Chemicals 2025: Will the industry be dancing to a very different tune?
Chemical
companies have been riding high, but the trends that have underpinned that
performance are shifting. Companies should reflect carefully on their strengths
as they move into this new territory.
Whenever over the past decade we have examined the chemical industry’s
capital-markets performance, a very similar picture has emerged. On the basis
of total returns to shareholders (TRS), the chemical sector has, over the long
term, outperformed not only the overall market but also most of its customer
industries and raw-material suppliers. Within chemicals, the commodity and
specialty subsectors show similar performance, while diversified companies have
trailed. There have been variations on the theme over time, with petrochemical
players’ performance more affected by the naphtha-ethane spread and the
commodity cycle, while specialty players have been more affected by end-market
growth and mergers-and-acquisitions activity, but the variations have not
changed the overall sunny picture.
The impetus behind this strong performance
has been the chemical industry’s ability to significantly increase earnings on
a base of total revenues and invested capital that has grown more slowly, at a
rate tracking close to global GDP growth. This ability has been underpinned by
the following factors.
First, the chemical industry has increased
its productivity over time and has distinguished itself by holding onto the
resulting profitability gains, unlike many other industries that also raised
productivity but simply competed the gains away. How did the chemical sector
achieve this? Looked at overall, the sector appears fragmented, but two decades
of portfolio restructuring have created a highly concentrated industry
structure in many segments. That has put those chemical companies in a strong
bargaining position relative to customers and suppliers.
Next, the chemical industry has benefited
tremendously from China’s economic growth of the past two decades. China’s
capacity could not be built fast enough to meet domestic demand, so chemicals
had to be imported. This allowed West European and North American players to
grow while their home markets were experiencing near stagnation.
Last, we must keep in mind that the
chemical industry has an intrinsically sound business model: its products
enable the “world of things.” Without some support from the chemical industry,
hardly any of what we touch, of the buildings we live in, the food we eat, and
the healthcare we receive could exist. The industry as a whole is therefore
positioned to profit from a wide range of trends, from sustainability to
e-mobility, from commodity demand surges to major changes in consumer behavior.
Along with these strong fundamentals,
there have been a number of positive developments that have benefited specific
segments of the industry, and helped the industry’s overall capital-markets
performance. The most notable have been the availability of stranded gas in the
Middle East and shale gas in North America, and the upward trend in many
agricultural-commodity prices from 2000 to 2013.
Turn of
the tide?
But this golden era may be coming to an
end. Some important indicators have changed over the past few years. While the
industry’s 15-year performance still looks good, a closer look at the past five
years is less favorable: not only have chemicals lagged the total stock market
since 2011 in TRS performance but the industry’s return on invested capital
(ROIC) performance has flattened, and for some chemical subsectors, decreased.
This slowdown in financial performance
reflects important changes in the chemical industry’s fundamentals. First, the
industry is finding it increasingly difficult to hold onto the benefits of its
productivity-improvement efforts. Paradoxically, this is happening just when
advanced analytics and digital approaches are creating a new wave of
opportunities to accelerate productivity gains. Why is the industry having
these difficulties? There are signs that one of the cornerstones of the
industry’s performance—its concentrated industry structure—may be weakening.
How is this showing? The level of competitiveness appears to be significantly
increasing in many segments because of the number of new entrants, mostly
Chinese, and related to this, overcapacity is increasingly a challenge in many
product areas.
A second factor is slowing growth in global demand. The
GDP growth rate in the
all-important Chinese market has fallen
and may decline further. Even more important is that China’s per capita
chemical consumption is reaching the threshold where it is decoupling from GDP
growth and is projected to lag behind that growth in the future. China has
moved from its investment stage—built up infrastructure across the country
while much of its population has equipped itself with new homes, consumer
durables, autos, and other possessions—to an economy more characterized by
services and “upgrades,” which provide much less demand for chemicals. A
middle-class car that a Chinese buyer trades up to does not necessarily contain
more polymers than an entry-level model.
Looked at globally, we estimate that the
last decade’s 3.6 percent growth rate for petrochemicals may go down by between
0.5 and 2.0 percentage points over the next ten years, depending on assumptions
for regional GDP growth. For an industry with an estimated capacity creep
somewhere between 1 and 2 percent annually, this could be a dramatic shift.
Other sectors are likely to see similar reductions in growth rates—although the
growth in overall chemical demand will continue to outpace GDP. In
agrochemicals, for example, changes in diet as well as the potential to tap
enormous productivity reserves in the existing food chain could suppress
overall chemical demand.
There are also signs of longer-term shifts. We
think the specialties
model is increasingly under threat. A long-standing belief in the industry is that moving portfolios
downstream and to a higher specialties content is a reliable way to help solve
the challenges of growth and value creation. But we are increasingly skeptical.
The universe of specialties is not well defined and as a result is hard to
quantify, but we think it is getting smaller. Innovation to develop new
differentiated—and thus specialty—products has become a game of inches. With
the exception of innovative crop protection, we would be hard pressed to name a
single chemical blockbuster developed in the last ten years. Even in
application development, the segments where consumers are willing to pay for leading-edge
solutions are not getting bigger, since the fastest-growing markets (China and
India) have only a limited appetite for premium grades. Expanding in
application development will compensate for only part of the margin erosion in
the upstream core business.
Digital
innovations may further hasten this trend; an increase in e-commerce driven by distributors or platforms
such as Alibaba could even accelerate this commoditization of specialty
companies’ product and service offerings. In certain areas, such as
agrochemicals, that have more of a B2C character, Internet platforms may become
as disruptive as we have seen in other consumer spaces. Our skepticism about
specialties is reinforced by our research, which shows that segment
profitability already appears to be much more dependent on industry structure
(in effect, the number of players) than on the technology content of companies’
offerings. But that industry structure is changing fast as many new—in
particular, Chinese—players enter the game.
Next, the global playing field is leveling
off again, and so potentially shutting off another growth avenue. Chemical
production has historically tended to be local—produced in the region where it
is consumed. But the last ten years have seen a departure from that pattern:
significant imbalances in raw-material prices (the cost of stranded and shale
gas versus oil), labor costs (China versus developed economies), or just
regional mismatches in supply and demand (China growth) resulted in a
significant internationalization of the chemical industry and related growth
opportunities for many players. However, given the context of oil prices moving
to lower levels since 2014 and Chinese labor costs rising, it is fair to
speculate that this development might go into reverse in the coming years.
As if all of these shifts were not enough
to deal with, the global chemical industry must also recognize that it has to
operate in an environment that is increasingly nationalistic. The trade and
investment policies of a number of emerging-market countries have always been
somewhat protective (and may have become even more so recently), and the incoming
US administration appears to embrace a similar attitude. As Brexit and other
developments underline, a similar trend can even be observed in Europe.
In parallel with this resurgence of
nationalism, state-owned enterprises (SOEs) are taking an increasing share in
the industry. SOEs’ share dropped sharply during the 1980s and ’90s, when many
governments sold their stakes in national oil companies, many of which owned
significant chemical activities. With the rise of China and other developing
countries, this trend has reversed. SOEs, however, often are held accountable
to different standards than private and listed players—financially,
strategically, and otherwise. They also tend to have much deeper pockets than
publicly traded companies, which may find it difficult to compete when it comes
to the development of new technologies.
This list would not be complete without a mention of the
debate around the circular
economy. This is mostly relevant
for plastics, but since plastics consume the majority of petrochemical
products, this has the potential for industry-wide impact. We estimate that
roughly two-thirds of all plastic ends up in a landfill or the environment at
large. Because plastic waste degrades slowly, it accumulates, and it is not
unlikely that the chemical industry will become subject to regulation and
pressure from customers to do more regarding recycling and demand reduction.
Given the rather low growth rates projected for the sector, as previously
discussed, such regulation could potentially result in a scenario in which the
need for conventionally produced material would not only stop growing but even
(though not in the short term) could shrink.
If just a few of these shifts gain
substantial momentum, the chemical industry will face a decade very different
from, and much tougher than, the last one. What are the implications for the
industry?
Into a
new world
The first and perhaps most significant
implication would be that with growth rates only a little above annual capacity
creep, there will be less need for new builds. Most new investments will either
replace existing assets or need to displace others. For example, the new
crackers in North America will target Asian markets and compete with exports
from Middle East producers. The latter’s exports to Europe may increase as a
result, increasing pressure on European petrochemical players in the medium
term. While this scenario seems remote in today’s environment of record
profitability for European petrochemical makers, good times rarely last
forever, and the need for closures could resurge. More broadly across the
industry, companies could be forced to restructure in almost all parts of the
world, and we foresee players trying to attain greater economies of scale
through new waves of M&A.
The only major exceptions might be
India—where all indicators suggest that the local growth is going to continue,
albeit from a low base—and China. But many areas of the Chinese chemical market
these days are already oversupplied and overserved. We would argue that Chinese
supply needs a broad and drastic consolidation.
Incumbent specialty-chemical players must
prepare for further encroachment of commoditization and erosion of their
historical advantages when attackers from developing markets gain more
experience and become increasingly technologically savvy. The value-add
potential of many Western specialty-chemical conglomerates will be challenged
even more intensely than today, and so will their questionable claim that they
can upgrade their portfolio in a way that generates value for shareholders.
At the same time, the long-heralded shift
of the chemical industry’s center of gravity to Asia will actually take place.
As much as Western players have tried to prepare themselves for this
development, many still have only a limited grasp of what this will mean and
the mind-set shifts required to face the fact that they will move from the
center of the industry to its sidelines. The historical track record of
multinational companies in China and other Asian countries has been mixed at
best. At some point, they will need to consider much closer partnerships with
Chinese players to grab hold of one of the last opportunities to become an
insider in what will be the largest chemical market. There may be a fit here
with the interests of local companies: as Chinese players grasp the
opportunities for consolidation in their home market and expansion globally,
they may value access not just to Western companies’ technology but also to
their successful business approaches.
As a general statement, strategies for
chemical companies may become simultaneously simpler and more challenging. They
may become simpler because the imperatives of productivity improvement and
functional excellence—in other words, executing a chemical-business model
better than most competitors in the field—will be even more obvious than today.
Without this executional excellence, companies will lack the financial strength
and the credibility to lead in a game that will include a lot of M&A.
Strategy development, however, will also become much more difficult: it will be
much more challenging to identify the remaining opportunities for growth that
exceeds GDP and to develop approaches to capture those opportunities in a
value-generating way.
We are the first to acknowledge that any
attempt to look into the future has limitations, and we present this
perspective based on careful observation of the industry as a starting point
for participants thinking about strategies for the next decade. As chemical
companies head into this new and more challenging territory, they need to take
stock of their strengths and weaknesses. Here are some questions to advance
that reflection:
·
How is the industry structure of the segments in which you
participate going to evolve, and what are the implications for future
profitability?
·
How can you increase your presence in China as a foreign-based
company, in view of the changes under way that we have outlined in this
article? And if you are a Chinese company, what role will you play in a likely
consolidation of the industry?
·
What are your strengths, and how can you build on them through
transformational M&A to become a champion in your target segments?
·
What will be the most value-creating operating models for
multibusiness companies that straddle specialties and commodities?
·
How will you use digital to ride the next wave of commercial,
supply-chain, and operations performance improvement?
By Florian Budde, Obi Ezekoye, Thomas Hundertmark, Manuel Prieto,
and Theo Jan Simons
http://www.mckinsey.com/industries/chemicals/our-insights/chemicals-2025-will-the-industry-be-dancing-to-a-very-different-tune?cid=other-eml-alt-mip-mck-oth-1703
No comments:
Post a Comment