Is Middle East Disruption Pushing India’s Chemical Sector into a Margin Squeeze Phase? 

Synopsis: Middle East disruptions cause oil prices to rise above $100, increasing input, energy, and logistics costs. Delays of 25-30 days and 3x freight negatively impacted exports, particularly for commodity chemical companies.

The ongoing geopolitical tensions in the Middle East have caused a structural shock for the chemical industry in India. The Indian chemical industry is highly dependent on imports of crude oil, LNG, and LPG, which is a major cause of concern for the industry. The increase in crude oil prices, which has risen above $100, is affecting all the players in the industry. This is causing a phase of margin compression for the industry.

Sharp Increase in Raw Material Prices Across Value Chain: 

The rise in prices of crude oil is causing the prices of raw materials such as benzene, toluene, phenol, propylene, and styrene to rise. These raw materials are widely used in petrochemicals and further downstream products. Companies that trade in commodity chemicals are facing a challenge in passing on the increased costs to their consumers due to high competition. On the other hand, for speciality chemical players, the problem may exist for a short period, as they have the ability to renegotiate their prices and raw materials contribute a smaller part to their cost structure.

Higher Energy Costs and Operational Pressure

In addition, prices for LNG as well as natural gas have increased significantly, with some production units in the Middle East already suspended. This, in turn, is causing higher operating costs for gas-based production, which includes fluorochemicals, ammonia-based intermediates, as well as certain specialty chemicals. Moreover, higher freight rates and insurance costs are also impacting the cost of exports for certain companies.

Extended Shipping Routes Increasing Time and Cost

Shipping difficulties have caused companies to take longer routes such as the Cape of Good Hope. This has added a further 25 to 30 days to the journey. This has caused higher working capital requirements since money is stuck for a longer period. The freight rates have also tripled, making transport a major cost component. For low-value, high-volume products such as chemicals, many export deals are no longer viable at current pricing. In addition, the cost of raw materials used for imports has gone up by 5 to 10 percent due to higher freight and insurance costs.

Disruptions in Key Feedstocks and Supply Chains

Brent crude has majorly remained above $100 per barrel, with the chances of increasing further if the disruptions continue. The prices of LNG and natural gas have increased, and the supply of LPG has been disrupted from the Gulf, resulting in the increase of commercial prices. Around 90% of the import of methanol to India moves through the Hormuz route, and the prices have also become volatile. 

Almost two-thirds of the naphtha trade of Asia also moves through this route, and the stock levels are depleting, thereby affecting the production of benzene, ethylene, and propylene. The fertilizer trade is also affected, as around one-third of the total fertilizer trade moves through the Hormuz route, resulting in the increase of prices of urea and ammonia.

Sector Outlook: 

However, the impact on companies may vary. Companies that have pricing power, niche companies, and long-term contracts are likely to be better placed to deal with the increase in costs. Companies that are heavily dependent on crude-based materials are likely to be more vulnerable to the increase in costs. Export-oriented companies are facing double pressure of increasing costs as well as decreasing realizations. Until the situation stabilizes in the Strait of Hormuz, the sector is likely to be volatile, and a cautious and selective approach is recommended. 

Target Price given by Axis Securities: 

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