Middle East Geopolitical Tensions Drive Chemical Profit Divergence: Upstream Recovery vs. Downstream Pressure

Upstream & Midstream Raw Materials: Cost Shocks Transformed into Profits, Gross Margin Elasticity Unleashed

Amid cost volatility caused by the current geopolitical conflict, upstream and midstream chemical products have become the primary beneficiary sector. Rising crude oil and energy prices have directly boosted corporate profits, with gross margins rebounding across most products. This is mainly attributable to the strong pricing power, tight supply-demand balance and robust demand of upstream and midstream commodities.

As basic raw materials and core intermediates directly downstream of crude oil and naphtha, upstream and midstream products are located at the source of the entire chemical industrial chain, with costs highly correlated with international crude oil prices. Against the backdrop of tightened supply and rising costs triggered by geopolitical tensions, they are able to pass on cost pressures to downstream segments via pricing power. For some products, price increases even outpaced raw material cost hikes, rapidly lifting industrial profits out of loss-making territory.

Typical basic raw materials including melamine, acrylic acid, methyl ethyl ketone (MEK), caustic soda and ethylene glycol have achieved the strongest profit recovery across the industrial chain. Among them, previously loss-making products such as melamine, acrylic acid and caustic soda turned profitable driven by synchronized rises in costs and product prices, delivering remarkable profit improvements.

Melamine recorded a gross margin of -11.22% (loss-making) before the event, which rebounded to 38.07% in the week ending April 3, representing a nearly 50-percentage-point improvement in profitability. Acrylic acid also recovered from a loss of nearly -10% to above 30% profitability. Supported by concentrated supply and import gaps, MEK and ethylene glycol saw higher gross margins, with profitability significantly improved compared with pre-event levels. Benzene, the core feedstock of the aromatic hydrocarbon chain, also posted steady profit recovery, with its gross margin rising from 3.78% to 9.97%, featuring far better margin elasticity and stability than downstream sectors.

Overall, profitable upstream commodities share common characteristics. All are downstream derivatives of crude oil or naphtha, featuring high industrial concentration, strong global tradability, vulnerability to external factors such as geopolitical conflicts on the supply side, and rigid demand support on the demand side. Free from obvious overcapacity pressure, they also hold certain pricing power over downstream links. Rising costs will not lead to a rapid contraction in demand, enabling them to convert cost pressures into profit growth and become the key segment with improved profitability under the impact of this geopolitical incident.

Downstream & End-use Products: Failed Cost Pass-through, Squeezed Profits and Shrinking Gross Margins

Downstream end-use products have faced substantial operational pressure amid the current cost surge. Upstream raw material price hikes cannot be effectively passed on to downstream end customers; rising costs directly compress corporate profit margins, leading to a general decline in gross margins. Some products have even turned from profitable to loss-making. This is mainly driven by weak terminal demand, intensive industrial competition and weak pricing power over downstream customers.

Located at the end of the chemical industrial chain, downstream end-use products directly serve terminal consumption sectors including home appliances, automobiles, building materials, textiles and agricultural materials. Since the outbreak of the Middle East incident, terminal consumption demand has not recovered noticeably. Instead, it remained sluggish under the combined impact of rising costs and weak macroeconomic expectations. Faced with continuous upstream raw material price increases, downstream manufacturers have neither sufficient room for price hikes nor strong demand support. They can only digest rising cost pressures passively, resulting in continuously narrowing profit margins and declining gross margins. Downstream sectors have thus become the weakest links in terms of profitability across the industrial chain.