Daily Chemical Reactions | Sunday Thematic & Weekly Recap

Confusion Overload: Uncertainty High, Visibility Low Amid Mixed Indicators; CEO And Planner Nimbleness Is Paramount 
November 8, 2020
Commodities Mentioned:
PVC, PP, PE, Ethylene, Chlor-Alkali, IPA, MDI, TDI, Butadiene, Paraxylene, Styrene, Benzene, PBT, Acrylonitrile, Propylene, Waxes, Crude, Naphtha, Natural Gas, NGLs, Polyols, Lithium, Bromine, Methanol, Acetic, Acetate
Companies Mentioned:
Lyondell, Exxon, Westlake, Formosa, Oxy, Shintech, Olin, TPC, Sinopec, Invista, Kraton, ARLANXEO, Aramco, Avient, Braskem, DSM, Eastman, Evonik, FUCHS, Harima, Kuraray, Marathon, Mitsubishi GC, Momentive, Orion, PQ, Reliance, Sasol, Sekisui, Shell, Solvay, Sun, Teijin, Toray, Tosoh, Trinseo, Umicore, Univation, Nova, CP, Celanese, Dow, Brenntag, Avient, Borealis, Chemours, Koppers, Mitsubishi, Lummus, Polynt, Sibur, Tokai, Trecora, Williams, Avery, Baker, BMW, Leggett & Platt, Huntsman, Covestro, BASF, Albemarle, Lanxess, ICL, Grace, LG, Arkema, Univar, Hengli, Petronas, Showa Denko, SIBUR, Adani, ADNOC, Arkema, Asahi, Axalta, Chart, Compass, Daicel, DuPont, Ferro, IMCD, Kolon, Kumho, Linde, Merch, Nippon Shokubai, Neste, Venator

C-MACC Sunday Recap 39

 

Confusion Overload: Uncertainty High, Visibility Low Amid Mixed Indicators; CEO And Planner Nimbleness Is Paramount         

  • This week we focus on distraction and fundamental uncertainties that extended beyond the headline grabbers: the US election and COVID. Global consumer and business behaviors are changing because of low visibility and related market ambiguity into 2021, turning forward planning into a risky guessing game.
  • Management expectations became increasingly negative during 1Q reporting, as COVID spread, with early reporters less negative than later reporters. 3Q reports have been generally very positive, but later reporters have been increasingly more cautious, with good reason based on our analysis.
  • Despite a lack of visibility, we point to limited volume growth in 3Q 2020 as a sign that better profits have been all margin driven, with production constrained for several reasons. Unconstrained production could swamp demand in 1H2021 with the inevitable negative move in pricing and margins – these are commodities. 

Last week we discussed 26 Chemical and related products and 90 Companies

FREE TO READ

Two important housekeeping items this week.

  • We would like to welcome Mariel Molina to the C-MACC team. Mariel joins us in a sales and marketing support role, having spent most of the last 5 years in construction administration, directly related to the chemical industry.
  • We formally launched our Project & Advisory business at the start of November and the business is summarized in a brief presentation on our website linked here. We always expected to be in this business, but not this quickly.  The acceleration is demand driven and the website shows a couple of examples of our work that we have been allowed to disclose.  Please contact us for more information.

One illustration of uncertainty (and volatility) is the new unemployment numbers, while the job creation numbers are becoming a good offset, the job turnover is extremely high and the overall unemployment numbers suggest that the number of people not seeking employment in the US is rising. In Exhibit 2 we show the longer-term history just to illustrate the uniqueness of what we have seen in 2020.

Exhibit 1: Weekly Unemployment Filings are falling slowly; job creation is high, but uncertainty created by high turnover and volatility should not be underestimated

Exhibit 2: The longer-term picture shows just how dislocating 2020 has been and supports our argument that we should not be relying on historic proxies

Uncertainty

While the two advisory engagements listed on our website were investment based, much of our historic skill-set and experience relates to what we are seeing in the World today – planning ahead through uncertainty – in this case unprecedented uncertainty with multiple antagonizing forces. In last week’s recap we talked about a consensus in corporate reports on limited near-term visibility and we do not see that ending quickly, even with a conclusion to the US election, mainly because of COVID.  

We also talked about “situational awareness” with respect to corporate planning and positioning and remind all of our clients that we are in a period in which it is very difficult and potentially dangerous to look for historic proxies.  Borrowing from Declan Kelly, Chairman and CEO of Teneo, we are not in a “new normal”, we are in a “new different”.  This is not helpful for planning, and within the industrials and materials industries, we had better hope that we are heading through a period of “different” towards a new period of normal, or capital allocation decisions will be complex, and all but deleveraging and increasing returns to shareholders will likely be risk adjusted into the “not now” box.  This, of course may not be a bad thing for shareholders.  We have always advised investors to stay away from most chemical companies when they have money burning a hole in their pockets (the exceptions would be Westlake and Ineos).  However, simply burying your head in the sand may result in genuine opportunities being missed.

Exhibit 3: US COVID progresses again

The last two weeks in the US have been a great example of how distracting things can be.  Over the last fourteen days, much of Europe has gone into another round of COVID lockdown, while the US has the infection trajectory shown in Exhibit 3 (above).  Despite this, the news coverage has been largely concentrated on the election in the US and the COVID escalation has been relegated to the second page.  With no election it would be front and center on page one.

We, like everyone else, are fed up with COVID, and it is understandable that fatigue is setting in in the US and Europe with respect to social distancing and staying at home. This time around it is likely that it will be the broad overwhelming of healthcare systems that will trigger more direct government intervention rather than the rising rate of infection.  In the meantime, most companies have learned how to operate during COVID, and the necessary incremental infrastructure was put in place during the first lockdowns.  Clearly, any further and longer restrictions will have irreparable impact on the hospitality industries, but even without formal lockdowns, as infections rise, consumer behavior will change.    

But while both the US election and COVID are on the list of uncertainties facing corporates, they are also distractions from other underlying business changes that are currently making fewer national headlines but are no less important.  For the chemical industry these include future feedstock dynamics in a World looking for a cleaner tomorrow, the direct impact the chemical companies themselves may be having on the environment, and a shareholder (and debt holder) revolution with respect to ESG. 

We are going to stay clear of more specific election based commentary today until we have clarity on the election, because while a Trump presidency would look very different from a Biden presidency, a Biden presidency looks very different with a balanced or Democrat led senate than a Republican led senate.  So, that uncertainty remains.

But behind the election and COVID news façade, the energy transition and other environmental initiatives continue.  The US Democrats would like to add a stronger state and federal component to the narrative, but absent that, the influences are already there.  We would focus on the following if we were engaged in a planning cycle today: 

  • COVID – what lasting impact will it have on consumer/corporate behavior – will certain products see a permanent step up in demand (maybe food packaging and cleaning products), and others see a decline – perhaps transport related, especially aerospace.
  • Energy transition and the potential impact on the US competitive advantage – could lower oil demand and higher gas demand (partly for LNG) permanently raise gas prices versus oil and raise ethane values versus naphtha. We are already seeing some next wave US chemical projects being put on hold, but this is likely broader uncertainty driven rather than a concrete view on relative US ethane pricing. A loss of competitiveness in the US basic chemicals will work its way down the chain, lowering margins for all, especially in an oversupplied market.
  • “Reverse globalization” – does this encourage China to build more chemical capacity more rapidly to reduce imports needs. The biggest import need today is polyethylene and we have seen a number of facilities start-up in 2020, with more expected in 2021.
  • Plastics waste and recycling/renewable efforts – last week we had 17 headlines on the subject: this week 13. While all of these initiatives are small individually, they will begin to add up to something significant enough to eat into demand growth for virgin plastics.
  • Finance – cost of debt and value of equity. ESG is changing the landscape, and while the overall focus remains targeted on fossil fuels, chemicals will not be immune and already ESG rankings, whether they are deemed accurate or not by corporates, are impacting investors decisions and stock performance – see our recent piece on ESG and equity value linked here.  But it is not just stock valuations, as lenders are also feeling pressure to clean up their debt portfolios and Private Equity firms are also increasingly under an ESG microscope from their investors.  This could lead to some very cheap companies relative to EBITDA, but limited scope to buy them because of a lack of borrowing power for low ESG rated businesses.    

In our experience, chemical companies are fairly good at developing plans – 12 month and 5 year, but far less good at adapting those plans on the fly as things change around them.  We could cite several examples here, and we use them all the time when helping clients one on one, and would be happy to discuss on that basis.  “Group think” is a major constraint to “out of the box thinking” and we see several companies today that appear to have drunk too much of their own “cool-aid”.  We also have examples of companies that are very good at thinking on their feet and these generally correlate with those that have created the most shareholder value through the cycle.  But enough waving of our own consulting qualifications flag!

Otherwise Last Week

We continued to focus on results and noted, as indicated in the bullets, and more cautious tone from the later reports this quarter versus the early reporters – exactly as we saw in 1Q, but this time the later reporters were less positive on a broadly positive message, while in 1Q the late reporters were a lot more negative on a generally negative message.   The primary driver in both cases was the same – rapidly escalating COVID cases over the last month – Exhibit 3 shows the US, but Exhibit 4 shows the Johns Hopkins view of the World, and while the US is a depressing stand-out, upward trends prevail almost everywhere.

Facing the possibility renewed and stricter COVID related restrictions, albeit with a more open focus on how we can prevent economic collapse, it is important to recognize how fragile the 3Q recovery in chemicals has been and that it has all been margin related rather than volume, with the volume restrictions driving the margin.  US rail car shipments remain well below year ago levels – Exhibit 5 

Exhibit 5: US Chemical railcar traffic declined WoW and has again fallen below year ago level. There is a net increase in chemical capacity in the US in 2020 (there is in most years), and the lower rail volumes suggest that the industry is running well below capacity, especially versus the 5 year range given the investment in chemicals over the last 5 years.  Note that any polymer exports generally move by rail to container ports

Production has been limited by elective moves early in the Pandemic to try and match supply with demand amid an obvious reluctance by producers in the US to flood a limited spot market for what might have been a very short dislocation in demand.  As demand recovered, the storms came to the US Gulf Coast and closed capacity while inventories were low – this drove pricing and has created the better than expected margin environment in 3Q and into early 4Q.  Today we have supply chain imbalances versus demand in some segments that may be fleeting in nature – such as the durable goods bubble that we predict for the US, but which will likely back up into China – see report.

Our major worry is less related to a snap back in volume – given that there is currently economic incentive for almost every chemical facility globally to run at capacity.  We think this is inevitable.  The larger concern is the flattening again of the global cost curve and the potential drop in margin, especially in the US, if markets were to become competitive.  It is evident from corporate 3Q reports, especially for polyethylene, that the US contract price marker is less representative of transacted business than it used to be and to us the evidence suggest that the Asia spot price is more influential in determining realized margins for US producers, but despite this, 3Q profits were good.  However, attempts by US sellers to maintain market discipline is likely to see an import reaction, and we note the headline below on polypropylene.  With the addition of Braskem’s new facility and some areas of slow demand for polypropylene, we should be seeing US imports fall, not the reverse.  Given that the data is for September the imports were arranged too early to have been a reaction to LyondellBasell’s hurricane related issues in Lake Charles.

As every cycle has shown us, traders will exploit price arbitrages and buyers will always leave a little flexibility in their systems to exploit the availability of lower cost product, in part to get the cheaper prices, but also to get some leverage over their larger suppliers. 

Exhibit 6: Brent Crude rebounded relative to US natural gas last week, while Singapore and NW Europe Naphtha values declined modestly relative to USGC ethane. We highlight this chart as it displays the notably lower spreads relative to 4Q19 that we think lacks appreciation in the midst of outage-led derivative product tightness.

The natural gas price rise in the US is all about concerns around supply, especially supply associated with crude oil production and we got a hint of that concern in the natural gas inventory numbers last week, where an above-trend inventory trajectory turned meaningfully the other way – Exhibit 7.  Ethane has given up all its premium to US natural gas in recent months (Exhibit 8) and consequently, if gas strengthens, ethane will likely follow.

Exhibit 7: Note the most recent turn in inventory trajectory

Exhibit 8: US Natural Gas Prices have increased notably relative to USGC ethane during the past six months, and we note that the US$ per MMBTU spread between the two nears zero. We see the relative increase in natural gas prices as a cost headwind for methanol production and those using it as an energy source, such as for co-gen power at USGC chlor-alkali units, and view the relative weakness in part due to sizable US 3Q20 ethylene cracker downtime/outages.

Headline Summary

Each weekend we sift through the headlines that we gathered during the week prior and look for some themes that stand-out.  This week we focus on why Asia has become the compelling place to deploy incremental capital, and our now weekly review of ESG/Climate Change initiatives  

The Capacity Surge Continues in China and for good reason

The news that LyondellBasell’s PO/TBA project is over budget should not come as much of a surprise.  Missing constructions costs and timing has been the norm in the US in recent years rather than the exception and LyondellBasell has been a beneficiary as well as a victim, given the opportunity to buy into the Sasol complex at a much reduced prices because of Sasol’s cost over-run driven financial problems.  Whether it is large chemical projects or LNG facilities, the US E&C companies have been missing the target more often than they have been hitting them for years – McDermott is in Chapter 11; Fluor is on its third CEO and CFO in less than two years, and its quarterly financials are delayed and overwhelmed by over-run based charges.  Worley and Fluor have now said that they will not enter into any fixed priced projects going forward, but construction cost uncertainty may bring US investment to a halt, given the recent bad examples. 

Meanwhile in China, projects seem to be on-time and on budget (with both shorter timelines and lower costs than in the US).  Corporates that we have spoken to that were considering their next US investment are looking at China or Asia instead.  It is where the demand growth is and the risk of capital over-runs is lower.  Look for a perspectives piece on this subject from us before the end of the year – it is not just about regulations.

ESG/Climate Change

The more notable headline this week is the one on the carbon footprint of packaging.  This extends the discussion beyond recycle or renewable sources to what is the carbon footprint of the various alternatives.  Recycling that includes collection, transportation, mechanical sorting and then re-heating and molding is not without a carbon footprint and the transportation piece can be significant.  

 The week of November 2ndth – 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 – Stacking The Deck

  • The prevalence of petrochemical supply chain dislocations during the past six months has pushed the industry focus to near-term derivative supply and price shifts relative to production costs – the deck is stacking for a focus shift.  
  • Other items discussed in this report: the global petrochemical production cost curve flattens WoW; US PVC increases and hits a five-year high (again); and Asia spot Butadiene surges with derivatives, leading US values higher.     

Tuesday

Running On Empty (Maybe) – Indicators Point To Production Revival Despite Low Demand Visibility

  • Chemical sector 2H20 business update and downstream news highlights leaner supply chains in a period when per-unit profit supports greater production in most product chains – though most expectations imply supply lagging or moving higher with demand, the risk of an overreaction is high.
  • We note numerous corporate items (e.g. Aramco, Avient, DSM, Evonik, Fuchs Petrolub and Westlake updates; Kuraray, OQ Chemical and other price hike news; global outage, Lake Charles restart & expansion news, etc.)
  • Other items mentioned range from rising Asia spot styrene values relative to benzene and US levels (Ex. #3), to US Natural Gas near energy equivalent parity with USGC ethane (Ex. #2), to Walmart rejecting robot scanners.

 Wednesday

Counting Cards – Chemical Producers Broadly In The Hold Position, Evaluating The Hits Ahead

  • Varied views of 4Q20 seasonal demand start to emerge as the industry moves towards the end of 3Q reporting season – in our view, this implies downside risk to some bullish 4Q views given early in the reporting season.
  • We highlight several corporate news/update items worth note today (e.g. Borealis, Brenntag, Koppers, Mitsubishi Chemical, Trecora Resources, etc.).
  • Other topical items noted today range from the latest US ethylene contract settlement and derivate spreads, to sector implications from refinery margin pressure, to varied views of sector capacity growth amid demand uncertainty.

Thursday

Groove Is In The Heart – Industry Music Broadly Upbeat Into Year-End, Dance Styles Vary Greatly

  • We highlight a couple of notable sector findings today to frame areas of the global chemical commodity market that are likely to stay stronger for longer.
  • We discuss numerous corporate news/update items (e.g. Albemarle, Olin, Lanxess, Arkema, Solvay and Univar 3Q20 reports; BASF project news; Leggett & Platt comments on urethane and polyol market strength, etc.).
  • Other sector items worth note range from the latest US propylene contract settlement, to reports of US polypropylene imports reaching a six-month high in September, to North America chemical railcar traffic trends.

Friday

Prancing & Shadow Dancing – 4Q20 Sector Views Remain Cheerful, 1H21 Views Border On Wishful

  • Chemical sector order books and price hike announcements reflect broad-based demand strength WoW – we focus on Asia today as a leading indicator of sector health and discuss a few key commodity and earnings report items.
  • We discuss numerous corporate news/update items (e.g. Daicel, Formosa Plastics, Nippon Shokubai, Linde, Asahi Kasei and Trinseo business updates; Ascend, BASF and Trinseo price hikes; and multiple strategic reviews, etc.).
  • Other sector items worth note range from the movement in ex-US naphtha values relative to USGC ethane, to a review of the HDPE market on a global scale, to Peloton cycling to higher sales but facing product shipment delays.
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