INSIGHT: Downstream markets struggle with feedstock hikes

26 January 2011 17:39  [Source: ICIS news]

By Mark Victory

LONDON (ICIS)--Imagine an enclosed space. On the left hand side is a large rock, on the right hand side is a hard place. You are standing in the middle. Downstream manufacturers find themselves increasingly in this situation as Brent crude prices approach $100/bbl.

Feedstock costs are rising, but end-users are resisting price increases: the result is weakened margins.

“Suppliers have options, customers have options, but we have to sell at market level to be competitive,” said one manufacturer of finished goods made from polycarbonate (PC).

Difficulties in passing on cost-increases in Europe have been seen in the phthalic anhydride (PA), nylon (or polyamide), polycarbonate, methyl methacrylate (MMA), butanediol (BDO), polyacetal (POM), chlor-alkali, polyols, methyl ethyl ketone (MEK), methyl isobutyl ketone (MIBK), isopropanol (IPA) and isocyanates markets.

Eroding margins are linked to two major factors - weak demand in major petrochemical end-use markets such as construction, and the need to preserve market share. The impact of these two price drivers is perhaps best shown by the PA, polyvinyl chloride (PVC) and polycarbonate industries.

PA producers estimate that margins were eroded by €200-300/tonne during 2010 because poor consumption meant that feedstock orthoxylene (OX) cost rises could not be passed on to customers.

OX contract prices increased by €85/tonne over November and December, for example. During the same period PA spot prices were stable because of weak buying interest in construction - a major downstream market for PA.

“The PA price is more than a crisis, it’s a struggle for life,” one PA producer said at the time.

PA margins have improved by €30-50/tonne since the end of December, but this has not restored margins to October levels - the production ratio on OX to PA is 1:0.96. January OX contracts rolled over from December.

Poor construction demand in the fourth quarter of 2010 was linked to bad weather limiting activity. The fourth and first quarters of the year are typically the low season in this business and 2011 looks set to follow traditional trading patterns.

A similar effect is currently being seen in the PVC market. The loss of €10-20/tonne of margin in January due to higher production costs, coupled with the €30/tonne lost in the last few months of 2010 - when PVC prices could not be raised - meant that margins needed to increase by  €40-50/tonne to recover, even before rising energy costs were factored in, producers said.

A number of integrated chlor-alkali producers confirmed that ample supply and weak demand were the major factors behind downward price pressure. Demand in the PVC market remained 15-25% below pre-2008 financial crisis levels.

In the polycarbonate market players are targeting price hikes of €0.20-0.30/kg based on increasing costs upstream in the phenolics chain - driven by benzene. Because of competition from other plastics, finished goods manufacturers producing material from PC said that they will struggle to pass on costs without losing market share, because of strong inter-market competition and lower cost alternative products such as acrylonitrile butadiene styrene (ABS) or other styrenics.

“At a certain moment we said we wouldn’t pay [the polycarbonate price increases]. They [producers] said ‘then we won’t accept your orders’. There’s no room for negotiations. It means we can’t sell the volumes we’re aiming at,” one finished goods manufacturer said.

Resistance to price hikes in Europe may become firmer if the spectre of stagflation becomes a reality - as some economists are now beginning to fear.

Austerity measures across Europe in 2011 will limit government spending and raise public sector unemployment - providing the possibility of stagnant growth - whereas rising commodity prices and taxation increases will increase inflationary pressure. Since the majority of downstream markets are linked to GDP, this would have a major effect on chemicals demand.

Along with difficulties in passing through cost-increases, markets still working on quarterly contracts are also facing margin erosions, because the size of feedstock cost increases exceeded expectations in both the fourth quarter of 2010 and in January 2011.

Significant increases for January contracts took propylene to a record high of €1,070/tonne FD (free delivered) NWE (northwest Europe) and ethylene to a two year high of €1,110/tonne FD NWE. Benzene saw price increases of €149/tonne in January contracts with expectations of further hikes in February, and butadiene February contract prices rose by €100/tonne.

“Most customers came to the end of the year holding low stocks with the expectation of price stability. Now they have to buy and are forced to pay much more,” said an ABS buyer.

For the MA market, feedstock n-butane costs increased by €150-200/tonne during the fourth quarter of 2010, which was in excess of the predicted rises of €50-75/tonne which had been incorporated as a counterweight in MA fourth quarter contracts.

The volatility of feedstock movements makes it difficult for producers of downstream products to accurately forecast contract levels. When feedstock costs increase significantly it can lead to months of lower margins for those on longer term contracts. Tyre manufacturers find themselves in this situation in having to cope with rising SBR and natural rubber costs.

“There’s always a delay of three months to push through higher prices - it means we lose margins,” a major tyre maker confirmed.

The uncertainty of cost movements has led to a push for shorter term contracts in many downstream markets. This has already been seen in the SBR market, following a similar move in the feedstock butadiene market. Nylon producers and tyre manufacturers are considering similar moves.

“We have to look at the volatility of raw material costs over a longer period. If the volatility continues, we will need more regular price changes otherwise stock values will go down,” another major tyre manufacturer said.

It is the downstream markets that feel the squeeze as austerity measures bite and feedstock values rise.

($1 = €0.73)

Additional reporting: Heidi Finch, Julia Meehan, Amandeep Parmar, Helena Strathearn, Nel Weddle and Stephanie Wilson

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By: Mark Victory
+44 208 652 3214

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