Monthly Thematic Piece

The Depressing Current Outlook and the Depressing Math of Ethylene Margins
April 19, 2020
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Sunday Chemical Recap

The Depressing Current Outlook and the Depressing Math of Ethylene Margins

  • As the world thinks about re-opening its economies, in whatever form that might take, we focus on a couple of potentials. The first is the worst, which is a second wave of infections and an uptick in the shape of the curves. This will likely lead to individuals as opposed to governments dictating what happens next – people will likely choose isolation and lose faith in government advice. This is much worse than continuing the lockdowns but continuing the lockdowns for much longer looks politically difficult in Europe and the US.  Disastrous for many industries. 
  • The second is a cautious re-opening, maintaining social distancing and effectively leading very different lives until a vaccine is available – this is likely a slow recovery with economic “normal” unlikely to be reached for at least 12 months. In both cases, the commodity markets – energy, materials, chemicals remain oversupplied for a long time – volumes may improve but not enough to drive pricing power.

Key Points from the last week – the cost curve debate again

  • One of the risks to our flat cost curve argument has always been the potential for the rapid decline in ethylene co-product pricing, a discussion we have had with a couple of ethylene producers/marketers just this week.  Spurred in part by the first chart.

All charts are view-able in the PDF below 

Chart of the week:  Avg. global naphtha ethylene cracker cash cost closed last week at a 10yr low relative to USGC ethane – we highlight the trend below and note that the oil-to-gas ratio provides a rough rule for the global cost curve but can be misleading at times – we think 2Q20/3Q20 will be such a period.

  • However, this week we saw first-hand one of the inherent complications associated with tying to predict anything in the chemical space.  We had argued for rapid declines in propylene prices because of the consumer durable focus of propylene derivative demand.  
  • But… Propylene prices have shown strength in the US and in other parts of the world over the last week, despite no declarations of plant closures.  Why? Because the negative spreads on refinery FCC units (significant producers of propylene) – chart below – have caused refiners to cut back these units (as opposed to shutting down the whole refinery – which would have been a disclosable event for most).  
  • While we are already seeing, and still expect to see, significant declines in propylene demand (polypropylene, polyurethanes and acrylates all have exposure to autos, for example), the loss of FCC based product (as much as 45% of US supply comes from refineries) could support propylene globally relative to ethylene.  This only makes the case for a flat global cost curve even stronger – higher propylene values drive lower ethylene costs on naphtha and propane-based ethylene plants.
  • Refiners cannot cut back FFC units in isolation for long, as they simply produce other gasoline components such as alkylate, which will also have to be stored.  Ultimately we expect more broad refinery cutbacks/closures, but this will still hurt propylene supply relative to ethylene – it could also hurt aromatics supply – which would raise the values of benzene, toluene and xylene relative to ethylene, not as important in the overall ethylene cost equation as propylene but still relevant. 
  • The discussions around economic impacts of the Pandemic and how certain industries are benefiting while most are being hurt, all talk about demand impacts well in excess of 10% and economic impacts that now all suggest an inevitable and severe global recession.Prior to the emergence of the Pandemic we were concerned that 2020 would be an inflection point for basic chemicals, with the tail end of investment in the US and new investment in China adding capacity faster than the market would grow in 2020 and dropping operating rates enough to take away any market based price support.  A 5-10% decline in base chemical demand in 2020 (which may be a best case) will drive global operating rates lower than we have seen since the early 80s, and, when the dust settles – even if we now start a slow recovery – competition will drive prices for most products to the cost of the high cost producer, with a very real risk that the high cost producer is in the US.    
  • Rest assured that, as we build out our proprietary C-MACC price and margin forecast model – to be launched at the end of this month – we have an iterative process built into the model that takes account of refinery dynamics and co-product price variance.  While we have no crystal ball, we are certain that the checks and balances within the logic of our model will be appropriate. 
  • This week we published a Perspectives piece on why the oil price might be a distraction for chemical investors, with both demand and a dislocation in oil product prices far more important. We also published a Second Derivatives piece looking at why we believe that the E in current P/E expectations for many segments remain way too high regardless of attempts to restart economies.  
  • Lastly, we held two well attended and well received conference calls this week, with Raj Gupta and Dennis Reilley. They covered different topics, but with the backdrop of the Pandemic.  Please contact us for access to the replays.  

If you are a C-MACC client and have not logged on to our website and/or have lost the instructions – let us know and we will fix it – you should be able to fix any log in problems directly on the website as your name and email are already in the system.  Alternatively, email us with any PDF requests. 

The Week of April 13th– the link to each piece is on the day/date line & available by clicking on the title

Monday – Weekly Margin and Pricing Analysis

Global Chemical Update – Global Cracker Cost Curve Inverts, Hold Onto Your Skirts

  • The global cracker cost curve inverts week on week (WoW) in favor of naphtha relative to NGLs – profit headwinds continue to mount for USGC commodity producers.
  • We frame the current spot ethylene, propylene and benzene market WoW.

Tuesday

Don’t Be Hoodwinked & Other Chemical Items

  • March-quarter industry price, margin and volume data should not lift confidence in 2Q20 results – we see limited sector profits ahead.
  • Corporate items in the news today target the potential Tianqi move to sell all or part of its Australian lithium operations – to Oxea product allocations.
  • Other items of note today range from oil-and-gas commentary, to the India lockdown extension, to discussions of auto demand and plant restart targets. 

Wednesday

Words From The Wise – Takeaways From Our Event With Raj Gupta; Other Chemical Sector Items

  • We provide thoughts following our event with Raj Gupta yesterday and flag many near- and long-term items worth consideration – clients take note.
  • Corporate items in the news today include the LyondellBasell 1Q20 update & capex cut, Arkema dividend cut and Covestro guidance reduction.
  • Other items of note today range from oil-and-gas commentary, to the Asia price drop in Butadiene, to thoughts on sector leadership through the crisis.

Thursday

Oil Thoughts Before Our Call/Webcast With Dennis Reilley; Propylene Support; Other Items

  • We provide a few near- and long-term thoughts on the oil situation and its impact on the chemicals sector ahead of our call/webcast with Dennis Reilley.
  • We discuss propylene price support around the globe (some isopropanol incremental demand and lower FCC based production in the US) and comment to a couple of corporate items: Celanese and Nova Chemicals.
  • Other items of note today range from oil-and-gas commentary, to shifts in global chemical values, to thoughts on sector leadership through the crisis.

Friday

The Permian Likely Survives – Takeaways From Dennis Reilley; Propylene Tightness & Other Items

  • We provide thoughts following our event today with Dennis Reilley and flag many near- and long-term items worth consideration – take note.
  • We discuss refinery production cutbacks as helping to support propylene values and corporate items/updates from Alpek and Tronox.
  • Other items of note today range from crude oil comments, to chemical inputs in auto applications, to a status update on China lithium players. 

April 13th  Perspectives 10

Oil Price Moves: Why The Instinctive Trades May Be Wrong

  • As oil rebounds – so do Dow and LyondellBasell and the rest of the commodity group in the US. This may be false hope and places too much reliance on one simple indicator, which has worked in the past but may not now.
  • Two other fundamental shifts are equally important and suggest a different outcome. The global oversupply of condensate/light naphtha and chemical demand.  Neither of these two factors support the US Chemical Industry medium-term.    

April 17th  Second Derivative

The Wrong Economic Model – Again – Why the E is very wrong in PE Valuations

We are disheartened to still see articles and talking heads still trying to find proxies in the financial crisis of 2008. The smart money (there seems to be less of it than we thought) and the more realistic economists (even at some of the big banks) are calling for something akin to the “great depression”.  While this may be more accurate, it is also misleading in many ways. 

  • The great depression impacted the US disproportionately to the rest of the world – this time Europe and much of the rest of the World is just as badly impacted, and a recovering China is going to be hurt because of a lack of export demand.
  • We have far higher population and therefore potentially much higher unemployment than in the 1920 and in addition we have flows of information such that everyone knows everything immediately – which can be a bad thing as well as a good thing – reactions to news and data tend to be swifter.
    • In the 1920s the whole population did not try to buy 3 months of supply of toilet paper in the same week!
  • We have clear division in Governments with respect to re-opening the economies versus containing the virus – we expect containment to win here for several reasons:
    • The government cannot order people back to work
    • Corporations will not put their employees in harms way, partly because it is the wrong thing to do and partly because of potential litigation if they do, and by so doing cause further loss of life.
    • Families of those at high risk will likely not comply with anything suggested (including sending kids back to school) if they feel that they are putting family members at increased risk.
  • Consequently, we expect a measured “return to work” that allows people to socially distance appropriately until a vaccine is widely available, and this has several consequences
    • No quick recovery in terms of employment – and the risk that the unemployment numbers keep rising.
    • Continued subdued demand for gasoline and jet fuel as large numbers of people continue to work from home.
    • Public resistance to larger gatherings, even if they approved by government
    • Companies start looking for permanent ways to run their businesses within these constraints. Potentially bad for employment.
    • Because of the unemployment and the prolonged uncertainty – as well as the rollercoaster political positioning (especially in the US)
      • A mortgage crisis
      • An auto loan crisis
      • Limited demand for new autos – even when production starts back up – leading to reduced auto production rates
      • Limited demand but also limited availability for air travel – as airlines try to find ways to operate and maintain social distancing – possible significant inflation in air fares as a consequence.
      • Restaurant, movie theater and sports inflation (leading to lower demand) as all try to operate with greater distance between attendees/patrons  

 

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