Dealing with volatility

02 September 2011 16:53  [Source: ICB]

Producers and consumers of chemicals have been coping with a period of unparalleled volatility in feedstock prices ever since the oil price spike of 2007. Along the whole value chain, there has been pressure to maintain margins by passing feedstock price hikes on to downstream customers.

How successfully this can be achieved depends on the health of downstream demand to the end-consumer. For many in the industry, 2010 and 2011 have seen continually improving trading conditions with healthy demand allowing price hikes to be passed through, albeit with a time lag. Nevertheless, there comes a point where demand destruction is a danger through product substitution or a decision to cease manufacturing.

© Beyond Neon Chemical manufacturers are having to learn to cope with huge increases and swings in feedstock prices, making swoops, dives and steep climbs commonplace

Germany's Bayer MaterialScience is a major manufacturer of polyurethanes (PU) and polycarbonate (PC). Major raw materials include benzene, toluene and propylene or propylene oxide for PU and also phenol for the PC business.

Peter Vanacker, the company's head of industrial marketing, highlights the extent of the volatility his company is experiencing. He indexed a basket of the company's raw materials. Taking 2002 as the base year, average prices after the financial crisis in 2008 went down as low as 92 and up to 155 at the peak, at the beginning of 2011 when phenol and propylene were at historically high levels.

Vanacker says the challenge is two-fold: volatility and high prices. BMS has been able to increase prices for its products thanks to recovery and strong growth - in Europe and emerging markets especially China - in most of the markets the company serves.

"It's not easy because, of course, our ­customers are also having to deal with this volatility, and it's also difficult for them to pass on costs into their markets. In general we've been able to pass on the increases on a BMS level. PC has been quite tight with very strong demand thanks to excellent inroads for applications in electronics such as flat screen TVs and netbooks."

Vanacker says the company's strategies are focused on trying to balance market price risks on the one hand and supply risks for major strategic raw materials. "By having the right mixture of mid to long-term contracts, short-term contracts and spot purchases, we're trying to mitigate the price risks whilst guarding against getting into a supply risk."

BMS company strategy has always been to produce in the region where demand exists because this is best from a supply, service and cost point of view. "We try to secure raw materials locally but also have a mix of global partners. If we're targeting high single digit [sales] growth then it's important to have the partners who can support us in this growth." Vanacker says that on average, raw materials make up 30-50% of finished product prices. Capital costs and energy are also important costs. He insists product substitution is not an issue for the company because its products are more likely to replace other materials than be replaced.

FEEDSTOCK HIKES HIT PROFITS

German specialty group Altana saw its first-half 2011 profits hit by high commodity feedstock prices, which could also result in demand destruction in end-use industries, according to the company's CEO, Matthias Wolfgruber.

Chemical and polymer feedstock hikes of 20%/year for two years running have forced Altana to increase its prices to downstream customers. But there is a danger that end users may substitute cheaper alternatives if price increases continue, Wolfgruber says.

Altana has been able to pass most of these increases on, but not all of them, because the company is tied into long-term contracts with customers. Wolfgruber expects margins to be slightly squeezed for full-year 2011, with the earnings before interest, tax, depreciation and amortization (EBITDA) margin falling by 1-2 percentage points from last year's 20.5%. "The biggest challenge this year for the ­downstream chemical industry has been the massive increase in the price of basic ­chemicals and feedstocks. We have mostly been able to pass them on because we are a true specialty business. But this is a stretch for our customers because we are far down the value chain, and it is getting harder to squeeze them," he says.

Wolfgruber adds: "It's a big concern - not that we can't pass the increases on, but that we will impact the end-user. They can choose different products or change their buying behavior. The big rise from crude oil will impact consumers."

Altana has not yet experienced a slowdown in demand, but Wolfgruber expects the second half of the year to be softer than the first.

"There will be an impact from all the efforts China is making to avoid a bubble and to slow growth. Also, the US market has challenges and there are the fiscal issues in Europe. But we still expect to deliver high single-digit top-line growth with lower single-digit profit growth."

Of all Altana's end-use markets, automotive is still growing strongly. However, Wolfgruber says construction is struggling while food packaging, although not as volatile, is not growing strongly. He adds that growth could also be slowing in electronic goods.

 

HOW BASF DEALS WITH FEEDSTOCK VOLATILITY

Karin Moeschke, head of global communication, ­procurement and logistics, answers our questions:

How does BASF cope with the current volatility in feedstock prices from internal and external suppliers - how difficult is this to deal with? Do you try to fix into long term contracts or have other ways of hedging prices to reduce volatility?

Feedstock price volatility is a constant focus of our activities. To a significant extent, BASF is naturally hedged via our oil and gas activities. Wherever we are not in a position to pass on the remaining price risk to the market, we actively manage that risk via our contracting and hedging strategy. We minimize procurement risks through our broad portfolio, our global purchasing activities and the purchase of additional quantities of raw materials on spot markets

Do you expect volatility in pricing to continue?

We continue to assume that the volatility of raw materials prices, at least in the short term, will be above the historical level.

What strategies do you have for passing price increases on to internal and external customers? Do you pass on immediately or absorb some of the impact of volatility to keep customers satisfied?

For the petrochemical market, prices are mostly transparent and based on raw material costs. The prices for base products like olefins or aromatics are mainly ­related to oil and the actual supply-demand situation. For higher-value products like acrylic acid or ethylene oxide, often price formulas are used to base their prices on olefin raw materials. So, of course, BASF prices are also related to these market prices. These market mechanisms are valid for external as well as for internal customers. Currently, customer stocks are on average rather low and demandis satisfying.

To what extent are customers willing or able to accept price hikes in the current macroeconomic environment? Is there sufficient demand and tight enough supply to ensure they continue to purchase?

In most cases downstream petrochemical customers are able to pass price increases on to their own customers. Because of this plus the transparency of the market mechanism, price changes are rather accepted.

Have you noticed any trend towards product substitution among your customers - either choosing a cheaper product line or a totally different technology? Can you give any examples?

For petrochemicals, in the case of high prices, demand can also abate to some extent, because of product substitution. For example polypropylene (PP) can be substituted for high density polyethylene (HDPE) or polystyrene (PS). There may also be a reduced propensity to buy from end-consumers.

By: Will Beacham
+44 20 8652 3214

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