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According to McKinsey, the chemical industry rests on a volatile foundation: the price and supply of oil. The oil price declines that began in 2014 found many chemical producers unprepared for the speed of the coming changes.

Drivers of oil price volatility

Oil prices have grown more complex as new supplies from U.S. light tight oil (LTO) drilling and new sources such as Brazil, parts of Africa, and other regions have opened up. At the same time, global economic growth has slowed, OPEC did not curtail production to keep prices stable as it has in the past, and energy use overall declined due to increased efficiency and green initiatives.

Impact on chemicals

LTO drilling production tends to have short life cycles – coming online quickly and falling off within a year to less than half of peak output. Producers tend to gravitate to LTO as a group, ramping up as oil prices start to rise rather than keeping output steady despite price volatility. Socioeconomic and political volatility in other regions tends to affect output. Taken together, these factors create supply and demand shocks that affect costs and margins in the chemical industry.

Crude oil and petrochemicals are coupled, given that oil is the basis of many commodity chemicals and others require oil for their production processes. Changes in the price of crude oil immediately impact the cost of basic building-block chemicals such as ethylene, propylene, naphtha, and LPG.

Commodity chemical prices are driven by the production costs of the marginal producer. Oil price shocks affect the cost structure of marginal producers, and the ramifications continue to downstream chemical producers who are forced to pay more for feedstocks or find alternatives.

Consumers also play a role as oil prices affect disposable income. This changes behavior at the gas pump and the thermostat, but also has profound effects on industries as diverse as housing, construction, and automotive. While demand shifts are more gradual than the abrupt shocks experienced in the early stages of the value stream, their effect is real albeit gradual.

Cost and price patterns

For chemical producers with prices and costs linked to the same commodity, oil shocks have minimal impact. However, agile producers who have undertaken a process of digital transformation may find that their ability to react quickly allows them to realize source savings faster than their prices decline.

Some manufacturers have an advantage based on regional conditions during price shocks. For example, North American companies used their access to low-cost shale gas ethylene to keep margins relatively high by avoiding high-cost Asian naphtha. However, as Asian naphtha prices have fallen recently, shale-based gas prices have not kept pace, resulting in margin pressure for these companies. Specialty chemical companies often fall into this category, benefiting from low oil prices but feeling the pressure on margins as they rise.

Other chemical manufacturing companies feel minimal price or cost impact from oil shocks. Specialized lubricants, additives, and chemicals whose value stems from their usage rather than the composition fall into this category.

Building the process and IT foundation

Chemical companies must transform their business process and IT landscape to respond to these volatility issues with the necessary agility and speed. Capabilities like real-time price and margin management at the lowest levels of granularity, multi-channel management with a single brand experience across all channels, extended partner collaboration, automated role-based workflows, and enhanced sales and operations planning processes all need to play hand-in-hand and allow predictive simulations to proactively serve customer and market needs at the best possible margins.

Start your journey now. Understand more about the value digital transformation brings to your company and establish the right platform and roadmap for transition.

Blog originally posted on Digitalist

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