Covestro flags heightened gas supply risks, potential production cuts

Covestro says it expects an “increasingly challenging” second half of the year and anticipates Russia’s war against Ukraine will continue impacting global supply chains, already-high energy and raw material prices, high inflation, and weaker global economic growth.

The company flags a heightened risk of potential disruptions to gas supplies from Russia to Europe, particularly in Germany, and says it could face the prospect of having to close chemical production facilities, entire plants, or product lines if the situation worsens.

The Russia–Ukraine war has “fundamentally changed the geopolitical situation and caused extensive consequences for the global economy,” Covestro says in its fiscal results for the second quarter, in which it reports higher group sales both year on year (YOY) and sequentially but lower net earnings due primarily to reduced margins.

The increased geopolitical risks mean that the continued supply of natural gas to Europe is subject to major uncertainty, it says. “If supplies of natural gas from Russia were to become significantly scarce or halt entirely, this could, depending on the duration, necessitate the closure of certain of Covestro’s production facilities, or of entire plants or product lines in Germany,” it states in its risk outlook for the remainder of the year. “This could in turn result in production outages of certain chemical precursors, intermediates, and by-products that are needed at other sites in the EMLA region,” it says.

The company benefited in the second quarter from a “faster than expected recovery after the lockdowns in China and an intact demand for our products,” says Thomas Toepfer, CFO of Covestro. However, in the second half of the year the macroeconomic risks “have once again increased significantly, particularly with regard to the very high energy costs and uncertainties in gas supply at our German sites,” Toepfer says.

Covestro’s manufacturing sites in Germany account for around 25% of the company’s worldwide core production capacity, it says. Covestro is initiating measures to reduce its short-term gas requirements in Germany, including switching to oil-based steam generators, while working to continue improving its existing production technologies and roll out new ones to further reduce gas and energy consumption, it says.

However, if supplies of gas are rationed later this year, this could result “in partial load operation or a complete shutdown of individual Covestro production facilities, depending on the level of the cutback. Due to the close links between the chemical industry and downstream sectors, a further deterioration of the situation is likely to result in the collapse of entire supply and production chains,” it says.

Based on a scenario where gas supply to its plants is reduced by approximately 25%, Covestro says this would have an estimated monthly low- to mid-double-digit million euros impact on EBITDA. Covestro has run scenarios for gas-supply curtailments of up to 40%, it says.

The company’s production sites at North Rhine Westfalia (West) and Schleswig Holstein (North) in Germany, however, are in favorable locations in terms of gas supply infrastructure and “compared to the average industrial customer,” it notes. Recently increased imports of gas from Benelux and Nordic countries are currently covering for the reduced level of gas imports from Russia, it adds. Covestro notes that its plants in Belgium, France, and Spain would likely be affected to only a “limited extent.”

The Chinese government’s zero-COVID strategy that resulted in lockdowns in the country during the first six months of 2022 also put the brakes on global economic performance, it adds. Existing and possible future tight restrictions in China in reaction to the further spread of COVID-19 “hold risks for the entire global economy,” it says.

Covestro still anticipates worldwide economic growth but is now assuming global GDP of 2.6%, down from expected growth of 4.2% given in its 2021 annual report. In all its main customer industries, the company also expects continued positive growth in 2022, with growth in the automotive industry projected to remain “strongly positive” at 6.0%, although this is down slightly from its prior growth expectations. It has also reduced its projected growth rates in its other main customer industries, with growth in the furniture and construction industries put at 2.6% and the electrical, electronics, and household appliances industry at 2.7%.

On 29 July, Covestro announced it had reduced its full-year forecast for 2022 due to a recent significant further increase in energy costs and the continued weakening of the global economy. In line with that most recent guidance, it anticipates full year 2022 EBITDA in a range of €1.7–2.2 billion ($1.74–2.25 billion), lowered from its previous range of €2.0–2.5 billion and slightly below analysts’ consensus estimate, as provided by S&P Capital IQ. It is also projecting EBITDA for the third quarter to be in a range of €300–400 million, with the lower amount in line with consensus.

Covestro has also flagged its soaring energy costs, with its global energy bill in 2022 now expected to come in at around €2.2 billion, up from its original estimate for the year of €1.5 billion, which was then raised to €2.0 billion in May before the latest hike. The latest estimate is based on average energy prices in the week of 25–29 July. The company says it purchases its energy under spot market conditions with no hedges.

For the second quarter, Covestro’s net profit fell 56% YOY to €199 million, in line with consensus, with EBITDA declining 33% YOY to €547 million, in line with its latest guidance and beating consensus. This was due mainly to significantly higher raw material and energy prices and lower volumes sold, which were offset partially by higher selling prices, it says. The decline in margins affected primarily the company’s performance materials segment. Group sales rose 19%, to €4.7 billion, due primarily to the higher average selling prices and beating consensus. In the first quarter Covestro posted net income of €416 million on sales of €4.68 billion, with EBITDA of €806 million.

In the performance materials segment, revenue in the second quarter rose 26% YOY to €2.5 billion due to increased selling prices, although logistical bottlenecks caused by lockdowns in China limited growth, particularly in the APAC region, it says. EBITDA fell 43% YOY to €367 million on lower margins. The segment focuses mainly on producing materials including polyurethanes and polycarbonates, as well as base chemicals.

The solutions and specialties division posted an increase in sales of 11% compared with the prior-year period to €2.2 billion, again helped by higher selling prices as well as exchange rate effects. EBITDA dropped 10% YOY to €213 million on lower volumes sold and weaker margins. The segment consolidates Covestro’s solutions and specialties businesses, producing products including polycarbonates, precursors for coatings and adhesives, MDI specialties and polyols, thermoplastic polyurethanes, specialty films, and elastomers.

“We can look back at what was overall a solid second quarter, and we even slightly surpassed our EBITDA forecast. Nevertheless, we are looking ahead to an increasingly challenging second half of the year,” says Markus Steilemann, CEO of Covestro. “The current geopolitical situation shows us all too clearly that there is no alternative to the transformation toward a sustainable, fossil-free industry landscape.”