Chemicals and Market Impact

The Exxon/Chevron shale headline is interesting, as the oil majors have made some commitments to shareholders concerning investment and capital spending since the Pandemic began, and while they appear to be sticking to their projections, it must be increasingly uncomfortable to do so. This is because the economics now work in the Permian and the independents are back with a vengeance. Historically, market share arguments would be made to ramp back up again, especially as Exxon, Chevron, and Oxy likely have the lowest incremental F&D costs in the Permian. Chevron and Exxon have the balance sheet flexibility to stick to their plans and make further consolidating moves if the oil price pulls back – Oxy does not. All three companies would likely face investor backlash if they increased E&P spending today.

A couple of headlines stand out today but the BASF capital markets day is probably not one of them. This is now becoming the norm; to provide an investor update tailored at focusing on clean energy and sustainability goals, and BASF’s expectations are not much different from others – there is a bold claim about 2050 and some harder targets by 2030. So far we have yet to see one of these presentations where the math is believable, and the investment targets in dollar terms all seem too low to meet a net-zero goal. To be fair, it is hard to know what will happen in 5 years, let alone from 2030 to 2050, and we would doubt that anyone has a good estimate today. BASF and others will likely end up spending multiples of what they currently project, but this may not be a bad thing – much of the spending will be backed by incentives (or encouraged by penalties) and all of the spending will be good for jobs and economic growth.

It remains very interesting to us that despite the apparent major shortages of chemicals and polymers in the US, the industry continues to operate at rates below those of a year ago, according to the ACC. We fully understand the Gulf Coast swing in February and are surprised that it was not worse, given the extent of the shutdowns we have been monitoring – March should be bad also because many of the shutdowns extended into March. While the bulk of the US chemical industry is in the Gulf Coast – as can be seen by the Gulf Coast influence on the “total US” bar, why production remains below 2020 levels in other regions is a little surprising. Granted, February 2020 was not impacted by the Pandemic and the economy was strong and demand for materials high, but with the import issues of the last 4 months and the move by US manufacturers and retailers to source more product from the US, we remain surprised that regional chemical production outside the US Gulf has not at least matched 2020 levels.

Asia polyvinyl chloride (PVC) prices reflect a five-year low relative to US spot levels, but both price points reflect five-year highs on an absolute basis.

The spread of the US supply problems to Europe is an indication of how much US polymer has been moving to Europe and how dependent the region has become on US material. This is not evident in publicly traded deals, as most, if not all f the material moving is on contract and intra-company (Dow moving to Dow’s customers, ExxonMobil to their customers, etc). But the production shortages in the US have impacted customers in each region.

The US polymer shortage is impacting supply in the rest of the world where the US is a major global supplier, but the benzene comments below suggest that this may not be the case where the US is not a major global player. Demand for styrene is high and prices of styrene and polystyrene are higher globally, but this alone is not enough to support benzene in Asia, where there has been a lot of new supply from ethylene units and where there has also been a strong pull on paraxylene to supply new PTA capacity. Reformer-based paraxylene has benzene as a co-product and the PTA expansion in China has been meaningful in the last few months. Separately, the phenol side of benzene demand is not looking as exciting as the polymer markets especially in some of the epoxy resin markets and in particular those facing the aerospace industry. This is a more significant demand impact in the US and Europe, but should also be felt in Asia.

The exhibit below shows a “crazy” 5-year extreme price difference between polymer pricing in Asia and the US, and scanning our longer-term database we believe this is an all-time extreme not just for the last 5 years. This is very bad for US polymer sellers in the medium to long-term, despite some windfall profits that may extend through 1H 2021. The high prices are doing a couple of things, they are encouraging plastic consumers to experiment with alternative materials and they are encouraging them to experiment with other suppliers, including imports.

While we are looking at price increases all across the board, the more interesting factor is the primary driver, which is the delayed restarts of enough US Gulf capacity to make a meaningful difference to availability. As noted in one of the headlines below, there will be corrective mechanisms and one of those may be the closure of some derivative consuming facilities, either because they cannot get enough product to operate or because they cannot pass through escalating costs. The current situation is likely to roll through into selective product and consumer good shortages, especially where the polymer or chemical content is high and the value of the product is low – some cheap plastic durables for example, or lower quality household products.

In today's daily, we discuss methanol pricing and show that the arbitrage with Asia is now negative, based on the near-term increase in US spot pricing. As with polyethylene, the major exporters are more concerned about the export margin over their costs, versus the difference between spot prices in each region. Certainly, where they have flexibility some US producers will try to divert methanol to the domestic market, but likely not at the expense of important export relationships and contractual obligations.