The cost of mill downtime: how low operating rates can impact mill costs and profitability

After being propelled by pandemic and stimulus tailwinds in 2020-21, North American containerboard and corrugated demand faltered in late 2022, dragged down by the sharp reversal of these tailwinds and an economy-wide destocking cycle. This forced producers to respond with large-scale downtime, sending US containerboard operating rates down to about 80% in September, where they remained for the rest of 2022.

Operating rates have also dramatically declined for printing & writing papers (P&W). The severe demand declines of 2020 were eventually met with a wave of capacity closures and conversions. As demand embarked on a recovery in 2021 and climbed well into 2022, the massive reduction in domestic supply combined with a lack of imports to drive operating rates to a multi-decade high.

In 2023, however, the surprisingly robust and persistent recovery in demand has given way to weakness, with the inventory headwinds afflicting much of the rest of the US economy now catching up to paper markets and import pressures rising to record levels.

As a result, P&W operating rates have retreated dramatically, with uncoated freesheet operating rates falling to just 81% in February 2023 and coated freesheet operating rates dipping to 64%, the lowest level ever outside of the second quarter of 2020.

Weak market conditions are forcing both containerboard and graphic paper producers to turn to downtime, which comes at a cost in that it handicaps mills’ ability to run at an efficient scale.

In this article, we will examine the impact of heavy downtime on mill costs and profitability.

Mill costs rise with reduced operating rates

Fastmarkets’ Analytical Cornerstone service offers detailed breakdowns of each mill’s needed inputs to produce a given grade, providing estimates of costs per ton for fiber, chemicals, energy, labor, other materials & maintenance, delivery, capital costs and expenses for sales, general and administrative (SG&A).

When operating rates decline, we assume that some input costs are essentially fixed, while other variable components remain unchanged on a per ton basis. In this article, fiber, chemicals, energy and transportation costs are treated as variable costs, while labor, other materials & maintenance, capital costs and SG&A are treated as fixed.

Reduced operating rates increase mill costs by distributing these fixed-cost components across a smaller amount of tonnage, handicapping margins and profitability. Figure 2 illustrates the inflationary effect of operating rates falling from an initial level of 95%, a typical level for containerboard and approximately the level of total P&W operating rates in 2022, to the 80% threshold reached by these grades in late 2022 and early 2023.

For kraftliner, we estimate that reduced efficiency has effectively raised cash production costs by 5-6%, offsetting most of the decline in input costs over the second half of 2022 and making the erosion of prices over the past two quarters even more painful. The addition of capital costs and SG&A expenses makes the inflation even stronger, with containerboard total costs per ton estimated to have been pushed up by 8-9% due to reduced utilization.

Variable costs such as pulp, fillers and coatings play a larger role in the higher value P&W cost structures, so the impact of spreading labor and other fixed costs across lower tonnage is somewhat reduced, with cash production costs and total costs estimated to have been pushed up by 3-4% and 5-6%, respectively. This pattern of a less-severe impact for higher value grades can also be seen in the fact that we estimate a slightly larger degree of inefficiency-driven cost inflation for semichemical medium.

Profit margins drop with reduced operating rates

Higher costs have consequences for mill profitability, pushing margins down. Figure 3 shows the negative impact of operating rates falling from 95% to 80% on profit margins, and the actual decline of operating rates has been even larger for some paper grades.

We estimate that cash production cost margins for kraftliner, semichemical, coated freesheet and uncoated freesheet have been pushed down by about 5% by reduced efficiency before accounting for any price declines. When including total costs, the impact expands to a 12-14% decline. Here, the decline in profitability is slightly more severe for the graphic paper grades because of narrower initial profit margins and higher production costs per ton.

The reality for each mill can be more complex

These conclusions were driven by the simplifying assumption that some cost categories can cleanly be categorized as variables and others as fixed. This is perhaps a reasonable way to enable a broad discussion of efficiency, but reality can often be much more complex, especially on an individual mill basis.

For example, some mills may be able to optimize their fiber and energy mix while operating at a lower utilization, unlocking slightly lower costs per ton, or they may be able to maximize the efficiency of digesters rather than their paper machines. Other mills may face “take or pay” contracts such that a reduced operating rate does not actually reduce costs, and contracts with electricity suppliers can be very complex.

To the extent that fixed costs occur at a corporate level, capacity closures that raise system operating rates could still create an additional overhead burden for a company’s remaining assets. Thus, a great deal of caution should be taken in attempting to apply this analysis to specific mills or decisions.

Operating efficiency and profitability

When times are good, an increased scale can improve operating efficiency and profits, at least as long as running equipment to its limit does not result in increased maintenance costs. But when markets are weak, reduced operating rates amplify the pain by preventing mills from running to their full or optimal potential.

Downtime can be a short-term coping strategy for downturns, but as a long-term solution, it ultimately represents a handicap on profitability. Supply adjustments are often perceived as being aimed at balancing the market to stabilize prices, but matching capacity to demand can also have an important impact on efficiency, which may put closures on the table once more clarity is gained about the true state of underlying demand and the extent to which inventory issues are exacerbating cyclical headwinds.

Learn more about our Analytical Cornerstone cost benchmarking tool and how it can help you compare production costs by mill and machine. Speak to our team or sign up for a demo today.