Is there a forward contract for commodity thermoplastics in your future?
Financial risk management executives at Louis Dreyfus Energy Corp. of Wilton, Conn., and Enron Corp. of Houston like to think so, and their hopes are being cautiously seconded by executives at some large resin-producing companies.
Shell Chemical Co. of Houston is investigating forward contracts for a number of petrochemical products, including thermoplastic resins, and there are indications — but neither confirmations nor denials — that Union Carbide Corp. is doing the same.
However, other firms, especially Dow Chemical Co. of Midland, Mich., are opposed to such contracts.Forward contracts and other risk-management tools are financial contracts designed to level prices for commodity materials. They have been used successfully with agricultural products for years, and in recent years they have been developed for petrochemicals.
Louis Dreyfus is developing risk-management tools for natural gas liquids and thermoplastic resins, and has launched forward contracts for polypropylene, polyethylene and polystyrene, said Tim Stuart, vice president and director of the natural gas liquids and petrochemicals business for Louis Dreyfus. Stuart spoke in a telephone interview Dec. 20 from his Wilton office.
Enron announced its plan to launch risk-management tools for thermoplastics in August, and has since initiated several contracts for PE, PP and PS, said Don Black, vice president for Enron Capital & Trade Resources. Black and Tim O'Neal, director of Capital & Trade Resources for Enron, spoke in an interview by telephone Dec. 20 from Houston.
``There is a wall in the value chain that is driving the move toward hedging contracts,'' said Donald Schober, business director for Unipol Polymers for Union Carbide, in a Dec. 13 telephone interview from the firm's Danbury, Conn., headquarters.
The ``wall'' Schober spoke of has been built by retailers such as Wal-Mart Stores Inc. and Target Stores, whose pricing policies often require suppliers to guarantee prices for commodity products for lengthy periods of time. Such requirements play havoc with suppliers of consumer products that use large amounts of thermoplastic resins, especially when prices for those resins can vary from 10-60 percent over the course of a year or two.
``Wal-Mart and Sam's Clubs have changed the value chain down to the wellhead [from petrochemicals to monomer and polymer production to processing, production and distribution of products]. The only way for a supplier to supply Wal-Mart and Sam's is to be more efficient and smarter. This has been a fundamental change,'' Schober said.
Part of being ``smarter and better,'' may be to use risk-management contracts for pricing, Schober said.
However, after raising such contracts as a possibility, Schober stopped short of saying whether Union Carbide was considering such contracts or, even, if his firm endorses the use of them. He declined to discuss them further.
Enron's Don Black said he believes companies such as Union Carbide and Shell are going through a soul-searching process, considering whether they could and should offer risk-management contracts to customers.
He welcomes the attention to the financial tools because it is a big business that would withstand increased competition. Besides, the entrance of such large, established resin producers would enhance Enron's and Dreyfus' legitimacy in the business.
David Naugle, a Shell executive based in Houston who has investigated forward contracts, could not be reached for comment.
Len Azzaro, commercial director for PE for Dow Chemical, said his company is aware of forward contracts but it is not interested in them nor is it considering offering such contracts.
``Some big buyers may be interested in these, but my time in the business has shown me there is a lot of uncertainty in the ethylene-polyethylene chain.
``There are too many unpredictable events — a plant blows up, a war breaks out in Iraq, a heavy snowfall happens when you don't expect it — that affect this industry,'' Azzaro said.
``Then, there are different grades of polyethylene. This is not a single, homogeneous commodity, like gasoline or corn, and it's not easy to put a single price on it,'' Azzaro said in a Dec. 23 telephone interview.
Jeffrey Taylor, manager for PE sales for Chevron Chemical Co. of Houston, agreed that putting forward contracts on polymers is a difficult and expensive task.
``There is not that much profit in this business, and to lock in a price you have to be willing to pay for it,'' Taylor said.
He acknowledged some of his customers are willing to pay for such a lock on prices.
``But we're asking them: Are you willing to share the risks?'' he said, adding that Chevron is working to develop more complex contracts for the few customers who answer yes.
Black and Stuart said they believe pricing for volume thermoplastics is moving toward being indexed or, at the very least, managed better.
``The chemical industry does not do a good job of managing price volatility,'' Stuart said.
``The best way to manage the large production capacities in the industry is to sell products at long terms, and at variable costs.
``This market may not evolve as other commodity markets have, because there is molecular diversity in petrochemicals, especially in polymers. However, with cost structures that are different and changing with new technologies, better ways of managing price volatility are emerging.
``The fact that prices for thermoplastics are volatile is a reason to use risk-management tools, as a way to compete,'' Stuart said.
While he and Black said they do not believe financial risk-management tools can be used in every segment of the plastics industry, Stuart said he believes as many as 10 percent of the companies that buy thermoplastic resins could see significant economic gains by using the tools.
Based on statistics from the Society of the Plastics Industry Inc. for 1994, the last year for which statistics are available, 10 percent of the plastics industry would represent firms with sales of more than $12.8 billion.