Green chemicals feedstock: Thoughts about supply risks and volatility - Part 2

High feedstock price is the new norm

‘Back in 2005, when oil price peaked at US$60/bbl, the community started admitting that a US$100/bbl price was a realistic work hypothesis. 6 years have passed since then, we have pushed the ceiling several times.’

This is exactly what we can expect for agricultural products too. Firstly, prices are related to oil price. Secondly, demand keeps growing (with a significant impact of biofuels). Thirdly, temporary and permanent risks upon supply & demand balance have a direct impact upon prices. Historical prices show an increase trend (circa +7% pa since 2000), with levels never seen before (figure 4).

There is a consensus that high prices will remain and this impacts the industry economics in 2 ways:

- Impact upon competitiveness vs. chemicals to be substituted (if the green chemical becomes costlier, buyers switch to petrochemicals)

- Impact upon margin levels

Questions are therefore: Which attrition can we accept? Which raw material cost burden can we handle? What can be passed over our selling price?

Figure 4: Oil price vs. agricultural crop prices (Frost & Sullivan analysis, based on IMF & USDA 2011)

Feedstock price volatility is the norm and is likely to worsen

‘Demand for agricultural commodities is quite price inelastic’ reminded the OECD/FAO in 2009.

Growing demand and more frequent weather events have impacted all agricultural commodity prices. Speculative trading also increases this volatility. The analysis of recent prices shows that price volatility is getting more frequent and has greater magnitude (figures 5 & 6).

There is no evidence that volatility frequency and magnitude will reduce dramatically in the coming years. Actually, it is a working hypothesis on many plans which points a central question: how do we address this negative factor given that:

- Cost risk increases with volatility

- And return is not certain, in particular when price peaks dissuade purchase

There is no single answer; both financial choices and industrial choices are concerned. Therefore, which mix of mitigation measures shall be adopted?

Figure 6: Palm oil & Rapeseed oil price volatility (Frost & Sullivan analysis, based on USDA 2011)

Mitigation measures: Some food for thoughts

Financial instruments have been largely used in agricultural business and remain valid risk mitigation measures to offset logistics and/or raw material costs (through swap and/or hedging). However, long term risks need upstream responses.

On top of these financial instruments, the biofuels industry gave example of feedstock diversification: For instance, Abengoa operates with barley, maize and wheat. Some plant can be feedstock specialised; other can be designed to handle various type of grains, this flexibility brings better cost resilience.

Not far from the biofuels challenges, the surfactant industry frequently faces the backward integration question, in particular with the new Indonesian crude palm oil tax raise (+25%). Not surprisingly, P&G is considering a JV in that space, according to Reuters (dated 23^rd May 2011).

The idea of (re-)organising the raw material supply is also defining the local ecosystem in the Champagne region, France. The network of companies, subsidiaries and neighbours (ARD, BioAmber, Soliance, etc.) creates a nearly circular supply system leveraging main/co/by-products: Each player takes a specific block (starch, glucose, straw, etc.).

This French example is equivalent to a fragmented bio-refinery; on the other hand, integrated chemicals platforms are also developed irrespective of the feedstock type, as illustrated by Martek/DSM (algae), Roquette (cereals) or Borregaard (wood). The use of the entire plant and the operations by building blocks certainly address some economics challenges: Value creation, operating cost, supply cost, etc.

The development of alternative routes can lead to differentiated feedstock, this way contributing to supply risk mitigation. Some companies intend to take advantage from this technology platform diversification. P&G, for instance, has ties in cellulosic chemistry (development agreement with Zeachem) and in sugar-cane-based chemistry (development agreement with Amyris).

Green chemicals feedstock plans are closely connected to technology choices. Similar to renewable energies, we probably have to build a mix of green chemicals technologies to cope with feedstock challenges. New generation of feedstock (wood, algae) are certainly seen as long range solution, Solazyme >$1billion IPO being an illustration of the hope lying in algae.

However, the economic equation remains fragile and partly depends on the equilibrium between bulk green chemicals & specialty chemicals, the former providing scalability the latter offering superior sales prices. This last point is a direct input to the ability to rapidly amortise the industrial assets, while the feedstock choice will the ability to capitalise on high conversion yields. The CHOREN bankruptcy in July 2011 is probably a good reminder that feedstock economics indeed count a lot.

Illustrations cited here can be found on Doris de Guzman’s blog: http://www.icis.com/blogs/green-chemicals/