- Main input prices remain at historically low levels somewhat benefiting the petrochemicals segment
- Specialty chemical companies are benefiting from the fight against environmental risks
- Specialty chemicals companies are less vulnerable to changes in the economic cycle
- End users highly impacted by the pandemic’s knock-on effects on economic activity
- Petrochemicals highly dependent on changes in the economic cycle
- Overcapacity in some Chinese segments like ethylene related products
- Increasing production capacity in ethylene and its derivatives
- Stricter regulatory environment forcing producers to overhaul their business models
- Significant legal risks resulting from effects of some chemicals on human health
Risk Analysis Synthesis
Two segments are under our scrutiny when dealing with the chemicals sector: petrochemicals and specialty chemicals. Petrochemicals are more tied to economic conditions, while specialty chemicals appear to be much more resilient. Because of its procyclical nature, the chemicals sector bears the full brunt of the global economic slowdown. Activity is declining in client sectors, such as automotive and to a lesser extent construction. Moreover, increased supply, induced by the opening of giant petrochemical plants in the United States, China, India and especially in the Arabian Peninsula, are likely to exert downward pressure on prices, particularly for ethylene and its derivatives. Finally, Coface anticipates that many actors in the industry could face legal cases, as the ones that targeted the tobacco industry or those currently underway in the pharmaceuticals sector in connection with the opioid scandal, which may result in financial agreements with some U.S. jurisdictions, in order to avoid harsh penalties.
Sector Economic Insights
The sector suffered from a fall in demand due to the pandemic induced lockdowns, which halted many production plants as well.
Economic growth rates around the world for Q1 and Q2 were negative. The United States (U.S.) recorded a 31.4% decline year-on-year (YoY) for Q2, after a 5% drop in Q1. China, the first impacted country, experienced a 10% decrease in Q1, then rebounding to 11.5% in Q2. The Eurozone’s quarterly growth sank by -3.6% in Q1 and -12.1% in Q2. For 2020 and 2021, Coface expects 1.2% and 9.2% annual growth rate in China, respectively, while the United States should experience a 5.9% contraction before rebounding to 4.7%. The European Union will experience a large contraction, estimated at -8.2% in 2020, before rebounding modestly to 5.6%.
Major petrochemical feedstock and output prices have dropped on the back of the pandemic’s effects. European monthly average ethylene prices dropped by 54% between January 2020 and May 2020 (the time series’ lowest point). Butadiene prices, for instance, behaved in the same way, as monthly average prices also dropped by 85%. While prices rebounded since then, by 65% in June 2020, the downward trend remains. This is in fact far from a total recovery, as these represent only 25% of January prices. The current weakness felt in the auto markets across the globe is continuing to impact sales of raw materials for tires. Xylene prices took a similar path, as they fell by 58% between January and April 2020, before rebounding by 48% between April and June. This solvent is used widely during manufacturing processes, and its trend reflects the woes experienced by several industries such as leather processing, rubber, metalworking, etc. Purified terephthalic acid (PTA) is showing continuous signs of distress due to lower activity and sales in textiles.
Other challenges include the difficulties experienced by client sectors, such as automotive and construction, since chemicals are upstream of their production processes. These industries are coping with various challenges, including the fact that some of their markets are maturing. This is particularly a concern in the automotive sector, with falling or stagnating vehicles sales in the main markets. Meanwhile, the construction sector is expected to grow at a slower pace than that observed so far overall, despite the accommodative policies implemented by the main central banks in order to support activity in the sector.
Like for many other sectors, the protectionist environment, created by the trade war between the U.S. and China in particular, is hurting the petrochemicals segment. Retaliatory measures targeting petrochemicals specifically resulted in China completely closing its market to U.S. petrochemicals. As a result, American producers are being forced to search for new markets.
Several major projects (launched in the past) are underway, in order to build petrochemical plants with the objective to expand business in parts of the world where the raw material supply is plentiful, including the United States, the Persian Gulf and Asia (China and India mainly). These plants will boost production capacity and will exert pressure on petrochemical prices, as demand is maturing. For global specialty chemical companies and petrochemicals, the Q2 2020 net margin bottomed at 7.12% and 4.92%, respectively. These margins have nearly halved since Q2 2019. The net debt ratio rose simultaneously by 4.3 and 1.4 percentage points, respectively. This latest evolution may create pressure for companies in the forthcoming months, when debt will have to be repaid.
Specialty chemical companies, while being impacted by the ongoing pandemic and the risk of an ‘uncontrolled’ second wave, have shown better resilience than petrochemicals. Indeed, they were in a relatively more favourable situation before the crisis. Entering this niche market requires 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 high value products, such as particulate emission filters that open up positive prospects in the context of the fight against environmental risks. However, the fortune of this segment is linked to the pace of the recovery, which is not expected to be fully and globally met before 2021, at best.
Differentiated recoveries depending on different regions worldwide and risks of an uncontrolled second wave.
China seems to have recovered from the effects of the severe lockdown it imposed during the first quarter of 2020. Industrial production rebounded sharply in June from the lows reached in February: 104.8 versus 86.5. The manufacturing sectors in Japan and Korea showed a modest rebound in their monthly index of end-June 2020 after suffering the most in May. In the Eurozone, the rebound in manufacturing production was observed in end-June when compared to the low in April (a month when lockdowns were fully enforced in the continent): 91.4 versus 73.3. Better car registration figures recorded in the continent since then, induced by the restart of many production plants, is one of the main explanations behind these higher figures. However, we should remain cautious while exploiting these trends, as the latest figure is 13 points below the average of January and February 2020 (around 104 points), before the onset of the pandemic in the continent. In the U.S., analysis of manufacturing production figures shows a similar landscape to their European counterparts. Thus, as of end-June 2020, the index rose by around 10 points compared to the low in April, reaching 94. However, the latest data point is 12 points below the 2019 average, while the pandemic is accelerating in the country. Therefore, another dip during the summer cannot be excluded.
Sectoral reconfiguration will continue to be mainly driven by both regulation and the evolution of consumers’ preferences
Like many sectors, the chemical industry is facing stricter regulations. These rules, which aim to limit environmental risks resulting from the processes used to produce chemicals themselves or final chemical products, are increasing 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 are spurring calls for changes to production models employed by companies in the sector. For instance, the NGO Greenpeace recorded that 34 African nations out of 54 banned plastics, notably Eritrea since 2005. Many African governments are banning plastic bags, particularly those for single-use, of which the wastes are plaguing the continent. Importing or producing plastic bags in many countries is a criminal offence and domestic producers are marketing substitutes made from reusable textile bags like in Morocco or biodegradable ones like in Togo.
The rising demand from consumers and public opinion to limit plastic use for environmental concerns is also prompting shareholders to pressure management boards in complying with these changes in consumers’ preferences. The issue of recycling represents a risk for the sector, in view of growing citizen awareness around the world about its importance, particularly due to media coverage of the effects of micro-plastics ingestion on marine animals, 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.
The ongoing restructuring among actors in the sector is mainly due to the consequences of long-term price dynamics. According to Wood Mackenzie, a total of 50 million tons per year of ethylene projects are underway globally. Some projects could be cancelled, but a big share is already under construction or in the engineering phase. We expect these additional capacities to exert further pressure on prices of ethylene related products in the forthcoming years, as Wood Mackenzie forecasts additional demand for ethylene to reach 6 million tons per year. This trend will have a severe impact on margins. Other chemical commodities, such as paraxylene glycol, methanol and propylene, are following the same trends. There is overcapacity in these products, which exerts downward pressure on prices and will ultimately contribute in reducing the main producers’ margins. Naphtha and ethane prices have also been highly volatile since 2018, due in particular to the uncertainty of the U.S. trade policy and its impact on oil prices, as naphtha is a crude oil-derived product, while ethane prices are correlated to 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.
Last update : October 2020