Key Points:
Global PP markets will likely face tough price/profit conditions in 2020. In our view, unlike with polyethylene, we find PP profit risk lacks proper notice.
Other Chemical items of note: Methanol strength; PVC price watch; Nova update; chemical private equity to stay active downstream; PFAS news
- Polypropylene (PP) markets face significant potential headwinds in 2020/21, and in our view this setting is much more appreciated by industry participants than sector equity investors. To set the stage, we flag the latest PlasticsExchange report in LINK that discusses the modest uptick in US spot values in early 2020 following a generally steady decline in prices since May 2019. It is important to also point out one thing that this chart does not show – the spread between PP and polymer grade propylene (PGP). In May 2019, per our model, this price spread was US$0.18/lb, which compares to roughly US$0.17/lb today. In our view, this spread will likely shrink in 2020. So, why do we think the issues ahead are being passed over? A few reasons for this:
- North America does not represent the bulk of the PP capacity additions. Per our view, NA capacity additions will add only ~2% growth to the global market in 2020, which the major additions comprising a 1bn lb capacity addition from Braskem in LaPorte, TX [LINK] and a ~550m lb addition from Formosa Plastics Corp. at Point Comfort, TX [LINK]. Though these expansions are sizable, we estimate total global capacity growth will post in the 8% range this year and note a ~6% uptick is targeted for 2021. The key global capacity driver is Asia, and we highlight an ICIS report that displays the additions in LINK. We model global demand growth in the ~4% range.
- Greater investor comfort currently surrounds the PP market relative to other polymer chains, such as polyethylene (PE), in our view. We argue that a lack of sizable PP capacity adds during the past few years and generally healthy demand (autos, etc.) in the 2015-2018 period increased profit margins and with them investor comfort in PP fundamentals, and we find that the 2019 price weakness is being easily excused by a weaker polymer grade propylene (PGP) market, depressed auto demand and trade war linked uncertainties. The bulls continue to highlight the sturdy PP-to-PGP price spread. Thus, the the supply/demand red flags suggesting price weakness ahead, in our view, seem to lack investor notice/appreciation per our talks.
- Major producers appear in a “wait and see” mode on PP and focused more on defending the issues at hand. We do not view it as a surprise that producers are not making a big deal of the global PP production capacity increases set for 2020/21, as many things (oil-to-gas spread, production delays, etc.) can shift and abruptly swing petrochemical sector profit spreads. This noted, we argue that the PP capacity build-out does not face the same risk of delay as exhibited by the PE build outs of 2018-2020 – the key basis for our view is that a notable chunk of the PP unit additions are being tied to existing monomer streams and also a broader set of upstream channels (refineries, PDH, etc.) and not simply ethylene crackers. Investors should take note.
Major PP producers include: Lyondellbasell, SABIC, Braskem, ExxonMobil, Formosa, Total and Sinopec. Among the majors, we advise investors to take note that the PP profit exposure at Lyondellbasell is notably understated in its quarterly PP production totals – the primary reason for this is that a signficant portion of LYB PP chain profit is tied to its compounds business and JVs. We highlight capacity in its 2017 databook [
LINK] and its 3Q19 production totals in the earnings release supplement [
LINK] to showcase this, and also note its 2019 investor day slides [
LINK] that tend to focus more on the PE cycle, intermediates business and related expansions.
- Other Chemical industry items worthy of note today:
- Global methanol prices on avg. reflect an upward trend and sit at multi-month highs, but it is also important to keep in mind that prices have simply bounced from 2019 lows reached in 4Q – see chart within the ICIS report LINK and also commentary within the Platts Americas report in LINK. Per our readings, the key reason for the methanol price strength is multiple temporary global production outages, including a LyondellBasell La Porte, TX unit. We find acetic acid [LINK] values in China have not exhibited the same strength as methanol [LINK] – a negative for non-integrated acetic producers in the region near-term that could result in production cuts if the methanol outage/price strength persists. Celanese and Ineos are two major global acetic producers worthy of note, and LyondellBasell and Eastman Chemical are among the key US producers.
- US polyvinyl chloride (PVC) producers are scratching tooth and nail for price hikes in January and February after an unchanged MoM contract posting in December – see in LINK. Beyond upstream input cost moves, we find buyers focused on the capacity start-ups at Westlake and a February PVC turnaround at Formosa. Per our view, ex-US markets show little sign of life in early 2020, as exhibited by the China spot trend in LINK, and we thus see US contract prices as dependent on domestic product availability uncertainty and NA demand. The major US PVC producers include Westlake, OxyChem, Formosa and Shintech.
- The CEO of petroleum and refining for the Mubadala Investment Company of the Emirate of Abu Dhabi is not considering a sale of Nova Chemicals per a recent Bloomberg report – see write-up of the news in LINK that also discusses its recent decision to divest its 50% stake in Novelis and highlights its Sarnia polyethylene (PE) expansion targeted for start-up in 2021. Many thought Nova would be sold in mid-2019 after news hit that CP Chem had offered more than US$15bn for the company [LINK]. We suspect Mubadala is likely waiting for a bit of support/improvement in market fundamentals before considering a sale. In our view, the opportunity to “sell well” in basic chemicals was in 2018, and it is cyclically typical for sellers to miss peak opportunities because they are blind to the idea of a downturn. Mubadala itself was a huge beneficiary of Nova failing to sell at a market high, despite significant interest, only to become a “distress” sale to Mubadala at the bottom.
- An ICIS report that estimates 60-70% of value created from private equity ownership in the chemicals sector comes from the improvement in operations (and most notably growth, not cost cuts) – see LINK. We flag this article today, as we do think concerns around growth will linger in the near term and face some uncertainty in 2020 with the US presidential election, but the likely consequence is that this results in fewer private equity dollars flowing into capital intensive/upstream chemical sectors near-term. We continue to see the appetitive for downstream investment, as exhibited by the recent private equity purchase of the construction chemicals business at BASF [LINK], as high as we find higher growth rates relative to the upstream sector in this area. We also think restructuring/realignment efforts to unlock value will remain a key message among the large global chemical firms in 2020. Basic chemcials are always a difficult space for private equity as the interest only arises at cyclical low valuations, which we are not close to today. If valuations fall further we are likely to see “self help” industry mergers before things get cheap enough for private equity to step in, though we think there will (of course) always be the exception here and there.
- We find the US House of Representatives passed a bill on Friday to regulate PFAS [see LINKS 1, 2 and 3] and has ratcheted up investor concerns across a number of chemical producers, notably Chemours, 3M and DuPont and Corteva [see LINK]. The bill needs Republican support and per our reading simply does not have it, so it is unlikely to become law. Still, in an election year, we see discussion of PFAS as something to keep on your radar; especially, given a number of lawsuits are already in motion, such as the one by the state of NY noted in [LINK]. All told, we do not see PFAS concerns fully dissipating anytime soon; looking around for proxies, the selling pressure on the impacted stocks never really goes away until there a full court approved settlement. In general things have to get much worse than they are today to bring all parties to that table.
