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Mixed Outlook for Chemical Industry

NEW YORK ( TheStreet ) -- After the sharp declines in the last two years, we expect worldwide chemical production (excluding pharmaceuticals) to recover, albeit at a slow rate. At a global level, we currently expect chemical production to require another couple of years to recover to levels seen before the crisis.

In industrialized countries, severe declines in production as a result of the recession will have longer-lasting effects. The North American chemical production is expected to experience above-average growth in 2010, with domestic demand improving from the key customer industries on the back of a recovering global economy. Chemical giant BASF is expecting about 10% growth in the US chemical industry on the back of rising demand for exports.

In response to the slow recovery in demand, chemicals companies have been disciplined in bringing capacity onboard, resulting in meaningful improvements in the bottom line. We believe aggressive efforts in working capital reductions, supply chain optimization and productivity improvement should yield margin benefits. There is also a chance of accelerating capacity growth in 2011-2012, assuming that older projects do not get cancelled. We expect a strong cash flows and underleveraged balance sheet to support growth opportunities for chemical producers going forward.

End-Market Scenarios

Demand for chemicals tracks global industrial production and global GDP very closely. The chemical industry was particularly affected by the weak industrial demand in the second half of 2008 and in the first half of 2009. The drop in production in the chemical industry has been almost in sync with lower production in the key customer industries of housing, construction, automotive, electrical, furniture and paper. Nearly 10% of the chemical demand in the country is directly tied to the housing sector, and an additional 10% is tied to the auto sector.

The automotive industry has started showing signs of recovery while the housing sector continues to be sluggish. We expect automotive production to be higher in North America, though a weakness is expected to persist in Europe . Production in the paper and textile industry is expected to improve, primarily as a result of growth in emerging markets. The electrical industry is expected to pick up with increased industrial investment.

Other industries including food and agriculture are also likely to gain pace with the recovering economy. The construction industry, however, is expected to remain weak.

Trends in Raw Material Markets

The chemical industry is a large consumer of oil, natural gas and energy, which are widely used as an energy and feedstock input. During 2009, oil prices rose 87% from about $40 per barrel to more than $75 per barrel, re-attaining Oct. 2007 levels. Prices for the chemical raw material naphtha soared in almost exactly the same way as the oil price; naphtha rose throughout 2009 from an average level of $340 per metric ton in January to well over $600 per metric ton in October.
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