Watch the full 30-minute session below or read on for the highlights
Pulp trade has exploded since the launch of Shanghai Future exchange (SHFE) softwood pulp futures in 2018. The physical pulp market trade is around 68 million tonnes per year, but the financial trade from just the first eight months of the year reached 890 million tonnes. This is more than 20 times the physical market and it is projected to reach over one billion tonnes by the end of 2021. NOREXECO launched two new China futures contracts in June 2021 that are tailor-made for the international pulp and paper industry.
Where next for the global pulp market? Iron ore can help us divine the future of pulp futures.
Learning from the iron ore market (00:03:50)
The futures market is a natural stage in the evolution of a mature commodity market. You start with a mainstream product, which matures and becomes the basis of a secondary product that people can trade, and finally, the market develops to the point where there are lots of options for people to get what they need from it. Eventually, we will have a market where willing buyers and sellers meet and transact on a price many years ahead on a mature futures market.
Iron ore has taken this path – pulp is following.
Typically, the Chinese prices lead the global market and there is usually a 4- to 6-week lag until the rest of the market picks up. This is exactly what we can see to date. This China premium has now started to fade, and the net US and Northern Europe prices are starting to pick up above China for both northern bleached softwood kraft (NBSK) and bleached eucalyptus kraft (BEK). The supply side shifts are now offering producers higher margins, and they are in a good position to make the most of the market conditions.
Producers should also be finding ways to protect that margin moving forward. But how can they do so in a market with strong price volatility?
The highly volatile spread between NBSK and BEK is similar to the spread between high-grade iron ore from Brazil and medium-grade iron ore produced in Australia. The ability to manage this risk in the physical iron ore market was crucial. As a result, another contract was created on the Singapore Exchange (SGX).
Pulp now faces a similar path with the SHFE and other emerging pulp contracts.
China and its influence on the market (00:06:27)
“The way we look at price-driven supply and demand in the West is not necessarily the same when it comes to China. Policy is a very big thing [in China] and they play a long game.” – Andrew Glass
Because China accounts for a third of global pulp demand, changes in China’s consumer demand and policies have the potential to shift global markets. For instance, when the Chinese government banned recovered paper (RCP) imports, their changing domestic supply of and demand for replacements was felt globally. Global paper and packaging producers need to keep a close eye on the domestic Chinese market. This includes domestic trading activity on the SHFE and the growing pulp futures market.
According to Andrew Glass, in a parallel market in iron ore, when prices were high and producers were doing well under fixed-price contracts, the Chinese government stepped in to support the Chinese players suffering from tight margins by introducing new regulations to help curb the high prices. Price volatility ensued and forced international players in the market to rethink their strategies.
Transparency is inevitable (00:16:59)
While price transparency may be viewed in a negative light by some, it is an inevitable stage in the market’s evolution. Digitalization, investor preference and customer sophistication will likely drive this change in the pulp market.
Proactivity in preparing for the transition to price transparency is the key to being successful. If the market moves on and the journey becomes a forced one, the only option left is to play catch-up with competitors.
Pulp market participants have the opportunity to learn from more mature commodity markets such as iron ore, and a useful case study comes from BHP. They took the lead in encouraging the adoption of iron ore futures. In doing so, they were able to communicate to regulators, tax authorities and customers that they have rules and regulations in place to ensure price transparency. Despite losing money along the way, they are now successful in their core business, and they are able to mitigate the risks of price volatility through several means. This includes price contracts linked to the index on the futures market.
The benefits of a futures market (00:21:15)
“We are on track to reach twenty-times the size of the physical pulp market now on the SHFE alone – it’s a going concern if you don’t get on board.” – Matt Graves
Settling on a price for a long-term contract between a buyer and seller can be difficult. Price will fluctuate depending on the market condition. Buyers will want to buy cheap, while sellers will want to sell high.
The futures market can offer optionality to both buyers and sellers. It enables them to take advantage of the markets at different points in time as price fluctuates. By taking transactions on a floating price, they can use an index to determine prices and trade on that throughout the year. This means that when the price goes down in the year, the buyer can buy all the futures needed to deliver against their contract in payment, and when the prices go up in the year, the seller can lock in all of their contracts. The market creates opportunities for both the buyer and seller to be winners throughout the year.
The market also provides flexibility for all parties to derive value from the market and can act as a tool that helps buyers or sellers achieve what they are looking for more creatively. For example, the buyer may not have the financial capacity to transact in the market, so they may choose to pay a premium and ask an agent to trade on their behalf.
Learn more about the SHFE and the future of the China pulp futures from our report here.
Find out more about the iron ore market and an example of price volatility in the market here.