Mirova B(ey)ond Green - Chemistry, the ugly duckling of ESG...shunned by markets in 2023

Laure Nottet, Credit Analyst, Mirova
Hadrien Gaudin-Hamama, ESG & Impact Analyst, Mirova

The chemical industry is one of the sectors most dependent on fossil inputs, which account for fully a third of the industrial sector's CO₂ emissions. Furthermore, the sector boasts more than 350,000 toxic substances, the majority of which have not been assessed for their toxicity with respect to the environment or health, and contributes to 2 million deaths a year, while nondegrading substances pollute our ecosystems, including PFAS,¹ known as ‘forever chemicals’.

The chemical industry is difficult to reconcile with responsible investment, especially as its products are often used in a wide range of sectors, some more virtuous than others. But chemistry is also:

• A catalyst in the value chain to accelerate the transition of other industries – the chemical industry is the source of many ‘raw materials’.

Reducing the sector's environmental impact calls for replacing fossil inputs with bio-based raw materials, improving product circularity, reducing water consumption and pollution, and enhancing transparency about product composition. Already, in response to toxicity issues, many players are now doing more to assess the effects of their products on the environment and health, with a view to developing non-hazardous substitutes. In addition to emissions avoided thanks to the circular economy, most players are working to reduce their CO₂ emissions by improving energy efficiency, electrifying their processes, using renewable energies such as biomass, or implementing CO₂ capture and storage solutions (CCUS).

• Essential to the circular economy, given that almost half (45%) of global emissions that cannot be reduced by the energy transition can be eliminated by transition to a circular economy.²

Here, a number of solutions are deserving mention, including water treatment solutions from Ecolab, SNF and Solenis, green hydrogen solutions from Air Liquide and Linde, and natural food additives from Symrise. These are all companies in which Mirova invests and which, according to Mirova, belong to the 20% of companies in the sector – Barclays Euro Aggregate Corporate index universe – that are ESG-eligible. Although chemical companies are particularly vulnerable to natural disasters because of their massive infrastructure, and thus have all the more incentive to fight climate change, behavioural changes vary with regard to ease of adoption. They require major investment in both research and assets, particularly for commodity chemicals, which involve vast industrial complexes. In Europe, where production is becoming much less competitive due to inflation, manufacturers are investing both to diversify their supplies and to reduce their CO₂ emissions in order to comply with increasingly stringent regulations. In the United States, tax benefits offered under the Inflation Reduction Act are also encouraging manufacturers to invest in this direction. However, rising interest rates could weigh on their ability to transform, although this was not felt in 2023, as most chemical companies maintained good access to finance despite a difficult year.

To participate in this transition financing, Mirova has invested in several green bond issues in the sector, albeit only a few. We have been highly selective. After a record performance in 2021, driven by a post-Covid rebound, the chemicals industry faced a rapid downturn from mid-2022, reflecting an economic landscape, parts of which deteriorated under the influence of the Ukraine/Russia conflict combined with other factors:

• Inflation and rising interest rates weighed on many markets that chemical companies depend on, such as construction, materials, consumer goods and agriculture. As a result, the entire value chain had to contend with prolonged and massive destocking by customers, further penalising volumes and resulting in capacity utilisation rates well below historical levels.
• In addition to the fall in volumes, competition has been exacerbated by the arrival on the market of new production capacity, particularly in Asia, where economic activity has been slow to recover but where production is more competitive and has been redirected towards exports.

Against this backdrop, it has been more difficult for Western chemical companies to pass on cost increases via prices. Yet they sorely needed to, as profitability was squeezed by the continuing high cost of raw materials (mainly fossil-based) and energy inflation, chemical manufacturers being traditionally major consumers of electricity and gas.

Many companies in the sector have had to revise their targets for 2023/2024 downwards. While an improvement was initially expected as early as mid-2023, players now agree that the upturn is unlikely to appear before mid-2024. The end of destocking should lead volumes to rise slightly, but there are still many uncertainties, since other end markets, such as the automotive industry, could in turn experience a slowdown in 2024. In an environment of persistently high costs, the sector's profitability is likely to improve only marginally.

However, performance varies from one chemical sub-segment to another:

Groups operating in industrial gases (Air Liquide, Linde) benefit from a degree of resilience, as they have little exposure to cyclical markets while benefiting from long-term contracts with their customers. On the other hand, petrochemical companies, whose business has historically been the most cyclical (commodity chemicals), have suffered most from the worsening environment (Evonik). The resilience of speciality chemicals players (DSM, Ecolab, Italmatch, SNF, Symrise, Solenis) depends on their degree of specialisation. Those further down the chain offer higher value-added products, giving them greater pricing power.