C-MACC Sunday Recap
Big Oil’s Dilemma: Chart a path to exit or Double Down.
- The BP-Ineos deal gave us an opportunity to talk “Big Oil” strategies. US oil companies need to adapt to deal with ESG, climate change and peak oil – BP’s likely route is one path, Aramco’s is directionally opposite. Standing still unlikely to work
- Continued strength in basic chemical prices in Asia, speaks to strong economic recovery in China, but is likely distracts from weakness elsewhere; US ethylene contact prices were up on higher ethane, but the spot market suggests oversupply.
- We struggle with conflicting data in feedstocks, with forward curves suggesting stronger natural gas and weaker ethane (which we think may be mutually exclusive outcomes without a decline in US ethane demand).
This week we discussed 25 Chemical and related products and 42 Companies
Separately, for those who are not full-service clients, reports can now be purchased individually on our website. www.c-macc.com
See PDF Below for all charts
The Chart of the Week (Chart #1) is taken from the BP-Ineos piece that we published on Friday (linked here and below). The Oil industry is being assaulted from many angles – with the climate change and ESG pressure far lower in the US than in Europe but building. Oil industry executives have some tough choices to make over the next few years, and in many cases Chemicals will be involved – in BP’s case we are assuming that the current view is that you do not need to grow chemicals, to consume oil if you plan to have much less oil. Others face very different options.
Chart 1: Since 2014 the Energy sector has consistently underperformed the S&P 500. Early underperformance was driven by the decline in oil prices in 2014/15, but the recent widening gap (pre-pandemic) has as much to do with multiple contraction for the energy companies as it does multiple expansion in other S&P sectors. As ESG money flows continue, it is almost inevitable that ESG funds will outperform (simply based on flow of funds). Reinvention for energy companies is one option, consolidation and downstream integration aimed at raising the E and the PE weakens, is another. Standing still is likely not an option.
In the report we talk about the inconsistency of management of chemicals businesses within the major oil companies, with BP and Shell showing more volatile strategies than others and ExxonMobil showing the most consistent approach with respect to hydrocarbon integration. We also talk about the rapid and important emergence of Aramco, which has gone from no real presence in Chemicals to one of the top players within the last 5 years. Aramco is looking to secure demand for its hydrocarbons, which is slightly different from ExxonMobil, which has been opportunistically upgrading its hydrocarbons and very different from BP, which looks like it is moving away from hydrocarbons, especially oil.
Chart #2: We attempt to show how the oil majors have evolved over the last 50 years (starting with the unbridled investment in chemicals in the 1970s), with most of the data taken from an exhaustive search of old annual reports. The diagram is cluttered but shows a move away from broad investment, towards consolidation and focus – but with a step up in opportunistic capex for most over the last few years, focused in the US. It is likely that BP would have joined this investment wave, in our view, had it not been for Macondo.
Moving back to the near-term.
Chart #3 shows recent history and forward curve derivations of the US ethane/natural gas spread. While the curves suggest that the ratio might return to March 2020 levels by the end of the year, we struggle to see how this happens without a major drop in US ethylene production (which is possible, but not expected). The run up in ethane has been caused by a couple of coincident events, the start-up and full operation of all the recent ethane-based ethylene capacity and the near-term reduction in Permian oil output and associated NGLs, caused by the sharp drop in oil prices in March and April. The Permian is also a significant producer of associated natural gas, but despite that cutback, natural gas prices have remained very weak, even with cuts in production outside the Permian as well. Inventories continue to rise and are close to 5-year highs, as US consumption has been lower than expected and LNG demand has evaporated. For ethane to weaken – as suggested in the forward market – either demand must fall or supply increase. We have seen some weakness in ethane from its June peak, as Permian production has picked up in June, but this has simply added to the natural gas oversupply, keeping natural gas prices low. Unless ethylene demand falls, weaker ethane because of more supply should mean depressed natural gas – also because of increased supply.
Without prolonged depressed demand for US ethylene, it is likely that ethane will strengthen in 2021 and the forward curve should begin to reflect that sooner rather than later. The strength would come from the effects of limited new investment in the Permian, with current expectations that production will begin to decline because there are not enough new wells to offset the declines, beginning late this year. If oil remains at current levels, production from existing producing and completed wells should rise, but limited new capital will be committed and production will ultimately decline later this year, bringing down ethane volumes. With one new ethylene unit due online in 2021 (Baystar), ethane demand will be higher assuming the US export arbitrage remains. As we noted in the second bullet – prices in Asia are high enough to justify exports of ethylene and most derivatives from the US today.
As we have discussed in several reports since the pandemic began, it is not that hard to make a case for depressed ethylene operating rates in the US, despite what we see happening with relative costs and the export arbitrages today. In the Perspectives piece that we wrote about stagnation (link), we discussed the idea that we could have three to four years of globally depressed operating rates for ethylene and that the relative price of ethane and crude oil would dictate where those cuts were felt most severely. The US would be penalized if crude oil remained weak and ethane prices rose based on more limited shale-based availability. While current pricing for ethylene and derivatives in the US and in Asia is very supportive of operating in the US for export, it will be interesting to see, as we enter reporting season, how much voluntary ethylene production cutback there has been in the US in 2Q 2020.
As evidence of the weak natural gas market we repeat an updated Chart 2 from last week. Natural gas jumped off its lows on Monday of last week, co-incident with the announcement of Chesapeake’s Chapter 11 filing. Given the freedom to operated grated by Chapter 11 protection, we would not expect any of the bankruptcies in the sector to decrease production and potentially see higher production as the mindset changes from potentially “helping to balance the market” to maximizing the cash available to creditors.
Chart #4: Despite dedicated natural gas cutbacks and associated cutbacks in the shale-based oil fields, slower domestic demand and a severe drop in LNG demand is keeping natural gas in surplus. Inventories last week approached a five-year seasonal high – helping to keep prices lower despite a bounce off the lows of a week ago.
The week of June 29th – click on the day or the report title for a link to the full report on our website
- Spot market trends move broadly in favor of US petrochemical producer margins WoW, and we highlight strength in Asia HDPE despite falling local margins. The export arbitrage for US producers remains attractive.
- Our conversations late last week highlight rising confidence surrounding USGC spot market profit trends – we generally agree, but we see the question of spread durability mounting for US producers ahead of 2Q20 result reports.
- US Natural Gas prices spike higher amid production concerns and point to support for a flatter petrochemical cost curve – we discuss the market.
- Two other primary items to think about today: a) polyethylene (PE) price support in China a mix of logistical issues and production constraints; and b) US polymer-grade propylene contracts step higher in June and polypropylene nominations arrive for prices hikes – we model tighter 3Q PP-to-PGP spread.
- Other items of note today range from oil-and-gas news, to views on BP, Ineos, Shell & Enterprise/Marubeni, to the ACC data posted this morning.
Ready to Play – Methanol Has Stayed in Time Out Longer Than Most, But New Batteries Have Been Put in Its Chinese Toys & Friends Are Gathering
- Methanol may be an exception; USGC margins have faced downward pressure since March – we find signs of stabilization and present our view.
- 2H 2020 is likely to continue to show volatility – and other commodity items noted today include recent improvement in China SBR prices, weaker European PP and PE fundamentals, and the US July benzene contract.
- Other relevant sector items of note include oil-and-gas commentary, the continued Aramco focus on crude-to-chemicals, and AI use in waste mgmt.
- Asia ethylene strength has been both a common theme and benefit for US C2-chain exporters in 2Q20 – we question the durability of this trend today.
- Other commodity topics today include US propylene production limping higher, support in a key Butadiene derivative and further methanol thoughts.
- Other relevant sector items of note include oil-and-gas commentary, the uptick in US chemical rail volume WoW, and weakness in Aerospace inputs.
- The sale of BP Chemicals to Ineos makes sense for both companies and is in no way out of step with our thesis of committed oil producers moving further downstream. It perhaps gives some insight into what BP does next.
- Oil majors are already making decisions about how they want to position themselves for the future, but we believe that some further major moves will need to made by many companies over the next 24 months, and while they may be as radical as the path chosen by BP, they could be directionally very different.
- With the completion of the BP deal, Ineos will become a larger and more diverse basic chemical conglomerate and a more significant consumer of oil fractions. Ineos is a very large business, but not too big to buy and would be a major downstream integration play for any number of oil majors.