When will materials prices stop rising?

KANSAS CITY, Mo. - With its decision yesterday to increase prices for its gel coat, unsaturated polyester resin and vinyl ester products by $0.04 per pound for both the gel coat and unsaturated polyester resins, and $0.15 per pound on Vinyl ester and vinyl ester blended resins (effective April 18), Cook Composites and Polymers became the latest marine materials manufacturer this year to raise its prices.

Price increase announcements have been coming at a fairly steady clip from materials manufacturers for many months now. With that in mind, Boating Industry wanted to give readers the opportunity to learn more about the factors contributing to those increases by sharing the transcripts of interviews conducted last fall with a few of the companies involved.

Boating Industry interviewed several marine industry materials manufacturers to ask them what is causing the price increases and when, or if, they expect those increases to end.

The first transcript is of an interview with Emilio Oramas, the business manager for AOC, a supplier of resins, gelcoats and other additives to the marine industry.

The second is an interview with marine resins supplier and manufacturer Reichhold. Those being interviewed are:
Bill Schramm, North American director of business management.
Donna Massari, vice president, supply chain.
Phil Bridges, open molding business manager.

AOC Interview

Boating Industry - What has been driving the steady rise of materials prices the industry has been experiencing?

Oramas - All of the major raw materials that we use are derived from either crude oil or natural gas, so in essence, oil and natural gas are the feedstocks for petrochemicals.

In the case of natural gas, the price of natural gas in October 2001 was below per million (British Thermal Units.) When you look at August of 2004, the price of natural gas is above $6 per million BTU.

In the case of oil, when you go back to October or November of 2001 oil was below $20 per barrel, and you saw that [in the fall of 2004] it got as high as $49 per barrel.

There are geopolitical and global economic factors affecting crude oil. In the case of natural gas there are specific issues pertaining to the U.S. economy and the U.S. market.

Our natural gas prices are one of the highest in the world. And the reason for that is that we have a lot more industry and also electricity generation that has switched to natural gas over the last several years because of emission and pollution factors creating an accelerated demand for natural gas. And although we have vast reserves, we don't have the transmission lines that will allow us to move the natural gas to market.

Boating Industry - Are the shortages a problem of supply or demand?

Oramas - Well I will tell you, the trends are the following:

You have the fundamentals that are affecting oil and natural gas. People will say, well the price of oil was up but it has come back down. But the problem is, you have millions of barrels of oil all ready in the pipeline at those prices. So those prices need to work their way through.

The reality is when you go back and look at crude oil prices, trading in the range of just above $20 per barrel in 2001, that you've more than doubled the price of oil in the last four years. There are fundamentals that are still going to be there. I have not talked to anybody who says oil will get down to those levels again. Not for the foreseeable future. We've heard of very well known traders in the commodities market buying oil futures at $45 a barrel.

(Editor's Note: A March 31 story from the Associated Press quotes analysts who have predicted that oil prices could top $100 a barrel.)

On the natural gas side, some of the problems are fundamental problems. If you were to have all of the permits and all the capital to build a new pipeline today to transmit the natural gas you're going to be exploiting, it's still going to be a good 8 years before that pipeline is operational. So there are fundamental issues in energy policy that need to be addressed at the government level.

The second major trend is what has happened in the polyester resin raw materials market. As long as demand continues to be stronger than supply, because economies comeback, because markets comeback, because products run short, or suppliers have maintenance problems, there's going to continue to be pressure on these polyester resin ingredients.

The last major trend that is important is what is happening to the markets that use polyester resins.

In the case of the marine industry, you know how the marine industry has successfully rebounded this year, but when you look across the board, polyester resin consumption is up from last year. We have seen a spike in polyester resin consumption across all major markets or categories. What happens is increased demand for polyester resin at a time when you have limited availability, or allocated availability, of some of the ingredients and all-time high prices for those ingredients, and all-time high prices for the precursors to those ingredients.

So you have a convergence of many factors that are affecting the situation.

Boating Industry - Are suppliers moving to correct the situation?

Oramas -In the case of AOC, we have been very wise in how we have structured our purchases over the years, where we have not been affected by shortages like in the case of maleic anhydride, like some of our competitors have. Some people are getting by, some people are having difficulty with the ingredients, other people have positioned themselves well and are fortunate they have not had the difficulties some have.

It's hard to speak for the industry in general, but I know that from data which is shared with us by the American Composite Manufacturers Association, we know through market-growth data that ACMA collects that the polyester resin business is up this year.

It's a little bit of every man on his own trying to make the best of a difficult situation. Some people are positioned better than others. We've done OK.

We have implemented increases in the marketplace since the beginning of the year that total in the neighborhood of $0.34 or $0.35 per pound on resin prices.

Boating Industry - How big of a problem is this for the industry, is this something you're up nights losing sleep over?

Oramas - These are extraordinary times. I've been in the business 20 years, and I've had to talk to people who were in the business in the 70's, when they saw the oil embargo, for them to equate these times to those times back then.

Where we struggle the most is in the customer base recognizing, the magnitude, immediacy and rapidity of the increases that we have been hit with.

Customers think that the polyester resin industry is getting rich, when in reality we convert all these petrochemicals and we make a resin or a product that is somewhat specialized. In reality all you try to do is pass along these increases as quickly as you can.

We've had very difficult months as an industry where we have not been able to keep up at all with the increases that have been passed on to us. Increasing the level of awareness and having a higher level of sensitivity on the part of the costumer that these things need to be passed along to them and they in turn need to pass these along is something that is really paramount.

If anything we lose sleep over that, making sure we're being fair, that all we're trying to do as an industry is pass these costs along so in the long term we can continue to invest in this business and be a reliable supplier for them in the future.

Reichhold Interview

Boating Industry - What's behind the price increases that have been going on?

Schramm - I think it probably goes to the source, which is raw materials. We talk about raw materials, and it's become even more critical because we, as resin suppliers, have tried to absorb a lot those costs.

That is why you have seen, if you track the announcements that are put out, more recently they are almost every single month. That is not an indication of the way the raw materials have been going, because they've been increasing since January of this year, actually in January is when they started kicking up. We tried to absorb some of those but we've just reached the point where we can no longer can do that and the raw material costs have just accelerated.

Massari - In most of our major commodities in raw materials we are seeing unprecedented high levels, particularly in pricing and there are many factors that are contributing to them,

I call it 'the perfect storm.' You've seen record, historic highs of crude oil and natural gas on a global basis. The basic energy feedstocks that feed into energy to run our plants but also into the materials, and we've seen that all year long in the major products.

Our producers who produce the raw materials for us have seen that and tried to absorb some of those costs, but they are running on lower inventories because they can't continue to maintain higher levels of inventory of a very high-cost product. Crude oil right now is running above $40 a barrel and nobody every predicted that. People are asking “How high will it go?” because we've never seen those high levels in this industry, or at least for many, many years.

Also the U.S., at least with the manufacturing sector has higher natural gas costs than other regions of the world. And that's a disadvantage for U.S. industry.

We're seeing $5 and $6 a dekatherm (a unit of heating value equivalent to 10 therms or 1,000,000 BTUs), where historically it's been $1.50 to $2.00 to $2.50 a dekatherm. Whereas most of the regions of the world, like Saudi Arabia and Asia, have very different dynamics and we have to compete with those in the U.S. industry.

It's a combination of both increased demand and decreased supply. There's very strong demand out there.

Our producers are running at higher rates, we're running at higher rates, and supply does get limited. When you run at capacity and when you have supply disruptions, even small ones, when we look at some of our global commodities that will cause an imbalance very quickly in the marketplace.

In raw materials that will cause prices to go up, It's a domino effect and we've just been seeing that all year. These producers have been running hard. In the past couple of years that haven't been able to turnaround and put in the capital reinvestments in that they've wanted to and they've got to do that now. With a better economy and the increased demand you run into very tight situations. So it's the combination of increased demand from the economy and, I don't want to say decreased supply, but trying to keep things balanced.

Boating Industry - Is this the worst you've ever seen it?

Massari - Yes it is. I've pulled 20 years of historical data and I can't match what we are seeing today. Some of our major commodities are at historic highs for pricing. We just have not seen this before and we've got to deal with this.

Schramm - I just might add, unfortunately giving away a little bit of my age, but if we go back into the 1970s, '73 or '74, we saw much the same situation.

Boating Industry - How did it turn around then?

Schramm - Again, it was the supply issue. I was in Houston and I can remember seeing on the news that they couldn't bring crude in for processing. The reality was though that the newscasters got in helicopters and there were all these tankers lined up out in the gulf, they just weren't bringing them in. So there was a shortage driven by some other factors.

Bridges - One thing people have pointed out, when we're talking about this internally, is a lack of refining capacity too. It's not just the product, but being able to make it. You can get the crude, but there haven't been any new refineries built in the U.S. in 25 years. It's not just an issue of getting the crude oil to our shores, then you have to do something with it. Or you've got to buy it elsewhere, and then it's going to cost more because of that.

Boating Industry - So this is a problem that has been in the making for a while then?

Massari - Yes. This has been continuing. And probably where we didn't see it as much, but it was still out there, was in 2000, 2001. But we had a depressed economy, so we didn't see the demand. But they still weren't building refining capacity. The infrastructure hasn't been built for a long while.

Schramm - And what is inherent to that, is that if demand is down and pricing and profitability is down, who wants to reinvest? That has a ripple effect all the way through the entire system, and then all of a sudden you throw rapid growth into that, there hasn't been that reinvestment, and you're short on capacity, you're short on a lot of things.

Massari - From the purchasing side, most producers major are working hard to get back to reinvestment economics, running their businesses differently to produce the right profits so they can invest. They've become a whole lot more disciplined in the last couple of years to get back to reinvestment economics.

Boating Industry - You mentioned December (2003) as when prices really started going up noticeably, is that correct?

Massari - It was probably fourth quarter, we really saw it become strong in November or December of last year. But that fourth quarter time frame is when things really started moving upwards. Typically in December we see prices go down because of year-end dynamics and we weren't seeing that, and it continued through the early part of this year and just really hasn't stopped.

Boating Industry - Was there some sort of trigger for that?

Massari - There was probably another overriding factor that we haven't touched on yet. In most of our major markets that I track on the raw materials, Asia has had a very strong influence in just buying. They're still growing by double digits in China and Japan to some extent, in their buying patterns. And through last year we saw some very unique buying patterns, and some of the major commodities, where typically that volume would be used in the U.S. was being exported in certain materials. The takeaway is that Asia has rebounded in its buying patterns. They've changed and increased so that also contributes.

Schramm - On the flip side of that, what you had was the demand for resin that goes into marine structures going up through March of this year, compared to last year, was a 28-percent increase. Demand was up significantly.

Bridges - We get the resin numbers from the American Composites Manufacturers Association, and we just got the first-quarter numbers and overall it was 11 percent for resin and 28 percent for the entire marine segment, so it's huge. If you remember back to the third quarter numbers, the GDP had increased at 8.2 percent for the third quarter of last year, so that was huge, and you could see at that point where it was ramping up. It should have been slowing down at the end of the year, and it really wasn't. It was cranking.

Boating Industry - Are things just going to keep getting worse?

Massari - On the raw material side a lot of our raw materials are on allocation right now, and that just tells you that things continue to be tight. We're not foreseeing a lot of relief through year-end. We hope, and you want to believe it, but with the allocations on some of these major commodities, were not anticipating relief.

We'll get relief if demand goes down. We continue to see tight markets on the raw materials. If you ask me about next year, we're forecasting much higher numbers than what we thought would happen this year, based on the tighter demand. I think were in some very different dynamics today.

Boating Industry - Would there be a magic bullet that could cure the situation, OPEC producing more oil?

Massari - Well I think you hit right in on it, right now there is so much vulnerability if you look at the crude oil, with what OPEC does.

When OPEC makes a decision to increase output by a certain amount, that immediately sends different pricing decisions throughout the global marketplace. So there is a strong influence there. If I had my way, it would be a welcome relief if we could change some of the dynamics on crude oil. Whether it be OPEC, or Venezuela, or refinery capacity in the U.S., or a combination all thereof. That is a strong influence today in the dynamics of our raw materials. It is not, however, the only influence. We do have supply/demand issues with the derivative products that come off of crude oil that also will affect things.

Schramm - I think it is a perfect storm, because it's all of those things. And just pulling one item out of that equation doesn't really change it. It's a confluence of factors.

Boating Industry - What's the level of concern at the company?

Bridges - It's something where the entire industry is effected, it's not just Reichhold. It's all suppliers and everyone is getting hit with this all at the same time. The good thing for our industry right now is that the demand is up. But as you see, part of that demand causes other problems, so it's something we have to deal with on a daily basis, and we'll continue to have to deal with it for the foreseeable future.

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