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Tough Times For Propylene Buyers

There is little doubt that the advent of shale is opening the spigots for massive amounts of new ethylene production in North America. However, a consequence of all the additional production of ethylene is much less production of propylene. Chuck Carr, a propylene analyst at IHS Chemical, gave a great overview of the situation at IHS’s petrochemical conference down in Houston late last month.

As ethylene makers seek to take advantage of the abundance of ethane by cracking less naphtha, they are producing far less propylene. A naphtha cracker, Carr pointed out, will make about a half ton of propylene for each ton of ethylene produced. An ethane cracker will only put out about 20 kilograms of propylene for each metric ton of ethylene made. The amount of propylene coming from steam crackers has declined by 30% in only a few years. Overall, after reaching a peak of about 16 million metric tons in 2007, North American polypropylene production has declined to about 14 million metric tons. Some 54% of propylene is made in oil refineries, only about 40% is now made in ethylene crackers.

Propylene prices are rising, putting polypropylene makers in a tough position. As I heard over and over again at the IHS conference and then at NPE, a plastics trade show put on in Orlando last week, high polypropylene costs are tempting plastics converters to switch to high density polyethylene when they can. Soft drink bottle caps are a key battleground application. If they have seemed a little different lately, now you know why.

One company that jumps out at me as being in a tougher bind than most is Braskem, which recently purchased the polypropylene businesses of Sunoco and Dow Chemical. According to Carr’s presentation, the company has the largest deficit of propylene in North America. In fact, Braskem has no production of propylene in the region.

The company’s Marcus Hook, Pa., plant is downstream from Sunoco’s Marcus Hook refinery. Or at least it was. Sunoco idled the refinery in December and looks to permanently shutter the unit over the summer. It is ending a supply agreement with Braskem in June. The supply agreement covers about 60% of the facility’s 350,000 metric tons of annual polypropylene capacity. A contract with another supplier in the region covers 19% of the capacity.

In its 20-F regulatory filing put out this week, Braskem says it being supplied by Sunoco out of Sunoco’s Philadelphia refinery and from other sources. The polypropylene unit is still operating at normal levels. The company is also in discussions for long-term supplies of propylene from other refineries in the Northeast. “At this time, we believe that, provided Sunoco continues to supply us until June 2012 or we are successful in sourcing additional feedstock supply, the operations and capacity utilization of our Marcus Hook, Pennsylvania plant will not be materially affected,” the company says. The company also raised the prospect of delivering to customers from other plants.

One wrinkle for the Braskem is the Philadelphia refinery. Sunoco is seeking a buyer for that refinery as well. If it can’t, Sunoco is planning to idle it by this summer as well. That would limit Braskem’s options a bit. But maybe Petrobras or PBF Energy or someone else will buy the refinery or something. I do hope that Braskem finds a way to keep the polypropylene unit running.

There seems to be propylene issues at the plants it purchased from Dow in Seadrift and Freeport, Texas. A propylene supply agreement, presumably from Dow, is set to expire in 2013. Dow will likely use that to make its own propylene oxide, acrylic acid, and epichlorohydrin. Braskem, however, probably has more options on the Gulf Coast than it does in the Northeast.

Petrochemicals, Front And Center

I took my usual seat at IHS’s World Petrochemical Conference at the Hilton Americas in downtown Houston today, front and center, as I have for 12 previous annual conferences run by CMAI. “The world is right when you’re sitting in the front row,” Mark Eramo, vice president of chemical industry research and analysis, said as he passed. He has given the big ethylene talk each year that I have attended the conference.

IHS purchased CMAI since the last conference. I was worried that IHS might mess with a good thing. The conferences have been a bigger and bigger draw year after year. IHS made some changes, but they were for the better. Instead of a keynote by an august petrochemical executive, there was a panel featuring five of them.

That forum gave me the impression that petrochemical executives may be exuberant about the prospects of feedstocks from shale, but they are also realistic. Since the last conference, five companies—ChevronPhillips Chemical, Dow Chemical, Shell Chemicals, Sasol, and Formosa have announced new U.S. ethylene crackers. “Not all crackers that have been announced may be built, certainly not in the announced timeframe,” noted Ben van Beurden of Shell Chemicals.

Jim Gallogly, CEO of LyondellBasell, made a similar point. “It’s likely you won’t see all the crackers advanced,” he said. Lyondell, for its part, is focused on expansions of existing U.S. facilities, to the tune of half a new cracker’s worth of output.

Also, Gallogly mentioned that his company would be interested in a “condo” cracker, perhaps at an existing facility. As I understand the concept, this would be a cracker that would have two or more partners, each with a defined offtake. I remember Dan Smith, a Gallogly predecessor, talking about this concept about a decade ago, just when the Middle East and Asia started getting all the petrochemical investment. If I had to guess how this might play out today, I would think it would be an project involving Lyondell, a partner with access to feedstocks, and maybe a partner trying to back-integrate an ethylene derivative such as ethylene oxide, alpha olefins, or vinyl chloride monomer.

Curiously, in the Q&A, van Beurden kept on getting asked why Shell announced a cracker and Gallogly kept on getting asked why LyondellBasell hasn’t announced a cracker. In fact, one attendee brought up the exact same two problems I noted with Shell project—that Shell no longer makes polyethylene and that Monaca, Pa., is relatively isolated from the rest of the petrochemical world. Van Beurden said there is as a big advantage being close to the converters—customers would enjoy quicker delivery and less working capital tied up in inventory. He also said there was an infrastructure solution to the isolation problem.

As far as Eramo’s talk goes, while here in the U.S. the profits have been enormous, the global industry is actually beginning to climb out of a cyclical supply-side trough. Demand for ethylene is 127 million metric tons globally, he noted, and growing at a 4.3% annual clip. It is forecast to reach 157 million tons by 2016, at which time the industry will likely see operating rates at around 90%, when the industry should see peak profitability.

As You Sow Flies The Flag Of Victory Over McDonald’s

McDonald’s is testing double-walled paper coffee cups at 2,000 of its restaurants, primarily on the West Coast, to replace the expandable polystyrene cups it currently uses. McDonald’s says it testing market acceptance, performance, and operational impact of the new cups.

The advocacy group As You Sow, which organizes shareholder resolutions at companies to improve environmental performance, is claiming victory, noting that this comes “in response” to a shareholder resolution it put in McDonald’s 2011 proxy. The resolution asks the board to issue a report on more “environmentally beneficial beverage containers” and the like.

When I asked McDonald’s if the action was because of As You Sow’s efforts, a spokeswoman responded, “This test is a result of our efforts as a company to continually seek more environmentally sustainable solutions.”

According to As You Sow’s press release, the measure received the “support of nearly 30% of total company shares voted.” That is technically true, but a somewhat flattering way of putting it. The measure received 23% “FOR” votes, 55.44% “AGAINST” votes, 21.57% abstentions. As You Sow’s 30% throws out the abstentions.

As You Sow says the 30% result is great for an environmental resolution. Perhaps. Its website also has advice on how shareholder proposals ought to be interpreted:

In most cases, an investor with 3% ownership in a company would be one of the top shareholders and thus even single digit votes may gain considerable attention from a company. Social proposal votes more than 10% are difficult to ignore and often result in some action by the company to address the shareholders area of concern. Votes that receive 20-30% or more have garnered strong support from mainstream institutional investors and send a clear cut single to management. Only the least responsive of companies is willing to ignore one out of every three or four of its shareholders.

I can go both ways on this. More than two thirds of the votes cast for the cup proposal didn’t even want McDonald’s to study paper cups. Would ignoring them somehow make McDonald’s super responsive to the wishes of its shareholders? On the other hand, it could be that some institutional shareholders reflexively vote these down because they see the shareholder proposal as a subversive tactic. These same shareholders might not object, or even notice, if McDonald’s management did a trial run of paper cups without proxy prompting.

If I were a McDonald’s shareholder, I might have voted for the measure as stated (why object to a study?), but I wouldn’t think that a major rollout of paper coffee cups would have much chance of success. We must remember that McDonald’s coffee is hotter than a thousand suns. (That might not be a scientifically precise statement.) Remember that lawsuit? This is probably why the company still uses EPS when it gave up on plastic packaging for burgers a couple of decades ago. A McDLT won’t burn you; the coffee will. I doubt a paper cup, even a “double walled” one, will contain the extreme heat quite like plastic. International Paper’s Hold & Go cup either is or is something like the cup McDonald’s will use. If the cup performed as well as plastic, the press release introducing the product probably would say so. It doesn’t.

Monaca, Pa!

Shell Chemical has selected the Pittsburgh area town of Monaca, Pa., as the site of its new ethylene cracker complex. Actually it will be in Potter and Center Townships, which are near

Monaca, Pa. (Pop. 6,286, according to Wikipedia). But that narrows it down a lot more than what Shell was previously saying: “I don’t know, Appalachia somewhere or something.”

Monaca is a bit of a chemical town. It is host to a Nova complex that makes Arcel polystyrene resins for foams and expandable polystyrene. Nova calls this the Beaver Valley site. (If that name conjures an image of a valley teaming with beavers felling trees willy nilly, I know the feeling.)

This doesn’t mean that the plant is a done deal. As its press release explains:

“The next steps for this project include additional environmental analysis of the preferred Pennsylvania site, further engineering design studies, assessment of the local ethane supply, and continued evaluation of the economic viability of the project.”

The company isn’t saying much more about the project. It will feature an ethylene cracker and downstream polyethylene and ethylene glycol plants. We already knew about that. There’s nothing new about the size or the timing.

I do have a couple of thoughts about the project:

1) Isolated ethylene and derivatives complexes never work out. If the ethylene cracker goes down, how do you run the derivatives plants and where does the ethane feedstock go? If one of your derivatives complexes goes down, do you run the cracker at reduced rates? It would be nice to see another cracker complex built in the neighborhood that would be connected to the Shell site. I suspect that we’ll probably hear from another company with cracker plans in the region before long.

2) I doubt Shell will build its own polyethylene plant. It hasn’t had any skin in the polyolefins game since it sold its stake in Basell to Access Industries in 2005. I am expecting a partner of some kind on the polyethylene unit. If it does go it alone, I would think that the plant would spew out commodity grades of polyethylene. One example of such a product would be high-density polyethylene for extrusion blow molding—used to make milk jugs. Shell would need something that is relatively easy to sell. Also, the company wouldn’t want to do a lot of switching of grades at the plant because of potential problems with excess ethylene, as I mentioned above.

All this aside, it is great to see such a big chemical plant being contemplated for the region.

Will Hambrick Head Berkshire Hathaway?

Warren Buffett’s annual letter to Berkshire Hathaway shareholders is out this week. Normally, the annual letter of one of the most widely read documents in the business world. This year, given that Warren Buffett has been in the news so much recently with the Buffett Rule and all, it is probably being perused more closely than usual.

There is something for the chemical industry in the letter:

On September 16th we acquired Lubrizol, a worldwide producer of additives and other specialty chemicals. The company has had an outstanding record since James Hambrick became CEO in 2004, with pre-tax profits increasing from $147 million to $1,085 million. Lubrizol will have many opportunities for “bolt-on” acquisitions in the specialty chemical field. Indeed, we’ve already agreed to three, costing $493 million. James is a disciplined buyer and a superb operator. Charlie and I are eager to expand his managerial domain.

I wrote up a small story in C&EN based on this passage. The idea being that Lubrizol is on the hunt for more small acquisitions. My boss, assistant managing editor Mike McCoy, had an even more interesting interpretation of the line “eager to expand his managerial domain.”

Mike suggested that maybe “managerial domain” would extend to the whole of Berkshire Hathaway. In other words, perhaps Buffett has Hambrick in mind as a successor.

I snickered at first. It seems like a crazy idea because it would have Buffett giving the keys to the kingdom to someone who has only been with the company since September. And Hambrick would go, in relatively short order, from running a mid-sized specialty chemical maker to heading all of Berkshire-friggin’-Hathaway.

BUT…Mike isn’t the only one to so speculate. This well-reasoned article by Harry Wallop in the Telegraph puts Hambrick as one of four possible candidates along with BNSF CEO Matthew Rose, reinsurance chief Ajit Jain, and Geico boss Tony Nicely.

The “eager to expand his managerial domain” appears in paragraph following the revelation that he has come up with an unnamed successor and two backup candidates. Why was James Hambrick the next thought to come to mind?

The phrase “eager to expand his managerial domain” is a cutesy way of hinting at a successor. Warren Buffett is fully capable of cute. Here he is playing the ukulele on television.

Another line from the letter that I would like to overanalyze is this: “James is a disciplined buyer and a superb operator.”

That is an enormous compliment coming from Warren Buffett. Picking stocks and buying companies is what Warren Buffett does. Go to any business section of any book store and you’ll oodles of books on Buffett’s methods. (One in this genre, The Intelligent Investor by Buffett’s mentor Ben Graham, is essential business reading.) Buffett calling Hambrick a disciplined buyer is kind of like John Elway saying “nice pass” to a kid tossing a football around on the beach.

Lubrizol’s track record of acquisitions is pretty good. The Noveon acquisition back in 2004 diversified the company away from lubes and additives. A couple of years ago it did lose a bidding war to BASF for Cognis. Backing off might have taken some discipline.

Another interesting deal was its purchase of Dow’s thermoplastic polyurethanes business for $61.4 million at the end of 2008. The business generated $74 million in revenues in 2008. The deal occurred right when Dow’s JV with PIC of Kuwait broke up and the company was left struggling to finance its purchase of Rohm and Haas.

Last year I was talking about that period in Dow’s history with Dow CEO Andrew Liveris. “One of the assets, I won’t tell you which one, I think we sold in a rush,” he said. “It was a small sale so it didn’t matter.” I suspect, but obviously don’t know, that he meant the thermoplastic polyurethanes unit. If that is the case, I wonder if Buffett, who holds billions of dollars worth of Dow preferred stock, noticed.

Let’s not forget that Buffett isn’t planning to step down while he is still able to function and wow us with mean uke solos. He’ll have plenty of time to groom a successor.

Eastman Buying Solutia

I arrive the office this morning, bright and early, as usual.

“Your Top 50 U.S. chemical company survey will get smaller by one company,” C&EN assistant managing editor, Mike McCoy, said.

“Do you want me to guess?” I said.

“Solutia is one of the firms.”

“That is the company being acquired,” I reply.

“That’s right.”

“PPG is buying them,” I guessed.

“No, but that’s an interesting guess,” Mike says. It was a very good guess.

“Ashland?”

“No, too soon.” Ashland, Mike realized, just bought ISP.

“Eastman!”

“Very good!” Mike exclaimed, very impressed.

Indeed, Eastman is buying Solutia in a $4.7 billion transaction. The relevant details are in my Latest News story here.

I have a few observations:

1) It seems like a nice, square deal for all parties. My calculations put the cash and stock portion of the deal at $3,357 million and the debt at $1,377 million, combining for the ~$4.7 billion price. The cash and stock represent a 13.8x multiple over adjusted earnings of $243 million.

2) Since declaring bankruptcy in 2003, Solutia has honed its business where it has a strong position such as hydraulic fluids and polyvinyl butyral (PVB) interlayers for windshields. The cash cow of the portfolio is the technical specialties business, which generated a 38% EBITDA margin. It makes the hydraulic fluids, heat transfer fluids, and insoluble sulfur, used to vulcanize rubber.

3) Integration? PVB is made by reacting polyvinyl alcohol, which Solutia makes, with n-butyraldehyde. It just so happens that Eastman is America’s largest producer of n-butyraldehyde, which it uses to make oxo derivatives like 2-ethylhexanol.

4) Solutia is an ex-Monsanto business. Sterling, which Eastman acquired last year, is a former Monsanto unit. Spooky? Yes. Coincidence? Probably.

President Obama Champions Manufacturing In The SOTU

During last night’s State of the Union address, the president spent roughly the first quarter of the speech talking about manufacturing. Does Obama have the right solutions? Time will tell. (It is an election year, so little will get done anyway.) But the Administration has certainly identified the right problem: the need to turn around manufacturing in the U.S.

The speech began with the auto companies:

On the day I took office, our auto industry was on the verge of collapse.  Some even said we should let it die.  With a million jobs at stake, I refused to let that happen.  In exchange for help, we demanded responsibility.  We got workers and automakers to settle their differences.  We got the industry to retool and restructure.  Today, General Motors is back on top as the world’s number-one automaker.  (Applause.)  Chrysler has grown faster in the U.S. than any major car company.  Ford is investing billions in U.S. plants and factories.  And together, the entire industry added nearly 160,000 jobs.

We bet on American workers.  We bet on American ingenuity.  And tonight, the American auto industry is back.  (Applause.)

What’s happening in Detroit can happen in other industries.  It can happen in Cleveland and Pittsburgh and Raleigh.  We can’t bring every job back that’s left our shore.  But right now, it’s getting more expensive to do business in places like China.  Meanwhile, America is more productive.  A few weeks ago, the CEO of Master Lock told me that it now makes business sense for him to bring jobs back home.  (Applause.)  Today, for the first time in 15 years, Master Lock’s unionized plant in Milwaukee is running at full capacity.  (Applause.)

Let’s make one thing clear: “bankruptcy” isn’t the same thing as “going out of business”. The public seems to conflate those two things, perhaps for understandable reasons. Usually the 11 o’clock news stories about bankruptcy filings are discussing local retailers. Retailers are usually laden with a lot of working capital—namely inventory—and not a lot of fixed assets (Usually some readily sellable real estate and store infrastructure). Such retailers are easily liquidated and simply disappear.

Big manufacturers have a lot of equipment that isn’t as easily transferrable to other firms. If there had been a normal bankruptcy procedure, GM and Chrysler, could very well have emerged as successful car companies. LyondellBasell went through bankruptcy around the same time. It emerged, and it is now making manufacturing investments again.

However, it is also likely that the government-controlled procedure might have allowed for a more orderly process, especially in regards to a labor-management agreement. And the government likely offered the financing on more attractive terms than private banks would have been able to provide in the middle of the financial crisis.

Much of the remarks had to do with tax policy:

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Georgia Gulf To Westlake: Not So Fast!

You may have heard that Georgia Gulf has rebuffed a $30-per-share takeover bid from Westlake. Here are a few points:

1) By my calculations, the bid is worth just over $1 billion, or close to $1.7 billion, including Georgia Gulf’s long term debt. Georgia Gulf’s expectations for EBITDA (earnings before interest, taxes, depreciation, and amortization) for 2011 are between $245 million and $255 million. This makes the offer seem a little cheap. However, Georgia Gulf’s book value (equity less intangibles and goodwill) is about $243 million.

2) Georgia Gulf has been through heck and back. It bought building products maker Royal Group technologies for $1.6 billion in 2006. Congratulations if you recognize that this was the worst possible time for a company to increase its exposure to the housing market. The downturn didn’t bankrupt Georgia Gulf, but it came close. The company almost got delisted from NYSE when its market cap slipped under $75 million. It needed time from creditors for payments due. Moreover, a debt for equity swap amounted to a quasi-bankruptcy: shareholders were diluted, though not completely wiped out.

3) Strategically, this is a no-brainer for Westlake. Both are integrated chloro-vinyl companies. Westlake is integrated back into ethylene; Georgia Gulf isn’t. Both make fabricated products, with Westlake’s business oriented towards pipe and Georgia Gulf leaning towards window and door profiles. Westlake also makes polyethylene. Georgia Gulf has a cumene/phenol business.

4) Expect more to come. I would have to think that Westlake will follow with a tender offer. And given that the stock is trading at above $30 per share, I would expect to see Westlake sweeten the deal somewhat. I’m not terribly sure if the bid makes it into the courts or to a proxy fight.

5) Georgia Gulf is preparing a defense. Westlake already owns about 4.8% of Georgia Gulf. A poison pill, in the form of a rights offering to Georgia Gulf shareholders, will prevent Westlake from owning more than 10%.

6) Georgia Gulf had a staggered board until 2010. A staggered board means that not all of the directors are up for reelection every year. Now, Georgia Gulf directors are up for election when their term ends. By my reckoning, Georgia Gulf has five of its eight directors up for reelection later this year. Three will serve until 2013. This might present an opportunity for Westlake to stack the board, depending on the nomination process.

7) I wouldn’t be surprised to see competing bidders. The last big takeover drama in the industry was Air Products’ run at Airgas. There were few potential suitors for Airgas. There may be more for Georgia Gulf. Mexichem comes to mind. It is trying to buy Wavin, Europe’s largest producer of plastic pipe for about $650 million. Why not drop that and string together a Georgia Gulf bid? Braskem also comes to mind. It is the big wheel in Brazilian chloro-vinyls and has been acquisitive in recent years in the U.S., buying both Dow’s and Sunoco’s polypropylene business.

8) There are echoes of Air Products/Airgas in Westlake’s bid. Both Airgas and Georgia Gulf called their unsolicited bids opportunist attempts to take advantage of share prices that were temporarily in the cellar. Both Air Products and Westlake responded that with their offers, shareholders of the target companies wouldn’t have to wait for fortunes to turn around to see a payday. Nearly a year ago, Air Products was forced to drop its $70 bid. Now Airgas is trading at above $80 per share.

9) One has to concede the first riposte to Georgia Gulf. Shares were worth more than $40 last year before the grumblings over European debt last summer. Georgia Gulf had been on the upswing in recent months. Westlake seems to be acting now before its opportunity slips away.