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Pinching Pennies

Chemical firms plan a 25.1% capital spending cut and a 1.8% drop in R&D spending in 2009

by Marc S. Reisch
February 16, 2009 | A version of this story appeared in Volume 87, Issue 7

Credit: Lubrizol
A technician runs a polymerization experiment involving alkyl methacrylates in Lubrizol's rheology control lab.
Credit: Lubrizol
A technician runs a polymerization experiment involving alkyl methacrylates in Lubrizol's rheology control lab.

THE WORLD has changed since C&EN last surveyed future-oriented spending plans among companies that make their living from the business of chemistry. The mild economic climate of early 2008 has given way to the stormy credit-restricted reality of early 2009. And whereas expansion of R&D and capital spending budgets was the rule in 2008, this year many chemical firms are pinching pennies in order to survive.

Last year's booming capital expenditure plans have turned into this year's 25.1% spending slash for a group of 13 U.S. chemical firms. The companies forecast they will spend just $7.5 billion on new plants and equipment in 2009, compared with nearly $10 billion in 2008. If they follow through on their plans, it will be the first time in five years that the group has reined in spending, and with the steepest cutback in a decade.

R&D outlays for a subgroup of six firms have also turned negative in 2009, only much more modestly. The companies plan a 1.8% cut in R&D budgets to $699 million, versus $712 million in 2008. They also report that R&D spending contracted 0.1% in 2008, ending a seven-year string of increases that started in 2001.

"You can't just turn R&D on and off," explains economist Frederick M. Peterson, who heads consulting firm Probe Economics. Research requires highly trained professionals who often work on multiyear projects. However, capital spending is a different matter, and when it comes to cutting those budgets, "corporate boards can be pretty myopic. They either have the money or they don't," he says.

At this time last year, the housing and automotive sectors were beginning to decelerate, but most U.S. chemical firms expected only a mild domestic slowdown. After all, demand was rising in most sectors of the global economy; Asia, in particular, was roaring. Very few observers predicted back then that problems in the U.S. housing market would instigate a full-blown global recession. But they did, and now many chemical firms have been forced to cut capacity, employment, and stock dividends to conserve cash and pay their loans.

The Conference Board, a New York City-based business research group, says it expects businesses to continue to cut back on investments in structures, equipment, and software in the months ahead. The board, well-known for its Consumer Confidence Index, a number that is on the decline, also surveys chief executive officer confidence in the economy. At the end of 2008, the board found that CEOs from a range of industries are extremely pessimistic about economic prospects for the first half of 2009.

Assessed in meteorological terms, the overall forecast for future-oriented spending is hazy, with heavy storm clouds on the horizon.

THAT PESSIMISM carries over to CEOs at some of the biggest U.S. chemical firms. Dow Chemical's chairman and CEO, Andrew N. Liveris, said in a conference call with investors earlier this month that "we are preparing for the recession to persist through 2009 and are running our business accordingly. We are assuming that the late-2008 demand levels will continue for several quarters and possibly beyond."

For that reason, Dow is cutting its 2009 capital expenditure budget in half to $1.1 billion while still "maintaining safe and environmentally compliant operations," Liveris said. Because of the upheaval at the firm over the aborted K-Dow joint venture with Petrochemical Industries Co. of Kuwait and the now-postponed purchase of Rohm and Haas, Dow could not even estimate its R&D budget for 2009.

Lubrizol CEO James L. Hambrick points out in his firm's most recent earnings report that the company has reduced both its operating and capital budgets in 2009. "If economic conditions deteriorate further, we are prepared to implement additional measures as necessary," he adds. Lubrizol has scheduled an almost 20% cut to its capital budget in 2009. The firm plans to cut R&D expenditures by a little more than 3%.

Assessed in meteorological terms, the forecast for future-oriented spending is hazy, with heavy storm clouds on the horizon. After the rapid deterioration in chemical sales and earnings in late 2008, only six firms were prepared to supply both R&D and capital spending data for this year, compared with 14 last year.

Combined 2009 R&D and capital spending budgets for the six firms are down to almost $4.0 billion from the decade high of $4.4 billion in 2008. The group's future-oriented spending hit a decade low of $2.2 billion in 2001.

Because of the run-up in capital spending in recent years, the ratio of investment in new equipment to investment in research is still historically high. Budgets for 2009 direct 82.4% of funds to capital projects, just a tad below the decade high of 83.9% in 2008. At the decade low in 2001, 77.0% of future-oriented funds were directed toward capital improvements.

Funding devoted to R&D does not fluctuate as much from year to year. So when the economic outlook is poor, a larger share of budgets tends to go to R&D. This year, 17.6% of future-oriented spending will likely go to research, up from 16.1%, the decade low, in 2008. The 10-year high was 25.1% in 2004.

The number of firms willing to provide investors and the press some insight into future-oriented spending plans varies from year to year. Under better economic circumstances last year, 17 firms provided forecasts for capital expenditures and 14 firms provided them for R&D. This year, 13 firms provided insight into their 2009 capital spending budgets and a mere six revealed their R&D forecasts.

LAST YEAR, for instance, Dow supplied both an R&D and a capital-spending forecast, but this year it could estimate only capital spending. DuPont was unable to provide either forecast last year, but this year it supplied a budget for new plants and equipment. And quite a few firms that provided R&D budget estimates last year were unable to do so this year, including Cabot, Cytec Industries, H.B. Fuller, and NewMarket. Neither Hercules nor Rohm and Haas appears in the 2009 survey. Ashland bought Hercules last year, and Rohm and Haas is anticipating a merger this year with Dow.

Budgets can and do change over the course of the year. Companies surveyed in early February 2008 expected to increase 2008 capital spending by 8.6%. However, firms participating in this year's survey say they actually boosted capital spending by 13.3%. In contrast, last year's group planned to increase R&D spending by 6.0%. This year's group reports that it actually cut R&D expenditures by 0.1%.

Of the 13 companies surveyed for their 2009 capital spending plans, only two plan to increase spending on new plants and equipment, one plans no change, and 10 plan to cut spending. This compares with 11 that increased spending in 2008 and two that reduced it.

H.B. Fuller, which plans a hefty 50% increase in capital outlays to $30 million, says just about all of the increase comes from a new technology and manufacturing center it is building in China. The remainder of its budget is devoted to normal maintenance and upkeep.

Many of the 10 firms that are reducing capital spending are doing so to preserve cash during a time of economic uncertainty. Eastman Chemical, for instance, is cutting expenditures by about 40%. However, the firm says it is still investing in new projects, such as a copolyester facility and a gasification complex, to be in a position to benefit when demand picks up again.

C&EN predicts that the group's capital spending as a percentage of sales will be 4.7% this year, down from 6.2% in 2008. The estimate assumes group sales will decline 2.5% in 2009, compared with last year. The ratio hit a 10-year high in 1999, when spending on capital projects reached 8.1% of sales. The decade low occurred in 2004, when the group spent only 4.6% of sales.

Of the six firms surveyed for their R&D spending outlook, only one plans to increase spending in 2009, two plan no change, and three plan to cut their budgets from 2008. This compares with four that increased expenditures in 2008 and two that cut their budgets from 2007.

W.R. Grace, still operating under court bankruptcy protection, is the only firm to reveal a planned boost in R&D spending. Still hoping to emerge soon from bankruptcy in fighting trim, the firm plans to spike research spending by 9.6% to $91 million this year.

IN 2009, C&EN estimates, the group's R&D spending as a percentage of sales will be 1.9%, about the same as last year—and the low point for the decade. The 10-year high was 2.8% in 1999.

Inflation inevitably wears away at the purchasing power of dollars devoted to research. The $699 million dedicated to R&D this year by the six companies represents just $551 million on a constant 1999 dollar basis. The inflation-adjusted high for the decade was $584 million, set in 2007.

Other surveys of spending plans find that many chemical firms are ratcheting down investment in new plants and equipment. According to the American Chemistry Council's economics and statistics department, "narrowing margins, austere market conditions, lower operating rates, and a high level of uncertainty" have led many chemical firms to drag out or delay a number of projects.

Economists at the chemical industry trade group surveyed member companies in November and found that capital spending is likely to slip 1.8% in 2009—considerably less than the 25.1% fall that C&EN's more recent survey suggests. On the basis of their earlier survey, the economists also said they expect spending to improve by 1.6% in 2010.

ACC's economists also projected a 2.8% uptick in chemical R&D spending in 2009—better than the 1.8% decline C&EN projects. ACC predicts a 2.4% rise in R&D in 2010.

Taking a macroeconomic perspective on research, the "2009 R&D Funding Forecast," put together by R&D Magazine and the nonprofit research group Battelle, predicts that R&D spending in the U.S. will reach $383.5 billion this year. The figure includes government, industry, and academic funding and marks a 1.6% decrease in inflation-adjusted spending. The report, issued in December, notes that changing business conditions will also affect industrial funding for research, which it predicts will slip 1.3% in inflation-adjusted terms in 2009 to $257.4 billion.

The economic outlook for 2009 is very different from what it was just a year ago. As Dow's Liveris points out, "We all have to realize that the world has shifted quite dramatically, and we have to find a reasonable way to respond to those changes." At least for the year ahead, that means businesses will likely continue to restrict R&D and capital expenditures.

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