Daily Chemical Reactions

One Piece At A Time – Input Sourcing & Inventory Levels Remain Hot Sector Topics, Autos In Focus
May 6, 2021
Commodities Mentioned:
Plastics (PVC, PP, PE, PS, PET, etc.), Isocyanates, Propylene, Ethylene, Bromine, SBR, Carbon Dioxide, Hydrogen, Methanol, Natural Gas/NGLs, Crude/Naphtha
Companies Mentioned:
Albemarle, Arkema, Evonik, Henkel, Linde, Lonza, Myers Industries, PQ Group, W.R. Grace, Aramco, Shell, Pemex, BHP Group, Devon, Suncor, HollyFrontier, Axalta, Braskem, LyondellBasell, Michelin, CarbonLite, BASF, Perstorp, Livent, Lanxess, DCM, Element Solutions

Daily Chemical Reaction

One Piece At A Time – Input Sourcing & Inventory Levels Remain Hot Sector Topics, Autos In Focus

Key Points:

  • March-quarter industry reports continue to target strong demand, tight supply chains & input sourcing issues. This report discusses a few relevant auto market trends worth considering amid considerable disruption.
  • We highlight pertinent chemical sector corporate updates (e.g., Albemarle, Arkema, Evonik, Henkel, Linde, Perstorp, PQ Group, & W.R. Grace)  
  • US refinery operating rates rise, but US chemical rail traffic falls WoW.
  • This report discusses plastic recycling & other ESG industry trends.   

See PDF below for all charts, tables and diagrams

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Exhibit #1: US auto demand remains robust, and inventory issues are mounting, spurring consumers to move into the used car market. See the surge in the Manheim US used car value index in Exhibit #10, and we highlight an article titled “If you have an extra car to sell, there may never be another time greater than this”. Notice of a tight car market has surged with 1Q21 earnings reports and related business updates, though our research shows that this has been a developing issue since mid-2020. This report flags a few relevant comments from 1Q21 earnings calls and business updates, the consensus expectations that 2Q will market the trough in auto production due to the chip shortage, and the rise in input costs working in favor of keeping new-car prices elevated into 2H21.    

Source: Bloomberg, C-MACC Analysis, May 2021

General thoughts today. An item that is easy to see from the freeways in Houston is the depletion of auto dealer on-lot inventory. Our feedback from those recently in the auto market is that it is difficult to find new and used cars given considerable demand strength. With this note, we highlight data from the auto industry today, showing auto sales, the PPI trend as representative of chemical input cost inflation, and the surge in used car values, to put forth the views that high prices are likely here to stay in 2021. When we factor in auto producer disruptions targeted for 2Q21 due to input shortages, notably a result of the lack of chips, we argue that conditions could worsen before they improve for US auto buyers. Interestingly, we find that the producers of chemical inputs into the auto market are enthusiastic about their products and note the hit from lost sales to the auto industry. See Exhibit #7 for an estimated percentage of the market share of the significant polymers targeting the auto market. A relevant question that we find not asked on earnings calls is whether this setting allows auto manufacturers to catch up on inventory of chemicals, though lagging elsewhere, and thus starts a “one chain or piece at a time” walk to normalization of supply chains in this category. Today, we find supply chains notably lean, as shown with commentary ranging from Albemarle to Henkel. All told, inventory replenishment will result in higher than normal demand for chemical products in the near-to-medium term. Still, we find most chains able to satisfy the level of true underlying demand more than. Commodity prices will ultimately trend lower in our view, though 1H22 is likely when we can comfortably call for lower levels. Today’s other takeaways target Albemarle lithium commentary that we view as supportive of views recently put forth by its peer, Livent, and its optimistic view of the bromine market, which is positive for peer producers Lanxess and ICL. See Exhibit #2 for the Albemarle view of each product. The other major item of note, in our opinion, is the surprise drop in chemical rail traffic WoW, which we link to logistical issues and likely producer inventory builds. However, we see volume in 2Q21 reflecting levels on avg. above that of 2Q19 based on our production outlook. We also highlight the plastic recycling diagram in Exhibit #5, and note innovations in this area, such as the BASF investment in watermark technology to help with sorting. Current chemical market conditions are hot, outlooks are positives, and management teams are broadly enthusiastic.

Global Chemical Sector Corporate Items:

The emission targets that have been suggested by the Biden Administration and will likely be ratified at the COP26 meeting later this year, while likely unrealistic, are a significant boost to the EV industry, and once again the issue of battery capacity and availability is grabbing the headlines.  As we have suggested in prior research, Lithium is only one of a few raw materials that signal problems for the auto industry as producers try to introduce mass-market EVs, as opposed to what has until now been largely a luxury option.  Metal prices are increasing, composite and other polymer prices are increasing and lithium pricing is increasing.  Interestingly, Lithium is most likely the one area where we can see corrective supply action, as the lithium suppliers have high valuations and should have little trouble raising capital for new projects. While the current pricing dynamic is good for Albermarle and other producers, and it may last a while, we will inevitably see fresh capital thrown at new lithium opportunities and lithium recycling, which will eventually provide a correcting mechanism.  We have always been of the view that the barriers to entry in lithium are much lower than the legacy producers would suggest, and we expect supply-driven price volatility in lithium, even if there is a rising trend for several years.  We would be more concerned about other critical metal pricing, where new projects look harder to fund.

Exhibit #2: Albemarle flags improving lithium and bromine trends but sees a weak refining catalyst market in 2021.

Source: Albemarle Earnings Call Presentation – 1Q21, May 2021

Energy/Upstream:

The drop in crude and oil products inventories should not be a surprise and neither should be the higher refining operating rates. The US economy is reopening and with it demand for gasoline and jet fuel.  We still believe that gasoline will have a sharper snapback than jet fuel, simply because there are few safe international destinations right now and this will not rectify quickly.  Gasoline demand will likely surprise to the upside frequently over the next few months and the refining rates shown in Exhibit 3 will rise further.  This will likely have negative implications for US propylene prices and also possibly for benzene prices. 

Exhibit #3: US average refinery operating rates increase WoW to surpass 2020 average utilization for the time of year but remain below 2019. Refineries produce ~45% of US propylene and ~60% of US benzene. Total US gasoline stocks rose WoW to stay comfortably in the five-year range for the time of year – see EIA chart in LINK. This report highlights several global energy and chemical trends impacted by US refinery production that is worth consideration.

Source: EIA, Bloomberg, C-MACC Analysis, May 2021

Supply Chain & Commodity Chemicals:  

The fall in rail car shipments is surprising but is possibly a consequence of customers wanting more inventory and holding on to rail cars for longer – this will be fine if the US demand growth for chemicals and polymers is strong enough to keep US units running at high rates, but a desire to move more polymers to export facilities would be severely hampered by a reduction in rail car availability.  There is not much of an option to switch to trucking as larger polymer consumers are equipped to take rails cars, plus there is the well-documented shortage of drivers. 

Exhibit #4: US Chemical rail volume fell WoW, falling below the level seen in 2019 but well above the YoY level.  We think shipments will stay at or above 2019 average levels in 2Q21. See the exhibit below & AAR charts in LINK.

Source: AAR, Bloomberg, C-MACC Analysis, May 2021

Sustainability, Clean Energy, Recycling & ESG:

Since we began our more dedicated ESG and Climate work we have challenged one of the fundamental beliefs of the “green” energy advocates, which is the ready availability of abundant cheap clean power quickly.  Our concern has been that at a global level the demand for renewable power is likely to grow so quickly that the industry cannot keep up, and while the expected learning curve shape might continue at a process, delivery, and assembly level, capacity constraints would overwhelm these gains.  We began talking about raw material limitations earlier in the year and have focused on it intensely in recent reports – including our Daily from yesterday and the ESG and Climate piece also from yesterday.  The inflationary fears around metals (and around shipping constraints) are now mainstream, with good coverage in the FT today and on CNBC yesterday.  The Albermarle call, discussed above, confirms the inflation and expected continued inflation in Lithium prices.

Separately, the article highlighted below talking about cost increases for the European Chemical Industry because of the carbon price increase is broadly correct but will impact some companies more than others, and some companies not at all.  The Cap and Trade mechanism in Europe will result in companies increasingly having to buy credits (raising the price) if they cannot meet the carbon-cap limits which are getting increasingly tighter.  However, not everyone is included in the system – the original plan included power plants and “large” industrial sources – which included the larger chemical complexes but not many of the smaller ones.  One of the reasons why the carbon price is rising is because most of the low-hanging emission reduction opportunities have been taken by now, leaving the harder and more expensive ones left.  Even at €50 per ton, few large CO2 emitters can afford the cost of carbon removal and are therefore better off buying the credit – which will impact earnings as the article suggests. 

The dynamic in Europe could be very interesting and very different from what we are seeing in Canada for example.  In Canada, the impacted industries know that by 2030 they will be paying a C$100 per ton carbon tax.  They are investing now to avoid or minimize that tax – lots of carbon capture and some green hydrogen projects.  In Europe, the price is there today but is still not high enough to spur investment beyond the large publicly assisted projects that we see in the UK and Scandinavia.  The article below may be missing a critical point, which is that the European carbon price could get much higher than it is today because investments to remove carbon need it to.  But investments take time, and in the meantime, carbon emitters in Europe could see rapidly escalating costs of compliance.  In its planning assumptions a year ago, bp assumed a carbon price in Europe of $100 per ton.  This is likely a critical factor in its decision to build a blue hydrogen facility in the UK.  A lower carbon price assumption might not have helped justify the facility. The real risk to those impacted in the European chemical space, which would include BASF, Dow, LyondellBasell, Total, Ineos, Borealis, Shell, and others, is not the impact of the €50 per ton carbon price today but the risk that it could quickly move much higher and stay there, while investments to lower carbon emissions catch-up. The 45Q carbon credit in the US provides a future target for investors – $50 by 2026 – designed to encourage investment now, but it is not high enough on its own to make the impact that the emission goals in the US call for.  This would be a relatively easy move for the Biden administration to make – increase the credit, and possibly make it last longer than the current 15 years, acknowledging that CCS is needed for 25-30 years.

Exhibit #5: We highlight an exhibit today from a report from The Conference Board framing the plastic recycling and management market and offers an outlook for the future of plastic solid waste management. See report in LINK.

Source: The Conference Board, Bloomberg, May 2021

Other Industry & Downstream:

The auto industry dynamic is fascinating not least because US consumers are sucking up new and used vehicles as fast they can – driving the price inflation that we see in Exhibit 6 – but because this is happening at a time when many Americans are looking at lower vehicle utilization going forward as at least some of the working population will embrace the work from home opportunities that have been introduced because of the Pandemic.  It is an interesting exercise to do in any part of the country, but we suspect that if you walk around any US neighborhood today you will find vehicles parked on streets and in driveways that look like they have not been touched, or have been barely driven in months.  The argument that the vehicle is a sunk cost holds water in many cases, but the annual cost of insurance and maintenance makes no sense for a vehicle that travels less than a thousand miles a year, especially with low-cost alternatives like Uber and Lyft.  

The very high price of used cars will eventually encourage people to sell the third or fourth car they own if it is getting no use, and we believe that the chip shortage, the increased demand for delivery services, and other supply chain disruptions in the auto space are creating a significant bubble. 

Whether these bursts and dissipates slowly or quickly in part depends on the Administration and whether or not they propose moves to make EVs more attractive and ICE vehicles less attractive.  Note that to hit the Biden emission goals in the automotive space, the US needs to take 130 million ICE powered autos off the road by 2030 – see our ESG and Climate report No 22.  The suggestion of a gasoline tax would take the wind out of the auto market overnight.

Exhibit #6: US used car values reflect notable strength, amid strong demand for autos amid new car supply issues

Source: Manheim Index, Bloomberg, C-MACC Analysis, May 2021

Exhibit #7: We provide an estimate of the % of each polymer consumer in automotive applications. Polyurethane and Nylon products reflect the greatest relative exposure to autos as a % of their total end-market consumption.

Source: Corporate Reports, Bloomberg, ICIS, C-MACC Analysis, May 2021

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