VOLUME 1, ISSUE 2 May 2014

The interplay of geopolitics, supply and demand have reduced pricing volatility

and led to a temporary balance in global crude markets in recent years.

The price of crude oil exerts an out-sized effect on the cost of raw materials used in adhesives, sealants and surface treatment products for general industry. That’s because many of the raw materi-als are derived from crude oil. The price of crude oil also sets transportation costs for the movement of raw materials and finished products around the globe.

While deciphering raw materials price movements goes far beyond simply tracking global crude price trends, under-standing those trends can help to better put raw materials cost gyrations into context. There are three interrelated driv-ers of crude oil prices: geopolitics, supply and demand. Speculation by traders who bet on the impact of these drivers tends to further amplify price movements.

GeopoliticsUnrest in oil-producing regions tends to increase volatility in crude prices. Chronic underinvestment in Venezuela, home to the world’s largest oil reserves, has restricted output for years. Libya’s produc-tion has declined 80% since last summer’s

turmoil. Ongoing tensions surrounding Iraq’s nuclear program have reduced its crude exports by 1.5 million barrels per day. Meanwhile, rising violence in Nigeria, home to Africa’s second largest reserve after Libya, has curtailed production.

Citigroup estimates that geopolitical conflicts are keeping 3.5 million barrels per day of oil production offline. Now, the growing crisis in Ukraine should increase tension in global oil markets.

Global crude prices often spike in times of heightened political unrest and uncertainty. Surprisingly, prices have moved only moderately with the escala-tion of recent conflicts. Analysts say that a strengthening global supply outlook may be responsible for the recent price stability.

SupplyAccording to the U.S. Energy Information Administration (EIA), U.S. crude produc-tion has grown by 60% since 2008, due largely to the boom in shale oil. Production in Canada has grown by 1 million barrels per day. If not for this increased production offsetting losses from traditional sources, global production would be lower today than it was in 2005, University of California, San Diego econo-mist James Hamilton wrote recently.

“North America’s shale boom has been a huge calming factor,” IHS Energy analyst Lysle Brinker told Bloomberg Businessweek recently. “Without it, we might be seeing $150 [per barrel] oil by now.”

Growing U.S. production has reduced imports to the country in effect freeing up barrels of oil to supply regions of the world that previously relied on shipments from Iraq, Libya and others. As a result, markets have remained relatively well-supplied.

DemandThe International Energy Agency (IEA) forecasts global oil demand to grow by 1.3 million barrels per day in 2014. Market watchers are keeping a close eye on China, though. In recent years, China’s stellar economic growth has sustained strong energy demand. Slowing growth rates in 2014, however, have already manifested in a 3% drop in crude demand in Q1 2014.

A strengthening U.S economy should lead to improved domestic demand. Uncertainties surrounding the magnitude and nature of the global response to Russia’s recent actions in Ukraine are clouding any clear picture of European demand levels.

CRUDE OIL’S DELICATE BALANCE

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Dimer fatty acids are the dominant raw materials used in the formulation of

polyamide-based hot melt adhesives. Suppliers have consistently raised prices in recent years, putting pressure on the cost of polyamide adhesives.

Fatty acids extracted from natural oils, including rapeseed (canola) oil, crude tall oil (CTO) and cottonseed oil, are processed to produce dimer fatty acids. Rapeseed oil, used predominantly in the European market, is the only dimer fatty acid feedstock traded on international commodity markets. This makes its price movements relatively transparent. Details of crude tall oil (used in North America) and cottonseed oil (used in China) are much more obscure and difficult to track with little transparency in pricing or sup-ply conditions.

To add to the potential ambiguity surrounding polyamide pricing, not all polyamide adhesives are created equally. Grades can range from low-quality, commodity grades to highly specialized, high-performance grades. This means that while raw material prices are an important component of cost, they are not the only pricing factor at play, especially at the high end of the performance spectrum.

Highly modified or highly specialized grades require several additional processes to deliver the desired performance char-acteristics. These steps demand additional handling and energy input, which can add considerable cost to the end product.

FeedstocksBy the beginning of May, European rapeseed oil prices were up over 5% since the start of 2014. If economic growth accelerates, demand should pick up. One

polyamide supplier announced an increase of €110 per metric ton in February.

Complex pricing dynamics drive the market for crude tall oil, which is pro-cessed into tall oil fatty acids used to make dimer fatty acids. CTO is a byproduct of the Kraft wood pulping process. Demand for pulp, which is used to make cardboard and paper, controls the supply of CTO.

Reduced supply and increasing demand have driven CTO prices higher in recent years. The economic recession and an increasingly mobile, internet-enabled world have reduced the demand for paper. Paper mills have closed and CTO produc-tion has declined. At the same time, novel applications from the oil and gas drilling sector, have created new markets, increas-ing demand and driving up prices.

In recent years, North American

polyamide suppliers have steadily increased prices. Prices rose 8-to-10% in 2012 and an additional 10% last year. One supplier announced a new increase this year.

Cottonseed oil is extracted from the seeds of the cotton plant after the cotton lint has been removed. Demand for cottonseed oil for food applications has increased in recent years. Since cottonseed oil doesn’t need to be hydro-genated, it allows food processors to make trans fat-free products, like potato chips and donuts, which meet growing consumer demand.

In China, the U.S.D.A. forecasts an 8% drop in cottonseed production as farmers plant other crops this year. Recent changes to the country’s support policy are increasing farmer uncertainty about the crop’s profitability.

OutlookThe balancing effect of new North American supply on production declines in other regions has led to one of the most stable periods of oil pricing in recent years. Several large oil companies expect this relative stability to persist and are using $110-per-barrel oil prices in budgeting and forecasting activities.

Some analysts, however, say that growing supply could outpace demand and lead to a price crash. At the low end of the price range, Citigroup predicts $70 per barrel. The Energy Information Administration forecasts that Brent could drop into the $92-per-barrel range by 2017 before resuming a steady rise.

Other analysts claim that ongoing

geopolitical conflicts will act as a floor to global prices, helping to maintain prices above $100 per barrel.

Saudi Arabia’s oil minister agrees. “One hundred dollars [per barrel] is a fair price for everybody—consumers, producers, oil companies.” Ali al-Naimi told reporters at an energy conference in Seoul recently. “It’s a fair price. It’s a good price.”

Whether it is “the” price remains to be seen. In the meantime, stable pricing, albeit at historically high levels, is reducing upstream volatility in raw materials markets. This doesn’t mean that prices won’t rise. It means that inflationary pressure will come largely from other cost drivers. n

CRUDE OIL’S DELICATE BALANCE, Continued from page 1.

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VOLUME 1, ISSUE 2 — May 2014

UPDATE: POLYAMIDE ADHESIVES

Improving home energy efficiency, lightweighting automobiles and reduc-

ing harmful emissions from construction products are important trends driving the growth in polyurethane use in recent years. The problem is that demand growth for some key polyurethane raw materials is forecasted to grow at twice the pace of capacity growth in the next several years. This mismatch, coupled with rising demand, could lead to supply tightness and higher prices.

Polyurethane adhesives compete for the same raw materials as polyurethanes used in large industries like construction and transportation. Since the adhesives industry makes up such a small segment of the global polyurethanes market, it tends to be a price taker rather than a price setter.

Understanding the basic raw materials used to formulate polyurethane adhe-sives, along with the important drivers of competing end-use markets, can help users better navigate volatility in polyure-thanes supply and pricing.

What are polyurethanes?From the foam in a car’s cushioned leather seat to the padding in a child’s skateboard helmet, a new home’s spray-in insulation to the mattress in the master bedroom, polyurethanes make daily life safer and more comfortable. While the largest volume of polyurethanes is used in components for the construction and automotive markets, approximately 5% goes into adhesives, sealants and coatings, many of which are specially formulated for use in the construction and transportation industries.

Polyurethanes are produced by react-ing isocyanates with polyols. The types of chemical components used dictate the performance characteristics of the polyurethanes produced.

Isocyanates: MDIMethylene diphenyl di-isocyanate (MDI) is derived from benzene, a byproduct of the crude oil refining process. Unlike many raw materials that are driven by traditional market forces of supply and

demand, the benzene market fluctu-ates in response to the economics of the refining and, more importantly, the gasoline markets.

Benzene markets have grown extremely volatile in recent years. This is due to a complex interplay of mar-ket drivers that include supply-demand imbalances, declining gasoline consump-tion and shrinking inventory levels. This tightened benzene markets and led to record-setting price levels. When benzene prices are high, MDI produc-ers must raise prices to account for the higher feedstock costs.

According to data from Merchant Research and Consulting, polyurethane foams, used mostly in insulation, con-sumed 83% of global MDI production in 2013. Only 12% of MDI is destined for the adhesives industry.

Huntsman Chemical, a global pro-ducer of MDI, forecasts a seven-to-eight percent compound annual growth rate (CAGR) in MDI demand between 2013 and 2018. About half of this growth is due to increasing substitution of MDI for existing products or processes, including

RMF 101: POLYURETHANE

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UPDATE: POLYAMIDE ADHESIVES, Continued from page 2.

VOLUME 1, ISSUE 2 — May 2014

The U.S.D.A estimates this could reduce cottonseed oil production by 1.2% this year and by 10% in 2014-15.

A drop in production of this magni-tude should tighten supply and move prices higher. If it leads to a shortfall, imports, likely from regions including the U.S., where prices are up 70% since late last year, will be necessary to meet demand.

While the pace of polyamide price increases has been uneven around the globe, suppliers everywhere continue to push pricing. Higher raw materials, energy and transportation costs are all affecting prices. The magnitude of the increases varies with grade—lower-quality formulations are rising less than more specialized grades. All, however, will move higher this year. n

Polyester Polyols

Natural Oil Polyols

5%

5% 66%

12%

Castor Oil

PETROCHEMICALS

BIO SOURCES

Benzene Propylene

MDI Adipic Acid Propylene Oxide

POLYEURETHANEADHESIVES

TDI

Polyether Polyols

Toluene

Published by Henkel Adhesive Technologies. For more information about raw materials issues, please contact your local Henkel representative. Raw Materials Facts Disclaimer — The information given herein is based on our research, compiled from public news sources, experts from the chemicals and adhesives industries, and from personnel at Henkel Adhesive Technologies. While this information is, to the best of our knowledge and belief, accurate, no guarantee of its accuracy is made. © 2014 Henkel Corporation.

for fiberglass and polystyrene in insulation applications, TDI (see below) in furniture and automobiles, and rubber and EVA in footwear. However, capacity expansion is limited and forecast to grow at only half the rate of demand expansion. This mis-match could maintain upward pressure on MDI prices in the near future.

Isocyanates: TDIToluene di-isocyanate (TDI) is derived from toluene, which is produced at refineries in the same process as benzene. Gasoline prices, however, have an outsized effect on toluene market dynamics. Toluene’s high octane value makes it a valuable compo-nent of gasoline. When fuel prices are high, refinery operators will leave toluene blended in the gasoline stream rather than extracting it to sell to the chemical industry.

According to IHS Chemical, TDI production consumes only 5% of global toluene volumes.

Roughly 87% of global TDI produc-tion is used to make flexible polyurethane foam—the kind used in bedding, furniture and automotive interiors—according to Merchant Research and Consulting data. Only 5% of TDI is destined for the adhe-sives industry.

The TDI market is expected to grow at 5.5% CAGR through 2016. Demand growth in recent years has been espe-cially strong in Asia.

PolyolsThe polyols used in polyurethane adhesives formulations include polyester polyols, polyether polyols and natural oil polyols. All impart unique performance characteristics.

Polyester polyol is derived from adipic acid, a derivative of benzene. According to IHS Chemical, polyester polyol production consumes only about 5% of global adipic acid production. The major-ity of adipic acid is used to produce nylon 6-6, a versatile chemical used in carpets, pipes, machine parts, airbags and many other common items.

The polyester polyols market is subject to the same benzene-related market dynamics as discussed earlier for MDI.

Benzene markets tend to be volatile. Adipic acid markets don’t respond as quickly to upstream price gyrations. Adipic acid prices increased around the globe in Q1 but appear to be stabilizing in Q2.

Polyether polyol is produced from pro-pylene oxide, a derivative of propylene. The majority of propylene is produced in olefins crackers—petrochemical plants, often associated with refineries, that break complex long-chain hydrocarbons into smaller, simpler molecules, called olefins.

Crackers can process a range of feeds from naphtha, derived from crude oil, to ethane, a component of natural gas. In the past decade, rising crude oil prices and the growth in production from vast, low-cost shale natural gas resources have dramatically changed the way petrochem-icals are produced in North America. This has resulted in a shift to cheaper ethane feeds. The problem is that when cracker operators chose ethane over more costly naphtha, the production of propylene drops from 16% of the output to 3%. The shift has resulted in a 30% reduction in North American propylene production since 2005, according to IHS Chemical. While naphtha cracking still predominates in Europe and Asia, these regions are also experiencing a move towards lighter, less expensive feeds. The end result has been a global tightening of propylene supply and escalating prices.

Castor oil, extracted from castor beans, is a natural polyol. India is the largest global exporter of castor oil. As a result, the Indian castor seed growing conditions, harvest and crushing sched-ule drive the market. In addition, China has emerged as the dominant importer of castor oil; the country’s buyers tend to drive global pricing.

Castor seed prices usually spike dur-ing planting season in July and August and retreat during harvest in December, January and February. This year, prices are bucking the trend. One reason is that irregular rainfall in recent years has reduced yields and led farmers to decrease the number of acres planted with castor crops. Both have lowered the volume of carryover stocks, the reserve that supplies the market between harvests and acts as a buffer to any supply shocks.

In addition, unseasonably cool

temperatures during the 2013-14 season have slowed bean development, delaying ripening and harvesting by as much as two months in some regions. According to Acme Hardesty, a U.S. castor oil distributor, the 2014 crop size may be the smallest since 2010. Meanwhile India’s Q1 2014 exports are on pace with the same time last year. This suggests that castor oil production could fall short of export demand before the end of the year.

Pricing directionsDemand for all polyurethanes is improv-ing with the arrival of warmer weather in the northern hemisphere. Many produc-ers of polyurethane raw materials are reporting strengthening demand. In some cases, this has led to price increases.

North American MDI producers increased prices by 5% in Q1. Additional increases of almost 7% have been announced for mid-May and June. In Europe, prices were up just over 2% in the first quarter with announced increases of 6% now being discussed. Prices have been relatively stable in Asia this year.

Tight supply and improving demand coupled with rising energy and transpor-tation costs are leading TDI producers to raise prices. North American producers increased prices by 4% in Q1. Pricing was stable elsewhere. Suppliers have announced additional increases for Q2.

Global polyester polyols prices have been largely flat this year. Polyether poly-ols prices were steady in Q1 but North American producers announced a 4% increase for May. Castor oil prices have increased almost 7% since the beginning of the harvest in November. Analysts expect prices to continue the upward trend when planting begins in July.

All of this is putting weak inflation-ary pressure on the cost of polyurethane adhesives. While prices are holding at current levels, this could shift quickly if demand improves. All eyes are watching the U.S. economy to see how strongly it rebounds from the weather-related depressed demand levels of Q1. If economic growth accelerates, as many economists predict, and consumers start buying more houses and cars, polyure-thane demand will rise and take adhesives prices higher as well. n

RMF 101: POLYURETHANEContinued from page 3.

VOLUME 1, ISSUE 2 — May 2014