In the US, about 1,200 US companies produce basic industrial chemicals, with combined annual revenue of $120 billion. Large companies include divisions of multibillion dollar companies like Dow, DuPont and Occidental. Several dozen companies have annual revenue between $100 million and $1 billion, and several hundred have revenue between $10 and $100 million. Although the overall concentration of the industry is not high (the top 20 chemical companies control only 50 percent of total industry revenues), specific market segments are often dominated by just a handful of competitors. For example, eight companies control 85 percent of industrial gas production, eight control 95 percent of alkali production, and only six companies manufacture soda ash, etc.

COMPETITIVE LANDSCAPE

Demand depends on the overall strength of the US economy, because most industrial chemicals are used in the manufacture of more complicated products like fibers, plastics, paints and paper. The profitability of individual companies is closely linked to volume of production because of large fixed costs. Big producers have large economies of scale in production, which is why some chemicals are made by just a handful of companies. Small companies can compete effectively by making specialized or highly purified products.

PRODUCTS, OPERATIONS & TECHNOLOGY

Industrial chemicals include gases like oxygen and nitrogen, dyes and pigments, chlorine and caustic soda, sulfuric and nitric acids, and thousands of organic chemicals. Unlike advanced chemicals that are manufactured through complicated chemical reactions, most industrial chemicals are made by extraction and purification from natural substances, including minerals, natural gas, petroleum, plants, air and water. Oxygen and nitrogen gas are made by freezing air, phosphates from marine deposits, ethanol by fermenting corn, chlorine from salt water, and a large number of chemicals are made by boiling petroleum.

Manufacturing facilities are often located close to raw materials. Because production facilities often consist of equipment that is specialized for the product being made, and because of economies of scale, most companies operate a single, large production plant and produce only a handful of related products. Manufacturing operations focus on obtaining the highest possible yield of finished product from the raw materials. Access to high-quality raw materials is a primary consideration. Many companies either own their raw material supply or acquire it under long-term leases. Most producers of soda ash, for example, obtain raw material under long-term leases from mining operations in the Green River area of Wyoming.

Extracting basic chemicals from raw materials typically requires large amounts of energy. For many products, the cost of energy can be 30 percent or more of the total manufacturing cost. In many industrial processes, energy is used in the form of steam, which often is generated from coal. Energy-intensive chemical plants are often located where the cost of energy is low, such as near hydroelectric plants or coal mining areas.

Because producing industrial chemicals is usually a purification process, many producers (especially those that use minerals as a raw material) must dispose of large quantities of waste materials, of which there may be many pounds for each pound of finished product. Some wastes, like the mash that remains after corn has been fermented to ethanol, can be sold as animal feed or fertilizer, but many have no economic value.

The technology used to produce most industrial chemicals is well known and relatively simple, involving basic chemical reactions. Phosphates, for example, are made by dissolving phosphate rock in sulfuric acid; chlorine is made by passing an electric current through salt water. Many plants are highly automated with computerized process control systems because the control of chemical reactions is critical in providing the best possible yield of product.

SALES & MARKETING

The major customers for industrial chemicals are other chemical and manufacturing companies that use them in their own manufacturing processes, consumer products companies that use them directly to formulate products like detergents and toothpaste, and wholesale dealers that resell them in smaller quantity to a variety of small customers. Companies often have large, long-term contracts with a few large customers. In some cases, a producer with a long-term contract will build a plant next to the manufacturing facility of a major customer. Many products however, are sold to a wide variety of customers through a sales force that may consist largely of chemists or chemical engineers who can explain product properties and understand technical requirements.

The more basic the product, the more sales depend purely on pricing. For bulky products, like soda ash or phosphates, transportation costs to a customer's location can be a significant factor. Prices for many products are linked to the cost of energy.

FINANCE & REGULATION

Industrial chemical plants are highly automated and capital-intensive. Individual pieces of equipment can be very expensive. With high fixed costs, changes in production volume quickly affect profits. Maintenance costs are often high. New plants with the latest technology routinely cost more than $100 million, a primary reason why most companies in the industry are large. To avoid production interruptions, inventories of raw materials are typically high. Research and development costs are often high, as companies try to refine their manufacturing process and find new uses for their products.

Like other manufacturing operations, industrial chemical plants are subject to a variety of environmental and safety regulations, administered by state agencies, OSHA and EPA. Many industrial chemicals companies are involved in remediating past chemical ground contamination at plant or disposal sites. DOT regulates transportation of many chemicals. Often, major environmental issues are associated with storing or disposing of large amounts of waste materials.

REGIONAL & INTERNATIONAL ISSUES

Because they use large amounts of energy, and sometimes natural gas or petroleum as a raw material, many manufacturers of industrial chemicals are located in Texas and Louisiana. Other concentrations are in New Jersey, West Virginia, Alabama and South Carolina.

International trade in industrial chemicals is fairly large. Basic bulk chemicals like gasses, acids and caustic soda can be made anywhere and are not traded internationally, but refined products and many organic chemicals have a high value-to-weight ratio that warrants international transportation. Annual US exports and imports of industrial chemicals are close to $30 billion. Imports come from Canada, Ireland, Japan and Germany. Exports went to Canada, Mexico, Belgium and Japan.

RECENT DEVELOPMENTS

QUARTERLY INDUSTRY UPDATE

Hurricanes Reduce Chemical Capacity, Availability - Hurricanes Katrina and Rita caused property damage that reduced US chemical production capacity. Credit Suisse First Boston reports that 5 to 10 percent of North American polyethylene production capacity was offline in October 2005 due to hurricane damage. The damage, combined with capacity losses due to plant turnarounds, contributed to a 13 percent loss in North American ethylene capacity. As a result of polyethylene shortage, prices have increased and are expected to remain high as production is expected to be impacted through at least February 2006.

Accidents Must Be Quickly Reported - Chemical producers failing to properly report accidents face stiff penalties. In October 2005, the EPA settled cases with three Ohio companies that reported leaks of hazardous chemicals hours after they occurred. The Ohio plants that accidentally leaked chemicals such as anhydrous ammonia and chlorine were charged tens of thousands in fines and required to install additional leak detection and safety equipment. Chemical producers must ensure proper plant and equipment safety and reporting procedures to avoid dangerous accidents and EPA sanction.

Gulf Emergency Plans Effective - Chemical manufacturing plants in hurricane-affected areas successfully avoided harmful accidental release of chemicals. According to the American Chemistry Council, a survey following Hurricanes Katrina and Rita shows that US plants in the South found that emergency shutdown plans were generally effective. Because Texas and Louisiana rank first and third in chemical production, chemical release due to hurricane damage was a concern. Chemical producers face significant emergency preparedness responsibilities due to the potentially harmful nature of many chemical products.

Waste Chemicals May Have Value - Chemical plants may reduce waste and cut costs by improving synergies. A study of Dow Chemical plants in cooperation with the Department of Energy found that up to 155 million pounds of non-chlorinated waste could be reused each year in other products or processes such as fertilizer or water treatment. Dow could save up to 900,000 MMBtu of energy each year and reduce costs by $15 million. Chemical producers may find new ways to generate revenue and lower costs by considering alternative uses of waste products.

Energy Costs Stifle Manufacturing Capacity Investment - High energy costs are causing some chemical manufacturers to reconsider investing in new Canadian production plants. A survey of 72 major Canadian industrial firms by the Coalition of Industrial Energy Consumers finds that many companies feel Canada's high natural gas and electricity prices may cause them to shift expansion investments to other countries. And 60 percent cite energy costs as direct causes of higher prices charged to customers. Significantly higher than average energy prices in North America are likely to stifle capital investment and cause higher prices for chemicals.

BUSINESS CHALLENGES

CRITICAL ISSUES

Demand Highly Cyclical - Demand for industrial chemicals is more volatile than in the rest of the US economy. In the latest recession, when total US industrial production was down 4 percent, production of industrial chemicals was down 13 percent. From 1990 to 2000, production was down 6 percent in alternating years.

• US production of basic chemical products plummeted 22.9 percent in October 2005 from the year-earlier period.

Sensitivity to Energy Costs - Extracting and processing basic chemicals from raw materials typically requires large amounts of energy, usually in the form of heat. Many chemicals also use natural gas or petroleum as a raw material. Since energy costs can account for more than 30 percent of manufacturing costs, even small changes in energy prices can affect profitability.

• Prices for crude oil, petroleum products, and natural gas are projected to remain high during the remainder of 2005 and through 2006 because of tight international supplies and hurricane-induced supply losses.

OTHER BUSINESS CHALLENGES

High Capital Investment Requirements - Many producers of industrial chemicals can't afford to make the large investments required to obtain newer technology, processes or equipment. Newer manufacturing processes are often more efficient at increasing yields, or producing chemicals of higher purity, or using energy and other inputs more efficiently.

Customer Concentration - Basic chemical manufacturers often sell large quantities of product to just a few customers or to customers all in the same industry. The fortunes of some chemical manufacturers are therefore closely tied to the success of their large customers or the success of an end-use industry. For example, a large percentage of soda ash produced is used to manufacture glass containers.

Low Margins - Competition in the sale of commodity products is based mainly on price. Strong competition has kept prices for many commodity chemicals low, squeezing the profit margins of producers. Low margins can keep companies from making the capital investments necessary for future profitability.

Competition from Substitute Products - Because advanced chemicals and other products can be manufactured several ways, producers of industrial chemicals compete with each other and with substitute products. This can limit producers' ability to raise prices if their own manufacturing costs rise, and can threaten the long-term viability of a business if a substitute product becomes more popular.

Access to Raw Materials - Access to a large supply of high-quality raw materials is essential for industrial chemical producers. Some companies actually own and mine the minerals or other materials they use, but most enter long-term supply contracts that specify quantities and prices. The precise terms of supply contracts can have an important effect on long-term profitability.

Environmental Regulations - Four of five wastewater treatment plants and chemical and industrial facilities in the US pollute waterways beyond what federal permits allow. The average excess is ten times what the permit calls for, according to the US Public Interest Research Group. Chemical plants say some violations are due to unintentional circumstances like storm water runoff or equipment upgrades.

TRENDS AND OPPORTUNITIES

BUSINESS TRENDS

Increased Productivity - Industrial chemical production plants have become more automated, both to cut costs and improve the yield of finished product by more precisely controlling the process. From 1990 to 2000, while US production of industrial chemicals increased 14 percent, the number of workers in the industry decreased almost 50 percent.

Prices - Prices for commodity chemicals were virtually flat during the past decade, a major reason inflation remained low. From 1991 to 2001, average prices increased just 14 percent. With prices flat, producers have had to increase the efficiency of their manufacturing operations to stay profitable.

Electricity Cogeneration - Because of the large amounts of heat needed in many chemical processes, many chemical plants operate their own steam plants, which can be fitted with turbines to produce electricity as a byproduct. The electricity can be used within the plant or sold to the local utility. Cogeneration (by all industrial plants) supplies more than 10 percent of total US electricity needs.

INDUSTRY OPPORTUNITIES

Methanol for Fuel Cells - Although production models aren't yet on the road, cars powered by fuel cells using methanol will be more energy-efficient than gasoline-powered cars, and will emit no pollutants. Methanol could be dispensed from gas stations, just like gasoline. Methanol is often made from natural gas, but can also be made from methane gas and biomass fermentation.

Gasoline Additives - Produced from grains such as corn, ethanol is a source of oxygen used to enhance the burning characteristics of gasoline. Demand for ethanol is expected to grow steadily, as it is used to replace for methyl tertiary butyl ether (MTBE), a gas additive being banned in California and other states.

Disinfectants - Deteriorating drinking water quality in many US locations, and the growing volume of waste being processed in sewage treatment plants, will expand demand for chlorine, caustic soda and other disinfectants. Basic industrial chemicals, rather than more-complicated ones, will probably be preferred as disinfectants because of low cost and lack of toxic byproducts as they're dissolved in water.

Synthetic Materials - Plastic materials and synthetic fibers are being used in more products as superior replacements for natural materials. Industrial chemicals are the base most synthetics are made from.

Oilfield Chemicals - The world market for oilfield process chemicals will grow at an average of over 6 percent annually, reaching $2.3 billion by 2007, says Business Communications Co. While drilling and production chemicals are the largest segments in dollar terms, enhanced oil recovery chemicals, although a small segment, are expected to grow 22 percent annually through 2007, as existing oil wells mature and require enhanced recovery techniques.

Rubber Processing Chemicals - Global demand for rubber processing chemicals is forecast to rise over 4 percent annually through 2006, as rubber manufacturers increase chemical use, according to Freedonia Group. The increase is due to growth in non-tire rubber product manufacturing and the continued popularity of performance and larger SUV-type tires, which require more chemicals.

INDUSTRY FORECAST

The output of US industrial inorganic, organic and other chemicals is forecast to grow at an annual compounded rate of 5.2 percent between 2005 and 2008.

Chemicals Manufacturing Growth Slows



Source: IERF, Inc.

First Research forecasts are based on INFORUM forecasts that are licensed from the Interindustry Economic Research Fund, Inc. (IERF) in College Park, MD. INFORUM's "interindustry-macro" approach to modeling the economy captures the links between industries and the aggregate economy.

QUESTIONS TO ASK

BORROWERS: CONVERSATION STARTERS

How does the company mitigate cyclical demand for chemicals?
Demand for industrial chemicals is more volatile than in the rest of the US economy.

How does the company protect itself from fluctuations in energy costs?
Extracting and processing basic chemicals from raw materials typically requires large amounts of energy, usually in the form of heat.

How does the company finance capital projects and inventories?
Many producers of industrial chemicals can't afford to make the large investments required to obtain newer technology, processes or equipment.

What opportunities do methanol fuel cells present for the company?
Although production models aren't yet on the road, cars powered by fuel cells using methanol will be more energy-efficient than gasoline-powered cars, and will emit no pollutants.

What steps is the company taking to capitalize on projected demand for ethanol? Produced from grains such as corn, ethanol is a source of oxygen used to enhance the burning characteristics of gasoline.

What opportunities does the company see in supplying basic chemicals to waste and water treatment facilities? Deteriorating drinking water quality in many US locations, and the growing volume of waste being processed in sewage treatment plants, will expand demand for chlorine, caustic soda and other disinfectants.

QUARTERLY INDUSTRY UPDATE QUESTIONS

What opportunities does the company see in the potential value of its chemical waste?

Some chemical manufacturers have managed to reduce costs and find new sources of revenue through creative internal and external uses of production waste.

How have higher energy prices impacted plant investment?

Many chemical producers faced with unforeseen energy expenses have been forced to delay or relocate capital investments.

OPERATIONS, PRODUCTS AND FACILITIES QUESTIONS

How many production facilities does the company operate? Most companies have just one plant.

How old is the plant? Many industrial chemical plants are old, 30 years or more.

What products does the company manufacture? Industrial chemical companies often have just one or two product lines.

What major raw materials does the company use? Minerals, natural gas, petroleum and plants are common materials.

Where does the company get its raw materials? Most companies have long-term supply contracts.

How important are energy costs? Energy costs are often more than 30 percent of total production costs.

What type of energy does the company use? Coal and natural gas are often used.

Have yields at the plant increased or decreased in recent years?
Yields are typically measured as finished product versus raw materials.

CUSTOMERS, MARKETING, PRICING, COMPETITION QUESTIONS

What are the major end-uses for the company's products?

Does the company have a few high-volume customers? Customer concentration is typical.

Does the company have long-term contracts with big customers?

What percentage of total production goes to big customers?

How much of total production does the company sell to wholesalers or through brokers?

How many competitors make the same product? There are often just a few competitors for each product.

Are there substitute products that the company competes against? There are often other products with similar characteristics, that can be used by customers.

Is there a dominant company in the industry that is the price leader?

REGULATION, R&D, IMPORT, AND EXPORT QUESTIONS

Does the company export or import products or raw materials? Imports and exports account for 20 percent of industry volume.

How does the company find new uses for its products? Companies often work with large customers to develop new products or uses.

How much does the company spend on R&D? R&D is used to lower production costs, support existing products and find new end-uses.

Has the company been named a responsible party for any Superfund sites? Many chemical companies are currently paying for poor past environmental practices.

Does the company have any other environmental contamination problems? Many older chemical plants have contaminated grounds.

What types of environmental controls does the company use to prevent pollution?

ORGANIZATION AND MANAGEMENT QUESTIONS

How large a work force is needed to run the plant? Chemical plants have become more automated in the past decade.

Have annual sales per employee been increasing? The industry average is about $500,000, but this varies widely, depending on the product.

How much technical knowledge does the sales force have? Many salespeople are chemists or chemical engineers.

How does the company recruit and retain workers? Chemical plant workers are often highly paid.

FINANCIAL ANALYSIS QUESTIONS

How large an inventory of raw materials does the company typically carry? To avoid production interruptions, companies may keep large inventories of raw materials.

How much does the company spend annually for maintenance and capital improvements? To be productive, chemical plants require a high level of maintenance. Capital improvements are constantly needed to keep pace with better technology.

What percentage of total manufacturing costs is fixed, variable? Chemical plants often have high fixed costs.

Has the company recently made large capital investments? A new chemical plant can easily cost more than $100 million.

How does the company finance capital projects and inventories? Because their collateral is of high value, chemical companies often use bank loans. Larger companies may issue debt securities.

If handling imports or exports, how does the company protect against currency fluctuations? Some companies use various financial hedging strategies.

How seasonal is the company's cash flow? Depending on the product, there can be wide variations from quarter to quarter.

BUSINESS AND TECHNOLOGY STRATEGY QUESTIONS

What future does the company see for its current end-use markets? Most industrial chemical companies depend highly on a few large end-use markets.

Does the company see future changes in raw materials' quality or availability? Many high-grade mineral deposits are found in only a few places.

Are technological developments changing the economics of production? Computers and sensors have allowed greater automation for many chemical processes.

Does the company focus mainly on reducing costs, increasing volume or developing new products or uses? These are three major avenues to profits for commodity products.

Does the company plan to expand into other products? Many chemical companies have found higher profits in specialty chemicals.

Is the company thinking about acquisitions?

*"The purpose of the Profiles is for sales call preparation and general business and industry analysis. Profiles provide general background information only and are not intended to furnish detailed information about the creditworthiness of any individual borrower or purchaser or to be used for making any loans, leases or extension of credit to any individual borrower or purchaser. First Research, Inc. is not an investment advisor, nor is it in the business of advising others as to the value of securities or the advisability of investing in securities, and the Profiles are not intended to be relied upon or used for investment purposes."

*First Research authorizes Gordon Brothers Asset Advisors to use the contents of First Research Industry profiles in Gordon Brothers Asset Advisors marketing materials. Industry Intelligence used with permission from First Research.  To learn more visit www.firstresearch.com or call 866-788-7389. © 2005 First Research, Inc. All Rights Reserved.