Chemicals Companies Risk Losing Market Muscle

LLDPEChina1

By John Richardson

IT used to be so easy. All you had to do was build a feedstock-advantage plant outside China and/or build a plant in China and demand would take care of itself.

The reason was that China was on a roll from 2001 onwards thanks to its accession to the World Trade Organisation, which brought down tariffs and removed quotas that limited exports by volume.

It used cheap labour, subsidised land, cheap energy and an artificially undervalued Yuan to take maximum value of these more open markets through subsidising manufacturing. Companies were also allowed to ignore environmental laws in order to give them even more of a competitive edge.

And the West voraciously gobbled-up Chinese exports because of easy credit and favourable demographics, which created a Supercycle of demand from 1983 until 2007.

This was wonderful news for the global chemicals industry as it was able to ship lots of chemicals and polymers to China, which were turned into finished goods and often sent back to the countries where the raw materials originally came from.

Paul Satchell, the UK-based chemicals analyst, perfectly describes what impact this had on the chemicals industry’s pricing power.

“Prior to 2004, the industry (particularly in commodities) had been seen collectively as a price-taker, with customers being largely in control of negotiations,” wrote Paul, who works for Canaccord Genuity, the investment bank,  in a December report.

“One of the key impacts of this had been that chemicals stocks were often marked down when input costs rose.

“2004 changed that perception markedly. The underlying reason for the change was the extraordinary levels of demand for chemicals during that period, mostly driven by China and other emerging economies.

“Pricing power in commodity chemicals is contingent on tight supply/demand balances: high capacity utilisations. Volume demand was so strong in a wide range of chemicals that suppliers enjoyed exceptionally good pricing power for an extended period.

“The oil price approximately doubled during 2004, which would previously have been seen as potentially disastrous for petrochemicals manufacturers. However, many companies  actually increased their operating margins during this period.

“Companies managed to pass-through more than 100% of input cost increases, supported by the strength of volume demand.”

Then, of course, came the September 2008 global financial crisis which left some major petrochemicals and polymer producers on the verge of bankruptcy.

But life quickly returned to normal for some, thanks to China’s enormous 2008-2009 economic stimulus package.

Things turned pear-shaped again from April 2011 until around the middle of this year as China fought inflation, but a renewed surge in lending and more government stimulus has led to, on the whole, a pretty good 2013.

Where do we go from here?

The ability of Western chemicals companies to shift volumes, and thus retain pricing power, will be sharply curtailed, we think, because of the profound changes taking place in China’s economy.

Capacity additions in basic petrochemicals, particularly in polyolefins, don’t seem to factor in the implications on growth of these changes.

Nowhere else in the emerging Asia compares with China, as the chart above reminds us. In volume terms,  these other countries simply cannot catch up.

And so unless chemicals companies take a realistic approach to growth and investment, they could be back where they were before 2004, when they were price-takers rather than makers.

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