High EU gas costs, an opportunity for Indian chemical companies

Export ramp-up and import substitution are key triggers

There’s an interesting investment thesis arising out of the squeeze on Russian gas supplies to the EU. Europe’s chemicals producers, which depend on Russian natural gas for feedstock, are struggling. At the same time, gas shortages have led to a sharp spike in electricity tariffs. As a result, EU production of chemicals, such as ammonia, caprolactam, methanol, and melamine, has been drastically curtailed.

Since the EU is a large producer of ammonia, this results in downstream shortages in industries like nitrogen-based fertilisers and other chemicals like caustic soda and soda ash, which are vital for downstream industries.

Apart from supply chain disruptions, cost structures are unviable for European plants, given the prevailing prices of gas and power. Under normal circumstances, power costs account for around 7-8 per cent of revenues for chemical manufacturers, while natural gas is a major feedstock. As of now, EU gas costs are up 5x and ditto for power tariffs.

This presents possible opportunities for the Indian producers of ammonia, fertilisers, caustic soda, and others. While Indian businesses are also experiencing cost escalation, the differential versus EU costs structures are likely to be very favourable.

Indian firms, however, will have to look at possible disruptions in supplies of intermediates and upstream chemicals, such as nitric acid, which are used across several industries. There is also the likelihood of partial demand destruction in the EU. But overall, the supply tightening will probably lead to a surplus of demand over supply in many segments.

There are possible near-term and medium-term opportunities for quite a few Indian chemical companies, which can look to ramp up exports to the EU. Apart from this, Indian companies that import from the EU will also be looking for import substitution, which is again an opportunity.

This is all speculative in the sense that it’s a rapidly developing situation and nobody can be sure about the contraction in supply versus the contraction in demand.  Setting valuations will be difficult given the fluid nature of the supply-demand situation and difficulty in judging realisations.

However, investors could start looking at several possible segments of the industrial chemicals industry. Gujarat Alkalies and Chemicals, Chemfab Alkalis, Punjab Alkalies and Chemicals, and Meghmani Finechem are some caustic soda producers. There’s a host of ammonia and nitrate fertiliser firms, such as GNFC and RCF. Deepak Fertilisers may also see an uptick in offtake or realisations. Clean Science, Anupam Rasayan, and Fine Organics are other specialty chemicals outfits that can see gains in the medium term.  SRF is another player that can see long-term gains but it will be under pressure in the near term.

Supply chain management and leveraging existing relationships with the EU, as well as building new relationships with potential EU customers will be key in the next two quarters.

Gujarat Alkalies, Chemfab, Meghmani Finechem have already seen strong share price trends in the past month and the market is clearly responding to the caustic soda squeeze. Clean Science and SRF have also seen a surge in share price.