
sulfur emission control as well, at least on kraft recovery boilers. In general, the
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TABLE VII-6
BLEACHED SOFTWOOD KRAFT PULP COST DIFFERENTIALS IN U.S. MIDWEST FROM
SOUTHWEST U.S. AND WESTERN CANADA
(1975 dollars per short ton)
Basis: Assume costs other than wood, transportation, duties and water/air/
noise controls are the same in both producing locations. Control
costs are based on reported OECD averages (1975) and ADL, estimates
(1983).
Southeast Western U.S. Cost Advantage
1975 Differential Items U.S. Canada (Disadvantage)
Wood 53 90 37
Transportation 20 33 13
Environmental Controls See Table VII-8 ( 6)
Net Differential 44
1983 Differential Items
Wood and Transportation 73 123 50
Environmental Controls See Table VII-9 ( 7)
Net Differential 43
SOURCE: Arthur D. Little, Inc., estimates,
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Canadian and Scandinavian air emission levels and timetables are more lenient
than typical regulations faced by the U.S. krai't pulp industry. Note, however, that
the standards and timetable vary considerably among the 50 U.S. state implemen-
tation programs (SIP).
No regulations are being promulgated or proposed in either Canada or Scandinavia
to reduce pulp and paper mill noise levels.
Current (1975) cost differentials for water and air effluent control between the United
States, Canada, and Sweden were taken from projections made in a 1972 survey by the Organiza-
tion for Economic Cooperation and Development (OECD), for the product sectors selected in the
trade analysis (Table VII-7). A comparison of reported 1970 and projected 1975 data indicates
that, in general, U.S. mills are already spending more, but that Canada and Sweden, according to
their projected 1975 expenditure levels, are rapidly catching up.1
In the absence of a more definitive and current assessment of pollution control expenditures
through 1977 by foreign paper industries, Arthur D. Little's analysis employed the 1975 OECD
data. Thus far, no foreign country has announced its intention of going further than the 1977 U.S.
BPT water effluent controls. For this analysis, therefore, it was assumed that when U.S. mills
reach the BAT water effluent level in 1983, competing mills in Canada and Sweden will have
reached the BPT level and the corresponding cost differentials will reflect the maximum cost
disadvantage to the U.S. mills resulting from water effluent regulations between 1977 and 1983.
Similarly, for air pollution control costs, it was assumed that by 1983, the cost differences
between U.S. mills and those of Canada and Scandinavia would be equal to the cost increment
for existing U.S. mills between 1977 and 1983. In essence, this amounts to moving the U.S.
average control level to the current Oregon standards which are the most stringent SIP regu-
lations in the country. (Oregon standards, however, will become even more stringent.)
It was assumed that neither Canada nor Sweden would have noise abatement regulations by
1983. Thus, the cost differential for the U.S. mills will equal their full cost for noise abatement by
1983. Table VII-8 shows the estimated 1983 U.S. environmental cost disadvantages versus
Canada and Sweden for the products covered in the trade analysis.
3. Computation of Wood Cost Differences Between the
United States, Canada, and Sweden
The second basic component of the balance of trade analysis was an assessment of the
current manufacturing cost advantages by the United States, Canada, and Sweden for the major
exported/imported products studied. The analysis assumed that the major cost differences, other
than for environmental control, would continue to be those for wood, transportation and duties.
To simplify the analysis, other manufacturing costs (labor, chemicals, energy, overhead, etc.) in
aggregate were assumed to be about equal to each other in these countries. Costs for transporta-
tion and duties were obtained from current publications or from contacts with importers and
exporters. Wood costs were obtained from recent Arthur D. Little studies and were updated to
1975 as necessary using current industry and government publications in North America and
1. The relative differences between these costs are likely to be more reliable than the absolute cost levels owing to
OECD's methodology whereby producers' cost estimates were accepted without attempting to standardize their
assumptions or the individual cost items included.
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TABLE VII-7
IN.TER-COUNTRY COMPARISON OF WATER AND AIR POLLUTION CONTROL
EXPENDITURES. 1970 and 1975
(1970 dollars per metric ton)
Basis: December 197U Exchange Rates
Products United States Canada Sweden
Sulfite Pulp 1970 3.47 0.62 9.76
Projected 1975 18.01 11.22 15.91
Kraft Pulp and Paper 1970 2.21 0.03 1.64
Projected 1975 11.80 5.02 5.25
Newsprint 1970 . 0.91 0.51 3.62
Projected 1975 3.75 3.55 4.86
SOURCE: Survey of member countries by Organization for Economic
Cooperation and Development (OEDC) in 1972.
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TABLE VII-8
ASSUMED INTER-COUNTRY POLLUTION CONTROL COST DIFFERENTIALS. 1983
(dollars per short ton)
Basis: Mid-1975 Dollars and assumptions that Canadian and Swedish mills
will have reached U.S. BPT (1977) water effluent control level
by the time U.S. mills reach BAT (1983) levels, these countries
will have lower costs for air effluent control equal to the
projected U.S. cost increment between 1977 and 1983 and that
they will bear no costs for noise abatement.
Product
U.S. Disadvantage Versus Canada and Sweden
Unbleached Kraft
Linerboard
Bleached Kraft Pulp
Dissolving Sulfite Pulp
Newsprint
Water
4.70
6.10
9.70
6.00
Air
0.50
0.60
0.40
0.50
OSHA Noise
0.60
0.60
0.90
1.40
Total
5.80
7.30
11.00
7.90
SOURCE: Arthur D. Little, Inc. (cost differentials)
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Scandinavia. Table VII-9 shows the wood species and conversion factors employed in developing
the critical wood costs estimates. Appendix I (Volume III) gives additional background for the
estimates on Swedish wood costs and for newsprint wood costs in North America.
D. LIMITATIONS OF ANALYSIS
Small volume import/export products were excluded since they typically face
relatively high tariff barriers making them less sensitive to environmental cost
differentials. If some of these products are affected, the tonnage involved would
have little effect on the U.S. trade balance.
Intercountry production/distribution cost differentials included only items whose
cost differences most significantly affect total delivered cost: wood, transportation,
and duties. To the extent that aggregate costs for other factors of production also
vary, estimates of U.S. competitive advantages could change; currently rapidly
rising labor costs in other countries are increasing the competitive advantage of
U.S. mills.
The analysis assumes that U.S. mills will maintain their approximate current six-
year lead time (in implementing water, air, and noise controls) over their counter-'
parts in key competing countries; the projected environmental cost differentials
would change to the extent that this lead time changes and/or, if the proposed 1983
water effluent guidelines are changed.
Since estimated national environmental cost differences were small in comparison
with the current overall cost advantage enjoyed by U.S. mills in the domestic or
export markets, any variances from the above assumptions and estimates would
have to exceed their likely limits to change the conclusions.
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TABLE VII-9
WOOD USAGE AND COSTS - BY REGION AND PRODUCT, 3.975
Region S.E. U.S. W. Canada
Wood
Species Slash & Loblolly Pine
Density-lb/ft3 32
Delivered Cost $/Cunit 36
Wood Usage and Cost/ Air Dried Short Ton (ADST) of Product
Product Cu/ADST $/ADST
Sweden
Sulfite Dissolving
(33% yield) 1.7
Bl SW Kraft
(38-41% yield)
Linerboard
(53% yield)
1.48
1.12
Newsprint
(See Appendix 1-3
for various furnishes)
61
53
40
34
Hembal - Spruce
24
46
iduct
Cu/ADST $/ADST
2.24 103
1.95 90
1.50 69
43
Spruce & Pine
24
72
Cu/ADST $/ADST
2.24 161
1.81 130
1.50 108
SOURCE: Arthur D. Little, Inc., estimates.
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