Time - It's Not On Our Side: Petrochemicals In The 21st Century
James N. Sullivan, Vice Chairman of the Board
International Petrochemical Conference
San Antonio, Texas
Before we get started, let me express my appreciation for the NPRA's invitation to share a few thoughts with you.
Whether we're suppliers, customers, partners or competitors, it's always in our interests to discuss the industry's directions, and continue exploring ways to overcome common challenges. If we're fortunate, each of us will find a few ideas to take home . . . to enhance the chances that our companies will succeed today, and in the 21st century.
I want to offer special thanks to my friend John Peppercorn, president of Chevron Chemical Company - and his senior vice president and also my friend, Darry Callahan, who is here today - for having faith that what I say will do their outfit justice.
Of all the operating companies within Chevron Corporation, Chemical has for years been a leader in how it manages its business. In fact, Chemical is often a few steps ahead of the corporation, and we learn a lot from its best practices.
OK, this morning I want to spend most of our time talking about the challenges that we in the petrochemicals industry all face. I'd also like to describe a few of the options and choices that confront individual players. Finally, I'll talk a little bit about the things my colleagues at Chevron Chemical are doing to get a jump on you our competitors.
As you're all aware, we're today on the downward slope of the chemical cycle, a repeat of the last valley that occurred in the early 1990s. Two years ago, the industry did gangbuster business. But as is often the case with chemicals, plant expansions led to increased supplies that outstripped demand and suppressed margins.
Most projections show those margins hitting bottom next year. And it may be a rough period, oddly enough, because we've done some things quite well. This industry is as lean and productive as it's ever been. Employment is at the lowest point in a decade, and labor productivity is at an all-time high.
Consequently, it will be difficult for manufacturers to squeeze additional earnings from broad-based cost cutting. Gains, then, must come from breakthrough thinking and operational excellence.
Now, I must admit that Chevron's corporate management hasn't always been patient over the cyclic nature of the chemical business. Even though we know these swings are inevitable, I'm as guilty as the next executive in expressing disappointment over periods of lower earnings.
However, I think all of us in Chevron have come to the realization that since we're a big, integrated company, we can handle the fluctuations. And we're now starting to evaluate Chevron Chemical's performance over the life of an entire cycle.
Sure, we love those heady years with an 18 to 20 percent return on capital employed. And, we get a little edgy when it falls to 6 or 8 percent. But over the entire cycle, an average return of 12 to 15 percent makes chemicals a pretty darn good line of business.
We also think it's going to be a terrifically good line when the next cycle peaks, if current trends hold, around the turn of the century.
Of course, no one can really predict with any great confidence what's going to happen in the profoundly mystical market of chemicals. However, there seems to be an apparent difference in this particular cycle.
Absent a recession or a huge increase in oil prices, cycles are typically described as lasting - from peak to peak - for about seven years. This time, some folks say that we may be facing a five-year run.
When you ask planners, economists and industry experts why we're in a shorter time frame, the quick answer is the economic growth in Asia and South America. Most forecasters predict annual chemical demand increasing by double digits in China and other fast-growing economies in that region. And yet, that's just one obvious explanation.
Still, other observers claim that the chemical cycle is dead, that the globalization of the industry has killed it. That's the conclusion of one research firm that studies the market.
It likened the chemicals business to commodity agriculture, with operations running at full capacity, earning relatively little, and with few opportunities for individual companies to grow. Whether or not you agree, globalization will surely have a dramatic impact on regional market cycles.
In any event, I get the sense that several forces have combined to change the dynamics of this cycle, and in the 21st century, may well change the very nature of our business.
We all know that chemical products are fundamental to modern life, and that our business is meshed with nearly every human activity. As a result, we must take into account some large-scale economic, social and behavioral trends, all of which influence our industry's very nature.
Which brings me to the subject of time.
If you'll bear with me for a personal digression, I'd like to tell you what happened to me a few years ago on a visit to Chevron's refinery in Pascagoula, Mississippi, where I'd served a couple hitches in the '70s.
After a tour of a new benzene plant that uses Chevron's Aromax technology, I was pulled aside by several young engineers, who proceeded to give me an unscheduled briefing on new instrumentation they'd just installed on another plant. They'd just replaced, and I quote them, "a bunch of lousy, antiquated junk."
It took a few seconds before I realized that the lousy junk was instrumentation that I'd installed 20 years before.
My first inclination was to box a few ears. But these engineers were so proud that I bit my tongue and held it . . .
In retrospect, it's remarkable that my instruments lasted that long. But the fact is, their new instruments will likely be outdated within a decade, and the next generation will last only half as long. And that's because we live in a world in which utility and time are constantly being compressed.
This compression affects nearly every human activity, and it's been sneaking up on us for a long, long while.
The late O.B. Hardison Jr., a cultural critic and brilliant scholar, wrote eloquently of what he called "the curve of evolution." He started with the billions of years it took for single-celled organisms to evolve into mammals, and the 12 million years it took hominids to turn into modern humans.
The shift from hunting and gathering to agriculture occurred about 10,000 B.C. But the earliest civilizations didn't arise until about 4000 B.C., just as the use of copper gave way to bronze. The Iron Age didn't come about for another 3,000 years.
Even as great empires rose and fell, a good 1,500 years went by before Columbus and others launched the Age of Exploration. Columbus died 250 years before the start of the Industrial Revolution. But moving from there to the Age of Steam took a century. The switch from steam to electricity and the internal combustion engine took just 50 years. And the following 50 years saw the advent of aviation, radio, television, atomic fission and space flight.
You can see how technology-dominated evolution is curving relentlessly higher. And it manifests itself in time compression just about everywhere you look.
For example, the modern supermarket is nothing less than a collapsed time zone. It's where we've literally squeezed hours from the process of acquiring and preparing food, and reduced it to minutes. These are foods, I might add, that often are encased in plastics.
While it's said that Internet time should be measured in dog years, I think the life span of hamsters might be a better metric.
Communications technology! What a marvelous, mixed blessing. It wasn't that long ago that I could make a decision and put the issue aside for a couple of days. Now, with the miracle of e-mail, I'm getting feedback from many of our employees within 15 minutes - whether I want it or not.
And speaking of computers, a good PC used to last about 5 years. Today, the machine on my desk probably has less than three years of useful life.
There's a lot of plastic in a computer housing, not to mention all the packing foam and shrink-wrap around all those instruction books that I've never been able to decipher. But this kind of time compression - how fast products are designed, brought to market and grow obsolete - is in many cases good for chemical-makers.
And it's especially true for those companies that move swiftly enough to capitalize on new technologies, lead change and pioneer ways to satisfy customer needs.
Entire markets are also going through rapid evolution. Take Eastern Europe, where nations are likely to skip a whole generation in product packaging, moving straight from glass to plastic.
Because there are so many socio-economic forces on this accelerated path, it seems to me that the chemical cycle - often drawn on charts to look like a symmetrical pair of smooth ocean waves - could one day be reduced to chop.
To suggest that we're in the last chemical cycle is like claiming we've reached the end of history. When profits are low, people have a natural tendency to adopt attitudes of gloom and doom. And although we can't know who or what might make history just a few years hence, historical evolution will surely happen.
Meanwhile, time compression and globalization will certainly change the wave. Consider that even while Asian chemical demand is soaring, production capacity in the region is projected to grow at an even higher rate.
What this leads to is one argument for caution, even as we plan for an increase in chemical demand. And we face still other serious issues that are also influenced by time.
For example, the environment merits great attention, especially in developing nations where we're counting on the greatest growth. Environmental movements in these countries won't evolve over two or three decades, as was the case in North America and Europe. Instead, thanks to a well-organized international environmental movement, a stringent and punitive regulatory climate can develop almost overnight.
The social and political forces that can trigger this are already converging in the Far East.
I'm sure most of you have seen news reports on a growing concern in Asia, describing how economic growth has led to an equal increase in pollution. In this increasingly affluent part of the world - as elsewhere - the middle class is willing to pay the price for a cleaner environment, and political leaders are listening.
Moreover, as one industrialist told Fortune magazine: "People here want to go right to the latest standards."
It's true that many Asian nations have environmental laws modeled after U.S. and European regulations. But enforcement has been uneven and spotty. That too is changing.
Last December, Bangkok police began enforcing anti-littering laws, handing out fines with a zeal similar to what you might find in Singapore. Bangkok is a great city and one of my favorites. But since its littering problem had grown severe, such enforcement is a welcome move. (Now if they could just address the traffic congestion!)
My point, though, is that if easygoing Bangkok can crack down on an environmental issue, others will, too. And it may not be long before regulators look at the origin of the trash, not just the litterbugs.
We've got to get ahead of the curve in developing nations, and use what we've learned in North America and Europe. For example, while the CMA's Responsible Care program still has a way to go, it has helped change public perceptions of the chemical industry in the United States. We have an opportunity to really get ahead of that curve in other parts of the world.
Thanks to voluntary programs that emphasize outreach - to government officials, emergency-response providers and the general public - the industry has demonstrated its real concerns about safety, health and environmental issues.
Responsible Care isn't mere public relations. Its codes of management practices - covering pollution prevention, safety, product stewardship and other aspects of chemical operations - truly make participants better neighbors. Citizen advisory panels, reporting on monitoring procedures and third-party audits all contribute to trust.
Trust is the foundation of effective advocacy, which can smooth the way toward reasonable regulations. But outside of North America and Europe, few of us have a complete program in place.
So today, I'd like to suggest a couple courses of action.
First, we must adopt principles and practices similar to Responsible Care wherever we do business. The most important role that any company can play in this issue is through the work done just outside the plant gates.
Second, to ensure that regulations make economic sense - for business and a host country - we must step up our advocacy efforts. In each nation where we find ourselves doing business, it's essential that we band together and speak with one voice.
Coordinated advocacy is about the only way we can meet the challenge of a well-organized movement, which has little interest in balanced environmental regulations.
OK, these are just a few of the major economic trends and public policy issues we all face. Now I'd like to talk briefly about how individual companies might deal with investment choices and options.
A number of North American companies, for example, are trying to meet Asian demand by boosting exports. Still others are building new plants in those nations. At Chevron Chemical we're doing both.
Before I get to that, I want to sound another note of caution about the dangers of over-expansion.
Now, this might sound like a mixed message with motives less than pure. Yes, Chevron Chemical has expansion plans, and here's Sullivan urging everyone else to restrain themselves.
Well, I'd be delighted if competitors conceded markets to Chevron. I know that's not going to happen. But when I talk about the areas in which we're expanding, you'll see we're making very calculated and specific choices.
Because new plants require huge capital investments, most companies are forced to focus almost exclusively on recovering the cost of capital, which means turning out the greatest volumes possible at the lowest possible price. But this is increasingly difficult when competitors match lower costs.
Few of us are large enough to dampen and control the cycle by staking out a dominant position. And yet, forward-looking firms can use the cycle to their advantage . . . putting aside cash at the top of the cycle and using it to buy assets from marginal competitors that do not prepare well for the bottom.
Having said that, I don't believe that a company can really purchase success. There is no substitute - or superior strategy - for operational excellence.
Still, what's good for some investors is tragic for the losers, who will have destroyed value - for themselves, stockholders or citizens of a country with a national chemical company. So, as we look at these cycles and make big investments, we all must make sure that we do so in ways that minimize this risk.
Yet another strategy that's gaining favor these days - and it does help in mitigating risks - is taking part in mergers and alliances. We're seeing a lot of these in the petroleum refining and marketing sectors, and even in several upstream ventures. And they're a natural evolution in chemicals.
Multi-participant ventures are one of the few means remaining to cut cost structures. They can also allow companies to focus upon specific areas in which they do well.
That brings me to Chevron Chemical, where focusing on what we do best is a key strategy.
Ironically, most of the chemicals we're making today, and the best businesses we've got, are the result of our 1984 merger with Gulf. Frankly, Gulf had a much better handle on chemicals than did Chevron.
We got out of the fertilizer consumer products and agricultural chemicals businesses in the early 1990s, divesting about a billion dollars in assets. But we reinvested most of that money into core chemical areas in which we believed Chevron could excel. For any company that's thinking about growth in the 21st century, it's wise to stay within areas of expertise.
Our U.S. growth is driven mainly by a commitment to enhance core products growth. However, just as our Corporation has a strategy of focusing on diverse, global ventures, so too will Chemical take on more of a multi-national flavor.
Our international business now represents about 12 percent of Chevron Chemical's assets. Over the next decade, we're planning for it to reach 30 percent.
What's also important is that we've concentrated on areas in which we are a low-cost producer, and where we have the benefit of technology and operational excellence.
In this era of unpredictable cycles and compressed time, such a formula would well serve any business. The winners in the 21st century will be companies that are the most efficient and reliable suppliers. The companies that are good at quickly developing and applying new technologies. That are open to alliances and innovative ways of doing business. And, I might add, that are great companies in which to work.
For all the discussion about new plants, partnerships and such, probably the most critical thing going on within Chevron Chemical involves the human dimension of our business.
Now, I don't want to give away too much about what we think is a tremendous competitive advantage. But I will say that we've learned that we can engender great creativity and discretionary effort from our people . . . if we are all aligned with our business objectives . . . and focus on reinforcing behaviors and results that help us meet those objectives.
This is, plain and simple, once again about trust, but in this case, in the talent and dedication of our front-line employees.
And you know what? Trust has some real time-saving advantages. Late last year, Chemical brought together 120 employees from all levels, and asked them to improve job selection processes, career development programs, upward feedback and our performance review system.
Now, these are the kinds of bureaucratic issues that corporations wrestle with for months and even years. But those 120 employees came up with changes that won widespread acceptance throughout Chevron Chemical. And they did it in just three days!
It's a rare and wonderful thing when, in this accelerated world, you can actually coax time onto your own side.
In closing, I'd like to again thank you for listening to these musings. I feel like this talk has made me something of an exception to the rule of compressed time. But I do have the sincere hope that you've found a few of the observations worthwhile. Thank you.
Updated: March 1997