United States Petrochemicals Report Q2 2008

The likelihood of a recession, coupled with the challenges posed by Europe's new regulatory structure in the chemicals sector ,will make 2008 a tough year for US petrochemicals producers. However, the downturn is likely to be short-lived, with a rebound expected in 2009, according to BMI's latest US Petrochemicals Report.

Surveys reveal that 40% of US companies have a limited understanding of the European Union's Registration, Evaluation, Authorisation and restriction of Chemicals (REACH) regulatory regime, making them less prepared than their Asian and European competitors. Most firms surveyed said they had yet to complete risk assessments on how REACH would impact their businesses. Two-thirds of North American organizations say they have limited knowledge of the operational impacts that the EU legislation could have on their businesses. This lack of awareness could have a negative impact on business and could lead to disruption. However, US majors appear to be determined to be ready for the pre-registration process, beginning in June 2008 and ending in November 2008, despite the complexity of registering chemicals produced by other companies but used in the manufacturing of their products. These complexities could be overcome by reducing the number of suppliers, which could lead to some merger and acquisition (M&A) activity involving smaller independents.

Several US chemical companies either reported a drop in first-quarter earnings in 2008 or warned that they will fall short of estimates. due to the weakening of the US economy. The worst affected were those exposed to the construction and housing markets. On the upside, domestic petrochemicals producers will benefit from the weak US dollar, which helps improve both their external and domestic competitiveness.

A decline in demand will therefore be partly offset by growth in exports and a fall in imports. With the US's domestic petrochemical production chain relatively self-sufficient, the impact of dollar depreciation on petrochemicals producers that depend on imported feedstock will not have a profound impact on overall profitability. As such, BMI does not envisage recession in the petrochemicals sector, but does expect stagnation, at least in the first half of the year.

BMI believes that petrochemical producers will find it difficult, but not impossible, to increase margins substantially in 2008, with limited flexibility in price-setting in an increasingly competitive market. The 50% increase in the ethylene prices made 2007 a difficult year for polymer producers. Polymer demand showed signs of softening in Q407, as producers reduced their inventories at the same time as the housing market continued its slump and the automotive market stagnated. With demand likely to be subdued in 2008, producers will depend on a fall in feedstock prices to bolster their profit margins. This will be achievable if cracker production issues that plagued the industry in 2007 are resolved and crude oil prices decline.

In BMI's view, while 2008 will be a tough year, the US economy is sufficiently resilient and flexible to bounce back over the medium term. Our core scenario is that the effects of the sub-prime mortgage crisis and the credit crunch on the petrochemicals industry should be overcome by end-2008. Furthermore, we subscribe to the theory that US currency weakness and robust growth in emerging markets should allow net exports to contribute further to domestic expansion.