For most of the past 20 years, the chemicals industry has generated returns above those of the broader capital markets.1 However, after reaching record heights during the COVID-19 pandemic, the chemicals industry may be facing a new era: global indexes have increased 24 percent per year since late 2022, while chemicals stocks grew less than 2 percent per year over the same period.2
It remains uncertain whether the current dynamics will lead to a return to the cycles that the industry experienced over the past several decades or whether the factors behind today’s conditions—overbuilt capacity, high energy prices, regionalization, inflation, workforce and demographic shifts, and new regulations—represent lasting structural changes that will reshape the chemicals industry.
In this article, we take our annual look at the chemicals industry’s performance and the factors that may be influencing its current trajectory. We also propose questions that industry stakeholders could consider as they navigate today’s competitive landscape—one that calls on companies to focus more on innovation and make bolder moves.
A new period for the chemicals industry
In previous articles,3 we outlined the reasons why the chemicals sector outperformed the broader market over the past 20 years: demand growth in Asia, improvements in productivity, access to new feedstocks such as shale gas, and favorable positioning in the value chain. A closer look shows that the strongest performance occurred in the 2008–11 and 2015–17 time periods and also during the COVID-19 pandemic. The period from 2003 to 2021 delivered total shareholder returns of 11 percent per annum; ROIC increase to 14 percent, from 8 percent; 5 percent top-line revenue growth per year; and a seven- to tenfold multiple expansion (EV/EBITDA FY+2).
But for many chemicals executives, the years since 2022 have been the most challenging of their careers. Reversing the long-term trend, the chemicals sector has underperformed the broader stock market (exhibit).
Part of this outcome is attributable to steep share price declines (–12 percent per year) among Chinese-listed chemicals companies and to global indexes being buoyed by outperforming tech companies. Even when adjusting for these factors, the gap remains.
The forces contributing to the industry slowdown
There are several potential reasons—with both short- and long-term reach—for the chemicals industry’s lagging performance.
The following are among the short-term drivers:
- Energy prices in Europe (chemical companies based in Europe account for almost 30 percent of our sample set) remain higher than in prepandemic years.
- The pandemic depleted chemical stockpiles, which then needed to be replenished. This destocking and restocking cycle, compounded by pandemic-driven supply chain issues, magnified short-term market fluctuations.
- Interest rates and inflation, which affect many demand centers for chemicals, such as the construction, automotive, and consumer-packaged-goods industries, slowed chemical growth.
We see early signs that these factors, and the near-term pessimism they likely triggered, could be easing. But the industry’s performance remains significantly below its previous trajectory.
Over the long term, several structural factors point to lower-than-historical returns for the chemicals industry:
- The industry is reaching the limits of linear demand growth. As GDP grows, chemical consumption typically matches or exceeds the rate of growth.4 But as economies mature, this correlation weakens, and the curve flattens. An increasing share of high-growth regions is arriving at the flatter part of this curve. In addition, some developed regions face GDP and chemicals industry declines due to demographic changes, energy prices, and regulatory changes.
- Capacity additions often led by state-owned enterprises far exceed demand growth, especially in Asia. As an example, in the five years between 2023 and 2028, China is expected to add more than 20 million tons of annual capacity in polyethylene, while its annual demand is expected to increase by less than 10 million tons. The country’s accelerated drive for self-sufficiency, fueled by economic and geopolitical forces, may significantly change trade flows in many value chains. The effect of this shift is nuanced and depends on the interchangeability of product grades, shipping economics, and tariffs. It nevertheless has, in general, depressed global capacity utilization rates and industry margins outside China. Meanwhile, regions with cost-competitive petrochemical feedstocks, such as the United States and the Middle East, have also continued to increase capacity and production, putting pressure on industry margins, especially in Europe.
- Fundamental innovation appears to have stalled, and many products are commoditizing faster than before: the traditional strategy of end-market application tailoring has become increasingly competitive. One reason for this is that chemical companies have gotten closer to their customers but not necessarily to their end markets. They have focused more on incremental innovation, rather than on designing transformative solutions that address unmet needs for end users and command higher margins.
- A changing regulatory environment, especially in Europe and the United States, adds another layer of complexity. New regulations have affected compliance costs and companies’ operational strategies. Carbon taxes and land use regulations have put pressure on industries, further impacting domestic demand.
All of these factors have led investors to lower their long-term expectations. EBITDA multiples dropped to 7.6-fold in 2023, from 10.5-fold in 2021.5
How chemical companies can create value in an uncertain world
Despite increased competitive pressure, moderating industry demand, and geopolitical and regional change, chemical companies can continue to capture significant value if they take the right steps. The following five actions will be critical.
Prepare for growth without overextending on costs or losing discipline on inventory
Inventory levels have fluctuated wildly over the past five years. Demand could increase in the coming quarters: some experts expect the destocking and restocking cycle that has worked against the industry to temper. But companies may be wise to maintain tight controls on costs and inventory because even with expected short-term growth, long-term demand will likely moderate. This situation presents a unique challenge to chemicals executives, who should seek to properly time growth and production to these trends. In any case, efforts to maximize variable costs relative to fixed costs should be seen as no-regrets moves.
Continue to invest in innovation
Leading chemical companies have consistently developed distinctive solutions that accelerate and enable broader megatrends. These solutions have included pioneering lightweight materials in automotive applications, enabling miniaturization in electronics, and extending shelf life in food packaging. The ability to identify and invest in innovations has proven to be a key differentiator for outperformers in this sector.
Today, leading companies are working with their customers and other stakeholders to offer solutions in promising areas such as recycled materials, the microbiome and personalized nutrition, carbon removal, and advanced water purification. Additionally, the energy transition and the burgeoning climate technology sector are spurring innovations in the hydrogen economy (for example, advanced membranes and storage materials), water treatment solutions (for example, advanced filtration and bioprocessing), and next-generation batteries (for example, sodium solid state and sulfur cathodes).
While these pools are structurally attractive because of their high growth potential and high margins, companies should make a realistic assessment of their starting point and abilities before jumping in: history abounds with examples of companies that delved into exciting areas without a clear advantage, destroying shareholder value.
Chemical companies could do well to boldly reallocate capital toward areas in which they are uniquely positioned to create value. The typical process of surgical budget realignments is unlikely to suffice. For some companies, this may mean making hard choices—but such moves can strengthen their position in areas where they have unique competencies.
Prepare for structural shifts in select chains
Market environments such as these often spur waves of consolidation, and we believe that there are ample instances of chemical companies with complementary skills and joint value creation potential. In chemicals, we have seen large-scale M&A propel outsize returns in the past. It seems reasonable to assume that in a context where key value pools are eroding, competition is intensifying, and customer demands are ever changing, industry consolidation—at least in some chains—might be the result.
Leverage technology to change business
In chemicals, as in all industries, digital innovations and technology are fundamentally changing business models and value pools. Generative AI (gen AI) is beginning to make an impact on back-office, supply chain, and commercial functions in many chemical companies. However, there are some chemicals-specific use cases for technology that could transform the industry in the coming years:
- Gen AI-enabled R&D, especially in materials discovery, process optimization, materials optimization, and formulation optimization. In the past, computational materials science felt like science fiction, confined to university laboratories and with limited potential for real-world impact. Now, recent advancements in gen AI, machine learning,6 and low-cost computing are allowing a rapid acceleration of breakthroughs in R&D. In the past five years, computational tools have led to the discovery, without benchtop experimentation, of millions of alloys, crystals, and molecules, many of which are expected to have commercially useful properties.
- Technology-enabled commercial growth. Gen AI opens completely new avenues to commercial growth through gen-AI-assisted lead generation, new market identification, and new cross-sell opportunities. For example, through the use of newly developed AI tools that suggested new applications for its products and new customer leads, a leading chemicals company identified a pipeline two to three times its current business and is expecting a 10 to 20 percent real revenue increase as a result.
- Technology-enabled operations excellence. Technology-enabled improvements in operations have not yet been exhausted. We often see at least 5 to 10 percent efficiency increases in productivity in chemical production facilities after companies adopt advanced analytics, sensor technologies, and predictive maintenance improvements.
Rethink engagement across geographies
Previously, chemical companies chose to expand globally primarily by investing in China, Thailand, and other Asian markets and by locating back-office work in low-cost countries. This approach is now outdated: investors are looking for the next wave of value creation while navigating geopolitics. Chemicals executives should therefore ask themselves the following questions about their geographic strategy:
- How can we identify and capture the next big growth markets?
- How can we ensure our supply chain is resilient to geopolitical shifts?
- How can we participate in Asian markets, particularly in China, at an acceptable return while managing geopolitical risk, local-market demand shifts, and intellectual property (IP) challenges?
- How should changes in European manufacturing—tightening regulation, changing local demand and demographics, and increasing energy costs—affect our strategy?
- How can we identify and mitigate our risks from natural disasters such as droughts, floods, and storms?
- Where should we place R&D and engineering hubs given trade-offs among countries in talent supply, cost, and strength of IP protection?
Although uncertainty exists, addressing these questions will be critical as management teams align on footprint decisions, which can last generations.
Chemical companies today face a more volatile and uncertain landscape. Companies may need to consider a much wider set of scenarios when testing strategic and operational decisions. They may benefit from commitments to innovative markets that play to their strengths, but they will need conviction in their strategy. While long-term growth may slow for the chemicals industry, bold and innovative companies should still be able to capture value.
