Daily Chemical Reactions

Moth To A Flame – Chemical Sector Profitability To Lure Production, Western Markets Most At Risk
October 27, 2021
Commodities Mentioned:
Plastics (PVC, PP, PE, PU, PC, PET, etc.), Benzene, Lithium, Carbon Dioxide, Hydrogen, Natural Gas/NGLs, Crude/Naphtha
Companies Mentioned:
BASF, Dow, Huntsman, Covestro, Petrobras, Equinor, Repsol, BorsodChem, Entegris, Cabot Corporation, Epsilyte, Siam Cement, Iberchem, Croda, Meghmani Finechem, Mitsui Chemicals, SK Chemicals, Pregis, Linde Group, Wacker Chemie, Axens, Sumitomo Group, Berry Global, Avery Dennison, Trex, Toray, Invesco, Vestas, Bloomsberry, Linde, Stellantis, Neste

Daily Chemical Reaction

Moth To A Flame – Chemical Sector Profitability To Lure Production, Western Markets Most At Risk

Key Points:

  • Global chemical production faced several notable headwinds in late 3Q that helped spur commodity prices upwards and offset some cost inflation. We anticipate a supply response as most producers are incentivized to run.
  • We flag pertinent chemical sector corporate updates (e.g., BASF,  Siam Cement, Neste, Cabot Corp., Repsol, Epsilyte, Mitsui, Linde & others).
  • We find relevant ESG items worth notice, ranging from EU carbon value weakness to the decarbonization initiatives noted in our ESG report in LINK.
  • We note numerous other pertinent chemical sector items in this report.

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Exhibit #1: MDI-polyurethane prices have moved higher in October, reflecting an upward trend relative to global benzene prices that have occurred across all major markets per our estimate since July. We highlight this trend following positive general business trends from Dow and BASF in this area. In our view, peer MDI producers Huntsman and Covestro to flag generally similar business trends with upcoming 3Q21 reports. Our research today also comments on other relevant commodity and downstream industry trends worth notice.

Source: Bloomberg, C-MACC Analysis, October 2021

General thoughts. The earnings report from BASF is the stand-out earnings release overnight. We find several positive business developments that offset a few well-known pockets of weakness due to curbed global automotive production. Slide 9 discusses the impact on its surface technology business within the earnings call slides in LINK as an example. We also highlight global chemical production estimates within the BASF slides (Ex. #4) show a volume slowdown with the ACC chemical production data this morning that shows a decline in volume in September relative to August. Storms in the US and power cuts in China are the major drivers of the moderation in global production rates in 3Q21. We also note a few mounting pockets of weakness, such as in US durable good orders in September, and we note higher global feedstock costs into 4Q21. Indeed, we argue that it does not bode well for margin trends after production returns during the next few months. We find most global producers incentivized to run on an integrated basis; especially, in the US. Ex. #1 highlights rising MDI prices relative to regional benzene costs, which we think will ring positive for MDI-polyurethane profit commentary with upcoming 3Q21 reports from Huntsman and Covestro. Indeed, we find these markets tight despite some pockets of demand weakness, as previously noted in automotive, and we find Dow and BASF 3Q21 reports on the isocyanate and MDI-systems markets as implied to be generally constructive. When we broaden our scope to the overall commodity sector, we find a setting where production could ramp quite quickly. We will not be surprised to see significant Western premium price shrinkage during the next 3-6 months relative to Asia and, in some cases, Europe. Demand not holding up as consumer dollars shift to other areas, such as travel relative to durable goods, is a considerable risk for many chemical producers. With this in mind, we find few announcing major capacity additions, as is typical when margins notably expand. We tie this development to near-term optimism but low visibility into multi-year demand trends both from an existing product and market share perspective when considering alternative products, such as those with recycled content.  In our view, this sets up a period of a likely weak profit setting in 2022/23, relative to 2021, but then a possible notable price and profit upcycle for the industry. In our view, this long-term view will be the focus of most sector investors as industry profit potentially moderates in upcoming periods. Other items of note include a European carbon price that remains roughly 9% below its early 4Q21 high. We highlight several news items showing global freight rates moderating as supply is scrambling to find other paths to get into consumers’ hands. 

Energy/Upstream:

There are lots of discussions around the durability of higher energy prices and energy inflation is a central topic on some earnings conference calls and in many of our discussions with clients, especially those at chemical companies with the unfortunate task of having to prepare a 2022 budget, which of course includes a forecast of costs.  We see continuing strain on the US and global natural gas system and, behind what will inevitably be some seasonal weather-related price volatility, a stronger market that could endure for years. The rate of addition of renewable power does not seem to be able to keep up with demand growth and replacement needs caused by some fossil fuel-based power plant closures around the World.  Natural gas (LNG) is the natural plug-in replacement, and we continue to see underinvestment, relative to natural gas prices, as a consequence of ESG related pressure around capital spending.  We would advise all clients to look at a 2022 scenario with natural gas, and oil higher than current levels.

The very high LNG prices give a significant marginal competitive advantage to countries and regions that are long natural gas, such as the US and the Middle East, and even if the LNG prices shown in Exhibit 3 moderate materially in 2022, US chemical producers with either a high methane cost component or high power component should benefit.

Exhibit #2: The EIA expects US consumers to spend more on heating fuels, primarily driven by higher prices. We follow our commentary on increased Natural Gas and Propane expenditures from yesterday to note a more inclusive chart.

Source: EIA – Winter Fuels Outlook, October 2021

Exhibit #3: High Natural Gas Prices In Europe and Asia support US LNG exports, even considering higher US prices.

Source: EIA – Winter Fuels Outlook, October 2021

Supply Chain, Commodity Chemicals, & Chemical Sector News:  

As mentioned above, the BASF and ACC data in the charts below indicate how much production was impacted by storms and feedstock/power availability in recent months.  With prices still high in the US and for most products in Europe also, not only are companies incented to run, but they also have the capacity available to do so.  This is not the case in China for some production impacted by power outages and it is not the case for some production globally that is looking at punitive methane pricing because of LNG pricing.  Otherwise, we would expect 4Q to show very strong production both sequentially and year on year.  On quarterly calls, we have heard a number of companies talk about the need to rebuild inventory and see this as a reason for demand to stay stronger for longer.  Inventory needs by customers are generally impacted by end demand but also by the expected direction of prices – if prices look like they are going to rise a customer will buy more now – if they look like they are going to fall, inventories become less of an issue.  As we head through 4Q and into 2022, this becomes a hard call to make, as while US pricing and European pricing for many chemicals and polymers have been well above costs, setting up record 3Q profits for many, we have the energy inflation issue that is shown very clearly in the exhibit above, and fear of an energy spike, giving chemical producers a genuine cost argument, may cause customers to keep the inventory build goals that they have been indicating in 3Q. We may have more production in 4Q 2021 but we may see less pricing downside if the consensus view moves to higher energy prices for longer.

Exhibit #4: Global chemical production increased by around 4 percent in 3Q21 YoY, per BASF and industry data. All regions recorded growth; it was most pronounced in Europe and Asia, excluding China. However, several temporary factors – such as the global semiconductor shortage, Hurricanes Ida and Nicholas in the US, and power cuts in some provinces of China – led to overall lower growth rates compared with 2Q21.

Source: BASF 3Q21 Earnings Call Presentation, October 2021

Exhibit #5: US Chemical Production Declined in September.

Source: American Chemistry Council, October 2021

Sustainability, Clean Energy, Recycling & ESG:

Our ESG and Climate Piece today focuses heavily on COP26, which begins this weekend, and has been the subject of many of this week’s stories, as attending countries make their concerns and preferences known and as companies and lobbying groups try to be heard.  The highlighted FT article today talks about the minimum needs from COP26.  We highlight this because we have been talking about the same things for months – the significant gap between what is pledged for 2030 and what is needed, and the need to attack emissions of methane and CO2 aggressively.  The methane issue can likely best be achieved through legislation – especially as some of the leaks around the world may not belong to anyone, who could benefit from an incentive or be penalized for the leak.  The CO2 emission issue will always be bet addressed through a pricing mechanism on carbon.

Separately, we get a sense that China’s goal of net-zero by 2060 has legitimized the goal for others, with Russia and now Saudi Arabia joining the 2060 club.  In recent work, we focused on the competitive edge that China might gain from being a decade late – China: A Challenge With 2060 Goal But Also A Possible Edge. The advantages discussed in this report might also accrue to Russia and Saudi Arabia.  We do not see this ending well, especially if others with significant climate goal challenges decide that this is a better club to join.  

We include the Hydrogen Council chart in Exhibit as a reminder that there are many ways to move along the path to net-zero and we need all of them.  Each technology and solution will have its place and, perhaps more important, its time.  Ultimately we need to move towards a ground transport system that is dominated by electric power and hydrogen – either as a direct fuel or through fuel cells.  But the timing will be key and we cannot ignore the many vehicle analysis studies that suggest ICE-based cars and light trucks will not peak in use before the mid-2030s.  To try and move that transition faster we would need to pay people to switch from perfectly good ICE cars to electric ones – this adds to costs in a transition that is already expensive.  Sustainable gasoline may be a cheaper path to allow for a less forced move to EVs and one that does not cause undue economic harm or drive unintended consequences.

Exhibit #6: The Carbon price in Europe has fallen ~4% since the start of 4Q21 but is ~75% higher YTD.

Source: Bloomberg, C-MACC Analysis, October 2021

Exhibit #7: Greener, Faster, Cheaper: A Combination of Battery and Fuel Cell Electric Technology Is Key to Successfully Decarbonising Global Transport – Hydrogen Council.

Source: Hydrogen Council, C-MACC Analysis, October 2021

Other Chemical Industry, Demand & Downstream News:

Shipping rates are coming down slowly, and the delays at the ports on the US West coast are also easing (slowly).  We have seen these trends in the past this year only for them to reverse again, so we should likely not start to celebrate, but it is a better direction.  It is not a  good direction if you are a US seller of polymers to US customers as the opportunity to import polymers from Asia may rise as costs (including the cost of delays) fall.  However, despite marginally better distribution we still see reports of potential holiday season shortages, which likely guarantee that the shortages will occur.  This may be another reason for chemical and polymer customers in the US to look for more inventory as they see rising apparent demand from their customers in the near-term 

There is no let-up on the calls for higher inflation and we may just be changing who or what is in the driving seat, from supply constraints to higher energy and other input costs, although both seem to be driving the fears for now.  While we would expect some of the supply chain issues to ease in 2022, we are less convinced that energy costs will fall and this would lead us to believe that higher inflation could linger. 

Exhibit #8: California Gross Container Traffic Fell In September MoM, But Remains Above Three Year Average

Source: Bloomberg, C-MACC Analysis, October 2021

Exhibit #9: Freight rates from China to US West and East Coast Ports fell modestly WoW, though rates remain near historic highs. We flag an article titled Happy Halloween for boxship operators to show the tight global market.

Source: Bloomberg, C-MACC Analysis, October 2021

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