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Smarter Perspectives: Chemical

Podcast: What’s Next for Those Across the Chemical Industry?

Guest Kevin Duffy, Steve Katz (host)

This podcast features a discussion centered around the numerous global factors that continue to add complexity to an already strained chemical industry as we approach mid 2022.

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Steve Katz:

Hi everybody, and thanks for taking time out of your busy schedule to listen in on our Hilco Global Smarter Perspective Podcasts. As return listeners know by now, I'm your host, Steve Katz, and if this is your first time with us, well, then welcome. We are glad that you could tune in.

Steve Katz:

Our discussion today is centered around the economic volatility, supply chain unpredictability, and the overall global upheaval that are keeping the road ahead a bumpy one and a difficult one for sure to navigate for those across the chemical industry. Joining us again to talk about that is our guest from Hilco Valuation Services, Kevin Duffy. Welcome, Kevin.

Kevin Duffy:

Thanks, Steve. Glad to be with you and the listeners today on the podcast.

Steve Katz:

And we're glad that you're back to shed some light on what's been going on and what's still going on obviously in the chemical industry. So let's jump right into it.

Steve Katz:

Listen, the way I understand it, it's not like difficulties in the industry just began along with the start of the pandemic, but that they definitely became more complex at that time like a lot of other industries that we've seen. Since that time, as you and I have discussed on a couple of occasions, a lot of businesses up and down the chemical supply chain have been operating more or less in a crisis-oriented mode.

Steve Katz:

Can you take us through what triggered the problems that are causing the situation that's really now facing the industry since the start of COVID?

Kevin Duffy:

Sure, Steve. Early in the pandemic, when demand for transportation fuels fell drastically and refineries closed or ran at reduced rates, the supplies of feedstocks like naphtha and propylene decreased significantly. The chemical industry found itself in short supply of key inputs and unclear about how demand for industry staples might evolve.

Kevin Duffy:

After the initial shock of the lockdowns and economic downturn, a few bright spots revealed themselves, namely the elevated demand for plastics and packaging for the food and healthcare sectors, from takeout containers to personal protective equipment or PPE. That strong demand did a lot to help buoy the chemical industry in the short term.

Kevin Duffy:

Then came the weather. The 2020 hurricane season had a record-breaking 30 named storms and 11 landfall storms in the United States. While an average season has three major hurricanes, 2020 had seven.

Kevin Duffy:

Because of a significant portion of the US chemical production is concentrated in the Gulf Coast, many chemical plants are in the direct path of the Atlantic hurricanes. When Hurricane Laura approached the Gulf Coast in August 2020, there were widespread plant shutdowns. Stock prices of US chemical companies surged in anticipation of short supply and high demand. The storm's impact on critical infrastructure was, fortunately, less significant than that of Hurricane Harvey's in 2017.

Kevin Duffy:

Hurricane season was followed by a deep freeze in 2021, including a storm, much of the Southern US was ill-prepared to weather. Power outages and shutdowns there had a negative impact on chemical production and capacity once again. In fact, a hundred percent of capacity for certain chemicals, such as butadiene and polycarbonate, was offline for a time.

Kevin Duffy:

In March 2021, the storm outages coincided with domestic consumption that remained robust, and prices for chemical inputs surged. The weather continued to menace the industry with more Gulf Coast hurricanes in 2021, which was the third most active year on record and the sixth consecutive year above-normal Atlantic hurricane season.

Steve Katz:

So that alone is a lot and that's a lot of forces working against the industry and what was arguably one of the most complex time periods in history, but that wasn't the extent of the challenge. Not to beat a dead horse because it seems everybody is talking about supply chain issues these days, and I think you and I even talked about it last time when we got together.

Steve Katz:

But for the chemical industry, there have definitely been really distinct challenges involved in that situation. So can you talk a little bit about what some of those are?

Kevin Duffy:

Yes. While the weather was wild, the global supply chain proved to be perhaps the most formidable foe for the chemical industry, and for essentially every other industry on both a domestic and global level. In fact, we have reached the point where supply chain issues might be a legitimate response for why everything is taking longer than normal to be manufactured, transported, and delivered to market.

Kevin Duffy:

Shipping container shortages, too few truck drivers, and overall labor shortages across multiple industries have all contributed to skyrocketing shipping rates, record-breaking commodity prices, and extensive shipping and transportation delays.

Kevin Duffy:

The chemical industry is no exception. Global chemical supply chains have been under immense pressure. Normal flows of products have been delayed and often canceled due to a lack of capacity. Prices in turn have spiked to unsustainable levels. There are too few new ships nearing completion, and there have been too little capital investment in the shipyards for robust or rapid turnaround.

Kevin Duffy:

These factors have contributed to fears that the system may not rebalance for years. Prior to 2020, the shipping sector has been unprofitable for an extended period and the number of shipyards globally was declining. Even in areas where investment in shipyards is currently active, we expect it will be some time before the benefits of those capital improvements on the part of the shipyards are realized. Needless to say, strain on the global chemical supply chain due to the shipping crisis is likely with us for the foreseeable future.

Kevin Duffy:

Late in 2021, the American Chemistry Council or ACC surveyed chemical manufacturers doing business in the US. In the ACC's January 2022 report, the Council noted that 67 corporate respondents, of that 93% reported costs into the several millions of dollars due to the supply chain and freight transportation disruptions. In the past year alone, two-thirds reported lost production and over 90% reported shipping delays and increased transportation costs.

Kevin Duffy:

Although the delays and price increases may have been most acute in the shipping arena, the impacts were felt across the railroad and trucking sectors as well. Not surprisingly, those respondents also indicated that relationships with customers have been strained, and in several instances, customers had to shut down their production entirely due to delays and uncertainty. One respondent called the situation unsustainable.

Steve Katz:

So where are we at now? Could the COVID issues still persist? And now there's also some question about the nature of the inflation that we've been seeing in the market as well. Where are things headed? What light can you shed on that for us?

Kevin Duffy:

Unfortunately, as the first quarter of 2022 comes to a close, most of Asia is experiencing a COVID-19 surge from the Omicron variant. China's zero COVID policy has led to lockdowns in several major cities and subsequent labor shortages and work stoppages at key shipping ports. The policy is proving to be difficult to sustain, so China is tweaking its approach, but it will be a bit of time before the resulting supply chain issues abate.

Kevin Duffy:

Of course, we cannot forget inflation. The economic community's position on pandemic-induced inflation has evolved in the past year. The debate about whether the inflation was transitory versus systemic played out for some time with most economists arguing, it was a temporary result of the large economic stimulus to combat the pandemic.

Kevin Duffy:

Since inflation did not ease as economic recovery continued through 2021 however, the conversation began to shift more towards the systemic causes and the larger term impacts of inflation.

Kevin Duffy:

By the first quarter of 2022, it became clear that the Federal Reserve would act by raising interest rates. On March 16th, 2022, the Fed raised interest rates by a quarter-point to 2.5%. It was the first rate increase since 2018. The expectation is that rates will be raised incrementally through the remainder of the year, with the year-end target rate approaching 2%.

Kevin Duffy:

Interestingly, the 2% year-end prediction is a full point higher than the estimate Federal Reserve board members and bank presidents backed only a few months ago in December 2021. GTP growth is expected to slow, and in general, the risk of ultimate recession to the economy, which of course impacts the chemical industry are increasing.

Steve Katz:

Okay. So there's also a lot going on globally? And we talked about what's been happening with the Fed and rates, but how is the larger global picture playing into everything that's happening?

Kevin Duffy:

Inflation and supply chain constraints have both contributed to rising fuel prices. As if both of these major factors were not enough to manage, the war in Ukraine has brought a new challenge that throws an even bigger wrench into the global economy and chemical industry. Ironically, it's not that long ago that some in the chemical industry were talking about the downside impacts of falling crude oil prices, back when no one was flying or driving much.

Kevin Duffy:

Change is constant and now the pendulum swings in the other direction with crude oil prices skyrocketing. The European Union is heavily reliant on both Ukrainian and Russian gas and oil. The energy challenges facing the EU are immense and there is no quick fix. As the war drags on, disruptions in supply are going to be acutely felt by Europeans. The price of natural gas has risen sharply enough that some chemical producers will likely suspend their production operations for a period of time.

Kevin Duffy:

Naphtha oil prices are also downstream consumer confidence in spending. We're also now seeing margins for naphtha-based ethylene producers in Europe, turning negative for the first time since ICIS Chemical Business records began. They had, of course, been falling since the start of the year as producers struggled to pass on increasing naphtha feedstock and energy costs.

Kevin Duffy:

I also want to point out that several key pipelines move oil, gas, and ammonia from Russia into Europe, and the countries that the Druzhba pipeline runs through, except for Germany, are reliant on Russian crude oil for more than half of their imports. Chemical production downstream will be negatively affected, and the consensus right now is that chemical production in the EU will not be maintained at normal rates without alternative sources of crude being found for European producers.

Steve Katz:

Okay. Very interesting, and the pipeline is also an interesting fact given what's going on now with the war in Ukraine, and obviously that's choking off a lot of that supply.

Steve Katz:

Listen, we only have a couple of minutes left, but to wrap it up, can you share your thoughts on what we can expect to see in the industry as we move forward through the rest of the year?

Kevin Duffy:

Absolutely. Outside the acute downturn at the beginning of the pandemic, the consistent and strong demand for chemical industry products has been a bright spot for the industry. Data from ACC's weekly chemical and economic trends for the week ending May 20th, 2022 indicates that producer prices increased for a 23rd consecutive month in April.

Kevin Duffy:

Year over year prices were up 19.3% with double-digit gains across all major segments, other than consumer products. While the gains are positive, there's certainly a tipping point. It remains to be seen if a prolonged war in Ukraine will propel us there. In the near term, we expect to see continued bottlenecks across the supply chain.

Kevin Duffy:

Global producers that can leverage multiple production facilities, as well as multiple transportation methods for their products, will no doubt be at an advantage. Lobbyists and legislators continue in their efforts to address supply chain challenges. Some progress has been made via implementation of extended service hours at ports, as well as truck driver recruitment and certification programming.

Kevin Duffy:

The chemical and other industries are working together to promote policy changes that will reform ocean shipping rules, gross vehicle weight regulations, and more competitive and reliable freight rail service rules.

Kevin Duffy:

If the war drags on, we may see signs of belt-tightening, general wariness, and uncertainty about how long the war will last. Likely has chemical industry scenario builder preparing for a worst-case scenario, i.e. recession, and a less worst-case scenario, i.e. moderate downturn pressure on demand.

Kevin Duffy:

There are some bigger picture issues to consider as well. Deloitte published its 2022 chemical industry outlook in January. While the war was not factored into the company's predictions, the outlook did state that sustainability and decarbonization is likely to be one of the top five critical areas of focus for most US chemical companies this year.

Kevin Duffy:

Sustainability is certain to be an issue that will long outlive the pandemic, the war, and inflation. Accordingly, as the Deloitte study points out, most chemical companies plan to increase their investment in research and development, that leverages advances in decarbonization, renewables, recycling, and circular economy technologies.

Kevin Duffy:

This energy transition will take time, but there are real opportunities for the chemical industry to play a pivotable role in these areas. There is speculation and hope that while making themselves greener, the chemical industry will play a role in fostering collaboration across and among industries, sectors, and countries. That collaboration in turn might just lead to new business products and partnerships while having a positive impact on the environment overall.

Kevin Duffy:

Many factors affecting the chemical industry during the current period are unpredictable. It remains to be seen if in combination, these will put enough price pressure on markets to significantly dampen demand. The general expectation that economies around the globe will continue to recover from the pandemic in 2022 is now playing out with a new twist since the outbreak of the war in Ukraine, and global GDP and industrial production forecasts have been tempered as a result. It looks like the bumpy road continues for the foreseeable future.

Steve Katz:

All right, Kevin. Thanks for all that detail. Really appreciate it. Insights and perspective on why this has shaped up as such a difficult and complex period for the industry is really appreciated. I think this gives our listeners a little bit better idea of what we can expect ahead through the rest of the year. So it's great to have you on the podcast as usual and look forward to having you next time.

Kevin Duffy:

Great. Thank you. My pleasure.

Steve Katz:

Kevin, how can people best get in touch with you? If you can just give us your email and then the phone number you prefer?

Kevin Duffy:

Sure. My email is kduffy@hilcoglobal.com, and my phone number is (847) 849-2989.

Steve Katz:

Okay, great. Listeners, if your business or a business in your portfolio is actively involved in the chemical industry and experiencing challenges, I would encourage you to reach out to Kevin. He can certainly bring a very relevant valuation perspective and also help you to address monetization thoughts or capital needs that you may have, as Hilco actively engages in those disciplines as well, bringing best-in-class solutions there.

Steve Katz:

We hope as always that this Hilco Global Smarter Perspective Podcast provided you with at least one key takeaway that you can put to good use in your business or share with a colleague or client to help make them that much more successful moving forward as well. Until next time for Hilco Global, I'm Steve Katz.

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