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Chemical product price pressure may ease
Fri Mar 17, 2006 1:28 PM ET

FRANKFURT, March 16 (Reuters) - Raw materials prices are likely to stabilise in 2006, easing pressure on product prices, chemical industry executives told Reuters, but they warned customers would feel the bite if input costs kept soaring.

Chemicals companies cannot keep absorbing higher raw material charges, especially after crude oil soared 72 percent over the past two years, executives said at a Reuters summit on the chemical industry in Frankfurt.

This would be a blow to the European Central Bank, which has warned companies not to push higher energy costs through the pipeline and spur an inflationary spiral. While the chemicals industry is a largely intermediate producer, executives said they had only so much wiggle room on costs.

Degussa, the German specialty chemical company, for instance, listed raw material and energy costs as the biggest challenge it faces in 2006. Its energy bill rose 20 percent last year to 1 billion euros, and it responded with a 3-4 percent product price increase in 2005. More may be needed.

"In general, we will not be able to balance that completely with restructuring. We will have to go out and raise prices," Degussa's Chief Executive Utz-Hellmuth Felcht told Reuters.

A $1 rise in a barrel of oil takes 10 million euros off its earnings.

Similarly Lanxess, the world leader in synthetic rubber and certain basic chemicals, raised its product prices by 9 percent in the first nine months of 2005, said Matthias Zachert, the company's chief financial officer.

"We tried to fully push raw material price increases through to the end market," said Zachert, which it was able to pull off thanks to its leading position in 70 percent of its key markets.

Lanxess expects raw material costs to be broadly stable this year, with a slight pickup in the second half. If input prices rise steeply, though, it will raise its product prices again.

"If raw materials pick up again, of course we have to go back to product prices. But if raw material prices are stable we will not go through to our customer," Zachert said.

Rainer Guntermann, euro zone economist at Dresdner Kleinwort Wasserstein, said this pattern of a protracted period of commodity price rises triggering a series of product price increases is the very inflationary risk the ECB has warned of.

"The result is likely to be we will see core consumer inflation start to creep higher without any obvious explanation," said Guntermann.

Indeed ECB President Jean-Claude Trichet has regularly warned businesses not to pass on higher energy costs. On March 2, he cited as an inflationary risk "stronger wage and price developments than expected due to second-round effect of past oil increases" -- a signal this would invite more rate hikes.

Already producer prices, which measure industry costs before they reach the retail level, have risen 4.6 percent in the euro zone in 2005, more than double the consumer inflation rate. Previously it has taken about a year for producer price gains to show up in consumer prices.

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But corporate executives at the Reuters chemicals summit said they had limited scope to absorb costs after a round of corporate restructuring and tough competition.

"If energy goes up by 20 percent, if you do all the cost cutting in fixed costs, you save 4-5 percent. That is not enough," said Degussa's Felcht.

Degussa is having to be more intelligent about its pricing structure, emphasising service and quality of product in order to justify its price rises to customers, he said.

Already the chemicals industry has moved many of its customer contracts onto a quarterly renewal cycle, rather than six months to one year or longer, giving them the flexibility to raise prices more quickly, Lanxess's Zachert said.

He forecasts oil at $50-60 dollar a barrel in 2006. Bayer AG (BAYG.DE: Quote , Profile , Research ), the chemicals and pharmaceutical company, suffered a rise of 100 million euros in its energy bill last year.

"I don't expect any relief from oil," said Chief Executive Werner Wenning. Bayer forecasts crude oil in the $60-65 a barrel range this year, the mid range compared with $40-$70 seen in 2005. As for other raw material prices, Bayer sees them remaining around fourth-quarter levels. So far it has increased prices.

"We have been able not only to pass this effect to our customers, but also to increase our margins," he said.

Bayer said its margins rose to 17.9 percent in 2005 from 14.1 percent the year before.

Asked about ECB interest rate increases to check the inflationary impact from high oil costs, the executives were sanguine and viewed it as no damper on moderate growth prospects for Europe.

"We have to expect increases in Europe over the next couple of quarters," said Bayer's Wenning. It will not hurt European growth, which he estimates around 2.5 percent including the UK. "Not for the time being, no."

The ECB has raised its benchmark rate by 0.5 percentage points to 2.5 percent in the past three months and is expected to keep raising rates to 3 percent this year. Zachert said Lanxess already had issued new debt to take advantage of low rates in Europe, so was not concerned.

Source: Reuters

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