Commodity & Specialty Chemicals Report
An analyst says that most companies have been able to achieve price increases to offset the high oil and gas prices.
Frank J. Mitsch, Managing Director, joined BB&T Capital Markets in January 2006 and follows the chemicals sector.
TWST: How was business in the chemical space relative to expectations in the first quarter?
Mr. Mitsch: Actually, the facts are better than the surrounding mood in terms of
the equity markets. Companies have been able to push through some measure of
price increases, mostly offsetting the high oil and high natural gas prices.
While demand domestically has not been stellar, demand in the export market and
overseas has been very solid. Overall, we are thinking that the chemical sector
is in pretty decent shape.
TWST: Is domestic demand just reflecting the economy?
Mr. Mitsch: Yes. Clearly anything that has been tied to the housing market has
been long-suffering, certainly in late 2006, 2007 and year to date here in 2008.
You also have some softness on the automotive side, with a strike and weakness
in downstream demand there. You have seen some pockets of softness domestically,
but this weakness is not as pronounced in Europe, and certainly not in Latin
America or Asia.
TWST: How about on the ag side? Given the strength there, has that been some
help?
Mr. Mitsch: That has clearly been a major help for those companies that have any
sort of tie-in to the ag space. Such leaders, as Monsanto (MON) have been doing
extremely well, and also some of the fertilizer names, including Potash Corp.
(POT) and Mosaic (MOS). Even DuPont (DD), which derives a quarter of its sales
from the ag space, and Dow Chemical (DOW), which derives about 10% of its sales
from the ag space, are doing very well in that business. FMC (FMC) is another
name that has exposure to ag, coming off of a very strong South American season
and going into the very strong North American season right now. Ag has certainly
been one of the brightest spots for chemical demand.
TWST: What kind of price increases have the companies been able to get away
with?
Mr. Mitsch: It varies by different commodity products. Generally speaking,
prices have been higher across the board than when we started the year. The
areas where you have seen the most amount of strength are such areas as
chloralkali, where, although chlorine prices have been a little lackluster given
the weakness in housing, for caustic soda (its co-product), the price increases
have been absolutely phenomenal! Caustic soda is a commodity that is used by the
alumina industry, among others, and on a regular basis we hear of the pain
coming out of Alcoa and other companies because they have to pay much higher
prices for caustic soda, given the tightness of that market. Going back a year
ago, nearly all products have seen major price increases, as shown in the chart.
TWST: We have oil at $113 a barrel. How much pressure has that put on margins in
this space?
Mr. Mitsch: I'll tell you, it certainly hasn't helped matters any! But this is
where companies have been trying to be proactive. If you are buying such
hydrocarbons as naphtha, which is related to crude oil, or something related to
natural gas, you have definitely been trying to be aggressive in raising prices.
They have been successful in raising prices, but in some areas perhaps not as
much as the underlying raw material. We expect to see some catching up in the
second quarter take place. Dow Chemical, among others, has suffered a bit here
in the first quarter. Dow is the largest buyer of energy out there. We believe
that when they report their results, we will see this impact.
TWST: With energy prices continuing to ratchet up here, are they going to be
able to get further price increases to offset that as we look forward?
Mr. Mitsch: The answer in 2008 is yes! At the end of the day, what is going to
drive their ability to raise prices will be the supply/demand balance and
operating rates. Assuming that whatever North American recession we're currently
feeling will moderate in the second half of the year, and assuming the globe
doesn't head into a recession, which is what the consensus among economists
would suggest, then the demand side of the equation looks like it is going to
hold up. With a limited amount of new supply this year, we believe that with a
bit of a lag, Dow, NOVA Chemicals (NCX) and others will be able to pass through
these higher hydrocarbon costs.
The jury is out a bit more on 2009. We will have to wait and see how much new
capacity is actually started up successfully in the Middle East. There has been
a lot of talk of new capacity in the Middle East. So far, most of those projects
have been delayed, and whatever has started up has not been enough to ruin the
supply/demand balance. We will wait and see how successful companies in Iran,
Saudi Arabia, etc., are in terms of getting new supply online in 2009.
TWST: Are the plants being built or is this still in the talking stage?
Mr. Mitsch: They are being constructed, but as you know, costs of the materials
themselves have skyrocketed. The cost of engineering and design help has also
skyrocketed. It has been very tight. Construction costs and availability of
materials are problematic and have conspired to slow down the rate of new supply
that has been talked about, quite frankly, for the past five plus years.
TWST: It is not new talk.
Mr. Mitsch: It is not new talk at all. We make the case that some of the
consulting firms out there have been talking about this for the past five years.
Five years ago they said that within a two-year time period, the industry would
be in an oversupply mode, and then in the following year they said it would be
another two years before it would be in oversupply mode. They have been playing
that game, as we talk about in our recently published report, "Tall Tales from
Texas!." Now people are talking more about an 18-month time frame. That is why I
say that what goes on in that part of the world bears watching very closely.
