- Main input prices remain at historically low levels, which somewhat benefits the petrochemicals segment
- Speciality chemical companies are benefiting from innovative products aimed at tackling environmental risks
- Speciality 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
- Increasing production capacity in ethylene and its derivatives, which results in overcapacity
- Stricter regulatory environment forcing producers to overhaul their business models
- Significant legal risks resulting from the effects of some chemicals on human health
Risk Analysis Synthesis
Two segments are under our scrutiny when dealing with the chemicals sector: petrochemicals and speciality chemicals. Petrochemicals are more tied to economic conditions, while speciality 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 very weak in client sectors, such as automotive, and, to a lesser extent, construction. Moreover, increased supply, brought about 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, such 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.
Notes for the reader
Net margin: ratio of profits to sales
Profitability: GOP on turnover
Sector Economic Insights
The sector has suffered from a fall in demand due to the pandemic induced lockdowns
For 2020 and 2021, Coface expects annual growth rates of -18% and 7% in China respectively, while the United States should experience a 4.8% contraction before rebounding to 2.9%. The European Union will experience a large contraction, estimated at -8.1% in 2020, before rebounding modestly to 5.5%.
Major petrochemical commodities 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 have rebounded since then, by 65% in June 2020, the downward trend persists. This is in fact far from a total recovery, as these represent only 25% of January prices. The current weakness felt in auto markets across the globe is continuing to impact sales of raw materials for tyres. Xylene prices followed 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 lower or stagnating vehicle sales in the main markets. Meanwhile, the construction sector is recovering at a very different pace depending on the different regions we cover: while activity remains weak overall, a positive dynamic stands out - particularly in the residential real estate segment - despite the difficulties that persist. This recovery is indeed perceptible in major markets such as China and the United States.
Similar to 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. Consequently, American producers are being forced to look 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 Arabian peninsula and Asia (China and India mainly). These plants will boost production capacity and will exert pressure on petrochemical prices, as demand is maturing. The trajectory of companies in the sector at the global level remains worrisome, with decreasing margins and increasing net debt levels. The net debt ratio rose simultaneously by 1.6 and 2.3 percentage points, respectively. This latest evolution may create pressure for companies in the forthcoming months, when debt will have to be repaid.
Speciality chemical companies, while being impacted by the ongoing pandemic’s consequences on economic activity and the risk of an ‘uncontrolled’ second wave, have exhibited better resilience than petrochemicals. Indeed, they were in a relatively more favourable position before the crisis. Entering this niche market requires continuous and costly R&D investment over several years. Another factor that protects speciality chemical companies from competition is the expertise that 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, which 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 achieved during 2021.
Differentiated recoveries depending on different regions of the world due to the impact of the pandemic
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 October from the lows reached in February: 106.9 versus 86.5. The manufacturing sectors in Japan and Korea also showed a strong rebound in their monthly index at the end of October 2020 after suffering the most in May. In the Eurozone, the rebound in manufacturing production was observed at the end of October when compared to the low in April (a month in which lockdowns were fully enforced on the continent): 97.4 versus 73.3. Better car registration figures recorded on the continent since then, brought about by the restarting of many production plants, is one of the main explanations behind these higher figures. However, we should remain cautious when exploiting these trends, as the latest figure is 16 points below the average for January and February 2020 (around 110 points), before the onset of the pandemic on the continent. In the U.S., analyses of manufacturing production figures shows a landscape similar to that of its European counterparts. Thus, as of the end of October 2020, the index rose by around 16 points compared to the low in April, reaching 94. However, the latest data point is 5 points below the 2019 average, while the pandemic is experiencing a third wave in the country.
Sectoral reconfiguration will continue to be driven mainly by both regulation and the evolution of consumers’ preferences
Like many sectors, the chemical industry is facing stricter regulations. These rules aim at limiting environmental risks resulting from the processes used to produce the chemicals themselves or final chemical products. These rules are increasing production 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 out of 54 African nations had banned plastics since 2005, notably Eritrea. Many African governments are banning plastic bags, particularly those for single-use, the waste from which is plaguing the continent. In many countries, importing or producing plastic bags 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 to comply with these changes in consumers’ preferences. The issue of recycling represents a risk for the sector, in view of growing citizen awareness globally 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, 50 million tonnes per year of ethylene projects are underway globally. Some projects could be cancelled, but a large share are 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 coming years, as Wood Mackenzie forecasts additional demand for ethylene to reach 6 million tonnes 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 to a reduction in the main producers’ margins. Naphtha and ethane prices have also been highly volatile since 2018, due in particular to the uncertainty of 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 : February 2021