🏭 Welcome to Feedstockland

Good morning. Today's edition of The Column is unlike anything I’ve ever sent out before. As mentioned back in June, I'm going to start writing longer-form higher-value essays and sending them out occasionally. I'm doing this because I'm trying to figure out what the future of the chemical industry might look like, and if I'm going to do that, I need to understand how we got here (see Chesterton's Fence).

Understanding how we got here means understanding why we chose to invest in certain process technologies, at various times, and in various regions. Because successful investment occurs at the intersection of technical and economic constraints, most of my longer-form higher-value essays will probably explore those constraints. Once I've built up a decent framework I'll use it to write about specific cases and companies. Or at least that's my current plan.

This essay just scratches the surface of the economic constraints. I'm attempting to answer questions like: Where do chemical companies fit into the broader economy? What role do they play? And are they actually creating value?

Realizing complexity:

If you studied chemical engineering, and you ask a fellow chemical engineering graduate why they chose to study chemical engineering, nine times out of ten they will tell you: "I liked chemistry and was good at math in high school.". If you dig a little deeper you'll find that you share a few aspirations and interests—such as a shared desire to understand where stuff comes from, and an interest in taking something useless and making it useful.

That aligns pretty well with Wikipedia's definition:

But as the years go on we come to find that the term "raw material" and "useful product" are increasingly obscure, and that the process of converting "raw material" into "useful product" actually requires many different processes, operated by many different companies, and at various locations along the value chain.

I felt it brewing, but it didn't really set in until I was actually at a chemical plant. For me that was outside of Houston at LyondellBasell's Bayport Polymers Plant, pictured below:

In typical 20-year-old fashion, I was rather concerned about the meaning of work, as science for science's sake was only satisfying enough to keep me engaged in school. Since the meaning of work has to do with how useful the work is to society, I ended up asking the question: what value was this polypropylene production site creating for society?

To understand value creation we need to look externally, so I started asking questions about where the "raw material" (propylene) for this plant was coming from, and where the "useful product" (raw polypropylene pellets) was going.

The problem I ran into was that this plant sits right smack in the middle of Feedstockland—the blurry middle region of the economy where "raw materials" and "useful products" are so similar in value that you can use the term "feedstock" to describe either of them.

This terminology makes it hard to understand the role of the chemical industry in society because as individuals we don't get the same sense of value creation you'd find at the ends of the value chain (e.g. converting mined ore into aluminum, or combining parts to assemble a car, etc.).

Unfortunately, even after covering 1,000+ press releases from chemical companies over the life-span of this newsletter, I still don't get this sense of value creation. I mean sure, you can sell raw polypropylene pellets at higher prices than propylene, but is this polymerization process actually creating value, or is something else going on here?

My hypothesis:

Intuitively, based on its existence, I think most of us are inclined to say that this polymerization process must create some value, however marginal.

If you’re a chemist or chemical engineer, your knee jerk reaction is probably something like this:

“Of course polypropylene is more valuable than propylene! You can use it to do all sorts of things, like package our goods for safe transport, or make those blue COVID-19 melt-blown masks. You can’t do any of that with propylene, so we must be creating some value.”

The problem with this logic is that you can say the same thing for the companies upstream. A company doing propane dehydrogenation is probably saying something like this:

"Of course propylene is more valuable than propane! It's used to make all sorts of things, like making polypropylene for packaging goods and for melt-blown masks."

If the value of propylene is the sum value of all its end uses, and the value of polypropylene is sum value of all of its end uses, then the difference is zero and no value was created.

That's why listing off all of the end uses for a certain chemical may get you through a conversation about what you do, but it doesn't really feel that satisfying. And I think that's where most of us get stuck—we know making chemicals has a purpose in society, but we're afraid to question whether we're actually the ones creating value.

Here’s the bottom line:

Chemicals and materials are only as valuable as the most valuable human application for the chemical or material in its current physical state. For fluids that's typically their fuel value (burn propylene from a distance), and for solids it's typically their filler value (use those pellets to fill a hole in your yard).

Like it or not, the actual value creating process doesn't occur until you get to the end of the value chain (molding that polypropylene into packaging, melt-blowing it into a mask, etc.).

And for companies creating a novel chemical or material, you're still probably not the one creating the value, you just have the leverage to capture more value. That's why margins are higher for speciality chemicals—they are used only for a few applications, so their producers can capture a greater percentage of the eventual value creation.

When you make a commodity chemical that is used for thousands of different applications, you have basically no leverage, so you capture a tiny percentage of the eventual value creation. That's probably why economics professors and titans of industry argue that commodity chemical production is akin to a public utility, just to a lesser extent.

The implication:

See, when you’re in Feedstockland, your job isn’t to create value, your job is to subsidize value creation downstream by creating novel materials, by producing existing materials with novel inputs, or by reducing the cost to produce existing materials.

Doing so maximizes the number and magnitude of human applications that can trace their roots to a given chemical or material. It's through this maximization that individuals in the industry can find meaning in their work, and it's how chemical companies can justify capturing value that they don't create.

That value is captured in dollars and cents because captured value is synonymous with the financial concept of value. It's this financial concept of value that provides the economic constraints for making a profit in this industry. And profits are important because building anything requires investment, and investment requires expected returns.

In other words, we can't hope to understand how the chemical industry got to where it is without understanding how it makes money:

1. Application Creation: Creating a new chemical or material that enables a novel application.

2. Application Replacement: Replacing an existing chemical or material that enables an existing application.

3. Application Expansion: Expanding the demand for an existing chemical or material that enables an existing application.

Growth in the chemical industry was rapid and dominated by application creation (e.g. Teflon for non-stick pans) and application replacement (e.g. polyester fibers for clothing) during the post-war era.

From the early 1980s to now (or perhaps 2020) growth was slowed to GDP-driven rates as application creation is almost non-existent and application replacement became a trickle—leaving behind only application expansion, hence the GDP-driven rates.

But I think something might be different now. I think we may have reached an inflection point in application replacement where the development of sustainable alternatives to materials, even if they are identical from a molecular point of view, is picking up.

And if that's the case I will have plenty to write about.

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