Chemical industry: Making the dragon go "puff"
Worldwide demand for chemicals will continue to grow but at a lower rate, forecasts the American Chemistry Council (ACC), Arlington, Va., a trade group whose membership includes major American chemical companies. Its “Year-End 2007 Situation and Outlook” report issued in December predicts modest production rises in 2008 and 2009 of 2.1% and 2.3%, respectively, capital growth of 6.3% and 6.0%, respectively, and moderate increases in both profit margins and R&D spending.
This comes against the backdrop of strong performance by the U.S. chemical industry in 2007, notes ACC. Driven by the low value of the dollar and robust economic growth overseas, exports reached a record of $154 billon last year and are expected to continue to rise, to $169 billion this year and $180 billion in 2009. Last year saw the first trade surplus in chemicals for six years, with exports outpacing imports by $500 million. The surplus should grow to $2.1 billion in 2008 but flip back to a $1.8 billion deficit in 2009, predicts ACC.
The industry faces some high risks, cautions ACC. These include the ongoing financial problems and an oil price shock, according to its chief economist Kevin Swift. “These are the things that could rain on the parade,” he explains.
That the parade was likely to see some of the wet stuff was becoming apparent by the time the International Monetary Fund (IMF), Washington, D.C., published its “World Economic Outlook” (WEO) in October. Up to then, the global economy had been expanding vigorously, driven by 11.5% annual growth in China, 9% in India and almost 8% in Russia.
The WEO predicts healthy growth to continue into 2008, with emerging market economies continuing to serve as the main growth engine of the world economy (Figure 1). However, it warns: “The IMF’s projections are based on the assumption that market liquidity is gradually restored in coming months. But there is still a distinct possibility that recent turbulent conditions could have a deeper effect on credit availability than envisaged by the IMF in its baseline scenario, with considerably greater macroeconomic impact.”
Such macroeconomic issues clearly affect chemical companies, but few are revealing too much about the impact.
DuPont, Wilmington, Del., for example, told securities analysts in November that it expects lower demand from the U.S. housing and auto markets in the fourth quarter but that strong sales growth outside the U.S. would more than make up for it.
At the end of September, Dow, Midland, Mich., announced a 10% increase in sales.
This prompted Andrew N. Liveris, chairman and CEO, to say, “We posted record quarterly sales with substantial [double-digit] growth in Europe, Asia Pacific and Latin America… all this underscores that our strategy to grow internationally…is working.”
However, that upbeat news was tempered in December when Dow announced that it planned to trim 1,000 jobs or about 2.3% of its total workforce, in an effort to shed underperforming businesses and boost global efficiency. The cuts are expected to save the company up to $180 million/year, “freeing up capital and resources that will be directed toward value-creating growth opportunities,” according to Liveris.
BASF, Ludwigshafen, Germany, had based its original 2007 economic outlook on three factors: annual global economic growth of 3.5%, an average oil price of around $70/bbl (for Brent crude), and an average exchange rate of $1.35/€. In October, Kurt W. Brock, its chief financial officer, observed: “On the basis of what we’re seeing today — and I would like to stress the word ‘today,’ — there’s nothing to suggest that we should be pessimistic about the nearer future. Of course, we are looking at what is happening with regard to the larger picture in the United States, and we expect growth there to slow somewhat. Nevertheless, we should not forget that this means that U.S. growth will still be around 2%. That’s a growth rate we didn’t dare to dream of only a couple of years ago in Europe.” The company says it won’t make any further statements before its financial outlook for 2008 is released in February.
A building concern
Meanwhile, an October 2007 report from the Institute of Supply Management (ISM), Tempe, Ariz., showed that the U.S. manufacturing sector expanded for the ninth consecutive month. At the same time, however, this growth was the lowest for eight months.
“It does appear that the slowdown in the financial, housing and transportation segments has spilled over into manufacturing,” commented Norbert J. Ore, chair of the ISM’s manufacturing business survey committee.
The ACC agreed. “Overall it’s clear that sub-prime and related problems have affected housing and are now affecting manufacturing,” states its November “Chemistry and Economic Trends” newsletter. ACC points out that, on average, the housing sector purchases $8 in chemicals for every $1,000 of output, and more than twice as much indirectly for products such as pipes, coatings and sealants.
Construction spending in the U.S. in 2007 was worth $1.163 trillion, estimates the U.S. Department of Commerce’s Bureau of the Census, Washington, D.C.. However, this represents a year-on-year rise of just 0.3%.
The view from Brussels
The relatively modest growth expected in the U.S. is prompting serious concerns in Europe. For instance, the Brussels-based European Commission (EC) in its autumn economic forecast predicts growth moderation in Europe, from 2.9% in 2007 to 2.4% in both 2008 and 2009. Issued in November, the report takes account of “turbulence in the financial markets that has caused tighter financing conditions and increased uncertainty.”
The analysis assumes that the financial distress will gradually peter out. However, it warns: “Some segments of the financial markets are still malfunctioning, and a more prolonged period of uncertainty cannot be ruled out.”
“Clouds have clearly gathered on the horizon with this summer’s turbulence in the financial markets, the U.S. slowdown and the ever-rising oil prices,” said Joaquín Almunia, economic and monetary affairs commissioner.
As far as chemicals, the European Chemical Industry Council (Cefic), Brussels, is predicting industry growth — excluding pharmaceuticals — of just 1.9% in 2008. That compares with 2.1% in 2006 and an expected final 2.6% in 2007. In terms of growth in gross domestic product (GDP), Cefic believes that only North America and Japan will fare worse, with South America (up 4.8%), Eastern Europe (up 5.6%) and the emerging Asian markets (up 7.6%) driving worldwide growth (Figure 2).
Cefic’s forecast also comes with a proviso with regard to the region’s sensitivity to a number of downside risks: “First, the continuing U.S. dollar weakness against the euro weighs more and more heavily on the export performance of E.U. [European Union] industry. Secondly, continuously high oil prices, though they have apparently so far had only a limited dampening effect on the overall macro-economic environment, will lead to higher production costs and lower consumer and business confidence. Last but not least, the financial crisis in the U.S.A. could have a stronger than expected impact on the world economy.”
Cefic won’t comment at this point on how it might revise its forecasts given the continuing weakness in the U.S.
Developing countries, particularly China and India, clearly provide the bright spots in the outlook for the next several years.
The construction sector is driving growth in India. Just 10 years ago the market for construction chemicals was non-existent, notes Frost & Sullivan (F&S), Mumbai. It says the market is worth 10 billion rupees today and predicts it will rise to over 40 billion — or just over $1 billion — by 2013.
“Construction chemicals account for only 2% of overall construction costs but the benefits are in multiples; rising awareness, changing lifestyles and, most importantly, the increasing spending power of the end users will be the key drivers in the sustained expansion of the Indian construction chemicals market,” noted F&S’s Dominic Britto.
However, it’s China that’s really leading the charge. The country’s consumption of chemicals is booming. A small but typical example is the expected increase in demand for flame retardants. This should rise from 529,500 tons/year today to over 800,000 tons/year by 2012, according to F&S’s Dan Xu. “China has increasingly become the global production base for electronic products and a key region for consumption of plastics. The increase in demand for electric and electronic equipment as well as ongoing development of the building and construction and automotive industries spell good news for the growth of the Chinese flame-retardant chemicals market,” he said.
In November, such buoyant consumption, coupled with brisk exports, prompted the Asian Development Bank (ADB), Mandaluyong City, Philippines, to raise its economic growth forecast for China to 11.2% from 10% earlier in the year.
“The faster-than-expected growth momentum built up this year is expected to carry into 2008,” said Zhuang Jian, senior economist of ADB’s China Resident Mission. This is the highest growth rate since 1994 and is largely being driven by industries such as chemicals, oil processing, electricity and steel, he added.
A new set of statistics released in November by China’s Ministry of Commerce underscores the importance of the country to world trade. It revealed that in the first 10 months of 2007 the value of both Sino-U.S. and Sino-E.U. bilateral trade exceeded $200 billion. For the first time, the E.U. came out on top, with trade worth over $287 billion, versus $248 billion for the U.S. and $191 billion for Japan.
However, it’s important to remember that the U.S. receives one-fifth of all Chinese exports and that any downturn in the American economy will have serious repercussions there. In fact the People’s Bank of China estimated that every 1% drop in U.S. economic growth translates into a 6% fall in Chinese exports.
Hardly low interest
The sub-prime-loan debacle remains a continuing concern that clearly has ramifactions for the overall economy and, with it, chemical makers. While initially it was viewed as a short-term problem, today the doomsayers are gaining the upper hand.
For example, in November, Jerry Webman, the chief economic and senior investment officer with Oppenheimer Funds, Denver, Colo., commented that as each day passed more and more was learned about the size and scope of “unsavory loans” that remain on U.S. banks’ balance sheets. With consumer confidence plummeting, house prices falling and commodity prices rising, he pointed out that some commentators were already using the “r” word — recession. However, Webman did point to the third consecutive monthly decline in overall jobless figures as a “glimmer of hope in an otherwise dark backdrop.”
ACC’s Swift agreed that job growth is the only positive development at the moment. But he also warns: “If we get three months of job growth of less than 75,000 per month, we will be looking at recession. This jobs growth is holding up the U.S. economy. If it decelerates — well, exports are doing good, but they won’t make up for a softening of consumer sentiment...,” he concluded.
Former U.S. treasury secretary Lawrence Summers offered a bleak outlook in a late November article in the Financial Times, the prestigious U.K. business newspaper.
“The odds now favor a U.S. recession that slows growth significantly on a global basis.” He cited a number of factors for this, including indications that the housing sector may be in free-fall in terms of both construction and prices.
Just one day earlier, BP Chairman Peter Sutherland struck a similar note. Speaking on Irish television channel TV3, he said that the current global financial crisis could cause considerable trauma throughout the whole of 2008 because of a lack of understanding about its causes.
Sutherland, who also is chairman of Goldman Sachs International and a former E.U. competition commissioner, echoed the fears of the People’s Bank of China when he said: “The problem is everyone says that we can rely on growth in China and India, but China exports most of its products to the United States so if the U.S. is in a recession, this is a problem.”
Because the background of the crisis is neither fully understood nor fully played out in regard to providing credit and liquidity to institutions, he described the situation as very complicated — and one that isn’t helped by the U.S. economy being in a mess.
Sutherland described as “terribly depressing” an IMF meeting earlier in November and other meetings since of central bank governors. “People didn’t understand the extent of the problem. So I think it’s a dangerous period for the world,” he concluded.
ACC’s Kevin Swift describes Sutherland’s remarks as “fair comment,” noting that just about half of the economic gurus he monitors now are talking about a possible recession.
He also agrees with Summers’ sentiments: “There’s a lot of talk about decoupling and there is no doubt that the relationship between U.S. growth and East Asian growth has changed. However, if the U.S. sniffles, there is still no doubt that the rest of the world gets a cold.”