How will Brazil's floods impact the pulp and paper industry?

One of the current issues facing players in the Brazilian containerboard market is the impact of flooding in Rio Grande do Sul on demand in the country. Although it is difficult to estimate, especially with downward revisions to gross domestic product (GDP) forecasts, we still believe the impact of flooding on paper products demand in 2024 will be limited as the negative impact should be offset by positive results.

Several pulp and paper mills were directly or indirectly affected by this tragedy.

So, what does this mean for paper product consumption? For ease of explanation, we will discuss it in two time periods: short-term (next 1-3 months) and medium-term (next 4-12 months).

Short-term impact: harder to assess

In the short term, operating rates at existing factories in the state are expected to decline, reducing output and raw material consumption. However, other paper mills across Brazil may be able to temporarily increase operating rates to offset production losses at the Rio Grande do Sul mill.

At first glance, the impact of this tragedy on the production side should be minimal, regardless of the paper type. However, consumption of paper products by local industry will decline as manufacturers partially or completely halt production during the disaster.

The main impact on packaging paper consumption will come from containerboard, although this is primarily produced out of state, and the animal protein and food industries, which are reporting double-digit losses due to rationing of animal ingredients in the major beef and food industries and yield loss. Exports are also expected to fall in the short term, reducing packaging paper consumption.

However, containerboard consumption is also expected to increase significantly in the short term as people across the country use cardboard boxes to send donations to disaster-stricken areas, thereby increasing demand for goods transportation. Given the two opposing forces, it is difficult to assess how the net impact on corrugated box consumption and shipments will change in May and June.

Medium-term impact: Demand growth will be above average

Looking ahead 4-12 months, it is easier to expect demand for paper products to grow faster than average, although GDP is expected to decline over that period.

First, we can assume that a significant portion of the packaging and paper stocks held by local industries will be lost due to flooding. Therefore, the simple fact that economic life will return to normal is enough to foresee an unusual one-time increase in demand for these products, which are likely to be supplied by states not affected by the tragedy, given Rio Grande do Sul's low capacity share . This should apply to all industries and businesses, not just major packaging and paper consumers.

Secondly, we can also assume that due to flooding many businesses and individuals will have to replace some of their assets – goods, machinery, furniture and even appliances. Increased demand for these durable goods should support the production of these items elsewhere in the country, thereby stimulating consumption of paper products, especially packaging, for transport to Rio Grande do Sul.

Third, from a political perspective, government spending should be high in 2024, with municipal elections taking place as scheduled. Typically, election years are characterized by increased spending on advertising, leaflets and even promotional items to increase public approval. Although government spending is limited by austerity laws, tragedies like this often serve as justification for declaring emergencies and spending beyond government budgets. So the incentive for governments to increase spending is higher than normal given the tragedy and the election.

However, many people's income losses will be negative as they may rely on credit to restore their homes and replace durable goods, which may limit normal day-to-day needs in the medium term due to rising debt levels.

Summary: Opposing forces cancel each other out

Our tentative conclusion about the demand consequences of the Rio Grande do Sul tragedy is that opposing forces—those that increase demand and those that decrease demand—should appear simultaneously in the short term, canceling each other out, making this essentially a A zero-sum situation. Any one-time gains from reconstruction are likely to be immediately offset by a sharp drop in demand as consumer debt levels rise.

The risks we analyze relate primarily to the inflationary impact of crop losses in Rio Grande do Sul. The state is Brazil's largest rice producer and an important fresh food grower. These commodities are often very sensitive to supply shocks and occupy an important position in consumer budgets. Therefore, a sudden rise in food prices could lead to a reduction in purchasing power across the country, limiting consumption of paper products elsewhere in Brazil.