Trends and Outlook for the Chemical Industry
The U.S. chemical industry is a mature yet diverse industry that includes tens of thousands of products, from basic building block chemicals—such as chlorine and ethylene—to sophisticated specialty chemicals and pharmaceuticals. The industry also produces consumer products—such as cosmetics and laundry detergent—and agricultural chemicals (i.e., fertilizers and crop protection). Not surprisingly, the chemical industry is among the largest of manufacturing industries, with annual shipments of more than a half-trillion dollars.
The chemical industry was among the hardest hit during the downturn that began in mid-2001. As growth returned to the manufacturing sector in 2004, shipments of chemical products rose 8.1 percent to $516.2 billion. Shipments of basic chemicals led with gains of 16.9 percent as prices rose due to higher energy costs. This year, chemical shipments have continued to gain, and by year-end are expected to rise 6.8 percent to $550 billion, again with sales of basic chemicals posting the largest increase. Prices of chemical products rose 5 percent in 2004 and are expected to see larger gains this year as energy costs are significantly higher and demand remains firm. These figures are shown graphically in Figure 1.
The value of shipments is determined by measuring both the volume and price of the chemicals. To look only at trends in production volumes, we turn to the industrial production measures available from the Federal Reserve System. (See Table 1.) Following the longest and steepest downturn since World War II, the chemical industry rebounded in 2004, with volumes growing by 2.9 percent. Expect chemical production to grow by 2.8 percent in 2005, as growth in the industrial sector continues to expand.
Basic chemical production experienced a 5.1 percent rebound last year as the manufacturing recovery gained momentum. Because basic chemicals are at the foundation of the majority of consumer and industrial goods, the best indicator for this segment is manufacturing activity in its entirety. Overall industrial production is set to rise 3.6 percent during 2005, with the second half of the year posting slower growth as high oil prices drag on the economy.
Inventories-to-sales ratios, which had been running at historic lows, have started to creep up, signaling more cautious production growth. Basic chemical production will continue to grow during 2005, although at a slower pace of 2.3 percent. Organic chemicals, including petrochemicals and derivatives, will continue to see gains of 3.5 percent this year, following a 7.3 percent gain in 2004. Inorganic chemicals will see 0.5 percent growth, and plastics will grow at a modest 1.8 percent rate.
Production of specialty chemicals will increase by 2.3 percent in response to the growing demand for specialty materials. Paints and coatings will grow by 4 percent, as housing sales continue to defy expectations. Production of other specialties (i.e., fine chemicals, industrial cleaners, food additives, electronic chemicals, plastic additives, etc.) will grow 2.5 percent during 2005.
Production of pharmaceuticals will see a return to slightly faster growth as exports of pharmaceuticals are up and the demand for new products grows. Consumer products growth is linked to consumer spending, which will continue to grow, buoyed by job and income growth. Agricultural chemicals will be the only sector to see negative growth, largely due to decreasing nitrogenous fertilizer production as a result of higher natural gas costs, which has made imports more attractive.
Lost Chemistry and the Trade Impact with China
The chemical industry is the largest export industry in the United States, accounting for $109.3 billion in exports in 2004 and representing 22 percent of chemical production. However, growing imports have caused the trade balance in chemicals to deteriorate during the past decade. Much of the import growth has been in finished pharmaceuticals and pharmaceutical intermediates from Western Europe, especially from Ireland. In fact, Ireland recently surpassed Canada as the largest source of chemical imports into the United States. In 1995, the chemical industry posted a $20.4 billion surplus. In 2002, amid recessionary pressures and a strong dollar, the chemical industry posted its first-ever trade deficit. In 2004, the trade deficit declined to $3.6 billion on robust export growth. As exports continue to remain strong in 2005, look for further improvement in the deficit to $2.5 billion in 2005.
As mentioned above, the U.S. chemical industry has seen a sharp erosion of its trade position during the past decade. However, the true impact of the trade deficit goes beyond direct chemical trade. The overall trade deficit in manufactured and agricultural goods more than tripled, from $180.5 billion to $651.5 billion. As U.S. manufacturing has been replaced by imports from China and other countries, so has the portion of the U.S. chemical production that would have occurred had those goods been manufactured in the United States. A recent analysis by the American Chemistry Council (ACC) suggests that this “lost chemistry” amounted to $46.6 billion in 2004, with China accounting for 29 percent of the total. Among the chemical industry’s downstream consumers, the largest “lost chemistry” impacts are in transportation equipment, apparel and textiles, computers and electronics, and plastics and rubber products.
Energy Consumption and Increased Insulation Needs
The business of producing chemicals is extremely energy-intensive, consuming 6.4 quadrillion BTU, or about 6 percent of total U.S. energy consumption. The chemical industry is unique in that it uses energy not only as a fuel source, but also as a raw material. It is the largest manufacturing consumer of natural gas.
For many years natural gas was inexpensive and abundant, compared to oil. For that reason, the greater part of U.S. petrochemical capacity was built to convert natural gas-based feed stocks—such as ethane—into chemical products. In fact, 70 percent of the U.S. petrochemical sector is based on natural gas feedstocks, compared to Europe and Asia, where 70 percent of their petrochemical production is derived from petroleum-based feedstocks. As a result, the United States enjoyed a cost advantage to petrochemicals from abroad. However, in 2001, amid a sharp increase in natural gas prices, the industry’s position tumbled and many plants that depended on natural gas feedstocks were idled, some of them permanently.
The price of natural gas relative to oil is a key competitiveness indicator. When the ratio of the price of oil to the price of natural gas is above 7, Gulf Coast petrochemicals are relatively competitive. When that ratio falls below 6, Gulf Coast petrochemicals are relatively disadvantaged. The ratio hovered around 7 for much of the first half of the year. It appears now that oil prices will remain high for some time to come. Most forecasters agree that the price of oil will average between $50 and $54 per barrel during 2005, with moderate increases anticipated in 2006. The price of natural gas will also remain tight as demand from all sectors continues to outpace supplies. Look for natural gas prices to average above $7 this year, with higher prices in 2006.
In 2004, the chemical industry spent $52.1 billion on energy alone, more than double the industry’s energy bill in 1999. Because energy is such a major cost of production, energy efficiency is a priority in the chemical industry. Since 1973, fuel and power energy per unit of output has declined 46.5 percent. There is still work to be done. According to a recent survey by ACC, 3.5 percent of capital budgets will be spent on energy-savings projects. This trend will drive insulation sales to the chemical industry.
The chemical industry is present in nearly all 50 states, but is concentrated in about 10. The top 10 states accounted for 65 percent of the industry’s output in 2003, the latest year for which state data are available. Table 2 shows the top 20 chemical-producing states. Among the states that have seen the fastest growth in the chemical industry are Alabama, Minnesota, Iowa, Florida, Massachusetts and Missouri.
Capacity Utilization and Profits
Capacity utilization in the chemical industry rose from 73.8 percent in 2003 to 75.4 percent in 2004. Capacity utilization will tighten further to 76 percent during 2005. Generally speaking, as capacity utilization rises, profits follow. After-tax profits in the chemical industry fell from $58 billion to $48 billion in 2004; however, this amount reflects a sharp decline in pharmaceutical profits, as many profitable drugs were taken off the market, or their patents expired. Excluding pharmaceuticals, profits gained 3.4 percent to $16.8 billion, about 3.3 percent of shipments. The industry’s gain in revenues—reflecting higher capacity utilization rates and higher prices—were eroded somewhat by substantially higher energy bills.
Capital Expenditures Increase
As profitability has improved in the chemical industry, capital budgets have expanded, pushing the investment cycle forward. As a result, capital spending rose by 2.4 percent to $21.6 billion in 2004, about 4.2 percent of the value of shipments. Excluding pharmaceuticals, capital spending rose 5 percent to $14.2 billion, or 3.9 percent of shipments. And following several years of growing “to-do” lists, maintenance and repair expenditures by basic and specialty chemical companies rose 11 percent to $4.1 billion in 2004. This year, companies expect to do even more. According to ACC, the chemical industry will boost capital spending by 10.3 percent in 2005, followed by a 5.6 percent gain in 2006.
The largest category of capital spending is for major process equipment, accounting for 42 percent of capital expenditures, followed by information technology with 22 percent, and buildings with 20 percent. The remaining 16 percent is spent on other equipment, other structures and transportation equipment.
The largest motivation for capital spending is the expansion of production capacity, followed by the replacement of worn-out plants and equipment, according to ACC. Figure 2 shows where 2004 capital budgets were spent.
An increasingly important trend in capital expenditures reflects the global expansion of the chemical industry. According to ACC, in 2004, 71.1 percent of the capital budgets of American chemical companies were for U.S.-based projects; another 2.3 percent were in Canada; 1.4 percent in Mexico; 2.9 percent in China; and 1.9 percent in other Asian countries. However, by 2009, the geographic distribution will shift dramatically, with only 58.6 percent of capital budgets being designated for the United States. Canada and Mexico will gain slightly, but China and other Asian countries will account for
9.1 percent and 5 percent, respectively.
The United States currently accounts for more than a quarter of global chemical shipments. However, as the industry evolves in response to the new manufacturing paradigm, this share will likely diminish. New capacity is emerging in the Middle East—near low-cost feedstock—and in Asia, where proximity to new manufacturing capacity is the main driver.
Drivers for the Next Decade
As the chemical industry continues to evolve and respond to changing business conditions and technologies, several key drivers will shape the industry’s development for the next 10 years.
Increasing globalization. Increasing prosperity in developing countries will drive chemical sales in all categories. Partnered with the relocation of the manufacturing base to developing nations, the focus of the global chemical industry will no longer be centered in the developed world.
Nanotechnology. The development and commercialization of nanomaterials (the use of microscopic particles) will revolutionize materials science.
Biotechnology. Companies are racing to take advantage of research reports that are published almost daily. Growth will accelerate in biotechnology products, as well as new processes being developed that use biotechnology.
Service innovation. Companies are moving to capture higher value-added sales by converting products (i.e., paint) into services (i.e., car painting services for OEMs).
Demographic changes. A growing senior population in the United States will drive pharmaceutical sales. At the same time, older Americans typically consume fewer chemical products per capita than younger Americans.