Issue Date: June 21, 2004
With an economic recovery in the U.S. driving strong demand and capacity additions few and far between, producers of commodity plastics such as polyethylene, polypropylene, polystyrene, and polyvinyl chloride ought to be boasting about profits, not complaining about them.
Unfortunately, high feedstock prices are giving them reason to lament. Polymer makers have been able to increase prices, but not quite fast enough to offset the high hydrocarbon costs. And in addition to hurting their bottom lines, high oil and natural gas prices are creating uncertainty about a sustained recovery in polymer consumption.
Polymer makers have ample reason to worry. In 2003, escalating feedstock prices put a damper on what otherwise would have been a good year. At the time, U.S. demand for polyethylene, polypropylene, PVC, and polystyrene showed nearly identical patterns. Demand was strong early in the year as inventories were built by firms that convert polymers into other products. Then in late February, natural gas prices hit record levels of $18 per million British thermal units (Btu), and oil prices climbed above $36 per barrel, driving up costs for ethylene, propylene, styrene, and other plastics feedstocks.
Polymer producers, in turn, had to push up their prices. Jerry Parker, vice president of Equistar Chemical’s polymers business, recalls that polyethylene producers tacked a 5-cent-per-lb energy surcharge onto their invoices. Converters used up their inventories, and polymer demand evaporated.
By the second half of the year, customers had to buy again. “Since the inventory reduction, we have had a relatively steady increase in demand both domestically and in exports,” Parker says. And the trend continues. “It appears that business is stronger today than it has been in over three years,” he adds.
It’s tempting to speculate that this year will be a repeat of 2003. Oil prices have seesawed around $40 per barrel. Natural gas prices, though much lower than they were two years ago, are still more than $6.00 per billion Btu, about twice the norm of the late 1990s.
In turn, prices along the petrochemical chain are going through the roof. Scott McEwen, vice president of Atofina Petrochemicals’ polypropylene business, says prices for polymer-grade propylene are among the highest ever seen. From 23 cents per lb a year ago, they are now 32.5 cents—more expensive than ethylene, a rare occurrence.
McEwen explains that a big driver for propylene this year has been high gasoline prices, which are luring refiners to alkylate propylene for blending into gasoline instead of putting it on the polymer market.
But producers are optimistic about some key differences between this year and last. Kevin McQuade, polystyrene business director at BASF Corp., says he has seen strong polystyrene demand throughout the first half of the year, without the second-quarter slip he saw a year ago. Moreover, he says the demand represents genuine pull from the marketplace, not simply converter inventory buildup like last year.
It is a positive sign that converters and resin producers are busy trying to keep up with consumer demand, McQuade says. “When we look at inventory at both producers and converters, we see that the entire chain is still fairly lean, so we do not at all anticipate a dramatic falloff in demand as we did last year,” he says, noting that he expects demand in North America to increase by 3% this year, instead of decreasing by 3.5% as it did in 2003.
Producers of other resins agree. Atofina’s McEwen says high polymer prices—more than 50 cents per lb for polypropylene—are keeping converters from buying more material than they need to. “If people had the option, they would not buy; they would wait for the price to drop,” he says. That they are still buying under such conditions tells McEwen there is strong demand. He predicts polypropylene demand will post 6% growth in North America this year.
Barry Hendrix, vice president of sales at OxyVinyls, a joint venture between Occidental Chemical and PolyOne (formerly Geon), says PVC demand is 3.6% ahead of last year. He partially credits low interest rates. “The housing market has been very strong for an extended period of time,” he says. “There is no doubt that low interest rates are a significant driver of that.”
High North American prices for natural gas, which determines costs for about two-thirds of U.S. ethylene, had until recently made the U.S. industry uncompetitive in a world that mostly cracks oil-based naphtha. With natural gas currently cheaper than oil on an energy-content basis, this situation has at least temporarily reversed. As a result, Equistar’s Parker is seeing increased strength in polyethylene exports.
DEMAND IN CHINA, Parker adds, has been particularly strong, soaking up excess capacity globally. Moreover, the declining dollar has made it difficult for Asian finished products makers to export to the U.S., in turn boosting demand for U.S.-made products. “The overall economics for converter products coming into the U.S. has been weak,” he says. “There are higher freight rates. There are higher costs for ethylene. The domestic producer is less impacted by imported resins or products.”
Rick Salvador, vice president of Nova Chemicals’ North American styrenic polymer business, says strong Asian demand has aided the world market for styrene. “Demand in Asia is so large it consumes everything,” he says. China, for example, absorbs 17% of global demand for styrene. He says it would take five new styrene plants to cover China’s growth through 2007. But instead of building all the plants it needs, China imports styrene.
The strong demand has boosted operating rates at all kinds of polymer plants, which had been running well below their capability because of the huge capacity increases that occurred between 2000 and 2002 and because polymer demand grew little between 2001 and 2003. Since May 2003, polyethylene operating rates have climbed from 80% to just over 90%, Parker says.
Pedro Suarez, Dow Chemical’s commercial vice president of plastics for North America, says the polyethylene industry has finally put the worst behind it. “After seven years of margin compression in the chemical industry, increased demand and continued economic growth began to move polyethylene off the bottom of the cycle in 2003,” he says.
In polystyrene, BASF’s McQuade says operating rates are in the low-80% range. However, Nova’s Salvador says styrene operating rates of close to 92% are more telling because there is much more capacity for polystyrene than styrene. At 92%, he says, profitability in the entire styrenics chain improves.
OxyVinyl’s Hendrix says PVC operating rates have climbed from about 90% at the beginning of the year to 95% today. Some markets are extremely tight because of an April explosion at a Formosa Plastics plant in Illiopolis, Ill., that killed five workers and shuttered part of the plant indefinitely. Tile makers are said to be looking for PVC for flooring anywhere they can.
Resin producers say a good balance in supply and demand for their products as well as high raw material costs have combined to push their selling prices upward. “Producers are adamant about getting their prices up,” says Patrick Duke, a polymers analyst with Houston-based DeWitt & Co.
And prices are hitting record levels. For example, Duke says the benchmark price index for polyethylene has risen from 46.4 in December to 52.2 today. In December 2001, it was 31. Similarly, the polypropylene price index has risen from 43 in December to 53 today. The annualized average price index for polyethylene so far this year is 49.2, even higher than the 48.7 reached in 1988 at the peak of the petrochemical cycle. When adjusted for inflation, however, the current index is lower.
Duke says feedstocks are more responsible for the higher prices than the supply-and-demand balance. William Campbell, vice president of polyethylene at Atofina Petrochemicals, agrees. “What we’re seeing now is a sustained increase in raw material costs with little downside,” he says.
But feedstock costs alone didn’t push up polyethylene prices, Equistar’s Parker says. After a long period with no help from market tightness, resin producers have finally found additional leverage, he says. “Our ability to move through the price increases is much greater today than it had been three years ago. The operating rate improvement is supporting the effort as well.”
Craig Blizzard, marketing director at Basell North America, has seen the same effect in polypropylene. “Customers generally understand the need to cover our costs,” he says. “But now there is more of an influence from supply and demand.”
Resin producers have also succeeded in their two-year program to take customers off “price protection,” a system whereby large customers’ contracts allow them a grace period of 30, 60, or even 90 days after a price increase is announced.
Price protection made it difficult for resin producers to keep up with increased feedstock prices, BASF’s McQuade explains. Sometimes, he says, profits were lost permanently because customers, knowing that prices would rise when their price protection expired, filled up their inventories. Then when the price hikes kicked in, customers used up stock rather than buying more resin.
Resin producers resorted to price protection out of desperation to win business during previous bad times. However, Nova’s Salvador says the practice is being uprooted. “It’s been going down continuously. Our CEO must sign off on any price protection we put into new contracts,” he says. “We have not asked him to sign off on anything.”
Resin producers say changing price protection is already making it easier for them to raise prices. McQuade believes there will also be long-term rewards. He explains that lack of price protection puts more pressure on converters to pass their costs along to their consumers. When polymer makers were absorbing the high feedstock prices, converters didn’t need to talk to their own customers about escalating costs. “There is some pressure on converters to put pressure on the final consumer,” he says.
ANOTHER CHANGE that polymer producers hope is permanent is the increase in price elasticity of demand—the sensitivity of demand to higher prices. Polyethylene demand, for instance, has typically tumbled when prices have hit 50 cents per lb because converters see this as a signal to stop buying. In response to the collapse in demand, prices typically tumble as well.
With polyethylene prices marching right past this mark and other resins at unusually high prices, producers hope they are seeing price elasticity of demand change to their advantage. “Elasticity is at a higher level now than what we have historically seen,” Campbell says.
And despite their ability to raise prices, resin producers unanimously agree that they still aren’t keeping up with the increase in their own raw material costs. Jim Telljohann, general manager of styrenics at Chevron Phillips Chemical, says raw material prices still weigh on resin producers’ profits. “We have been successful, but there still are difficulties,” he says. “Margins are still being squeezed.”
With such poor profitability, producers say it will be a long time before they see the incentive to invest again. Dow’s Suarez predicts that for the foreseeable future the only capacity expansions that will occur will be small projects to improve plants. “When our margins are under pressure, we are unable to continue the pace of investment,” he says. “At this time, it is vitally important for Dow and its customers that margins are restored to profitable levels.”
Basell’s Blizzard says a lack of investment underscores how difficult the last trough of the business cycle has been for polypropylene. He says Basell has the potential to add capacity by upgrading and restarting polypropylene lines it had mothballed, but it currently has no plans to do so. “Our margins have to get better before we bring on additional capacity,” he says.
OxyVinyl’s Hendrix says that in the entire chlorovinyl chain from chlorine to vinyl chloride to PVC, capacity is being shuttered, much less being added. He blames profitability. “Even though we are having a tighter market, due to the high cost of raw materials, profit margins are less than they were a year ago,” he says.
Producers are also concerned about the longer term impact on demand posed by higher raw material prices. For example, Parker says that over time, high polyethylene film prices may prompt end users to trim down the amount of packaging used for their products. “It is all about the higher energy cost and the impact on growth. I’m worried about that,” he says.
Parker forecasts that in the coming years, low-density polyethylene demand will be flat, while linear low-density polyethylene and high-density polyethylene demand will rise at a 4 to 6% annual clip.
Polypropylene potentially faces a more direct challenge. Much of its growth has been because its high versatility at a low price drives substitution of both engineering plastics and high-volume plastics such as high-density polyethylene. With the closing of the historical gap between ethylene and propylene costs, and with propylene now selling for even more than ethylene, this advantage may start to be undermined.
Monte G. Edlund, vice president of Huntsman Polymers, contends that polypropylene’s advantage has not eroded. “Sooner or later demand has to slow down to GDP [gross domestic product]-type growth, but on a cost-per-cubic-inch basis it is still the best buy,” he says.
Going even further, Basell’s Blizzard doesn’t think polypropylene will slow down from its usual two-times-GDP growth rates anytime soon. “We have no expectations that demand will let up,” he says. “If anything, we have expectations that it might accelerate.”
As polypropylene makers improve their products’ properties, new markets emerge. For example, as the clarity of the polymer improves, polypropylene is able to compete with polyethylene terephthalate in some markets. As processability improves, it more effectively competes against polystyrene in thermoforming markets.
Meanwhile, to reinvigorate a product that has slowed to one-half GDP growth, polystyrene suppliers have been looking to specialty grades as well as copolymerization and blending polystyrene with other materials.
Nova, for instance, has been pushing copolymers of methyl methacrylate and styrene. “We have spent money in the last few years to develop new products that are designed for polystyrene processing technology,” Salvador says. “There are new products for use in microwaveable applications and fast processing products that can compete with polyester resins. They are styrene based, but they are not traditional polystyrenes.”
McQuade says BASF has been blending its Styrolux styrene-butadiene copolymers into polystyrene to improve polystyrene’s toughness without losing its inherent clarity. The company has had success in markets such as the clear baskets used to package strawberries and other such fruits at grocery stores, warding off a potential threat from polyethylene terephthalate.
Telljohann has a similar strategy with Chevron Phillips’ K-Resin styrene-butadiene copolymers. “Everybody tries to move up the food chain—to improve the properties and take market share away from the next set of markets,” he says.
Makers of every polymer want sustained growth. The more pressing issue now is coping with the last obstacle to fully restored profitability: high feedstock prices. Companies would love feedstock prices to ease, but they realize that’s unlikely in today’s volatile energy markets. Instead, they would be content just to pass along the costs to their customers.
Atofina’s McEwen sums up the plight of resin producers: “At 95% operating rates, we wouldn’t expect to be in the financial situation we are in today.”
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