Storm creates price and supply woes

In the wake of hurricane Katrina, specialties makers confront costlier raw materials on top of long-term competitive issues

By Gordon Graff -- Purchasing, 10/6/2005

The specialty chemicals sector has been grappling with spiraling raw materials and energy costs for several years. But the entire chemical industry faces new economic hardships—and potential shortages—since Hurricane Katrina barreled through the U.S. Gulf Coast late in the summer, leaving behind not only a trail of human misery but gutted refineries and chemical plants as well.

Beyond the immediate crises caused by the storm, specialty chemical suppliers have long been confronted with gradual commoditization of their products, plus competition from low-cost suppliers, particularly from Asia. Keenly aware of these challenges, major players in the field are enlisting a raft of strategies to control them.

The hurricane had the most impact on industrial customers who rely on a few key specialty chemical ingredients. One company, Fiber Glass Systems, a San Antonio, Texas manufacturer of glass fiber-reinforced epoxy pipes for the oil industry, found that the storm wiped out communications with the plant of its sole supplier of triethylenetetramine (TETA), an epoxy curing agent essential for its operations. Loss of that plant, located 20 miles east of New Orleans, would have had astronomical consequences for the company, said Jim Rhodes, vice president of corporate purchasing at Fiber Glass Systems. Rhodes was relieved to find several days later that the plant was intact, but fretted that the facility might be out of commission for several weeks due to utility interruptions and lack of personnel, many made homeless by the storm.

But hurricane-related outages at huge Gulf Coast refineries and chemical facilities threatened to create much wider supply disruptions for manufacturers and users of specialties and other chemical products. According to Chemical Market Associates, the hurricane shut down some of the Louisiana and other Gulf Coast operations of such giants as Dow Chemical, ChevronPhillips, Shell, OxyChem, Georgia Gulf, Ineos Phenol, Wellman, Huntsman, Hercules and BASF. Among the specialty chemical building blocks affected by the outages were benzene, mixed xylenes, chlorine, phenol, ethylene oxide, propylene oxide, propylene glycol and ethylene glycol. While it was not clear in the immediate aftermath of the storm how long these units would be down, estimates by industry sources ranged from several weeks to several months.

Despite these woes, the specialty chemicals area has been reasonably healthy. Sales in the industry for the U.S., Western Europe and Japan amounted to $256 million in 2003, accounting for 77% of world output of specialties, reports SRI Consulting. In that year, says the firm, the five largest specialty chemical segments—active pharmaceutical ingredients, pesticides, electronic chemicals, advanced ceramic materials and specialty polymers—had a combined market share of just over 40%. Currently, the fastest growth in specialty chemicals (5% or higher), says SRI, is in active pharmaceutical ingredients, dyes and pigments, high-performance thermoplastics and radiation-curable coatings (see table). Stagnating or declining growth (less than 1%) is seen by SRI in pesticides, textile chemicals, lubricating oil additives, synthetic dyes, rubber-processing chemicals and mining chemicals.

By all accounts, the biggest single issue in the specialty chemicals field is the surging price of raw materials, a problem worsened by the chemical shortages and oil price hikes caused by the recent hurricane. Rhodes says that prices of the specialty chemicals he buys "almost doubled" in 2004, but have been "somewhat stagnant" for much of 2005. He expects that to change very soon.

"Prices of epoxy resins we buy are based on $50 [per barrel] oil," says Rhodes. With the sudden leap of oil to $70 late in the summer, he anticipates that resin suppliers will try to recoup the difference by the end of 2005 in the form of higher prices.

Even before the latest round of hikes, rising raw materials and energy rates had been a perennial headache for specialty chemicals producers. "We have experienced significant increases in natural gas, freight and raw materials costs," says John Salvatore, president of Degussa Corp. of Parsippany, N.J. "We have passed on some, but not all, of these increases to our customers," he adds. But the burden of higher costs will have to be borne up and down the specialty chemical supply chain, Salvatore stresses. When it comes to sudden jumps in costs, he continues, "we cannot continue to be the 'shock absorber' of the industry."

Because of competitive pressures, few specialty chemical producers have been able to pass along to their customers the full amounts of their own cost increases. To stay afloat in today's environment, therefore, many firms are trying to rein in their own costs. Many of these efforts involve changes in raw materials procurement practices. A spokesman for Clariant, the huge Muttenz, Switzerland-based supplier of specialty chemicals, says the run-up in the firm's raw materials costs has been partially offset by an average 2% increase in selling prices for most of its products this year.

Clariant has created a specialized group which aggregates sourcing activities worldwide in order to consolidate volumes and boost its purchasing power. Similarly, Degussa leverages its buying power by organizing its procurement program across departmental lines. According to Salvatore, the company also emphasizes close working relationships with its strategic suppliers. This can have practical benefits, but in some cases, says Salvatore, through negotiations "we have been able to mitigate an increase in the cost of certain materials, delay price increases for a month or two, or obtain other price concessions."

At Sigma-Aldrich's SAFC unit, which does custom chemical manufacturing, Ed Roullard, vice president for marketing and supply chain, says his organization uses a checklist to rate its suppliers by cost, reliability and other factors. The company then selects suppliers with the highest ratings.

Many specialty chemical makers are also sourcing in low-cost countries such as China or India. The best way to source in Asia, says Paul Bacon, director of Rhodia Eco Services, is to have an active presence in the region. Bacon, who until this past June was the vice president of purchasing at Rhodia Corp., says his company buys about $125 million per year of raw materials from Asia, an amount that is up by 25% in the past 18 months. Products purchased in the region include pharmaceutical intermediates, coating intermediates, and chemical packaging. To get the best deals, says Bacon, Rhodia has set up procurement teams in two key Asian cities—Singapore and Shanghai. These buyers, he adds, are connected to Rhodia's worldwide procurement network. Procurement managers in, say, North America, can relay RFQs (request for quotes) to the Asian sourcing team, which passes them along to their contacts in the region.

Specialty chemical makers also must contend with defection of their customers to lower-priced vendors, especially those in Asia. "It is our principle not to enter into price competition with low-cost producers," says the Clariant source. Instead, he adds, the company retains customer loyalty by emphasizing value-added services such as extensive technical development.

Sky-high energy rates have also taken a toll on specialties and other sectors of the chemical industry. Most suppliers of specialty chemicals "have their cost structure based on $6 [per million Btu] natural gas," says Rhodes. By early September, however, disruptions caused by Hurricane Katrina had pushed up spot prices and futures for natural gas to a record $12/million Btu. (In the chemical industry, natural gas is also a feedstock as well as energy source.) Many chemical producers will have no choice but to pass on these increases to their customers, says Rhodes.

Of course, energy volatility is a fact of life these days, and most chemical firms have planned for it. Salvatore says some Degussa business units employ natural gas hedging programs, adding that these efforts have been "very successful." Meanwhile, energy used in transportation of specialty chemicals has also taken a big bite out of profits. At Lonza Performance Chemicals in Allendale, N.J., Allan Kushins, head of new ventures, says that his company has imposed a surcharge on customers to cover higher transportation fuel costs.

Whether they are broad-application herbicides, novel emulsifying agents, or active ingredients for anti-anxiety drugs, specialty chemical products tend, sooner or later, to become commodities, especially once any patents for them expire. Companies recognize this and are taking various proactive measures. According to the Clariant spokesman, the company constantly renews its product portfolio based on its customers' needs. About one-third of the firm's product slate, he adds, is composed of products less than five years old.

Kushins says Lonza weighs-in early with new products that are geared to the changing marketplace. One example of this, he adds, is Lonza's recently launched environmentally friendly substitute for copper-chrome arsenate, a wood preservative that was voluntarily removed from the marketplace after questions about its safety arose. Another example of innovation at the firm, says Kushins, is a new line of personal care formulations based on chemicals derived from natural sources.

Meanwhile, Salvatore says Degussa Construction Chemicals has extended its e-commerce initiative by seamlessly integrating the firm's suppliers and customers using Internet-based technology. Under this system, he explains, customers can "quickly see a range of solutions, orders can be tracked and delivery dates made clear."

At Sigma-Aldrich, Roullard says his SAFC unit remains competitive "by continuously taking costs out of our systems." Process improvements and higher reaction efficiencies are the typical pathways to these savings, he notes.

The SAFC division also offers a plethora of services that complement its chemical offerings. For example, it provides its pharmaceutical customers with the documentation, including traceable histories, needed to obtain regulatory approval of new drugs.

The strength of the customer-vendor ties will be tested as never before if, as expected, specialty chemical producers and their raw materials suppliers boost their prices significantly to cope with the startling run-up in oil and natural-gas rates. Dramatically higher chemical prices, not to mention gasoline at more than $3/gal, could put a damper on downstream consumer spending, warns Rhodes. If that happens, he adds, chemical makers "could find themselves in the same situation as in 2002 or 2003, when they weren't making a reasonable return" due to depressed demand. Whether things play out this way, says Rhodes, will depend on how soon those knocked-out refineries and chemical plants in the Gulf region get back online.