Market outlook: Cost savings sweet spot

The hot topic these days in oil and chemical markets is still the recent sharp drop in the price of crude oil that began in July 2014, and the impact price drop has had on downstream product prices, or in some cases the lack of an impact.

During this time, EU15 2014 auto sales, finished higher by 5.6% over 2013. With lower energy prices, consumers have more money to spend and after an extended period like this, an increase in auto sales is likely. ICIS Consulting projects a 3.6% to 4% increase in 2015 EU15 auto sales.

For most manufacturing sectors, raw materials represent the largest component of cost, averaging about 65% of Cost of Goods Sold (COGS). For automobiles, it is closer to 85%.

For this reason, the price of raw materials is very important to a business’ success. As the largest cost driver for most raw materials, the cost of crude oil is very important to the price of raw materials. If we look at some of the key raw materials and feedstocks, we can see how much they have dropped and calculate the impact on other products.

Most companies have the top few purchased products that represent the largest share of cost. These top tier purchased products receive the most attention and resources to insure a competitive price, and rightly so. In the automotive industry, metal products fall in this this top tier of spending.

Many times however, the highest potential for cost savings are in the second tier of purchased products. These represent a smaller spend, are usually managed by junior purchasing team members or an overloaded senior person, and often have a more complex value chain that is more difficult to understand. One of these second tiers is comprised of petrochemical related products in the automotive industry.

UNDERSTAFFED

To make matters worse, many purchasing departments are understaffed. This provides for some low hanging fruit (savings) in the second tier of purchased products that does not exist in the over-worked top tier.

To take advantage of these savings, it requires a knowledge of the product value stream, inter-relations and feedstocks. Here is a sample value stream for xylenes, a key ingredient for PET. Mixed xylenes are produced by catalytic reforming of naphtha, from the pyrolysis gasoline stream in a naphtha steam cracker and by toluene disproportionation. Paraxylene (PX) is the largest volume isomer of the mixed xylenes with nearly all PX demand coming from the polyester chain.

Naphtha, a distillation component of crude oil, is a key feedstock for many petrochemicals, including butadiene, ethylene, propylene, xylene, and gasoline. Since 2006, the US use of naphtha to produce ethylene has declined substantially as crackers shift to using more low cost ethane. Normally this would drive the price down, but because of high global demand, US naphtha exports have increased 13 times since 2006, and prices have remained high until the recent oil price drop.

Looking at the petrochemical relationships for PET, crude oil highly correlates to naphtha with an 88% R-squared value. Xylenes correlate to naphtha 87% and paraxylene correlates to PTA 97%. PTA correlates to paraxylene 99.5%. So, we can see this is a highly correlated value chain that is formula priced, for the most part.

Knowing these relationships help ensure that you are getting the full benefits from lower cost crude oil.

• James Ray is a Senior Consultant with ICIS and is the Instructor for the ICIS Advanced Purchasing Course. He is based in Houston, Texas, US.