Perfect Storm for US Chemicals?

chemical plant

[This article was originally posted on LinkedIn December 22, 2014]

I don’t normally comment in this area, or even track it closely, but I’ve seen some recent information suggesting that the US chemical industry may be in for a rough ride for the next few years. Though I’m not an expert in this area, I’m passing along some of this information here, as there are a number of chemists and chemical engineers in my LinkedIn network that may be interested in this.

Here are the sources for the comments here:

If you read these articles, or listened closely to the webinar (the webinar recording has not yet been posted, but his slides are available—again, for ACS members—at the webinar link above), there are some warning signs for the US chemical industry.

As anyone tracking the chemical industry at all knows, the recent advent of inexpensive natural gas from US wells developed by hydraulic fracturing has led to both high profits for the chemical industry and a boom in construction of US production facilities as the industry works to on-shore capacity to take advantage of low feedstock costs. In February of 2014, the American Chemistry Council reported that there were then announced or in-progress 148 projects totaling $100 billion in investment linked to low-cost natural gas in the US. This has, of course, been widely hailed as a beneficial for the chemical industry, and the US as a whole as a creator of jobs and economic growth.

But… here’s the rub: The chemical industry (again, as is obvious to anyone involved in it for any length of time) is highly cyclical, largely as a result of herd mentality that seems unbreakable. When capacity is tight, or feedstocks cheap, profits go up, and everyone rushes to invest in new capacity. And of course, those investment decisions are based on evaluation of then-prevailing construction costs, product pricing, and profit margins. But, as there are multi-year lead-times on these investments, and because everyone rushes to invest, by the time all the new capacity comes on-line either prices for feedstocks have risen (due to increasing demand from all the new capacity) or product prices have fallen (ditto), and there is huge over capacity (ditto again). Also, costs, pricing and margins all change, so the original justification for the investments may no longer be valid. At that point, with margins and utilization rates low, profit collapses, investment stops, unfinished projects are cancelled, and the industry has to ‘batten down the hatches’ and wait for the cycle to turn upward again.

The article and webinar cited above suggest to me that the cycle is about to turn down again. Here are the warning signs as reported in those sources:

  • Construction cost overruns are rampant, and likely to change operation economics drastically. The C&EN article reports that one plant in LA, originally scoped at $4.5 billion is now likely to cost over $8 billion.
  • Welders and pipefitters are in such short supply that they are commanding $100/hr for their work.
  • According to Paul Hodges, global industrial chemical production capacity utilization which averaged ~ 94 % from 1987-2008 has averaged only ~ 85 % since 2009.
  • Also according to Paul Hodges, US demand for the downstream products that would depend on all the new-capacity under construction in the US has been nearly flat. Mr. Hodges further suggests that, with the EU economies still weak, and China scaling back growth forecasts, there is little prospect for that demand to grow.
  • The C&EN article also notes that falling oil prices actually hurt the US chemical industry. Yep, while US producers (increasingly, thanks to the recent investments) rely heavily on natural gas as a feedstock, much of the rest of the world (not all, but much) relies upon petroleum feedstocks. While oil was high, this gave US production a big advantage; as the price of oil falls, that advantage goes away.
  • In a point related to the preceding one, Mr. Hodges notes that a gap between the per BTU cost of oil and gas (with oil more costly on this basis) had emerged over the past 4 years, but is not likely to persist (and, the fall in oil prices is already reducing it). As it is this gap that led to the recent advantage for, and consequent profitability of, the US chemical industry, that advantage will be eroded as this price gap subsides to more historical levels.

So, as has historically been the case, the US chemical industry appears to have over-invested in capacity, and is seeing cost-overruns, with no excess demand to absorb the capacity, just in time for product prices to collapse and for alternative producers to become more competitive. That’s one of several reasons that this no-longer-practicing chemist has diversified away from work in solely in the chemical industry.

What do readers of this post think? As noted, I am far from expert in these topics, and am basing this post almost exclusively on one article and one webinar. Will the US chemical industry in fact be in for a rough ride? Is there now a perfect storm of overcapacity, cost-overruns, collapsing demand and strengthening competition?