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MARKET WATCH

Indexing Options for Recycling Contracts

Posted by Suzanne Hearn on March 13, 2014
You’re getting ready to sign a contract with a waste recovery vendor, and you’re negotiating the index that will be used to determine the amount of your payment or rebate for the old corrugated shipping containers (OCC) and other paper and packaging products that you recycle. Here’s a not-so-hypothetical question:

Which of the following indexes will be most relevant for your business?

1) An index based on a US average

2) An index based on the region in which you operate

3) An index based on a customized geographical region that accurately reflects your footprint

 

Let’s assess each of these options individually.

Option 1: If your company has a footprint that spans from the Atlantic to the Pacific, you might think a national index based on the US average would be fair. But that would depend upon where the majority of your stores are located, especially the higher volume ones. Let’s look at a hypothetical example based on the Weighted Average OCC Price per Ton by Region table below.

Retailer X has 1,000 stores, and each averages 200 tons of recycled OCC annually. With a national index at roughly $120 per ton in 2013, 200,000 tons of OCC would be valued at $24 million. That would be ideal if most of your stores were in lower priced regions like the North Central and the Midwest. But what if your stores were distributed in the following fashion: 25 percent each in the Pacific, Southeast and Atlantic regions, 10 percent each in the Southwest and North Central regions and 5 percent in the Midwest?

As the Added Value of Regional Indexes chart shows, if each recycling contract was tied to a regional rather than a national index, nearly $1 million more in revenue would have been generated in 2013. With the right data, sustainability and recycling program managers can negotiate for an index that will most accurately reflect market forces and prices in their own geographic areas and increase the revenue they generate from their recycled paper and packaging.

Option 2: Geography is key when choosing an index. The closer the geographic match between a regional index and the majority of a company’s stores, the better that index will be. So if all or even the vast majority of your stores are in one region, an index pegged to a regional index will provide you with fair market value for your recycled materials.

Of course, one glance at the price table above, and anyone with a majority of their stores in the North Central region might be tempted to negotiate for a national index instead. Keep in mind, however, that a waste recycling vendor would be severely disadvantaged in this situation, and this could lead to erosion in service quality over time, resulting in a higher cost to a retailer or city.

To ensure the smooth operation of core activities at retail stores, for instance—the receiving, unpacking and shelving of consumer goods or groceries—as well as compliance with shopping center requirements for storage quantities and pick up times, large retailers rely upon the quality and consistency of the service they receive from their waste recovery vendors.

Another reason this strategy is short sited is that market trends reverse themselves. A high price region in one year might be a lower price region the next and vice versa.

For municipal governments, other geographic factors influence the choice of index. While the Southeast regional index may be appropriate for Charlotte, North Carolina or Atlanta, Georgia, the market in South Florida is significantly different. Why? The flow of recovered fiber into Florida is complicated by back haul issues. Essentially, there are very few months in the year in which Florida grows or manufacturers enough produce or other goods to send trucks back to the northern part of the region. Diesel costs for the two-way trip must be shouldered solely by the sale of the recyclables, making it a less profitable situation for waste recovery vendors.  As a result, on these off months, these vendors won’t send recovered fiber to Florida. This restricts supply and causes recycled paper and packaging prices to move higher.

What this means is that a city manager might want to start with the Southeast average then negotiate an additional premium for those months when supply is typically restricted.

Option 4: The best index in any given market is one that accurately reflects market conditions and the supply and demand interactions in your market area—a geography not determined by city limits or state lines or even broad regional boundaries. The more meaningful geography for a large retailer is its actual footprint.

Let’s say, for instance, that all of a company’s 220 stores are located within the region marked on this regional map. (Note: the regions in the price chart at the beginning of this post are tied to this map.)

Market2Mill region map

Ideally, the index source should be able to isolate only those transactions that occurred specifically in your operating geography (with both point of origin and point of delivery)—in this case a weighted average price for transactions in the lower Midwest, eastern Southwest and western Southeast—and develop a company-specific index that will provide you with an advantage during negotiations.

For municipalities, a customized index would narrow down the regional index to the smallest geography possible and then, with a clear understanding of market forces in that geography, adjust the index to accommodate historical market patterns.

Ultimately, sustainability and recycling program managers at large retailers, counties or municipalities should be proactively exploring the options available to them for indexing their recycling contracts. A geographically specific index will increase the confidence that both you and your waste recovery vendor have in the fairness of that index, and that will improve your trading relationship, thereby guaranteeing excellent service throughout the life of the contract.

Topics: recycling contract index, Recycling Contracts, recycled paper and packaging

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