Monthly Thematic Piece

Auto Industry Recovery – Important For Chemicals – Unclear
July 30, 2020
Products Mentioned:
Propylene, Benzene, Toluene, Xylenes, Polypropylene, Polyurethanes
Companies Mentioned:
Amazon, Google, Borealis, LyondellBasell, Dow, BASF, Huntsman, Covestro, Trinseo, SABIC, DuPont, Alranxeo, PPG, Axalta, Nippon Paint, Goodyear, Michelin, Cabot, Orion Engineered Carbons
Subjects Covered:
Economic Growth, Auto Demand and Manufacture, Used Car Sales and Values, US Vehicle Miles Driven, Gasoline Demand And Refinery Operating Rates

C-MACC Perspectives No 25

 

Auto Industry Recovery – Important For Chemicals – Unclear

 

  • Our analysis suggests that new auto sales will likely be volatile over the next 2-3 years but will be below the levels seen in 2019 consistently, and that only part of the 1H2020 pent up demand will materialize.
  • The surge in used car availability has so far been met by a surge in demand (in the US) likely from delivery services  (take out and Amazon) – we think it is a bubble, as is the surge in luxury used car sales likely from rental car inventory.
  • Overall we expect demand for paints and polymers in Autos not to recover to 2019 levels – possibly for ever, if economic hardship intersects with a growth in Taas. We are equally pessimistic about gasoline demand – and while it will grow, it may not see 2019 levels in the US and Europe again.  This could elevate propylene pricing into materials that are seeing subdued demand such as polypropylene and polyurethanes

See PDF below for all Exhibits 

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The auto industry is a key consumer of chemicals and plastics, and gasoline demand has implications for refinery operating rates, profitability and co-product output, most import being propylene and naphtha for the chemical industry, but we should not forget the substantial aromatics (benzene, toluene and xylenes) output from many refineries. How the auto industry evolves as the world works through the Pandemic (note that we are not saying “emerges” anymore), is a critical factor in how some product demand fundamentals will develop and how some raw material and base chemicals fundamentals will develop. 

Exhibit 1: We are using the most recent OECD economic forecast, with their base case now our upper case, their “second wave” our low case and a weaker OECD base case (because COVID has become much worse since they published) as our base.  Economic growth and new auto sales are not well correlated, but we are guided by the forecast in our estimates – the Chart shows rolling 4 quarter production estimates.  The Companies includes are shown in Exhibit 2

With our chemical industry focus, we have needed to keep an eye on autos at all times, but we have now stepped a little further over our skis and with the help of our first summer intern – George Willis – we have some scenarios and some conclusions.  Exhibit 1 shows our new car demand model through 2021 – from the 15 producers we have used as our base.

Interestingly, as we go to press it is looking like the premises behind the OECD economic forecasts may already be wrong – we are seeing a dramatic continuation of the rise in global COVID-19 cases and a reversal in economic activity in several countries/regions, including the US.  More government stimulus will come but at some point, consumer caution may drive less of that cash into frivolous spending and more into savings or spending on essentials. 

Exhibit 2: Rather than attempt to model the global market we are taking data from 15 of the largest auto producers – listed below

Another interesting indicator of US auto manufacturer behavior this year is rail car movements of autos and auto parts – Exhibit 3.  We are choosing to show how cumulative rail car movements are showing relative to 2019.  The deficit peaked at around an 18.6% decline but has shown no sign of compensation for the lost volumes – using this metric would suggest that the “pent up demand” may not be there or at least it is certainly not there yet. 

Exhibit 3: Rail car movements of autos and auto parts troughed at only 12% of prior year numbers in April but while they have recovered there is no sign of making up for the lost volumes yet. This gives us more conviction for our base case forecast

As we think about vehicle utilization, we note the Vehicle Miles Traveled for the US so far in 2020 and provide a forecast in Exhibit 4.  Our forecast assumes that some of what we are seeing in late July drives behavior for the rest of the year – school districts offering remote learning across much of the country – either based on decisions now or based on decisions as outbreaks flare up once schools restart – and companies extending work from home periods – although we hope for not as long as Google – July 2021.

Exhibit 4: The US has seen limited growth in vehicle miles traveled for years, which already had a depressing impact on gasoline demand as fuel efficiency improved and continues to improve based on C.A.F.E. standards.  The dip again in miles driven from August in our estimates draws on some of the recent refining operating rates and gasoline demand numbers but assumes that movements are restricted (by choice) through 2020.

Part 1 – Conclusions For PlasticsPaints Etc.  

In our base case we end 2020 with the 15 companies above producing roughly 14 million fewer cars and light trucks than in 2019 – in the downside case we are looking at a reduction of 18 million vehicles.   The average vehicle has close to 200kg of plastic today (440 pounds), and so in the base case the reduction by the producers above would lower plastic consumption globally in 2020 by 2.8 million tons (6.15 billion pounds).   In the low case we would be looking at a fall in demand of around 3.6 million tons or just under 8.0 billion pounds.

In the grand scheme of polymers, this is not a lot, as Autos only account for around 10-11% of global plastic demand.  But it is a much bigger deal for some polymers versus others. The data in Exhibit 5 is taken from  European study on polymer demand – for the US, the larger volumes of SUVs and trucks probably skews the data a little but not by much – the bigger vehicles use more steel or aluminum, but they also use more plastics and likely in the same ratio.

  • Polypropylene: is the largest polymer used by volume, but Auto’s is less than 15% of polypropylene demand – with most of the material used in fenders (bumpers), front and back. Some polypropylene producers are more exposed than others – Borealis outside the US – LyondellBasell in the US and Europe.
  • Polyurethane is the most impacted – while its use is slightly lower than polypropylene in absolute terms in most regions – more than 20% of polyurethanes end up in vehicles from interior dashboards to other interior structures and seat cushions. Polyurethanes is a big business for Dow, BASF, Huntsman and Covestro, but LyondellBasell is very levered to the raw materials.  
  • There are a group of other polymers that are focused mainly on autos but there are smaller in their specific company exposure: Trinseo has some styrene copolymers and polycarbonates, as do BASF and SABIC; Covestro has polycarbonates.
  • DuPont has exposure through polyamides and other specialty application.  

Exhibit 5: A European picture of plastic demand by end-market.  Autos are important, but not nearly as important as packaging and building and construction, but more important to some polymers than others.

Paints are a different story as the market is very concentrated and the impact very direct – in most cases auto paint producers are paid per vehicle as the vehicle leaves the production line – i.e. they carry all of the inventory and risk until the vehicle is finished.  Despite essentially being a 4-horse race; PPG, BASF, Axalta and Nippon Paint, the business remains very competitive with new models and new production lines bid very aggressively by each producer. 

The lack of auto production in Q2, in the US and Europe had a direct (linear) impact on paint revenues and a magnified impact on profits because of high incremental margins – PPG’s second quarter slide 8 from its 2Q report is a good summary – Exhibit 6  

Exhibit 6: Auto OEM an refinish volumes were down more than 50% in the second quarter, which likely reflects April at almost zero volume in the US and Europe.  PPG’s Industrial Coatings segment, which contains the Auto OEM business saw revenues down more than 50% in April, recovering to down 18% in June – directly reflective of auto production volumes  

If our base case forecast for auto production is correct, OEM paint numbers are going to disappoint for all of the major paint producers for the rest of the year. 

The Used Car Wildcard

A wild card in the new car forecast is the sale of used cars – we expect the used car market to be flooded because of stale inventory on new car lots, a flood of vehicles being released by hire car companies and rising unemployment driving further car sales.  However, the Manheim used car index, which tracks the value of used cars sold at auction, shows an interesting recovery in used car volumes/values.  Exhibit 7 show that we hit a record in June and look set to hit a second record in July after the collapse in April and May.  Exhibit 8 shows the jump in value by vehicle type.  We find two possible take-aways and points of interest:

  • We believe that the jump in compact and mid-sized vehicles and some of the smaller SUVs is driven by the rapid growth in delivery services – from Amazon to Grub-Hub/DoorDash etc.
  • The more interesting and higher value jump in luxury and pick ups is likely to leave a larger dent in the new car market – very low interest rates have made these used cars more affordable, and especially for luxury cars some of the rental car liquidation will have helped. We see the highs for luxury cars and pick-ups in Exhibit 8 as another risk to demand for new vehicles and it gives us more confidence that our lower projections are realistic and perhaps not pessimistic enough.  

Exhibit 7: The reversal in the Manheim index was at first a surprise to us after the expected fall in April, but we believe that the reasons noted above are the driver of the recovery, combined with ever lower interest rates – however – consumers cannot borrow indefinitely – especially with high unemployment – and the used car gains may come at the expense of new cars.

Exhibit 8: An increase in availability of luxury cars and pickups may be driving the gains as rental car companies dump inventory and dealers try to move stale inventory of barely used vehicles to make room for new production.   

We will shortly get the July unemployment rate from the Bureau of Labor Statistics, but the June numbers are summarized in Exhibit 9.  With respect to new auto demand we are focused on two risks:

  • The recent rise in COVID in the US and the fresh outbreaks in Europe and Asia suggest that we are in for a bumpy ride and that this will give employers pause before thinking about expansion in any industries.
  • While this is a broad generalization, the jobs being lost today are increasingly higher paid jobs – Airlines, Oil Companies, some Service Companies and Chemical Companies. The jobs being added are low income – either service industry returning to work slowly or delivery jobs arising from the increased “stay at home” normality.

Exhibit 9: Unemployment remains well above the levels seen in the financial crisis – and this is a global issue – not just focused on the US.

These trends are likely to continue – people losing $250,000 to $400,000 finance jobs are finding that the employers can fill the rolls for 30-40% less – too many qualified people.  Faced with a pay cut or unemployment, what would you do?  There will be a wave of people who have the flexibility to (and chose to) take early retirement, but these people are doing so with smaller nest eggs than they anticipated and are unlikely in the market for a new car!

Are there some sour grapes here – “I can’t afford a new car so no one else should be able to either!”  No: I can afford a new car but the current uncertainty and the limited use that my two cars currently have cannot support a single argument as to why I would or should want one.

So, in conclusion – we see tough times ahead for US auto producers and their suppliers – the same in Europe.  We could see 2020 and 2021 volumes well below 2019 volumes.  This is bad news for all of the suppliers, and we suspect that estimates – especially Q4 2020 and 2021 are too high across the board. 

  1. The auto makers themselves are going to have to trim margins to the bone to move vehicles – and will seek every cost saving they can get from their suppliers
  2. The materials and paint makers are likely to operate well below efficient utilization rates for some time while at the same time facing greater pressure to reduce their own prices.    
  3. Most levered are BASF (Materials and Paint), PPG and Axalta (Paint), DuPont, Covestro, Borealis, LyondellBasell, Huntsman, Dow (Materials). Goodyear, Michelin, Arlanxeo for rubber and tires and Cabot and Orion Engineering Polymers for Carbon Black. 

Part 2 – Fuel Consumption Implications

We have seen the impact on the refining industry of the depressed operating rates and earnings will roll out this week likely showing significant losses, mostly because of operating inefficiencies at the lower rates – Exhibit 10. 

Exhibit 10:  US refinery operating rates collapsed in March and April, have recovered only slowly, stalling at times, and we expect the slope to be gradual at best as some of the early attempts to reopen the economy in the US have resulted a major surge in the COVID virus and more restrictions have been re-imposed.

Our Vehicle Miles Traveled projection (Exhibit 4) not only drives our view on lower vehicle sales (less need, less use and less wear and tear), it also drives a view of continued depressed US gasoline demand, perhaps not as low as suggested by the most recent points in Exhibit 10, but well below 2019 levels.  What does this mean for chemical production? 

We have been most focused on propylene because the lack of refinery supply has significantly impacted the supply/demand balance in the US despite the downturn negatively impacting the demand for many propylene-based products.  Propylene comes from FCC units on a refinery and as the chart in Exhibit 11 shows, margins have been negligible.  We tend to think of an FCC units as a producer of gasoline volume – i.e. it upgrades lower valued crude components to fractions appropriate for gasoline blending – it is not a big contributor to octane values. Reformers produce octane (as well as aromatics for chemicals) and as shown in Exhibits 12 and 13, not only has gasoline remained at a reasonable premium to naphtha in the US (naphtha is the reformer feedstock), but premium gasoline (requiring more octane) has maintained a healthy premium over regular.  Consequently, refiners would appear to have more incentive to run reformers than FCC units.  This fits with the dynamics in chemicals in that we are reporting much more tightness in propylene than we are in benzene or xylenes. 

If refining rates remain low for the balance of 2020 and into 2021, propylene shortages may continue.  This will add pain to the auto suppliers relying on propylene as a feedstock – polypropylene, polyurethanes and coatings.  

Exhibit 11: FCC margins dipped below zero in May but have barely recovered since.  With lower demand for refined products these margins are not enough to justify high operating rates  

Exhibit 12: Naphtha has maintained its discount to gasoline through the first half of the year, maintaining margins for reforming

Exhibit 13: Premium gasoline pricing should keep octane demand and pricing high – further supporting reformer operating rates.

Risks – Of Course We Could Be Wrong!

While all the data points to a bad recession and a depressing prolonged climate for consumer sentiment, we have become much more of a consume rather than save culture than we were 40 years ago.

  • The first stimulus checks went on used car payments by the looks of the Manheim index and on electronics based on data from retailers like Costco and Target.
  • We did a quick analysis on google trends – inputting the names of several car makers several well know makes and the phrases “new car”, “used car” and “buying a car”. We aggregated the data and it is shown in Exhibit 14.
    • For those not familiar with Google Trends “100” is the month with the most searches for that phrase. Given that we are aggregating 15 searches in the chart we are not going to get 100, but a couple of things to think about
      • Google has an increasing user base, so trends usually slope upwards
      • June 2020 showed the highest search levels for our vehicle set and phrase in the 5 years (so likely an all-time high), after a 5 year low in April
      • In June – “buying a car” was at 100; as was “Ford F150”; “Nissan Rogue” was at 99, as was the “Audi Q5”  
    • If the economic data and outlook are correct, but we still get strong new auto demand, an auto credit crisis is inevitable.

Exhibit 14: The Interest Remains!

 

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