North American polyethylene makers don't agree on many things, but recently they've found harmony on one topic: price protection.
And the consensus is that the sooner the PE industry rids itself of price protection, the better off the industry will be.
Loosely defined, price protection is the amount of time a customer is given from the announced date of a price increase until the customer actually is expected to pay. The practice typically stretches anywhere from 30-90 days and is in effect for PE and most other commodity plastics. In some cases, price protection is written into contracts, while in others, it's solely a verbal or handshake agreement between resin supplier and customer.
But the practice has become a thorn in the side of PE makers as they've been unable to pass on volatile moves in the price of natural gas feedstocks to their customers in a timely manner. Profit margins have eroded, prompting most PE makers - led by Nova Chemicals Corp. of Pittsburgh -to announce unprecedented energy surcharges in late February. The 6 cent move on PE - and 4 cents on polystyrene - was designed to recapture margin lost via natural gas run-ups.
The surcharge was largely successful - and its success may eventually alter the playing field between resin makers and buyers.
``What had been a way to buffer our customers from [natural gas] costs has become a financial nightmare for Nova and our customers,'' Nova President and Chief Executive Officer Jeff Lipton said when discussing price protection at Chemical Market Associates Inc.'s World Petrochemical Conference, March 26-27 in Houston.
``We can't be big brothers to our customers anymore,'' Lipton said. ``We allowed customers to buy on consignment and take their time to pay and we gave them advance warning of price increases. We rationalized that they were small and had difficulty passing on the increases.''
Pricing protection at Nova had evolved to the point where Lipton estimated that 60 percent of the firm's resin volume now is sold under 90 days price protection. Another 30 percent of Nova's volume is sold under 60 days, with the remaining 10 percent receiving 30 days.
``Buying feedstock on a daily basis and pricing polymers on a quarterly basis doesn't work in today's environment,'' said Bob Beil, vice president of PE for Dow Chemical Co. of Midland, Mich. ``Immediate price relief was mandatory.''
Beil further described price protection as ``an antiquated practice that's unique to North America.''
Even executives at Atofina Petrochemicals Inc. of Houston - one of the few PE makers that didn't announce a surcharge -agreed that price protection needs to be reduced or eliminated.
``Polyethylene started as a specialty market, but certain practices like price protection crept in as more companies entered the market,'' said Atofina PE Vice President Kevin Boyle. ``We saw the rise of large customers and we began to treat polyethylene like a commodity. We whittled away at prices and volume, but we still gave price protection.''
But Boyle added that he wasn't sure a surcharge was the answer to the price protection problem, saying it seemed like ``a short-term response to changing a long-term practice.''
Many PE makers are now retracting the surcharge after having it in effect for the month of March. A surcharge formula released by Equistar Chemicals LP of Houston links the surcharge to an ethane feedstock level that equates roughly to a $6 per million Btu level for natural gas.
Unit prices for natural gas were around $5 March 31, far below the $9 levels they hit in late February. But Dow's Beil pointed out that even if natural gas normalizes around $4, that would be 1.5 times higher than its historic average.
``It looks like $4-$5 natural gas is what North American buyers should plan on in the short-term,'' Beil said. ``And if natural gas normalizes at a historically high level, polymer prices will have to adjust accordingly.''
Nova's Lipton took things a step further, suggesting the plastics and chemical industry take a cue from the 1976 movie Network, in which actor Peter Finch said to his fellow employees at a corrupt TV network, ``I'm mad as hell and I'm not going to take it anymore!''
``That's what the chemical industry has to do: Pound the table and shout out loud,'' Lipton said. ``We can't continue to subsidize and buffer our customers.
``We must deliver a reasonable return to our shareholders or be out of business,'' he added. ``Reasonable customers should understand this.''
Pat Duke, a consultant with Houston-based DeWitt & Co., said the successful surcharge was a means for resin makers to test the waters on pricing.
``Resin makers now have learned that they can implement [a surcharge] and get around a cost spike,'' Duke said at his firm's World Petrochemical Review, March 26-27 in Houston. ``I think they'll put that in their pocket and write it into new contracts.
``There will be a very strong effort to rein [price protection] in to 30 days maximum,'' Duke added.
Although North America's current PE supply/demand balance isn't very tight and normally would not support price increases, Lipton said the industry ``needs to stand up and make these price increases happen.''
``It's a matter of preservation at this point,'' he said. ``The financial implications of what we're doing should be clear to everybody.''