The ICRA analysis reveals the key factors that have cumulatively affected the outlook of the domestic petrochemical and chemical sector
ICRA has observed a distinct weakening of credit quality across the various sub-segments of the Indian petrochemical and chemical sector over the past 6 months, one that has translated into a number of rating downgrades. The Indian phenomenon mirrors the trends seen in the global markets that have of late been witness to some bankruptcies and a significant decline in profitability.
With the Indian import duties for most chemicals declining steadily over the past decade and given that these chemicals can be transported with relative ease across continents, the domestic petrochemical and chemical industry has been pricing its products largely on import parity pricing (IPP) basis. Thus, even in the absence of physical imports of a particular commodity chemical, its domestic pricing is largely governed by the global demand and supply dynamics.
Given this background, it is not surprising that the domestic petrochemical and chemical industry will be experiencing a rough patch at a time when the recessionary trends continue to afflict the global economy, particularly the automotive, construction and retail sectors, which are some of the largest consumers of commodity chemicals and polymers.
The global trend apart, there have been several other factors that have contributed to the weakening of the profitability of domestic petrochemical and chemical producers.
After a cyclical downturn during 1998-2002, the Indian petrochemical and chemical producers enjoyed an extended period of cyclical upturn in prices from 2003-07 with the global demand for most chemicals rising steadily and delays in commissioning of new projects preventing significant capacity additions. This had led to the operating rates of plants remaining quite high. However, the operating environment began to change in 2008 as crude oil prices spiralled up, especially after they went past the $100 per barrel (/bbl) mark.
In a rising oil price environment, the prices of most petrochemical feedstock began to rise as well, especially in the second quarter (Q2) of 2008-09, but with the producers unable to pass on the increased price to end consumers, the tolling margins tumbled down.
The situation worsened in the Q3 of 2008-09, when oil prices fell precipitously, pulling down the prices of finished products and feedstock further, in varying proportions.
The price corrections were in the band of 50-70% from the respective peaks for different products across the petrochemicals value chain. It has been observed across cycles, both in India and overseas, that when petrochemical prices move in a steady direction either upward or downward, consumers tend to postpone their purchase decisions, preferring to draw down from their inventory holdings, which in a way further amplifies the cyclical downturn.
Following the sharp price fall in raw materials and finished products, the domestic producers of petrochemicals and chemicals suffered inventory losses on mark-to-market (MTM) basis, especially in the quarter ended December 2008.
With the fall being both sharp and rapid, most producers and traders could not lower their inventory holdings and thereby suffered huge losses. Inventory losses have had a major impact on the profitability of petrochemical traders, who, even under normal circumstances, have to put up with low trading margins.
While the recent price recovery in most petrochemicals and chemicals sectors is a comfort factor from the rating perspective, significant oversupply is also expected in the medium term.
A report by ICRA Limited |
