The Urethane Blog

Epoxy Comments from Westlake Q2 Discussion

WESTLAKE CORP Management’s Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

08/03/2022 | 02:37pm EDT


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.


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.