For the past few months, European chemical industry participants have been engrossed in contract negotiations, whether for the entirety of 2023 or the first quarter of the year. Supply contracts and contract pricing length have been the focus of these negotiations. With volatility affecting the energy, feedstock and utility sectors as well as an uncertain economic outlook for the year ahead, these negotiations have dragged on for longer than in previous years, and in some cases are still to be concluded.
A key trend has seemingly emerged from the contract negotiations — industry participants have tended to shift from long to short-term contracts. This has been observed across different base chemicals and is applicable to the frequency of pricing changes within term contracts as well as the duration of the term contracts.
During periods of volatility, flexibility and the need to operate with agility is imperative. The cost of not being able to react to market volatility during uncertain times can be significant. Contract parties are unable to adjust to any market developments for three months when a quarterly contract price is agreed. It also means that agreements need to be made with a view to developments for the next three months too, when good visibility over demand and other factors is limited to the next month.
Two European base chemical markets where a shift from quarterly towards monthly prices has been observed are methanol and caustic soda.
Adoption of Monthly Contract Prices
Argus launched a monthly European methanol contract price assessment in February 2022 in response to growing market interest. Typically, methanol contracts in Europe settle on a quarterly basis, but liquidity in monthly methanol contracts will probably increase in 2023 as additional market participants negotiate these contracts.
Beyond the need to react faster to market volatility, Europe is the only region to use a methanol contract agreed on a quarterly basis. The US and Asia-Pacific use monthly contract prices. Also, participants in the newer methanol user segments like methanol into fuels can be exposed if using quarterly contracts, so alignment with the fast-moving nature of these markets is imperative. Another consideration is with a quarterly contract price in place for three months, the European methanol spot price can significantly dissociate from the quarterly contract price as the spot price reacts to the latest market developments
Traditionally, the majority of the European chlor-alkali industry has used quarterly contract prices for caustic soda. The two main cost factors in the production of chlor-alkali are salt and electricity. The rise in European electricity prices over the past two years has significantly altered the cost structure of European chlor-alkali production. Producers have used different strategies to mitigate this, for example by introducing electricity surcharges or passing through significant price rises in quarterly contracts (the Q4 2022 caustic soda contract price for Northwest Europe on an fd basis more than doubled).
Some market participants in certain European regions have sought to move to monthly caustic soda contract prices to better react to the change in utility costs and the caustic soda supply-demand balance. In November 2022, Argus launched a caustic soda monthly contract price for central and eastern Europe. In December 2022, Argus launched a caustic soda monthly contract price for Germany. The majority of business across northwest Europe remains set on a quarterly price.
Methanol and caustic soda would not be the first chemicals in which the European market has shifted towards monthly contracts following a period of major volatility and high uncertainty. The precedent was set by aromatics, including benzene, which moved to monthly contracts in 2002, and more recently olefins, which adopted monthly contracts in 2008 after the global financial crises.
A Move Towards Shorter Supply Term Contracts
Another contracting development has been a shift from annual term contracts to shorter durations. With the challenging macroeconomic situation and high inflationary environment in Europe, consumer spending has dropped. Offtake for most base chemicals and commodity polymers has declined. In Europe, demand for polyolefins and PVC was significantly lower in the second half of 2022 compared with the first half. Many market participants have commented that it is extremely difficult to budget volume for the year ahead — budgeting has become increasingly challenging and many companies have shifted from a quarterly to monthly budget process to forecast volume and pricing. In response, market participants have altered their supply contract term length. In the polyolefins and PVC markets, industry participants have looked to adopt quarterly supply contracts for 2023, when historically annual supply contracts were prevalent. This shorter-term duration for supply allows market participants to react to reduced sales volumes or a rebound in offtake and moderate plant operations, inventory levels, sales and procurement accordingly.
After the volatility of the past few years, the European chemical industry is implementing additional strategies to react to market changes, including a move towards short-term contracts in 2023. Nevertheless, long-term pricing and supply contracts have been maintained to provide stability and certainty. Consumers still require material to run their units and need a guarantee that product will be delivered. During the rebound in demand after Covid-19, many chemicals markets swung to an extremely tight position, leading to buyers scrambling for product. And as we have seen in the recent past, market conditions can alter quickly.
A combination of supply contract and contract pricing length best serves industry participants in the European industry.