How has the prolonged downturn affected the chemical industry’s ratings?

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Danny Krauss:

So if you're just looking here in North America in 2025, downgrades outpaced upgrades at a ratio of nearly six to one, and that spanned both investment and spec grade companies. We also did see a few fallen angels, namely Huntsman and FMC. As a broad statement, especially chemical companies have definitely held up better than commodity producers in downturns.

Vincent Valk:

Hi, and welcome to the Chemical Week Podcast. I'm Vincent Valk. Our guest today is Danny Krauss, director of Corporate Ratings for Chemicals at S&P Global Ratings. S&P Global Ratings released its annual outlook for a chemical industry credit a few weeks ago, and I thought it would be a good time to have Danny on the show to discuss what's in the outlook and some of the key factors for the industry's financial condition in 2026. Hi, Danny.

Danny Krauss:

Hey, Vincent. How are you? Love the podcast. Thank you very much for having me on.

Vincent Valk:

Great, and thanks for joining us. So I'll start with this. I think it's no surprise to you or to probably most people listening that the industry is in a tough environment. It doesn't look like it's going to get much better through '26, and it's been in a tough environment for a while.

But how do the sector outlooks differ? I know we're in this downturn and specialty chemicals usually fare somewhat better during cyclical downturns, but this one has been especially long. We're talking two or three years now. So are there any differences in the sector outlooks and any unusual things going on there?

Danny Krauss:

Yeah. So I'd say at a very high level, rating actions have been overwhelmingly negative across both commodity and specialty chemicals. So if you're just looking here in North America in 2025, downgrades outpaced upgrades at a ratio of nearly six to one, and that spanned both investment and spec grade companies. We also did see a few fallen angels, namely Huntsman and FMC. But to your point, as a broad statement, especially chemical companies have definitely held up better than commodity producers in downturns.

Generally, they do benefit from stronger pricing power. At times, they're specced in with customers and they can cater to more niche markets. Also, they're not nearly as impacted by the significant overcapacity additions that the commodity players are contending with, particularly in China. And I'll give you this example for US producers.

So if you look at some of the large commodity petrochemical producers, they're going to end 2025 with EBITDA that's down about 50% from what many analysts expected coming into 2025. Now, compare that to the large US specialty paints and coatings producers who only saw 2025 EBITDA drop in the mid-single digit percentage area versus expectations coming into the year.

Vincent Valk:

Yeah, that makes sense. And just for clarification purposes here, for our listeners, fallen Angels, that's companies that were once investment grade and are no longer investment grade?

Danny Krauss:

Correct. In both cases of FMC and Huntsman, we lowered them from BBB- to BB+ at the time of the rating action.

Vincent Valk:

Got it. And it might be a little bit in the weeds, but you mentioned coatings. Are there any differences that you can discern in terms of the outlooks for sub-sectors and specialties? I covered specialty chemicals for a very long time, and as I'm sure you know, one of the issues with specialty chemicals is that it's kind of everything.

Danny Krauss:

Yeah. And they cater to so many different end markets.

Vincent Valk:

Exactly.

Danny Krauss:

And we can get into some end markets that are bright spots. I was listening to one of your podcasts about the 2026 themes, and you touched on AI and data centers and any companies that have been exposed to those end markets have really outperformed the overall market.

Vincent Valk:

Yeah, for sure. That's definitely a story that we'll be following this year. One of the things in the report that jumped out at me was that it looks like ratings outlooks are somewhat worse, at least for North American chemical producers than for their European counterparts, which seems a bit counterintuitive given the relative states of the industry in both regions. Granted the industry is not in great shape globally, but North America's done somewhat better than Europe. So why is it that the outlook for credit at least seems to be weaker for North American chemical producers than for European chemical producers?

Danny Krauss:

Yeah, I think there could be a couple of factors at play there. First I'd say, Europe tends to have a higher percentage of specialty chemical companies as a percent of their total coverage. Also, the charts in our report group the entire EMEA region together, which includes the Middle East companies. So we expect those companies to continue to benefit from being in the lowest cost region and in certain instances, they get uplift from potential government support.

Vincent Valk:

The government support angle there is interesting because another big thing that I think we're going to be following a lot this year is industrial policy. Such an important aspect of the industry that really was not on anyone's radar five or 10 years ago. Anyway, back to the regional point. Are there any other notable regional differences in the outlook?

Danny Krauss:

Yeah. So I mentioned the Middle Eastern producers benefiting in cases from government support. I'd say the same can be said for some of the producers in APAC, particularly China. So in certain commodities their variable margins have been negative for several years running, but the government is providing financial support in an effort to progress towards some of their self-sufficiency targets and to keep their labor employed.

I think if we're talking about cost positioning by region, despite some of the short-term headwinds we saw in January with the spike in natural gas prices, which was driven by some of the weather issues, we would still expect US producers to hold their position towards the lower end of the cost curve compared to the more NAFTA-based European and Asian producers. We do expect some narrowing in the oil-to-natural gas ratio in 2026 versus where it had been in the past few years when it was elevated.

But we think the US is going to continue to remain cost-advantaged, trailing only the lowest cost region in the Middle East. And if you look at our current oil and gas price deck, we would expect that the Brent oil-to-Henry Hub natural gas ratio to average around 15x over the next few years, which should continue to support the US cost advantage.

Vincent Valk:

Yeah. That obviously has been the big tailwind for the US industry for some time. In the report you said that you expect some very mild earnings improvement this year driven mostly by cost-cutting initiatives. To what extent is this really about cost-cutting? And how much room is there for chemical makers to cut costs even further, given that we've already seen multiple rounds of restructuring efficiency initiatives that, pick whatever term you want to call it, we've already seen this play out quite a bit in recent years?

Danny Krauss:

Yeah, we've seen a lot of cost reduction initiatives spanning both commodity and specialty chemical producers. I'd say if you look at our report in aggregate globally, we're projecting mid to high single-digit percentage median EBITDA growth in 2026 and 2027. If you look specifically at the petchem producers, this growth is essentially all coming from cost-cutting.

So our base case is that the petchem sector earnings troughed in 2025, but for that to truly occur, it's imperative that companies deliver on these cost savings initiatives. Now, there are a couple of bright spots in terms of some sub-sectors that could drive growth, which we can touch on in a little bit. I'd say there's probably some room to cut costs further.

Vincent Valk:

Yeah, for sure. You mentioned in the report also the forecast calls for sustained improvement in operating rates and margins starting in 2028. Leaving aside the fact that that still is a couple of years out, what is the rationale for expecting that to happen on that timeline? And is there a case that the trough could last even longer than that?

Danny Krauss:

Yeah, so I'll preface this with saying that many in the industry have continued to be surprised to the downside over the last couple years. If we were recording this podcast a couple years ago, I think many would've thought that the worst of this was behind us by now. But clearly that hasn't played out. But maybe I'll take ethylene as a key example. You can look at our colleagues at S&P Energy whose assumptions are that operating rates actually modestly drop further in 2026 and 2027 as new supply additions primarily coming in China continue to outpace demand growth.

So the current forecast is that operating rates should start to improve in 2028, but that recovery will be modest at best. The key driver there is that that's the first forecasted year that we're projecting global demand growth will exceed new supply additions. We've also seen some announcements of permanent capacity closures and strategic review of assets accelerate in 2025, and we would anticipate further actions to come in 2026. But as you know, between announcement and when the capacity actually comes offline is going to take some time, particularly if you're talking about some of the larger integrated facilities and ones in Europe.

Bottom line is we think a lot more capacity rationalization is needed. The industry is just so oversupplied with how much capacity has come online this past decade. You combine that with the fact that while China's GDP is growing in that 4 to 5% range, final investment decisions were made on some of these China facilities when their GDP was expected to grow well north of these numbers. So demand, while growing, is much lower than we had previously expected. So if you assume operating rates in the industry need to get into that mid to high 80% range to signal a more healthy operating environment, S&P Energy doesn't have ethylene getting back there before the end of this decade.

Vincent Valk:

So that's almost a case that it could last beyond 2028.

Danny Krauss:

Yep. The can has been kicked down the road several times now, and visibility remains very limited in the industry. We hear that across the spectrum of companies. So yeah, there definitely is some downside risk to that modest improvement in rates numbers, I'd say a lot of that is contingent on additional capacity closures coming to market.

Vincent Valk:

Yeah. So you mentioned capacity rationalization. Obviously, that's been a really big story in Europe and we've also seen some stuff in Japan and South Korea. Do you anticipate that it's still mostly going to be those regions because of the cost advantage in North America and even more so the Middle East? Or do you think that maybe we would start to see some of that particularly in the Americas?

Danny Krauss:

I'd say our base case is the bulk of capacity rationalization is going to happen in Europe and APAC outside of China. We think China is going to continue to move full speed ahead with their self-sufficiency initiatives. And like I said, many of these facilities haven't been making money for several years, but they continue to operate because the government is providing financial support to many of these companies.

Some of them are state-owned enterprises. So yeah, I would expect APAC and Europe are going to remain the higher cost regions and we think Japan, Korea, and various countries in Europe are going to bear the brunt of the capacity rationalization.

Vincent Valk:

Yeah. So already I've seen that playing out, I suppose. And there's just one more thing on China, just to hold on this before we move to the next one. We've seen some talk in recent months of the phrases they use is anti-involution of shuttering older capacity that is maybe not profitable in China. Is that playing a role in your forecast at all? Or is it a situation where net-net, even if China does shut some old plants, they're still bringing so much online that capacity is being added overall, is probably the way to put it?

Danny Krauss:

Yeah, I would still expect capacity additions to far outweigh any reduction, particularly in China. A lot of the older facilities that have been mentioned as potential closure candidates are much smaller in size, so it takes a bunch of them to actually move the needle compared to these world scale facilities that they're bringing online.

And in conversations with our colleagues that work out in APAC, look, on paper, the anti-involution push is a step in the right direction. They're acknowledging some of the issues that the industry is facing, but let's see it get put into practice first before seeing that it's going to move the needle too much.

Vincent Valk:

Yeah, that's true. Right now it's more talk than anything else. So I want to shift to demand now and demand in key end markets looks flattish, maybe some very modest growth or relatively small declines too, but flattish overall. What are the key upside and downside risks for demand? Are the risks weighted to the downside? I know you mentioned earlier in the conversation some potential bright spots, so where are the risks weighted?

Danny Krauss:

So maybe I'll start with the negative and I'll end with the positive on this question. So yes, risks definitely are our way to the downside, and this is really evidenced by over a third of the companies here in North America are on CreditWatch negative or carry a negative outlook, signaling further downside pressure at the rating. And we have very few companies on positive outlook or CreditWatch positive here in North America. Say here in the US, downside risks could emerge if the US cost advantage erodes with a sustained increase in natural gas and ethane prices.

We mentioned demand hasn't been great, but it's been chugging along. So anything that knocks that off pace, if any of the key regions dip into a recession, that's a clear downside risk. And I was just looking at his last publication and our economist puts the probability of a recession here in the US over the next 12 months in the 25 to 30% range. So clearly a bunch of downside risks. And we talked about all the oversupply in certain sub-sectors, particularly the commodity part of the spectrum.

Going to the positive and the bright spots, like I mentioned, anything that's tied to AI and data centers, so products that go into chips, semiconductors, electronic chemicals, they've really grown at multiples of the sector average. Fertilizer producers have proved to be relatively resilient over the last couple of years. Also, we've had a couple of companies like Air Products mention aerospace has held up pretty well too. As many people know, a lot of these companies are exposed to building and construction.

So to the extent we see a drop in mortgage rates spurring an improvement in the housing market, that could be a catalyst for some upside, though that's not really in our base case forecasts currently. And lastly, I'd say it appears inventories at the customer level have been run pretty lean. So to the extent that customers gain confidence in an improvement in the macro picture, any restocking effect would be a boost for chemical manufacturers.

Vincent Valk:

Sure, that makes sense. And finally, want to ask a little bit about the purely more financial side of things. Your report talked a bit about the potential for more debt restructurings by issuers on the lower end of the rating spectrum. Do you have a sense of the investor appetite for these kinds of deals, especially considering the persistently weak operating conditions that we've been talking about and on the financial side of things, just a general sense of volatility and uncertainty in financial markets? I imagine it would be a pretty heavy lift for any company, especially a company with lower credit rating that wants to go out there and try to restructure their debt.

Danny Krauss:

Yeah, absolutely. These out-of-court restructurings have really taken off across corporates in recent years. Some of the positives for these out-of-court restructurings and why it can be appealing are that they tend to be cheaper, there are lower legal and advisor fees and it's, in many cases, a much faster close avoiding bankruptcy court.

I would say some of the challenges are it requires high cooperation from the creditors, just a few holdouts could impact the ability to get something done. It definitely can be tougher for companies with complex capital structures. And then last point, in many cases, these out-of-court restructurings lead to less deleveraging than going through bankruptcy. So it's essentially the company's really kicking the can down the road to the future.

Vincent Valk:

But I guess, if we have seen more of these, there is an investor appetite for them and assuming that is the case, why is there an investor appetite for them?

Danny Krauss:

So there has been, in North America, one or two in the past year that I can think of. I think the investor appetite centers around: it's faster, it's cheaper. If you have a concentrated number of creditors, it's a bit easier to get done. This can get done in the matter of weeks. In some cases, maybe one or two months compared to bankruptcy filings with entering Chapter 11, which could take months or even years in more complex situations.

Vincent Valk:

Got it. Well, certainly a lot to keep track of in 2026. Thanks very much for your time, Danny.

Danny Krauss:

Great. Thanks for having me, Vincent.

Vincent Valk:

And this is Vincent Valk signing off for Chemical Week.