Europe

One sign is promising: an expected continuation of the economic growth throughout the world that supported the strong export performance of the European chemical industry last year.

But other signs have European chemical industry executives and analysts remaining cautious. Although predictions are that the world's economic situation will continue to improve, that growth is expected to moderate slightly this year. That, in turn, will cool demand for European chemical exports, already highly priced compared with competing regions because of strong currencies in Europe. And there are few signs of a sustainable economic upturn in Europe itself to make up for diminished exports.

"Global economic growth picked up in speed over the past few months, with North America and Asia still acting as the driving force. Triggered by the worldwide upswing, signs of a recovery have become apparent in Europe," observed Utz-Hellmuth Felcht, chairman of Degussa, at his company's annual third-quarter press conference in Düsseldorf in November. The signs of recovery have even become apparent, he added, in Germany--the region's traditional locomotive--but "to a weaker extent."

But will that growth continue? The signs are mixed.

One of the major problems facing the region's chemical industry is currency. For several years after the launch of the euro--the single currency now in use in 12 of the European Union's 25 member countries--the U.S. dollar was the world's monetary muscleman. Of course, a strong currency is great for macho swaggering, but a weak currency gets the export sales. At that time, chemicals priced in euros looked compellingly inexpensive compared with those priced in dollars, which seemed ridiculously overpriced.

But the tables have turned, with little likelihood that the dollar will strengthen significantly this year. So for European manufacturers, whether of petrochemicals or downstream consumer-oriented products, selling outside their region or selling in competition with now-cheaper imports is set to remain a significant issue this year.

It's a challenge the industry recognizes, however, and is working to come to terms with. In fact, the Brussels-based European Chemical Industry Council (CEFIC) predicts a slight improvement in chemical industry output this year, following moderate recovery in 2004.

European Union chemical output--excluding pharmaceuticals--rose by 2.4% last year. CEFIC economists predict growth of 2.6% this year in the 25 members of the EU; CEFIC membership takes in non-EU countries as well.

That improvement won't be across-the-board, however. In 2004, all European chemical sectors showed improved growth compared with 2003. This year, CEFIC is predicting a further pickup for pharmaceuticals, petrochemicals, plastics, and synthetic rubber. But the organization sees a slowdown in consumer chemicals, specialty and fine chemicals, and basic inorganics.

Pharmaceuticals have outperformed the growth of the European chemical sector for many years now, CEFIC economists point out. If pharmaceuticals are included, the overall output in the EU chemical industry is predicted to grow by 3.0% this year, up from 2.7% last year.

HOWEVER, the currency issue translates directly into slower growth in gross domestic product (GDP) throughout the region. Deutsche Bank economists calculate that the dollar's fall in late autumn 2004 could subtract 0.5% from Europe's growth rate this year.

"A strong appreciation of the euro, in context of worsening external imbalances, or further rises in oil prices may bear disproportionately on continental Europe, where growth is still over-reliant on exports, and high oil prices do not find their counterpart in high output growth and energy demand." So writes Jean-Philippe Cotis, chief economist of the Organization for Economic Cooperation & Development, in its latest economic outlook, published in November.

Individual country assessments of the outlook for their chemical industries show some of the variations around the region.

In France, for example, chemical industry growth this year of 3.2% over 2004 is expected to be led by consumer products--soaps, fragrances, and household cleaning products. The Paris-based Union of the Chemical Industry forecasts growth of 4.0% for that sector this year. Growing at a slightly slower pace will be organic chemicals, up 3.6%, and inorganics, up 2.4%. Chemical specialties should see a 2.0% increase over the past year.

In Finland, chemicals remains one of the most optimistic sectors of industry, boosted by an improvement in production that began in mid-2004. The country's Chemical Industry Federation cites predictions of ETLA, the leading economic research institute in Finland, which forecasts production growth in excess of 4% this year.

The Association of the Dutch Chemical Industry (VNCI) is uneasy about continued growth. Dutch chemical sales were up by 9% in 2004, but 8% of that rise was due to increased selling prices and only 1% to greater production output, according to Rein Willems, VNCI chairman.

Willems notes that "2004 was a turbulent year for the chemical industry, due to the high oil prices and the deterioration of the competitive position caused by the strong euro." One result was that--in contrast to previous years--the Dutch growth in output was lower than in neighboring countries.

More generally, long-term high oil prices and the euro's high exchange rate could retard the European economy and impose pressure on the sector's sales, Willems adds.

CEFIC economists agree with that assessment. "If the high price of oil seen in 2004 persists, it could reduce overall economic growth and hence demand for chemicals," warns its economics report, published in late November. On the other hand, the report notes, many economists expect that the global economy will cool somewhat this year, and oil demand growth will revert closer to the long-term trend, with oil prices expected to ease toward a range around $30 to $35 per barrel.

Despite high oil prices and political uncertainties, last year the world economy experienced one of the strongest recoveries in the past 20 years, fueled by North America and Asia, CEFIC points out. This year, the organization adds, the economic environment remains favorable, albeit with a modest deceleration in world GDP growth.

On the consumer side, CEFIC says the signals are less encouraging. Case in point is Italy, according to forecasts prepared by Federchimica, the Italian chemical industry association. For the traditional sectors such as chemicals for textiles, clothing, and leather, "there has been no real recovery because the ever-increasing competition from Far Eastern countries has been limiting exports and absorbing a higher and higher share of the internal demand," economists at Federchimica said in a recent outlook note.

"INDUSTRIAL ACTIVITY in Italy has been suffering from this situation because these sectors are more important than in other European countries," Federchimica added. As a result, in 2004 growth in Italy was lower than elsewhere in the EU and will be "only moderate" in 2005 and 2006. In the short term, the Italian economists added, "there is no real prospect for a good recovery in sight."

That is an assessment that Malcolm Mitchell, chief chemicals economist at BP, would not argue with. Mitchell says he is "hawkish on Europe. Domestic demand is still dead in the water--the countries can't get that going. They've been dependent on exports. If exports slow, given the exchange rate, Europeans are in for quite a difficult time. Europe is just in a funk, and it is difficult to see how to get out of it."

Despite his concerns regarding the robustness of a recovery in Europe, Mitchell sees grounds for optimism: "I've been saying for years that things will get better, and they actually did last year. Throughout the whole chemical industry, results have gotten better, even with very high oil prices."

He says a general sense seems to be developing that because of strong demand, buyers are becoming increasingly concerned about supplies of materials, even if at a higher price. "Capacity utilization is getting to levels where buyers want to make sure they can get hold of product."

Mitchell is convinced that European chemical producers will see a decline in volumes this year because of continuing low domestic demand and exports hit by lower priced competition. However, the industry's profitability will be enhanced by what he sees as "still pretty reasonable demand and a tightening supply-demand balance. It would be disappointing if, at the end of this year, the industry didn't look better in profitability than right now."

Maintaining and boosting profitability, however, does depend upon maintaining profit margins. And that is a challenge, some industry observers say.

ICI's chief financial officer, Tim Scott, told securities analysts in December that "raw material cost inflation is set to be a feature of 2005," as it was last year. Despite its shift from commodities to consumer-oriented specialties, he noted, raw materials account for 70% of the company's total variable costs. "Further price increases continue to be essential to meet current market expectations for pretax profits for the year," Scott said.

Price increases--producer prices rose, on average, by 1%--were one factor boosting sales by the German chemical industry last year, which rose 3.5% compared with those of 2003. "This increase was only moderate in view of raw material costs that went up at breathtaking speed," Jürgen Hambrecht, president of the German Chemical Industry Association (VCI) and chairman of BASF, told VCI's December economic outlook press conference.

However, the situation was encouraging enough that he could proclaim, "At last the recovery of the global economy has also reached parts of the German chemical industry."

After what Hambrecht termed "a hesitant increase" in the first half of 2004, "growth in German chemical output clearly improved in the second half of the year. It is particularly worth mentioning that all of us were surprised because this year we saw very little of the otherwise usual summer slump." The result was that at the end of the year, VCI upped its forecast for 2004 by 0.5%, to an estimated production growth of 1.5 to 2%.

Main beneficiaries of the growth in 2004 were chemicals going into industrial processing, Hambrecht said. Output of inorganic basic chemicals rose by 8%. Fine and specialty chemicals were up by 4.5%, and polymers rose 1.5%. Petrochemical output was up by 0.5%, according to the official production index, Hambrecht noted, although VCI believes that figure to be too low.

ON THE OTHER HAND, according to VCI estimates, other sectors showed no recovery. For example, manufacturers of detergents and personal care products were adversely affected by weak demand from domestic consumers, Hambrecht observed. The 1% production growth that was actually achieved, he explained, "came solely from abroad." Even the country's production of pharmaceuticals stagnated at the level of 2003.

The country maintained its high rate of chemical exports, Hambrecht reported, with exports climbing by 14%. On the other hand, imports also went up by 10% last year. "The business situation of German chemical companies improved noticeably in the second half of 2004. The main reason was the good global economic development, which reached Europe at long last," Hambrecht said. "This strongly stimulated the export business. By contrast, domestic business progressed only slowly."

In fact, according to the OECD outlook, domestic demand actually fell in Germany in 2004; what recovery was seen resulted almost exclusively from exports.

Most companies, Hambrecht added, "are expecting the good development to last, but some factors dampen their optimism." Among those factors is an expectation that, this year, the dynamic growth seen in the U.S., Japan, and the newly industrialized countries in Asia will slow down somewhat. But developments in Europe "cannot make up for this," he said.

The recovery of the German chemical industry "will continue in 2005 but with weakening dynamism in the course of the year," Hambrecht predicted. Nonetheless, because of the relatively low production level in 2004, the German chemical industry's output this year is expected to increase by 2 to 2.5%. Producer prices are expected to rise slightly this year, so VCI is predicting that chemical sales in Germany this year will go up by 3.5%, led again by business from abroad rather than at home.

COVER STORY

World Chemical Outlook - Introduction