"If they are too big to fail, make them smaller." - George P. Shultz
Ludwigshafen am Rhein is a small city on the banks of the Rhine River in Germany. Founded in 1844 by the Bavarian King Ludwig I and sitting opposite the river to the better-known city of Mannheim, its name literally translates to “Ludwig’s port on the Rhine.” While many readers may not have heard of Ludwigshafen, it is a critically important industrial city. The chemical giant BASF SE is headquartered there, and BASF doesn’t do anything on the small.
Take the company’s corporate restaurant. Formally called BASF Gesellschaftshaus but known colloquially to its many English-speaking business visitors as the BASF Casino, the restaurant’s 100-plus rooms and six venues parade corporate excess. Built in 1900 and heavily renovated to mark its centennial anniversary in 2000, the Casino’s luxurious décor, countless staff, fine cuisine, and sheer size harken back to the days when such monuments to corporate power were considered critical investments in company morale. Dining at the Casino, one can’t help but feel that it all makes sense.
And then there is the company’s wine cellar, a four-story structure constructed a year after the Casino which allegedly holds approximately one million bottles of wine. Why a publicly traded chemical company located in an otherwise sleepy industrial town of fewer than 200,000 residents needs such a collection is a question many on Wall Street might ponder, but to the leaders of BASF such inquiries would surely be nonsensical. The wine cellar exists because it exists, and the thought of it not existing is absurd. Some things simply don’t belong in a spreadsheet.
Haute cuisine and corporate oenophiles aside, Ludwigshafen is most relevant to today’s discourse because it is home to the largest integrated chemical complex in the world. Mere blocks away from the Casino lies the fence line delineating this staggering display of technical complexity and raw industrial might. With approximately 2,000 buildings and 200 production plants, BASF’s Ludwigshafen site is home to roughly a third of the company’s total global production. All told, nearly 20 billion pounds of stuff is made there every year, and that stuff serves as the starting material for countless global supply chains.
Last week, the Wall Street Journal published an important story about how sanctions on Russia – however justified the motivation to impose them might be – are beginning to backfire in ways Western leaders seem to have been unable to calculate in advance:
“For years, BASF SE, one of the world’s largest chemicals companies, built its business model around cheap and plentiful Russian natural gas, which it uses to generate power and as feedstock for products that make it into toothpaste, medicines and cars.
Today, dwindling Russian gas supplies are proving a threat to the company’s vast manufacturing hub here—the world’s largest integrated chemical complex spanning some 200 plants. Earlier this month, Russia started throttling back its supply of gas to Germany and other European countries. In response, company executives are doing what was unthinkable just a few months ago: considering how to potentially shut down the complex if gas supplies fall further.”
Last year, we wrote a piece called Where Stuff Comes From that explained the critical and irreplaceable role of carbon-based feedstocks in society. In a related piece published a month ago titled Crazy Pills, we argued that the world simply cannot live without Russia’s oil and gas. In Ludwigshafen, we are beginning to see the convergence of those two conclusions. Why did the chemical industry evolve in a way that concentrates so much activity in so-called “Verbund” sites like Ludwigshafen and what would be the impact of this site’s closure? Let’s dig in.
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The German word Verbund means “a composite” or “to combine.” In the context of the chemical industry, BASF defines Verbund to mean “the physical integration of production, market platforms and technologies which tie the businesses together.” There are sound engineering and economic reasons to concentrate the production of as many materials as possible in one central location, and BASF pioneered taking this concept to the extreme. Whether it is the production of electricity and industrial-grade steam needed to run chemical plants or the treatment of the industrial wastewater that comes out of them, economies of scale yield durable cost advantages in the marketplace. Scale in centralized services necessitates more factories to take advantage of that scale – a symbiotic feedback loop that catalyzes industry consolidation into huge Verbund sites.
For example, Ludwigshafen is home to three world-scale natural gas cogeneration power plants. These facilities turn natural gas into electricity and steam at combined efficiencies of 87%, which are then consumed by the chemical plants onsite. Beyond energy, natural gas is also the direct feedstock to Ludwigshafen’s giant ammonia and acetylene production facilities – two critically important global commodities which benefit immensely from being produced at integrated sites. Ludwigshafen is also home to one of the largest wastewater treatment facilities in Europe. The plant is so big that it not only handles the needs of the Ludwigshafen site but also allocates about one-sixth of its capacity to treat municipal water from the surrounding communities.
The logistical benefits of Verbund sites are enormous – the ultimate manifestation of just-in-time inventory economics. Co-location allows for several steps in a value chain to be interconnected directly, with the output of one plant serving as the immediate input for the next. Precious few molecules are wasted with engineers highly motivated to find utility for all byproducts. There are some 1,770 miles of pipeline crisscrossing Ludwigshafen and flinging molecules from one plant to another is a symphony of engineering genius.
As one would expect, the Verbund concept has been replicated at other large sites across the globe. Dow – which for more than a century was known as The Dow Chemical Company until public relations consultants presumably convinced executives to remove the offending parts – is the anchor of a massive complex in Freeport, Texas. The site began construction during World War II and rivals Ludwigshafen's scale and significance. Dow and Saudi Aramco are joint venture partners in Sadara, the company behind the largest chemical plant ever built in one go. The facility is located in Jubail Industrial City II, Saudi Arabia, and cost an estimated $20 billion to construct. BASF and SINOPEC are JV partners in a Verbund site in Nanjing, China, and BASF has committed to build another one in Zhanjiang. In the business of chemistry, bigger is better – a legacy that can be directly traced back to Ludwigshafen.
For all its benefits, scale does come with one critical weakness. Verbund sites are point sources of vulnerability in our economy. Whether it be hurricane risk in the Gulf of Mexico (Freeport), terrorism risk in the Middle East (Sadara), or political risk in China (Nanjing), the industry has long been mindful of the need for contingency planning and increased supply chain robustness as hedges against losing some of the capacity at these sites for periods of time. We doubt many had the complete and indefinite loss of a Verbund site as a scenario in their wargaming, especially not Ludwigshafen.
Unfortunately for the global economy, war is anything but a game. By handing over its energy cards to Russia’s Putin, Europe has made him the chip stack leader in the BASF Casino. As summer progresses and Europe begins to panic about energy supplies for the coming winter, Putin is pressing the advantage given him by crimping the amount of natural gas being supplied to the Old Continent. According to Reuters, the situation is getting urgent:
“BASF, the world's largest chemicals company by sales, is working on emergency plans for its Ludwigshafen site, Germany's single-biggest industrial power consumer that accounts for more than 1% of the country's total demand.
Provided supply does not fall below 50% of the site's maximum natural gas demand, BASF could continue to operate Ludwigshafen, which spans around 200 production sites and needs 6 terawatt hours of electricity each year, but at reduced capacity.
The exact reduction would depend on the availability of gas, as well as oil as a substitute, BASF told Reuters, but said if supply were to drop significantly below 50% over a sustained period, it would have to shut production.”
Calculating the impact of a complete loss of Ludwigshafen is challenging. At a minimum, it would produce a significant inflationary pulse across the economy at a time when central bankers can least afford one. The price inelasticity of demand for the big commodities involved is high, and the resulting interruption of inventory availability so close to the origin point of countless supply chains would be heavily felt.
Beyond the high-profile commodities, there are almost certainly dozens of specialized chemicals produced at Ludwigshafen where BASF holds substantial global market share. These materials find their way into complex formulations downstream, and their loss would quickly be felt in unexpected ways. Many procurement teams that assume they have multiple suppliers for important inputs will find that they all trace back to Ludwigshafen, and the disruption of reformulating using substitutes (assuming it is even possible) will be enormous. Expect the phrase “fourth-party risk” to suddenly become part of the news cycle.
We conclude with a nod to the sad irony that BASF invented the Haber-Bosch process for the production of ammonia, and Ludwigshafen was the home of its early commercialization more than 100 years ago. No technology has enabled more humans to thrive than the economic production of ammonia, and its proliferation around the world made globalization possible. That Ludwigshafen could be an early victim of a transition back to a multi-polar world seems somehow unfair, and yet stands as powerful proof of the consequences of getting energy policy wrong.
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Amazing piece and one of the best insights im enjoying to read.
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