By Eugenio Piliego, Director, and Klaus Kobold, Associate Director, Corporate Ratings

The sector is vulnerable to the repercussions of the war in the Ukraine through its reliance on oil-based products which make up the lion’s share of chemicals feedstock, especially for fertilisers and polymers. Next to electricity, natural gas represents an important part in the energy supply for the industry. Where the European sector is more fortunate is that many companies have little direct exposure to Russia or business with Russian companies.

On the supply side, the war and sanctions against Russia are set to have a material impact on some European chemicals companies, notably suppliers of fertiliser which depend heavily on natural gas for which Russia is one of Europe’s principal providers, notably in Germany.

Fertilisers are made of nitrogen – which is derived from natural gas – in addition to phosphorus and potassium. The spiralling price of all these commodities is forcing farmers to tighten their belts – with an impact on demand for fertiliser. European fertiliser makers are also cutting output because of surging natural gas prices.

Norway-based Yara International halted all purchases from Russian sanctioned companies and individuals affected by sanctions and is temporarily reducing production at its Ferrara (Italy) and Le Havre (France) plants to approximately 45% of capacity. Hungarian producer Nitrogenmuvek Zrt is looking to reduce Russian dependence on fertiliser imports and has halted energy-intensive ammonia production. The exact dependence of Europe’s fertiliser suppliers on Russian natural gas is not clear but we assume it is material.

European chemicals companies: Russia exposure and sanctions response

The near-term impact on the rest of the European chemicals sector is less dramatic. Larger chemical companies have relatively marginal exposure in terms sales, around 1-2% for many, and, according to our estimates, unlikely to exceed 5% even when precise data are not public. Such exposure is in line with some other sectors and Russia’s small 2% share of global GDP.

Most of the large chemicals have already made public announcements to stop investments in new business in the country, while fulfilling existing contracts to the extent possible under the sanctions. In terms of production assets in Russia and Ukraine, the situation for large chemicals is manageable as output mostly addresses the internal market while impairment risk is not material.

However, some companies have relatively important individual ties with Russia. Typical of many large German industrial firms, Linde AG has had close ties with sanctioned state-controlled energy supplier Gazprom, with which it signed a contract in 2021 to build gas processing and LNG plants in Russia worth billions. Belgium’s Solvay SA is suspending the dividend payment it receives from RusVinyl, its integrated polyvinyl chloride joint venture with Russian petrochemical maker Sibur.

The surge in energy prices, which predates the Russian invasion, has already had a significant impact on European chemicals suppliers. BASF SE – Europe’s largest chemicals supplier by sales but which derives only 1% of its revenue from Russia – is a good example. The German company has announced price increases for various products, including a 35% hike early this month for additives for plastics, citing higher raw material and transport costs.

Larger specialty chemical companies are generally able to pass on higher raw material as opposed to energy costs to customers as production typically requires limited quantities of oil products.

In contrast, energy costs within the chemical industry are generally not included in regular price negotiations with customers, unlike other raw material costs. The incidence of energy costs also varies across different production plants depending on energy sources and pricing. A Eurostat study from 2017 found that energy costs for refineries represented a couple of percentage points as a portion of sales, while the proportion increases to mid-single digit for organic chemicals and fertilisers. Considering that in 2017 oil, gas and electricity prices were significantly lower than today, energy costs in 2022 are going to be moderately higher, still in single-digit proportions, but offsetting cost savings achieved from recent energy efficiency initiatives as BASF has acknowledged.

Some European chemicals such as LANXESS AG and Solvay SA have introduced surcharges on products to compensate for higher energy prices, though this is an exception rather than the rule for now.  Other companies are including energy within the basket of costs passed on to customers. Industrial gases supplier Air Liquide SA and specialty chemicals supplier Evonik Industries AG are relying on the positive effect of hedging in place to help control energy costs.

Energy-related surcharges may not work well for suppliers of intermediate products such as ethylene and propylene which tend to have less pricing power.

Cushioning the blow of rising raw material and energy costs is still robust demand for chemicals as the global economy recovers from the shock of the Covid pandemic.  The danger is that the war in Ukraine starts to rub off on business sentiment, industrial demand and economic growth in Europe and the rest of the world in addition to pushing production costs even higher.

For a round-up of Scope’s latest rating action and analysis of the unfolding crisis triggered by Russia’s invasion of Ukraine in February and its impact on European sovereigns, banks, corporate sectors and markets, please follow this link.