Daily Chemical Reaction
The Battle of Evermore & Other Items
- We follow our China commodity chemical comments from yesterday with our thoughts on the impact of US delays new product introductions.
- We will host calls/webcasts with BASF, Braskem, Dow and Lanxess during the next ~2 weeks to discuss current events & their growth ambitions.
- Other items today range from Chandra Asri 2019 results to shippers lifting US-to-Asia ethylene transport capacity.
- US manufacturers delay the introduction of new goods due to coronavirus disruptions – see discussion in LINK. We view this commentary as worth note following the issues that we noted yesterday [see LINK] that discussed the ongoing rebound in China commodity chemical production in late 1Q20/into 2Q20 amid a demand/downstream production setting in Europe and US that is limited – see our report in. When we tie in the issues with postponed new consumer products and an ever shortening product life cycle across the specialty chemical sector, we see this as cutting into sector pricing power and the ultimate return garnered on sector R&D spending at this point of the cycle – in our view, and not to take this train of thought to its most negative point, it at a minimum provides a negative near-term setting for companies arguing to spend their incremental capital/excess cash on R&D projects rather than storing dry powder.
- Back to basics – a flatter global petrochemical cost curve (see fig. 1) will result in greater ethylene cracker co-product production (fig. 2). Before we get into our overaching view of this trend and discuss why to take notice now along with winners and losers, we flag a couple of client calls that we have set up for the next two weeks to discuss the topic of a flatter global cost curve, global supply chain issues linked to COVID-19 and different views toward commodities, integration/flexibility and specialty product to drive returns this decade. Our current conference call/webcast list with dates is below – let us know if you have interest in participating:
- BASF – March 24 – a large global integrated chemical producer that is pushing its end products downstream – we see the ability to hold price/add value in a lower cost chemical world as the key question for its heavy-chain integrated model. We view the firm as well positioned on a relative basis to more commodity-focused peers, and view its new CEO (former CTO) Martin Brudermiller as a leader keenly focused on specialty products in a world of shortening product lifecycles, increased horizontal purchasing manager relationships and changing trends, such as its increasing battery material exposure [LINK] with the higher adoption rates for EVs in mind.
- Braskem – March 27 – a large Americas petrochemical producer that’s in the midst of adding USGC polypropylene capacity [LINK] and was in merger talks during the past ~2 years with recently with LyondellBasell [LINK]. Also, see slides in LINK.
- Dow – March 30 – a large global commodity chemical producer with above-avg. feedstock flexibility on the USGC and a broad international reach. We view the firm as well positioned for a cycle advance in its complex, heavy chains (MDI, etc.) and see the firm as well positioned to outperform the large USGC commodity peers with respect to profit growth in 2020/21.
- Lanxess – March 31 – a chemical producer that has progressively pushed its product base downstream toward specialty products during the past five years, as evidenced by its multiple downstream unit business additions and the exit from its core commodity portfolio with the completion of the ARLANXEO sale in early 2019 [LINK]. We think the Lanxess portfolio is well positioned in a flatter petrochemical cost curve world focused on value-added product.
- Now, to the topic of greater ethylene cracker co-product production in a flatter cost curve world. We chose today to return to the basics (instead of running through each co-product one-by-one) and highlight a basic dynamic that we think is important to consider in a world of lower oil and heavy chain natural gas liquids (NGLs), such as propane and butane, relative to USGC natural gas/ethane. This is simply that different feedstocks yield a different mix of co-products and that ethane, with an ~80% yield to ethylene, can be viewed at a general level as on-purpose production – any step up to a heavier feed boosts co-product volume dramatically, and we see a US market that can crack up to 83% ethane likely flexing heavier and this metric sitting in the 65-70% area in early 2Q20 given our view of both propane and light naphtha reflecting cracker cost advantages, falling ethylene derivative export values and a depressed USGC spot ethylene market that remains under pressure in part under pressure as the result of lower maintenance in the US YoY and derivative production outages. Other items adding downward pressure to global cracker co-product values include their significant link to refinery and on-purpose production assets (see chart in LINK that displays less than half of global production of propylene coming from ethylene crackers, and reports in LINKS 1 and 2 from 2014 discussing the tightness in propylene as a result of the move to ethane as a USGC cracker feed and the related expansions ahead).
- So, why take notice now? China chemical production from ethylene crackers (that mostly consume heavy feeds) and refinery production is returning in the midst of a flatter cost curve. See fig. 1 for global ethylene cracker cost curve and LINK to article noting China refinery benefits from lower crude oil values. We also note that the majority of 2020/21 Asia ethylene cracker expansions are based on heavy feeds (mostly naphtha) – see slides 41 and 42 in LINK. And, we find USGC ethylene crackers incentivized to run heavy feeds. All in, this suggests co-product values are set to remain under pressure, and also flag our recent views on the weakening US propylene market in LINK. In our view, the primary risk to our overarching, high-level view of depressed co-product values would be the result of either production outages, an uptick in crude relative to gas and/or an abrupt uptick in global derivative demand that runs at a premium to that of production returning.
- Who are the winners/losers in chemicals? The winners are net buyers of cracker co-products that produce products with above-avg. price support, and we view Sherwin Williams in paints, Huntsman in MDI-systems, Lanxess in compounds or Eastman in films. We also see benefits from integrated heavy-chain players, such as BASF, and view US players with above-avg. feedstock flexibility (to shift between light and heavy feeds to optimize returns), such as Dow, as positioned well on a relative basis to US players stuck to light feeds. The net losers of this setting comprise commodity co-product derivative areas where more production is set to come onstream, such as in polypropylene, and a collapsing derivative-to-monomer spread is likely to come forth that will unlikely offset any feedstock/cost-plus upstream benefits. In our view, LyondellBasell and Braskem are examples of two firms that will face headwinds from this development in 2020/21.