INSIGHT: Margin landscape changed with record oil

16 June 2008 17:31  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS news)--So far, it’s been a tough June with margins under the greatest pressure for years squeezed by ever higher feedstock and energy costs.

Liquid feed cracker margins have been in negative territory and the impact of higher costs felt further downstream, forcing reductions in operating rates and plant closures.

Producers have sought to push through across-the-board price increases but it remains to be seen whether these can be made to stick.

The jump in crude prices on 6 June was not so much a turning point as a wake-up call that the battle to pass on higher costs in 2008 is going to be different.

Chemical producers have been battling with higher feedstock and energy costs for years but with well balanced supply and demand have been in a position to pass those costs on.

If you operate in a relatively tight market, then you might expect to have some success in this regard.

Rohm and Haas has recently talked of an energy surcharge and in at least one of its markets, acrylics, is in a dominant enough position in North America to be able to implement this.

In longer markets, though, the future looks bleak as feedstock naphtha and ethane prices and energy costs soar.

Late last week Citigroup gave a verdict on the sector that was far from positive.

Radical times call for radical measures, it suggested, in a discussion of the raw material cost squeeze and the announcements by so many companies - Dow Chemical, Huntsman, Nalco, Lubrizol and Rohm and Haas among them - of significant price increase.

“Surcharges tend to take away fundamental ‘value capture’ that rewards innovation and service,” the banks’ analysts said, and pointed out that customers are quick to reference these surcharges when the cost of the underlying commodity declines.

Indeed, surcharges pass on the cyclicality of raw materials to the customer. That is probably fine when capacity is tight but not when customers can find alternative sources of supply.

In the bank’s view, the relative impact of oil, natural gas, naphtha and ethane inflation on first line derivatives, or olefins and aromatics, is between 70% and 80%.

It is between 50% and 70% on polyolefins, urethanes, epoxies and acrylics, and between 20% and 30% on specialties, paints, soaps and coatings.

The upshot is that the second quarter will have proved to have been difficult for most chemicals makers, caught between raw material and energy cost price inflation and lower demand growth.

Further input on expected demand growth will be forthcoming from industry experts within a few days following meetings in Europe last week.

Given the sharp downturn in the US and economic pressure worldwide, chemicals growth estimates are likely to be down.

But will the oil price continue to rise throughout 2008 and into 2009 as some have predicted in recent days? Or is the worst – a 40% rise in six months (natural gas prices are 64% higher) – over?

Crude prices fell briefly on Monday as the oil markets absorbed the news that Saudi Arabia intended to increase production but were soon rebounding to new record highs close to $140/bbl.

Yet the production increase could be significant and could ultimately have a marked impact on prices.

More should be revealed at a ‘crisis’ summit in Jeddah on 22 June, a meeting between crude producers and consumers that has been called “unprecedented”.

The cost squeeze on chemicals from higher priced oil and natural gas has been significant and forced predominantly naphtha-based producers to cut back operating rates.

South Korean cracker operators cut back rates last week in the face of the onslaught from higher naphtha prices.

According to the latest ICIS margin data many naphtha cracker operations in Europe will no longer be contributing to fixed cash costs. That position is not sustainable for an extended period. Liquids cracking in the US has also been difficult to say the least for months.

Last week could have been a better time to be a standalone polyethylene (PE) maker in Europe, rather than an integrated player as cracker margins turned down but higher polymer prices lifted PE margins.

The margin analysis has shown how difficult it has become for producers to cover sky-rocketing costs with higher prices. It is fine so long as customers - plastics converters and the like - are willing or at least able to pass their costs on down the chain.

These are unusual times for chemicals. Further robust information on growth prospects for the sector is awaited with interest.

To discuss issues facing the chemical industry go to ICIS connect
Click here to find out more on the European polyethylene margin report
For more on the impact of the oil price on chemicals read Paul Hodges Chemicals & the Economy blog

By: Nigel Davis
+44 20 8652 3214

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