Risk and reward: The complex ecosystem of the global chemical industry

Published: August 14, 2017

Doug Collins, Vice President – Regional Director, Risk Services – Americas at Atradius, explains how the health of global and national economies play a major role in the financial security of the chemical sector’s complex ecosystem, as does end-market demand for chemical products and the volatility of input costs.

To be successful, it’s imperative for both chemical companies and businesses trading with them to understand the many factors at play, such as those outlined in a recent Market Monitor from Atradius, a trade credit insurer. The report, which focuses on basic chemicals, petrochemicals, fine and specialty chemicals, analysed the sector’s performance in 10 countries.

The good news is that the global chemical industry’s performance is positive. Business financials are generally robust, and compared to other sectors, the industry maintains good payment practices and low insolvency rates. Solid growth is expected in China, the United States, Poland, Saudi Arabia and Indonesia, while middling growth is predicted for the Czech Republic, Spain and the United Kingdom. The outlook is most weak – although still fair – for Brazil and Italy (Figure 1).

Figure 1 – Outlook for the 10 countries included in the report is fair to good 

A Complicated Ecosystem

End-market demand, of course, is tied to the health of the broader economy. The automobile sector, for instance, is a sizable customer for the chemical industry, which in turn has benefitted from strong automotive demand in the US since the last downturn.

Another major customer is the oil and gas sector, where oil prices have translated into less demand for chemicals used in the exploration and extraction sectors, hitting smaller companies particularly hard. On the other hand, this trend helps companies – such as fertilizer producers – that use petrochemicals as a raw material in their products. At the same time, the volatility of oil prices remains a hurdle for chemical companies, given profit margins are often narrow and fixed costs high, meaning that volatility of input costs significantly affects financial performance.

But it’s not just uncertainty in pricing that chemical companies must take into consideration. Geopolitical uncertainty also abounds. Take climate change, for instance. Efforts around the world to curb emissions could have a major financial impact on chemical companies, which are big producers of CO2. Another area of geopolitical uncertainty is the potential renegotiation of trade agreements such as NAFTA. Finally, major infrastructure projects proposed by President Trump, if approved, would benefit US chemical businesses providing polymers, coatings, adhesives, solvents and other materials used in the construction industry. But on the other hand, potential import taxes would negatively impact supply chains.

A Deeper Dive

Brazil, the riskiest of the 10 countries Atradius analysed in its report, demonstrates well how the economy, end-market demand and the cost of raw materials are intertwined. Over the past two years, payment experience has been negative and insolvencies increased, especially in the agrichemicals sector, which suffered a dramatic commodity price decrease in 2014 and a drought in 2015 and 2016. In addition, a weak Brazilian Real increased the cost of critical raw materials, hurting domestic producers already suffering from weak demand.

Brazil is expected to see a modest rebound in 2017, as interest rates ease and demand revives. The agrichemicals segment in particular is predicted to benefit from stability in commodity prices and a strong harvest in many segments, although it remains susceptible to the volatile weather patterns, market prices and a volatile BRL/USD exchange rate.

Compared globally, the US chemical industry is performing particularly well, outside of the oil and gas sector. Production is expected to increase 3.6% in 2017 and 4.8% in 2018, as many subsectors enjoy the cost advantage of shale gas. In fact, exports of US chemicals linked to shale gas are predicted to total $123 billion by 2030. Although US chemical companies are heavily reliant on banks versus capital markets for financing, the risk here remains low as overall the banks are favorable toward the chemical industry. In addition, the underlying economy is relatively stable – growth has been slow but consistent, holding at 2 to 2.5% since 2009. That stability helps companies better predict pricing and demand, no small feat for the chemical industry, which relies heavily on historically volatile raw materials such as oil.

The Urge to Merge

Although the overall performance of the global chemical industry is solid, some major hurdles exist. Growth has slowed, profit margins are lower than in the past and the cost to develop and test new chemicals is increasingly prohibitive. To offset these risks, many companies – particularly in the agrochemicals, basic and specialty chemicals sectors – are consolidating through M&A activity.

M&A volumes reached $237 billion in 2015 and $220 billion in 2016, with similar results expected for 2017. The largest deals included the $130 billion Dow Chemical and Dupont merger and the $66 billion Bayer and Monsanto agreement. The buying frenzy is supported by low oil and gas prices, as well as the support of external investors and the current low interest rate environment.

This M&A activity has generally been positive, with companies spinning off non-core assets, or through acquisition to build economies of scale, a smart strategy considering the high fixed costs inherent in the sector. However, as asset values rise, the risks of M&A are increasing as well, particularly on leveraged buy-outs which are especially vulnerable raw material price volatility or demand shifts due to a faltering economy, making debt-service obligations more difficult.

The risks inherent in the chemical industry can be tricky to navigate. To manage input costs, the use of price hedges can reduce volatility and lock into profits, while investment in the latest production technologies can provide a competitive advantage. To manage risk and support sales growth, trade credit insurance helps companies mitigate the credit risk of trading with domestic and overseas customers, as well as alerting policyholders to potential economic, credit, and geopolitical problems.

Atradius offers trade credit insurance to protect businesses’ trading relationships, while also minimizing the risks of volatile markets abroad. Doug Collins is Vice President – Regional Director, Risk Services – Americas. In this leadership role, he is responsible for Atradius’ risk underwriting activities in the Western Hemisphere. Doug can be reached at [email protected]


Copyright © 2017 Mack Brooks Speciality Publishing.