As the ratio of pricing between Brent crude and US natural gas rises, the US ethylene cost advantage is spiking, and as long as the US is producing enough natural gas to feed domestic demand and allow the LNG facilities to run at capacity, the advantage can remain. This gives the US a significant cost advantage and assuming that there is spare capacity the US industry can step up and support Europe if needed. However, it is not clear that there is much spare capacity, either in the production units or in the logistics to get the product to ports or across the Atlantic. There is a surplus of liquid and gas carriers today, but the container problems are global and the inflation and supply chain issues that we seem to be stuck with are likely to keep containers tied up in excess inventory that consumers will want to keep building as a cushion for a less certain supply outlook. The shipping issues are only part of the problem for Asia, as even with better opportunities to export, the region is seeing escalating production costs because of the movement in crude oil and naphtha pricing. We are in an unusual position where strong demand in the US is keeping domestic prices higher than in Asia, despite costs in the US that are low enough, especially for polyethylene to move material to Asia at costs well below the cost of manufacture in Asia. This dynamic can last for a lot longer in our view as long as oil prices remain elevated versus US natural gas. An abrupt turn will occur if US natural gas production falls below domestic demand and LNG demand – this would cause a spike in US natural gas prices. For more see today's daily report.
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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.
The upwards pressure on crude oil prices will likely drive propane prices much higher in the near term and this will significantly impact propane dehydrogenation (PDH) costs in the US and put further upward pressure on propylene prices and prices for propylene derivatives. Note in the exhibit below that US polymer prices are turning slightly more positive relative to Asia again. While some of this will be cost-based issues in the US, especially for polypropylene, higher freight rates (again) continue to make it difficult for producers in Asia to maintain attractive operating rates and make it harder to push prices higher to reflect what are now rapidly escalating costs. The oil moves today may result in more capacity closures in Asia, which should lead to better pricing, but as we noted in our Weekly on Monday (and likely more extreme today) outside of US ethane-based ethylene producers, no one is making money producing ethylene today. Prices are going higher.
More confirmation from Covestro that global demand growth is strong, supporting reports that we have seen from most companies over the last few weeks. Some have struggled with raw material cost squeezes and either late attempts to raise prices or pricing lags in contract agreements, but almost all have pointed to very strong demand outside of auto OEM. We have questioned how much of this strong demand is inflation-driven, but it is very hard to tell as the last time we had significant inflation we did not have such an interwoven global supply chain as we have today, and consequently, it is harder to assess how much pre-buying may be going on, not because of fear of higher prices but because of fear of supply. Note that we have at least two European automakers (VW and Renault) shutting down facilities this week because they cannot key parts from Ukraine. This adds to the already problematic path for parts from China as well as the semiconductor shortage. If everyone is looking for a little bit more it would explain the very high 1Q 2022 demand that all are talking about and it likely means that inflationary pressures will continue as chemical and polymer makers try to make more, against a backdrop of higher raw materials and find it easier to increase their prices because their customers are as concerned about availability as they are prices.
Fear of shortages is the one factor that is most supportive in terms of helping to push through pricing and the events in Europe and their associated impact on energy prices should be all the support that the chemical and polymer industry needs to push pricing through that will cover cost inflation. Buyers of raw materials and intermediate products will naturally look to buy a little more than they need in the near term, both to ensure that they get something ad to try to build a bigger inventory cushion. This will have the effect of pushing apparent demand higher, making the pricing initiatives easier. Few will push back on pricing if their primary concern is availability. Looking at the BASF results summarized in the chart below, demand is already very robust and this will lead to higher utilization rates and higher volumes for chemical producers as well as high pricing. The commodity producers are likely more interesting here as they can move prices much more quickly than the specialty companies who might see margins squeezed over the next couple of months. None of this is good for inflation. See more in today's daily report.
It is likely a difficult day for the European chemical industry as all of the fuel prices that they depend on are rising quickly, which will force many difficult decisions over the coming days. There are a couple of factors to consider – what happens to costs and margins if energy prices remain inflated, and what happens if energy availability becomes an issue and plant closures are necessary. In a world that is already reeling from inflationary pressure that we have not seen in four decades, there is at least an acceptance that prices can move higher, but the energy-dependent European industrial and materials companies will need to move prices quickly and meaningfully to absorb their higher costs. If natural gas supplies from Russia are halted, Europe is likely going to need to allocate supplies, as there is no easy fix given an LNG system that is already at capacity. Industry will likely take the hit to ensure power for heating and cooling. This will drive product shortages in Europe, especially for chemicals, which will likely make it easier to get the pricing necessary to cover costs.
Westlake Chemical began today at a 52 week high on the back of very strong earnings but has retreated with the market. Westlake has been one of our favorite ideas since founding C-MACC in part because we believe in the diversification strategy into building products and in part because the PVC market has not seen the same level of overinvestment as polyolefins globally over the last 3 years. Westlake’s view of the housing and construction market aligns with ours and by breaking out this segment of the business Westlake should see some valuation benefit from the more stable earnings that this segment should provide. Note that the focused building products companies trade at significantly higher multiples than chemicals. We expect Westlake to get earnings and multiple boosts from here.
While it has been a long time coming, and it is unclear whether COVID hindered or helped, the DuPont materials exit is not a surprise and we noted after the IFF deal that we believed that Ed Breen was not done. During his time at Tyco, Mr. Breen showed a very clear ability to identify better owners for businesses that were lost in a conglomerate structure. We had always anticipated the same with DuPont and the business that is moving to Celanese is one we had expected to move and we had discussed previously. This should be a win for both companies as DuPont begins to look much more like a stable margin specialty chemical company with a portfolio that is becoming more ESG centric – see today's daily – while Celanese now has a large and comprehensive portfolio of polymers that are critical to the transport sector and should be able to drive both revenue and cost synergies if the company manages the integration well.
Albemarle’s share price is tumbling today on the news that the company is experiencing cost over-runs in its lithium business and that this resulted in a 4Q loss. The company has tried to deflect with some very bullish views of potential lithium demand, based on EV production growth estimates, but the cost over-runs are another indication of how much inflationary pressure is within all industries today and this news will likely have a negative sentiment impact for any company with material capital spending plans for 2022. The loss at Albemarle comes despite higher lithium selling prices for existing output. We remain very concerned that, despite high capital costs, the technology barriers to entry for the more commodity grades of lithium required for most batteries are very low, and that with the hype around potential demand – as indicated by Albemarle – too much lithium capacity will be built, ultimately causing wild swings in prices. If we get a negative swing in pricing coincident with new capacity start-ups, where the new capacity cost more than planned, we could see some poor returns on investment periods during this decade. To be clear, we expect lithium demand to grow very quickly, but we expect supply to grow quickly also. See more in today's daily report.
The CF slide below shows very clearly the US competitive edge when it comes to making anything that has a natural gas base, and while we tend to talk mostly about ethylene, ammonia, urea, other ammonia derivatives, and methanol are all seeing significant cost advantages. The Chinese coal-based costs are better than those in Europe and Asia based on natural gas but margins remain well below those in the US. The challenge with the coal-based chemistry in China is that it has substantial CO2 emissions, and the facilities were not designed for carbon capture. As China develops a carbon cap and trade market and as these facilities get included, costs will rise significantly.