INSIGHT: Big producers confident as sector holds on to upstream margins

03 August 2011 17:23  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS)--How are producers managing the balance between costs and prices in the ongoing battle to improve margins?

Second-quarter financial results indicate that for most, the answer has been well. Profit margins were up on the second quarter of last year. And they held relatively steady compared with the first quarter of 2011.

Lower product prices in China during the quarter, however, constrained returns. And towards the end of the reporting period, lower product prices in other regions exposed widening unease, with slower demand growth and weaker market sentiment.

Manufacturers have had their eyes on the lacklustre US economic recovery, China’s battle with inflation and the cutbacks accompanying the eurozone debt crisis.

Chemical producers have benefited greatly from tight markets and high prices for many months and, thus far, 2011 has proved to be a banner year for most firms. But it has not all been about prices.

Chemicals demand forecasts for 2011 have been raised since the beginning of the year as a result of the strong start. BASF last week suggested that global chemicals growth in 2011 could be between 5% and 6%, although it said the rate of growth would differ considerably between regions.

ICIS data show that key petrochemical prices continue to fall, particularly when reported in US dollars. The steepest falls over the past month have been of almost 10% in US and European benzene prices and 6–8% in paraxylene (PX) prices across all regions.

In June this year, the ICIS Petrochemical Index (IPEX) hit its highest point since the 2008–2009 crash, but has tracked lower since. It is made up of a basket of prices for ethylene, propylene, benzene, toluene, paraxylene (PX), styrene, methanol, butadiene (BD), polyvinyl chloride (PVC), polyethylene (PE), polypropylene (PP) and polystyrene (PS).

High BD prices – up 15% in the US and 7–8% in Europe in the past month – have helped underpin the index, but there are reports that BD users are starting to close plants because they have become uncompetitive.

But the ICIS data also indicate that producers upstream are managing the cost/price relationship very well despite the recent impact of lower product prices.

China ethylene and PE margins are lower than last year, but improved last month compared with June.

Northeast Asia ethylene margins have been tracking upwards since April and were higher last week. Both low density polyethylene (LDPE) and high density polyethylene (HDPE) margins are higher than last year and up on June on integrated and standalone bases.

Margins for ethylene producers in Europe improved last week on lower naphtha costs. They have been falling since the end of June on lower ethylene contract prices.

The lower naphtha costs fed through into stronger PE margins in spite of lower polymer prices.

In the US, higher ethane costs constrained contract ethylene margins, although higher spot ethylene prices managed to lift spot margins.

The picture these numbers paint is of an industry still managing to hold onto margins despite a somewhat weaker price environment. It is too soon to determine whether the slight uptick in China prices can stick in the current environment – overshadowed by the government’s drive to curtail inflation.

And while no company can be certain of margin growth, they can do all it takes to hold on to returns in a tricky market environment.

Dow Chemical CEO Andrew Liveris said in a 27 July conference call that China’s industrial economy was still doing very well. “They're managing themselves down very nicely,” he added, pointing to official GDP growth numbers of 8–9%, which translate into chemicals and plastics growth of 12–13%.

“We’re not seeing any issue here with polyethylene in terms of demand, especially our polyethylene, which is very much into applications such as agriculture, for example, and films and packaging in general, industrial packaging and the health and hygiene medical markets,” he said.

“We are seeing the demand growth, good volume growth and decent price power.”

In an investor note released on Wednesday, Bernstein Research, part of Hong Kong-based AllianceBernstein, said it believed BASF could hold on to pricing power in the second half of the year, although it focused on so-called niche commodities.

“We believe ‘niche' commodities – commodities with pricing power due to a highly concentrated supplier base, such as MDI [methyl di-p-phenylene isocyanate] – are increasingly interesting at this point in the chemicals cycle,” its analysts said.

“We expect the margin improvement seen in Q2:11 [the second quarter of 2011] for the ‘niche’ commodities to continue as the concentrated industry structure allows pricing power for the next 12–18 months.”

And Bernstein Research added: “Management has not detected a fundamental (negative) shift of demand across any of their businesses. They also report July 2011 order intake above July 2010 and an 'unpronounced' summer lull with auto production remaining strong in particular. Dow Chemical's Q2:11 comments are also supportive.”

The message from producers is one of relative confidence in volumes and of retaining the pricing power they have enjoyed for a long period. It remains to be seen whether they are proved to be fundamentally wrong later this year.

For the time being, their apparent optimism is being borne out.

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By: Nigel Davis
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