C-MACC Sunday Recap
This is not the time to be driving while focused on the rear-view mirror
- Two major items stood out to us this week: a) corporate 2H forecasts showed notably more caution than that given with prior 2Q20 reports; and b) the market is shifting quickly, and we found some major mistakes made by companies that in our view resulted from the use of stale consulting data/commentary. In response to it, we saw a pick-up in demand for our work. We have issued multiple free Aug. trials – email us to be added to the trial list if you are not a full-service subscriber.
- We published perspectives research last week targeting the auto market – an important chemical end market that is likely to face stiffer demand headwinds in 2H20 and 2021 relative to most expectations and this may keep some chemical product chains from snapping back to pre-COVID peak levels until beyond 2021.
- We tend to find comfort in the chemical chains/stories that are already “down and out” and where everyone seems to know it, such as in acetyls and methanol. We more cautiously approach market segments that have seen COVID-19 spurred demand (and price/margin strength), such as in packaging and disinfectants (see our IPA/acetone comments below), and those set to face raw material headwinds in 2H20, such the buyers of propylene. Indeed, we find volatility across the chemical sector poised to stay high into 2021. Reach out to us for advice.
This week we discussed 21 Chemical and related products and 76 Companies
See PDF below for all Exhibits
This week we have noted increases in the level of caution in forward projections from companies presenting 2Q earnings versus the week before. Some of this is mix – we have had more consumer durable focused companies reporting – and some of it is companies paying closer attention to the incremental economic data, which is deteriorating – not necessarily versus a weak 2Q but versus prior 3Q and 2H expectations.
Exhibit 1: 2Q GDP showed a record drop in the US, but more and more caution is emerging with respect to 2H economic expectations.
The second Exhibit is taken from Statista and is worth including because it puts Q2 into a longer historic context and is an other pause for thought given the broad market “bright side” view that seems to be accompanied by every piece of negative news.
Exhibit 2: This Statista chart puts the US Q2 GDP into a much broader historical context – we saw a 10% quarterly decline during 1958!
As COVID cases continue to rise around the world and as we see more and more bubbles of concern in countries that thought they had the virus under control, the UK, Spain, Australia, China and others, it is clear that we may not be through the worst of COVID yet. The economic and health debates around lockdowns versus increased economic activity continue, and it is clearly questionable as what sort of path forward makes most sense and this will inevitably lead to patterns of behavior that constrain economic growth for the rest of this year regardless of what is ultimately best on a country by country basis or what political leaders decide.
But what is clear so far is that both economists and corporates overestimated the decline in Q2, and we believe that they have overestimated the recovery in 2H 2020. In Exhibit 3, we show the two OECD scenarios that were created for the US in the middle of 2Q. At that point it looked like the first wave of COVID was under control and the OECD showed a recovery from 3Q 2020 but also showed a downside case based on a second wave in 4Q 2020. While the OECD overestimated the Q2 decline, the first wave has since become materially worse globally. In Exhibit 3 we include a C-MACC estimate of what might happen, assuming no real recovery before a vaccine is available and widely distributed and we have modeled 3Q 2021 for this to occur.
Exhibit 3: We expect zero growth in 3Q 2020 and a decline in 4Q, although not as bad as the OECD was forecasting in its 2nd Wave case. We are assuming no further aggressive lockdowns, but significant restrictions on gatherings and travel and clusters of COVID to keep the fear rate high until there is a vaccine
We have maintained since the beginning of the pandemic that it will be consumer behavior rather than political will which will dictate the rate of economic recovery and while government moves can help to influence consumer behavior, through stimulus packages, you cannot force people into situations that they feel do not offer an appropriate balance of risk versus gain. We are leaning heavily towards the view that the world cannot return to normal until there is a widely accepted vaccine that has been widely distributed and has been proven successful. By that time there are likely to have been some work/life changes that become more permanent and these will have positive demand impacts in some areas and negative in others.
- Some areas of work from home (WFH) are going to prove much more successful than others – where they are successful companies are more likely to adopt more permanent WFH policies as this will decrease office and infrastructure costs. We do not know how prevalent this will be at this time; but,
- It will have a negative impact on miles driven (less commuting) – lower crude oil demand
- It will likely have a negative impact on commercial real-estate investment – building products.
- Global companies are likely to radically rethink business travel and travel budgets – companies have saved millions of dollars on corporate travel over the last 4 months and depending on the efficacy of the alternatives – video and voice calls (Zoom etc.), they are unlikely to go back to historic patterns of travel.
- Jet fuel demand may not recover to 2019 levels ever again. Smaller planes – fewer flights.
- Incrementally lower demand for plastics from a hospitality perspective
- Permanent job losses in the airline and hotel industries (we are already seeing the airline losses).
- Stimulus packages (encompassing regulatory changes), especially in Europe, that have large climate change overlays. Greater subsidies for infrastructure that is focused on a lower carbon or more sustainable future.
- There has been discussion in Europe on taxing virgin plastic (as well as a proposal to charge for plastic waste) – there is a need for increased tax revenues and there is a desire to increase the incentive to collect and recycle plastic. While hard to measure and then monitor because of trade, taxing virgin plastic would be a way of raising tax revenues and at the same time encouraging recycling (assuming that recycled plastic is not taxed) – this would not be a good thing for virgin resin producers in Europe – LyondellBasell is an interesting case on this basis as it is not only one of the largest virgin polymer producers in Europe but it also has one of the more advanced recycle programs.
- There is a focus in Europe on transportation – not just the move to EVs but also some aggressive targets towards hydrogen fuel cell use for public transport first and other transport second. This could be good for those that can produce hydrogen with a low carbon footprint but would again eat into gasoline and diesel demand. Air Products has put its stake in the ground with its proposed Saudi Arabian JV to produce green hydrogen, but blue hydrogen (where the CO2 is captured and sequestered during natural gas based production) could be available much sooner (in Europe) and regularly produced hydrogen is available today.
- As you take some of these views together it is not hard to take BP CEO Bernard Looney’s idea, that 2019 might have been the year of peak oil demand, seriously. Weak economies (and transport fuel demand) constraining crude oil demand in the near-term and the pace to replace crude accelerating because of stimulus based incentives.
We are very much of the view that the world is going to return to a NEW normal (not the old one) and as an investor and as a chemical and chemical derivatives producer, you do not yet know quite what that will look like. Some products and product lines will see accelerated growth – others will see accelerated declines. It is going to be very important to watch the wind direction carefully, either to get first mover advantage or to avoid obsolescence. It is interesting to note the tone of our Private Client (Bespoke) work (both awarded and in discussion) has already moved towards projects and strategy review that reflect these issues.
This narrative leads nicely to a Perspectives piece this week in which we took a look at Autos and produced a forecast of auto production for the largest 15 producers outside of China. The analysis is summarized in Exhibit 4. Our concern from the discussion above is that we are too bullish in the forecast – even in the low case. The scenario would be continued downward pressure on economic growth and upward pressure on unemployment, coupled with irrational spending based on an historic view of economic opportunity, leading to a credit crisis and specifically an auto loan crisis (especially in the US) that dents new car demand for years.
Exhibit 4: See the Perspectives Piece published on July 30th
Headline Summary – We Have Tried To Stick With The Theme Above
One concern that we have had during the low price period of 2Q was whether some of the demand strength that emerged in China in May and June – and resulted in much higher pricing for some chemicals, especially ethylene, was that China was exploiting low prices and building opportunistic inventory. The article highlighted above suggests that this might have been the case for crude oil with China now surplus refined products. We have seen some signs of chemical and polymer surpluses also in recent weeks, and with China due to start several ethylene and polyethylene units over the next few months – a surge in chemical availability from China could meet a weakening demand environment elsewhere – perhaps leading to very quick price reactions. With India extending its lockdown for another month we would expect to see a negative reaction in PVC, but polypropylene and polyethylene could be casualties of new China supply or previous China overstocking. The highlight below is related.
- Three new large steam crackers are on course to start up in China in August, boosting demand for chemical feedstocks such as naphtha and LPG – see Argus note in LINK. We add that it will not only boost feedstocks but also derivative product supplies, which we think will put downward pressure on regional prices.
On its quarterly call last week LyondellBasell talked about the imminent start up of its JV ethylene project in China and emphasized that the project was on schedule. Consequently, we doubt that others in the link above are behind schedule. It is possible that some of the ethylene import demand that China saw in June and July was related to these start-ups. Rising supply from new players as demand surprises to the downside is never a good combination. The following link might also support the imminent start-up of new China ethylene capacity: Asia naphtha prices buoyed by spot demand; crack spread up.
- China acetone markets tightened significantly in April – see LINK – given a pull on IPA for disinfectant use [also see FT article for a general framework/background in LINK]. We flag the China acetone spot market collapse during the past month in LINK, and we at least highlight today that there are likely many products (some packaging products, etc.) that saw a COVID-19 surge that are set for a reset at some point.
- US IPA export prices decline; domestic, spot prices steady after falling last two weeks – see LINK – we tie part of the export drop to a looser Asia/China market as noted above.
These two headlines support the second bullet on the front page.
The week of July 27th – click on the day or the report title for a link to the full report on our website
- Abnormal regional spot market movements persist WoW, suggesting to us that many global chemical producers are having a difficult time matching production with derivative demand. Our confidence has increased recently that the petrochemical supply chains will not return to normal in 2H20.
- Three spot trends framed and discussed: a) US Refinery Grade Propylene (RGP) surges WoW relative to still rising Polymer Grade Propylene (PGP); b) Methanol prices rise globally, but NE Asia values reflect a greater discount to US levels; and c) USGC PVC prices rise, outpacing Asia values higher WoW
- We restate our view that any producer projecting more than a cautious stance towards the balance of 2020 is taking unnecessary risk.
- We discuss the August polyethylene price hike nominations following a few read-throughs from packaging sector reports and other industry findings. The packaging sector remains strong but there is risk of inventory build.
- We discuss several relevant 2Q20 reports (e.g. Huntsman, Michelin, RPM, Avery Dennison, Tokuyama & Koppers), and our view generally aligns with the Huntsman call for a “W” shaped chemical sector recovery.
- Other items worthy of note include news of Hanwha bidding for a stake in Sasol LCCP, three petrochemical facilities targeted for August start-up in China, and India PVC has been abnormally pushed toward China.
- Today, we discuss global chemical sector supply chain takeaways from 2Q reports, strength mid-week in US PGP and USGC methanol market support.
- We discuss June-quarter profit reports (e.g. BASF, Celanese, Enterprise Products, Orbia, OMV and Solvay among others) and profit outlooks. BASF has to date been more cautious than many for 3Q20 – possibly because of its heavy consumer durable focus (similar to Huntsman).
- Other items noted include European and Asia naphtha market trends, PE and PP market developments, and a resurgence in EV battery pack demand.
- We discuss our views of the likely most and least appreciated items facing LYB with its 2Q20 results based on peer reports and commodity trends. Looking at Valero’s numbers this morning there could be some major inventory valuation adjustments at LyondellBasell
- We discuss multiple sector 2Q20 earnings reports (e.g. DuPont, Methanex, Axalta, Kraton and Sekisui among others) and find mixed 2H expectations.
- Other items today range from HH Natural Gas forward curve trends, to a higher Aug. US Butadiene contract prices that follows global strength in BD spot markets, to an EU Council decision to charge for plastic waste.
- Early 2Q earnings reports gave outlooks that appeared too optimistic but we find more balance this week – we argue that those setting cautious expectations should see better relative equity performance into 2021.
- We discuss several sector earnings reports (e.g. AdvanSix, LyondellBasell, W.R. Grace, ICL, PQ Group & Reliance Industries) to close the week.
- Other items today range from China spot acetone prices retreating after a 1H20 IPA/disinfectant fueled surge, discuss the China PVC and caustic soda price setting and a mixed setting for Albemarle amid a few peer reports.
- 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