Proactive approach with resin can increase profits

Since resins comprise roughly 45 percent of processors' operating costs, resin prices determine to a large extent how profitable and competitive processors are.

It follows that the more control processors have over future resin costs, the more profitable and competitive they will be. Controlling future resin costs means utilizing forward (future month) resin markets and capitalizing on the opportunities they provide.

Processors can manage forward resin prices, and this article provides recommendations based on cost and risk management effectiveness.

Most processors have floating resin costs against fixed price products. So profit margins depend on what resin prices do. This is a speculative, hope-for-the-best approach to profit margins.

Resin purchase prices are spot or index-related. So resin costs float with the market and are often volatile.

Product prices are fixed. However — if customers agree — some processors attach resin-price escalators to product prices. Price escalators protect the processor from higher resin costs, but leave customers at risk. In a competitive environment and for large customers (e.g. big box retailers, automobile manufacturers) resin price escalators are a thing of the past.

Even for processors with resin price escalators attached to product prices, however, profit margins are volatile and unreliable. For processors without resin price escalators attached to product prices, profit margins are even more volatile and at-risk.

For all processors, competitive pressure and customer push-back make resin price escalators less and less feasible, particularly for large, credit-worthy customers. To defend against volatile resin costs, processors may change operations, product composition, and even cut back on personnel, but there's a practical limit to cost-cutting and it doesn't solve the problem. The solution is to go on offense against volatile resin prices, controlling forward resin costs in order to secure and, as will be shown, increase profit margins and sales.

There are two preliminary steps to controlling forward resin prices. First, specify objectives: Establish target profit margins for existing and new business. Understand customer needs for product prices.

Second, put it in writing: Identify, prioritize and approve the means and strategies to achieve the objectives. Assign responsibilities to execute forward transactions and track results. Ensure understanding and buy-in of owners and key decision-makers through signature approvals of a written, straightforward Policy.

Controlling forward resin prices

There are several ways to control forward resin prices. The first involves physical forward transactions with resin suppliers, in the form fixed-price resin purchases or purchases of price spreads to more liquid market alternatives like ethylene, propylene, natural gas liquids or crude oil. Finally processors can convert existing supply contracts to less volatile PetroChemWire calendar-average pricing.

Next, there are financial transactions: Purchasing resin futures, or futures in more liquid market alternative like olefins, natural gas liquids and crude oil; or swaps (index-settled direct transactions with counter-parties).

PetroChemWire prices are used by the Chicago Mercantile Exchange to settle resin and olefin futures. Analyses show historical PCW prices are highly correlated with spot prices and other resin price indexes. So resin futures are an effective forward-pricing tool for processors.

A futures account enables execution of forward resin purchases — anonymously or directly, without credit risk — with a financial counter-party. Futures transactions are CME-cleared. This avoids the cumbersome and intrusive process of establishing swap agreements with financial suppliers.

What customers?

Which customers should processors have in mind for using forward pricing tools? High volume, reliable and credit-worthy customers, including retail product producers, big-box retailers, auto manufacturers and medical device manufacturers interested in fixed price products three or more months ahead at or below their budget levels and without price escalators. These are existing or new customers.

As is usually the case for energy and other commodities, the forward curves (future monthly prices) for resin and olefin futures are declining. The most dramatic decline is in ethylene, the building block for high and low density polyethylene. Declining resin prices mean, if processors purchase forward resins against current product prices, their profit margins will automatically increase. If processors purchase price spreads to propylene and ethylene at current market, shifting their price risk to olefins — and then purchase forward olefins — their profit margins will increase even more.

Purchasing resins at declining forward prices creates opportunities to increase margins, but also to increase sales. Processors need not attach price escalators to sales contracts with existing or new customers since processors may lock in forward resin prices against forward sales. Thus, processors provide forward price certainty to existing and new customers at current product prices or lower — giving those processors a competitive advantage while capturing higher margins.

This proactive approach is new for many processors, but it is standard in other commodity-based businesses. It's also smart business, and processors who adopt the approach will secure and increase their margins and sales, while competitors still react to volatile resin prices.

Tom Langan is a margin risk management consultant dba WTL Trading. Contact him at [email protected]