Urethane Blog
Epoxy Comments from Westlake Q2 Discussion
August 4, 2022
WESTLAKE CORP Management’s Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)
08/03/2022 | 02:37pm EDT
Overview
We are a vertically integrated global manufacturer and marketer of performance and essential materials and housing and infrastructure products. We operate in two principal operating segments, Performance and Essential Materials and Housing and Infrastructure Products. The Performance and Essential Materials segment includes Westlake North American Vinyls, Westlake North American Chlor-alkali & Derivatives, Westlake European & Asian Chlorovinyls, Westlake Olefins, Westlake Polyethylene and Westlake Epoxy. The Housing and Infrastructure Products segment includes Westlake Royal Building Products, Westlake Pipe & Fittings, Westlake Global Compounds and Westlake Dimex. Prior to our segment reorganization in the fourth quarter of 2021, we operated in two principal operating segments, Vinyls and Olefins. The change has been retrospectively reflected in the periods presented in this Form 10-Q. We are highly integrated along our materials chain with significant downstream integration from ethylene and chlor-alkali (chlorine and caustic soda) into vinyls, polyethylene, epoxy and styrene monomer. We also have substantial downstream integration from polyvinyl chloride ("PVC") into our building products, PVC pipes and fittings and PVC compounds in our Housing and Infrastructure Products segment.
Performance and Essentials Materials
Ethane-based ethylene producers have experienced a cost advantage over naphtha-based ethylene producers during periods of higher crude oil prices. This cost advantage has resulted in a strong export market for polyethylene and other ethylene derivatives and has benefited operating margins and cash flows for our Performance and Essential Materials segment during such periods. In the past year, we have seen significant volatility in natural gas, ethane and ethylene prices, primarily due to changes in demand, the timing for certain new ethylene capacity additions, the availability of natural gas liquids, and the ongoing conflict between Russia and Ukraine. Our performance and essential materials such as ethylene, PVC, polyethylene, epoxy and chlor-alkali are some of the most widely used materials in the world and are upgraded into a variety of higher value-added products used in many end-markets. Our performance and essential materials are used by customers in food and specialty packaging; industrial and consumer packaging; medical health applications; PVC pipe applications; consumer durables; mobility and transportation; renewable wind energy; and housing and construction products. Chlor-alkali and petrochemicals are typically manufactured in large volume by a number of different producers using widely available technologies. The chlor-alkali and petrochemical industries exhibit cyclical commodity characteristics, and margins are influenced by changes in the balance between supply and demand and the resulting operating rates, the level of general economic activity and the price of raw materials. Due to the significant size of new plants, capacity additions are built in large increments and typically require several years of demand growth to be absorbed. The cycle is generally characterized by periods of tight supply, leading to high operating rates and margins, followed by a decline in operating rates and margins primarily as a result of excess new capacity additions. Westlake is the second-largest chlor-alkali producer and the second-largest PVC producer in the world, which makes Westlake a global leading chlorovinyls producer. Demand for our products in the first half of 2020 was negatively impacted by the onset of the COVID-19 pandemic. Global demand for most of our products started strengthening in the second half of 2020 and has remained strong through the second quarter of 2022. We expect global demand for most of our products to remain favorable throughout 2022. 25
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Table of Contents
On February 1, 2022, we completed the acquisition of Westlake Epoxy for a purchase consideration of $1,207 million. The assets acquired and liabilities assumed and the results of operations of the Westlake Epoxy business are included in the Performance and Essential Materials segment. This acquisition represents a significant strategic expansion of Westlake's Performance and Essential Materials businesses into additional high-growth, innovative and sustainability-oriented applications - such as wind turbine blades and light-weight automotive structural components. Because epoxies are produced from chlorine and caustic soda, the transaction also provides vertical integration with Westlake's global chlor-alkali businesses. With the acquisition of the Westlake Epoxy business Westlake is now one of the leading producers of epoxy specialty resins, modifiers and curing agents in Europe and the United States with a global reach to our end markets. Epoxy resins are the fundamental component of many types of materials and are often used in the automotive, construction, wind energy, aerospace and electronics industries due to their superior adhesion, strength and durability. Our position in basic epoxy resins, along with our technology and service expertise, has enabled us to offer formulated specialty products in certain markets. In composites, our specialty epoxy products are used either as replacements for traditional materials such as metal, wood and ceramics, or in applications where traditional materials do not meet demanding engineering specifications. We are also one of the leading producers of resins that are used in fiber reinforced composites. Composites are a fast growing class of materials that are used in a wide variety of applications ranging from aircraft components and wind turbine blades to sports equipment, and increasingly in automotive and transportation. We supply epoxy resin systems to composite fabricators in the wind energy, automotive and pipe markets. Epoxy specialty resins are also used for a variety of high-end coating applications that require the superior adhesion, corrosion resistance and durability of epoxy, such as protective coatings for industrial flooring, pipe, marine and construction applications and automotive coatings. Epoxy-based surface coatings are among the most widely-used industrial coatings due to their long service life and broad application functionality combined with overall economic efficiency. We also leverage our resin and additives position to supply custom resins to specialty coatings formulators. The raw materials that we primarily use to manufacture our epoxy products are chlorine and caustic soda, among others and are available from more than one source including internal sourcing and the open market. Prices for our main feedstocks are generally driven by the underlying petrochemical benchmark prices and energy costs, which are subject to price fluctuations. Depending on the performance of the global economy, the timing of resolution of the conflict between Russia and Ukraine, disruption in the global supply chain, labor shortages and costs, potential resurgence of the COVID-19 pandemic, the trend of crude oil prices, new capacity additions in North America, Asia and the Middle East in 2022 and beyond, the sustainability of the current, strong demand for most of our products, inflationary pressures and concerns over slower future economic growth, including the possibility of recession or financial market instability, our financial condition, results of operations or cash flows could be negatively or positively impacted. We purchase significant amounts of ethane feedstock, natural gas, ethylene and salt from external suppliers for use in production of performance and essential materials. We also purchase significant amounts of electricity to supply the energy required in our production processes. While we have agreements providing for the supply of ethane feedstock, natural gas, ethylene, salt and electricity, the contractual prices for these raw materials and energy vary with market conditions and may be highly volatile. Factors that have caused volatility in our raw material prices in the past, and which may do so in the future include:
•the availability of feedstock from shale gas and oil drilling;
•supply and demand for crude oil and natural gas;
•shortages of raw materials due to increasing demand;
•ethane and liquefied natural gas exports;
•capacity constraints due to higher construction costs for investments, construction delays, strike action or involuntary shutdowns;
•the general level of business and economic activity; and
•the direct or indirect effect of governmental regulation.
Significant volatility in raw material costs tends to put pressure on product margins as sales price increases could lag behind raw material cost increases. Conversely, when raw material costs decrease, customers may seek immediate relief in the form of lower sales prices. We currently use derivative instruments to reduce price volatility risk on feedstock commodities and lower overall costs. Normally, there is a pricing relationship between a commodity that we process and the feedstock from which it is derived. When this pricing relationship deviates from historical norms, we have from time to time entered into derivative instruments and physical positions in an attempt to take advantage of this relationship. Acquisition of Hexion Epoxy Business On November 24, 2021, the Company, through a wholly-owned subsidiary, entered into a Stock Purchase Agreement (the "Hexion Epoxy Purchase Agreement") by and among Hexion Inc. ("Hexion"), a New Jersey corporation, and solely for the limited purposes set forth therein, the Company. Pursuant to the terms of the Hexion Epoxy Purchase Agreement, the Company agreed to acquire all of the equity interests in Hexion's global epoxy business ("Westlake Epoxy"). On February 1, 2022, the Company completed the acquisition of, and acquired all of the equity interests in, the Westlake Epoxy business for a purchase consideration of $1,207 million. The assets acquired and liabilities assumed and the results of operations of the Westlake Epoxy business are included in the Performance and Essential Materials segment. Performance and Essential Materials Segment Net Sales. Net sales for the Performance and Essential Materials segment increased by $958 million, or 45%, to $3,104 million in the second quarter of 2022 from $2,146 million in the second quarter of 2021. Average sales prices for the Performance and Essential Materials segment increased by 27% in the second quarter of 2022 as compared to the second quarter of 2021. The higher Performance Materials sales prices were due to higher PVC resin sales prices. The higher Essential Materials sales prices were primarily driven by the higher prices for caustic soda, chlorine, styrene and derivative products. Sales volumes for the Performance and Essential Materials segment increased by 18% in the second quarter of 2022 as compared to the second quarter of 2021, primarily resulting from the acquisition of Westlake Epoxy in the first quarter of 2022. Income from Operations. Income from operations for the Performance and Essential Materials segment increased by $294 million to $965 million in the second quarter of 2022 from $671 million in the second quarter of 2021. This increase in income from operations was due to higher sales prices for PVC resin, caustic soda and styrene and higher margins for polyethylene, mainly resulting from strong demand for our products. Income from operations was also higher due to the acquisition of Westlake Epoxy in the first quarter of 2022. The increase in income from operations versus the prior-year period was partially offset by higher global fuel and power costs, higher feedstock costs and lower sales volumes for PVC resin. https://www.marketscreener.com/quote/stock/WESTLAKE-CORPORATION-14877/news/WESTLAKE-CORP-Management-s-Discussion-and-Analysis-of-Financial-Condition-and-Results-of-Operations-41186706/