Money that grows on trees

LOOK north from atop the 120-metre (390-foot) bleaching tower at the Horizonte 1 pulp mill, and all you see is plantations of tall, slender eucalyptus trees. They stretch from the factory gate, across the gentle undulations of Mato Grosso do Sul, a state in Brazil’s centre-west, all the way to the horizon. “That’s our competitive advantage,” explains Alexandre Figueiredo, who is in charge of production at the plant. Its owner, Fibria, is the world’s biggest producer of “short-fibre” cellulose pulp, which is used to make such things as newsprint, nappies and banknotes. (“Long-fibre” is used for high-grade paper and packaging.)

As its name suggests, Mato Grosso do Sul (roughly, “southern thick bush” in Portuguese) has vast expanses of cerrado, or tropical savannah, a chunk of which was long ago turned into farmland, some of which has more recently been planted with eucalyptus. Most of Fibria’s 568,000 hectares of plantations lie within 200km of its mills. Eldorado, a rival with a mill on the other side of Três Lagoas (a city of 115,000 that is fast becoming Brazil’s cellulose cluster), needs its lorries to drive only a bit farther. No other firm in the world has such ready access to its raw material. Add the balmy climate and rich soils of Brazil’s south and centre-west—where, as Joe Bormann of Fitch, a credit-rating agency, puts it, eucalyptus “grows like a weed”—and it is easy to see how Brazil has conquered 40% of the global short-fibre market.

Investment in technology is paying off, too. In the late 1990s Brazilians introduced a fast-growing eucalyptus variety that can be harvested after just seven years, compared with the two decades or more it takes to grow pine, the main source of cellulose pulp in the northern hemisphere. Next door to Horizonte 1, Fibria is building a high-tech nursery with technology devised by Dutch flower growers. Eldorado pioneered the use of drones to map the topography of its woods and optimise planting and harvesting.

Pulp producers are also thriving thanks to the storm that is sucking life out of much of the rest of Brazil’s economy. From his vantage-point, Mr Figueiredo waves towards the only clearing in the arboreal landscape: an unfinished Petrobras fertiliser plant a few kilometres away. Construction stopped in 2014, when the state-controlled oil giant emerged as the locus of a multibillion-dollar bribery scandal that may yet topple Brazil’s government (see article). That is in stark contrast to the frenetic activity directly below him, where a second, 8.7 billion reais ($2.4 billion) production line is taking shape that will more than double Horizonte 1’s current annual capacity of 1.3m tonnes, once it is completed in late 2017.

Recession and political upheaval have brought Brazil’s currency, the real, down by three-fifths against the dollar since 2011. That is a boon to pulp producers, who export nearly all their output. Standard & Poor’s, another rating agency, reckons that production costs in dollars dropped by $50 per tonne in 2015; another $40 per tonne was saved on maintaining mills. UBS, a bank, calculates that for every 10-centavo decline against the greenback, Brazilian producers’ earnings rise by $15 per tonne.

As the real has tumbled, global pulp prices have held steady, whereas some of the other commodities Brazil produces have slumped (see chart). As it rebalances from investment to consumption, China may build fewer bridges, hurting Brazilian iron-ore exports. But the Chinese are buying more bog roll; and over 40% of Brazilian pulp producers’ output is turned into tissue for the Chinese market. Between 2013 and 2023 annual toilet-paper sales will grow by 7.4m tonnes, with China accounting for nearly half of the rise, according to RISI, a consulting firm.

The combination of a cheap currency and healthy demand has pushed Brazilian producers’ margins to mouth-watering levels. Fibria’s rose to 53%, on record revenues of 10.1 billion reais, last year. With earnings equal to 75% of revenues in the fourth quarter of 2015, Eldorado’s margins set an all-time industry high. This helped ease its debt burden, which remains large compared with rivals’. Klabin and Suzano, two other big Brazilian firms, also had a good year, even if, as integrated producers of both pulp and its products, their mostly domestic papermaking businesses suffered in line with Brazil’s economy.

Can it last? Overcapacity is one worry. Last May CMPC, a Chilean concern, fired up a plant in Rio Grande do Sul state in southern Brazil that will churn out 1.3m tonnes of pulp a year. This month Klabin produced the first bales at a 1.5m-tonne plant in nearby Paraná state. Eldorado is breaking ground on its own expansion project in Três Lagoas, which could add another 2.3m tonnes to annual output. And that is just Brazil. Global capacity is poised to grow by 2.7m tonnes this year alone, estimates UBS; demand by just 1.5m tonnes. That will surely weigh on prices eventually. And the real has recently begun to pick up, as markets bet on a change of government and thus an end to Brazil’s political and economic paralysis.

Brazilian pulp bosses nevertheless seem chipper. If pulp prices fall, older, high-cost producers, mainly in the northern hemisphere, may go out of business, reducing any excess capacity. In the long run, demand for tissue can only grow. As Marcelo Castelli, Fibria’s boss, observes, the average Chinese still uses just over 5kg of it a year; in developed countries the figure is 10-20kg.

As for the currency, Eldorado’s boss, José Carlos Grubisich, notes that the industry survived a rate of 1.6 reais to the dollar five years ago. With the exchange rate now around 3.6, there is a long way to go before it begins to hurt. Even the rich world’s falling demand for printing and writing paper is not such a worry: it means there is less used paper for recycling, which should in turn shore up demand for “primary” pulp.

Though Brazil’s pulp industry is booming, it is on the lookout for new uses for its eucalyptus timber, from biofuels to green substitutes for plastics. In the past few years Fibria has bought stakes in several startups with promising technology, including one in Canada. It is sizing up two more. “Money can grow on trees,” Mr Castelli promises. “It just takes time.”