INSIGHT: Understanding how to manage volatility

06 July 2012 16:26  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS)--Chemical producers and consumers are not so much threatened by market volatility but they do have to be able to manage it effectively. Perhaps if there was more supplier-consumer collaboration across chemical value chains they would be better able to do so.

The increase in volatility in chemical prices and volumes since the 2008-09 crash has been significant. More closely managed supply, coupled with strict inventory management, has changed the way most markets work. Prices have become more volatile as a result, and also as fluctuating raw material costs are fed down the chain.

“Volatility has grown to be a major issue,” AT Kearney, says in its latest report on the chemical industry in Europe.

“Driven by the global financial crisis and its aftermath, most companies have established processes and tools to respond quickly to volatility and to mitigate their exposure to it, for instance by improving pricing and hedging,” the consulting firm adds.

“Volatility will undoubtedly continue to leave a significant impact on future chemical markets.”

Indeed, 55% of those responding to an annual survey of customer-supplier relationships in the European chemical industry feel threatened by higher volatility.

The disquiet of some in the sector is reflected in discussions underway about polymer and other commodity prices following the uptick in the oil price which began on 29 June.

Prior to that, petrochemical prices had been tracking oil and naphtha down, losing more than 30% of their value in a matter of months.

The sharp €170/tonne drop in the ethylene and propylene contract price in Europe for July reflected lower feedstock costs and the need to stimulate demand. Polymer producer customers, particularly, were holding back purchases as they waited for adjustment in olefins and subsequently polyolefins prices.

That led to a selling spree of polyethylene (PE) and polypropylene (PP) at the end of June given the low prices on offer, ICIS reported on Friday. Now, those offers have been withdrawn or are on hold given the rise in the oil price and producers’ concerns that they will lose margin.

As oil prices swing, so do upstream chemical prices and eventually intermediates and other products in the supply chain.

So how do companies manage these changes while preserving margins, trying to grow and raise profits; in effect to remain competitive?

According to AT Kearney, producers and chemical customers are taking a similar approach to managing volatility. According to respondents to this survey, effective internal planning processes; linking inventory management more closely to business outlooks; and using scenarios for investment decisions are the most widely used tools.

But the consultants believe that companies need to make sure that they have comprehensive warning systems in place to identify where volatility might hit next.

It may appear to be relatively simple at the polyolefin/converter interface, but companies still benefit from having well thought through scenarios in place. Testing one view of the future against another can prove invaluable.

AT Kearney believes that more effective collaboration across chemical chains can drive growth, release untapped value and drive competitiveness.

Improved collaboration could lift sales across the European chemical industry by between 2% and 4%, or €12bn ($15bn), to €25bn, it says. According to its survey, 48% of Europe’s chemical manufacturers and 57% of customers expect improved collaboration to lead to improvements of this magnitude.

“It is time for companies to more fundamentally question their business models and value chain and think intensely about increasing supplier customer collaboration along the entire value chain,” says AT Kearney Chemicals and Oil Practice partner Tobias Lewe.

If they do that, they probably have a better chance of securing competitiveness and of growing in an increasingly volatile world.

($1 = €0.81)

Read Paul Hodges’ Chemicals and the Economy blog
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By: Nigel Davis
+44 20 8652 3214

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