INSIGHT: Companies must ride the inflation wave

25 June 2008 21:57  [Source: ICIS news]

By Nigel Davis

HOUSTON (ICIS news)--Chemical makers can’t pass on higher feedstock and energy costs fast enough and the strain is beginning to show.

Dow Chemical  is a forthright if not aggressive company at the best of times. Its message to the market now is clear. Higher costs have to be passed on in higher prices. The announcement of a 25% across the board price increase, though, is unprecedented.

Producers have begun to wilt under the pressure from sky-rocketing oil and natural gas prices. Dow CEO Andrew Liveris says his company’s price increases are unavoidable although market reaction to earlier price hikes has been as expected.

Not all companies are as upfront as Dow but the industry generally knows it has to raise prices fast if it is not to suffer badly this year, probably just before the petrochemicals and polymers business at least heads into a supply-driven downturn.

Dow says its feedstock and energy costs are up 40% in the first six months of this year compared to the same period of 2007 and that those costs could be as high as $32bn (€20bn) in 2008. That compares with just $8bn in 2002.

The chemicals industry is a sector at the forefront of the sharp increase in costs that will ultimately be felt across industry and the wider economy.

Fears of stagflation are justified. Dow has not been alone in attempting to initiate across the board price increases; other chemical companies will follow suit. Steel makers and producers of other commodities are all talking about pushing their costs down the manufacturing chain.

Dow is a company that is doing a lot right: raising energy efficiencies, striving to become less commodity-oriented and positioned closer to specific end-use markets, but that does not shield it fully from such significant change in such a short period.

Not surprisingly on Tuesday, Dow’s share price was hit hard by the statement of intent and suffered its heaviest fall in two months. But Dow is entirely realistic. The company can’t continue to absorb freight costs in North America - it works on a “seller absorbs freight” basis. It is adding a truck and rails freight surcharge of $300 and $600 a shipment, respectively, that will add a fraction of a cent a pound to product prices.

It also intends to idle temporarily or cut back capacity at some production facilities. These moves have been and will be significant.

Dow has cut its global ethylene oxide production capacity by 25%: it is one of the world's top three players. Some 30% of its North America acrylic acid capacity has been idled.

Styrene capacity in Europe will be turned down 40%. And the European polystyrene operating rate has been cut by about 15%.

Significantly, also, it is not just upstream businesses that are bearing the pain. Dow has already cut back some latex rubber production. It says now that it will implement cutbacks in its automotive business involving plants, people and external spending. Styrofoam production in Europe has been cut back by 20%. This is the expandable foam used in construction.

The company, alongside many other chemicals makers, has been hit by a double whammy: the sharp run up in feedstock and energy costs and a downturn in significant end-use markets for chemicals - automobiles and construction.

Dow is being hit hardest in the US, and Liveris’s remarks, alongside those of DuPont chief executive Chad Holliday, were picked up in the media as clear signs of just how bad things might become.

In the coming weeks the extent of the impact of higher costs, not simply on upstream producers like Dow but on all chemical makers, will become more widely apparent. It will also become more widely apparent that cost inflation is the biggest challenge the industry faces and pushes all others into relative insignificance.

Companies will have to learn how successfully to ride the inflation wave.

($1 = €0.64)

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By: Nigel Davis
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