Planning for the next capital cycle in global chemicals markets Risk assessment, mitigation will be key

20:40 PM | March 24, 2014

Witte: US investments face the risk of construction and capital cost escalation and delays.

IHS Chemical will host the 2014 IHS World Petrochemical Conference and Workshops 2528 March at the Hilton Americas Hotel at Houston. The event will focus on the impact of the next capital cycle and the sustainability of an increasingly competitive global chemicals market. CW sat recently with Dave Witte, senior v.p. and general manager of IHS Chemical, recently to get his views on the industry’s current capital cycle.

IHS CW: What are the primary supply-side risks associated with the upcoming chemical capital build program that are focused on the United States and China?

Dave Witte: The risks depend on whether one is viewing the industry from the perspective of companies building the asset or those operating existing assetsand, perhaps more importantly, the competitive and market positions of the companies examined. For example, those building assets face construction and capital escalation risks or delays to the build cycle. Labor shortages and demographics are acute, and they come at a time of unparalleled capital build on the US Gulf Coast. Construction delays or increased investment costs are very real risks that have a substantive impact on returns.

Moreover, if you are building in the United States, leveraging on the shale windfall but still facing an oversupplied domestic market, capital risk is compounded by market risks. When this wave of product moves to the export market. there are really very few markets that can absorb the surplus. The risk of antidumping, protectionism, or cut-throat competition is very real.

As daunting as these decisions appear, they belie other key underlying riskssuch as how energy fundamentals will play out. Will technologies that have unlocked the gas-liquid volumes be usurped by other technologies or become subject to greater regulation? Will oil prices remain high, or will geopolitics and technological advances close the oil-gas differential?

In China, coal-based producers face a similar set of uncertainties. Since most of the economic advantage is built on coal-oil differentials, a key uncertainty deals with how coal pricing plays out. Another fundamental risk with coal-based investment is the intensive resource footprint. Water use is substantial. More worrisome, however, are the large emissions of carbon dioxide, which may soon have an associated penalty.

How about producers in high-cost markets?

European producers, for example, face stagnant growth and the threat of more competitive material impacting market share and overall price levels. There are a number of counteracting strategies. They could invest to improve their cost position. But, investing in an aged asset with questionable competitiveness is difficult.

In Asia, producers are loathe to simply walk away from markets that are in their backyard. And, their assets are newer and, in a number of cases, better positioned than European counterparts. However, China is a huge target for the low-cost North American producers, and many companies building in the United States have an established customer base with proven channels to market. There are no clear-cut, low-risk, easy-decision pathways, but producers will need to address these complex issues.

How are market players preparing for or mitigating these risks?

The key is detailed planning to understand the primary levers and the risks associated with each. For example, if there is risk of labor escalation, that risk can be mitigated with the proper engineering, procurement, and construction (EPC) contracting strategy. Interestingly, some players in the industry are taking a long-term view and partnering with academic institutions and government officials to develop programs that encourage workforce development.

From a competitive standpoint, producers are also using commercial contracts or financial instruments to help mitigate the risk.

To minimize market entry risks, producers are lining up with existing distributors, qualifying product in target markets, developing deeper brand recognition, and seeding future markets.

Those who are in higher-cost areas are also employing a wide-range of strategies. Some are shuttering high-cost operations and building scale by concentrating on those assets that are competitive. We see this today in Japan and Europe. Still others are investing in feedstock optionality by adding equipment and supply flexibility or shifting the mix away from commodity grades to higher-value product lines.

What are the uncertainties that could dampen or accentuate these risks?

Actual global economic performance is a key uncertainty. Since chemicals are used across virtually every end sector, from autos to electronics to consumer goods, demand growth is intimately tied to economic activity. The industry has been languishing with somewhat subpar growth over the last several years, since the primary engine of chemical demand growth, China, has faltered somewhat. The Chinese government is keen to gradually shift the economic mix to rely more on domestic consumption. But, there is uncertainty as to the pace that China will enact these changes and how effective they will be.

On the flip side, higher demand growthand IHS economists are becoming somewhat more optimistic as of latewill help to absorb the surpluses and allow a better market balance.

On the supply side, how capacity additions phase into the market is a key variable. Already, capital costs are escalating, permits are getting more difficult, and decision processes are being stretched out. Those that are coming to the EPC market a little later are more likely to run the risk of delays in the construction cycle.

All of these issues, and others, are situations that IHS is following. Our product experts are long-time, industry-seasoned veterans with a wealth of experience and contacts to develop the necessary fact-set, analyze the implications, and provide actionable insights for our clients. That is why we are the leaders in the industry and why the chemical industry relies on IHS to inform top executives as they make the critical decisions that shape their future.