European coatings companies, like other paint manufacturers across the world, are coping with a flood of increases in prices of their raw materials.

But most European producers, particularly those based in Western Europe, do have the advantage of having domestic currencies, particularly the euro now covering 15 countries, which have over the past year considerably appreciated against the U.S. dollar.

Many chemicals used in coatings formulations are priced in dollars.

The strong euro, Swiss franc, the various Scandinavian kroner currencies and to a lesser extent the UK pound have given coatings companies greater flexibility with their margins than competing paint producers outside Europe have, especially those in North America. Over the past year the euro itself has risen on the foreign exchange markets by approximately 20% against the dollar.

The currency benefit is also enjoyed by other downstream sectors in Europe but it can be valuable to coatings producers because of large numbers and variety of chemicals they use in their formulations.

“Chemicals imported from outside Europe or made from basic chemicals from outside the region are cheaper to buy with the euro or other strong currencies than elsewhere in the world,” explained Henrik Meinche, senior economist at the German Chemical Industry Association (VCI), Frankfurt.

“This can be quite a significant advantage when these chemicals are used to make intermediates, specialty chemicals or formulations like coatings,” he continued. “It dampens the effect of then having to sell a coatings or other product outside Europe priced in a strong currency like the euro. Coatings producers, for example, have greater freedom to adjust their prices in the global market-even increase them. They can widen their margins because they have paid proportionately less for their raw materials.”

In addition to currency differentials, coatings companies may also have the benefit of long-term contracts for some of their raw materials, especially for those which are not petrochemical derivatives, and of opportunities for hedging arrangements. Other competitive tools in the way companies procure their raw materials are needed to alleviate the steady decline in the gains to be made from the long-term appreciation of currencies like the euro.

But the ability to offset against lower raw material costs the higher exports prices stemming from a strong currency can only be maintained as long as customers outside of Europe are willing to accept higher selling prices.

The financial results of European coatings companies for the first months of this year are showing that they are achieving the robust growth in sales and profits of last year. Jotun of Norway, for example, whose domestic currency has appreciated against the dollar at the same rate as the euro, reported a ten percent rise in sales and 23% increase in operating profit in the first four months of 2008 compared to the previous period last year.

At the moment demand for coatings is strong enough in areas like Eastern Europe, the Middle East, Asia and Latin America for customers to accept higher prices, especially as they acknowledge the supply-chain effects of steep increases in energy costs.

“With a few notable exceptions, everyone at the moment seems to be able to put up their prices,” said David Thomas, chemicals analyst at Oxford Economics, Oxford, England. “Inflation is rising in many areas, which also provides extra scope for increasing prices.”

Inflation, however, may also be a warning sign. The introduction of energy surcharges by producers of titanium dioxide (TiO2), resins and other raw materials for coatings and other sectors could drive up price pressures even further.

Due partly to currency differences, coatings companies in Western Europe have been able keep down rises in TiO2 prices to below those in dollar-denominated areas of Asia. But TiO2 producers like DuPont and Huntsman Corporation have forced up prices for the pigment in Western Europe by recently introducing non-negotiable energy surcharges.

“In the past energy surcharges have been a way of embedding inflation into the pricing system,” said Thomas. “The last time energy surcharges were introduced widely was during the bad days of high inflation in the 1970s, which led to a big drop in demand in the early 1980s.”

Inflation is now going up to levels which some economists believe could become dangerous. In the euro zone it has risen to 3.7%, its highest level for 16 years.

It is beginning to rise sharply in the export markets where there has been strong demand for European coatings. In Russia, Ukraine, Turkey and other markets on the periphery of the European Union inflation rates have reached double-digit levels. In developing Asia, including the booming coatings markets of India and China, consumer inflation was averaging 7.5% in April, almost double the level of a year ago and close to a ten-year high.

“Once inflation hits a high level, people are no longer so willing to pay higher prices,” said Meinche. “Instead they want to pay as low prices as possible.”

In addition demand begins to falter as customers delay purchases because prices are falling and rely more on supplies from their own inventories.

“The latest rises in the oil prices have been a big impetus behind growth in demand because of the tendency for companies to buy when prices are going up,” said Thomas. “But once oil prices start to go down which could happen soon companies could immediately start destocking and some prices, particularly those of petrochemical derivatives which are supplied on short-term contracts, could come down fairly quickly.”

European coatings producers will be paying less for their raw materials. But they will also have the possible disadvantage of large inventories of raw materials purchased at a time of higher prices. Far worse is that the strength of the euro and other European currencies will be a big handicap in export markets where prices are tumbling.

“The negative impact will not only be in export markets but in the domestic markets as well where low-cost imports will be much more attractive,” said Meinche.

The European chemical industry and its major downstream customer sectors like coatings have been doing well so far this year because the world economy is growing at a relatively healthy rate. But once it slows down, market conditions could become much tougher.