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Three themes defining the supply chain challenges ahead

ICIS, ICIS Pricing, Uncategorised
By Jeremy Pafford on 31-Aug-2022

As summer wanes and autumn draws near, storm clouds continue to gather on the horizon and creep closer with every new record for the Dutch TTF gas price. It is not a hyperbole to say that this winter looks quite harrowing for many commodity marketplaces, and Europe is ground zero for what on paper looks to be a seismic event that could lead to governments there deciding between heating homes and businesses operating. Let us hope the doomsday scenarios do not come to pass. Regardless, the situation sets up three themes that I think define the rest of 2022 and likely start the narrative that will be 2023:

Upstream costs nearest the barrel or well will remain elevated

Natural gas prices likely will press higher across the world, with regional shortages a possibility for importers. Crude oil prices have drifted lower in recent weeks, but current levels seem likely to be the floor, especially with Saudi Arabia intimating that it could cut production in the near future to put an end to that market’s recent bearish tone. That means naphtha feedstock costs could remain high while their downstream derivatives continue to fall in price, or in the case of Asia, derivative prices will remain mired in the doldrums of weak domestic demand. Margins will tighten, and some chemical producers may decide that production is becoming economically unsustainable in the short term. This is absolutely a threat to security of supply for chemical and plastics supply chains.

This is not just a European issue amid record-high natural gas prices (where 13.5m tonnes of fertilizer and chemical capacity has been affected) or an ongoing issue in parts of Asia amid tepid demand and power rationing. It is an issue in the US as well, where styrene plant operating rates are below 80% capacity and one Gulf Coast producer has shut its plant down due to poor economics. ICIS Margin Analytics illustrate that situation, with US spot styrene margins nearly reaching breakeven levels amid record high benzene prices earlier this summer and tepid styrene demand.

While those in the US and elsewhere using ethane to make their chemicals are somewhat sheltered from high upstream costs, ethane prices have jumped alongside natural gas prices, as there is a natural tie there. Margins for ethane-based materials such as ethylene, polyethylene and polyvinyl chloride will be advantaged, but they may not be as healthy as they were earlier in the year.

Consumers have little ability to shoulder price increases

Whether in Europe, the US or even Australia, the consumer is not in a good place amid persistent inflationary pressures that are leading to more spend on needs (energy, housing, food) and less ability to splurge on wants (particularly premium brands and durable goods). Knock-on effects of this consumer stress show up in the supply chain in the form of retail inventory pile-ups such as what Walmart, Target and other retailers have been reporting. Just upstream, packagers such as Sealed Air feel that in the form of reduced volumes in consumer retail and fulfillment, as their CEO noted in a quarterly earnings call earlier this month. That, in turn, backs up into higher inventories for resin producers. For example, the US at present is at record levels for polyethylene (PE) inventories, as illustrated in the chart below posted this week by CDI’s Brian Pruett as part of an illuminating LinkedIn post on falling prices in the PE market.

Market conditions will mandate an evolution in the supply chain

We seem to be on the cusp of multiple flashpoints that will define the strategies in the short, medium and long terms for chemicals and plastics supply chains:

  • Europe may be able to weather winter gas shortages and record energy prices via cuts in industrial production, but the developing situation is unsustainable in the long run. Either industrial production will have to be curtailed in the long term or the continent finds new energy and feedstock sources, because a return to supply from Russia for gas, oil and refined products seems unlikely. The epicenter of European chemical production, Germany, is already coming to grips with what the long run could look like, with one manufacturing executive telling Bloomberg recently that “I fear a gradual de-industrialization of the German economy.”
  • Demand growth will be increasingly harder for manufacturers to sniff out with three major consuming regions – the US, China and Europe – dogged by recession. As my colleague John Richardson has written so eloquently about recently, China no longer is growing for growth’s sake, so chemical companies cannot rely on it to be a safe harbour for demand amid hardships in Europe and slow economic growth in the US.
  • Chemical markets will not return to pre-2021 behaviour. The Asian, US and European markets had optimised themselves among each other in the previous decade, with arbitrage windows among them never staying open too long due to willing and able traders moving products to maximise profits and meet supply-chain needs. Myriad logistics issues separated Asia from the European and US markets enough to make those arbitrage windows unworkable logistically for many. Despite container rates and availability easing, the markets are now operating in parallel, with the US and Europe still at large premiums to Asia (see IPEX graphic below). Europe’s high energy and feedstock costs prevent its products from dropping enough to reach current Asian prices, and the US has been priced higher than Europe on IPEX chemicals both historically and currently, so Asia prices will likely need to rise to return markets to their pre-2021 synchronicity. With China not in growth mode and its zero-COVID strategy showing no signs of ending, that seems unlikely in the short term. Moving supply chains closer to their respective homes may make such regional disconnects permanent.

Questions supply-chain participants should be asking of their businesses

Members of the chemical and plastics supply chains are searching for ways to gird their businesses to survive and hopefully thrive in the tumultuous months ahead. Here are a few questions they should be answering in their internal discussions surrounding the challenges ahead:

  • How have rising energy costs affected operations? How have we prepared for continued energy price pressures in the months ahead?
  • (For buyers/procurers) With many chemical and resin prices falling, how is our company optimising its sourcing strategies to make sure it is getting all of the decreases?
  • (For sellers)With many chemical and resin prices falling, how is our company optimising its selling strategies to protect margins?
  • What direct connections does our supply chain have to Europe? How have we analysed the supply-chain risks posed by those? What have we done to uncover possible indirect connections to European production that might pose a risk?
  • With consumer demand growth in question going forward, how does our company plan to differentiate its value from competitors? How does our department fit with that strategy?

Disclaimer: The views in this blogpost should in no shape or form be taken as actual forecasts and are my personal views only.