This is part one of my interview with Dow Chemical's (DOW, Financial) CEO Andrew Liveris. In this part we talked about oil, natural gas and how the JV strategy will effect their impact on Dow.
Hello Mr. Liveris
Andrew:
Hello Todd, nice to finally put a voice to the blog. Todd its been great reading your pieces......you track us very closely.
Todd:
Thank you. In full disclosure, I have been a shareholder for a few years now and quite a bit of my sons educational accounts is in Dow stock so I'm hoping you allow us to send them to the private school of our choice, not forced to a state one.
Andrew:
(laughing) I'm in I'm in. This is one of the nations core issues, but we won't get into that I know we have limited time. You have very thoughtfully put together some questions forward.
Todd:
Yea...let's get started..
Todd:
With the move in production to low cost nations underway, do you see a day when $125 oil and $12 nat gas become earnings drivers for the company as the price increases you are able to push on are in excess of input price increases? For example, say I make finished OJ. If the prices of oranges are going up, so are the prices of finished OJ. But, if I partner with an orange farmer, my input prices do not rise (or if they do, at a fraction of those buying oranges from the farmer), but I am then able to either increase my OJ prices along with other producers, OR become the low cost seller to increase market share. Does the analogy hold for Dow down the road?
Andrew:
It has been an interesting phenomenon as I have watched it rise since I got appointed. I almost feel like it's a job index, you know years in office and years of oil price rises. I don't think I've seen a decline except momentarily early last year.
Nat. gas is a US regional issue but will probably become a world issue but right now its still a US regional issue. Oil though is a world issue, and to your question then, if you have rising oil prices that are global in nature and all of its derivatives and they go up steadily then your point comes true. In essence for us it actually becomes a reason to raise prices but that is only as good as the consumer's ability to take those prices. Unlike the 70s, which was the last time this really all occurred this time around we have the Chinese consumer, and frankly that actually adds some optimism that we should be able to as a globe pay more for these precious resources in the value chain.
Now, you can't do it overnight otherwise you will kill the consumer, but over a period of time steadily rising inputs with strong new demand from places like China and other places (India, Middle East, Europe etc) then I think margin recalibration of a high oil price input all the way through the value chain including our part becomes very, very reasonable. Actually, the margin expansion which happened in the 70's, Dow had a whole philosophy back then if you go back and track it called Reinvestment Pricing. Others used the acronym RIP and they were having fun with us. {laughter} It really was the same scenario but at that time the buoyant demand was more the US and that actually became the big problem as it created inflation and stagflation.
But this time around we have China so there is a chance your scenario will come to pass as long as it is not surging or a surge up and then a surge down which creates volatility.
Todd:
When you make the move to the Kuwait and Saudi ventures, do you see a significant input price drop on Dow's part?
Andrew:
Well the Kuwait venture and the Saudi projects. Yes, I mean look firstly what we do there is we take advantage of natural gas prices way below world price and where you can see from our financials we are already making a lot of money in equity income from that. That is because those countries have said "I want to diversify our economies away from just oil and gas".
We are a great diversification hedge for them, that is why they are prepared to give us low input prices way below world price, way below US price for sure. On oil, OK the key for us there is I'd like to call it the Exxon model. I mean Exxon (XOM), which is almost like nation-state in its own right, they basically take oil at world price or they produce it at cost and when they distribute in their production systems. They are efficient allocators of resource to petro-chemicals to fuels of all sorts not just gasoline and they run their whole machine for profitability which means that net net their input costs of petro-chemicals is lower because they run the whole machine. Now with Kuwait Petroleum and with Saudi Armco that is exactly the model we're building.
We're building a refinery integrated petro-chemical model where the owners of the oil, Kuwait and Saudi Arabia respectively will be able to efficiently allocate the oil within that entire machine and of course we're a half owner the shareholders will benefit from oil integration so two physical hedges the gas one which is the stranded nat. gas with nation states that want to value add the gas vs burn it and second, refinery and oil integration with nation states who have oil who want to diversify away from just exporting the oil or who want to take the oil to places like China and want to participate in refineries and petrochemicals there.
Those are great physical hedges for the Dow Chemical Co. not well understood by the investment community. We're working really hard to make them understand it and you know the icing on the cake is that we got paid $9.5 billion for that privilege.
Todd:
So, you anticipate 2010 is the year those JV's (Kuwait and Saudi Arabia) should be up and running. ?
Andrew:
We are being conservative Todd. My recent investor presentation I showed 2011/2012 because stuff happens you know, TPC contracts capital costs etc. We're pretty good as project managers and so are our partners so conservatively we are saying 2011/2012.
Part 2: US energy policy
In this section Mr. Liveris and I discuss US energy policy (or lack thereof) and
Todd:
US energy policy. I had several questions planned here but you have been all over TV the last week and a half answering them for me..
Andrew:
(Laughing) And I am not done yet, I am determined to shake this all loose because we are just shooting ourselves in the foot very effectively as a nation.
Todd:
There was an "American Energy Production Act" Senate Republicans just introduced recently, have you seen it?
Andrew:
The drilling one right?
Todd:
Yes, they said it would produce an estimated 24 billion barrels of oil a day and 47 trillion cubic feet of nat. gas.
Andrew:
Certainly the bill recognizes the problem. It is a Republican bill and certainly I appreciate Senator Domenici's work on it. However, the country need a bill both Democrats and Republican can support
I was in Washington yesterday and I had meeting after meeting. I actually think I might get deported here eventually [laughter] . You know I'm just screaming from the rooftops to get real with our energy policy.
Todd:
Let's say you left Washington and they said "this guy is right, let's do everything he said we should". Even if they did that and they started at the earliest next spring, after the election, what kind of lag based on your experience is it 2 years, 5 years before anything they do now actually takes hold and excess production comes online.
Andrew:
Well we went through this in 2005 with the Lease Sale 181 in the inter-continental shelf of the US. The US gulf we were told that time and I think this is still very true that there are some known fields of oil and gas that can easily be tapped into current infrastructure especially on the US gulf they could be on the street in 12-18 months. Not as big as the numbers you just quoted, because on the outer edge that would be Anwar and that could be as far away at 4-5 years because of the pipeline.
We take a window and if you said "let's go now" I think the earliest is 18 months and the latest is five years. But something else happens which is very important. The world as speculators look at supply very differently. We have a real supply issue because demand is surging and everyone thinks that there is not enough supply. Supply is bottle-necked in two places. One is availability of actual oil and gas of course in our Country we're not accessing it and it will take 18 months to five years to accomplish that. Overseas its ships and freight and there are not enough ships on the water to get all this oil to everyone to get all this gas to everyone. So that's one bottleneck.
The second bottleneck is refining capacity which as you know this country won't permit refineries. I think the only one under construction today is Valero's (VLO) in Texas. No one wants a refinery in their back yard. So you have this ridiculous situation of Reliance building the world's largest refinery in India and all the products are for exporting to the United States.
So those two bottlenecks will take several years, if you take those two bottlenecks out by passing laws, I think there will be an instantaneous reaction to price.
Hello Mr. Liveris
Andrew:
Hello Todd, nice to finally put a voice to the blog. Todd its been great reading your pieces......you track us very closely.
Todd:
Thank you. In full disclosure, I have been a shareholder for a few years now and quite a bit of my sons educational accounts is in Dow stock so I'm hoping you allow us to send them to the private school of our choice, not forced to a state one.
Andrew:
(laughing) I'm in I'm in. This is one of the nations core issues, but we won't get into that I know we have limited time. You have very thoughtfully put together some questions forward.
Todd:
Yea...let's get started..
Todd:
With the move in production to low cost nations underway, do you see a day when $125 oil and $12 nat gas become earnings drivers for the company as the price increases you are able to push on are in excess of input price increases? For example, say I make finished OJ. If the prices of oranges are going up, so are the prices of finished OJ. But, if I partner with an orange farmer, my input prices do not rise (or if they do, at a fraction of those buying oranges from the farmer), but I am then able to either increase my OJ prices along with other producers, OR become the low cost seller to increase market share. Does the analogy hold for Dow down the road?
Andrew:
It has been an interesting phenomenon as I have watched it rise since I got appointed. I almost feel like it's a job index, you know years in office and years of oil price rises. I don't think I've seen a decline except momentarily early last year.
Nat. gas is a US regional issue but will probably become a world issue but right now its still a US regional issue. Oil though is a world issue, and to your question then, if you have rising oil prices that are global in nature and all of its derivatives and they go up steadily then your point comes true. In essence for us it actually becomes a reason to raise prices but that is only as good as the consumer's ability to take those prices. Unlike the 70s, which was the last time this really all occurred this time around we have the Chinese consumer, and frankly that actually adds some optimism that we should be able to as a globe pay more for these precious resources in the value chain.
Now, you can't do it overnight otherwise you will kill the consumer, but over a period of time steadily rising inputs with strong new demand from places like China and other places (India, Middle East, Europe etc) then I think margin recalibration of a high oil price input all the way through the value chain including our part becomes very, very reasonable. Actually, the margin expansion which happened in the 70's, Dow had a whole philosophy back then if you go back and track it called Reinvestment Pricing. Others used the acronym RIP and they were having fun with us. {laughter} It really was the same scenario but at that time the buoyant demand was more the US and that actually became the big problem as it created inflation and stagflation.
But this time around we have China so there is a chance your scenario will come to pass as long as it is not surging or a surge up and then a surge down which creates volatility.
Todd:
When you make the move to the Kuwait and Saudi ventures, do you see a significant input price drop on Dow's part?
Andrew:
Well the Kuwait venture and the Saudi projects. Yes, I mean look firstly what we do there is we take advantage of natural gas prices way below world price and where you can see from our financials we are already making a lot of money in equity income from that. That is because those countries have said "I want to diversify our economies away from just oil and gas".
We are a great diversification hedge for them, that is why they are prepared to give us low input prices way below world price, way below US price for sure. On oil, OK the key for us there is I'd like to call it the Exxon model. I mean Exxon (XOM), which is almost like nation-state in its own right, they basically take oil at world price or they produce it at cost and when they distribute in their production systems. They are efficient allocators of resource to petro-chemicals to fuels of all sorts not just gasoline and they run their whole machine for profitability which means that net net their input costs of petro-chemicals is lower because they run the whole machine. Now with Kuwait Petroleum and with Saudi Armco that is exactly the model we're building.
We're building a refinery integrated petro-chemical model where the owners of the oil, Kuwait and Saudi Arabia respectively will be able to efficiently allocate the oil within that entire machine and of course we're a half owner the shareholders will benefit from oil integration so two physical hedges the gas one which is the stranded nat. gas with nation states that want to value add the gas vs burn it and second, refinery and oil integration with nation states who have oil who want to diversify away from just exporting the oil or who want to take the oil to places like China and want to participate in refineries and petrochemicals there.
Those are great physical hedges for the Dow Chemical Co. not well understood by the investment community. We're working really hard to make them understand it and you know the icing on the cake is that we got paid $9.5 billion for that privilege.
Todd:
So, you anticipate 2010 is the year those JV's (Kuwait and Saudi Arabia) should be up and running. ?
Andrew:
We are being conservative Todd. My recent investor presentation I showed 2011/2012 because stuff happens you know, TPC contracts capital costs etc. We're pretty good as project managers and so are our partners so conservatively we are saying 2011/2012.
Part 2: US energy policy
In this section Mr. Liveris and I discuss US energy policy (or lack thereof) and
Todd:
US energy policy. I had several questions planned here but you have been all over TV the last week and a half answering them for me..
Andrew:
(Laughing) And I am not done yet, I am determined to shake this all loose because we are just shooting ourselves in the foot very effectively as a nation.
Todd:
There was an "American Energy Production Act" Senate Republicans just introduced recently, have you seen it?
Andrew:
The drilling one right?
Todd:
Yes, they said it would produce an estimated 24 billion barrels of oil a day and 47 trillion cubic feet of nat. gas.
Andrew:
Certainly the bill recognizes the problem. It is a Republican bill and certainly I appreciate Senator Domenici's work on it. However, the country need a bill both Democrats and Republican can support
I was in Washington yesterday and I had meeting after meeting. I actually think I might get deported here eventually [laughter] . You know I'm just screaming from the rooftops to get real with our energy policy.
Todd:
Let's say you left Washington and they said "this guy is right, let's do everything he said we should". Even if they did that and they started at the earliest next spring, after the election, what kind of lag based on your experience is it 2 years, 5 years before anything they do now actually takes hold and excess production comes online.
Andrew:
Well we went through this in 2005 with the Lease Sale 181 in the inter-continental shelf of the US. The US gulf we were told that time and I think this is still very true that there are some known fields of oil and gas that can easily be tapped into current infrastructure especially on the US gulf they could be on the street in 12-18 months. Not as big as the numbers you just quoted, because on the outer edge that would be Anwar and that could be as far away at 4-5 years because of the pipeline.
We take a window and if you said "let's go now" I think the earliest is 18 months and the latest is five years. But something else happens which is very important. The world as speculators look at supply very differently. We have a real supply issue because demand is surging and everyone thinks that there is not enough supply. Supply is bottle-necked in two places. One is availability of actual oil and gas of course in our Country we're not accessing it and it will take 18 months to five years to accomplish that. Overseas its ships and freight and there are not enough ships on the water to get all this oil to everyone to get all this gas to everyone. So that's one bottleneck.
The second bottleneck is refining capacity which as you know this country won't permit refineries. I think the only one under construction today is Valero's (VLO) in Texas. No one wants a refinery in their back yard. So you have this ridiculous situation of Reliance building the world's largest refinery in India and all the products are for exporting to the United States.
So those two bottlenecks will take several years, if you take those two bottlenecks out by passing laws, I think there will be an instantaneous reaction to price.
