Katrina causes waves in outlook

05 September 2005 00:01  [Source: ICB Americas]

SURGING OIL and natural gas prices, exacerbated by Hurricane Katrina’s Gulf Coast onslaught, will likely prompt Wall Street to take down third-quarter profit estimates for chemical companies. With crude oil topping $70 per barrel and natural gas touching $12 per mmbtu, chemical margins are being squeezed. However, profits could rebound in the fourth quarter as outages tighten supply.

“With crude oil and natural gas prices surging due to hurricane-related production shut-ins, Katrina will lead to a further spike in raw material costs for ethylene and polyethylene,” says Merrill Lynch analyst Donald Carson. He estimates that weighted-average ethylene feedstock costs will increase from 25.5 cents per pound in July to 34 to 35 cents in August.

“Incremental margin pressure from higher feedstock costs appears likely to outweigh potential for a margin boost via restriction of supply,” says Banc of America Securities analyst Kevin McCarthy. “Those with assets most likely to be affected directly include Georgia Gulf, Dow, Westlake, and PPG Industries.”

Concerns from the hurricane include a temporary lack of personnel, flooding causing shutdowns of longer duration, potential start-up problems, and the impact on energy in the short and long term, says the analyst.

“In previous hurricanes, many of the plants in the affected areas shut down temporarily,” says CS First Boston analyst William Young. “Most restarted without a problem, while others did suffer some damage, which meant a somewhat extended shutdown. Repair costs and lost output did impact earnings to some degree in certain instances.”

Chloralkali could be affected more than ethylene, according to Banc of America’s McCarthy. “Louisiana accounts for 20 percent of North American production capacity, but fully 33 percent of chloralkali capacity,” he says. “Units in western Louisiana near Lake Charles are less likely to be affected than those in the eastern part of the state near Taft and Plaquemine where Georgia Gulf and Dow have facilities.”

Prior to the hurricane’s impact, CS First Boston’s Young slashed third-quarter profit estimates across the board in the commodity group on climbing oil and natural gas prices.

“The surprisingly large jump in hydrocarbon and energy costs means that margin compression is worse than anticipated,” Young says. The analyst slashed third-quarter earnings forecasts on Dow Chemical, Lyondell, Eastman, Georgia Gulf, Nova, Westlake and PPG Industries.

The analyst cut his third-quarter numbers on Dow by 8 cents to 84 cents, Lyondell by 13 cents to 45 cents, Eastman by 20 cents to $1.25, Georgia Gulf by 15 cents to 70 cents, Nova by 25 cents to a loss of 30 cents, Westlake by 14 cents to 50 cents and PPG Industries by 15 cents to $1.10.

LONG-TERM BENEFIT?

While chemical companies will certainly feel short-term pain from feedstock price pressure and temporary shutdowns, margins may expand in the fourth quarter and beyond if the supply situation tightens and price increases get ahead of raw material costs.

“More intense raw material pressure, combined with low customer inventories and several unplanned mechanical outages, increases the chance of price hikes to higher levels than they might have been,” asserts Young. “Although we expect lower margins in the third quarter, owing to the normal lag in effecting price hikes, healthier spreads are likely as the fourth quarter commences.”

“Despite the initial negative impact from higher feedstock costs, Katrina will further tighten the ethylene/polyethylene market as producers shut down capacity as a precautionary measure,” says Merrill Lynch’s Carson. “With many polyethylene producers on sales allocation we believe that even a moderate reduction in effective capacity could lead to increased producer pricing power and significantly higher prices.”

Greenwich Consultants analyst Michael Judd sees Lyondell and Nova benefiting from petrochemical outages related to Hurricane Katrina.

“We expect petrochemical industry margins to increase sharply in the fourth quarter due to the supply outages and already-tight industry operating conditions,” Judd says. “This is likely the catalyst which leads to an industry peak in 2006.”

Chemical stock prices, which have lagged the overall market in past months, continue to stagnate. Dow Chemical, at about $43.50, trades near its 52-week low of $41.52 and far from the high of $56.75 reached just last March. DuPont sank to a new 52-week low of $39.22, versus its high of $54.90.

CS First Boston slashes profit estimates

	E3Q 2005	Change	E2005	Change
Dow Chemical	$0.84	($0.08)	$4.40	($0.10)
Lyondell	$0.45	($0.13)	$2.40	($0.20)
Eastman	$1.25	($0.02)	$5.70	($0.30)
Georgia Gulf	$0.70	($0.15)	$2.75	($0.22)
Nova	($0.30)	($0.25)	$1.40	($0.40)
Westlake	$0.50	($0.14)	$2.65	($0.25)
PPG Industries	$1.10	($0.15)	$4.65	($0.25)

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