BASF Mothership Under Siege as Shale Forces Bock to Fight

BASF SE has spent almost 150 years expanding its German chemical mothership into an organism the size of Midtown Manhattan, whose intricate web of pipes and interlocking plants use every bit of oil and gas brought in.

The so-called Verbund approach is being put to the test. The boom in U.S. shale gas hands competitors Dow Chemical Co. and DuPont Co. an 8 percent profit advantage because they pay less for natural gas, estimates Jeremy Redenius, an analyst at Sanford Bernstein Ltd.

While BASF’s two chemical complexes in the U.S. benefit from the cheap fuel, the flagship site in Germany’s Rhineland is under pressure to perform. Chief Executive Officer Kurt Bock is spearheading the response as he evaluates expansion at home and pushes deeper into higher-margin chemicals. BASF, which consumes as much gas-generated power as Denmark, is reviewing the location for projects, board member Harald Schwager said.

“We really squeeze everything out of every drop of oil,” Bock said yesterday at an American Chamber of Commerce event in Frankfurt. “Shale gas in the U.S. means that we have a disadvantage in energy. But we will be able to cope with it.”

Shale gas, where water and chemicals are forced underground to extract gas in a process known as fracking, is heralding a resurgence in American manufacturing as energy costs fall and companies can procure raw materials at a cheaper rate, according to Dow CEO Andrew Liveris. Dow this year approved a new ethylene cracker project fueled by local ethane.

‘Game Changing’

Dow isn’t alone. Chevron Phillips Chemical Co. is spending $5 billion on a new ethylene plant in Texas, and two polyethylene plastic plants. It estimates the industry may spend $30 billion on factories to take advantage of cheap gas. BASF itself is adding a 10th furnace to its Port Arthur, Texas cracker and a formic acid plant in Geismar, Louisiana.

Some of the chemical output is being exported to Asia, with Huntsman Corp. currently shipping some resins to China.

“If we look around the world right now, the U.S. continues to be a market that I probably am most bullish on” from a manufacturers’ point of view and cheap raw materials, Huntsman Corp. CEO Peter Huntsman said Sept. 11. “That’s here to stay. There’s been a genuine game changing event that’s taken place in the North American petrochemicals market.”

The U.S. advantage is already showing up in earnings. BASF’s chemical unit saw operating profit decline 35 percent in the second quarter, weighed down by input costs. Dow paid about $1 billion less for its feedstock and energy costs in the period, according to a company presentation. Shale gas and investments on the U.S. Gulf Coast have the potential to drive earnings up by about $2 billion a year in 2017, it predicted.

BASF added 2.4 percent to 66.55 euros in Frankfurt trading as of 10:00 a.m.

Environmental Hurdles

Shale-gas requires millions of gallons of water laced with acids and other additives, and environmental groups including Food & Water Watch and Greenpeace have sought bans on fracking because of concerns surrounding drinking water contamination.

Environmental concerns play a bigger role in Europe than in the U.S., according to Chief Financial Officer Hans-Ulrich Engel. Population density in Europe combined the need to drill more wells to recover shale gas than with conventional fuel hamper production.

For BASF, getting energy at competitive prices will be decisive in coming years, board member Schwager said in an e-mailed response to questions. Energy is a major part of the cost for some products, influencing investment decisions, and BASF in Europe is paying four to five times the amount of competitors in the U.S., he said.

Dangers Ahead

Even BASF’s Verbund approach to energy at Ludwigshafen can’t fully compensate, Schwager said. Heat generated by one plant is transferred for use by a neighboring one, saving 200 million euros ($256 million) a year. BASF’s Wintershall unit supplies the company with gas, which comes from the North Sea and Russia, via a pipeline and trading venture with Gazprom OAO known as Wingas. It also makes spot purchases.

The U.S. shale gas advantage has bigger implications than today’s energy prices, said Oliver Schwarz, a chemicals analyst at Warburg Research GmbH in Hamburg.

“What will hurt BASF more than the energy component is that gas prices in America could lead to new chemical production capacity being built up over the next decades,” he said. “The next generation of assets being built because of gas prices could certainly become dangerous to BASF.”

BASF’s answer is to pick its battles, investing in higher-technology materials where it can maintain an advantage and “pruning of the portfolio” where it can’t, Bock said.

Accelerating the move into service-oriented, higher-margin specialty products is BASF’s best defense, said Schwarz, who recommends investors buy shares of the German company.

‘Paradigm Change’

“BASF is going through a paradigm change,” Schwarz said. “There are rock-hard economic considerations behind it and it’s the best protection for them. The further they walk up the value chain, the more value-added steps they add and the higher the service component is, the less advantage suppliers with cheap raw materials and energy prices have.”

BASF is still investing in Ludwigshafen. Margret Suckale, the board member responsible for the site, hosted an opening ceremony for three new container cranes on Sept. 7. A day earlier, BASF said it will build a plant to make specialty zeolites used in diesel catalysts.

Ludwigshafen, with 160 factories and 1,709 miles of pipelines, last year secured a 1 billion-euro investment in toluene diisocyanate for polyurethane foams used in car seats. The plant is scheduled to come on stream at end of next year.

Rhine Beats Desert

“It may have come as a surprise to some people who would have thought that we would put it in the desert somewhere,” Bock said at a Sept. 5 briefing in London. “I can assure you that all of our calculations have demonstrated that it’s a very viable cost to do this in Germany, total cost considered.”

By contrast, BASF is exiting a styrene business and sold a nitrogen fertilizer asset. It has acquired businesses with 15 billion euros in sales to expand into chemicals for personal care, food and electronics, and made forays into enzymes and biotechnology.

Germany’s rejection of nuclear-generated power may add to BASF’s woes, Bernstein’s Redenius said. The decision to turn off nuclear plants may cost about 335 billion euros by 2030, according to a study by the technical university of Berlin. Energy prices may rise by as much as 30 percent by 2020 for private customers, according to Tuomo Hatakka, head of Europe at Swedish utility Vattenfall.

“It’s a double whammy for BASF to the extent it makes the utility prices go up in Europe compared to the U.S.,” Redenius said.

Uneven Field

This is not the first time BASF has faced an uneven playing field. The company shifted its research into genetically modified plants to North Carolina in January after years of resistance in Germany from the public and lawmakers.

Packing up 160 factories may be hard. Shale gas extraction in the European country is also running into public acceptance problems, said Dieter Franke, one of the authors of a study on the gas in Germany that was commissioned by the government.

“The amount of shale gas means it’s worth thinking hard about extracting it,” Franke said in a telephone interview on Sept. 4. “The next step is to have a public discussion on how much we value domestic extraction. The acceptance is not there at the moment.”

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