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Volume 87 Issue 2 | pp. 20-22
Issue Date: January 12, 2009

Cover Stories: World Chemical Outlook

Europe

A bleak midwinter outlook points to a long year ahead
Department: Business

ROGET'S THESAURUS includes a number of synonyms for "bleak": gloomy, dismal, grim, somber, dark, dreary. All of them point to one outlook for the European chemical industry in 2009—it's not going to be a pleasant year.

Rapidly fluctuating raw material prices are causing customers to anticipate lower prices in the future. So they are using up stocks on hand, rather than routinely topping off inventories, which is disrupting demand. Chemical producers are temporarily idling plants to ride out drops in demand. But the longer the idling, the more chance producers will decide that a plant is no longer economical to operate or to justify new investment. That is particularly true if the plant and its production stand to be hard-hit by competition from Middle Eastern producers, which are set to bring massive amounts of new capacity onstream over the next several years.

Those conclusions emerge from the forecasts of various consultants who follow the industry. The bleak view is also pinpointed in the latest forecast from the European Chemical Industry Council (CEFIC), which expects output in the chemical industry—excluding pharmaceuticals—to show an even greater decline than the 0.6% drop expected to be the final result of 2008.

In fact, in their forecast published late last year, CEFIC economists predict that the drop that began in the last quarter of 2008 will continue in the coming months, resulting in a decline in chemical production of 1.3% for 2009.

As CEFIC chief economist Moncef Hadhri points out, the 2008 drop was the first for the European chemical industry since 2003. After a modest start in the first quarter, output declined throughout the year—especially since the third quarter. During the second half of 2008, the effects of the economic crisis accelerated the downturn in key chemical industry customer sectors, including construction, automotive, and machinery and equipment.

"The time of the booming world economy is already over. The world is now facing one of the greatest international financial crises of the past decades," Hadhri says. "The latest indicators show very clearly that world economic activity and the global business climate have worsened."

With such discouraging data in hand, CEFIC has revised downward its expectations for the coming six months. "The worldwide financial and real estate crisis and the latest turmoil in the stock market have clearly further slowed down the global economy," Hadhri says. "The global economy is poised for a serious downturn [from] whose effects Europe will not be spared."

The downturn in basic industries such as automotive and construction have been well documented. But even industries such as consumer electronics—an industry sector traditionally resilient in economic downturns—is expected to be hit this year. When Nokia, the world's largest cell-phone manufacturer, issued a profit warning for the fourth quarter, the company said it expected global handset sales to fall in 2009 anywhere from 4% to 27%, depending upon the severity of the recession around the world.

According to the CEFIC forecast, most chemical sectors will show a downward trend and experience a more severe decline in 2009 compared with 2008. Consumer chemicals such as household cleaning products are the only exception. For this sector, the expectation of zero growth for 2009 is an improvement from the 1.4% output drop it showed in 2008.

"THIS YEAR will be very bleak," agrees Jonathan Tyler, a director specializing in the chemical industry at investment bank Houlihan Lokey. He recalls attending a chemical industry roundtable in November that "was dreadful," he says. "The people were completely pessimistic, and they were from companies that were not in bad shape. They didn't know what to do about their budgeting process for next year. Long-term is now 18 months."

He adds, "A lot of our work is restructuring. If things get bad enough, maybe the system will clear this quickly." In fact, that's about the only positive sign Tyler can see in the current situation. "Things may get so bad that actions get kick-started and apathy goes," he says. "Now, people are just sitting and waiting."

One way companies are delaying any action, points out David Thomas, senior industrial economist responsible for chemicals at the U.K. consulting firm Oxford Economics, is that they are postponing purchase of products for inventory. And that delay is having an immediate impact on demand.

Companies are depleting supplies they have on hand rather than topping off stores, according to Thomas. He sees a good chance this will continue in 2009. "It depends on the state a company is in. If it is strapped for cash, it will be buying as little as possible. Both chemical producers and users are trying to run with the lowest amount of stocks possible."

Destocking, or the drawing down of inventory, has begun to a great extent because of the rapid and dramatic changes in oil prices, industry analysts point out. Tobias Mock, primary credit analyst responsible for chemicals at Standard & Poor's in Frankfurt, notes that "the rapidly falling oil price and overcapacities in the petrochemical segment have resulted in price declines for key commodity chemicals of more than 50% from the peak in August 2008." That drop resulted, he adds, "in significant inventory destocking at customer levels, because they hope to be able to buy products at cheaper prices in a few months time."

In his latest chemical industry rating, published in December, Mock wrote, "We also expect the majority of companies to show inventory write-downs because of the rapid deterioration in raw material prices." In the medium term, he and his colleagues expect the lower raw material costs across the industry and the strengthening U.S. dollar to benefit the export-oriented European chemical industry. He warns, however, that any such benefit will take "some time to flow through the value chain and could only be expected to help chemical producers from first-quarter 2009 at the earliest."

WITH DEMAND in a funk, companies have been taking long end-of-the-year breaks. The European industry's traditional two-week shutdown over Christmas and New Year's is stretching out to a third or fourth week for some as a clutch of chemical companies temporarily idle plants.

Some of those temporarily idled plants "may not open again" cautions Oxford Economics' Thomas. He cites the temporary shuttering of two Terra Industries-Kemira fertilizer plants in the U.K. "You don't close these plants down for a week or two—they won't start up again immediately," he says. Terra and other fertilizer producers have idled plants in the U.S. as well (C&EN, Jan. 5, page 10).

But the downturn won't last forever. "We've got, in our forecast, a fairly slow pickup this year," Thomas says. "There will be a relatively sharp decline in the first quarter, and then a very slow recovery in the second quarter on through the year. Companies can't run with no stocks forever." Still, his forecast shows a decline in European chemical output of 1.6% for 2009.

Thomas argues that "what is pulling the industry down" is the basic chemicals sector, which saw output declines of 6 to 7% in most European countries in the fourth quarter of last year. Consumer-oriented products such as paints and coatings haven't been doing well, but have not seen a decline as sharp, he adds.

The pharmaceuticals sector has been holding up well, Thomas notes, but its relatively impressive performance builds on "a lousy 2007." Besides, in pharmaceuticals, "you don't hold great amounts of stocks. The prices are fairly stable, so there is no incentive" to build up inventories.

S&P's Mock also sees basic chemicals as the weak spot for Europe. "The sluggish economic environment, overcapacities for petrochemicals, and high volatility of the oil price will result in a very weak trading environment for chemical producers in 2009," he wrote. "We expect petrochemical producers and commodity producers to suffer most."

Mock sees weaker demand for specialty chemical companies as well. He added in his report, however, that these companies "should benefit somewhat from lower raw material costs. We therefore expect most of them to weather the uncertainties better than commodity producers."

There is even a bright star—everything is relative this year—in the agrochemicals sector, according to Mock. For agrochemical producers, "the significant decline in crop prices should also somewhat negatively affect profitability, but we still expect them to show solid earnings because the slowing economy should have only a minimal impact." Likewise, industrial gas producers "should weather the storm quite well because their business model easily absorbs the risks, although we also expect them to show somewhat lower earnings in the coming years."

And lower earnings, in turn, have an impact on investments for all companies, Thomas points out. As he sees it, companies will happily invest in plant maintenance because it allows them to take facilities off-line for a while. But as to other investments, he says, "those tend to need cash, and cash is short. Companies would like to upgrade, but they will be very wary."

Nor will there be any major additions to capacity, Thomas says. The major reason is the specter of capacity waiting to start up in the Middle East. All European producers of basic chemicals will be bracing for Middle Eastern competition, which is why "there will be a chance that some of these plants won't reopen. People won't be willing to spend money unless they're sure they'll need it. I think 2009, as far as investment goes, will be dead," he emphasizes.

New Middle Eastern chemical capacity definitely poses challenges for European chemical producers, agrees Chris Stirling, European head for chemicals and pharmaceuticals analysis for consultants KPMG.

"We don't see a lot of light for the next year," he says. "Most of the chemical sectors will get squeezed, and margins will be tighter and tighter because demand is so weak. And the long-term is not brilliant because of all the capacity coming on in the Mideast." Although delays have been announced for some projects in that region, Stirling notes, many will be completed on schedule, putting ever more pressure on European chemical companies.

Stirling addressed the prospect of Middle Eastern competition in a report on the European chemical industry published last month by KPMG. "With an abundant supply of cheap oil and gas reserves, Middle Eastern chemicals companies can access natural resources at greatly discounted prices when compared to their Western neighbors," he wrote.

"The Middle East-based companies have made the most of their natural resource and transformed their business from a supply of raw material to heavyweight, global petrochemicals production," the report says. "Our research shows that 53 plants could come onstream by 2012, which, if taken together with investment in Asia, could lead to European players being marginalized on the global market."

Stirling points out that the Middle Eastern chemical industry grew at 9.0% per year from 1997 to 2007. "We forecast that the region will grow at an average 9.5% per year until 2020, more than twice the global average," he says.

ACCORDING TO the report, chemicals is the European Union's third biggest industrial sector, but innovation levels have been falling due to high levels of regulation and difficulties attracting workers with a sufficient skills base. The European market is also highly fragmented and ripe for mergers and acquisitions (M&A).

"While the credit crisis has impacted M&A levels in all industries, our research shows that this could act as a catalyst to drive further market consolidation as well-capitalized trade buyers take advantage of the lack of competition from financial investors such as private equity houses," Stirling wrote. He points out a few self-help steps that European companies can take in the short-term. But in his opinion, the challenge to the industry "is to make the most of an historic upper hand in innovation and team up with Middle Eastern companies to access their resource advantages."

European firms, Stirling adds, are under pressure to review their basic strategies. And such reviews might, in turn, impact the region's merger activity. "M&A will be pretty tough," he concedes. "But there will be some distress situations. I wouldn't be surprised if some of the more robust players take advantage of this."

Stirling adds, "The chemical industry is as cyclical as one can find. It's better to invest at the bottom than at the top." But he acknowledges that raises the obvious question: "Where are we now relative to the bottom? There is probably a little way to go yet."

 
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