The Plastic-Bag Paradox; Despite Cheap Natural Gas, Raw-Materials Prices Remain High

September 5, 2013, 8:15 p.m. ET

The Plastic-Bag Paradox

Despite Cheap Natural Gas, Raw-Materials Prices Remain High

JAMES R. HAGERTY

MK-CG068A_PLAST_G_20130905175712

LOGAN TOWNSHIP, N.J.—Heritage Bag Co., which makes plastic trash bags around the clock at a factory here, should be sitting pretty. Heritage’s main raw material, polyethylene, is derived from natural gas. As the U.S. ramps up production of gas released from underground shale formations, output of polyethylene is expected to soar too, creating the potential for lower prices. “I think it’s our duty to use this gift of shale gas to rebuild our industrial infrastructure,” says Jim Morris, a bluff Texan who serves as chief operating officer of privately owned Heritage.There’s just one problem: Heritage and other U.S. users of polyethylene—makers of plastic bags, toys, housewares and myriad other items—aren’t benefiting yet. They may not benefit for years and can’t be sure it will fundamentally change the economics of their businesses.

Despite the shale boom, the price of polyethylene in the U.S. has generally risen over the past few years. The type Heritage uses typically costs around 75 cents a pound, up from an average of 64 cents in 2010, according to IHS Inc., a research firm.

Polyethylene makers, such as Exxon Mobil Corp. XOM -0.47% and Dow ChemicalCo., DOW +1.67% are enjoying lower costs because higher natural-gas production increases the supply of ethane, a component of natural gas used to make polyethylene. Instead of passing on lower costs to their customers, however, they are reporting fatter profit margins.

First-half earnings before interest, tax, depreciation and amortization in Dow’s performance plastics division, which makes polyethylene, were up 33% from a year earlier.

The polyethylene producers are making “insane amounts of money,” Mr. Morris. He isn’t, he says.

Dow Chemical’s chief executive, Andrew Liveris, two years ago published a book called “Make It in America,” suggesting ways to revive American manufacturing. Now, says Mr. Morris of Heritage, Mr. Liveris has a chance to “put his money where his mouth is.”

Enlarge Image

 

 

Misty Keasler for The Wall Street Journal

Heritage Bag, based in Carrollton, Texas, runs six U.S. plants and has annual sales of more than $400 million.

Mr. Morris argues that Dow and other chemical makers should try to ensure that the shale boom will lead to more U.S. output of finished plastic goods, such as the trash bags made by Heritage, rather than just more exports of polyethylene to his overseas rivals.

In recent years, polyethylene prices have been higher in the U.S. than in Asia, where big chemical companies from both the Middle East and the U.S. battle for market share. Mr. Morris would like a promise from Dow and other polyethylene makers that their customers in the U.S. won’t have to pay more than customers in other parts of the world. So far, he hasn’t received such pledges.

A Dow spokeswoman declined to comment on Mr. Morris’s suggestion but said the shale boom is “a once-in-a-lifetime chance for the U.S. to regain its competitiveness in manufacturing.”

Polyethylene accounts for around 70% of the cost of making a plastic bag; the other main costs include labor and electricity.

Heritage, based in Carrollton, Texas, has annual sales of more than $400 million and bills itself as one of the world’s largest makers of plastic trash bags used by restaurants, stadiums and other institutional customers. With six plants scattered around the U.S., Heritage employs about 750 people.

Heritage’s plant here in Logan Township, N.J., smells faintly of melting plastic. Polyethylene pellets arrive via a railroad line alongside the plant. The pellets are pumped through tubes into silos and later into the factory, where they are melted in an extruder. Blasts of air blow the molten plastic into a bubble that resembles a giant cigar, rising 10 yards or more. The plastic solidifies into a film as it cools; then it is shaped and sliced into trash bags.

Workers in shorts and T-shirts tuck the bags into boxes and load pallets for shipment. The plant also provides jobs for managers and machine-maintenance people, among others.

Heritage and other U.S. users of polyethylene eventually will get lower prices, once new production capacity is completed in 2016 and beyond, predicts Nick Vafiadis, a senior research director at IHS.

Dow, Royal Dutch Shell RDSA -0.14% PLC and others plan to spend billions of dollars to expand U.S. production of petrochemicals, including polyethylene. Mr. Vafiadis forecasts that U.S. polyethylene capacity will rise more than 30% by 2018 and nearly 60% by 2023.

Most of that increased production will be exported, Mr. Vafiadis believes, but he expects U.S. buyers like Heritage will benefit too.

Mr. Morris says Heritage would like to expand its U.S. production capacity and increase its exports, currently small. But that could happen only if Heritage is convinced that its polyethylene costs will be globally competitive.

The U.S. is already a big exporter of polyethylene and other resins, made from oil or natural gas, but has a large trade deficit on plastic products, such as bags and packaging film, made out of those resins. The deficit totaled $2 billion in this year’s first half.

Heritage’s Mr. Morris says imports of the types of trash bags his company makes are fairly small. But Chinese and other Asian companies account for around one-third of the market for plastic shopping bags often used at grocery and other retail stores, despite import duties imposed by the U.S. on those bags.

Stanley Bikulege, chief executive of Hilex Poly Co., a big U.S. maker of plastic shopping bags, says he believes the shale boom will help make Hilex more competitive by holding down raw material costs. Hilex mainly focuses on its home market but is looking at the possibility of more exports. “Is [exporting] a huge opportunity for us?” Mr. Bikulege says. “Probably not.”

William Carteaux, chief executive of the Society of the Plastics Industry, a trade group, says he sees scope for greater U.S. exports of products containing plastic, including auto parts and such health-care items as blood bags and catheters.

At IHS, Mr. Vafiadis sees a “renaissance” in the U.S. plastics industry.

For Mr. Morris, however, it is too early to celebrate. Before embarking on expansion plans, Heritage is waiting for assurances on raw-material costs.

“Entrepreneurs will take risks if there’s a clear path to the payoff,” he says.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: