Skittish Times

SPECIALTY AND FINE CHEMICALS companies at the Chemspec Europe exhibition in Munich, Germany, last month agreed that business is surprisingly good, given everything going against business at the moment. Record-high energy and raw material costs, the mounting strength of the euro compared with the dollar, and a slow-burn recession have ratcheted up the pressure on European and U.S. chemical producers, all of which say they are trying to raise prices for their own products.

Demand for chemicals, however, is up—as was attendance at the annual exhibition, managed by DMG World Media. Exhibition management reported that first-day attendance was more than 4,500, a 45% increase over the previous year's event in Amsterdam.

"Several industries need unexpected large volumes of chemical products," said Michael Hassler, director of business development at AllessaChemie. Agricultural chemicals, consumer products, cosmetics, and oil-field chemicals are booming, he said. And although AllessaChemie does not manufacture active pharmaceutical ingredients, the company has seen growth in its intermediates business as both start-up drug companies and big pharma firms bring new candidates forward in their pipelines.

AllessaChemie, formed in 2001 from the specialties businesses that Clariant inherited from Hoechst in the 1990s, is typical of the European chemical firms exhibiting at Chemspec in that it serves a wide range of markets with a component of its business—nearly half—done on contract. Revenue in general is up, Hassler said, and contract manufacturing revenue in particular doubled during the past fiscal year, which ended in June, and is expected to increase at least 30% this year. Demand for agricultural chemicals is particularly strong, primarily due to increased use in Asia, where diets are changing and people are eating more grain-intensive meat.

Hassler reported that his company will invest "heavily" in the next few years to increase capacity. "But investments will always be backed by contracts," he said. "It is not necessary to accept a lot of risk, and several customers know that they need to back us up with contracts." Last year, he said, AllessaChemie began three expansion projects at its plants in Germany, and the company plans at least four new projects this year.

Uwe Brunk, head of the agricultural business at German custom chemicals maker Saltigo, has seen a dramatic reversal of fortune in agricultural chemicals since last year. "The second quarter of 2007 was the worst quarter ever in agricultural chemicals," he said. "There were no inquiries on new or existing products." Things changed by the third quarter, however. The planting season was more productive than anticipated, and chemical stocks left over from the previous two years—compiled partly in response to concern about Asian soybean rust—finally ran out.

Saltigo's agricultural chemical revenues for the first five months of 2008 are up 20%, but Brunk questions whether this is sustainable. "The economy in the U.S. is stagnant, except for biofuels," he noted. And Brunk pointed with wariness to the specialty chemical industry's over-extension in pharmaceutical chemicals in the late 1990s and the ensuing collapse of the market. "I'm cautiously happy with the situation," he said.

Saltigo is concentrating on boosting production at existing custom manufacturing facilities and has no immediate plans to build new ones, Brunk said. The company announced last year that it would close two plants in Leverkusen, Germany.

Wolfgang Schmitz, Saltigo's chief executive officer, sees the company's three divisions—pharmaceuticals, agricultural chemicals, and specialties—on solid growth paths. At Chemspec, he enumerated "megatrends" that bode well for the agricultural business, including a world population that is expected to increase 25% by 2030. He pointed to shifts in eating habits in Asia as well as increased demand for biofuels.

Overall demand for pharmaceutical chemicals will increase about 4% annually in the coming years, Schmitz said, and Saltigo's pharmaceuticals division has been growing at about a percentage point above that. The specialty chemicals division, which serves markets including electronic chemicals, nutrition, and cosmetics, has experienced growth averaging about 2.5%.

A MOOD OF CAUTION at Chemspec could be gauged in the tentative attitudes toward capacity expansion. "Demand for agchems far exceeds expectations," said Georg Weichselbaumer, managing director of Weylchem, a German specialties manufacturer. "A year ago, we were all looking in each others' eyes, suppliers and customers, and we said, 'No. We will not invest. There is enough steel in the ground.' A few months later, everyone said that if we do not invest, we will not be able to meet the demand."

Weichselbaumer added, however, that he is not sold on the need for a major capacity expansion. Weylchem is making small investments in process efficiency and, like AllessaChemie, will consider more significant ones only with solid commitments from customers.

Although business is looking up—Weylchem will likely achieve double-digit sales growth this year—sales in 2007 were below those in 2006, according to Weichselbaumer. He added that rising prices for energy and raw materials are putting a lot of pressure on earnings and that the company is struggling to increase prices. "Customers are receptive to this," he said. "The main focus is on getting supply volumes up, and to do this customers know they have to kick in on the pricing."

Tony Bastock, managing director of U.K.-based Contract Chemicals, agrees that raising prices in the face of higher costs is imperative, and he said the industry is getting better at it. "We have to be agile," Bastock said, noting that producers have been hampered in their efforts to pass increased costs to customers in recent years by competition from Asia. But beginning last year, the industry became quite active on the pricing front, he said. "The biggest companies have been announcing price increases of 10 to 15%."

Overall, the pharmaceutical and agricultural chemical sectors are in good shape right now, Bastock contended. "It's a refreshing change from the past three years," he said. "It is driven in certain areas by special—and hopefully long-lasting—effects. The important area is the driver of agricultural chemicals." According to Bastock, Contract Chemicals' agricultural chemical sales have tripled over the past five years to become 30% of its business.

Robinson Brothers, another U.K.-based contract manufacturer, expects 35% sales growth this year, up from approximately 15% two years ago, Managing Director Adrian Hanrahan said. In April, Robinson boosted its flavors and fragrances business with the acquisition of Endeavour Specialty Chemicals, another U.K.-based firm.

Hanrahan lamented that the firm faces cost pressures that have nearly erased efficiency gains. "We are now using four times less energy to produce a kilo of material than we did five years ago but at the same cost," he said. "All our cost leadership moves have been absorbed in higher energy costs."

Meanwhile, U.S.-based Vertellus Specialties, formed from the merger of Rutherford Chemicals and Reilly Industries and owned by Wind Point Partners, is contending with international logistics constraints because of the high levels of industrial exports spawned by the weak dollar, according to Robert J. Morlino, president of health and specialty products. "There is tremendous export out of the U.S. right now, and it's difficult to get containers and book shipments," he said. "Sixty percent of our sales are export."

The company is seeing solid growth in its health care and specialties, agriculture and nutrition, and performance materials businesses, Morlino said. Its plastics and polymers operations are getting a boost from new products including dichlorodiphenylsulfone for high-temperature polysulfones and polyether sulfones.

Vertellus is studying a capacity expansion for its material in Seal Sands, England. It recently completed expansions in Delaware Water Gap, Pa., for alkenylsuccinic anhydride, used as an epoxy hardener and corrosion inhibitor additive, and it completed a pyridine expansion in Indianapolis last year.

"We really are cranking out a lot of product," Morlino said. "The downside is raw materials prices and energy costs." And the antidote is price increases, he said. Morlino added that Wind Point, which acquired Vertellus from Arsenal Capital Partners last year, is interested in growth through acquisition and that the firm may announce a deal by the end of the year.

Also under new ownership, VanDeMark, the phosgene chemistry firm purchased from Isochem last year by Buckingham Capital Partners, has seen a boost in interest for agricultural chemical intermediates. They account for nearly one-quarter of its business, according to CEO Michael A. Kucharski. "It is now a matter of choosing the right projects," he said.

The company, which synthesizes batches that generally range in size from 50 to 500 tons, currently has 10 to 15% of its capacity available for new projects, Kucharski said. "Next year, we could have 30% available, but there is a lot of business waiting in the wings." He said the firm has more latitude to pursue projects and can market more aggressively than when it was part of the large, state-owned French firm. "And it seems like everybody is knocking on the door with something to be done in the agchem area," Kucharski said.

The question hanging over suppliers, most of which were impacted by the pharmaceutical chemical downturn, is for how long? Solid revenue growth in a period of high oil prices and a recessionary economy creates a predicament perhaps best summed up by Weichselbaumer at Weylchem. "Currently, we like the situation," he said. "But it may all catch up with us."