Global Dynamics of the Pulp and Paper Industry - 2013 Box made in China largely from waste paper recovered in the United States and exported to China A roll of toilet paper produced in China from softwood pulp produced in Canada at a mill owned by a Chinese company. A piece of premium ink jet paper produced in the United States from eucalyptus pulp imported from Brazil. Pulp and paper one of most globally traded commodities in the world Almost 30% of all product is manufactured in one country and shipped to another More than 50% of Bleached Softwood Pulp is traded The global paper industry is more than just trading commodities: Swedish and Finnish companies are building mills in Uruguay and Brazil. International Paper has modernized a pulp mill in Siberia Chinese and Indian companies are buying pulp mills in Canada More and more we find decisions made in Board rooms in Memphis and Singapore and Stockholm inevitably impact mills in North Carolina and Louisiana and Mississippi Today’s discussion will focus on three important trends that have impact globally Richard B. Phillips, PhD North Carolina State University richard_phillips@ncsu.edu

Three Main Points Growing imbalance between where paper and board are consumed and where wood fiber is grown Imbalance gives USA industry better options for dealing with declining domestic demand … exploits our low cost softwood American industry can restructure to focus on production of softwood products and bioenergy for export and domestic consumption Traditionally wood pulp produced where the trees are Paper and Board manufactured locally where the jobs are What’s new is the increasing gap between where pulp is produced and paper is consumed Leads to imbalance where softwood fiber – whether in market pulp or in virgin linerboard – will become increasingly scarce, Will discuss how this helps position the American industry better with our problem of declining domestic consumption… Discuss how we can shift our assets towards more softwood products – where we can be the world low cost producer, and how we can incorporate some of the emerging bioenergy technology that fits well with pulp and paper infrastructure

1. Global Imbalances First, lets review magnitude of the imbalance of growing and consuming fiber

Consumption of Paper & Board Global Imbalances Consumption of Paper & Board Left hand chart shows consumption of main categories of paper and board products in North American and Western Europe Right hand graph same for the Rest of the World Rest of the world surpassed North America / Western Europe in 2004 and the gaps grows every year as western consumption declines and the developed economies grow Only tissue not declining in the west All grades increasing in the rest of the world Only tissue not declining in the West Graphic Papers declining rapidly Packaging declining slowly All grades increasing in the Rest of World Especially packaging Source: RISI

Production of Fiber Western World Wood Pulp Production declining Global Imbalances Production of Fiber North America and Western Europe historically the major pulp producing region Virgin wood production now declining in west while recovery of wastepaper increasing For the Rest of the World, wood pulp production increasing slowly – despite major increases in eucalyptus pulp from Latin America Reliance on Recovered paper in Developing Countries increasing dramatically World now consumes 1.4 tons of recovered paper for each ton of virgin fiber produced Future growth of Recovered Paper supply will be constrained by declining paper use in the West, practical recovery limits of around 70%, and the fact that recycled fibers tend to wear out after 5-7 cycles. Western World Wood Pulp Production declining Global RCP production exceeds virgin fiber by 40% Practical limit of ~70% recovery of domestic waste Practical limit on number of times fiber can be recycled Source: RISI

China Packaging China produces no Linerboard from virgin fiber Global Imbalances China Packaging Let’s focus on China as by far the leading consumer of papermaking fibers Many think of China as importer of commodities, but not case with Paper and Board Import almost zero Paper & Board Do import a very high percentage of pulp fibers Example: produce no virgin linerboard … all 100% recycled Current import 50% of all the recovered paper produced in the world … grow to 60% No other commodity – not coal, not cotton – is imported at such a high percentage of global trade Not possible to grow more recovered paper – subject to paper consumption rates, which are declining rapidly in the main sources of recovered paper supply for China China produces no Linerboard from virgin fiber Consume ~ 50% of all World exports of Recovered Paper, forecast to go to 60% How can P&B be recovered from Western Europe and North America when regional demand is declining? Source: RISI

China Price for Recovered Packaging Papers & Pulp Global Imbalances China Price for Recovered Packaging Papers & Pulp Packaging Waste Prices 2.5 x Price Increase since 1996 Softwood Pulp Price Pressure on recovered paper supply already leading to very high prices of fiber delivered to China Increased 150% since 1996, while market pulp increased 60% 1.6 x Price Increase since 1996 Source: RISI

Global Imbalances Forecast Fiber Gaps in 2020 Recovered Paper Bleached Softwood Pulp If present trends continue, the Asian countries will require more waste paper than is available in North America and Western Europe combined Situation with virgin softwood pulp even more constrained, as Asia will consume 25% more pulp than will be available from the western countries Doesn’t mean that Asia will run out of fiber but does mean they will have to pay more for it Phillips Forecast By 2020 Asia requires 110% of excess RCP in NA &WE … and 125% of Bleached Softwood available from West

2. Dealing with Declining Demand The forecast for growing demand for wastepaper in Asia will occur at the same time the consumption of paper and board will be declining in North America and Western Europe. No paper consumption, no waste to recover and export. This trend leads to an opportunity for the American mills to shift to more of an export basis with focus on high softwood content products

Decline in American Consumption Dealing with Decline Decline in American Consumption Printing and Writing and Newsprint Packaging The two graphs display the magnitude of the decline. Blue line is American consumption of Graphics papers, declining rapidly in recent years. Red line is American production, declining, but not as rapidly as consumption Means we import less and export more Packaging trends are similar except the declines are not as severe and the trend towards export is greater – in fact up 5 million tonnes during this period Paper Consumption down 10 Million Tonnes from Peak Paper Production down 7 Million Tonnes …modest increase in exports and decrease in imports Packaging down 7 Million Tonnes from Peak but stabilizing Packaging exports up 5 Million Tonnes Source: RISI

USA Southeast very competitive on softwood Dealing with Decline USA Southeast very competitive on softwood USA well positioned for export with high softwood content products … Both softwood chips and logs are the lowest cost in the world thanks to our abundant forests in the southeast and the superior forest management practices While our labor costs are higher than the low cost countries, quite competitive with other softwood producers in Western Europe and Canada Often asked about Russia with my experience there … hard to imagine any greenfield investment taking place there with multi-billion dollar infrastructure costs, corruption and with an increasingly dysfunctional government Source: FisherSolve® Q4 2012

Multiple Mill Options …None Easy Dealing with Decline Graphic Papermills Shut down machines and write off assets Convert hardwood to Viscose Dissolving Pulp Convert assets to softwood Absorbent Pulp Convert assets to softwood linerboard Convert assets to biofuels and biomaterials American mills that currently participate in production of declining products have a number of options … all are difficult but doable under certain conditions We will discuss the first four options now, and the fifth option in the third part of the presentation

Conventional Options Illustrated Dealing with Decline Conventional Options Illustrated Hardwood Wood Softwood Wood Hardwood Pulp Softwood Pulp Let take as a Base Case a two papermachine mill that uses about 70% hardwood and 30% softwood to produce uncoated freesheet: More than half the uncoated freesheet mills in the United States look like this, and many of those facilities are the most vulnerable from a manufacturing cost perspective. Papermachine Paper Papermachine Paper

Shutdown Dealing with Decline Hardwood Hardwood Chips Softwood Softwood Chips Hardwood Hardwood Pulp Softwood Softwood Pulp Shutting down one papermachine to match declining demand with declining supply is usually a step towards total mill closure, as now the overhead costs must be borne by lower revenue Papermachine Paper Papermachine Paper

Viscose Pulp Dealing with Decline Hardwood Hardwood Chips Softwood High  Pulp Hydrolysate Viscose pulp is best produced from hardwood in a prehydrolysis kraft mill, but typically a production decrease of 20-30% is experienced. SAPPI has taken this approach at their Cloquest, MN, pulp mill, converting from market hardwood paper pulp to market viscose pulp, with the intention of upgrading to higher valued acetate grades. SAPPI is already in the business and know the markets well. A significant supply increase has emerged in recent years., especially from old Eastern Canadian hardwood mills, some of which are new players and some of which are allied with rayon producers in India and China … very likely that an over supply will be experienced for the short term until Chinese demand increases Pulp Dryer Viscose Pulp Papermachine Paper

Absorbent Pulp Dealing with Decline Hardwood Hardwood Chips Softwood Softwood Chips Softwood Softwood Pulp Loblolly pine not considered a premier papermaking fiber, but the thick summerwood fibers are ideal for diaper pulp, where the pulp layer functions as a transport medium for liquid to the super absorbent polymer layer. This may be a good option for transitioning a mill from paper pulp to absorbent pulp as has been done by International Paper at Franklin and Domtar at Plymouth and one machine at Ashdown AR. Papermachine Paper Pulp Dryer Fluff Pulp

Liner Conversion Dealing with Decline Softwood Softwood Chips Softwood Softwood Pulp Softwood Softwood Pulp Fine paper machines can be converted to linerboard, but with a substantial investment cost. This type investment is best done where softwood kraft is abundant, as IP did at Pensacola. Newsprint machine can be converted as well, but the fiber is more likely to be recycled. Newsprint companies will likely have to find their customers among the independent corrugator companies, as the mainline producers like Rock Tenn, PCA, Georgia Pacific and International Paper have already worked themselves into a high degree of integration with their own box plants. Papermachine Paper Board Machine Linerboard Export

Export Option Depends on Production Cost Dealing with Decline Export Option Depends on Production Cost Delivered to Beijing Finally, we should recognize that the American box plants are already fully supplied with liner. Any new capacity will have to be very low cost to survive in the American market Can find lower margin business, likely in Asia. Our lowest cost mills are still lower cost than all Japanese mills, and half the Chinese producers, even when delivering product to Beijing. As the cost of OCC to China continues to rise, our virgin kraft – based industry – especially on the west coast will become more competitive than domestic Chinese mills China OCC at $250 per Tonne Japan USA Lowest cost American producers more competitive to Beijing than 50% of Chinese producers, all Japanese Source: FisherSolve® Q4 2012

3. Biorefinery Options Biorefinery has broad definition that includes everything from producing wood pellets, to producing bioethanol, to more sophisticated products such as sugar fermentation products like xylitol and succinic acid, and lignin products like carbon fiber. Only wood pellets represent high volume application at present Many bioenergy concepts that have evolved are far too capital - intensive to become commercial reality. Our research group at NC State has focused its efforts for the past seven years on re-using pulp mill equipment and processes for production of biofuels and bioproducts

Absorbent Pulp + Pellets Integrating with Bioenergy Absorbent Pulp + Pellets Hardwood Wood Softwood Wood Softwood Pulp Pelletizer Wood Pellets I mentioned the Franklin Virginia mill conversion to fluff pulp earlier, but actually there is a wood pellet plant co – located with the pulp mill. When Franklin ceased operation as a paper mill, and other mills in southeast Virginia and North east North Carolina abandoned hardwood products, close to 2 million tons of hardwood supply was freed up to pellet producers, who enjoy locations near ocean – going ports to ship products to boiler in Europe who can then take advantage of carbon dioxide offsets. Papermachine Paper Pulp Dryer Fluff Pulp

Bioproducts Machine Shutdown Integrating with Bioenergy Bioproducts Machine Shutdown Hardwood Hardwood Chips Softwood Wood Autohydrolysis Bioproducts - Sugar - Ethanol Pellets Hardwood Pulp Softwood Pulp The biorefinery concept we have developed can be deployed in any mill which shuts down a paper machine, and frees up fiber or other applications. With hardwood, we can get high yields o sugars by autohydrolysis of hardwood chips With softwood, we do better with kraft pulp. With sugars we can ferment to ethanol or to sugar – based products with higher value. Papermachine Paper Papermachine Paper

Drying - Milling -Pelletizing Integrating with Bioenergy Wood Pellets Drying - Milling -Pelletizing Wood Pellets 500,000 BDT 490,000 BDT x $150 per Ton Bioethanol Autohydrolysis -> Enzyme Hydrolysis Biosugars 120,000 T x $900 per Ton We also have a concept of co-producing fuel pellets along with the bioproducts. If a mill has 500,000 tons per year of wood available, wood pellets are a low capital alternative to produce a commodity that sells for $150 per ton. The same amount of wood can be produce higher value than a boiler fuel by first extracting the sugars to sell at $500 per Ton or bioethanol at $900 per Ton … Then producing a lower quantity of higher fuel value pellets to sell at $165 per Ton Overall investment costs are higher but the economics are quite compelling when co-located at a kraft mill. OR 500,000 BDT 250,000 T x $500 per Ton AND Drying - Pelletizing Lignin Pellets 240,000 BDT x $165 per Ton

Integrating with Bioenergy $5.00 per MMBTU $35.00 per MMBTU Co-locating a biorefinery in a kraft pulp has a number of potential advantages: The wood fiber supply chain is already in place The pulp line can be re-used without technological compromise Proven technologies like pulp refiners and presses typically available. Blocks in Green likely new investments, but half the capital of a greenfield investment can be offset in co-location in an operating kraft mill. Even a mill that is recovery – constrained can operate an autohydrolysis process by recovery of the lignin as a fuel pellet Think about conversion from paper to biofuels and biomaterials as a way to upgrade products from near zero cash margin to on the order of 40% … of course with investment Lignin Fuel Pellets $8.00 per MMBTU

Integrating with Bioenergy Financial Analysis of Hardwood Autohydrolysis Co-Located with Kraft Pulp Mill Source: Nebraska Energy Office Here we see a summary investment analysis of converting a hardwood pulp line from pulp to biofuels. Even relatively modest 50% of theoretical yield still gives 63 gallons of ethanol per BDT You can see the significant contribution to profitability coming from selling fuel pellets for $165 per ton with the process residues Considering the investments and the cash flows indicates one would need a revenue of $1.73 per gallon of ethanol to earn a 12% internal rate of return … Which is well within the current and likely future prices that ethanol will enjoy

Summary and Conclusions Asia has become overly – dependent on cheap Recovered Paper that will become scarce and expensive in the future New softwood capacity will be needed to provide fiber to Asia American papermills have some good but difficult options … bioproducts may be an answer So, to summarize: Asian countries where paper and board growth is the strongest will continue to depend on recovered paper as their fiber source during a period of time when the availability of waste from western countries will be declining. New softwood capacity will be needed and American mills can produce softwood fiber better than anyone else can This leads to some attractive mill conversion options for American mills … not necessarily easy, but certainly doable. I also believe bioenergy production will find a place into the kraft pulp mill process, and will help the industry manage through decline of domestic demand Questions? Questions?