Resin Outlook 2004: Buyer Beware

Experts speaking at the Canadian Plastics Resin Outlook Conference were remarkably unanimous in their opinion that the fundamentals of the resin supply chain have shifted — infrastructure costs have risen, global sourcing has undermined pricing, and buying no longer follows traditional patterns.

The profit margins of resin producers are eroding and they will be looking to make changes in the coming years, beyond merely raising prices to cover their costs.

What can producers do to enhance their margins? Dow Chemical Co.’s Peter Sykes says much has already been done. In polystyrene operations, for example, “production costs, excluding styrene monomer, have been reduced by more than 40% in the past decade, but all that has done is keep producers afloat.”

In polyolefins, producers have idled almost 1.5 million tons per year of polyethylene capacity and more than 0.7 million tons of polypropylene in North America to improve efficiency.

Sykes suggested that in order to grow and prosper, producers must:

reposition price protection

improve capacity utilization

maintain R&D investment to improve product performance

educate their customers (processors) and processors’ customers about the changing cost landscape.

Price protection must go

Sykes made a plea for processors to help change OEM and retailer expectations for “stable, low prices”.

“We’re all being squeezed by the current situation. We must address challenges systematically over time to regain health and viability in our industry.”

Price protection must go

Sykes and industry analyst Bob Bauman of Nexant Inc. also finger price protection as a culprit. Price protection refers to the practice of announcing a price increase, but delaying application of the increase for 30 to 60 days on some accounts.

“Our margins are too slim to allow us to act as a buffer for downstream markets,” says Sykes. “Price protection is out of sync with today’s market conditions. It has widespread implementation in North America, yet it flies in the face of the macro trends: higher costs and higher volatility.

“We have to change our customers’ mindset and expectations. If the extent of a pricing change is too large for converters to absorb alone, it will have to extend to the consumer level.”

Dow has begun to address the issue of price volatility by producing literature explaining the pricing dynamics of certain resins that it hopes customers can use in negotiations with end-users.

Sykes also suggests that resin users evaluate risks when negotiating fixed vs. floating prices, and consider building in “re-set” points. Close communication between purchasing and sales/marketing staff is also key.

Polyolefins: tight supply will drive prices up

In 2003 the plastics industry was struck by some unforeseen events: high energy/feedstock prices, SARS, overcapacity, the Iraq war, low economic growth and low demand.

In North America, polyolefin prices first increased then decreased. “While prices increased, costs also increased, so (resin producer) profitability stayed poor,” explains Bauman. “First and second quarter earnings for many producers were negative. Price protection is a key reason for the problem.”

For 2004, polyolefin prices are expected to increase, while production costs decrease.

Inventory remains low throughout the resin supply chain, and inventory rebuilding will be a key component of sales growth during the next 18 months. “If one link in the supply chain increases its inventory by one week, it will increase sales by 2%,” Bauman notes.

Globally, there is very little new polyolefin capacity starting up, and polyolefin demand is increasing faster than new capacity is being built.

In Bauman’s words, “the stage is set for a strong 2004 and a fly-up in 2005.”

Demand for polyethylene will grow hand-in-hand with economic recovery, which brings prospects of a tightening market in 2004 and beyond. Chris Gick of NOVA Chemicals Corp. speculates that re-investment decisions by resin producers could be delayed due to the uncertainty of several decision inputs, and thus the period of tight supply/demand balance may persist longer than usual.

Looking ahead at the supply situation for PE, Gick notes that baseline operating rates will rise from a low of 90% in early 2004 to almost 100% by the end of 2007. This could be offset by 3.7 billion lb. of “speculative” capacity that may be added by late 2007. Either way, “we’re looking at a fairly tight PE market over the next several years.”

Bauman agrees that announced new capacity will not will not meet projected global demand. “We still need 45 new crackers which are not accounted for by those scheduled in China and the Middle East. There won’t be enough ethylene to meet post-2005 demand.”

In addition, most announced new crackers will be based on ethylene, so propylene supply will begin to tighten.

For polypropylene, forecast demand growth has been lowered due to the effects of a propylene shortage. Bauman says there will not be enough propylene available to meet global demand growth of more than 8%.

Polystyrene: feedstock limitations will drive increased prices

Peter Sykes, commercial director, polystyrene, North America, for Dow Chemical, explains that the growth rate for polystyrene has largely decoupled from gross domestic product (GDP) growth. PS has averaged 1% growth per year. Material substitution, especially by polypropylene and PET, continue to affect PS growth.

Sykes makes the point that polystyrene producers may have been the architects of their own doom by permitting an oversupply situation.

Latin America and Southeast Asia both have one and a half times more supply than demand, and Japan has 300,000 tonnes of excess capacity.

The result is that “we are carrying 20% more fixed cost than required to meet industry demand.”

Sykes feels the industry must focus its efforts on capacity utilization, rather than increasing capacity.

Looking at styrene monomer capacity, Sykes projects that capacity growth will fall short of the historical 4.3% annual growth rate, and so there will be a tightening of the supply situation. “Typically, tightening in styrene monomer causes polystyrene prices to rise. There’s a high likelihood of a price peak occurring in the next few years.”

PVC: prices rising in short term

PVC demand tracks GDP. This simple statement underlies most forecasts for PVC, however, one-time events do add volatility to the pricing cycle. In his address to the Canadian Plastics Resin Outlook Conference, Patrick Duke of DeWitt & Company Inc. recalled that PVC demand peaked in Oct. 2001, and then hit bottom again in May 2003. He cautions users to expect another sharp uptick in demand in 2004.

As a result, resin production cost and selling price will rise in the short term, but it is still an open question if margins will improve sufficiently to attract investment in North America and Europe beyond detbottlenecking and restarting idled capacity.

Duke notes that there’s been a 30 to 40% change in structural feedstock costs for PVC producers. Global political and economic instability have caused erratic behavior in the costs for crude oil, energy and other petrochemical building blocks. “Coupled with an unexpected surge in Canadian and U.S. natural gas price in the winter of 2000-2001, and again in early 2003, feedstock costs escalated beyond the ability of producers to cover margin loss. Overcapacity, along with unrelenting competitive and feedstock cost pressure, and a weakened world economy, left the global PVC industry in dire circumstances in 2003.”

PVC demand grew only 0.6% in 2003.

Globally, PVC demand is expected to grow to an average of 4.0% over the period from 2003 to 2010 as economic and supply fundamentals firm, says Duke.

The highest growth levels are expected in 2005 and 2006.

Already a huge consumer of PVC, China is also poised to grow as a producer. Of the 8.9 million tonnes of announced global expansions over the period from 2003 to 2008, China accounts for 87% of the total, Duke explains.

Looking at N
orth American PVC supply and demand, he says there’s certainly enough supply to satisfy demand. He estimates that operating rates from 2003 to 2008 will hover around 84%.

Engineering resins: nylon rising long-term, polycarbonate bottoming out

Nylon demand has been negatively affected by the manufacturing shift to Asia and by the reduced build rate of the Big Three North American automakers, since half of all nylon engineering resin consumed in the U.S. is used in automobiles, according to Jozef Venner, director, product management and product technology, BASF Performance Polymers.

This lagging demand, which Venner says is about in line with 1999 levels, is coupled with record feedstock and utility prices. “Increased feedstock prices have not been acceptably translated into the NAFTA nylon market, depressing margins.”

Looking forward, Venner notes that nylon growth will continue due to an improving economy and continued application development. A shift toward increasing nylon use in carpet will tighten the overall nylon supply/demand balance, which could translate to increasing nylon prices.

For polycarbonate, there are new applications in the works, but many of the markets for this material are mature. Producer margins are declining, and Ben Smith of Chemical Market Associates Inc. speculates that polycarbonate will become a pseudo-commodity resin, like ABS.

The optical media market which was so hot for polycarbonate in 2000, has now slowed.

Smith identifies potential significant new markets for polycarbonate in paintable auto parts, and automotive window glazing. If glazing takes off, Smith says it could become a 100,000 to 200,000 ton/year market.

In terms of supply and demand, he notes that capacity additions are planned each year from now until 2007. These are forecast to outstrip demand growth, which is pegged at 9% globally, but only 4% in North America.

Polycarbonate reached its lowest price in 2002, with a spot price of US$0.70/lb. According to Smith, that’s very close to the total cost per pound to produce polycarbonate in the U.S.

His conclusion is that polycarbonate pricing is now driven by supply and demand, and that producers are at risk of not getting the returns they need.

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North America bouncing back

While economies outside of North America are struggling, the economy of our largest trading partner is on the rebound, according to Peter Drake, deputy chief economist with the TD Bank Financial Group.

When Drake addressed the Canadian Plastics Resin Outlook Conference in early October, Q2 figures showed that U.S. real gross domestic product (GDP) was higher than the previous two quarters, and that U.S. business spending was on the rise.

He notes that the falling value of the U.S. dollar should help its domestic manufacturing sector, which he characterizes as “on the mend”, although there hasn’t been a corresponding increase in manufacturing employment yet.

On this side of the border, the fundamentals of the Canadian economy remain sound, and Drake expects the labor market to pick up in the early part of 2004.

He says the Canadian economy will likely not pick up as quickly as the U.S. economy in 2004, but that real GDP growth through 2004 should be 3%. This is approximately the same growth rate as in 2002. In 2003, GDP growth slipped to an estimated 1.8%.

On the subject of 2004 exchange rates, he says, “If I was running a company’s financials, I would plan on the Canadian dollar being about the US$0.75 to US$0.76 level.”

North American capacity reductions (2000-2003)

Polypropylene

Source: Nexant Inc., 2003

Polyethylene

Source: Nexant Inc., 2003