Raking through the MRF

The sharp change in the economic outlook over the past six months has revealed the fragility of the global recycling value chain. Too much reliance had been placed on China as a market for recovered materials. This outlet had blinded European politicians to the need to think longer term, and develop indigenous markets for recovered materials. The European waste industry has continued to be caught in the downdraft of Veolia Environnement's mid October, and not necessarily last, profits warning. The knee jerk reaction has been that all waste services corporates face the same predicaments. The reality is different, but equally it shouldn't detract from obvious public policy failures.

French market leader showing the strains
For the record, Veolia ES as the global leader in waste services is rightly viewed as a bellwether for the industry. After nine months in 2008 its global revenues were up 15.5% at €7.71bn, though operating cash flow was reported to be no better than stable – so margins were under visible pressure.

Veolia Environnement’s Gallic business model is bureaucratic and multi-tiered, and thus has poor response times to changing market circumstances. Furthermore, it’s clearly suffering the acquirer’s curse having paid top € for both Sulo in Germany and VSA Tecnitalia in Italy in mid 2007; neither are performing to its expectations. Notably, both are in markets which it had previously studiously avoided meaningful participation. Indeed the recent Veolia Q3 statement referred specifically to revenue contraction in Germany’s DSD (packaging waste).

An industry shaped by regulation
European Union environmental regulation has been driven for several decades by a bunch of highly effective, and at times almost evangelical, environmental NGOs. These lobbyists have secured a series of policy commitments, enshrined in directives, which have driven the pollution abatement and prevention agenda. Amongst their campaign honours are the Landfill directive, and most recently the Waste Framework directive.

Particularly in the UK, environmental regulation has tended to exhibit a distinctive “command and control” culture. This places emphasis on compliance with the law, and too little emphasis is placed on understanding the broader picture. In part this has been because the UK has been dilatory in applying EU legislation and has therefore been rushing to meet deadlines; a case in point being landfill diversion targets.

A recent National Audit Office report bluntly stated that DEFRA initially responded too slowly, and the report went on to conclude that achievement of the 2013 target of a halving of municipal volumes (vs. 1995 levels) to landfill was “challenging” – a polite way of saying that it was increasingly unlikely to be met. Thus the UK faces at being at risk of financial penalties.

Link between GDP & volumes of waste
There’s good circumstantial evidence of a close link between GDP and the volumes of waste that an economy produces. Historically poor data collection hinders empirical proof, however. Reliable data on tonnages going into UK landfills has only been available since the introduction of the landfill levy in October 1996, even though there was a previous licensing requirement to install weighbridges. Generally, EEA data (for Europe) is two years or more out of date.

A recession will undoubtedly halt the growth in waste generated by households – typically 450-500kg/head pa. Additionally, much reduced house-builder and developer activity in the UK is already reflected in lower volumes of construction & demolition wastes. Though, interestingly, Shanks has reported a much robust outlook for C&D wastes in the Netherlands.

What’s happening this winter is the painful coincidence of rapidly deteriorating economic circumstances and the relentless pincer of tougher environmental regulation. The latter is concentrated in those EU countries with a historically high dependency on landfill: Greece, Italy, UK & Eire feature. Combined, these developments have fundamentally changed some of the economic assumptions of the European waste industry.

Resource recovery and re-use is here to stay
Tougher environmental regulation – in particular the need to comply with the EU Landfill directive - has driven changes in disposal practices. Resource recovery, and re-use, is here to stay. Not enough thought has been given to what happens next. In those markets where incineration, or to use its contemporary more community friendly title of waste-to-energy (WTE), is accepted then this has become a prominent option in delivery of landfill diversion.
What the politicians also failed to consider was that these new environmental priorities are typically more expensive solutions, even in a favourable economic and market climate. Nevertheless, there’s an acknowledgement in many continental markets that cheap options aren’t acceptable.

There’s a wide range of business models in the European waste industry, and more ways to make profits than there are to skin a cat with nine lives. For example, those with landfill gas portfolios (e.g. Viridor, & Infinis) are enjoying buoyant profitability. Hence the illogicality of the knee jerk reactions to the current predicaments of some leading waste companies, in particular the French market leaders.

Particular attention has been focussed on the snarl-up in the recycling value chain. Tabloidesque stories of waste stockpiles may add drama but unfortunately are the reality and are here to stay, as the Environment Agency has been forced to acknowledge,

Supply/demand imbalances
In the UK, DEFRA officials have been alert to the inevitable supply/demand imbalances for quite a number of years. There’s also been the very public economic mess of the DSD in Germany, which should’ve been a warning.

Yet, upgrading the UK’s waste handling infrastructure hasn’t rated as a political priority. Politicians have been guilty of demonstrating that they haven’t learnt the lessons of the 1990s. But then the New Labour government of the past decade has at times treated its claimed environmental priorities rather akin to a shipping flag of convenience.

Recycling and recovery of materials from the waste stream – both municipal and industrial – is only the start of the process. It simply ticks the box of landfill diversion. In the 1990s there were periods when waste companies in the UK were being paid by local councils to separate out paper etc from co-mingled household collections only then to have to dispose of the recovered materials to landfill. That’s no longer an option for surplus recovered materials, hence the stockpiling at materials recovery facilities (MRFs) to which environmental regulators are now having to respond.

Secure and sustainable access to markets for these recovered materials is key. Prudent corporates have entered into long term off-take agreements with the likes of newsprint mills requiring post consumer paper and other specialist re-processors of recovered materials. However, such deals bring the trade off of stable prices below peak levels.

Waste handlers who are able to optimise quality are also going to be better off. Lower grades of paper and plastics have been the first to suffer from the lack of buyers.

Those without such off-take arrangements have typically relied upon waste brokers operating in international markets. A further risk in relying on international markets has been currency exposure – typically Far East markets paid in US$. Thus the recovery in the $ has been one bright spot.

For the past couple of years or so, otherwise empty container ships returning to China were loaded up with paper and plastics of any grade, but no more given the changes in the Chinese economy – the stimulus package (10th November) wasn’t orientated to boosting output of consumer goods manufactured from recovered materials. Rather, it’s about infrastructure and helping the inland rural regions. It’s notable that nearly half of China’s toy factories – big users of recycled plastics – are reported to have closed in the past year.
Last autumn, Veolia ES advanced the view to environmental regulators that market recovery will be evident post the Chinese New Year (the Year of the Ox started on 26th January). Unfortunately, this looked to be wishful thinking even before the Chinese purchasing managers index fell from 44.6 in October to 38.8 in November – then the lowest level since the series started in 2005 – and subsequently even lower. There’s an increasing weight of evidence to suggest that demand for Chinese products incorporating recyclates has experienced a step reduction.

Thus the gluts in Europe and in North America are here to stay – and almost certainly rather longer than politicians are yet ready to acknowledge. Household recycling rates in the UK are only c35%; each extra 10% will channel a further 3.5m tonnes pa to the volumes of material into the re-use pipeline.

Special circumstances
It’s worth stressing that both glass and WEEE enjoy special circumstances.

Glass cullet prices have held up well; producing glass is very energy intensive and thus demand for cullet remains firm. Glass recycling volumes in the UK continue to reflect the benefit from the switch from pubs to home drinking and thus more wine bottles.

WEEE is a separate market, again. All waste electrical & electronic equipment must now be recycled, under the relevant EU directive. If materials prices fall, then WEEE handlers can simply put up their gate fees to compensate.

Political antennae not functioning
Should politicians have seen this coming? Undoubtedly, yes; but in the UK their focus has been on ensuring landfill diversion targets are met rather than on what happens to the materials no longer going to landfill. Further, when WTE projects have been proposed elected representatives have often proved to be spineless. The decade plus required to get approval to construct the Belvedere facility in south-east London is testimony to political buck-passing, locally and in Whitehall.

But even when an upturn in demand does come about, what happens to the materials stockpiled in the interim? Waste paper deteriorates in storage, and poorer grades from Q4 may well be useless for recycling by end Q1, and will thus pose a disposal dilemma, and at whose cost? Therefore, in all likelihood, within months the UK will be back to dumping or burning materials previously separated from the waste stream.

It’s noticeable that some UK councils are switching to fortnightly collections, thus allowing more time for co-mingled wastes to deteriorate in quality before MRF sorting. Some are also co-mingling waste delivered to civic amenity facilities.

With no China, demand is likely to remain particularly weak for both paper and plastics. The emphasis on quality will rise further, and mixed wastes in particular are set to remain unwanted – probably to the point of negative value. Butter mountains look set to be replaced across the EU by less aesthetic equivalents of grubby post consumer paper and plastics. Communities close to MRFs, or hastily made available storage alternatives, will undoubtedly react.

Thus the problem of the waste that society generates has merely been moved on a stage, rather than been addressed. Semantic debates about when does waste cease to be classified as a waste after treatment or what constitutes a refuse derived fuel – which have recently preoccupied EU politicians - have added to the impression that the politicians remain detached from what’s happening on the ground.

Markets needed for recovered materials
More new markets need to be created for these recovered materials, and the recession is merely going to slow the increase in supply. Politicians could take a lead in promoting products utilising recovered materials, plastics are likely to remain a particular challenge for longest.

The UK’s landfill diversion targets are on a steep gradient and the “low hanging fruit” of recycling have already been plucked in most parts of the UK. Thus, even with the economic setback, 2009 and 2010 may well see less congratulatory press releases on waste data trends and increasing anguish over stockpiled recovered materials.

From the perspectives of the waste industry corporates, these recovered materials represent stocks or work-in-progress, either way tying up working capital. Furthermore, these carry the risk of future write downs due to either no market, or their deterioration in store. Also, there’ll be incremental insurance costs. Not a rosy outlook, but underscores the importance of differentiating between business models.