UNITED STATES ENVIRONMENT '\L PROTECTION AGENCY
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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 Regulations—those issued by EPA for existing and new capacity. Two levels
of control for the existing industry are assessed—that 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 Regulations—those issued by states (State Air Quality Implementation
Plans—SIP) for the existing industry, and those issued by EPA as they apply to
new capacity.
• Noise Regulations—those 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 SO, 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, 559o 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 PAPERBOAflD CAPACITY, 1974
Sector % of 1974 US. 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 7.81
Dissolving Pulp 3-8'
Printing/Writing Paper 18.8
Bleached Board and Brtstols B.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 4.3% for GNP and 6.5% 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
I. 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% higher than the
1975 price (S292 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 S15 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 ISc of the current
employment of all studied sectors. The mills have a total capacity of 1,400 tons per
day or 0.7rc 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 1.6rr of current employment for all studied product sectors. These 17 mills
have a total capacity of about 1,700 tons per day or Q.9c.'c 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
Lang-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
3
6
Poor profit
prospects —
noninlegraled
Poor profit
prospects —
nonmtegrated
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 concIusions.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 76f>o
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 55Ce 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
65'r 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)
Total
1975-1983
Direct Cost (Internal and
External Treatment)
Existing Capacity
Air 690
Water 2250
OSHA 320
Total Existing 3260
(2)
New Capacity
Air 30 120
Water 240 960
OSHA 30 120
Total New 300 1200
Existing and New Capacity
Air
Water
OSHA
Total Direct Cost
Indirect Cost
Replacement of capacity retirements induced by effluent
control 623
Capitalized maintenance for equipment used in
environmental control
Total Indirect
TOTAL 9057(1)
Notes: (1) To relate to the capital impact analysis ADL estimates that
1975 expenditures were $1£40 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 M
INCREMENTAL OPERATING COSTS FOR
EXISTING INDUSTRY COMPLIANCE1
(1975 Dollar* per Ton)
Total EPA Water SIP Air OSHA Noise
1975-1977 11 10 8.40 1 80 30
1978-1983 6.10 5.40 .40 120
Total 1720 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, 3%, ia 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 pnce 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(.r without additional
environmental costs (assuming the industry maintains a 13Sc 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 8Ct Long-run
environmental price increment will reduce potential consumption by 5c.r. 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
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TABLE 1-5
COSTS FOR TYPICAL NEW MILLS TO COMPLY WITH STUDIED REGULATIONS
vO
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
Mill Capj
Capacity $MM
(tons/day)
1000
230
ium 450
A 00
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
Total Compliance Costs
Ltal
%of Mill
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
Includescapital 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
Bleached
Sulfite
Mill Size (tons/day)lOO
Capital Costs
$ (Million) 15.8
$/ Annual Ton 158
Operating Costs ($/Ton) 2)
Operational
Capital-Related
Total
17.60
19.10
36.70
CONTROL COSTS1
( 1975 Dollars)
Bleached Kraft
100
10.5
105
9.80
12.70
22.50
250
18.0
72
7.50
8.20
15.70
500
28.5
57
6.20
6.90
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,
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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'
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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 34.5
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
tor 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 8(Kc 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.
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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 M 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 +25'6, -lO'.rj
OSHA Noise Regulations +25%, -50%. The foregoing cost variability is within the accuracy oi
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
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_•--fc»«
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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 lO'/n 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'f. 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't. to 22',r> over the range of 7.5 to 12.5?e 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
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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 (85-95rb) 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 mtercountry 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 79C;0 of U.S. imports and
45' i 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.
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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 Costa,"
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 1975.
• "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.
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