Sunday Chemical Recap
Forecasting and Estimating When All the Variables Are Unknown
Two important housekeeping items:
Conference Call with the Dow Investor Relations team on May 5 at 10am EST
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As we listen through and read countless quarterly conference calls, we conclude two things:
- It does not really matter how bad 2Q is, to a degree, as the market has mostly written it off for the Chemical sector. So far only BASF has suggested that it might make a loss in Q2, but we think that losses will be widespread, especially for those companies biased towards consumer durables.
- Some of these losses may be material surprises, but it depends on where consensus settles and we may see further sector weakness, regardless of oil price volatility as 2Q and 2020 estimates fall based on analysis of the 1Q reports and follow-up discussions.
- The collapse in ethylene margins may be a surprise, based on Q1 numbers, but as the chart of the week shows, there is too much of it, and the price trajectory in April in Asia sets the tone for the rest of the world for May and June. We expect losses in the US – as discussed in our first price forecast, published on Thursday and summarized in the second chart below.
- Please contact us if you would like to discuss the content of the price forecast or would like a copy of the model.
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- The shape of the recovery post Q2 is what matters – most of the large chemical companies can withstand a quarter of losses (Sasol may be an exception), but if the losses extend into Q3 and beyond then valuations for the sector remain far too high as even the most pristine balance sheets, or companies with ample liquidity (such as Dow and LyondellBasell), might have to make some strategically prudent rather than available liquidity based decisions with respect to dividends.
- To be clear – what we are attempting to do in Europe and the US with a gradual re-opening of economies is a Grand Experiment. There is no empirical data that suggests it can be done without a major re-emergence of the virus and while we have given the medical profession and their suppliers more time to prepare and equip, and while we may have better treatments, if it comes back, more people will die and we cannot predict how individuals, governments and corporations will react to that.
- We have seen Amazon accused of creating unsafe workplaces and there are likely class-action initiatives in the wings – the US may not handle a Pandemic well, but there is no shortage of expertise and supplies in this country when it comes to litigation.
- As an example of the risk being taken, Texas is moving towards reopening while both COVID cases and deaths are still accelerating. Given what we have seen in Singapore recently, it is not clear that COVID-19 is as constrained by heat as the regular flu.
- When China re-opened its economy at the end of March, we suggested that increased production would be met with decreased demand, given that most of the countries that were buyers of Chinese exports were going into their own shutdowns. This has turned out to be the case, with manufacturing activity in China in April constrained by demand rather than supply in many cases. In Chemicals we have seen some precipitous drops in Asia pricing as traditional export markets have dried up – India being one of the more important. Covestro showed an interesting chart in its quarterly release which shows its view of where we are from a demand perspective by region – see PDF. The concern with the China trend is that a lack of export demand will turn the trend back down as 2Q data becomes available. Factors like lack of demand in Europe and the US and the complete shutdown of India will have serious ramifications for Chinese demand.
- To be clear – what we are attempting to do in Europe and the US with a gradual re-opening of economies is a Grand Experiment. There is no empirical data that suggests it can be done without a major re-emergence of the virus and while we have given the medical profession and their suppliers more time to prepare and equip, and while we may have better treatments, if it comes back, more people will die and we cannot predict how individuals, governments and corporations will react to that.
- The same will likely be the case in the US and Europe because of the damage done to the economy and because of the increased levels of unemployment. Add to this the uncertainty, caused by the virus, caused by new social distancing rules and caused by what has been a generational shock to the system, we do not think that discretionary spending will bounce right back. We include a chart in the PDF that LyondellBasell shared in its report – which while incrementally positive for packaging demand, shows anecdotes that are not good for gasoline demand or for the restaurant trade – which will keep pressure on unemployment and consumer sentiment if true.
We remain very concerned about gasoline and jet fuel demand, especially in the US, as gasoline demand will drive utilization rates on FCC units – which has a major swing effect on propylene supply (currently tight, despite weaker demand). This was covered in detail in our price forecast study. The lack of demand for jet fuel – which may be far more prolonged than the drop in gasoline and diesel demand – has caused refinery reconfiguration and has contributed to the significant oversupply of naphtha and condensate, globally, which is giving basic chemical producers outside the US part of the competitive edge that they are enjoying today, even if they are struggling with oversupply of co-products other than propylene (especially butadiene, which we think could hit zero values in certain regions for a while).
Although refinery operating rates have bounced off a bottom in the last week – chart in PDF – they are not high enough to support the pricing of either refined products or crude oil. We believe that inventories are still building of both crude and products and that we will revisit lows for all. In 1992, as we slid into an economic slowdown, gasoline prices in Houston were below $1.00 for a while. Today they are 50% higher, despite a much weaker crude demand outlook and greater potential oversupply. One of the reasons why gasoline pricing is not lower is that all of the other refined products have terrible demand and pricing and offer the refiners no flexibility to lower gasoline pricing further.
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The Week of April 27 – 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 – The Cost Curve Speaks, Commodity Chemical Values Listen
- Weak demand and a flat cost curve pull most chemical values lower WoW. This is a trend that is likely to continue until profitability is minimal.
- Ethylene, propylene, butadiene, PVC & methanol trends are worth note. We expect to see volatility around a declining margin trend for most
- We provide our takeaways from following corporate releases (Celanese, PPG, 3M, LG Chem, Kemira, Sekisui & Koppers).
- We maintain a negative view on US ethylene and methanol near-term, and we highlight our general view for these contract market in early 2Q20.
- Other items of note today range from oil-and-gas commentary, to shifts in Asia benzene and Europe PU feedstocks, to California putting its single-use bag ban on hold amid COVID-19 issues.
Cooking for Recovery, Eating Disordered; Caustic Soda & Propylene Thoughts
- We provide our takeaways from following multiple corporate releases (Covestro, Enterprise Products, Sherwin Williams, Shin-Etsu & Worley).
- We discuss caustic soda and propylene pricing, and we see any 2Q US contract price support in these two products as likely to be short-lived.
- Other items of note today range from oil-and-gas commentary, to supply-chain items of note, to declining new ship orders amid trade uncertainties
Weak Demand Forces an Array of Industry Cut-Backs; Albemarle Shock Treatment
- Peer releases elevate concerns with investor expectations for Albemarle – we put forth a few items to frame our case – expectation cuts likely.
- We provide our takeaways from following multiple corporate releases (Dow, BASF, W.R. Grace, Kraton, OCI, Clariant, Wacker, Reliance).
- We quickly touch on the US PVC market after some planned outage news.
- Other items of note today range from oil-and-gas commentary, to supply-chain items of note, to India potentially extending its COVID-19 lockdown.
- 2Q20 issues noted with each sector earnings report are mostly well expected. Our concerns target many aggressive/hopeful 2H20 expectations.
- We provide our takeaways from following multiple corporate releases (Huntsman, LyondellBasell, AdvanSix, Phillips66, ExxonMobil & Olin).
- We quickly touch on the Butadiene market as prices are falling around the globe as a result of low demand and difficulties with storage.
- Other items of note today range from oil-and-gas commentary, to supply-chain items of note, to PE operating rate curbs with inventory builds in mind.
Ethylene Cost and Price Forecast
- We are already very concerned that our “downside” case may be correct for the near-term because of the reluctance by Permian producers to cut oil production and the extreme lows in oil prices. We think there is real risk that herd mentality (and pricing) causes all to make the cut decision together, dramatically lowering ethane availability for ethylene producers in the US Gulf and causing widespread ethylene closures because of lack of feed.
- Otherwise, the most important conclusion is around ethylene margins and these are summarized in the chart below for US Ethane based production for the three scenarios we have chosen. Note that in no case do we get back to the profitability seen in 2019 – even in 2022 – and regardless of feedstock.
The Message Is Consistent – On the Durable Side No-One Has A Clue!
Many of the major chemical companies have reported 1Q earnings this week and offered comments – if not guidance – on 2Q and beyond. Our thoughts:
- The food packaging and detergent markets remain robust and several companies saw volume growth in 2Q in these areas. Phillips 66 attributes the better polyethylene results at CP Chem to volume gains in 2Q. The detergent comments from the ingredient companies match the better results from Clorox etc.
- With any market re-opening likely to limit food eaten out of the home (many restaurants are suggesting that they cannot operate at 25% of capacity) we do not see much of a change in the environment for packaging polymers and 2Q could look very much like 1Q from a demand perspective – good for the food packaging companies, the food companies themselves and Amazon and other food delivery companies such as Walmart, although it looks like only Amazon has the critical mass to make money
- Sticking with Amazon, the comment that the company will spend billions on COVID related safety in 2Q, coupled with the increased sanitation associated with re-opening offices etc., suggests that the detergent markets could have a better 2Q than 1Q – so, good for the chemical suppliers of detergent ingredients but better for the household products companies. P&G, Clorox, etc., should continue to show better results
- As PPE becomes more necessary outside the healthcare system, in many re-opening service industries, and remains chronically short everywhere – the producers in these areas will likely see demand strength through most of the year.
- Durables appears to be a deep and dark hole that no-one is willing to offer an estimate for. All are indicating that 2Q will be significantly worse than 1Q and as chemical companies talk about plant closures and reduced operating rates, they are generally in product areas that are driven by durable demand. Today’s ISM numbers in the US confirm the significant slowdown in manufacturing, but we think there is likely much worse to come in May
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