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Volume 84 Issue 2 | pp. 12-15
Issue Date: January 9, 2006

Cover Stories: World Chemical Outlook

United States

The chemical industry enters 2006 with many of the concerns it had in 2005
Department: Business | Collection: Economy, Hurricane aftermath

The U.S. chemical industry teetered on a precarious slope in 2005, but it managed to keep its balance. Rapid run-ups in prices for oil and natural gas, used both for energy and as feedstocks, affected the industry just as the increased costs affected consumers throughout the country. August and September brought Hurricanes Katrina and Rita, which damaged plants in Louisiana, Mississippi, Texas, and other states. The storms cut production, especially of basic chemicals; further boosted oil and natural gas costs; and damaged the transportation infrastructure, preventing products from getting in or out.

But despite it all, the U.S. chemical industry turned in a pretty good year. From all appearances, it looks as if 2006 will also bless the chemical industry.

The bottom line in 2005 showed just how good the chemical industry was. Through the first nine months of the year, 24 chemical companies that C&EN regularly surveys racked up sales of $126.2 billion, up 12.5% from the same period in 2004. And these same companies reported earnings of $10.3 billion, a 48.0% increase over the first three quarters of the year before. Thus, the aggregate profit margin for the group rose to 8.1% from just 6.2% in the prior year's period.

But when final results for 2005 are in, it probably is safe to say that the fourth quarter, which bore the brunt of the hurricanes and the skyrocketing raw material costs of the period, will be below the figures for the aggregated first three quarters.

If there was any disappointment in 2005, it concerned chemical production. C&EN estimates that when December results are published by the Federal Reserve Board, the average production index for chemicals for the year will be down about 0.2% from the previous 12 months, when chemical output increased 3.0%.

The decline in production cannot be entirely blamed on the hurricanes. Output for some chemical sectors had been moving downward even before the storms. In October, C&EN noted that in August, chemical production, while still above 2004 levels, was 1.4% below its peak in March 2005 (C&EN, Oct. 2, 2005, page 28). This slowdown was even more apparent for basic chemicals, where the index in August was 8% below its peak in December 2004.

The hurricanes did ensure, however, that output for the year would be down from 2004. Between July, the month before the storms, and September, total chemical output fell 6.1%. But production of basic chemicals, with large concentrations of plants along the Gulf Coast, dropped 23.8% during that period. Within the basic chemical sector, inorganic chemicals fell 11.6%, and organic chemicals plunged 32.0%.

As a result, C&EN estimates total basic chemical production for the year dropped 6.6%, with a 1.5% decline in inorganic chemicals and a 9.3% fall for organic chemicals.

If anything saved the industry during 2005, it was the fact that producers, especially basic chemical producers, were able to push through price increases to help offset the rapidly increasing cost of oil, natural gas, and electricity used as fuel and feedstock.

The producer price index for the chemical industry and for all its sectors but one increased, with basic chemicals and plastic resins growing at double-digit rates. The index for inedible fats and oils was the exception, projected to fall 4.4%.

For the industry, the price index for total chemicals rose 9.5% in 2005, compared with a 7.2% increase for all commodities produced in the U.S. Within chemicals, plastic resins enjoyed the largest growth, rising 18.9% over 2004. Basic chemicals, the largest industry segment, showed an average price growth of 13.9%, accounted for by a 14.8% increase for basic organic chemicals and an 11.2% rise for basic inorganics.

Among other industry segments, paints were up 6.7%, agricultural chemicals increased 6.4%, pharmaceuticals rose 4.7%, and the hodgepodge "other chemicals" category increased 4.9%.

The result of the increased prices was a good increase in the value of chemical shipments. Commerce Department data show demand for chemicals in the first 10 months of the year rising 5.9% from the comparable 2004 period to $457.3 billion. Excluding pharmaceuticals, the remainder of the chemical industry did even better, with shipments increasing 10.5% during the period to $343.3 billion.

Chemical producers continued to work to hold down costs during the year, and one place that is evident is in employment. C&EN projects that by the end of the year, total chemical employment will have fallen by 8,400 to an average for the year of 878,400. And the average number of production workers for all of 2005 will be 513,600, down 6,400 from the 2004 average.

Downsizing and outsourcing continue to reduce the number of jobs, according to the American Chemistry Council. ACC predicts total chemical employment will fall to 875,000 in 2006 and to 872,000 in 2007.

The decline in the number of hourly production workers produced an increase in labor productivity, or output per hour worked, in 2005 of 2.7% to an index of 133.9 (1997 = 100). Unit labor cost-the cost of labor per unit of output-was unchanged at 93.1, however.

Foreign trade in chemicals during the year rose. When all months are reported, exports of all chemicals should be up 10.0% to $120.8 billion while imports should rise 12.1% to $126.9 billion. This, though, will almost double the chemical trade deficit in 2005 to $6.1 billion from $3.26 billion the year before. For 2006, both exports and imports will again rise, with imports outpacing exports. This will further increase the chemical trade deficit.

Next year holds a number of uncertainties other than trade, but most analysts expect growth to continue. Kevin Swift, chief economist at ACC, says: "After the hurricanes, there are better prospects for the U.S. business of chemistry in 2006. There are, however, still considerable uncertainties that need to be taken into account, including energy prices, exchange rates, and possible geopolitical shocks."

First to be considered in any forecast for the cyclical chemical industry is what the total economy is expected to be like. The National Association for Business Economics, in its economic forecast released in November, believes growth will continue. Carl Tannenbaum, NABE vice president and chief economist at LaSalle Bank in Chicago, says of 2006: "Our forecasters expect strong real [gross domestic product] growth of 3.3%, albeit with some changes in the composition of that growth. This should be enough to prompt more rate increases from the Federal Reserve." The estimate for GDP growth in 2005, according to the report, is 3.6%.

The NABE forecasters also predicted that personal consumption expenditures-an important economic driver-will rise 2.9% this year, slower than the 3.5% growth in 2005.

Because they had such strong performance in 2005 and are such a large part of the chemical industry, basic chemicals, and how they will perform next year, are on everyone's minds.

Fitch Ratings, a credit assessment firm, says in a report on the chemical industry that it expects commodity chemical producers to realize peak profitability in the first half of 2006. The duration of the peak margins depends on economic growth and the volatility of raw material costs, which are expected to remain high, although these costs are expected to moderate by year-end.

Fitch also says supply-and-demand balances should remain tight during the first half of 2006, because of additional planned maintenance turnarounds and low inventory levels. Producers, according to Fitch, should be able to raise prices successfully, which should continue to allow them to mitigate margin pressure and manage volatile raw material costs.

Credit rating firm Standard & Poor's, in a report on the chemical industry, is slightly less sanguine about the industry going into 2006: "While most North American chemical companies continue to benefit from a favorable supply-and-demand balance and strong pricing trends, high raw material prices test the abilities of both specialty and commodity players to preserve margins."

Within the basic chemical sector, ethylene is something of a bellwether. Analysts at Merrill Lynch said in a report at the beginning of December that, while ethylene prices and margins "will undoubtedly decline from current unsustainable levels, full-year 2006 ethylene/polyethylene margins are likely to be above 2005 levels."

They also noted that U.S. ethylene production should remain constrained in 2006, particularly in the first half of the year as planned and unplanned outages reduce U.S. supply by as much as 7% in 2006-only slightly below the 10% hurricane capacity loss in 2005. "Furthermore," they said, "we see U.S. demand rebounding 7% in 2006 after a 5% decline in 2005 due primarily to a drawdown of derivative inventories."

Fitch agrees, expecting operating rates for ethylene and polyethylene to continue to maintain high peaklike levels in the first half of 2006 as supply rebounds from the loss of production in late 2005.

Because of high capacity utilization, which Fitch puts in the mid- to high-90% range, one might expect some plant building. But the firm says capacity additions in North America are expected to be minimal this year with most additions replacing high-cost production and offsetting additional plant shutdowns.

Further downstream, Fitch says, intermediate chemical producers will continue to see pricing pressures as costs for most building blocks continue to increase. The firm expects that if demand remains solid, intermediate chemical producers will be able to push price increases through the chain over several quarters. The uncertainty is over how quickly their selling prices will increase.

Although analysts may see little growth in capital spending for ethylene, there will be spending on new plant and equipment throughout the industry. ACC notes that capital spending cycles generally lag behind cycles of industry activity, so improving profit margins will set the stage for moderate increases in new plant and equipment investment. According to the industry organization, capital spending increased more than 11% in 2005 over the year before to $24.1 billion. According to the industry organization, a survey of its members shows an expected 10% capital spending increase in 2006 to $26.5 billion, with perhaps an additional 6% rise in 2007 to $28.0 billion.

The ACC survey breaks down just where the spending is going. Spending on production expansion will increase to 29% of the total from 22%; capital spending on production facilities for new products will decline to 6% from 10%; replacement of worn-out plant and equipment will take 33%, up from 29%; and equipment to improve operating efficiencies will move up to 14% of the whole from 10%.

Although not giving exact percentages, ACC says spending on environmental protection and health and safety will fall slightly and the percentage spent on energy projects will remain unchanged.

Regarding the other leg of future-oriented spending-research and development-ACC says that as a result of lower profit margins over the past several years, companies appear to have moderated their R&D activity, with spending rising by 3.2% to $24.2 billion in 2005. There are few indications that there will be any significant expansion of R&D spending during 2006 and 2007, according to ACC, with a 3% gain seen in both years.

The bottom line is that the U.S. chemical industry has entered the new year with many of the same concerns as it had at the beginning of 2005. Feedstock and energy costs were high then, and they are much higher now. Concern over foreign competition and the specter of an increasing trade deficit in chemicals continues. And there is, of course, that ever-present worry about geopolitical events and how they could affect the fortunes of what is one of the most important industries in the U.S. and the world.

 
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