Volume 3, Number 2, April 2005
This newsletter is published in cooperation with the ISM Chemical Group.  



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In This Issue...
  • Chemical Industry News
    • Greener Computer Monitors: Computer monitors must meet more energy-efficient requirements to qualify for the ENERGY STAR label. Read more.
    • Plastics and the Electronics Industry: The worldwide plastic electronics market is forecast to grow $5.8 billion in 2009 and reach $23.5 billion by 2012. Read more.
  • Risk Management Feature: How can supply managers mitigate market risks, credit risks and reliability risks? Read more.
  • Commodity Report: Caustic inventories in the United States have been on a downward trend, making it possible for producers to continue announcing and achieving price increases. Read more.
  • Announcements: ISM launches supply management image campaign. Read more.
  • Additional Resources: Check out these links to additional resources on the ISM Web site. Read more.
  • Contact Us about ISM eDigest: Chemicals.

Chemical Industry News

Computer Monitors

EPA Goes Greener on Computer Monitors

According to the U.S. Environmental Protection Agency (EPA), computer monitors must meet more energy-efficient requirements to qualify for the ENERGY STAR label. For the first time, the specification addresses energy consumption while monitors are in use, as well as while they are idle. Supply management organizations may need to reconsider the models that they currently lease or own. However, many models on the market already meet EPA's new specifications.

By 2010, EPA estimates that the new requirements will result in carbon emission savings of nearly 5 million metric tons (carbon equivalent), or the equivalent of taking more than 3 million cars off the road. The previous computer monitor requirements called for only a "sleep mode" energy-saving function.

A specification for computer monitors has been in effect since July 1999, and market penetration of ENERGY STAR-qualified computer monitors has been estimated at approximately 95 percent of total units shipped. By raising the bar, EPA is taking advantage of new technology and encouraging further energy-efficiency progress for products sold in the United States and around the world.

As part of an existing agreement, the European Union will also update its specifications to reflect this revision to ENERGY STAR. This modification is EPA's first effort to coordinate an ENERGY STAR specification revision with the European Commission under the context of the agreement. The success of this revision process has set a positive precedent for additional specification updates starting or underway for printers, copiers, scanners, fax machines, computers and other office equipment.

For more information about the ENERGY STAR specification, visit the ENERGY STAR Web site.


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Plastic Electronics Market

New Report Says Plastics Will Change the Face of the Electronics Industry

Plastic electronics, based on conductive polymers and flexible substrates, will change the face of electronics, according to a new report, "Plastic Electronics Markets: A Technology Analysis and Eight-Year Forecast," from NanoMarkets, LC, a leading industry analyst firm. NanoMarkets forecasts that the worldwide plastic electronics market will grow to $5.8 billion in 2009 and reach $23.5 billion by 2012. The following are key findings from the report:

  • In 2009, NanoMarkets expects that displays will account for 46 percent of the plastic electronics market and that memory will account for 38 percent. By 2012, the markets for logic/processors, flexible solar panels and sensors will all be measured in the billions of dollars.

  • In 2009, 37 percent of plastic electronics products will come from the mobile phone sector, but by 2012, plastic electronics will make its impact felt in numerous other segments. For example, plastic electronics will enable (1) the creation and production of roll-up displays to be used with computers and mobile phones, (2) flexible solar panels that can be laminated to walls and ceilings or used to power portable equipment, and (3) ultra-low-cost RFID tags that will completely replace bar codes in retail outlets. None of these could be built using standard complementary metal-oxide semiconductor (CMOS) technology.

  • Electronics built on conductive polymers and flexible substrates offer some compelling advantages over CMOS platforms given their low costs, reduced power consumption, and flexibility. They can be printed using techniques similar to those of inkjet printing or rubber stamping, which could reduce the need for building giant fabs. This in itself makes plastic electronics a serious interest point for the industry, as the ability to produce circuits without significant capital expenditure or being forced to recoup costs through high-output manufacturing means that chip companies would be able to capitalize on market opportunities previously unavailable to them.

The report is targeted toward professionals in the following industries: specialty chemical and materials companies, semiconductor and semiconductor tool manufacturers, imaging and display companies, computer device manufacturers and component suppliers, as well as investment analysts, venture capitalists and technology researchers.

For more information about the report, "Plastic Electronics Markets: A Technology Analysis and Eight-Year Forecast," visit NanoMarkets' Web site.


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Risk Management Feature
Risk Management in the Chemical Industry

Whether it's to meet energy or feedstock requirements for their industrial processes, supply managers are faced with three classes of risk that — if left unaddressed — can seriously impact the financial performance of their company. Those three risks are:

  • Market risk
  • Credit risk
  • Reliability risk
Market Risk

Market risk (also referred to as commodity price risk) is the risk that critical commodities purchased by supply managers — whether for fuel or feedstock — suffer price increases. Not only can this force supply managers over budget, but it can ultimately shrink, if not eliminate completely, a chemical company's margin on product sold.

Credit Risk

Credit or performance risk is the risk that a chemical company's counterparty defaults on its obligation. Many companies already take steps to measure and manage the risk inherent when delivering product to customers 30 to 60 days prior to receiving payment (also referred to as "current exposure"). But not all supply managers recognize their exposure to suppliers, which typically are creditors. If supply managers contract to purchase a commodity at a fixed price for a period longer than the next month, then "replacement risk" exists. This is the risk that, should the supplier go bankrupt and can no longer supply the contracted commodity, and meanwhile the market price of the commodity has risen, the supply manager must now replace that commodity at a higher price. This can be devastating to both budgets and margins.

Reliability Risk

Reliability risk is defined as the risk when critical supplies that have already been contracted for are not delivered to a chemical company's facility on a timely basis. Some of the supplies are easily and quickly replaced in case of interruption, while others are more difficult to replace which can have a devastating impact on companies.

Consider natural gas supplies as an example. The deregulation of natural gas allows supply managers to arrange for the transportation of gas purchased from a marketer to their facility. When making such arrangements, supply managers must choose between firm and interruptible (pipeline) delivery of their gas. "Firm" supply gives the buyer the highest priority on gas flowing through the pipe, and can only be interrupted should there be operational issues with the pipeline (e.g., a leak, compressor station shuts down, explosion, etc.). "Interruptible" supply, as the name implies, is pipeline capacity that can be recalled by the seller under certain circumstances.

Interruptible pipeline supply is also a product of deregulation. Historically, natural gas utilities were required to purchase, on a year-round basis, the volume of pipeline capacity to meet the highest single day's demand. Thus, for much of the year companies had excess (and usually wasted) capacity. Deregulation allowed them to begin selling off this excess capacity, but did not relieve the utilities from their obligation to meet rate-paying customers' needs. The solution was to sell "interruptible" capacity, which allowed the utilities to recall the capacity should their customers' demand be unusually high (e.g., a spell of unusually cold weather that significantly increases heating demand).

Why would anyone take the risk of owning interruptible supply? Simple — on some pipelines, firm capacity can cost as much as 0.70 cents per MMBtu of gas throughput, while interruptible can be 0.05 cents or less. In their quest to save costs, some supply managers lose sight of the remarkable expense suffered when forced to shut down their entire operation for a period of time.

Mitigation Steps

With market risk, credit risk and reliability risk defined, it's time to investigate steps to mitigate these risks. Whether it's using cheaper substitutes or assigning replacement risk limits, chemical companies have several alternatives to manage risks.

Market/price risk. The simplest way a chemical company can manage this risk is to pass changes in commodity costs through to the customer by adjusting the price of the product it's selling. However, this may not always be possible or even practical in competitive markets. Another strategy is to use cheaper substitutes — for example, the ability to burn fuel oil instead of natural gas when it's more economical. Also, supply managers can contractually "fix" the cost of critical commodities, thereby protecting the company from volatile commodity prices for a period of time. A variation on this theme would include "hedging" the cost of critical commodities by using exchange (futures contracts) or over-the-counter instruments where available.

Credit/performance risk. As previously discussed, "current exposure" is commonly managed through a practice of reviewing existing and prospective customers to determine the amount of unsecured risk the chemical company is willing to grant. If a customer's needs exceed that limit, then some form of credit enhancement, such as a letter of credit or a parental guarantee, is requested.

Unfortunately, "replacement risk" has not been addressed with the same level of rigor. One solution to managing this risk is to assign "replacement risk limits" to suppliers in a manner similar to the current exposure limits described above. But, whereas current exposure is easily calculated (the value of outstanding invoices plus the value of delivered but not yet invoiced product), replacement risk is a little more involved. It requires calculating the "marked-to-market" (MtM) value of forward, fixed-price portions of supply contracts. ("Forward" refers to those months in a supply contract that are beyond/later than the current calendar month.)

"Marking" a contract "to market" involves calculating the amount, if any, by which the value of the supply contract has changed. For example, assume that a supply manager purchases 1,000 units of a commodity in February for delivery in June at a price of $100 per unit. A month later the price of that same commodity for delivery in June rises to $150 per unit. The MtM value of the contract has risen by $50 per unit, thus the MtM value is $50,000 ($50 x 1,000 units). If the supplier for this contract were to go bankrupt prior to June, the supply manager would have to replace the 100 units at the higher price of $150, thus paying $50,000 more than originally budgeted. If the replacement cost limit for that supplier had been set at only $40,000, this supplier would be over its limit. Also, keep in mind that if the price per unit dropped instead, there is no replacement exposure to the buyer because replacement costs would be lower.

In the wholesale energy business, it's common for the supplier to wire $10,000 (the amount by which the supplier is over its limit) to the buyer as collateral. But at the commercial level and for commodities other than energy, this remedy is not usually available. Diversification of suppliers is the simplest remedy available to manage this risk. But how many suppliers is the prudent number? To make this determination, a supply manager should consider (1) the price volatility of the commodities purchased and (2) the volume of commodities purchased. If commodity prices are volatile, the MtM values can change significantly, and if volumes are large even a small change in price can produce a large change in MtM value. If volatilities and/or volumes purchased are high, a greater number of suppliers should be used.

Reliability risk. There are several ways chemical companies can protect themselves from the risk of a critical commodity not being delivered in a timely manner. One strategy that is common in the energy industry is to structure the supply contract so that it's "firm with liquidated damages." This means that the supplier is obligated to make timely delivery, and if it fails, it will compensate the chemical company for any incremental costs (relative to the original contract) in replacing the commodity. Such an arrangement, however, is not available in all markets. A second strategy is to have backup suppliers, but they may not be able to respond quickly enough to avoid serious consequence. To alleviate this possibility, a chemical company could choose to keep a calculated amount of surplus commodity on hand.

In the case of natural gas, it's critical to understand the full impact if supply is curtailed before contracting for interruptible supply. As with any form of insurance, it may be cheaper in the long run to pay the additional cost for increased reliability. Another solution is to build in the capability to switch fuel sources. Many chemical companies use equipment that can consume fuel oil or propane in the place of natural gas. By installing storage facilities large enough to supply several days' operation, a company can enjoy the lower costs of interruptible natural gas supply, while being protected from curtailment.

Conclusion

Today's supply managers face risks that are much different than just five years ago. Prices of many chemical commodities are higher and much more volatile — both of which threaten budgets and profit margins. These increases in risk also affect a company's suppliers, so their financial viability must now be monitored in ways that historically applied only to customers. And as our economy moves continually closer to a Just-In-Time (JIT) business model, the risk surrounding reliability of supply becomes paramount. To continue to be successful, supply managers in the chemical industry must adapt to the demands of these changes.

By Dunham Cobb, president of Dunham Cobb & Associates, Inc., Stuart, Florida. To contact the author or sources mentioned in this article, please send an e-mail to author@ism.ws.


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Commodity Report
Price Increases Continue in Caustic Soda Amid High Demand and Tight Supply

The primary factor driving sustained high caustic soda prices is a very tight supply-demand balance. Despite caustic producers running their units hard in 2004, there continues to be high demand for caustic as well as tight supply. Additionally, caustic inventories in the United States have been on a downward trend. This is making it possible for producers to continue announcing and achieving price increases.

Energy also is playing a part in contributing to high caustic prices, although it's minor compared to the effects of high demand and tight supply. The high caustic prices naturally affect raw-material costs for all caustic soda buyers. But from an industry perspective, the primary markets affected are pulp and paper, and alumina, because they're the largest single product end-use markets for caustic.

With the exception of Tigard, Oregon-based Equapac and Houston-based Shintech, little new caustic soda capacity is expected to be constructed in North America over the next several years. Caustic margins are expected to continue climbing and peak this year, with electrochemical unit (ECU) values staying above $600 per short ton for all of 2005. Effective operating rates in the United States are expected to be around 98-100 percent for the first and second quarters of 2005.

2004 Caustic Soda Demand Pie Chart

By Steven Brien, global business director, chlor-alkali and vinyls for Chemical Market Associates, Inc., Houston. To contact the author or sources mentioned in this article, please send an e-mail to author@ism.ws.

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Announcements
ISM's New Endeavor: Supply Management Image Campaign

Supply Management Month activities in March 2005 marked the launch of ISM's supply management image campaign, which is designed to increase awareness of the vital role of supply management in business today.

During 2004, several supply management professionals were brought together in a series of focus groups. From the information gathered, we developed the image campaign theme: Supply Management: Maximizing Opportunities, Managing Risk.

Supply Management Image Campaign Logo

In addition to responding to media requests, ISM is aggressively seeking opportunities for sharing the value of supply management and gaining coverage in print and broadcast media. A volunteer team of supply management professionals from various industries is being trained to speak on behalf of the profession.

For information on ISM's supply management image campaign and public relations activities, visit the ISM Web site.


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Additional Resources
A Wealth of Information at www.ism.ws

Visit ISM's Web site, www.ism.ws, for more supply management resources. The site provides published articles, conference presentations and reference materials that pertain to supply managers in all industries. Here are some items that might be of interest:

  • How can supply managers benefit internal business units and extend their influence throughout the organization? In the article, "Cross-Examining Business Trends>," find out how supply managers are accomplishing this by understanding the goals of other business units, recognizing how a business unit trend impacts supply management and learning how supply management can impact the critical trends that are occurring.

  • The worldwide electronics industry is undergoing a major transition brought on by the European Union's (EU) ban on lead in electrical and electronic applications. With a compliance deadline of July 1, 2006, widespread implications loom over every level of manufacturing. In the article, "EU Leading the Lead-Free Way," Jill Schildhouse addresses how the new EU legislation will impact your business, the technological challenges the industry faces, what countries beyond the EU are turning to lead-free production and which organizations are involved in the lead-free initiative.

  • In an effort to reduce greenhouse gas (GHG) emissions, U.S. companies are establishing sustainable supply chain partnerships. In their article, "Curbing Carbon Dioxide With Cutting-Edge Partnerships," Jan Canterbury and Anne Choate discuss the innovative activities taking place between companies. Whether it's climate cool vehicle interiors or supply chain incentive systems, a trend is occurring to reduce GHG emissions.

  • Want to know how a chemical company is reducing its total cost of ownership in traditional and nontraditional areas of spend? In her 2004 Conference Proceedings article, "Procurement Value Creation at Bayer," Soheila Lunney, director, strategic procurement solutions and services for Bayer Corporate and Business Services, discusses how in addition to establishing stretch goals and utilizing best practices, the company developed and successfully implemented a comprehensive strategic sourcing and negotiation management process.

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