Some observations in chemical sector

I have been working in the USD 3 trillion chemical industry since the past 4 years and I have observed that this industry has peculiar and unique things which are not generally observed in the other sectors.

1.      Strategic Joint Ventures between competitors - The chemical industry must be the only industry in which fierce competitors have joint ventures extensively. (Yes, Samsung and Apple too fall into a similar category but that is an exception).

E.g - SABIC and Exxon Mobil are strong competitors w.r.t crude refining and petrochemicals. However, they have set up JV Al-Jubail Petrochemical Company (KEMYA) in the middle-east to make specialty elastomers.

Three things determine JVs in this sector:

a. Access to the RMs

b.Access to technology

c. Access to markets.

Pure economic factors come into play. Producers are even ready to consume materials supplied by competitors if the landed price at their premises is lower than their supplied price.

For eg:- Akzo Nobel in India uses a product called tertbutylhydroperoxide (TBHP) manufactured in Europe by a competitor (LyondellBessel) even though Akzo Nobel is the world’s leading manufacturer of this product with plants in Japan, China and USA.

The only place where there can be differentiation is the Specialty chemicals segment which makes up around 20% of the total industry. For the bulk / commodity segment differentiation doesn’t fetch any premium.

Access to Raw Materials and ensuring supply is another major reason for JVs. Jurong island in Singapore is one shining example where most of the large chemical companies have invested together so as to enjoy access to raw materials easily.

In countries like India, China where technology development is a constraint, JVs happen where a foreign company brings in technology and the foreign company gets market access.

Thus, competitors are strategic partners in this sector.

2.      Trader’s knowledge and contribution is most important – To gain economies of scale, the chemical plants, especially for the bulk commodity chemicals, are of large sizes and are concentrated at few locations (where raw material is available). As a result, the chemical manufacturers are heavily dependent on the traders to distribute their products worldwide. Because the manufacturers are dependent on traders, they generally do not know much about the local markets. The knowledge about the end user market is generally amongst trading population. A few occasions, I have found that traders and middle-men have better knowledge about the applications of a product as compared to the manufacturer. A lot of middlemen are also required for regulatory approval of the products for use in food and pharmaceutical industry. These regulations are different in different countries. 

      Thus, distributors and traders play a significant role for this sector and contribute to the growth of the sector much more when compared to other industries.

3.      Low profile & information asymmetry – The industry is generally low profile with not much news about this sector appearing in the news and media (other than Oil and gas). The technology barrier which causes information asymmetry plays a major role in keeping the number of major players limited in this field. Constant innovation and changing regulations also causes limited information about different manufacturers and their processes to be in public domain. As a result, consultants and market researchers play a strategic role in this industry – much more than any other sector in my opinion. Also, because the industry is generally B2B and understanding the products require some technical knowledge, very limited information is generally known to general population and as a result the industry is low profile. Since the industry is generally upstream, the growth in chemical sector sets the pace of other downstream sectors and I believe that chemical sector acts as an indicator for other industries.

4.      Growing and Hiving off –  The chemical sector is one of the oldest industries in the world and as such there are plants that have been in place since a long time with managements changing over a period of time.  A look at the histories of Evonik and Ineos since 1890's till today show the intensive M & A’s that have happened for a chemical plant. Probably, consolidation is a regular characteristic of the chemical sector. As companies grow by M&A’s, the number of products increase and there comes a time when it is not possible for a company to oversee all these products and so to optimize the product portfolios, some sectors of the acquired company are hived off. Most of the M&A’s in this sector is based on the concept of hiving off a particular business unlike other industries complete companies are generally sold or acquired.

5.       Technology and Risk – The chemical sector thrives on innovation. New products, processes, applications are discovered continuously. Manufacturing any major new product on a commercial scale requires setting-up a capital intensive plant. There is always a risk that the new technology or the process may not work on a commercial level. There have been several occasions when technology has failed to help produce the desired product and the whole capital expenditure had to be written off. Also, because of the race to be the first to come up with products, there have been cases when excess capacities have been created and the margins have been rendered to nil on many occasions. At present such a thing is developing in USA. Because of the envisaged shale gas boom, a lot of capital intensive plants producing ethylene & derivatives are being developed. There shall be excess supply of these ethylene derivatives in the future and unless new applications for these are developed, there is a risk of the capex to fail partially or completely.  Thus, risks associated with this sector are high and have huge implications.

The chemical field is such a vast and complex field that many people fail to recognize the enormity of this sector. Large chemical companies like Dow, Exxon, BASF, Chevron, Shell, DSM, Akzo Nobel, Lyondell, Reliance, etc. have become so huge in size and contribute so significantly to the GDPs of their respective nations that they have a major say in the policy making.