We provide a few thoughts on US spot ethylene and US caustic soda price trends in early 2020 – we find both markets hopeful for improvement YoY.
Other Chemical items of note: PPG earnings release; US/China trade deal; Canada petrochemical project update; Formosa news flow
- USGC spot ethylene closed yesterday at US$0.22/lb, which is relative to its US$0.19/lb close on Friday last week. Looking abroad, the avg. price of ethylene closed on Friday (1/10) in Korea at US$0.35/lb and at US$0.36/lb in NW Europe. The cost to produce one pound of ethylene on the USGC currently sits at US$0.07/lb co-product integrated if based on an Mt. Belvieu ethane feed, US$0.12/lb if based on propane, and we estimate cash costs based on naphtha on average in Europe and Asia running in the US$0.25-0.27/lb range. The US contract price for ethylene settled last month around the level of current naphtha cash costs per our model. Now, we realize this throws a number of metrics at you at once, but there a two key items to point out from it:
- We think US spot ethylene, though recognizing that it is a smaller portion of the market than contract, will gradually tighten toward Asia/Europe cash costs as derivative production (that mostly ties to export/global product prices due to its fungibility across most intermediates and base polymer markets) and ethylene export flows increase from the USGC. But, this is not to say that we anticipate global derivative price support – we simply see the profit spread for integrated US derivative producer as set to shift/reside more with monomer production (cost advantage that rests with the spread between low cost (US) and high cost (Asia) feedstock). We think that US ethylene derivative production will expand until the non-integrated portion of the spread shows no profit for an integrated producer, and we think increasing export flows will work in favor of contracting the non-integrated portion of many ethylene derivative (PE, etc.) profit spreads from both directions (lower derivative prices as a result of more global production and more relative US ethylene price support as a result of more outlets for US ethylene, even considering the 25% China import tariff noted below in the trade deal bullet).
- Investors should take note of US commodity derivative producers that hold spot ethylene input cost exposure, such as potentially at OxyChem and part of Westlake in vinyls, and see some potential pressure at Celanese for portions of its VAM production that are likely tied (in part) to a spot market ethylene feed to allow for derivative production flexibility. For the most part, a walk up in spot ethylene prices will not impact US integrated derivative producers, as the price of ethylene tends to only impact them if it shifts global derivatives prices, though we do remember a time when derivative production rates were cut and ethylene sold into the market by some producers as the price of ethylene had moved high enough to make it more economical to sell than to move it downstream into their particular derivatives. We don’t see this repeating as the US needs to use integrated economics to drive derivative exports. While the derivative producers who need spot ethylene will likely need some spread support to participate in the export market, as new integrated derivative capaicty comes on line, there is a leverage shift back in favor of the ethylene market, which was not there in 2019.
- The commodity trend that stood out to us overnight is the persistent weakness in the caustic soda market – see Sunsirs China spot values in LINK, and we note that US export values closed last year in the US$200-220/mt range, down from a US$390/mt level to begin 2019. We suspect improved run rates in chlor-alkali at the start of the year, likely led by vinyl production, along with tepid 4Q caustic demand are the key drivers of the early 2020 weakness. We suspect this will be a hot topic with 4Q19 chlor-alkali player earnings releases, and we note Alcoa foresees higher Aluminums demand in 2020 YoY (caustic is used in Alumina refining) [LINK]. Note that US PVC expansions, together with increased ethylene integration at Westlake and Oxy/Orbia may push more PVC into the export market pulling up chlorine demand faster than domestic caustic growth – so we think the caustic weakness may continue.
- Other Chemical industry items worthy of note today:
- PPG (PPG) reported 4Q19 results this morning [earnings release in LINK] that missed Street expectations [LINK]. PPG grew sales ~1.5% YoY (ex-currency) in 2019 but adjusted EPS on the same basis jumped ~8% YoY in 2019 despite a higher effective tax rate YoY, but benefitting from a ~3% lower share count. Improvement in profit margin was a key driver, and we suspect that lower raw materials costs (propylene derivatives, ethylene derivatives and natural gas to name a few) were a key driver of profit growth YoY. As we evaluate its 2020 guidance, we think it paints a picture in which management does not anticipate the same benefits YoY, and we find the company factoring in a 2H20 demand recovery in industrial coatings into its 2020 guidance. PPG will host its earnings conference call at 1pm ET today [LINK], and we will provide thoughts after the event. Auto sales expectations for 2020 are generally not that rosy, which (if correct) will also be a challenge for PPG (as well as Axalta and BASF).
- The US, China trade deal signed yesterday appears to have little impact on chemical and plastics sector – the majority of the traded deal benefited the US through a planned sale of Agriculture products and finished goods to China, and it included terms to help protect intellectual property. Both countries abstained from new tariffs, and China benefited from the cut of US tariffs on an assortment of products to 7.5% (from 15%). See the ICIS report in LINK for detail, and we note the China tariff exemptions on a few chemical products announced in late 2019 [LINK] and that it has not removed its 25% import tariff on US ethylene [LINK]. All told, we do not view the phase-one deal between the US and China as a sizable positive for the US chemical and plastic industry players beyond lifted confidence that the US and China are coming to terms. We suspect that phase-two could have improved implications for the industry at large.
- The petrochemical plant expansions and new developments in Canada continue to show progress. The major Canadian petrochemical projects include an ethylene cracker and PE expansion at (Nova Chem.), and two on-purpose propylene facilities and derivative polypropylene (PP) – the Inter Pipeline Heartland Petrochemical project still targeting a late 2021 start per the article in LINK, and the Pembina and the Kuwait Petrochemical Industries Co. joint venture (CKPC) development announced an agreement with Fluor last week [LINK] and, though it lifted its project cost estimates, and still targets a mid-2023 completion of the facility. Per the cost estimates we have seen, the two PDH units and derivative capacity additions noted above comprise 80% of the C$10bn currently invested in expansions and proposed developments. In our opinion, the projects noted above will stay in motion, unlike the Nautical Energy urea and methanol project that was abandoned last year as the company was unable to lock in a fixed contract for construction costs [LINK].
- We are keeping a close eye on Formosa for two reasons:
- Its new 1.5m mt ethylene cracker and a 400,000mt polyethylene (PE) facility at Point Comfort, TX did not start-up by year-end 2019 as planned [see LINK], and it appears that the company will give a status update by the end of January per our reading. We suspect it will start up in late 1Q19.
- The est. US$9.4bn Formosa sunshine project in Louisiana [LINK] received air permits [LINK], which is a major hurdle to clear and tends to generally suggest the project is moving toward development. We are not convinced that this project will move forward (more to come on this), and also highlight an article from today in a New Orleans newspaper [LINK] that discusses a conservation and community lawsuit towards the air permits and Sunshine project. Indeed, activist opposition to the project appears high. We also note the abandonment of a project by Wanhua in Louisiana as construction costs appeared to have ballooned past their initial estimates [LINK], and this project also received notable activist opposition.