C-MACC Sunday Thematic & Weekly Recap 99
Inflation (Especially Energy Costs) – Biggest 2022 Wildcard
2021 Coverage Summary – Companies Discussed and Products Covered
- Our thematic coverage was broad in 2021, but the focus on inflation and energy increased as the year progressed, and we think these present the major wild cards for 2022.
- Inflation risk is most focused on energy, but food and metals could also present problems – prices rose in 2021, and supply/demand balances will likely stay far from normal in 2022.
- We expect US and European manufacturers to see another year of opportunity to spur output, even considering loosening global supply chains, as we anticipate reshoring demand will rise.
- ESG issues – mainly around emissions and plastic waste/recycling will become more integrated into corporate strategy in 2022, but measurement and oversight could remain inadequate.
- Otherwise, we look at declining US polymer margins, hydrocarbon price volatility, and its impact on new capacity planning for chemicals, Huntsman’s portfolio moves, and trade.
Last week we discussed 30 Chemicals and related products and 113 Companies.
Our Sunday Thematic research coverage for 2021 breaks down by major topics, as illustrated in Exhibit 1. We have taken more than one topic for any given report if the coverage was significant – we produced 51 Sunday reports in 2021. Note also that ESG topics rank second despite our dedicated ESG and Climate service, which tackles major themes each week. Some of the impetus for the more extensive coverage of ESG topics was the COP26 conference in 2021, but we would also note that emission abatement and plastic waste are two of the more important strategic issues facing the broad chemical industry today. Exhibit 2 shows the breakdown of coverage by quarter, highlighting how much more critical energy costs and inflation became in the second half of the year. These are the two most significant wildcards for 2022 in our view and are connected, as energy costs could be a major contributor to inflation this year.
In Exhibit 3 we show a breakdown of the “others” category. The auto sector took a front-row seat in 2021 because of the shortage of semiconductors and the resulting cutbacks in auto production – important in the context of the very strong consumer spending patterns in the US and Europe despite this, and also because auto production consumes significant volumes of polymer and paint. Weather also featured more times than it would have 15-20 years ago, but no less than it did in 2020. It is illustrative that one of the second-tier reasons for Dow’s large expansion announcement in Canada versus the US Gulf was lower Hurricane risk.
Exhibit 1: Broad subject focus of C-MACC Sunday Thematics in 2021
Exhibit 2: Coverage breakdown by quarter shows how energy and inflation became more important and 2021 progressed
Exhibit 3: Breakdown of the “others category”
In our view, inflation is the most significant wildcard for 2022 – and to illustrate, first an anecdote. The picture below is of a 1970 Mercedes 300 SEL – a 6-liter monster of a car that Graham’s father coveted for years. He finally bit the bullet and bought a used model in mid-1973. Graham’s father was a national health service doctor in the UK – the family was certainly not poor, but this car was a stretch. In the 70s in the UK most family doctors made numerous housecalls during the working day and “on-call” nights and weekends, so the car was well used. In 1974, the price of crude oil tripled and the cost of UK petrol doubled. In a small family microcosm, the most glaring impact of the inflation in energy prices (at least to a 13-year-old) was that the car had to be sold – the 6-liter gas-guzzling engine was traded for a 2-liter engine as it was too expensive to run the Mercedes. As the 70s progressed cars in Europe got ever smaller and less powerful.
As an importer of almost all its crude oil in the 1970s, the two oil shocks helped drive aggressive inflation in the UK– Exhibit 5 – more so than in the US – and the accompanying decline in GDP – Exhibit 6. As we enter 2022, we have much higher international natural gas prices than we had a year ago and Brent crude oil prices are almost 50% higher than they were on January 1st, 2021. While US natural gas prices have eased over the last couple of months because of milder weather, we are adding much more incremental LNG capacity over the next 12 months than the EIA is predicting for increases in natural gas production, and we fear a squeeze on US natural gas that could result in much higher domestic prices.
Exhibit 4: The most attractive car available to a middle-class Brit in 1973!
Exhibit 5: UK Inflation was dramatic in the 1970s and caused significant issues with pay increases – creating some civil unrest
Source: Macrotrends
Exhibit 6: Until COVID, the oil shocks of the 1970s helped drive 2 of the worst recessions in the UK
Source: Macrotrends
Exhibit 7: Higher Shipping Costs May Lift Asia’s Low Inflation.
Source:IMF, Hellenic Shipping News, December 2021
But energy is not the only inflationary wild card in 2021, materials, food, and transport could all play a part. In Exhibit 7 (above) we show an IMF chart that is focused on regional inflation in 2021. This IMF article notes that “Asia’s inflation has been more moderate versus other regions, affording central banks room to keep interest rates low and support economic recovery. However, Asia’s tepid price gains may see greater momentum next year.” We also note an article from early December titled,Amid rising inflation around the world, Asian countries are a safe haven. Import dependence and the higher cost of freight have played a significant part in the shape of this chart. The comparisons between inflation in the US, Europe, and Asia in Exhibit 7 show just how much the supply chain has impacted the various regions, with surpluses in parts of Asia unable to find export markets, creating local oversupply and lower prices, while shortages in the US and Europe drove inflated prices in part because of higher transport costs. As we look towards 2022 we expect the supply chain component of inflation to ease, but potentially be overwhelmed by energy, material, and food inflation.
Food inflation is partly supply chain and labor availability driven, but it is also likely to be impacted by energy inflation in 2022. High global natural gas prices materially affect nitrogen fertilizer costs (see article linked below from today’s FT), which will either have to be passed through in higher crop prices or will result in lower use – driving lower yields, lower production, and shortages – having the same impact on pricing. Potentially making matters worse will be the rise in demand for carbohydrates for renewable fuels and materials – probably incremental in 2022 and more meaningful in 2023. This may impact canola more than corn, given the biofuel refinery conversions in California and their need for vegetable-based oils to supplement waste oils and fats. Prices have already risen steeply in 2021 (Exhibit 8) but could move higher again in 2022
Exhibit 8: Canola prices are rising more quickly than corn and soy, but all a showing steep upward trends
Source: Bloomberg and C-MACC Analysis
In Exhibit 9 we show our (renewables) metals price index, which continues to climb and is now 50+% higher than it was 2 years ago, with cobalt and lithium leading the charge at around 100% higher. As Exhibit 10 shows, these are critical components for EV and renewable power manufacture, and with 2022 forecasts for all suggesting much stronger growth, we do not see the materials supply/demand balances improving, suggesting that pricing will go higher. Energy shortages today, will only add more upward pressure to build more renewable capacity quickly and add even greater inflation risk to both components and the materials used to make them. We are concerned that, on the metals below, only lithium is seeing significant capital thrown at increasing availability, suggesting that while lithium may peak in pricing, other metals could keep marching up.
Exhibit 9: We discussed the cost inflation of critical minerals used in the energy transition in an early December ESG weekly report titled, Coming Up Short: Materials Availability To Limit Climate Progress.
Source: Bloomberg, C-MACC Analysis, December 2021
Exhibit 10: Energy Transition Likely to Skyrocket Demand for Critical Minerals, says IEA. And, we follow this report with an article titled, 2021 was the year clean energy finally faced its mining problem. We also highlight the report titled, Metals Shaping the Energy Transition, providing a more detailed breakdown and projections.
Source: IEA, Natural Gas Intel, December 2021
Inflation could impact the chemical and related industries in several ways in 2022 and we list a few thoughts below:
- Will a shortage of key energy sources in 2022 help to change the narrative around energy transition, pushing the “clean fossil fuel” agenda and resulting in more investment in US natural gas and LNG, and possibly crude oil production – but with associated emission reduction investment?
- Could support for clean coal use step up – is our coal/pet coke to hydrogen thesis crazy or not?
- Will material shortages, price increases, and supply chain issues keep a limit on renewable power installation in 2022 as it has in some parts of the world in 2021?
- Will materials and labor inflation change some capital investment plans for the chemical industry if project costs are revised higher and companies start to factor in construction delays because of material shortages?
- Could the same issues knock some of the “new materials” off track for polymers and renewable fuels – i.e. will construction costs inflate to levels that create financial problems or cause major delays?
- Will energy inflation be enough to slow economies globally – resulting in demand shortfalls – oversupply and break-even margins (or possible losses as industries try to move prices up against rising costs)?
- Could recessions or fear of recessions force governments to shift policy towards countering inflation and stimulating growth, perhaps at the expense of current energy transition plans?
While we believe that a mega-cycle is coming for chemicals because of lower investment rates over the next 5 years, we doubt that there will be many signals in 2022 (especially in 1H 2022 to invest in the sector)
Otherwise, Over The Last 2 Weeks
Chemical end-market demand generally held up in December. We view the Mastercard update highlighting an 8.5% uptick in US holiday retail sales as evidence that overall consumer demand is strong. Many omicron-linked concerns about in-store shopping have led to upped online orders, and we continue to see the downstream demand environment constructive for most chemical producers. Our focus remains on the trajectory of high US producer margins, partly due to domestic premium prices that are now contracting, and on movements in feedstocks into early 2022. As shown in Exhibit 11, where we use high-density polyethylene (HDPE) as the example polymer, 4Q integrated producer margins were lower relative to 3Q21.
The negative momentum in US polymers prices is overwhelming all other factors in the eyes of public shareholders, with Dow and LyondellBasell share prices both down 6% since October 1st, underperforming the S&P500 by 16%. The data in Exhibits 11 show that current industry profitability is very high and much higher than it was in 2019 when share prices were roughly where they are now. Our expectation is for profits to fall in 2022, (because of the disconnect with Asia – Exhibit 12) but not to the levels seen in 2019 unless there is a significant increase in US natural gas and NGL pricing relative to crude oil (which is possible). But while these stocks look very attractive based on historic relationships to cash flow, we cannot ignore years of experience covering this sector which says that no one gets interested until the earnings revisions bottom out – so not yet, and likely not in 1H 2022. Complicating the story is the lack of clarity around what sort of EGS penalty is implied in current valuations and whether it could get worse as ESG funds grow, which they surely will in 2022. In our ESG and Climate report, we looked at some chemical stocks that could benefit from the rise in energy transition and infrastructure spending in 2022 and are less exposed to commodity polymer global oversupply.
Exhibit 11: US polyethylene (PE) margins have declined relative to their 1H21 peak but remain significantly higher YoY and are also much higher than 2019 levels.
Source: Bloomberg, C-MACC Analysis, December 2021
Exhibit 12: US polyethylene (PE) spot values have fallen toward Asia levels since 3Q21, and given new US production in 1H22 and a likely loosening of supply chain tension, we anticipate downward pressure on US spot levels near-term.
Source: Bloomberg, C-MACC Analysis, December 2021
Looking at Exhibit 13, it is clear that planning for consumers of hydrocarbon feedstocks is a challenge, and this is especially true for anyone looking at new projects, adding to our view that new project announcements will slow in basic chemicals, setting up for a major upcycle after 2023. The volatility in relative feedstock prices over the last ten years likely means that you would need to be able to demonstrate profitability under a wide range of possible feedstock price scenarios, while at the same time assuming that prices are set by marginal costs. Today global prices are set by marginal costs as parts of Asia are operating at break-even economics, with the much more profitable US and Europe impacted by feedstock advantages in the US and higher freight costs for polymers trying to enter the US and European markets. The US trade balance (shown later in Exhibit 18) is partly influenced by rising prices on some imported goods because of higher freight costs. While we continue to see some basic chemical expansion announcements, there have been periods of relative feedstock costs over the last 10 years where any project would have looked unprofitable. The volatility in the chart confirms that any producer will have better and worse times throughout a facility’s operating life, and consequently, start-up timing can be everything. Losing money for the first few years of any project’s life can destroy any ROI goals.
Exhibit 13: We highlight a Platts article focused on 2022 that expects naphtha to remain key steam cracker feedstock on pricier LPG and an Argus article noting that European Naphtha prices are finishing the year high relative to crude and gasoline.
Source: Platts, Bloomberg, C-MACC Analysis, December 2021
Following on from the comments above, the Asia butadiene price trend is a great illustration of how bad the year has become for ethylene producers in Asia and especially in China. Butadiene and propylene prices in the region have collapsed relative to ethylene and given the predominant heavy feedstock use in the region, co-product credit declines have effectively raised ethylene costs versus history. With the low co-product credits and the constraints moving products from the region to other parts of the world, it is significantly more profitable to move ethylene from the US to Asia rather than making it locally. We remain concerned that US natural gas prices could move significantly higher in 2022 and drag up NGL prices, but in the meantime, the arbitrage to move US ethylene to Asia should remain attractive.
Exhibit 14: CFR China butadiene falls $35/mt to a 16-month low. We view downward pressure on butadiene prices as negative for mixed C4 processors in the US, such as at TPC Group. But, the trend may benefit consumers, such as Kraton and Invista, if downstream prices can hold.
Source: Bloomberg, C-MACC Analysis, December 2021
In our ESG and Climate report, we highlighted inflation as one of the most significant risks for 2022 and the estimates in exhibits 15 and 16 do not leave us any less concerned. The US has struggled to meet solar installation plans for 2021, falling short of early-year estimates because of limited equipment availability and higher equipment prices. While some of this has been the result of the supply chain challenges of 2021, some shortages have also been the result of very strong global demand. The idea that we can increase solar installations in 2022 without creating more supply issues (and more inflation) should be questioned, especially in light of planned additions in China, which will consume an increasing share of Chinese solar modules.
Exhibit 15: According to the EIA, solar power and battery storage will likely account for most of the 78 GW of capacity additions in 2022 and 2023. We also highlight an Argus discussion of this development in LINK.
Source: EIA – Energy Monthly, December 2021
Exhibit 16: Solar and battery storage growth will increase as a total of electricity generating capacity additions in 2022-2023, but we also highlight that natural gas and wind additions reflect support in 2022 but a lower share in 2023.
Source: EIA – Energy Monthly, December 2021
As we head into 2022 we have divergent natural gas markets, with shortages in Europe and Asia driving a “cargo” battle for incremental LNG, while US prices fall because of very unusual December warm weather, resulting in lower than usual declines in natural gas inventories. We still see natural gas prices as the real wild card for 2022, starting almost immediately as New Years Day saw a cold front sweep the US, driving temperatures down to seasonal norms and lower in some areas. At the same time, the new Venture Global LNG terminal in Lousiana is starting operations, hot on the heels of the most recent expansion by Cheniere. New LNG capacity during 2022 should lift US export volumes by as much as 2 BCF per day versus 3Q 2021 and this is at odds with an EIA forecast that shows minimal production growth in the US in 2022 – less than 0.25 BCF. We are seeing today that demand for LNG looks to be supply-driven – i.e. if you can make it there is a buyer, and US natural gas prices could spike if the rest of the winter is cold and LNG sellers become the marginal buyer. Note that in our Daily on Tuesday (and again above) we questioned the ability of the US to meet its 2022 renewable power growth goals, given component shortages and cost inflation – already a factor in 2021 – shortfalls in renewable power generation will put increasing upward pressure on domestic natural gas demand.
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 look at the continued evolution at Huntsman – something that we do not see fully reflected in the share price yet, and the expanding US trade deficit.
Aligning Executive and Senior Management Compensations Schemes With Strategy
We want to focus on the Huntsman strategic review of its Textile Effects business, but in the context of the proposed management compensation program that was also discussed in last week’s release (below). If you are going to use total shareholder return (TSR) as a key factor in executive and senior management compensation (which is aligned with shareholder goals), then it must also be core to your corporate strategy. Every action or proposed action should be looked at through the lens of how it will align with the core strategic goal. Hunstman may be doing the right thing by looking to sell its Textile Effects business because it has a lower EBITDA margin than other businesses in the portfolio, but is this necessarily what a shareholder is looking for? In our experience, shareholders pay more for earnings certainly – so lack of volatility – and growth. Margins are important but margin improvement is only important if it impacts growth. Margins can be improved through divestment, but unless the divestment increases earnings certainty, and/or the growth rate of the remaining business, the divestment may have limited impact. That said, Huntsman is thinking about this correctly, and has been active in transforming its portfolio in the past – some might say too active – but we would not be in that camp. Compare this story with LyondellBasell, which has had the TSR component in its compensation scheme for years, but has not – in our view – managed the portfolio with that in mind. Acquisition and capital spending programs have in theory added to core EBITDA (not the case for the Bora JV in China today), but they have not done anything to address volatility, and investors are rightly questioning the cost of the growth – given the increased debt load. If LyondellBasell management was truly focused on TSR, the company should separate its much higher value compounding and licensing business from the core. See our past work on LyondellBasell
- Huntsman Announces Review of Strategic Options for Textile Effects and Compensation Plan Aligned with Financial Targets. Management notes that a timetable or a deadline for the conclusion of this evaluation has not been set and notes, “We have been transparent about our continued evaluation of divestment opportunities that are both in line with our strategic goals and in the best interests of our shareholders.”
Exhibit 17: We highlight a slide from the November 9, 2021, Huntsman investor day presentation to show the current Huntsman portfolio. We think it is also worthwhile to see slide 6 in LINK that shows the ongoing transformation at the company toward a higher value portfolio, and slide 11 that discusses its 2022 and beyond goals. Interestingly, if the Textile Effects business is cut from the mix and 2021 margins hold in the other businesses, Huntsman will meet its EBITDA margin target range of 18-20%.
Source: Huntsman Investor Day Presentation, December 2021
The US Balance of Trade
The US trade balance (Exhibit 18) looks concerning and has been made worse this year by the inflationary impact that logistic costs have had on imports. Someone is eating the higher freight costs – as shown in Exhibit 19 – with most of the holiday imported goods seeing as much as 40-50 cents per pound of inflation in transport costs – not much for higher-priced goods, but a lot for cheap clothing, toys, and other dense products. While some of the lingering freight rate issues should begin to clear in 2022 and loosen global supply chains, the trade balance is likely to deteriorate further unless a couple of changes take place – aggressive efforts to reshore manufacturing to the US and/or a broader policy of support for US fossil fuels (with stricter emission limits) to allow for increased US exports of LNG and crude oil. Note that the trade balance has deteriorated over the last 10 years despite a meaningful improvement in the US energy trade balance, as illustrated in Exhibit 20. A 5 million barrel per day swing at a crude oil equivalent value of $50 per barrel is worth a positive of close to $10 billion annually to the trade balance since 2015, suggesting that the thirst for imported goods is even greater than implied in Exhibit 18. From a national security perspective alone the US government should be falling over backward to make reshoring decisions as easy as possible.
- The US economic recovery has outpaced other countries
- Domestic manufacturing has improved but failed to mirror demand
- Viewpoint: Petchems keep driving US LPG exports to Asia. Argus notes, “US exports of LPG into Asia are expected to continue to grow in 2022 as ongoing petrochemical demand in the region bolsters demand for US feedstocks, particularly propane. The US continued to ship more than twice the volumes of LPG to Asia versus Europe in the second half of 2021, even as a spike in European heating demand improved the arbitrage to the region early in the fourth quarter.”
- Why isn’t Big Oil drilling more as gas prices surge? The answer is more Wall Street than White House
- Holiday sales jumped 8.5% as shoppers shrugged off higher prices, according to Mastercard
- US liquefied natural gas exports grew to record highs in the first half of 2021
- Logistics Hiring Surge in California’s Inland Empire Can’t Satisfy Demand
- China’s LNG Buyers Clinch Term Deals in Final Days of 2021
Exhibit 18: The US goods trade deficit hit a record in November.
Source: Bloomberg, C-MACC Analysis, December 2021
Exhibit 19: Freight rates for shipments from China to the US fell WoW, but remain significantly higher YoY. See article titled, 2021: a year of Covid variants and milking the freight rate cash cow. We also highlight an article titled, Import activity shows how uncertain companies are about 2022.
Source: Freightos Index, Bloomberg, C-MACC Analysis, December 2021
Exhibit 20: The U.S. exported slightly more petroleum than it imported in the first half of 2021 – EIA
Source: EIA – Today In Energy, December 2021
The week of December 27th – 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 – Ocean Eyes
- US spot polymer values fell relative to global monomer values WoW, and we foresee a shrinking US polymer price premium relative to Asia as a major integrated profit risk for 1H22. We flag and discuss relevant regional trends.
- However, several factors favor upside surprises demand growth for US chemicals, polymers, and other materials covered in a mid-December Sunday thematic, Happier New Year: US 2022 Upside Demand Surprise Scenario.
- Other global commodity trends flagged in this report comprise monomer, polymer, and feedstock indicators relevant to gauging sector profitability.
Fade Away – US Integrated Polymer Margins Shrink In 4Q21, Further Erosion Likely In 1H22
- US spot polymer prices weakened in 4Q21 and will likely decline further in 1H22, but integrated producer profit should stay above 2019 levels. We study this development along with a discussion of other significant industry issues.
- We flag pertinent chemical sector and other corporate updates (e.g., Shell, Rio Tinto, Mastercard, Versalis, ExxonMobil, Hanwha Solutions, & others).
- We note relevant ESG items worth notice, ranging from US wind turbine capacity additions to developments in renewable natural gas (RNG).
- We discuss numerous other pertinent chemical sector items in this report.
Shivers – US Price Inflation in 2021 Notably Outpaced Asia, 2022 Now in Focus; Strategic Reviews Ongoing
- US consumer price inflation in 2021 surged in the US relative to Asia, but we do not see a repeat of this development in 2022. We discuss US price-led profit strength and strategic reviews as sector players streamline portfolios.
- We flag pertinent chemical and other corporate updates (e.g., Huntsman, BASF, Maersk, Flotek, Northvolt, Pemex, Aramco, Shell, Kyocera & others).
- We note relevant ESG items worth notice, ranging from global hydrogen developments to renewable industry investment trends. We also highlight our weekly ESG thematic published later today in LINK.
- We discuss numerous other pertinent chemical sector items in this report.
You Got What I Need – US Trade Deficit Hits A Record In November, More Reshoring Needed
- The US trade deficit for goods hit a record level in November amid strong consumer demand. We find the case for reshoring US production compelling and discuss other research framing our macro views into 2022.
- We flag pertinent energy, chemical, and broader industry updates (e.g., Solvay, Pemex, Trinseo, Valero, Odfjell, IMCD, Hugo Boss, & others).
- We flag varied ESG items worth notice, ranging from estimated renewable US electricity capacity growth to clean-energy updates. We highlight our ESG weekly, 2022 – Policy Key, But Inflation Will Distract – Maybe Beneficially.
- We note numerous other pertinent chemical sector items in this report.
Turn The Page – A Case For US Commodity Chemical Equity Outperformance; Mega-Cycle View Emerging
- US commodity chemical industry profit peaked in 2021, but producer equities underperformed other chemical sub-sectors. We provide a case for why commodity chemical equities could outperform most peers in 2022.
- We discuss pertinent energy, chemical, and other corporate updates (e.g., Archaea Energy, ExxonMobil, Pemex, Paloma, Chemtrade, IKEA, & others).
- We highlight relevant ESG items worth notice, ranging from carbon price trends in Europe to broader clean energy input cost inflation. See our ESG weekly, 2022 – Policy Key, But Inflation Will Distract – Maybe Beneficially.
- We discuss numerous other pertinent chemical sector items in this report.
Weekly Climate, Recycling, Renewables Energy Transition and ESG Report (CRETER) No 57
2022 – Policy Key, But Inflation Will Distract – Maybe Beneficially
- Our ESG and climate coverage in 2021 was generally balanced but trended more toward policy in 2H21, partly due to holes left by COP26 and also due to inflation.
- Rethinking energy transition policy in the light of energy shortages and higher prices will be critical in 2022 – failure will drive underinvestment & higher prices.
- Coal or heavy hydrocarbons to hydrogen with CCS looks like a win all around as it could create unsubsidized hydrogen minimizing natural gas or renewable power.
- It will be interesting to see how polymer companies rate their challenges in 2022 – will plastic waste be more or less of a stakeholder issue than carbon footprints.
- Otherwise, we look at the rise in “intent” for CCS but the lack of investment, wind and solar installation rates, ESG definitions (again), and energy M&A.
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