C-MACC Sunday Recap 62
Got to get you into my life: Why you need our help!
- This report highlights some of the many unusual challenges facing important business strategy decisions today, both for traditional businesses and for new entrants in the climate change and sustainability-related industries.
- For the traditional industries all the current data may be meaningless and a poor predictor of what is to come, while the economics of NOW is still driving investment decisions. For the new industries, unrealistic assumptions around future economics will likely lead to plans not becoming projects or projects losing money
- We are busy helping companies identify irrational exuberance versus what is real, but we can help more. More than at any time in our 35 years of consulting and research experience, a second opinion is necessary.
Last week we discussed 25 Chemical and related products and 98 Companies.
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We highlighted a chart in one of our dailies this week that fits under the heading of “a picture painting 1000 words”. It is repeated below. This is not, as advertised, a story about carbon capture and storage and use, it is a story of very unrealistic expectations – optimism and irrational exuberance. With 4x more capacity proposed than built, most of the plans that were thrown out proved to be uneconomic and have never got off the ground. Behind these announcements, there are likely some companies that we have never heard of that did not make it past the idea stage.
Exhibit 1: From a report titled Explaining successful and failed investments in US carbon capture and storage (CCS) using empirical and expert assessments. This report from late 2020 discusses what has caused CCS project failures and what has resulted in success.
Source: IOPScience, April 2021
Exhibit 1 is about optimism much more than it is about CCUS. It is about unrealistic opportunities and unrealistic economic projections. It is also about the dangers of using the economics of NOW as your driving force. Note that the largest ramp-up in proposed projects for CCUS was in the 2011 to 2014 period – when oil prices peaked – enhanced oil recovery (EOR) was more valuable because of the price of oil and consequently, the returns on the CCUS probably looked very good – plus there were Obama era incentives available to those promoting EOR. The “economics of Now” approach to planning and investing has resulted in charts like this in the past for other products – ethylene in the late 1980s, and again in the US in 2013/14 – LNG 4 years ago.
We fully expect to be able to draw a similar chart in ten years for green hydrogen that will likely have a similar shape – lots of announcements but far fewer completed projects. More important, it will likely have the same economic challenges as the CCUS projects that did get built have today – poor economics. The EOR profit drivers are relatively cheap CO2 and high crude oil prices – today they have neither, but the escalating 45Q tax incentive is helping a little bit more every year – Exhibit 2. For green hydrogen, the drivers are cheap renewable power and limited competition. For the most part, these projects are greatly underestimating the competing needs for renewable power and the physical limitations concerning the rate of addition of new capacity (see the renewable energy section of our ESG, Climate, etc. report this week linked below), and they are underestimating competition, both from blue hydrogen (which may not be perfect but which may be good enough) and from electric power over fuel cells.
Exhibit 2: The current profile of 45Q tax credits – they plateau in 2026 and extend at those levels for 14 years
Separately this week we weighed in on a post from Mark Carney talking about the inadequacies of current climate initiatives relative to proposed needs – summarized in Exhibit 3.
We responded to the post on LinkedIn – which can be found here – by pointing towards the immediate virtues of carbon capture and the comments are copied below. Reacting to the challenges posed by Mr. Carney some of the comments showed just how poor an understanding of economics, practical constraints, and simple math sit with those who feel they have the solution. One comment suggested that if we simply wait 3-4 years we will have enough renewable power to replace fossil fuels and solve all of the carbon problems. The naivety shown in this comment is a problem because it is shared (perhaps not as extremely) by others, and it is influencing decisions around supporting transitionary moves. If CO2 is the problem and if it is the cumulative impact of CO2 in the atmosphere that matters, we should be doing what we can to reduce emissions now, and not base our plans on unrealistic expectations of new technologies arriving quickly, and sit around doing nothing while we wait. The challenge is to get long-term support for the transitionary moves so that they appear economic for those best placed to implement them.
Response to Mark Carney LinkedIn post by Graham Copley
“The easiest way to make a big difference quickly, without undue economic stress, is for all countries to actively support large-scale Carbon Capture and Sequestration (CCS) – moves that will create investment and jobs. This action could reduce global carbon emissions by billions of tons a year and be at a large scale relatively quickly with the right incentives. These incentives however cannot just focus on the economics of CCS itself, as they must also embrace the need for blue (rather than green) hydrogen, ammonia, and other chemicals as well as lower carbon LNG, and low carbon natural gas power plants, as necessary transition steps for the medium to long-term (30 years). While we wait for enough renewable power to be built to make some of the longer-term hydrogen and other power-intensive solutions become affordable, we can either ignore a process that could meaningfully impact cumulative emissions for 25-30 years or embrace it. Just because it is not the cleanest solution and not the likely end-game does not diminish its value”.
Exhibit 3: Expectations for global temperature rises under different scenarios – versus the Paris Agreement goals
Source: Mark Carney LinkedIn Post
But the misinformation and exuberance are not restricted to the climate change space today and we are seeing evidence that some elements of the chemical industry are extrapolating from far too few data points and making claims (and plans around) demand growth expectations that have no basis in historical correlations and have no sound basis to suggest that history is not still a good guide. This is likely not helped when respected institutions such as Goldman Sachs (as they did this week) bring forward their forecast of peak oil (to 2026 fro 2027), but at the same time state that anything but chemicals and jet fuel will show “anemic” growth from 2025. The new oil to chemical projects announcements in recent weeks are in many cases restatements of intent, originally made pre-COVID, but some are new. Also, new facilities continue to start up in China and more technology licensing deals are happening every week – suggesting that more projects are under consideration.
In summary, we see a lot of bad ideas being pursued (traditional chemicals and clean energy) by companies that have either not enough analysis behind their projections and assumptions or who are believing the rhetoric rather than doing the work. In many cases, there are near-term PR or political drivers, in other cases it is defensive, and in others, it is driven by cash flows.
- “We have to do something in ESG to make our shareholders happy”
- “They have a green hydrogen project in their country so we should too”
- “Chemicals is the only long-term growth avenue for oil – so we should build more chemical capacity”
- “Prices are high and we are making a ton of money – plus our customers say we should expand”
Every one of these reasons may be a good reason for certain investments, but today there are likely far more projects being discussed on these terms that should go ahead. We fear that many companies could lose a lot of money and at the same time fail to achieve any of the primary or secondary objectives.
At C-MACC we have a growing list of clients to our subscription services, but the real upside surprise has been the level of bespoke work that we have seen, given our relatively short company history and also given that we are not alone offering these services, whereas our subscription product is unique.
More and more companies are looking for a sounding board as they look at strategies that might be tangential to their norm and as they face shareholders with a changing perspective around what is important. C-MACC offers a collection of experiences and skillsets that combine well in these situations:
- We understand the chemistry and the engineering required to make something commercial
- We understand economics – both broadly and at the project level and have decades of financial modeling and project economic experience.
- Our subscription client base includes both manufacturing companies and investors (public and private)
- We are not interested in supporting an initiative for our clients – we are focused on making sure that it is the right initiative – pursued in a way that offers the highest reward versus risk opportunity. We are not paid based on a success fee – so we have no issue telling a client to stop something.
- With the wave of “new” initiatives we bring significant experience with project successes and failures and can apply the learnings from both, especially in many of the subjects du-jour; CCS, Hydrogen, biomass, and water are some specific examples.
- Our Subscription Products and their production process ensure that we are current on almost any relevant subject/product/initiative at all times
We have expanded our staff and we have a contact base that puts us one degree of separation from any expert we would need to augment a project. Give us a call.
Otherwise, Last Week, (while we worked on several specific client initiatives)
The polymer chart in Exhibit 4 can be looked at in wonder, but also possibly with a degree of foreboding. It is an indication of the strength in polymer demand in the US relative to supply, with both sides playing their part. Demand is high because of the compounding effect of high consumer demand, the desire by US retailers to source more from US suppliers, and the supply chain shock effect which is likely persuading US manufacturers that they should hold a bit more inventory. On the supply side, the Texas freeze could not have been better timed to cause additional chaos: note how relative pricing started to correct in the week before the freeze. We are seeing some of the heat come out of the US market in recent days, but the foreboding comes from the lack of real pricing reaction in Asia – a region that has been largely dependent on imports of most polymers.
If the new capacity in Asia (several new start-ups in China last week alone) and increased availability in the Middle East is enough to keep supply adequate in Asia, what will happen when US production and demand settle and the US polymer surpluses reemerge? Polymer pricing in Europe is also high and that is a home for some of the US surplus, but it is a long way down to find another export market. US polymer producers will likely have a very strong 2Q and while likely declining, the good times could drag into 3Q. However, we would not be spending any anticipated 4Q profits yet unless you believe that weather will continue to play a larger part in lowering available production capacity each year than it has in the past. As Exhibit 5 shows, integrated HDPE margins in the US, based on ethane feed, have now exceeded the peak seen in 1988.
Exhibit 4: US average spot polymer values, using PE, PVC & PP broadly as a general gauge, reflect a five-year high premium relative to Asia spot levels.
Source: Bloomberg, C-MACC Analysis, April 2021
While we have seen a steady rise in oil products prices relative to US natural gas and ethane since the COVID lows – Exhibit 6 – we doubt that the trend can carry much further. Oil prices are high enough to encourage more exploration and more production – bp announced a major offshore find this week and Aramco also noted renewed offshore activity last week. This time last year everyone was overestimating the negative impact of the onset of COVID and a year on there may be an overestimation of the recovery – production could increase faster than demand for the rest of this year. As we noted above, Goldman Sachs has brought forward its “peak oil” forecast year to 2026 from 2027 this week, suggesting that growth for anything but chemicals and jet fuel will be “anemic” from 2025. With the impending rollout of multiple EV models (the new Mercedes S Class looks cool), we still believe that gasoline demand could peak by 2025.
Exhibit 5: US integrated High-Density Polyethylene (PE) based on a USGC ethane feed reflects close to historical record levels currently.
Source: Bloomberg, C-MACC Analysis, April 2021
Exhibit 6: The value of Brent Crude and Ex-US Naphtha has fallen relative to US Natural Gas and USGC ethane since early-to-mid March, but the price of these general chemical feedstock ratios remain at the high end of the 12-month range. A higher ratio is favorable for US chemical producer profit as its industry is weighted toward natural gas/NGLs.
Source: EIA, Bloomberg, C-MACC Analysis, April 2021
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 look at the inflationary impacts of trade and we add more color to the likely excessive build of new chemical capacity that we touched on above.
Logistics and Their Inflationary Impact
In our first headline summary this week we include a lot of charts as they support the headlines and the idea that shortages beget shortages as fear of having to close your plant and/or disappoint your customer, will likely encourage a US manufacturer to order more raw materials than usual to have a bit more inventory to fall back on – this strains an already strained system – see the freight rate headlines and exhibits 7 and 8. It is also putting strain on the rail system, as supply attempts to recover from the freeze – Exhibit 9. These inflationary drivers will cause a buyer of chemicals to assume that prices are going higher still and may encourage further – over-ordering to get ahead of the next price rise – this has inevitably been the case in March and April, whether it lasts through 2Q remains to be seen, but the correction, when it comes, could be as dramatic as the shortage and the pricing peak.
- Dry Bulk Market in Best Annual Start in a Decade
- Rising costs and less capacity: Shipping’s extraordinary global predicament
- Shipping Container Rates Expected To Remain Elevated Through Year
- Port Of Long Beach Sets Cargo Record In March, capping off its best quarter ever
Exhibit 7: The Freightos Freight Rate Index rises WoW, and we flag two articles worth note: first, Could container shipping rates stay this red-hot until 2022? And, second, see This could be the hottest summer ever — for freight.
Source: Freightos Index, C-MACC, April 2021
Exhibit 8: The Baltic Index currently sits at a level that reflects a five-year high for the time of year and near the high end of the five-year range. We model freight rates will stay elevated on avg. compared to 2019/20 for most of 2021 based on solid global trade trends.
Source: Baltic Exchange, Bloomberg, C-MACC Analysis, April 2021
Exhibit 9: US Chemical rail volume has increased for seven consecutive weeks since hitting a five-year low in mid-1Q21 due to winter storm-induced outages. Volume now sits above 2019 levels. See Exhibit below & AAR charts in LINK.
Source: AAR, Bloomberg, C-MACC Analysis, April 2021
Driving Towards an Abyss
A little over a year ago we wrote a piece highlighting the longer-term risks to plastics supply and demand because of oil company interest in chasing a market that they perceived to be growing faster than other oil products markets, and potentially running headlong into a plastic market that was either seeing slower growth because of concerns around plastic waste and sustainability or was declining.
A year of COVID-related uncertainty put some of the projects on hold, but as we move through 2021 we have a couple of factors driving the plastic bet again. First, demand for plastics is very high and pricing is “off the charts”, suggesting that converting oil to plastics could be profitable as well as a home for some of the oil. Second, with the climate agenda now front and center in every economy and more discussions around electric vehicles, hydrogen, and biofuels, the future for oil demand is looking incrementally bleaker. The economics of NOW thesis would support large-scale investment in oil to chemicals – either directly – or through refining to more common feedstocks. But…
- The plastic waste story has not changed – there will be moves to limit plastic use, there will be moves to recycle plastic into existing (and perhaps new) polymer markets, and there will be a lot of pyrolysis.
- The pyrolysis will produce fuel and whether or not it ends up in an ethylene plant or as diesel or fuel oil substitute, it is a negative for the oil industry as it is recycled oil when looked at from a life cycle perspective – or in the US it is a substitution of NGLs for oil – which is worse for the oil industry.
The current strength of the polymer market and the CURRENT problems with increasing recycling volumes present a very attractive opening for new investment in oil to chemicals today, and the supply chain disruptions could keep the market for polymers robust for the full year, although likely not at current levels. If a series of these investments go ahead, we see real long-term risk to the polymer markets 4-5 years from now.
- Big Oil bets big on plastics as investors sound alarm on stranded-asset risk
- Pakistani Engro plans construction of propane dehydrogenation unit and PP production
- Sinopec Engineering, ExxonMobil agree on EPIC contract for cracker complex in China
- WR Grace licenses PP process technology to new MTO Gas Chemical Complex
- China’s ZPC feeds new ethylene cracker with naphtha
- Maire Tecnimont awarded $500-million EPC contract for Advanced Petrochemical’s planned PP units
- Shell–CNOOC JV starts up POSM, derivatives units in Huizhou, China
- Sinopec Yizheng plans PTA, PET resin expansion in China
The week of April 12th – click on the day or the report title for a link to the full report on our website.
- US polymer price premiums reflect nearly a five-year high relative to avg. Asia levels. This report frames this US premium in a setting of recent declines in US monomer values, tight European markets, & elevated freight rates.
- Other items highlighted in this report: Ex-US naphtha values fall relative to US ethane WoW; US Butadiene rises WoW, while ethylene and propylene markets further loosen; Global polymer values hold up on average WoW relative to monomer values, suggesting rising polymer production ahead.
- This report comments on continued strength in global commodity chemical markets amid healthy global demand and lingering pockets of supply chain issues across numerous product chains. A quick return to normal is unlikely.
- We highlight pertinent chemical sector corporate items (e.g., CP Chemical, LyondellBasell, Nova Chemicals, Formosa Plastics, & OMV business updates; Multiple supply items, Capex targets, & notable sector ESG announcements).
- This report’s other relevant items include MDI prices keeping pace with raw material increases amid healthy demand and broad-based supply chain issues, thoughts on recent advanced recycling initiatives, and highlights a few key indicators pointing to continued strength in freight rates in 2Q21.
- This report comments on the differences in regional chemical production during the first two months of 2021 that generally support our view of global commodity market trends and a few notable variances between regions.
- We flag pertinent global chemical sector corporate items (e.g., Covestro profit guidance update; ExxonMobil, Clariant, Zhejiang Petrochemical, & Sasol facility news; Multiple industry items & sector ESG announcements).
- This report’s other items today include the US port of Long Beach posting record activity levels in March and the strengthening of international freight rates, the Covestro business update this week that we view positively for peer urethane & polyol producers, and the broad-based global initiatives to curb greenhouse gas emissions. We note cow methane emission cuts as an example.
You Need Love – Global Manufacturing Waters Rise, Supply Chains Muddy, Production Faces Rolling Fork
- This report highlights multiple global indicators set to support advancing chemical production beyond end-market demand strength. Expectations are high, but we view US polymer price premiums relative to Asia as vulnerable.
- We highlight pertinent chemical sector corporate items (e.g. Eastman & BASF comments on China; W.R. Grace & PPG updates; multiple commodity chemical production notices, Capex initiative items, & ESG action views)
- This report’s other relevant items include factors poised to benefit lithium markets, views on recent US chemical rail traffic & refinery utilization rate shifts, and a display of the US CCS project ramp into the close of 2020.
- Global commodity chemical markets are historically tight, with Western world markets showing the most notable imbalances. This report discusses a few recent developments suggesting a prolonged return to normal.
- We highlight pertinent chemical sector corporate items (e.g. PPG 1Q21 results; Formosa Plastics, Nova Chemicals, Shell, Ineos, & Pinnacle Polymers production updates; Multiple Capex initiative items & ESG action views)
- This report’s other relevant items include drivers of the rebound in USGC spot ethylene prices, views on global carbon dioxide (CO2) emissions from a country-level perspective, and recent views of relative US Dollar movements.
- While ESG inflows accelerate, definition and accountability remain a challenge, with the rewards of being an ESG darling creating an incentive to stretch claims and selectively interpret data. Regulators need to step in but are moving too slowly
- LyondellBasell introduced an important set of recycling/renewable labels for its polymers this week. The labels indicate the source of polymer production and make packaging decisions easier for consumers – we applaud this first-mover step
- While the US continues its inevitable congressional battle around climate change initiatives, carbon values are rising outside the US, driving investment decisions that could leave the US uncompetitive for some materials