Dow Chemicals' Wake Up Call

Implications: Dow seeks to lead the industry to try to recover the increase in energy costs.  An across the board increase makes sense if energy costs have equal effect on manufacturing costs.  The move certainly gives them another opportunity to raise the awareness of energy prices on chemical producers.

Analysis: Dow has proposed an across the board, 20% price increase for all of its products, worldwide.  The reasoning is the substantial hike in energy prices.  While chemical processes do use significant amounts of energy, more importantly, energy costs directly affect feedstock prices.

What would this mean in real terms?  Well, polyethylene would increase 15 cents per pound, propylene would be up 14 cents per pound, benzene would would be up another $1 per gallon.  Just for perspective, polyethylene prices have risen about 6 cents in all of 2008, after falling by 2 cents per pound throughout the first quarter.  Molders have demonstrated some pricing power, but can a flagging economy really swallow this?  We'll see.

Dow has led a very vocal effort to make lawmakers aware of the impact of high energy prices on chemical producers.  In past times, Dow was more unique in the US in that they were not an energy producer as well as a chemical producer.  Others like ExxonMobil, Shell and BP, for example, benefited from high energy prices, which soften the high cost of feedstocks to the chemical units.  Now, with more chemical producers independent, like Ineos and LyondellBasell, Dow's campaign may have more footing.

Just how do oil and gas prices affect margins?  The relationship between base energy prices and the main petrochemical -- ethylene -- are complicated.  However, my sensitivity analysis indicate that, at current energy prices, a 10% change in oil prices results in about a 4-4.5 cent per pound change in ethylene margins (in the opposite direction, of course).  A similar 10% change in natural gas prices shifts ethylene margins by 2.5 cents per pound.

Currently, again according to my analysis, an average, integrated polyethylene producer makes about 15 cents per pound EBIT, from buying feedstocks to selling HDPE.  Returns (ROI) are satisfactory, but not impressive.

It will be interesting to watch the market reaction as Dow pushes the chemical industry problems through the rest of the economy.  They have been tapping Washington on the shoulder for years.  If the rest of the economy starts tapping with them, maybe someone will turn around.