Commentary: Chemical companies must move fast with oil prices

Now that crude oil price volatility has been reintroduced into the equation, chemical companies must prepare to act quickly among several value chains

Chemical companies have been warned not to be complacent in the face of ongoing oil price volatility. Essentially, don’t assume too much – prepare for further price falls as well as possible price increases, and be ready to act quickly.

The table shown here is from the latest economics report from Germany’s chemical trade federation, the VCI. It clearly demonstrates the impact of crude price swings on naphtha costs and on downstream petrochemical product prices.

John Richardson, Asia consultant for ICIS Consulting, suggests in a 13 May post on the ICIS Asian Chemical Connnections blog that chemical producers should not be hoodwinked by recent crude oil price increases.

“The recent recovery in oil prices has been driven by speculators who have taken out an increasing number of long positions in paper markets,” Richardson said. He also suggests that companies must understand the role that the US Federal Reserve has played in returning the oil markets to “19th Century boom and bust cycles”.

Consultancy McKinsey claims that producers were underprepared for the magnitude of last year’s oil price shock and the speed of the impact on chemicals.

“Chemical companies need to develop the organisational agility to prepare for impending shocks and take rapid action when they occur, to capture value and minimise threats,” the consultancy said.

Supply volatility and OPEC’s reluctance to act has increased the likelihood of short-term supply/demand imbalances and rapid price spikes and falls, it added.

“The intersection of changing cost structures and price mechanisms due to oil shocks has a significant impact on chemical producers’ economics and reshapes value creation and competitive dynamics,” said McKinsey.

Chemical companies do need to better understand the impact of oil price swings on prices, costs and the competitive environment for different product chains in different regions. There is a degree of fluidity in the business now following a lengthy period of relative price and margin stability.

McKinsey believes that many senior chemical company managers are not fully aware of how their portfolio of products is exposed to oil price swings.

Different products chains are affected by oil price movements in different ways. The consulting group suggests there are three broad categories. In one, companies can play on their commercial advantage to shift costs rapidly downstream to help stabilise or improve margins, possibly for only a short period though.

In some markets regional impacts are asymmetrical, making players take decisions that eventually may lead to supply/demand balances.

Polyvinyl chloride (PVC) is a case in point. PVC prices fell when Asia naphtha costs dropped, putting some margin pressure on US producers. China’s coal-based acetylene route companies have emerged as the marginal producers and their costs ultimately have prevented PVC prices from falling further.

Some specialty products benefit when oil prices are low (lower costs) and face margin compression as oil prices rise. And some products, such as bio-based chemicals and certain lubricant additives appear, at first sight at least, to be impervious to changes in the oil price.

Coupled with a clear understanding of the impact of oil price movements today has to be the ability to react quickly. “Companies must monitor oil-price indicators and embrace exceptional analytical capabilities to be alert to impending oil shocks as soon as possible,” McKinsey warned.

That may mean that they have to widen their inputs and the bases on which their business scenarios are built.

They need to fully understand product chain exposures and be in a position to take decisive action to minimise risks, it added. Think financial hedging, contracting, feedstock choices.

Understanding the potential impacts is one thing – identifying actions is another. Ultimately companies need the functional and managerial agility to be able to act decisively when the oil price environment changes.

“Chemical companies need not necessarily fear oil-price volatility; in fact, the best ones will savour the opportunities it presents,” McKinsey said.