Coatings companies and many of their raw material suppliers in Europe are struggling to deal with the dual challenge of a huge slump in demand and the need to claw back last year’s massive rises in raw material costs.

Usually there is a time lag of several months or more between the impact of higher raw material prices on producers and their ability to compensate for them through higher selling prices.

This recovery of input costs is, however, extremely difficult at a time of poor demand. Furthermore economists are now warning that as soon as demand does start to pick up, perhaps later this year, there could be a steep rise in prices of commodities and basic chemicals because closure of upstream processing plants will have caused shortages.

The economic downturn is currently making it hard for companies along the coatings supply chain to achieve even minimal price rises, particularly those serving the deeply depressed construction and automobile sectors. In many cases they have to accept decreases in their prices in order to maintain market share.

Producers are using inventories of raw materials, which were purchased at a high price before the financial meltdown of last autumn.

“Margins are falling among coatings companies because they are unable to recoup higher raw materials costs,” said David Thomas, senior industrial economist in chemicals at Oxford Economics, Oxford, England. “Raw material prices have been coming down since late last year but with demand so low paint producers have been unable to exploit this decrease through their own price increases.”

Coatings producers in the UK have been badly affected by a combination of a slump in sales and shrinking margins. Because of a weakening construction sector, paint demand has already been decreasing for the last two years-by 2.1% in 2007 and 5.9% in 2008, according to Oxford Economics.

“Paints in the UK were first hit by a decline in construction and are now badly affected by the collapse of the car industry,” said Thomas. “We are forecasting a 6.7% drop in output of paints in the country this year. Production will then slowly recover to a 1.8% rise next year and 2.6% in 2011 before slipping slightly to growth of 2.4% in 2012.”

The financial pressure on UK-based coatings companies and ingredient suppliers has been aggravated by a fall in the value of the country’s currency, the pound, which has slumped against the U.S. dollar, euro and other major currencies by 20-30% over the past year.

As a result producers in the country have had to pay more for their imported raw materials while end-user prices have stagnated. The UK retail price index (RPI) fell to zero in March for the first time in 49 years.

Across Europe the priority for coatings producers and their chemical suppliers is effective margin management so that the problems of decreasing sales and the necessity to make up for earlier rises in raw material costs do not cause drastic falls in profitability. With many companies margins are being maintained through cost savings.

Last year AkzoNobel, the market leader in European coatings, was able to push through price increases before the recession began to bite. In the whole of 2008 prices for decorative paints and performance coatings went up by four percent compared with the previous year to offset higher raw materials prices, decreases in volume sales and adverse changes in exchange rates.

The company’s marine and protective coatings business did particularly well by being able to achieve higher sales with higher prices. The marine coatings operation improved its margins while raising volume sales by ten percent.

Hans Wijers, AkzoNobel’s CEO, said that the company’s objective is to raise its EBITA margin from 12% last year to 14% in 2011 by “driving margin management programs across the company.”

Tikkurila of Finland, whose parent company Kemira has postponed a stock market floatation because of the recession, made an operating loss of $12.6 million ($17 million) in the fourth quarter of last year. A decline in sales volumes reduced profits by $7 million while variable costs, including raw material costs, went up by $6 million compared with the same period in 2007. During the whole year variable costs rose by $22 million, which is equivalent to three percent of total sales.

The company has embarked on a cost-reduction exercise aimed at saving $25 million annually through measures including job reductions, temporary lay-offs and retraining.

BASF, which is a producer of coatings, dispersions and raw materials, partly blamed higher material costs for a 65% drop in operating profit last year in its functional solutions business, which includes its coatings activities. BASF Coatings suffered a profits fall because of the crisis in the automotive industry, its main customer, and “the continued pressure on margins resulting from higher raw material costs,” the company said.

Altana AG of Germany, which produces coatings, adhesives and effect pigments, claims that it is curbing the impact of raw materials despite rises in their costs. In the five-year period 2004-08, raw material costs as a percentage of sales has remained at approximately 60% in its coatings and sealants business and at approximately 32-34% with its Eckhart effect pigments operation.

Matthias Wolfgruber, Altana’s CEO, said that the company is focusing on margins and cash flow by taking steps like reducing personnel costs, freezing recruitment and cutting the investment budget.

After a decline starting in the fourth quarter of last year, raw material prices could soon start to go up again.

In a trading statement issued in February, Nuplex, the New Zealand-based company with a large coatings resins operation in Europe, warns that raw material costs are likely to increase “above current lows as surplus capacities are removed,” although it believes that they will probably not return to “former record highs” in the near term.

“As demand picks up again, there could be fairly sharp increases in raw material prices but not across the board,” said Thomas. “It will happen in fairly specialized products where there may already be signs of impending shortages.”

However other analysts believe that the increase in raw material costs will be much broader with prices of oil, metals and agricultural commodities already starting to climb.