Price and market trends: US polypropylene market considers shift from cost-plus pricing

16 November 2012 09:28  [Source: ICB]

Producers want to move away from formula-based pricing to market-based. Does this signal a tightening market?

As the 2013 contract negotiation season heats up, participants in the US polypropylene (PP) market are facing a new wrinkle with producers who are seeking to move away from cost-plus pricing.

Currently, market participants estimate that more than 90% of US PP customers are locked into a formula-based contract, which follows the monthly polymer-grade propylene (PGP) cost.

The formula allows for a set margin on top of any movement in the monthly PGP contract, depending upon the size of the buyer. So for instance, a small volume buyer would pay the PGP cost plus a margin of somewhere around 11-13 cents/lb ($243-287/tonne, €189-224/tonne).

While formula pricing offers clarity to buyers and suppliers who never have to argue about what prices will be, many suppliers say it is time for a change.

"Monomer plus does not make any sense any more," said one producer, who said it is in the process of negotiating with customers to move toward more market-based pricing. "All of the profits we are adding are coming from our contract for monomer. It is not healthy it's not profitable."

The problem with the formula-based contracts, suppliers say, is that they have essentially removed all margin from the business. While producers are able to recoup the costs when feedstocks rise, they are not able to increase prices when other costs, such as fuel, transportation or overhead, rise.

"If I am a processor [producer] and my freight goes up by 10% but monomer goes down for three months, I'm still up 10% on my freight, but my margin gets cut even more," said a distributor. "They have got to do something to get away from monomer."

It is difficult to pinpoint exactly when the market moved to monomer-plus contracts, but sources say the trend has been in place for at least the last five years.

"I think some of it traces back to when PP was long," said Phillip Karig, managing director of Mathelin Bay Associates, a US and European plastics industry consultant. "If you are a resin producer and the product is long, you want to go to a cost-plus type formula, because you want to be able to pass along your raw material costs."


 The balance of power may shift with a new pricing mechanism

Copyright: RexFeatures

Karig suggested any move away from formula pricing would signify a fundamental shift in the way producers are viewing the market.

"For them to want to move away from a raw material-type formula tells me that they think the market is going to tighten up one way or another," he said.

That is, in fact, what some producers have argued. In a 29 October letter to US PP customers, INEOS said 19% of North American PP capacity has closed over the past five years, and additional PP assets have lost enough feedstock supply to keep them from achieving full production levels.

"As a result, the polypropylene industry now lacks the slack capacity it has historically had to handle significant demand increases or even short term disruptions to production, whether due to weather or other causes," the letter states.

Producers are arguing that in a tighter market, supply and demand fundamentals should play a more significant role in price negotiations than feedstock costs.

Such a move away from formula-based contracts could benefit buyers, particularly if it helps to curb some of the volatility in the market.

One buyer said market pricing would benefit large buyers, but that it could be bad for small-volume buyers.

"It would take some time, but once margin is brought back into the producer side of the business, then larger buyers should be able to differentiate themselves from the small to medium-sized buyers," the buyer said.

Producers said they have already seen some willingness among large buyers to move away from formula-based pricing. But the transition will not be an easy one, and some market participants say they are not convinced it will happen.

It is not clear that all producers support the move to market-based or index-based pricing. Some market participants have argued it will be difficult for some producers to make the shift without support from the rest of the market.

Additionally, some producers are hedging their bets, offering monomer-plus contracts with additional margin built into the contract. So for instance, instead of a small-volume buyer paying PGP plus 13 cents/lb, they might pay PGP plus 15 cents/lb in 2013.

"I would say the goal is to improve the margin either way," said one producer, who said negotiations are taking place with both monomer-plus and market-based contracts being offered. "It is premature to say one way or another as far as what is really going to happen I think this industry is going to try to get improvement in whichever way they can."

By: Michelle Klump
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