INSIGHT: Feedstock costs hang over Q2 results

21 July 2008 17:09  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS news)--This is likely to be a miserable reporting season for chemical companies from Europe and the US.

The second quarter has proved extremely difficult with margins under severe pressure from skyrocketing liquid feedstock and energy costs.

Companies have continued to do everything they can to pass on the cost burden but the lag effect will have been felt. Past performance aside, the prospects for players linked in most ways to olefins and aromatics look grim.

Products sold into the depressed housing construction markets are under pressure. Demand destruction in downstream markets is making itself felt in aromatics.

Chemicals are beginning to feel the pinch from the global economic slowdown. Seasonal factors will come into play but there is concern that demand slowdown is affecting a wide range of petrochemicals and polymers.

Polyolefins demand appears to be holding up in Europe and North America but is depressed in Asia, where China demand appears persistently weak.

The polystyrene business is depressed. China demand is poor. Demand is such in Europe that the industry operating rate is only about 80%.

The ICIS news polyethylene margin report through June showed how bad things had become. The variable margin for typical naphtha fed crackers in Europe was negative for much of the month and integrated polyethylene margins were sharply lower.

Citigroup on Monday highlighted the pressure on ethylene makers and on producers of polyolefins from soaring feedstock costs.

Average cash margins for a naphtha cracker in Europe were at levels not seen since 2002 and some higher fixed cost crackers had lost money, the bank said in a note to clients. The cost increases were not limited to Europe given a sharp increase in US ethane costs since May.

The point is made that higher derivatives pricing has caused a surge in pre-buying which may have flattened derivatives producers’ profitability in the second half.

Cracker operators and polyolefins producers have, of course, not simply taken the rapid and steep naphtha and gas cost increases in their stride - polymer producers have worked particularly hard in their attempts to drive prices higher posting the need for significant price increases for June and July business.

The numbers collected by ICIS also suggest that integrated ethylene/polyethylene makers in Europe have regained a great deal of ground given the higher quarterly ethylene contract prices and higher polymer prices.

This past week, however, nearly all the recovery in integrated margin has been taken at the cracker. Standalone polyethylene margins are stronger now than they were in June but down on the first quarter.

Ethylene and polyolefins producers have had to claw back as much as they can in higher prices but they may yet have to pay for the move given the recent weakening in crude.

Customers that have been helped pass on higher costs will, in turn, expect to benefit should feedstock and energy costs move lower.

In such a situation, petrochemical producers could suffer further with relatively stronger feedstock costs but lower product prices at a time of still weakening demand.

Citigroup is of the opinion that derivatives demand is being hit by stock-building, particularly from plastics converters pre-buying ahead of expected feedstock-driven price increases.

Intriguingly, the bank adds, US demand is being driven by the domestic market and not by export volumes which appear to have fallen by about 10% since hitting record levels in April.

Indeed, as much of the rest of the world begins to feel the colder winds of an economic downturn there are signs that the US economy is in a healthier state than some, at least, might have expected.

The statistics showed a surprising gain in industrial production in the US last week but, as the American Chemistry Council (ACC) has pointed out, the increase was driven by utility and mining output.

The industrial production report showed that activity in June declined in basic and in agricultural chemicals. Regional surveys suggest that the softness extended into July.

On the back of declining sector-specific industrial activity, the chemicals business is also likely to suffer from the continued falls in home-building and the impact of rising inflation.

Sector companies have been hit by the construction slowdown but have not yet felt anything like the full impact of rising consumer inflation.

The sector will feel this squeeze in the second half, the prospects for which are hardly rosy. For ethylene chain chemicals, the future looks extremely difficult.

As Citigroup notes: “The surge in feedstock costs and a progressively weakening global demand environment has accelerated the decline to a pace that no-one anticipated."

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By: Nigel Davis
+44 20 8652 3214

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