Pulp & Paper: Sector Presentation Fernanda Torós

1. Pulp & Paper: Sector Presentation Fernanda Torós

2. Index • Overview of Pulp Types and Products • Main Short-Term Drivers and Associated Risks • Market Dynamics • Why Brazil? • What May the Future Bring?

3. Pulp & Paper: Overview of Pulp Types and Products

4. Pulp: Hardwood vs. Softwood • Pulp contains fibers and lignin. Chemical or mechanical processes are used to dissolve the lignin, a natural resin that glues fibers together in wood. • Hardwood fibers (harvested in Brazil) are especially suited for producing smooth papers for printing and writing. Sheets produced out of Softwood fibers would be too rough and too porous. • On the other hand, to manufacture paper bags, it would be foolish to consider using hardwood pulps; they simply would not have enough resistance to tearing. • Sometimes it’s recommended that the 2 types of fiber are blended together. In this case, the best overall mix of properties can be achieved. Source: http://www4.ncsu.edu/~hubbe/HW.htm Note: Brazil is a producer of Hardwood.

5. Global Pulp & Paper Figures as of 2002.

6. Pulp & Paper: Main Short-Term Drivers and Associated Risks

7. Despite LT Prospects, Pulp Price May Drop Further Despite good long-term prospects, pulp prices may drop further in the coming months due to: (i) Decelerating demand, (ii) Stronger USD, and (iii) Inventories at multi-year highs BEKP: Bleached eucalyptus kraft pulp (Market BEKP is produced mainly in Latin America and Iberia . Some is also produced in Norway and Thailand ). 7

8. (i) Decelerating Demand May Push Prices Down Pulp demand and prices in recession times Source: Hawkins Wright

9. Decelerating Demand: Shipments are Low... • Pulp shipments decreased 4.5% yoy in Sep 2008. It’s the highest inventory level since 1998. • Chinese shipments posted the worse performance, declining by 27% y/y. This confirms anecdotal evidences that Asian markets were reducing buying activity. This softer Chinese pulp demand is a problem for hardwood pulp producers (Brazilian and Chilean mainly) in the short term. • Shipments-to-capacity ratio of 86% in Sep is a minor recovery from the 82% at Aug, but still well below the long term average of 95%. This ratio points to very weak demand for pulp products in short term.

10. The Good News is: Decelerating but still Growing Note that Brazilian companies produce pulp from Eucalyptus...

11. And for Paper, Growth Still Nice in Latam/Asia Moreover, demand for paper and board in Latam/Asia may still keep a nice growth rate...

12. (ii) Stronger USD Against P&P Main Currencies • Good: (a) stronger USD may positively affect producers that export P&P and, therefore, have their revenues in USD - this is the case for Latam producers; and (b) stronger USD may also adversely affect non-integrated producers that need to buy pulp as input, such as some European and Canadian companies. Their costs tend to become higher, which decreases their competitiveness even further. • Bad: The strength of the USD will be negative for pulp nominal pricing - the commodity becomes more expensive in real terms as the dollar gets stronger and, therefore, nominal prices tend to “adjust” down.

13. (iii) Pulp Inventories at High Levels • Pulp inventories increased 3 days mom in Sep to 44 days and were up 15 days yoy. This compares negatively with the last 10 years average mom decrease in Sep of 2 days and historical average of 31 days for this month. Higher inventories were due mainly to weak shipments to the USA, Japan and China. Note: The Pulp and Paper Products Council (PPPC) released global market pulp statistics for Sep 2008 on Oct 23.

14. And Inventories are High Mainly in Hardwood • Higher hardwood stocks entirely explain the total increase in global inventories. This does not bode well for Brazilian producers. • Because of the liquidity problems faced by Brazilian companies (due to their speculative positions in FX derivatives), many analysts brought up the possibility that these companies (especially Aracruz, which has been maintaining inventory levels significantly higher than the industry average) may flood the market with pulp (“burn” inventory to make cash). This would help bring pulp prices to even lower levels.

15. But There Might be a Floor to Pulp Prices • Based on current producing costs (RISI data), there may be a medium-term floor to pulp prices: $740 and $600 per ton for softwood and hardwood, respectively. • Producing costs were up considerably over the last years. According to RISI, the average cost of the high cost producer (delivered to Europe) was up 25-30% over the past 2 years ($135/ton). These cost increases have not been entirely driven by energy or currency. In fact, modern pulp mills are typically net generators of energy. Particular cost issues include: • Chemical costs: there have been significant increases in prices of chemicals used in the pulp and papermaking process. Caustic soda prices were up 147% yoy in Oct/08. • Wood costs: both Europe and Canada have structural issues with wood costs (wood is the largest cost component of pulp production).

16. But There Might be a Floor to Pulp Prices Over the Long Run... • Long-term pulp price will be determined by producers’ marginal costs. These costs have been declining. New capacity in low cost areas such as South America and Indonesia, where higher forestry productivity and technology increases competitive advantages, will continue to force a shift down of the industry’s cost curve. This ongoing trend means that longer term prices may be lower due to lower costs vs. the current curve.

17. Price Cycles Source: Datastream, Hawkins Wright, UBS

18. Pulp & Paper: Market Dynamics

19. Supply Mgmt: Closures/Downtime to Bound Price Drops • In response to lower demand (and prices), the industry has started to increase downtime. Even low cost Indonesian and Brazilian producers have announced some. • Low pulp prices plus an increase in Russian logs export tariff (€50/m3) should lead to significant levels of capacity closures during 1H2009, particularly in the case of non-integrated European (mainly Scandinavian) producers. This could increase market share for Brazilians. • Producers have already announced 1.4M tons of capacity downtime in 2008 (837K tons just from Sep-Dec 2008). This represents roughly 3% of the market.

20. Closures in Europe: Mkt Share Increase to Low-Cost Hardwood Producers

21. Mkt Share May also Increase to Low-Cost Producers due to Capacity Decrease in N. America

22. But Pulp Industry is Still Very Fragmented...

23. Prospects: M&A Consolidation and Organic Growth • The Aracruz-VCP merger represents a step in the right direction, as consolidation should increase supply discipline. However, the industry is still very fragmented – i.e. Brazil represents 16% of the global market pulp market - and the interest of low cost producers in Brazil to acquire pulp producers in high cost areas is mostly non-existent. • Brazilian producers are among the most efficient in the world (see next section). There is a lot of potential for organic growth – and many expansion projects have been announced and/or are under construction. In the ST, however, capital restrictions could force Latam to slow the pace of capacity expansion. Source: Hawkins Wright

24. Pulp & Paper: Why Brazil?

25. Brazilian Market Share

26. Brazilian Companies: Comparative Advantage • Brazilian companies have: • (i) low cash production costs; • (ii) their own forests, available land for expansion, and forestry technology that leads to higher productivity; • (iii) plenty of water supplies; • (iv) access to logistics networks (e.g.: Aracruz has contracts with Julio Simões for truck and river vessel transportation, and VCP has contracts with ALL for train transportation); and • (v) in-house sources of energy (with the use of liquids and biomass from the forestry waste).

27. (i) Brazil: One of the Lowest Cash Cost Producers • Brazil is one of the lowest cash cost producers (US$ 380/ton). • If Pulp prices fall below the current level of US$715 to US$600 in 2010, as some analysts predict, many high cash cost producers (such as Canada and European countries) will start to get in trouble. Source: Hawkins Wright, UBS (Aug 2008) Note: Hardwood pulp is based on short fiber wood species with broad leaves, typically eucalyptus, birch aspen and mixed hardwoods. The hardwoods are simply harder than the softwoods because the fibers are shorter. Shorter fiber makes for denser cellulose fibers, but also for weaker cellulose. Thus, hardwood is well suited for copy paper, while softwood is required for lightweight printing papers and strong packaging papers. Among the bleached market kraft pulps, 55% is softwood pulp and 45% is hardwood pulp.

28. (ii) Brazil: Producers have their own Forests

29. The Highest Productivity in the World Source: Bracelpa

30. The Highest Productivity in the World Source: Bracelpa

31. Forestry technology leading to higher productivity • Improved forest productivity can be achieved by crossing seedings, cloning selection by end use, and better specific consumption of wood in mill operations. Source: Aracruz

32. (iii) Plenty of Water Supplies

33. (iv) Logistics Network • Some have their own ports for exporting outputs and importing inputs… E.g.: In Espírito Santo, Aracruz operates a pulp making complex that is fully integrated with company-owned eucalyptus plantations and a specialized private port, Portocel, through which most of its annual production is exported. • Brazilian companies move their inputs and outputs via trucks, river vessels, and trains... E.g.: Aracruz has contracts with Julio Simões for truck and river vessel transportation, and VCP has contracts with ALL for train transportation.

34. (v) In-house sources of energy Brazilian pulp companies tend to use liquids and biomass from forestry waste as source of energy.

35. Pulp & Paper: What May the Future Bring?

36. China is the Key Word • Since the late 1980s Chinese paper and paperboard consumption has grown by over 9% p.a., more than 3x the global growth rate of 2.8%. The growth has been accelerating, increasing by some 7-8 million tons between 1980-90, some 12 million tons between 1990-95, and some 18 million tons between 2000-04. The highest growth rates have been seen in coated fine paper and containerboard, and newsprint is also significantly higher than the world average.

37. China: Per Capita Consumption Still Below Average • In 2003: Chinese paper and board consumption at 40kg/capita is some 25% below the world average and compares to 300kg/capita in North America and 200kg/capita in Western Europe.

38. China has a lot of Potential • In 2006: China was the world’s 2nd largest paper and board market, consuming 66 million M.T. p.a. (50 kg/capita), despite low per capita P&B consumption. • China’s disposable income per capita is very low, at just US$890. It will take time for income to rise to a level sufficient to support higher paper consumption. PriceWaterhouseCoopers estimated that average income would rise to $5,000 by 2012. Reflecting the potential, some Eastern provinces have considerably higher disposable income (approaching US$12,000) and this has translated in to paper consumption 4x the national average.

39. China: Growth Path for Pulp Demand Looks Bright • Assuming that China follows Korea’s path, we can foresee a considerable increase in the country's pulp demand. • Current paper apparent per capita consumption: 176 kg in South Korea and 247 kg in Japan.

40. And the Good News is... • By the end of 2007, Latin America had become the main hardwood supplier to China, with a market share of 42%, against 34% from Indonesia.