Introduction
So long as demand holds up
Events such as the pandemic and the war in Ukraine have pushed the Singaporean chemical industry off its cyclical growth course. In the span of a few years, production, consumption, trade and price dynamics have gone through a rollercoaster of highs and lows, the shift in the price of crude oil from below US$12 in 2020 to over US$120/barrel in 2022 best reflecting this volatility. If 2020 was about frozen production and 2021 about supply chains struggling to sustain a rushed recovery, 2022 can be (reductively) summarized to inflation - the sign of a complex playout of tight supply, strained logistics, and unpredictable demand.
Singapore is an APAC outpost for almost 100 European, American, Japanese, Chinese, Korean, Malaysian, as well as local chemical companies with manufacturing, sales, or R&D - a sample of the world’s chemical industry and one of the biggest refinery complexes, all in a 728 km2 island off the Ecuador axis. Even if the country is far away from the crisis in Europe, its industry is directly caught in the whirlwind of global events, tied to the price of feedstocks as a direct relative of the oil and gas industry, in the open field of trade tensions, and at the whims of different consumer trends.
Though we refer to it as the “war in Ukraine,” the response has been global: So many countries have not combined to economically punish an aggressor since 1939. The last time Singapore imposed unilateral sanctions was 40 years ago. Reduced supplies from Russia - the world’s largest gas producer and the third-largest oil producer, and from Ukraine - the fourth biggest grain exporter, have been a big blow to the global economy. The World Bank has revised global GDP growth for 2022 from 4.1% to 2.9%, warning of subdued growth, and, in some countries, recession. Annual global inflation is projected to rise to 6.7%, which is twice the average of the last decade, according to the UN. In June, Singapore’s core inflation reached a 13-years high at 4.4%.
Multi-pronged inflation
Some inflation was to be expected as a result of the generous stimulus packages released by governments during the pandemic, and supply chain imbalances have also driven up logistics costs for bulk liquids, which are reflected in the pricing of goods. According to John Hong, APAC sales director and Singapore director at Infineum, shipping rates for Singapore-India trade routes have gone up by 500%, while the Singapore-US West Coast route prices are four times higher this year. The oil price, which peaked at US$120 in March this year impacting the costs of energy, transportation, and feedstocks, has now come down to about US$91 per barrel at the end of July.
For Singaporean-based producers and distributors of chemicals, the cost curve has become exponentially high. The cost of energy, in particular, already in the top 20 most expensive in the world and one of the biggest operational expenses for manufacturers on the island, is three times higher compared to last year. This is impacting profits. According to John Hong: “Chemical companies can normally absorb a 10-20% price increase and pass it on to consumers, but today the price is difficult to manage and it gets exacerbated as we speak by the Russia-Ukraine crisis. At Infineum, we grew our volumes, but we struggled to translate the higher sales into greater profitability.”
Singaporean players must also absorb other elements of cost volatility, including sustainability regulations pressuring the shipping industry (see our article on logistics), as well as expenses associated with acquiring and retaining talent in a highly competitive market (see our article on talent). All these costs have, so far, been managed on the back of strong demand. Almost all companies we spoke to this year posted strong growth in the first quarter of 2022, and record-level growth in 2021, both despite – and sometimes because of – the pandemic. However, the outlook is murky, and it hinges on the ability of chemical companies to pass on costs to the next segment in the value chain, and eventually all the way down to the consumer.
“The price of basic materials moves together with the oil price, and it is also indirectly affected by the price of diesel. When the oil price goes down, the cost of chemical materials comes down too, but customers typically expect some ‘savings’ to be passed on to them. On the other hand, when the oil price goes up together with the costs of our raw materials we face stiff resistance from customers to passing on the higher costs,” explained John Hong.
“Fundamentally, demand for chemicals and gases, including LNG, remains strong, led by APAC, even as LNG trade flows are being redirected to circumvent Russia. Even if there is a current risk that price spikes could suppress demand, the long-term fundamentals are unlikely to be changed by these deviations caused by inflation.”
Bas Verkooijen, CEO, Advario
Reading demand
At this point in time, whatever the chemical industry produced has been consumed, the high demand being both a contributing factor to high inflation and what has kept economic performance in check. However, reading current demand is complicated by two factors: The first is the belief that much of the consumption that has fuelled economic growth over the last year is the result of build-ups from the pandemic period. The other is the impact of inflation on consumer behaviour.
Lockdowns and disruptions in the semiconductor sector have given rise to pent-up demand, while a lot of manufacturers, fearing further disruptions, have built higher inventories. Both trends have sent a false positive signal to the market. For example, the construction sector is very active today, but most of the ongoing projects had been commissioned (and subsequently put on hold) before the pandemic: “In the short term, chemical companies supplying the construction industry will see growth, but the reality is that the construction industry is busy with projects approved before the pandemic and are buying ahead for whole projects rather than just in time deliveries, whereas the pipeline for new projects is quite empty. Financing for new projects is difficult and making the numbers add up is getting hard with inflation looming,” explained Gina Fyffe, the CEO of Integra Petrochemicals.
“Confusion best describes the state of the market. Everyone is trying to make sense of the war in Ukraine, politics in America and the supply chain issues in China. The investment community is driven by sentiment, which is fluctuating.”
Gina Fyffe, CEO, Integra Petrochemicals
On the consumer side, a phenomenon of “revenge spending” (making up for almost one to two years of being locked in the house with few spending options other than online shopping) has emerged, pushing up revenues in the retail, hospitality and travel sectors, brushing off fears of inflation. Fyffe declares herself baffled to see that retail and restaurant revenues have grown, even though wage inflation is dragging: “Are people spending because the dollar is worth more today than it might be in a few months’ time, or is this a rebound from two years of online shopping and people just want to take their masks off and go to the shops? It is unclear.”
Moving forward, inflation is expected to weigh down spending, especially on discretionary expenses and large goods. The housing market and the car industry will be particularly interesting to observe, considering the rise in prices for building materials and steel will challenge constrained consumer purchasing power. On the other hand, consumption of basic necessities is broadly expected to remain unharmed. “During periods of heightened inflation, people tend to put off buying a car or a new house. However, spending on everyday goods goes on, simply because people still need to go about their normal lives and look after their hygiene,” explained Chan Chian Yeow, site director at Croda Singapore.
Based on this broad distinction between basic versus discretionary expenses, chemical producers involved in the polypropylene (PP) value chain are more exposed to inflation, because about 18% of global PP goes into white goods like home appliances and 12% into automobiles, according to ICIC. On the other hand, polyethylene (PE) is more often used in day-to-day applications like packaging.
Meanwhile, consumer sentiment is volatile. In June this year, the Michigan consumer sentiment measured in the US fell sharply to a record low of 50.2. At the same time last year, this was at 81.2. 46% of respondents attributed their negative assessment of their current financial situation to inflation. The idea that inflation makes people poorer is well-ingrained in the public consciousness and is a factor of concern for most governments. Greater than the challenge of current inflation is the fear that the cost of living could spiral out of control.
Confusion in the markets
The fear of even higher inflation has spread to the investment community, compounded by the double fear of rising interest rates that have been announced to cool off economies. Even if the rises in interest rates have been arguably modest so far, they signal a potential shift away from an era of very cheap money and loose monetary policy. The Economist informs that no central bank in the G7 economies lifted interest rates above 2.5% in more than 10 years. Moreover, even mild increases in the interest rates may tip over the global economy, whose total debt has reached 355% of GDP, the highest level in history. Solid in the belief that the current rise in prices is not transitory, some commentators have warned of a stock market supper bubble just waiting to burst. The S&P 500 Index is down by more than 20% since the beginning of the year, with companies like Amazon, Alphabet, Netflix, and Tesla losing the most value. Meanwhile, nearly all of the top performers in the S&P 500 are energy stocks.
Clearly, current investment trends are shifting with mixed effects for Singapore’s chemical industry. The most obvious is that oil and petrochemical stocks are winning back investors. The stocks of the three largest petrochemical companies in Singapore, and the operators of Singapore’s three refineries, ExxonMobil, Shell, and Chevron, have registered above 35% increases, after suffering deep plunges during the oil price collapse in early 2020. At least in the short term, oil, refinery, and gas projects will be able to obtain easier financing as the world seeks to wean itself off Russian supply.
At the same time, higher input costs and lower cash margins tamper with the chemical industry’s ability to invest, which usually results in periods of underinvestment. This is unlikely to be the case for Singapore, argues Camy Loh, commercial manager, Chemicals and Gas, Vopak Singapore Terminals: “Within this cocktail of challenges, Singapore is a safe haven for investments in specialty chemicals with easy access into Southeast Asia, China and India. The number of chemical companies looking at the specialty segment in Singapore is at an all-time high.”
Europe’s scramble for oil and gas alternatives to free itself from Russian supply is perhaps teaching a bigger lesson than the impact of inflation, and that is the security of supply. Alexander Donau, APAC regional head at Leschaco, described the extreme situation in the logistics sector: “It is not so much about how much it will cost to get a product from A to B anymore, but more about ‘will I be able to?’”
The importance of stability is overriding the importance of costs. Singapore can widely benefit from this change in mentality as one of the most stable countries in the world.
Image courtesy of IMCD
CONCLUDING THOUGHT
“No doubt higher energy prices are dampening the government’s economic agenda to invest further downstream in the chemical sector, but I believe the danger is short-term and we are looking at a volatile scenario.”
Paul Nai, Managing Director, Lubrizol Southeast Asia