More confirmation from Covestro that global demand growth is strong, supporting reports that we have seen from most companies over the last few weeks. Some have struggled with raw material cost squeezes and either late attempts to raise prices or pricing lags in contract agreements, but almost all have pointed to very strong demand outside of auto OEM. We have questioned how much of this strong demand is inflation-driven, but it is very hard to tell as the last time we had significant inflation we did not have such an interwoven global supply chain as we have today, and consequently, it is harder to assess how much pre-buying may be going on, not because of fear of higher prices but because of fear of supply. Note that we have at least two European automakers (VW and Renault) shutting down facilities this week because they cannot key parts from Ukraine. This adds to the already problematic path for parts from China as well as the semiconductor shortage. If everyone is looking for a little bit more it would explain the very high 1Q 2022 demand that all are talking about and it likely means that inflationary pressures will continue as chemical and polymer makers try to make more, against a backdrop of higher raw materials and find it easier to increase their prices because their customers are as concerned about availability as they are prices.
Fear of shortages is the one factor that is most supportive in terms of helping to push through pricing and the events in Europe and their associated impact on energy prices should be all the support that the chemical and polymer industry needs to push pricing through that will cover cost inflation. Buyers of raw materials and intermediate products will naturally look to buy a little more than they need in the near term, both to ensure that they get something ad to try to build a bigger inventory cushion. This will have the effect of pushing apparent demand higher, making the pricing initiatives easier. Few will push back on pricing if their primary concern is availability. Looking at the BASF results summarized in the chart below, demand is already very robust and this will lead to higher utilization rates and higher volumes for chemical producers as well as high pricing. The commodity producers are likely more interesting here as they can move prices much more quickly than the specialty companies who might see margins squeezed over the next couple of months. None of this is good for inflation. See more in today's daily report.
It is likely a difficult day for the European chemical industry as all of the fuel prices that they depend on are rising quickly, which will force many difficult decisions over the coming days. There are a couple of factors to consider – what happens to costs and margins if energy prices remain inflated, and what happens if energy availability becomes an issue and plant closures are necessary. In a world that is already reeling from inflationary pressure that we have not seen in four decades, there is at least an acceptance that prices can move higher, but the energy-dependent European industrial and materials companies will need to move prices quickly and meaningfully to absorb their higher costs. If natural gas supplies from Russia are halted, Europe is likely going to need to allocate supplies, as there is no easy fix given an LNG system that is already at capacity. Industry will likely take the hit to ensure power for heating and cooling. This will drive product shortages in Europe, especially for chemicals, which will likely make it easier to get the pricing necessary to cover costs.
Albemarle’s share price is tumbling today on the news that the company is experiencing cost over-runs in its lithium business and that this resulted in a 4Q loss. The company has tried to deflect with some very bullish views of potential lithium demand, based on EV production growth estimates, but the cost over-runs are another indication of how much inflationary pressure is within all industries today and this news will likely have a negative sentiment impact for any company with material capital spending plans for 2022. The loss at Albemarle comes despite higher lithium selling prices for existing output. We remain very concerned that, despite high capital costs, the technology barriers to entry for the more commodity grades of lithium required for most batteries are very low, and that with the hype around potential demand – as indicated by Albemarle – too much lithium capacity will be built, ultimately causing wild swings in prices. If we get a negative swing in pricing coincident with new capacity start-ups, where the new capacity cost more than planned, we could see some poor returns on investment periods during this decade. To be clear, we expect lithium demand to grow very quickly, but we expect supply to grow quickly also. See more in today's daily report.
More earnings releases and more discussions of disruptions and higher costs! One thing that is clear from all the reports we have followed, whether from basic chemical companies or those downstream, is that no one has any expectation that the supply disruptions and inflationary drivers are going to end soon. In our Sunday Thematic, we talked about the possibility of demand remaining robust and possibly absorbing new supply in 2022 because of further inventory builds. The idea is that holding more working capital, while possibly less efficient financially, may be more prudent from a business continuity perspective, especially given the reputational risk of failing to fulfill customer orders. While there is appropriate concern that interest rates could rise significantly, lending rates are so low that the cost of holding more inventory would be immaterial for many companies. For many products in the chemical chains and across materials more broadly, global oversupply, where it exists, is not high, and a further upward swing in inventories in 2022 could easily keep tight markets tight and swing some more balanced markets to shortages.
Part of our confidence/concern that prices can continue to rise in the chemical space in general stems from what seems to be very strong demand – again confirmed in earnings reports overnight, as well as in the rail data from today's daily report, as well as inventory data that suggest we are below recent ratios to shipment trends. The inventory piece is the great unknown here because the supply chain shocks of the last 20 months will have reset expectations around “safe” levels of inventory and it is hard to judge whether the new “comfort” normal will be back to the trend in the chart or 50% higher! If the new comfort level is materially higher than in the past, demand growth will remain strong and price momentum could continue through 2022. Our expectations for a mega-cycle in basic chemicals and polymers – targeting late 2023 and 2024 could be dragged forward because of higher apparent demand the time to buy the equities could be now, on that basis.
With the linked Ashland release, we see another example of a downstream chemical maker struggling with higher input costs and general logistic constraints, and an inability to push through pricing quickly enough to avoid a margin squeeze. The opaqueness that Ashland discusses concerning some of the planning metrics for the near-term is impacting forecasts and estimates for many more companies than just Ashland but given the costs and the supply chain challenges, all are encouraged to push through pricing aggressively, and this suggests that we are far from done with the materials inflationary pressures that we have discussed at length in prior reports and the higher costs of some of these specialty chemicals will start to impact customer margins through 2022. Almost all the earnings reports that we see discuss strong end-market demand and whether this is final customer pull-through or a need to address chain inventory or both, it should support further price initiatives. For more on our inflation views see Inflation (Especially Energy Costs) – Biggest 2022 Wildcard.
While this is covered in more detail in our ESG report today as well as our daily report, we highlight the Wacker results below. This confirms a key inflation fear for renewable power, as we see the rapid increase in silicon and polysilicon sales at Wacker – Exhibit below. Wacker has certainly seen significant volume growth between the periods highlighted, but the step-up in demand will have allowed the company to move prices up., something we have been noting for months, but it is good to have confirmation. This is additional cost pressure for the solar panel manufacturers and is driving solar module prices higher. Given the expected demand growth for solar installations, we see no reason why this demand-pull should ease any time soon. While this is a problem for the solar industry, their materials suppliers could do very well for many years.
Following on again with our inflation theme, which features heavily in today's Daily Report, note that RPM’s release is riddled with references to inflation impacting results negatively as raw material and logistic costs increased. The commodity chemical and polymer producers have much more pricing flexibility than the specialty makers like RPM, and they can generally pass through higher costs quite quickly. For the specialty companies, there is generally a lag, as is clearly shown in RPM’s results, but they generally catch up with pricing as long as demand is robust, which it appears to be. The benefit for the specialty companies is that they can often hold on to price increases or at least some of the increase longer than a commodity producer can as raw materials and fundamentals ease. We expect the intermediate and specialty chemical producers in the US and Europe to have strong demand growth in 2022, as the reshoring momentum should continue and offset any risk of weaker consumer spending on durables as the year progresses. We have been more focused on companies that are selling materials into construction and renewable energy and EV markets, but RPM has enough exposure that it should also be a beneficiary as long as prices can keep pace with costs.
We have been asked a couple of times in the last week how US polymer (polyethylene in particular) pricing can remain so robust in a market where there is an inventory build going on. The PMI numbers are part of the answer. While we may be in the seasonally weaker part of the year, customers are still looking for more material than a year ago, and this makes the “we need a lower price” argument much harder, especially when the memory of 1H 2021 acute shortages is still fresh in the memory and when, more than likely, they are getting signals from their customers of a further step up in demand in 2022. We have done some traveling recently and the incremental demand for packaging polymers is very evident in the travel and leisure business, even if the number of travelers is still down. There is more packaging on airline and airport food and hotels are offering pre-packaged food for breakfast that would previously have not been individually packed. The reasons are obvious – safety and hygiene from the consumers' end and costs from the providers' end, as prepackaged food, can be bought in bulk and more cost-effectively and they likely have a longer shelf life.