Formulating A Complex Rebound

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Formulating A Complex Rebound

Post by Shirley on Sat Jun 18, 2011 1:51 am

Formulating A Complex Rebound

On Friday June 17, 2011, 4:33 pm EDT

A few years ago, a handful of analysts forecast long-term declines in the U.S. petrochemical sector as new capacity in Asia and the Middle East challenged the industry's competitive verve.

But fortunes have turned.

On June 6, Royal Dutch Shell (NYSE:RDSA - News) announced plans for its chemical division to build a "world class" ethylene refinery in the Northeast. In April, Dow Chemical (NYSE:DOW - News) said it planned a similar facility for the Gulf Coast, and would restart idled ethylene plants in Louisiana and Texas. A joint petrochemical venture between Chevron (NYSE:CVX - News) and ConocoPhillips (NYSE:COP - News) plans an equally ambitious Gulf Coast facility.

Estimated to cost more than $1 billion each, the projects are just one among many signals that the global chemical trade is rebounding hard from its 2008-09 slump, and that the U.S. segment figures prominently in the bounce.

The most profitable corner of the industry, specialty chemicals, is showing particular strength. Specialty chemicals makers are raising prices, almost across the board, in the face of rebounding industrial demand and rising raw materials costs.

One example: Naphtha, a key chemical feedstock, averaged $525 a metric ton in 2009, $710 last year and passed $1,000 in April.

Pricier raw materials were one reason Dallas-based Kronos Worldwide (NYSE:KRO - News) raised prices on its titanium dioxide pigments, used in coatings, plastics and paper, in May for the second time in several months.

Earlier, peer Rockwood (NYSE:ROC - News) raised pigment prices by up to 10%, citing "the rapid increase of ocean freight, raw material costs and energy prices." Albemarle (NYSE:ALB - News) boosted the price of certain flame retardants three times since February.

But the industry is also seeing wider margins in some areas, as a broad range of natural-gas-related feedstocks have fallen in price, due to the recent surfeit of natural gas supplies.

Those supplies lifted U.S. ethane production by 25% in 2010, "providing a significant feedstock cost advantage for U.S. petrochemical manufacturers," said Stephen Pryor, president of Exxon Mobil's (NYSE:XOM - News) chemical division, at a gathering of analysts in March.

Despite the price increases, manufacturers and industrial buyers haven't yet started to push back, said Michael Sison, an analyst with KeyBanc Capital Markets. Sales volumes have been growing in the mid to high-single-digit percentage range, lifting profits despite the price hikes.

"People are aware of the (price) pressures," Sison said. "It makes increases more palatable."

1.Business

The sector encompasses a wide range of companies. Praxair (NYSE:PX - News) manufactures and distributes industrial gases. Solutia (NYSE:SOA - News) makes specialty coatings. Polypore International (NYSE:PPO - News) makes filtration membranes. Sigma Aldrich (NASDAQ:SIAL - News) makes chemicals used in genetic research.

The industry differs from the basic chemicals trade, which produces commoditized chemicals and materials in much larger quantities. Specialized chemicals also have unique handling and transportation requirements. Many chemical makers offer a portfolio of services to support those needs.

Praxair, for example, provides pipeline and storage tank services that include cleaning, purging, leak detection and hydrotesting.

The value of such services can be as much as the value of the chemicals themselves, said Ray Will, principal analyst with IHS Global Insight's SRI Research.

The result helps further expand profit margins for specialty chemical companies beyond those of the basic chemicals sector, he added. Those profits are, in turn, attracting fresh interest as specialty and basic chemical companies compete for market share.

In 2009, Dow (NYSE:DOW - News) bought specialty coatings firm Rohm & Haas for $15 billion. DuPont (NYSE:DD - News) is closing in on a $6.6 billion takeover of ingredients and enzymes maker Danisco.

Late last month, Ashland (NYSE:ASH - News) agreed to buy International Specialty Products for $3.2 billion in cash.

Conglomerate Berkshire Hathaway (NYSE:BRKA - News) also grabbed a piece of the action, buying lubricant maker Lubrizol (NYSE:LZ - News) for $9 billion.

Such consolidation is reinforcing the industry's already-high barriers to entry.

• Name of the Game: Manufacturers can keep margins up by further specializing their chemical products and offering unique services. Companies must stay ahead of regulations and shifting preferences that favor more environmentally friendly formulations.

2.Market

Specialty, or performance chemicals are generally produced in lower volumes than basic chemicals. End markets include electronics, wastewater management, oilfield services, flavor and fragrance design, rubber processing, papermaking and solar panels.

The definition of specialty chemicals varies. So do estimates for the size of the industry.

Larry Sloan, chief executive of the Society of Chemical Manufacturers and Affiliates, gauged the market at $400 billion to $650 billion, depending on what types of companies were included.

The higher-growth areas: chemicals used in electronics manufacturing, auto emission control, cosmetics and so-called nutriceuticals, especially in developing markets like China and India, he said.

"There are specific sweet spots we're finding," he added.

Those sweet spots helped boost global specialty chemical output 7.5% in 2010 compared with 2009. It is expected to rise 5.9% in 2011, according to projections from the American Chemistry Council, with U.S. production seen lagging that of developing countries.

Also, specialty chemical makers are generally less prone to cyclical downturns than commodity chemical companies, said Will. For example, output of customized chemicals, which generally are made in batches, is easier to scale down. Producers of commoditized products rely more on large-scale plants running nonstop just to maintain their thinner margins.

3.Climate

Specialty chemicals may be getting a tad greener, as industrial customers demand compounds to help them use fewer resources and foster a better environmental image, Sloan said.

Chemical makers also anticipate the U.S. will follow Europe's lead in adopting stricter environmental regulations. Many companies are trying to get ahead of the curve, Will said, with some already responding to tighter European rules.

"There is pressure to reformulate to adapt to regulations," Will said.

Another sweet spot: Demand is rising for chemical products derived from sugars and other renewable sources to avoid paying for petroleum and natural gas feedstocks, Sloan said.

But just as the pressure toward new chemical formulations is increasing, the industry has been forced to pare spending on research and development to cut costs. In addition, companies are lobbying hard against legislative proposals to regulate chemical safety in ways that some see as potentially threatening to innovation.

4.Technology

The specialty chemicals sector hasn't hit a real, technological home run recently, said Sison. Instead, advances tend to come in increments.

"They're mostly singles and doubles," he explained.

The pace of technological growth may stay that way. Mergers often take place as a means to acquire new products, rather than develop them in house. But after companies merge, research departments get cut — a convenient way to maintain profit margins.

W.R. Grace's R&D spending fell to $60.3 million in 2010 from $70.1 million the year earlier. Albemarle's expenses edged down to $58.4 million in 2010 from $60.9 million.

Will said cutting research dollars after an acquisition is a pattern, especially among producers of lower-margin chemicals.

"I really can't spin a happy picture of R&D," he said. "We've seen a declining trend."

Some makers of higher-end products, however, are boosting research. Solutia and Sigma-Aldrich slightly increased R&D spending in 2010. Dallas-based Kronos Worldwide expects to increase its R&D budget between 35% and 54% this year.

5.Outlook

If the interest among nonspecialty chemical makers in acquiring companies in the sector is any indication, specialty chemicals appear to be headed for more deals.

Sloan also expects worldwide growth this year and next, fueled by the economies of China and India.

Member companies, many of which are small- and medium-size firms, are hiring and expressing more optimism.

Still, he notes a host of wild cards — inflation, a weak construction sector, persistent unemployment, the Japanese economy and possible asset bubbles in China.

"There's just a lot of uncertainty right now," he said.

• Upside: Sison said overall demand is holding up and he remains positive on the industry. The segment tends to outperform the rest of the economy, he said, especially in the earlier stages of a recovery.

The industry has been more disciplined in its price increases vs. past rebounds, he said. Wider use of enterprise resource management software has helped, giving more detail and better clarity across company cost structure.

• Risk: Multiple indicators point to possible trouble ahead.

The Economic Cycle Research Institute sees a global slowdown in industrial activity by this summer.

Japan's earthquake and tsunami disrupted supply chains and cut production in an already fragile economy.

China's industrial pace has slowed more than expected amid efforts to contain inflation. Recent surveys of purchasing managers there showed slower manufacturing activity.

Sloan is particularly wary of what he calls "impractical" legislation that could hinder innovation and competitiveness.

"That's the big enchilada," he said.

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Shirley

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Join date : 2011-04-16
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