INSIGHT: Outlook is bleak if feedstocks stay high

02 July 2008 16:15  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS news)--Large parts of the chemical industry are “over a barrel”, Citigroup’s US chemicals analyst P J Juvekar suggested in a client note on Tuesday. But the outlook for some of the sector appears remarkably strong.

Upstream and in the major polymer chains life is tough given the high price of feedstocks and energy and depressed demand growth. Margins have dipped negative and the future looks bleak with major capacity additions about to hit the market.

Juvekar’s remarks are telling: his advice to investors in the US market is “stay defensive”. Citigroup favours stocks like Praxair, Air Products and Nalco; what it calls, oligopolies, like Albemarle and Celanese and, in agriculture, Monsanto.

Rising energy costs hit all aspects of the industry from raw material ands and conversion costs to freight and shipping, Juvekar notes. Companies have applied surcharges and are aggressively implement across the board price increases. But the sector is running fast simply to catch up.

Certainly the commodity end of the business is most exposed and has to move fastest while speciality makers usually have more leeway and pricing power. Yet major industry segments: those selling into the troubled US housing construction market and into pressured automobiles are having a tough time of it.

Demand growth for chemicals across the board has slowed rapidly in North America and Europe and the forecasts are not good.

As one European industry economist has put it, the sector is hardly in rip roaring mode. Growth has not kept pace with gross domestic product. The industry faces some “very, very tough times indeed”.

This feeling is widespread. The growth forecasts published over the past few days by the US and European chemical industries are hardly sparkling. The projections have also been revised sharply downwards from those made six months ago.

The data on which they are based may not be the most robust; the risks associated with the numbers being on the down side.

Sector companies have to work flat out to militate against the impact of fluctuating and high energy and feedstock costs.

“The industry can no longer offer price protection to its customers," Juvekar says.

“The chemical industry in the US was built for $20-$30 oil prices and $2 natural gas prices not today’s energy prices. To effectively deal with this level of energy prices, the US-based chemical management teams need a different kind of thinking”.

Realistically, then, out goes the focus on revenues and in comes a closer appraisal of the impact of all actions on the bottom line. Working capital and inventories have to be managed better. Senior management has to balance market share issues and profitability, Citigroup says.

The feedstock and energy issue hits largely worldwide as does the growth slow won although there are havens of growth and, still, relatively robust margins.

In a report from its European chemicals team, Citigroup notes that BASF, for instance, has not had to follow the actions of it peer, Dow Chemical, in announcing rounds of blanket price increases, freight surcharges, shutdowns and restructuring.

This has something to do with the way in which BASF’s European plants are more highly integrated and of larger scale than those of Dow. But it has also to do with the product mix.

BASF is buoyed by its Oil & Gas business. And both it and the Agriculture business are said to be booming. The messages somewhat similar at Bayer where the crop protection business is said to be growing strongly. The group’s polyurethanes business is challenged but seems to be holding out well.

Bayer believes in a step change in crop chemical demand, driven by the need to boost yields, Citigroup’s European chemicals team reports. On the positive side for Bayer, east European demand is growing, Brazilian farming is becoming more intensive and there is a trend for farmers in the US and Europe to switch from the preventative to the curative use of pesticides.

The market price of grains has historically not until now supported this sort of change.

Inflated commodity prices work id different ways across the sector providing headaches for all but coupled with opportunities for some.

The diversity of the sector to some extent shields it from the worst but that does not mean that most companies are not exposed.

As an exception to the general rule, chemical companies in segments such as industrial gases or agriculture will continue to produce stronger profits despite feedstock cost increases and weaker US growth, ratings agency Moody’s said on Wednesday.

But it added that "Surging prices of oil, energy and other commodities are reverberating through the North American chemicals industry."

The outlook for the segment is negative and seemingly worse by the day. The fourth quarter, particularly, could be “very weak” for most companies in the industry, Moody’s says if feedstock and energy prices remain high.

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By: Nigel Davis
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