- Main input prices remain at historically low levels
- Specialty chemical companies are benefiting from the fight against environmental risk
- Specialty chemicals are less vulnerable to changes in the economic cycle
- Petrochemicals highly dependent on changes in the economic cycle
- Overcapacity in some Chinese segments
- Increasing production capacity in ethylene and its derivatives
- Stricter regulatory environment forcing producers to overhaul their business models
- Legal risk resulting from the human health effects of some chemicals
Because of its pro-cyclical nature, the chemical sector is bearing the full brunt of the global economic slowdown. Activity is declining in client sectors, such as automotive and to a lesser extent construction. Meanwhile, protectionism and the more restrictive regulatory environment due to environmental concerns represent challenges for an industry of which the net margins fell by 29 basis points in Q2 2019 compared to the same period in 2018. In addition, increased supply, owing to the construction and opening of giant petrochemical plants in the United States, China, India, and especially in the Arabian Peninsula, will exert downward pressure on the prices of some products, particularly ethylene and its derivatives. The standards that now apply in the sector will force participants to change their production processes in the coming years. In addition, Coface anticipates that the industry could be at risk of facing court cases, like the ones that targeted the tobacco industry or those currently underway in the pharmaceutical sector in connection with the opioid scandal, which may result in financial agreements with some US jurisdictions in order to avoid harsh sentences.
Sector Economic Insights
Despite the presence of several major projects, the chemical sector is suffering from the global economic slowdown and the protectionist environment
Coface expects global economic growth to slow from 2.5% to 2.4% between 2019 and 2020. Global manufacturing indicators are also on a downward trend due to increased political uncertainty and trade tensions between the United States and China, which are affecting world trade dynamics. With its tit-for-tat tariff hikes, the trade war is impacting a number of chemicals and derivative products and dimming the sector’s prospects. China has all but closed its market to American chemicals, one effect of which has been to divert US polyethylene export flows from China to countries in Africa and Southeast Asia. China, for its part, is obtaining part of its supplies from Persian Gulf producers.
However, the trade war is not the sole reason for the expected reduction in global chemical activity this year. Other factors include the knock-on effects of the difficulties experienced by client sectors, such as automotive and construction, since chemicals are upstream of their production processes. These industries are having to cope with various challenges, including the fact that some of their markets are maturing. This is particularly a concern in the automotive sector. Falling vehicle registrations and sales in the main markets affect sales at petrochemical and plastics companies, as cooler activity in the automotive sector reduces orders for chemical products such as plastics, foams, cables and hoses, technical textiles for interiors, and so on. Being themselves procyclical, these client sectors of the chemical sector are directly affected by the global economic slowdown. For its part, the construction sector is expected to grow at a slower pace than that observed so far overall, despite the accommodative policies put in place by the main central banks to support activity in the sector, particularly in the United States.
Several major projects, launched some years ago, are underway to build petrochemical plants with a view to growing business in parts of the world where the raw material is in plentiful supply, including the United States, the Persian Gulf and Asia. These plants will boost the production capacity of regional participants. The United States has a comparative advantage over several countries due to the abundance of shale oil in a number of basins in the west of the country and in Texas. It has become one of the largest producers and exporters of ethane, a derivative of natural gas, and liquefied petroleum gas, which is used in the production of ethylene plastic packaging.
Sector participants face a stricter regulatory environment
Like many sectors, the chemical industry is facing stricter regulations. These rules, which aim to limit the environmental risk resulting from the processes used to produce the chemicals themselves or the final chemical products, are pushing up costs. Several areas are concerned, from worker safety to the effects on the climate and natural resources. The governments of many advanced and emerging economies are paying close attention to environmental considerations amid growing public concern about climate change prevention and public health issues, which is spurring calls for changes to the production models employed by companies in the sector.
This shift among consumers and public opinion is also prompting shareholders to pressure management boards to comply with the changes to standards and in society. The related issue of recycling represents a risk for the sector, in view of the growing citizen awareness around the world about its importance, particularly following media coverage of the effects on marine animals of ingesting micro-plastics, for example. Coface expects that a more widespread use of recycling practices will accentuate the decline in chemical production in several developed and emerging countries in the coming years. Many countries have already adopted legislation reducing the use of plastic bags, and the adoption of such practices worldwide should reduce part of the supply, especially in low value-added plastics.
The petrochemical segment is facing a number of difficulties
Petrochemicals was one of the segments that benefited most from the global economic recovery in 2016 and 2017. However, it now faces numerous and mounting risks. Some of these are cyclical in nature, while others involve the structure of the sector and are already affecting its economic outlook.
Like many other sectors, the protectionist environment created by the trade war between the United States and China in particular is hurting the petrochemical segment. Retaliatory measures targeting petrochemicals specifically resulted in China completely closing its market to US petrochemicals. As a result, American producers are being forced to seek out new markets. More broadly, global producers in the sector are having to reconfigure their operations amid rising maritime transport costs.
In addition, the opening of giant factories in China and other Southeast Asian countries is exerting downward pressure on chemical prices, at a time when demand is less buoyant. This is having a severe impact on company margins, particularly in the case of products such as paraxylene, which is used in the production of solvents and plastics. The average monthly paraxylene price fell by nearly 40% in September 2019 on an annual basis, taking margins towards negative territory. Some producers may seek to restrict production in order to restore their margins. Other chemical raw materials, such as monoethylene glycol, methanol and propylene, are showing the same trends. There is overcapacity in these products, which exerts downward pressure on prices and will ultimately contribute to reducing the main producers’ margins. Naphtha and ethane prices have also been highly volatile since 2018, due in particular to the uncertainty associated with US trade policy and its impact on oil prices, as naphtha is a crude oil-derived product, while ethane prices are correlated with oil. The volatility of the abovementioned inputs (naphtha, ethane) is leading to a loss of competitiveness for companies in the sector, which are also having to hedge themselves against the related risk.
In addition, petrochemical firms are having to cope with the challenges affecting certain customers such as oil and gas companies. This industry is facing difficulties, with services companies and firms in the shale segment struggling particularly because oil production companies are investing less and tightening their pricing policies. Global oil and gas services companies saw their net margin reach 0.74% in the second quarter of 2019, up from -2.5% in 2018. Despite the slight increase, the thin margin points to a weakening in this segment rather than a real improvement.
The specialty chemicals segment is more resilient despite challenges
The flavours, fragrances and cosmetic ingredients sub-segment is in robust shape. From a structural point of view, the segment’s products are difficult to “copy”, which limits the competition for existing players. Entering this market require continuous and costly R&D investment over several years. Another factor that protects specialty chemical companies from competition is the expertise they have developed over time in a business where the tastes of end consumers are constantly changing. They are also developing products such as particulate emission filters that open up positive prospects in the context of the fight against environmental risks. As a result, they continue to generate comfortable margins, with EBITDA on turnover of around 22% at end 2018 according to Grace Matthews, a provider of M&A and corporate finance advisory services in the sector.
Like petrochemicals, the painting and dyes segment is being hurt by difficulties in the construction sector, as well as several industrial sectors, such as oil and gas and maritime transport.
Note for the reader:
- Net margin: ratio of profits to sales.
- Profitability: EBITDA on sales.
Last update : February 2020