C-MACC Perspectives 34 – The Recycling Disconnect
Paper Pressure: Plastic Recycling Unlikely To Keep Pace With Demand; A Brick Wall In 2030 With A Slow Incline Ahead
- Plastic recycling headlines are easy to find but most, in our opinion, are more about the headline itself and represent limited volume, especially in the context of the overall polymer market. Small problems being solved while large ones loom.
- There are significant challenges and costs to recycle large volumes of polymers, and without broad collection and separation standards, the chemical and packaging industries are working with at least one hand tied behind their backs.
- Meanwhile the wall or cliff approaches – consumer products companies have renewable/recycle packaging promises made; 2022/2023/2024 and major ones by 2030. As a result, alternatives are being evaluated, and the paper industry is innovating quickly with the view of market share gain relative to plastic alternates.
See PDF below for all charts
Over the last few months, we have noted that Amazon Fresh in Houston appears to have made a wholesale switch from plastic to paper. As an addict to Amazon Fresh, more so since the pandemic, the paper is a little annoying, in that produce that has come from a fridge, produces condensate and the bags lose structure and have to be handled carefully by the Amazon driver and by the customer. That said, certainly here in Houston, we have a much higher confidence that the paper/containerboard products that we leave for recycling are going to make it to a recycle program than everything else, especially the plastic. Amazon, of course can claim that its packaging is recyclable and renewable, which is the point.
Exhibits 1 and 2 illustrate the problem in the US and are taken from an EPA analysis published in September 2020.
Exhibit 1: There has been significant progress made in the level of paper and Paperboard recycling in the US since 2000.
Exhibit 2: the progress in plastics recycling has been much more limited from a volume perspective – it is also interesting to note the lack of apparent demand growth from 2015 to 2018 – although we would expect a pandemic step up in 2020
In Europe, the progress is a little better in that the volume of recycled plastic has doubled since 2006 – Exhibit 3. This is largely due to much more organized collection and separation at the consumer and waste management steps, especially in countries like Germany and the Netherlands.
Exhibit 3: Plastic packaging waste treatment in the European Union (EU-28) in 2006 and 2018 by treatment type (in million metric tons) – Source Statista (2020)
The polymer industry is doing a good job of identifying and exploiting recycling opportunities, but they are limited by the volume of polymer available in a clean and sorted form which can then be effectively recycled into a useable product either in the food or household products sectors. Meanwhile, companies like Procter and Gamble, Coke, and most major consumer facing packed good manufacturers have set ambitious goals of moving to 100% recycled/renewable packaging by 2030, with nearer term goals to ensure that all the packaging they use will recyclable. In part this driven by consumer and shareholder pressure, but there has also been some government intervention, especially in Europe, but also in some US states (the recent New Jersey plastic bag ban is an example).
The recycling chain is complex, and as we have attempted to show in Exhibit 4, while the packing material supplier can influence what goes on at the start and at the end, the piece in the middle – which is critical – is largely out of their control. One significant collaboration to-date is between LyondellBasell and Suez in Europe, where there is end to end collaboration, but they have chosen a market where recycling standards are very high and they are still limited on volume of polyethylene and polypropylene flowing through the system because collection and sorting within a reasonable trucking radius of the location is the limiting factor. We are told that the venture is profitable, but we don’t see much of a hurry to add a second location, so we would question how profitable. We had assumed that this facility would have reasonable pricing power – maybe not yet.
Exhibit 4: Very few countries and municipalities are set up to connect the start of the chain with the end. However, for paper and paperboard, which is easier to segregate at the consumer and waste handler points, much more material makes it from start to finish.
Unless the plastics industry can solve for the very poor rate of recycling, the large consumers of packaging are going to be forced to look outside plastic to materials that are easier to recycle, such as paper and paperboard, and possibly also aluminum, which also has a higher collection rate – Exhibits 5 and 6.
The lower recycling rate of aluminum in the US versus Europe is likely a function of collection and separation practice discussed earlier. Like paper and paperboard, aluminum should be easier to collect and separate that plastics because it is largely one material and easy to recognize. Plastics has the inherent disadvantage that a pile of recycled plastics likely contains at least four different materials; polyethylene, polypropylene, polystyrene and PET (a fifth could be PVC). Making matters worse is that a lot of consumer product packaging is colored or has other additives to impact feel. These products cannot be recycled as easily, as the pigment or plasticizer is generally a contaminant.
In addition to looking for solutions outside of plastics, polymer choice itself could also become a factor, as PET is widely recycled, and collection and sort rates are high. PET packaging tends to be easier to identify as it makes up the lion’s share of water and carbonated beverage packaging (other than aluminum). Consumer products companies could be encouraged to switch to PET simply because the availability of recycled PET is likely to be higher than that for polyethylene and polypropylene (which are harder to identify and separate).
Exhibit 5: US Aluminum recycling rates are much lower than we would have expected and much lower than Europe – see Exhibit 6
Exhibit 6: European Post Consumer Aluminum – Source data for 2019 from CRU and the forecasts are from European Aluminium. Not only does Europe already have a much larger share of aluminum recycled than in the US, but there are very firm plans to get much higher. The document, referenced here, also discussed how Europe can reduce the CO2 footprint associated with aluminum, partly through increasing the share of recycled material used.
But, stepping away from polymers may be the bigger risk as this might be demand that is lost for good.
Food packaging and consumer products companies are as aware of the recycling inefficiencies for plastics as the producers themselves and their initiatives into paper, for example, are in part driven by the concern that traditional plastic packaging will not be able to keep up with the recycling levels needed to meet 2030 goals. While most of the polymer producers are doing an excellent job of controlling what they can control, the gaping hole in what they cannot control is a problem – especially in the US. European recycling efforts could get a boost from the tax structure that the EU is proposing on countries for plastic that is not recycled, as it creates a monetary incentive to build the collaboration necessary to increased recycle volumes. While we may see similar efforts in some US States, this is likely to be a long way down the list of current Federal goals. As with emissions, a lack of Government direction in the US is leaving much of the pressure to change in the hands of public and private investors and the various ESG goals we have discussed previously. The ESG lobby is unlikely to do anything constructive to help connect the dots of broader polymer recycling initiatives as it is not high on the agenda.
The risk is highest where the demand destruction could be the greatest, either through substitution from recycled material or from other packaging materials
This is the inverse of the COVID driven consumables momentum, and we show the European sourced diagram below that we used in some of our earlier COVID work
Exhibit 7: breaks down the demand for polymers by broad segments – polyethylene is focused in packaging, and while this is important for polypropylene, the dependence is lower, as it is with styrene polymers in aggregate and polyurethanes (PUR). PET is essentially 100% packaging.
If we are concerned that recycling initiatives and use of non-plastic polymers will eat into base polymer demand, we should think about the following likely conclusions:
- Polyethylene will be the most impacted from a volume perspective, but the large players, Dow, LyondellBasell, Borealis, ExxonMobil, CP Chem, Nova and others, have aggressive recycling plans – the risk is that they are not enough and that they simply cannibalize existing production.
- As we think about other polymers – while they may not have the same packaging focus, any loss of packaging demand will likely throw overall supply/demand balances into surplus and hurt operating rates and margins.
- Polypropylene can continue to take share in durables, but this harder for polyethylene – especially low density and linear low density.
- Polystyrene may not survive at all as a packaging polymer, and while other durable styrene polymers and rubber should be fine, the loss of polystyrene demand will likely impact the whole chain.
- PVC and polyurethanes look good – as do epoxies – simply because the bulk of demand is in durables and in most cases there ae still some share gains to be made versus metals.
In our Sunday recaps we collate all the recycling announcements, but always point out that each is small in nature. Dow likely has the most ambitious program, but Dow’s customers probably want much more material longer-term than Dow can deliver. However, each current initiative is eating into demand for virgin plastic – slowly for now but accelerating, nonetheless. We are concerned that COVID is masking the real trends, especially when we include the step up in packaging demand and the spike in consumer durable spending, and that when we arrive a new normal we find that recycled product volumes have stepped up enough to destabilize the virgin markets.
Timing here is very important from a stock perspective.
- While we like the LyondellBasell opportunistic strategy of buying cheap normalized EBITDA, the current leverage would put the company in a bind if a confluence of factors caused the current margin structure in polyethylene (and polypropylene) to collapse quickly. LyondellBasell needs a couple of good years of EBITDA to get its debt per share lower. The chart below shows our best estimate of end 2020 net debt per share for LyondellBasell and a few other US companies.
Exhibit 7: The LyondellBasell number assumes a step up of $2bn to pay Sasol before year-end 2020 – all others are 3Q 2020 data.
- Dow is a little safer in that respect, but all the polyethylene producers could see disappointing demand growth and possible demand declines as the decade progresses.
- Styrene has seen a recent recovery, in part because China seems to be scrambling to get any durable packaging material it can right now and in part because of recovery in demand for engineering polymers and rubbers. At some point styrene’s fortunes are going to change for the worse, in our view, as polystyrene and EPS demand falls for packaging. Trinseo would be a loser, as would LyondellBasell because of its large styrene footprint and Westlake to a lesser extent. The winners would be the styrene buyers into unaffected end markets – Kraton, Goodyear and others. While part of Trinseo’s business would benefit, it would be unlikely to offset the downturn in the styrene market overall.
- The polyurethane and PVC businesses look likely to emerge unscathed, with the possible risk that polyethylene and polypropylene producers innovate to try and capture some durable market share, possible with new “foamed” polymer products. The future looks bright for Westlake, ShinTech, Covestro, Huntsman and the PO chains at Dow, LyondellBasell and BASF. Huntsman has more aerospace exposure than the others, which may be a drag for a while.
- The paint, adhesive and detergent sector should be fine and should benefit from lower cost raw materials as oversupplied ethylene and possibly propylene, should result in lower prices for derivatives such as acrylates, ethoxylates and acetates.
- At high level it is not hard to see a scenario that is worse for ethylene than propylene. This would keep propylene pricing above ethylene and should encourage PDH operations, especially if we see a coincident decline in gasoline demand, effecting propylene supply from refiners, as we are seeing during the pandemic. At the margin, if this is the case, you might see HDPE take some durables share from polypropylene.