A bullish outlook for demand

Prices bound to rise because of raw materials inflation

Tom Stundza -- Purchasing, 1/13/2005

Back in mid-2003, Andrew Rosenfeld predicted that 2004 would be "a transition year for commodity chemicals" with demand beginning to catch up to oversupply." He was correct. So what's his outlook for 2005? Bullish.

The Prudential Equity Group analyst anticipates both healthy demand—and higher prices—this year because he believes that the industry is entering "a sustained period of improving underlying demand growth" that will lead to tighter supply/demand balances. But he worries that the specialty chemicals subgroup will be pressured by rising raw materials' costs that will squeeze end-product market prices.

The improved pricing situation for the industry—but not necessarily for buyers of chemicals—is reflected in Purchasing magazine's Chemical Price Index which, based on buyer surveys, rose by 27% in 2004. That pricing momentum, coupled with good overall volume growth, has enabled the industry to garner healthy profits despite a surge in feedstock and energy costs.

"The supply/demand balance for essentially all products should continue to tighten in 2005, giving both the commodity and specialty names significant pricing power not seen in a number of years," says Rosenfeld in a research note that he wrote to his clients from his Menlo Park, Calif., office. "The tide has changed" because the continued growth of the global economy is leading to sustained demand growth for chemicals and resins.

That's why he says business conditions in 2005 "likely will be framed by a continued moderate expansion in the broad economy, with the chemical sector increasing its participation in the growth." The industry should do well financially, he says, even though demand and operating costs remain vulnerable to uncertainties surrounding the costs of oil and natural gas.

However, the outlook for the makers of specialty chemicals—especially chemical additives and catalysts—is not as encouraging because of tough competition in an expensive energy and raw materials environment. In addition, because many specialty chemical companies target specific markets, they can be affected more by declines or cyclicality in the markets they target. "At this point in time, the primary issue for the specialty chemical companies is the contractual pricing structures that do not allow them to pass on raw material price increases over a short time period."

Rosenfeld suggests that the commodity chemical industry could experience short-term volatility as it heads toward the peak of the demand and pricing cycle in 2005. "We do not believe the ride to the peak will be smooth and [we] expect a bump in the road by mid-2005," he says. Among the potential "bumps": expected capacity additions initiating operations at the same time, a slower-than-forecast global economy and planned (though untimely) restarts of idled ethylene plant that would take the market out of supply balance.

However, he cautions his outlook for commodity chemicals could be tempered by "shocks" to the global economy such as further acts of terrorism, other geopolitical events—or even the potential effect of a sustained $50 per barrel, or higher, crude oil environment.