PERSPECTIVE: SHALE GAS’S IMPACT ON U.S. CHEMICAL INDUSTRY

I believe that the Shale Revolution presents a once-in-a-lifetime opportunity unique to the United States that will have a profound impact on the chemicals industry.  Nearly 100 projects announced as of Q1-2013, $72 billion in potential chemical industry capital investments, $67 billion in additional output by 2020 (with new & permanent federal, state, and local tax revenue of $14 billion from increased chemical industry output by 2020, according to ACC)!

The Shale Revolution will create 17,000 new high-paying and knowledge-intensive positions in the chemical industry, will result in a $32.8 billion increase in United States chemical production, will cause $16.2 billion in capital investments to build new petrochemical and derivatives capacity, and will lead to $132.4 billion in United States economic output related to increased chemical production and capital investment.  The Energy Information Administration estimates that shale gas production will grow 113% from 2011 to 2040 and that its share of United States natural gas production will grow from 34% to 50%.  The primary end market consumers during this period will be the electric power generation end market and the industrial end market. 

The shale gas benefit to some of the specific chemical manufacturing industries is most pronounced to the following: resins and synthetic material manufacturing grew by 1.7% in 2012, but is projected to grow by 8.1% in 2025, basic organic chemical manufacturing grew by 1.5% in 2012, but is expected to grow by 9.5% by 2025, agricultural chemical manufacturing grew by 1.2% in 2012, but is expected to grow by 7.7% by 2025, and plastics and rubber products manufacturing grew by 1.5% in 2012, but is expected to grow by 4.6% by 2025.

Due to the shale gas boom, in which the ACC expects a 25% increase in ethane supply, 99% of which is used for ethylene purposes and 82% of ethylene is used for plastic resins, the United States will be the lowest-cost ethylene producer.  As such, the ACC anticipates the additional chemical industry output generated by this 25% increase will result in an additional $18.3 billion from bulk petrochemicals and organic intermediates, $13.1 billion in plastics resins, $1.0 billion in synthetic rubber, $0.3 billion in man-made fibers, and $0.2 billion in carbon black.  These outputs are expected to require a new capital investment of $16.2 billion in the forms of debottlenecking, brownfield projects, and greenfield projects.  As a result, there is the potential for a raw material cost advantage of up to 60% for products in the ethane-ethylene value chain.

In addition to the shale gas impact on ethanol supply, production of ammonia will become more domesticized as well, leading to large growth possibilities in the agricultural chemical manufacturing industry.  Further, the increased shale production has led to increased United States capacity for methanol, which could lead to a significant opportunity because presently accounts for half of the world’s consumption.  Hundreds of chemicals are also used in the fracking process, where roughly 2.5 million gallons of water and 1.5 million pounds of sand represent 99.5% of the fracking mixtures, and the remaining 0.5% of the mixtures is made up of chemicals.  Projects directly synthesizing heavier derivatives will also benefit from increased shale gas because they are experiencing greater returns due to being in shorter supply because of cracker conversions to ethane.

The input cost advantage in North America that is being led by an increasing abundance of nat gas and helping both organic chemical producers through NGLs as well as the inorganics through lower energy costs (Middle East being the one exception), the North American chemicals landscape looks to be the most promising world-wide for years to come, justifying the heavy domestic investment that the industry is set to see.  Key questions would remain in our ability to manage typical risks for a complex industry, such as environmental, regulatory, specialized credits and equity investment approach, proper tax treatments, infrastructure and access to realize the Shale gas driven potentials. What are your thoughts?

Chemical Industry Merger and Acquisition (M&A) Activity Gaining Momentum

In the first half of 2010, there has been a noticeable pickup in the level of M&A activity in the core chemicals industry. In fact, in the first half of 2010, there were more deals than there were in all of 2009; to date, there have been 23 closed deals in 2010 whereas 2009 saw only 20 deals for the whole year (and only 7 for the first half). In terms of actual value, the 23 deals in 2010 represent $29 billion whereas 2009 saw $25 billion in deals for the whole year. Median valuations multiples (i.e. EV/EBITDA multiple) are on the rise for deals within the industry this year, that is significantly higher than the 2009, 2008; however, actual transaction value remains lower than 2007. It seems that sellers are more focused in achieving their strategic objectives and buyer are more focused on the value (instead of multiples or price)....Everyone wins!!

Semiconductor industry (early in the supply chain) seems to experience a further gain along with the global manufacturing and chemical sectors’ continued advancement (at a slower pace). Housing and job growth was disappointing and employment recovery may take a very long time. On the other hand, inventory rebuilding of manufactured product is moving into a moderate growth phase. All of these data coincide with the major upswing in reported second quarter revenues and profits across the industry.

Not only has there been an increase in the number of deals, but they have been more focused towards smaller-scale transactions as opposed to large, transformative deals. This can be attributed to several factors, among which include the European Union’s Reach legislation, an expected increase in the US capital gains tax, as well as banks’ predilection to favor smaller deals that focus on add-on acquisitions as opposed to massive transformations. Furthermore, a good deal of M&A activity has been conducted by financial buyers as opposed to major industry players; in the first quarter of 2010, financial buyers accounted for only 6% of the M&A dollar value, which has since risen to 48% in the second quarter.

So, what does all this information mean for the industry as a whole and how can investors capitalize on these conditions? In terms of the chemicals industry, these figures convey a strong underlying value and demonstrate the beginnings of a vibrant recovery for the industry. Furthermore, in terms of capitalizing on investments, the data indicates that the market is leaning towards smaller, operational value-adding deals for numerous reasons, and it is an ideal time for investors to take advantage of this new, and probably lasting, development in a recovering market.

1H-2010 M&A Update Slide Link: http://www.slideshare.net/ennovance