Issue Date: January 12, 2004
Most economists, security analysts, and chemical company executives see 2004 as a turning point for the U.S. chemical industry, predicting at least modest improvement this year over 2003. But we've been on this road before.
At this time last year, economists were predicting a slow first six months of 2003, followed by greater improvement in the second half of the year. That was certainly true for sales, but not for earnings--at least through the first three quarters, the latest data available. Sales for 25 companies regularly surveyed by C&EN rose 9.4% in the third quarter over the same period a year earlier--the best comparison of the year. But earnings from continuing operations in the third quarter declined 12.8%, the worst performance of the year.
As one chemical company executive told C&EN a few months ago, "every time it looks as if we are turning around, we get smacked down." He ticked off the Sept. 11, 2001, attacks; increasing feedstock costs in 2002; the Iraq war and its aftermath; and the rising feedstock costs of 2003.
In 2003, he certainly was correct. The rapid increase in feedstock costs turned everything around. At this time last year, industry experts were projecting that output of chemicals would increase about 3.5% in 2003 while chemical prices would rise somewhat less. In fact, chemical production, when final data are released by the government, may be up about 0.1% at most, but prices will have increased by about 6.5%, as chemical producers struggled to raise prices to offset the natural gas price increases.
This is even more evident in the basic chemical sectors of the industry where, in 2003, output fell about 1.0% while prices soared about 11.0%.
The result of the rapid rise in prices for the total chemical industry will be an increase of about 8.5% in the value of shipments of all chemicals in 2003, with essentially no help from the increase in production. Although data are not available for basic chemicals, shipments for the remainder of the chemical industry, excluding pharmaceuticals, should be up about 11% in 2003.
Despite huge gains in 2003, foreign trade did not bolster the chemical industry much last year, as import growth continued to outpace that of exports. Based on 10-month data, C&EN estimates that when the final data for 2003 are published, chemical imports will have topped the $100 billion mark for 2003 with a final figure of about $101.5 billion--an almost 18% increase over 2002. Exports will rise at best by about 14% to $92.6 billion, resulting in a deficit of about $8.9 billion, a 74% increase over 2002.
Like 2002, just three of the eight chemical sectors will show deficits in 2003 when final figures are released. Pharmaceuticals will be the largest, at some $12.8 billion, followed by organic chemicals at $12.3 billion, and inorganic chemicals at $1.7 billion. Again excluding pharmaceuticals, the rest of the chemical sectors combined actually showed a surplus of almost $4 billion.
And perhaps because the weakening dollar made imports less competitive in 2003, or because demand was lower, the decline in the trade balance--exports minus imports--was much less than it had been in the two previous years. In 2003, the balance fell $3.8 billion from a year earlier, compared with $5.7 billion in 2002 and $5.4 billion in 2001.
This may well continue into this year. Economists at the American Chemistry Council (ACC) predict that, although the fall in the dollar will improve U.S. export potential, imports will continue to gain, but at a slower pace than in previous years, resulting in a slight decline in the 2004 deficit to about $8.5 billion.
The outlook for the total U.S. economy for this year seems to be generally positive, according to a number of sources. And the forecasts were getting to be more optimistic as 2003 progressed, especially after the government reported an 8.2% increase in gross domestic product for the third quarter.
The Federal Reserve Bank of Philadelphia's survey of professional forecasters taken in late November predicts GDP growth of 4.3% for 2004, up from an estimate of 3.7% when the survey was taken in the third quarter of 2003.
In another survey taken in November, the National Association for Business Economics predicts GDP growth of 4.5% in 2004, compared with final 2003 expansion of 3.0%. Duncan H. Meldrum, NABE's president and chief economist at Air Products & Chemicals, says: "After two years of poor resolution, the economic landscape is coming into focus. We see a stronger expansion developing, one that should be sufficient to gradually put idle resources, both workers and factories, back to work."
EMPLOYMENT was the biggest worry in the NABE forecast--that insufficient job creation would limit the growth of consumption. But respondents gave this scenario only a 15% probability of occurring.
Closer to the chemical industry, there is cautious optimism. In an earnings forecast in December, Rohm and Haas Chairman and Chief Executive Officer Raj L. Gupta said: "We continue to see signs that the economic recovery is finally materializing. In October, we saw the highest ever monthly sales for our current portfolio, and while that pace has slowed slightly as the year ends, this top-line improvement will help bolster our gross profit margins."
T. Kevin Swift, senior director of ACC's economics and statistics department, says the chemical industry will improve this year but will, once again, lag GDP growth. Swift predicts real chemical industry production growth of about 3.3%.
ACC's annual Performance & Outlook Survey predicts that within the 3.3% increase in chemical production this year, basic chemical output will be up 2.0%. This increase will be led by a 3.3% rise in plastic resins and 2.3% growth in petrochemicals and intermediates. Higher value-added sectors, according to the trade group, will show greater growth, with life sciences and consumer specialties leading--each with 3.8% annual growth.
Besides the improving economic growth, the industry will also be helped by inventory building. Swift says that, after a lengthy period in 2003 when downstream customers were reducing inventories, it appears that they are now restocking.
Within the chemical industry, however, it appears that inventories are still being held in check at all levels of manufacture: materials and supplies, work in progress, and finished goods. In fact, according to Commerce Department data, these have been declining for the past few months.
And the inventories-to-shipments ratio for chemicals has generally been falling for the past year as shipments have increased faster than inventories. The ratio for all chemicals in October was 1.31 compared with 1.42 in the same month in 2002. This translates to inventories representing 1.31 months of current shipments.
However, this figure is skewed by pharmaceuticals, where inventories often represent more than two months of shipments. Eliminating pharmaceuticals, the ratio for the rest of the chemical industry declined to 1.05 in October from 1.20 in the same month the year before. This is getting close to the 1.00 mark, which some feel is the lower threshold for inventories. In fact, some sectors, such as petrochemicals, may already be below it.
Any increase in production will have some effect on employment because, in the past few years, as production has declined, the production workers have borne the brunt of cost-reducing cuts in employment. While the number of production workers fell once again in 2003, it was the first year since about 1999 that layoffs in the nonproduction ranks were greater than among those who actually turn out the products.
However, during 2003, even as output in some sectors increased, employees were working longer hours. This, seemingly, is normal after a recession because employers like to see a sustainable recovery before committing to personnel additions.
Between November 2002 and the same month in 2003, total employment in the chemical industry, according to the Labor Department, fell by 16,800 to 907,900. The number of production workers in the same period declined by 4,700 to 524,800. This is a far cry from the year before, when the number of production workers plummeted by about 17,300 as plants were shut down and companies downsized.
It is difficult to call, but given an anticipated increase in output this year, the rolls of production workers should at least stabilize. But what happens in the nonproduction ranks is anybody's guess.
If employment is relatively stable or up next year, chemical companies are going to have to return to the basic business formula of selling more products to bolster profits. And given that production and demand will increase, that's just what companies will do, but they will not come close to the previous earnings peak.
ACC FORECASTS that chemical industry earnings before income taxes, depreciation, and amortization (EBITDA) should rise almost 11% from 2003. EBITDA from basic chemicals is forecast to increase 16% this year; from specialty chemicals, 9%; and from all other chemicals, 9%.
If "every time it looks as if we are turning around, we get smacked down" turns into a chemical industry mantra, it will probably be natural gas prices that again do the smacking. Because of the importance of natural gas as both an energy source and a feedstock in the U.S., a continuing high price could affect the chemical industry beyond this year, especially in areas where the U.S. industry competes with other countries that depend on naphtha as a feedstock.
ACC says another cold winter could put the U.S. in the same position as last year. The group's forecast says that, in addition to another possible cold winter, "manufacturing demand has been on the rise in recent months, and all indications point to an industrial recovery during 2004. This will place additional demands on already tenuous natural gas supplies. This invites the potential for sustained high natural gas prices in the short term and, without mitigating policies to curb demand and increase supply, the long term as well."
Donald D. Carson, chemical analyst at Merrill Lynch, says: "Natural gas pricing is the key determinant of the timing and magnitude of the upcoming ethylene/polyethylene peak in our view. A decline in U.S. gas prices to $3.00 to $3.50 per million Btu could stimulate inventory restocking by domestic customers and improve export demand. If natural gas prices remain at $4.00 per million Btu in 2004, two years of strong growth in domestic demand would be necessary to achieve sustained nameplate ethylene operating rates in excess of 92%, the threshold for a tight market."
Thus, for many reasons, industry executives in the U.S. are hoping for a decline in the price of natural gas. It would provide cheaper energy, cheaper feedstocks, a more competitive position against foreign competition, and a greater sense of stability within the industry. And stability in all phases of operations is what the U.S. chemical industry, as well as the security analysts who follow chemicals, have desperately needed for the past few years.
Production declined for most chemical categories
|PRODUCTION INDEX, 1997 = 100||2000||2001||2002||2003a||CHANGE 2002–03|
|Basic inorganic chemicals||96.8||95.6||95.8||93.2||–2.7|
|Resins, synthetic rubber & fibers||103.2||92.1||96.2||94.6||–1.6|
|Pharmaceuticals & medicines||116.6||124.9||126.8||127.1||0.2|
|Paint, coatings & adhesives||100.4||97.8||101.1||104.2||3.0|
|Soaps, cleaning compounds & toilet preparations||99.0||101.3||96.3||96.7||0.4|
|a C&EN estimates. SOURCE: Federal Reserve Board|
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