Daily Chemical Reactions

Dancing In The Dark – 2022 Specialty Profit Outlooks Too Positive, Growth Capex Becomes More Selective
March 3, 2022
Commodities Mentioned:
Plastics (PVC, PP, PE, PU, PC, PET, etc.), Clean Energy Minerals, Carbon Dioxide, Hydrogen, Natural Gas/NGLs, Crude/Naphtha
Companies Mentioned:
Evonik, Huntsman, Koch, Sumitomo Chemicals, ExxonMobil, Aramco, Petronas, Pioneer, Engie, Technip Energies, Adnoc, Covestro, Elementis, Westlake, Piedmont Lithium, LanzaTech, Twelve, Nutrien, Brenntag, GMS, Lenzing, Braskem, SI Group, Synthomer, Celanese, Ineos, Keurig, Macquarie, Sika, Neste, Marathon Petroleum, Maersk, Republic Services, Air Liquide, Siemens Energy, Aqua Metals, Continental Resources, MMEX Resources, Johnson Matthey

Daily Chemical Reaction

Dancing In The Dark – 2022 Specialty Profit Outlooks Too Positive, Growth Capex Becomes More Selective

Key Points:

  • Strong consumer demand and moderating input costs are positive factors backing many 2022 specialty producer profit outlooks. We discuss mounting risk facing these views and considerations limiting sector growth Capex.
  • We highlight pertinent energy, chemical, and other corporate updates (e.g., Evonik, Huntsman, Koch, Sumitomo Chemicals, Piedmont Lithium, others).
  • We discuss relevant ESG items that range from Evonik using global CO2 values as a consideration with long-term projects to an EIA non-hydro energy outlook. We also highlight our latest ESG weekly research in LINK.
  • We discuss numerous other pertinent chemical sector items in this report.

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Exhibit #1: We update our price index for February prices to show the movement in critical mineral values (see Exhibit #7) used in the energy transition. This price index has increased more than 90% since the start of 2021, supporting why inflation warnings are a significant highlight of many non-integrated specialty chemical sector 4Q result reports. We also note our research on lithium and Electric Vehicle (EV) market trends in LINK.  

Source: Bloomberg, C-MACC Analysis,  March 2022

General thoughts. Commodity price inflation is anything but a “new” global development in early 2022, though it remains a significant issue. We continue to find specialty producers calling for moderation in input costs in 2022, and we add Evonik to this growing list, with the view being that 1Q22 will market the input cost peak. While we suspect commodity prices are likely to moderate in the medium term as global production improves, global supply chains normalize, and many logistical issues dissipate, we also find rising energy costs and a slower-than-expected dissipation of other cost pressures suggesting that input/commodity chemical prices for many non-integrated specialty producers could stay stronger for longer than most expectations. Today, we find little evidence of a commodity chemical price collapse. The other item that Evonik noted in its 4Q21 results presentation is that global CO2 prices are now a consideration when viewing its large growth project Capex options. We view this as a limiting factor for many specialties but more so for new commodity chemical growth investments. We suspect that this trend supports a mid-decade global commodity chemical megacycle that will likely impact most downstream product chains. With this point in mind, we find corporate activity picking up to streamline operations and maneuver into markets with advantageous structures that allow producers to push for value over volume. In our view, these are specialty-linked producers that will likely win the battle with inflation over time, and we view Huntsman as an excellent example of where this should work well. We also see the recent Celanese/DuPont engineered materials combination as an M&A transaction with this general view in mind. We find Westlake and Olin in a good spot, though for slightly different reasons based on their entire product suites, on this basis in Chlor-Alkali. In our opinion, those that can push products based on value over time are the ones most likely to drive incremental returns higher over time. Other items within this report worth considering include the proposal for a Texas green hydrogen hub. We also highlight multiple downstream reports that support the case for strong current consumer demand. Downstream product demand holding up amid likely further inflation of prices is another question, and we highlight our recent thematic titled Will Inflation Curb Early Year Demand Strength?.

Energy/Upstream:

As we see oil and gas prices rise, we are starting to see more analysis around how much gas and oil exports could be cut back from Russia in a more organized rather than event-driven manner. There seems to be a continuous flow of gas that is under longer-term agreements with Gazprom, but as the IEA analysis below shows, there are levers that Europe can pull to limit demand going forward, but none of the moves are instant and some rely on renewable additions that we believe will be a challenge to meet in full this year – see our ESG and Climate work for more on this, and the chart of the day above shows some of the acute metals inflationary pressures that the renewable power companies are facing and we questioned the optimism in First Solar’s negative guidance yesterday because of these cost increases.

The EIA estimate that delivered energy demand will grow in the US through 2050 should not be a surprise, given expected underlying economic growth, but emphasizes the point that we made earlier this week, which is that we cannot afford to be too cute with energy policy and that the US needs to put security alongside climate change and not behind it. Again note that we do not believe that energy security and energy transition are mutually exclusive – see yesterday’s ESG and Climate Piece

Exhibit #2: Europe can cut natural gas imports from Russia by more than 30% within a year – IEA. We highlight this headline but also note that in 2021, the European Union imported 155 billion cubic metres of natural gas from Russia, accounting for around 45% of EU gas imports and close to 40% of its total gas consumption, per the IEA report.

Source: IEA, March 2022

Exhibit #3: US average refinery operating rates increased WoW to 87.7%, which is roughly in line with the 2019 and 2020 levels for the time of year. US refineries, per our estimate, produce ~45% of US propylene and ~60% of US benzene.

Source: EIA, Bloomberg, C-MACC Analysis, March 2022

Exhibit #4: US energy consumption will grow through 2050, driving by economic growth – EIA. We highlight the breakdown of the EIA forecast by fuel source in Exhibit #5, highlighting a rising share of non-hydro renewables.

Source: EIA – Today In Energy, March 2022

Supply Chain, Commodity Chemicals, & Chemical Sector News:

The Huntsman activist defense presentation highlighted below does a very good job of explaining why Starboard is focused on a set of concerns that the company has already addressed and while we would generally not comment on something like this, we agree with Huntsman’s assessment that the proposed Board changes bring nothing to the table. Where the Starboard activity may help is improving Huntsman’s communications, as while the company has done a good job, in our view, of repositioning, it has done a less good job, until now, of communicating what the changes mean. The presentation linked below does a much better job than anything we have seen from the company in the past. To be fairer to Huntsman, the chemical industry has always had trouble communicating strategy shifts and portfolio transformations to stakeholders and there have been several instances of good stories not turning into good businesses – Eastman had some false starts in the past but has not been alone with these problems. It often takes some time for investors to believe in a new business model and this is where good corporate communications strategies can help. This presentation is a good start for Huntsman

We talk about supply chain issues in other parts of this report and we will be more focused on some of the transactional moves we are seeing to combat supply chain challenges in our Sunday piece this week. The risk for Huntsman and others moving more downstream is that we run out of raw materials that are critical to the Huntsman’s operations. The company has already battled (successfully) higher raw material costs in 2021, but it has been decades since large sectors of the chemical industry have faced real shortages – causing companies to choose between what they make and what they do not make.

We talked about overly optimistic guidance from a couple of companies during the week and we would put Evonik in the same boat as their energy pullback assumptions assume that the Russia/Ukraine conflict will be short and localized, but more important will have a limited post-invasion impact, which we believe is highly unlikely. The events of the last week will crystalize views about energy dependence and energy security and while the West will be forced to buy some hydrocarbons from Russia going forward, the risk premium is likely to stay on energy for a while. If the conflict lasts longer, Evonik’s assumptions will be very adrift – we would be advising clients to avoid guidance in the current environment or provide a range based on clearly defined different assumption sets.

Exhibit #5: We highlight Evonik’s expectation that raw materials and logistic headwinds will face throughout 2022, with 1Q22 seeing peak headwinds. In our view, there is considerable risk that these issues will not dissipate as fast as planned.

Source: Evonik – 4Q21 Investor Presentation, March 2022

Exhibit #6: Huntsman highlights it push for product value over volume, which we think is enabled by its participation in well-structured markets. We see this endeavor as a benefit to spurring incremental returns over time.

Source: Huntsman – Annual Meeting of Stockholders Presentation, March 2022

Exhibit #7: Energy Transition Likely to Skyrocket Demand for Critical Minerals, says IEA. We also highlight the report titled, Metals Shaping the Energy Transition, providing a more detailed breakdown and projections, and an infographic titled, Visualizing China’s Dominance in Clean Energy Metals that shows significant processing capacity in the country.

Source: IEA, Natural Gas Intel, March 2022

Sustainability, Clean Energy, Recycling & ESG:

The Evonik discussion around CO2 prices is both relevant and important as CO2 values will be a critical component of investment decisions for many industries going forward. Those waiting for explicit guidance on CO2 prices are likely to be disappointed as we are not seeing much global coordination today and as we discussed yesterday, the European market, which had been the better indicator in our view over the last 18 months, has collapsed in the wake of the Russia/Ukraine conflict as some countries ask for it be suspended, while speculators are assuming that lower gas supplies into Europe will lead to lower emissions and less demand for credits. One of the options here is to take the bp approach and assume a carbon price in investment decisions. Early last year, bp indicated that it would fix on a carbon price of $100 per ton in its longer-term planning. We believe that this is a ballpark steady-state for CO2 pricing but that traded prices could be quite volatile around that level, depending on the mechanisms used. But even if we have a consistent carbon price, we will see significant changes in industry costs and competitive cost curves based on the various costs of carbon abatement. We have written in the past that we could see huge benefits to the US manufacturing base because of the combination of relatively low-cost hydrocarbons and relatively low-cost CCS opportunities. By contrast, we see costs rising steeply in places like central West Europe, where the local CCS opportunity is off the table. Even if Europe can produce cost-effective blue hydrogen on the coast, getting it to central Europe will be an issue. The landscape is less clear in Asia, but we expect to see some competitive edge for countries with low-cost CCS options – Malaysia, Indonesia, Thailand, and parts of China.

The issue with the non-hydro renewables forecast that we see in the EIA chart below is that it assumes the supply chain for parts and materials for the wind and solar industry will not only not be interrupted, but that component capacity can be added at a rate to meet demand growth without contributing to more cost inflation. These are industries with true global supply chains – China makes roughly 80% of the World’s solar modules, for example. In the same way that we have seen the auto industry under severe pressure because of a lack of semiconductors over the last year, we could see the same issue with solar modules as demand grows and especially if China accelerates its solar installations and if trade routes remain congested. Exhibit 1 would suggest that the challenges to meeting near-term renewable power predictions are acute.

Exhibit #8: Evonik highlights that global CO2 prices will be used as a parameter for large investment decisions.. Given a lack of certainty regarding the outlook for global CO2 values, we think this suggests a conservative approach to Capex.

Source: Evonik – 4Q21 Investor Presentation, March 2022

Exhibit #9: Non-hydro renewables will play a greater role in meeting US energy consumption through 2050 – EIA.

Source: EIA – Today In Energy, March 2022

Exhibit #10: A major new hydrogen project in the US, dubbed the “world’s largest’ green hydrogen production and storage hub is set to be developed in Texas with a capacity of 60GW.

Source: H2-View, March 2022

Other Chemical Industry, Demand & Downstream News:

The manufacturer’s new orders numbers in the FRED chart below are an indication of some of the labor pressures in the US and the willingness to spend on equipment that can lower labor needs – this is not about machines replacing workers and more about machines allowing manufacturers to operate who cannot find reliable sources of labor. In its recent analyst call Deere talked about the success it is having with autonomous farm machinery and if a farmer can plow a field remotely or harvest a crop with one driver instead of two, it not only creates savings but also improves reliability as you are not waiting/hoping for the other driver to show up.

In our Sunday piece this week we will revisit reshoring, which is also likely driving up manufacturer’s orders, in the light of the rallying cry for buying American that resonated during the State of the Union address this week. While this is a nice sentiment for any country, the economics of the last 30 years have driven investments overseas to lower costs. The timing of the rallying cry is good, as it comes after 18 months of supply chain issues that have helped cause inflation, but also likely scared many US retailers and manufacturers concerning product availability, which is often more important than price. Some of the reshoring ambitions will bump into constraints in the US, not least of which will be material and labor shortages, but we also have very cumbersome and lengthy permitting processes in the US which can also be off-putting for investors. With the right leadership and incentives, both Mexico and Canada could become beneficiaries of the US interest in shortening supply chains. We would still need to see a significant upgrade in the US rail networks to make those moves effective.

Exhibit #11: Manufacturers’ New Orders: Nondefense Capital Goods Excluding Aircraft surged into 2022, continuing an upward trend since mid-2020. Part of the strength is the result of a limited ability to source workers.

Source: US Federal Reserve Research, March 2022

Exhibit #12: Container Traffic Into Three West Coast Ports Rose In Early 2022. We also highlight Long-Term Ocean Freight Rates On The Rise Again, As Demand, Congestion And Geopolitical Uncertainty Squeeze Shippers.

Source: Bloomberg, C-MACC Analysis, March 2022

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