Daily Chemical Reactions | Sunday Thematic & Weekly Recap

A Tricky Tomorrow – Sector Momentum Durability, Energy Transition Complexity & Political Uncertainty Are All Scary
October 25, 2020
Commodities Mentioned:
Bromine, Chlor-Alkali, TDI, MDI, Carbon Black, Styrene, Propylene Glycol, Butyl Acetate. Ethyl Acetate, Nylon, Polyethylene, Polypropylene, PVC, PET, Polyols, MTBE, Bitumen, Ethylene, Propylene, Benzene, Crude, Natural Gas, Butadiene, Butanediol, Ethane, Epoxies, Building Products, Industrial Gases
Companies Mentioned:
Westlake, Formosa, Exxon, CP Chem, Nova, Lyondell, Shintech, Oxy, Olin, Methanex, SCC, Natgasoline, PPG, BASF, Albemarle, ICL, Lanxess, Amcor, Aramco, Brenntag, Covestro, Borealis, MEGlobal, Hexcel, Huntsman, Ingevity, Phillips Carbon, Orion Carbons, Lotte, Alpek, Sabic, Tokai, Trinseo, Akzo, PPG, Sherwin, Avery, WD-40, Stepan, AOC, Indian Oil, Kraton, LG Chem, Neste, Unilever, Nouryon, Reliance, Sanyo Chem, Nippon Shokubai, Saudi Kayan, Tesla, Halliburton, BHP, Total, AmSty, Braskem, Axalta, Dow, Wanhua, Celanese, Sasol, REPSOL, JM, Eastman, Novozymes, Sika, Yansab, Airbus, Asian Paints, BorsodChem, BP, Zhejiang Satellite, HEXPOL, Kurita Water, Lonza, Lummus, Mattel, Mitsubishi Cheml, Sonoco, Poscol, Saras, Sinopec, Ube, Air Products, Linde, Exxon, Chevron, Valero, BYD, Hino Motors, Orbia, RPM, DuPont, Fuller, Solvay

C-MACC Sunday Recap

 

A Tricky Tomorrow – Sector Momentum Durability, Energy Transition Complexity & Political Uncertainty Are All Scary

 

  • The World needs chemicals and polymers, and 3Q results broadly confirm this case and show a stronger recovery post-2Q COVID lows than most anticipated only a few weeks ago. We discuss the patterns of consumption and the current resurgence of COVID, resulting in pockets of demand being stronger for longer.
  • Separately – if we look at the Presidential debate last week we note Joe Biden’s intent to address climate change goals, but also note the extreme difficulties that he (and others) have in articulating the path – we provide some perspective.
  • We discuss our sector views given historic levels of uncertainty with most forecasts, both from a macro level, because of COVID and the US election, and from a chemical supply/demand perspective because of so much capacity off line and because of the varied timelines for different supply chains to return to normal despite current global economics generally encouraging all to operate.

Last week we discussed 29 Chemical and related products and 95 Companies

Free To Read

As Halloween approaches, we discuss a future as likely to trick as it is to treat. Last week we published our monthly price forecast and we also published a third piece in our series on ESG and climate change.  On the forecast, we effectively sidelined ourselves for the next few months as we can come up with extremes with equal weighting, based on possible moves in COVID, the US election and chemical industry capacity utilization.  We are more constructive with respect to the idea that a Global stimulus plan will help 2021 and 2022, but we still believe that there will be plenty of basic chemical capacity and show moderate positive margins – Exhibit 1.  However, we can construct a scenario where margins contract sharply for the next few weeks and into early 2021 before a recovery.  Generally, the stocks follow the commodities, but in the event of a clear election win in the US and a broad stimulus expectation, stock reactions may be muted – that said, the sector is not cheap today.

Exhibit 1: C-MACC Ethylene Margin Forecast October 2020

We wrote out third “changing investment backdrop” piece focused on ESG investing and its potential impact on and interaction with climate change and other sustainability actions.  We raised the argument that ESG may be a relative rather than absolute challenge, given that sector neutral ESG funds seem, so far, to be preforming as well as unconstrained funds, while at the same time potentially offering investors less sector intense risk, especially as some of the sectors with inherently low E&S footprints see aggressive multiple expansion.  In Exhibit 2 we illustrate what has been happening in the oil space and use the analysis to discuss action versus messaging.  Total has taken very concrete steps to address its carbon footprint and other stainability efforts and consequently has outperformed.  Chevron has done a better PR job and has been more conciliatory towards the idea of climate change and emissions, but otherwise has not taken any more action than ExxonMobil.

Exhibit 2: ExxonMobil has produced very substantial sustainability reports and has been an advocate for a carbon tax in the US for years, but it looks like the reasoning might be a desire to be told what to do, rather than make any pro-active moves.  Chevron has talked a much better climate game recently but has not done very much – Total has been much more active, but not as active as BP, which has seen its stock price punished.  We compare Total with Chevron and Exxon in the chart but note that Total trades in Europe and the comparison is illustrative only, given that some performance is influenced by regional multiples and indices.

The crux of the report focused on the need to distinguish yourself relative to your peers, as an active ESG manager with a sector neutral approach does not need to own Dow and LyondellBasell, or Air Products and Linde, or Eastman and Celanese.  We believe that both Dow and Linde have an opportunity to take action that would get them noticed (and preferred) relative to their peers (LyondellBasell’s recent investments have its 2019 carbon footprint – Exhibit 3 – rising significantly and Dow could get noticed by taking definitive action to move the other way).  How much this would get noticed and how much it would matter is a more complex issue – see the report for more details.

Exhibit 3: Sources for all of these data are corporate sustainability reports – they are intended to include Scope 1 and Scope 2 emissions, but there is no guarantee that each company is using the same measurement techniques and criteria.  We suspect that they are a good relative guide, however.

Somewhat related – we have some views on energy transition that are connected to the ESG work, but stem from some of the confusion highlighted in the presidential debate.  A path to Carbon Neutrality is complex and it is very easy to create scare tactics and inflammatory views at both extremes of current thinking.

Energy transition – taking the longer-term (30+ year view) does not need to create any of the following:

  • Inflation in energy prices
  • Major job losses
  • Significant increases in national debt

However, if mismanaged it can certainly cause all three

  • Banning fracking, for example, would put the price of oil back into the hands OPEC and it is simply financially (mathematically and physically) impossible to replace the demand for transport fuels quickly enough to offset. We cannot invest fast enough in renewable fuels and electric and hydrogen-based transport to be able to throw away hydrocarbons tomorrow.  Inflation would be rampant

We Need To Build “Bridges”

Hydrocarbon based fuels can be phased out over time and in the meantime, they can be decarbonized, though the increased use of natural gas to produce power and to make “blue” hydrogen – this is an on-going “bridge” but hydrogen is in its infancy.   Carbon Capture and Storage (CCS) at the point of manufacture, which will make a significant difference to the carbon footprint – another bridge, while we wait for economic new low or no-carbon technology. 

Scope 3 emissions for transport fuels are much harder to offset, but it will be decades before we have enough affordable electric vehicle capacity to eliminate hydrocarbon-based transport fuels. 

  • In the meantime, the offsets can be some of the reforestation initiatives that several oil majors in Europe are discussing, or direct air capture (DAC) of CO2 and sequestration – which is expensive. These are additional bridges.

In our view, consolidation in the oil industry will continue: See today’s FT article – yet another deal

  • Some oil reserves will be abandoned as too expensive
  • Over time oil investment will fall, but it will be demand and price driven
  • Jobs will migrate to other industries – especially new energy – more wind, more solar and new hydrogen initiatives.
    • This is no different to countless industrial revolutions/evolutions that have accompanied economic progress for centuries.

But we will still need chemicals and plastics, and these will be largely hydrocarbon based for the foreseeable future.  Chemical and polymer companies will need to reduce their environmental footprint more proactively than refiners, power companies and oil companies – all of which will likely achieve lower footprints simply by the progressive closure of redundant operations.    

The challenge for any US administration and Governments around the World will be to get the combination of government investment and industry “carrot and stick” incentives/legislation right, to ensure a transition that makes sense for all stakeholders and progresses at a rate that is fast enough, but does not create dislocations in supply versus demand, sudden changes in employment or rapid changes in commodity prices.  

bp has taken a radical approach to its portfolio and climate change objectives and while it has not underperformed as badly as ExxonMobil since 2018, it is faring much worse than Total – Exhibit 4.  We would argue that this what happens when you let very black and white shareholders/activists own the narrative rather than potentially more holistic state or global led initiatives.  The US needs to rejoin the Paris Agreement at a minimum to provide common sense leadership (if such a thing is possible). 

Exhibit 4: bp has arguably done too much too soon, including the lower-case name change (in our view – almost as annoying from an auto-correct perspective as IHS). Investors are no longer sure what they are buying and are very nervous about cost increases and lower earnings.  bp has significantly underperformed ExxonMobil over the last 12 months.

Otherwise Last Week

 It was a week of positive earning surprises, albeit against very conservative early quarter guidance and a Sell-Side that is now so risk adverse that few move estimates without a corporate public prompt.  While we do not produce earnings estimates, we have been highlighting both the better demand and margins in 3Q for months and we are not surprised by any of the numbers we are seeing and nor are our clients. 

If we are surprised by anything it is the confidence going forward – although it not uniform.   While 3Q has been better than expected, it remains weak year on year as summarized by the ACC data in Exhibit 5.  Furthermore, and as we have covered more than adequately over the last few months, production shortages have been a major issue in part because of an over-correction in 2Q versus actual demand and then because of planned outages and storm related outages in the US.  There is ample capacity to produce almost every chemical and polymer needed and there is economic incentive to do so.   As we summarized in our price forecast, we believe that coordinated stimulus could help drive consumer based demand in 2021 and 2022, and prolonged COVID issues could help demand for food packing and PPE, but we still have a lot of capacity globally and we do not expect a spectacular 2021 and 2022.  Our higher US ethane-based margin forecast in Exhibit 1 relies on no upside surprises to natural gas and ethane pricing

Exhibit 5: American Chemistry Council (ACC) estimates point to improved US chemical production, adding to the stair-steps higher in July and August from June. We highlight this chart to show the improvement but also that a notable amount of capacity is offline.

We also noted last week how the global cost curve is flattening again from a feedstock perspective.  This is largely irrelevant in a tight market, where pricing sits well above costs, as is the case today, but if our concerns about untapped capacity are correct, we hit oversupply without much regional competitive advantage – Exhibit 6 – which is not good for the US.

In the chart the naphtha to ethane ratios are more important than the oil to natural gas ratio, but naphtha generally follows oil and ethane generally follows natural gas.

Exhibit 6: Natural gas prices surged this week relative to Brent Crude, and we highlight ex-US naphtha falling relative to US ethane – the global petrochemical cost curve took a dip lower WoW, which we generally view with concern for US based producers

Headline Summary

In the price forecast that we published in September – linked here – we talked about a possible upside scenario for chemicals based on a boost to economic growth in China, partly driven by a desire to stimulate the economy post COVID, but also to try to replace export demand with domestic demand if there are active reshoring efforts in Europe and the US.  It is far too early to see any effect of reshoring initiatives, but the Chinese economic boost is evident today and chemical prices are rising to support both domestic demand and demand for the export of finished goods to the rest of the world as retail spending has recovered  – particularly in the US.  Note the headline on Long Beach Port Utilization.  The higher iron ore demand is more likely local infrastructure driven.

Meanwhile, in the US…  The flatter cost curve and demand uncertainty has likely impacted both of the decisions below, although the CP Chem decision has also likely been influenced by cash flows, with neither Chevron nor Phillips 66 that interested in increased pro-forma debt in the current environment

ESG/Climate Change

The headlines continue to dominate – with most of the focus on recycling and carbon this week.  There are several recycling initiatives discussed, but our view is that they are largely cosmetic, and only begin to scratch the surface of polymer demand – there is an article linked that supports this view.  We do not believe that meaningful recycling is possible until all of the stakeholders are aligned – including consumers and municipalities and in areas of large enough populations for the volumes to be meaningful.

This week Dow talked about recycling 1 million tons of polymer by 2030.  On the one hand this is a commendable target given the logistic issues, but on the other hand it is less than 10% of Dow’s pro-forma global polyethylene capacity.

The week of October 19th – click on the day or the report title for a link to the full report on our website

Monday – Weekly Margin and Pricing Analysis

Global Chemical Update – More Than A Pipe Dream

  • Polyvinyl chloride (PVC) spot prices hit five-year highs in the US and Asia, and we maintain a positive view of PVC relative to other major polymers.  
  • Other items of note: avg. China PVC and caustic soda values both reflect spot price support WoW; Ex-US petrochemical production costs fall WoW; US methanol spot values reflect a growing premium to Asia per our model.

Tuesday

Moving On Up – 3Q Sector Results Continue to Beat Street Views, East Side Outlooks Deserve Scrutiny

  • Chemical sector 3Q results and 2H20 updates continue to beat stale Street views that in many cases reflect a reluctance to take any action or risk amid historic uncertainty – we approach fresh broad-based optimism with concern.
  • We note numerous corporate and sector items (e.g. PPG, Ingevity, Phillips Carbon Black, Hexcel & Trinseo business updates; Tokai Carbon, MEGlobal & LyondellBasell price hike efforts; global outage & expansion news, etc.)
  • Other items mentioned today range from rising demand for brominated flame-retardant demand from EVs, to more items supporting global tightness in PVC, to our walk around the sector highlighting numerous relevant news.

Wednesday

Isolation Renovation & Food Packaging – Stand-Out 3Q Demand Ascensions With Uncertain Dimensions

  • Chemical sector 3Q20 results this week display notable strength in home improvement product demand and global food packaging demand – we see demand optimism continuing in 4Q but rising stamina concerns in 2021.    
  • We highlight two exhibits: a) US LDPE integrated margins relative to the five-year range – we discuss our concerns with profit margins despite better-than-expected demand; and b) AkzoNobel paints/coatings volume trends.
  • Other items worth mention range from corporate items (e.g. AkzoNobel, Silgan, Stepan, Avery Dennison, WD-40, LG Chem, Saudi Kayan results), to several price hike initiatives, to the ex-China push for rare earth materials.

Thursday

Connecting The Dots With Different Plots – 3Q20 Chemical Sector Results & Broadening Data Sets

  • Chemical sector 3Q20 results broadly reflect QoQ demand growth, lean supply chains and higher per-unit margins – we foresee many of these trends holding for most of 4Q before fundamental headwinds begin to multiply.  
  • We highlight several corporate news/update items worth note today (e.g. Alpek, Axalta, Dow, Sasol, Sika, Valero and Yansab 3Q20 updates, etc.).
  • Other items of note today range from Asia butadiene and butanediol price strength, to WoW reductions in US refining operating rates and rail traffic, to multiple global petrochemical facility start-ups targeted for mid-to-late 4Q20.

Friday

Over The Hills But Not Far Away – Lean Supply Chains & Outages Mask Production Potential

  • US chemical production improved on a month-to-month basis in 3Q20 but levels remain lower YoY – we discuss the current production setting alongside multiple 3Q20 sector earnings report to display rising commodity price risk.  
  • We flag several corporate news/update items worth note today (e.g. Air Liquide, Dow, Hexpol, Mattel, Sonoco, and Ube Industries 3Q updates, etc.).
  • Other items of note today range from Asia butadiene and styrene price strength, to a flattening of the global petrochemical production cost curve WoW, to global government stimulus efforts to support consumer health. 

Thursday Perspectives – Price Forecast

Uncharted Waters – Planning When History Is No Guide

  • Readers of our Daily work will be familiar with the unexpected boosts to chemical demand and profitability that have characterized 2020. COVID has upended conventional thinking and calls into question any historic proxy.
  • 3Q was better than expected for many chemical companies and better than their own guidance, suggesting many are surprised by the state of the recovery. Recent consumer spending data sheds some light but also raises questions.
  • Our general view is unchanged, but the longer demand is inflated, and prices high, the more capacity will be encouraged – especially in Asia and the bigger the fall will be when demand normalizes. We discuss likely winners and losers. 

Friday Perspectives – ESG

ESG: Is It About Outrunning Others Rather Than The Bear?

  • This report looks at the measures being taken by companies to improve the E&S segments of their ESG standings, both and actual and cosmetic – and shows some interesting initial data with respect to success.
  • It also covers the issue of whether absolute or relative behavior will matter the most and examines how companies might improve valuations by playing the relative game.
  • Chemical industry participants with strong climate change narratives, while not sacrificing earnings (yet) appear to be outperforming those with weak arguments – we question what will happen when companies start taking decisive action.
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