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.
