The U.S. chemical industry "feels overwhelmingly upbeat" these days in part because of abundant, low-cost natural gas supplies from shale resources, but operators need to prepare for a big transformation of their businesses before chemical supply outstrips demand, according to a new report by KPMG LLP.
Just two years ago the U.S. chemical industry "seemed well rationalized, but with few opportunities for significant revenue growth" and beyond research and development, "precious little expansionary investment," KPMG chemical industry specialists said in a report on the future of the industry. "However, with the commercialization of shale gas in the U.S., the industry has seen a remarkable turn of fortune."
Several risks are on the horizon, with "the most problematic" likely to be the plethora of new capacity additions that may lead to an oversupply within the national market, "returning the industry to the cyclicality that was such a problem in the past," the authors said.
The domestic chemical industry's growth projections also are tied to global chemical sales. While the U.S. economy "has returned to growth, overall it remains a mature market, which could not absorb all of the announced new capacity. Similarly, Europe and Japan have seen somewhat sedate growth, while the emerging markets have boomed ahead with China, India and Latin America in the lead," the authors said.
"Clearly, U.S. chemical companies will need to place strong focus on developing their supply lines into the new growth economies, and this will require a significant transformation of operating models for U.S. companies [that] have traditionally been focused on the domestic marketplace," said KPMG's Mike Shannon, who is the global and U.S. leader of the chemicals and performance technologies practice. He co-authored the report with KPMG's Paul Harnick and Tom Meike.
"One would be hard pressed to overestimate the impact of the commercialization of shale gas on the U.S. chemical industry," Shannon said.
At its root, the unearthing of U.S. shale gas reserves "has driven down the natural gas price and created a massive competitive advantage for U.S. companies. The cost implications for the U.S. chemical industry have been impressive. Generally, a ratio of 5:1 between crude oil and gas prices is enough to make the U.S. chemical environment 'favorable'. At today's prices, the disparity is more like 9:1, creating lasting advantages for U.S. producers."
Even with an ongoing regulatory debate across the country about unconventional gas, commercializing these new reserves "has already heralded in a new era of growth and prosperity for the U.S. chemical industry," said the authors. "And while some risks still remain on the horizon, there is little doubt that the U.S. industry is embarking on a path that will lead to massive competitive advantage and significant transformation within the industry itself."
However, domestic chemical operators have to make "significant investments in supply chains, overseas sales and potentially joint ventures with emerging market producers to ensure they have captive markets for the new shale-related capacity due on stream," said Harnick, global COO for the chemicals and performance technologies practice.
Chemical companies had spent a big part of the past four years examining ways to cut costs within their organizations, which will help in the transformations to come, KPMG said.
"This cost cutting and operating efficiency combined with the impact of cheap gas feedstock have driven profitability and cash generation across the industry," said the authors. "The environment of economic uncertainty and a strong desire to achieve financial flexibility in the face of continued market turbulence has led many of the top U.S. chemical companies to build up significant war chests and financial reserves that are now being cracked open to enhance shareholder value and take advantage of synergies in the market."
With those war chests, the domestic chemical operators "have started to focus on optimizing their portfolios and combining complimentary and supplementary product slates that will provide stronger revenue streams and/or access to new markets," creating "an environment ripe" for merger and acquisition activity.