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Also discussed in this interview are BASF’s strategies for the other feed additives which the company produces and why it will remain a key supplier of those ingredients to the global feed industry.
Q1. During the summer of 2008 the market price for both Vitamins A and E reached historically high levels. Some analysts now question the grounds for such price hikes. How do you explain what happened during that period?
Was there a true physical shortage of product and how is it explained that the market then moved to oversupply in such a short time frame?
This development is actually a combination of various and unrelated factors that impacted the price and volume hike in summer 2008. To fully understand last years development one has to examine what happened in 2007. At the end of 2007 it was reported in the press that Chinese producers were facing environmental problems including effluent control and waste water treatment issues. Existing facilities were reported to be not sufficient to cope with actual production levels. In some cases, local authorities were imposing and actively enforcing more stringent standards. The production of some feed additives including Vitamins was affected and concerns arose that such measures could potentially limit the availability of some additives for the feed industry.
In addition, the coal supply from the inner parts of the country to the industrial centres close to the coast was interrupted due to the earthquake and the snow storms in March 2008. Coal is still THE major energy source for the chemical industry in China.
Significant delays or at least speculation on possible delays of shipments before and during the Olympic Games in Beijing added to concerns from within the feed industry that the supply of key additives would not be sufficient to cover demand. The global recession had not yet surfaced at that time and the demand for feed additives was constantly increasing in line with rising meat consumption.
At the same time most manufacturers had to consider routine maintenance overhauls that are usually scheduled for the summer period when demand is seasonally lower than during the remainder of the year. As a consequence, end users as well as distributors and traders where buying significantly more material than their immediate needs. This practise resulted in high inventory levels worldwide and along the entire feed/food chain. Speculation by some traders on rising prices played an additional strong role in the fast price increase of 2008.
Producers tried within their best means to adapt their output to this sudden spike in demand but nevertheless became physically short. This in turn gave new fuel to the upward price trend.
The buying patterns of end users had changed significantly, especially during the first half of 2008. Traditional behaviour of spot or quarterly buying was replaced by very long term coverage. This suggested to producers that there was a strong need for product and that significant demand would need to be covered.
After the Olympics the world economy turned, slowly at the beginning and it was not obvious to the industry that meat consumption would be affected as well. Usually meat consumption is quite robust in comparison to other industrial goods. The combination of reduced meat consumption, lower output of feed production and warehouses full of raw materials created significant issues for end users, especially in the USA. The consequence was a sharp correction so that demand for most feed additives (not only vitamins) dropped significantly especially in the fourth quarter of 2008.
This entire development came as a surprise to many of the customers as well as to most of the suppliers. However, this is not a completely new phenomenon. In economic science this effect is known as the "Bullwhip Effect", which is nothing else than the multiplication of small changes and perceptions up the chain. There are even mathematical models, which can describe these effects quite accurately.
Q2. The price of crude oil has fallen significantly from its high’s of 2008. How has this affected your input costs for Vitamins’ A and E?
The prices for many additives but in particular VE and VA are driven by supply and demand as can be seen today.
Q3. Critics of the BASF Verbund argue that during periods of reduced demand your cost structure for certain downstream products is significantly increased. Is this true and how does this affect operations at your Vitamin production site?
As you move up the value chain you have both variable and fixed costs in each step. When this process happens within the Verbund you have synergies thanks to side streams for other products. However, each product must incur a portion of the fixed costs so that all fixed costs are distributed over many products in the chain. Regardless of volumes produced you will always have those fixed costs attributed to each product.
Those companies who are not operating within a fully integrated process are frequently subject to purchasing agreements which have a ‘take or pay’ obligation. In such cases a buyer of intermediates would commit to taking a volume of product. If the buyer does not fulfil this obligation the seller would apply a ‘pay clause’ i.e. an additional cost which will compensate the supplier for the lost business. Normally the higher up you go in the value chain the greater the exposure to such ‘take or pay’ agreements.
However, most of today’s Vitamin A and E producers are backward integrated even if the extent of such integration is smaller for some manufacturers.
For most chemical processes one can say the lower the utilization the higher the cost per unit is. When production facilities have to run at utilization rates of e.g. 50%, (if this is at all possible) producers have to take into account:
• The increase of raw material prices from suppliers (as many of these contracts have volume dependant prices and even take-or-pay clauses)
• The increased energy consumption, e.g. switching the facility on and off
• More frequent product changes for campaign production requires additional cleaning times and additional costs for cleaning agents
• Specific personnel cost increases as the production requires a minimum of personnel in order to continue operations
• Unforeseen lower demand causes higher inventories, maybe shelf life problems and thus more analytical and quality assurance issues
...just to name the most important ones. In some cases it is technically not even possible to run a production facility at utilization rates below 50%, which makes a complete shut-down necessary. In such unsatisfactory circumstances the fixed costs of course remain but economies of scale do not apply.
Headquarters of the BASF Group – Ludwigshafen
The heart of the BASF Group is BASF SE headquartered in Ludwigshafen, Germany.
With its over 200 chemical production plants, several hundred laboratories, technical centers, workshops and offices, it is the largest integrated industrial complex in Europe.
Q4. Vitamins A and E have followed similar price trends in the past. However the scale of production differs considerably for each item. How does this affect the cost structure and supply of each ingredient when global demand is weak?
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"The core problem today is that without a clear visibility from customers of future demand, producers are faced with operating production sites at very inefficient utilization rates .... In such circumstances it may make more sense to have extended shutdowns."
Dr. Christopher Rieker
Director Global Marketing Nutrition Ingredients
BASF
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In somewhat commoditized products price is strongly driven by supply and demand. As demand for both vitamins is coupled through feed production and ultimately through meat consumption the similarities are quite evident for this side of the equation. But also the supply side has strong similarities for both vitamins concerning chemical complexity, capital intensity and technological challenges. Therefore, one would expect that trends are somewhat similar. In Q4/2008 the demand pattern of consumers had changed from longer term to very short term (“hand to mouth”).
The various shut downs of production sites was the logical consequence of the low and short term demand of Vitamin A and partly Vitamin E. The core problem today is that without a clear visibility from customers of future demand, producers are faced with operating production sites at very inefficient utilization rates which could be as low as 50%. In such circumstances it may make more sense to have extended shutdowns. Such shut downs had been published earlier and refer to any kind of industry considering the current financial crisis worldwide. However, if buying patterns suddenly change then it is technically not possible to simply restart production at short notice and catch up with the volumes which might be required by the market. Unused capacity means lost volumes. |
Q5. How does this scenario affect operations at your Vitamin production site?
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In the case of BASF we are conducting a combined maintenance overhaul for Citral, Vitamin A and E during June 2009.
This shutdown will last approximately 4 weeks, depending on product groups. Such an overhaul has to be planned several months ahead.
Third parties who are essential to such shutdowns also plan ahead and cannot adjust their schedules at short notice.
Of course, we have inventories to overcome the overhaul situation; however, those inventories were planned based on the demand pattern before the recent market changes. Nevertheless, we are confident that we will be able to supply the immediate demand of our regular customers.
Neither the current demand situation nor the production of Vitamin A or E allows any changes in market share from a BASF standpoint. It is our sincere intention to be and remain a reliable partner to the feed industry as we are today. Our “Verbund” production site helps us to live up to this promise.
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Vitamins A and E
"Nevertheless, we are confident that we will be able to supply the immediate demand of our regular customers"
Dr. Christopher Rieker
Director Global Marketing Nutrition Ingredients
BASF |
Q6. The Financial performance of Vitamin producers was positive in 2008 thanks to historically high prices which were maintained during that period. Some premix customers express concern that producers are now fine tuning output in order to maintain market prices at levels which are unreasonably high. Is this a fair comment?
The financial performance in 2008 was an outcome of the market dynamics described and discussed above. There was a completely different market environment for several years before that, and during that period BASF had serious difficulties achieving a reasonable profit level. Nevertheless, BASF remained committed to serving its customers through those difficult days.
In 2008, the financial performance of feed producers and premix producers was also very good as can be seen from corporate results published in the media. The most important issue in this regard is proper portfolio management. Some products will have to compensate others in order to ensure sound profitability. No profitability means no investments, no R&D, no service and so on, which ultimately endangers the future of this vital industry. In a few cases like vitamin C, it is becoming obvious what the results of a year-long non investment-level of suppliers will trigger: the exit of some players resulting in a reduced number of choices for the customers
Concerning future output, BASF has made it clear from the beginning that we see no need to produce if we do not have demand for our products.
If we can identify actual demand we are committed to production and will ensure supply. However, the current indications of actual demand make an appropriate production planning very difficult and we are not prepared to produce for a demand that might turn out not to be there.
Q7 . You have stated that your business needs to generate reasonable profits so that R+D and new investments can continue. Some would argue that Vitamins A and E are ‘mature’ products requiring little or no new R+D. Do you agree?
Investments are needed to follow the growth of the market. Both products are produced from complex chemical steps which require ongoing process improvements to ensure we remain a competitive producer. Additionally we need to allocate resources to allow us to prepare for plant expansions in line with market growth. Beside this, the constantly increasing regulatory requirements (e.g. re-registration in the EU, new Food Safety law in China) force us to constantly invest in a variety of application- and stability trials.
Q8. Is it really necessary to allocate resources today towards plant expansions? Surely we have sufficient overall capacity on hand to meet the actual demand for Vitamins A and E?
Plant expansion projects are not based on 1 – 2 year short term plans. Our time horizon is 8 – 10 years and the growth is driven by GDP growth, change in eating habits (more meat consumption). Despite this current economic crisis the fundamentals of our target industry go in the direction of growth. We need to allocate resources today to plan for future demand which would arise in the years to come. We also need to consider other industry segments which have a direct relationship with the production of feedgrade Vitamins. e.g. In the food industry we had recently explored the need for a very clear Vitamin E solution for the mineral water sector for instance. Resources and investment are needed for such a project. Of course the production of foodgrade and feedgrade Vitamin E are very closely linked and interdependent.
Irrespective of what product line you look at an acceptable profitability level is required to justify investment. Each company has competitive investment decisions and the money available is not unlimited. Resources are allocated to business segments which will provide a decent return. Therefore it is in everybody’s interest that each step in the value chain earns a reasonable profit on the capital invested.
Q9. We have discussed the volatility which the Vitamin E market has encountered during the past 18 months. Premixers are now asking will such sharp price and volume swings continue in the coming weeks / months?
Supply and demand will determine the value of vitamin E. The future global supply and demand pattern is very difficult to predict. What is important to note is that market stability is in the interest of all participants in the value chain. When we are in an environment where buyers purchase less because they think prices will fall and more when they believe prices will rise, instability is generated. This leads to poor visibility in terms of true demand and therefore makes it difficult for a market to find its true reference. Poor visibility therefore leads to waste and ultimately somebody has to pay for this inefficiency.
Q10. Where do you think the vitamin E price will be once this supply / demand balance is achieved?
This is an extremely difficult question to answer and would mean crystal ball reading. We do not expect prices to fall to the previous historical lows. However, fluctuations will always occur due to the natural fluctuation of demand versus supply.
Q11. Prior to 2008 the chemical industry was a volume driven business. However, during the past 18 months industry has been exposed to both severe agflation and afterwards demand collapse due to the financial crisis. What has BASF learned from these experiences and how will it impact your pricing strategy going forward?
What we have learned from this experience is that we will only produce the volumes that the market actually consumes.
Here methionine * can be taken as an illustrative example. Volumes and prices are relatively stable and have always been relatively stable. During times when demand was sluggish and prices started to erode to unacceptable levels, producers reduced significantly the output and prices recovered. Here a satisfactory supply and demand balance is in place. This contrasts to the Lysine market where significant over-capacities exist and market prices are barely covering costs. This behaviour ultimately leads to market consolidation and eventually limits the customers’ choice for suppliers.
BASF exited the lysine business in 2007 for that reason. In the case of lysine the situation is difficult for investments as there is little or no payback e.g. production process improvements. In the case of methionine a margin that can be earned on the product can be used for R&D, process and production improvement. Higher market share (of no value) cannot help a company survive under such critical market conditions, therefore it is acceptable to temporarily lose some market share points provided this does not become a constant trend. Holding your position and growing with the market is the more promising and sustainable way from our perspective.
BASF were one of the first chemical companies to react to the sharp reduction in global demand experienced in Q3 2008. We announced production cutbacks but were initially accused by some of reacting too quickly and being too pessimistic. As it turned out we probably reacted a bit late. If there is no demand it does not make any sense to produce. The alternative; a dramatic reduction in price, does not create any additional demand.
* BASF is not and was never a producer of Methionine
Q12. The ability to accurately measure and predict future demand will be essential for those Vitamin producers operating at reduced capacity. Miscalculations in this regard could have a significant impact on the supply demand balance. During 2007 BASF divested its captive premix business and now sells exclusively to the ‘open’ market. Critics would argue that you are not as close to the final market as before and therefore less well placed to identify crucial shifts in demand. Is this a fair comment?
BASF had decided to divest its premix facilities as the value of a kg premix sold into the market was partly below the value of the ingredients.
Additionally our customers for feed additives where at the same time partly our competitors for premix. As a third point, BASF was not producing all of the additives that are used in the premix and had to source several ingredients from 3rd parties. Hence, the decision of the divestment of the premix facilities was the right one. The portfolio that we have today is the one where we see ourselves amongst top of the class.
To be able to have clear and accurate view on actual demand we are now moving closer to our customers. Without being perceived as a competitor anymore we can now openly discuss with our customers. Therefore we feel that our understanding of the market and of shifts in actual demand has even improved.
Q13. BASF remains a producer of ingredients such as Carotenoids, Enzymes and other Vitamins etc. What is your long term strategy for such products?
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In an increasingly competitive market a leading cost position, high technical expertise in formulation and customer intimacy are the main competitive success factors. We feel that we fulfil all of these criteria in all of our existing product lines. Our Vitamin B2 facility in Gunsan, Korea (the only plant in the world offering fermentation based non-GMO Vitamin B2) is operating smoothly in line with current demand and the business performance in this product is acceptable. We have a very competitive cost position on this product and will definitely remain a key producer of this item going forward.
Regarding d calcium Pantothenate, we have adapted our production process in a way that allows us to be more competitive and thus more sustainable than any competitor in the world. We intend to offer an even more competitive product later this summer.
New product launches would be our Natugrain TS, a new heat-stable NSP enzyme with very good product properties as well as our already launched CLA for dairy and swine.
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Vitamin B2 -
"We have a very competitive cost position ... and will definitely remain a key producer of this item going forward."
Dr. Christopher Rieker
Director Global Marketing Nutrition Ingredients
BASF
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Improved production processes as well as new products are the proof of BASF’s commitment to the Nutrition Industry. It is our wish and objective to make our customers more successful with our offering!
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Bullwhip Effect:
The Bullwhip Effect (or Whiplash Effect) is an observed phenomenon in forecast-driven distribution channels . The concept has its roots in J Forrester's Industrial Dynamics (1961) and thus it is also known as the Forrester Effect. Since the oscillating demand magnification upstream a supply chain reminds someone of a cracking whip it became famous as the Bullwhip Effect.
Causes
Because customer demand is rarely perfectly stable, businesses must forecast demand to properly position inventory and other resources. Forecasts are based on statistics, and they are rarely perfectly accurate. Because forecast errors are a given, companies often carry an inventory buffer called "safety stock". Moving up the supply chain from end-consumer to raw materials supplier, each supply chain participant has greater observed variation in demand and thus greater need for safety stock . In periods of rising demand, down-stream participants increase orders. In periods of falling demand, orders fall or stop to reduce inventory. The effect is that variations are amplified as one moves upstream in the supply chain (further from the customer). This sequence of events is well simulated by the Beer Distribution Game which was developed by the MIT Sloan School of Management in the 1960s.
The causes can further be divided into behavioural and operational causes:
Behavioural causes
* misuse of base-stock policies
* misperceptions of feedback and time delays
* panic ordering reactions after unmet demand
* perceived risk of other players' bounded rationality
Operational causes
* dependent demand processing
* Forecast Errors
* adjustment of inventory control parameters with each demand observation
* Lead Time Variability (forecast error during replenishment lead time)
* lot-sizing/order synchronization
* consolidation of demands
* transaction motive
* quantity discount
* trade promotion and forward buying
* anticipation of shortages
* allocation rule of suppliers
* shortage gaming
* Lean and JIT style management of inventories and a chase production strategy
Consequences
In addition to greater safety stocks the described effect can lead to either inefficient production or excessive inventory as the producer needs to fulfil the demand of its predecessor in the supply chain. This also leads to a low utilization of the distribution channel. Despite of having safety stocks there is still the hazard of stock-outs which result in poor customer service. Furthermore, the Bullwhip effect leads to a row of financial costs. Next to the (financially) hard measurable consequences of poor customer services and the damage of public image and loyalty an organization has to cope with the ramifications of failed fulfillment which can lead to contract penalties. Moreover the hiring and dismissals of employees to manage the demand variability induce further costs due to training and possible pay-offs.
(extracted from Wikipedia) |