There is an interesting difference between the base chemicals markets and some of the other broad commodities and intermediates, and we have economic growth that is testing the capacity limits for many commodities and downstream products, but the overbuild in basic chemicals, most recently in China, is putting significant downward pressure on pricing, as we highlighted in yesterday’s Weekly Report. Capacity shortages in intermediates and some specialties, which are driving the investments we highlighted in today's daily report and which are a steady flow of news this year, are leading to some expanding margins over base chemicals in select areas where capacity has not kept pace with demand.
The oversupply in China for many commodities is becoming more evident daily. Our research depicts this as supply-driven, based on the surge of ethylene and propylene and derivative capacity since 3Q 2020. Notwithstanding the Dow commentary (in our daily report today), the weakness in Asia in polyethylene will ultimately impact the US, as the US relies on international demand for at least 25% of its polyethylene production – much less for polypropylene. The gyrations in the ethylene and propylene markets, as shown in the chart below, indicate the US dealing with the differences between the two monomer chains. Far more ethylene and ethylene derivatives move offshore than propylene and propylene derivatives. Despite the ongoing strength in derivatives, the ethylene market is loosening. At the same time, propylene shows extreme volatility because demand remains strong and has seen greater production issues on a relative basis, per our estimate. Supply is barely keeping up, even as refinery rates increase, because of problems with PDH units, pipelines, and splitters, which would not be meaningful in a more normalized market, but make a difference when refinery supply is constrained. High propane prices, which could move even higher, keep upward pressure because of PDH economics and because they keep propane out of ethylene units.
The Dow announcement yesterday speaks to a much larger issue within the investment community in our view, which is that research fees have come down so much over the last ten years that the sell-side gets paid very little for doing any real research. We talked about the upside in 2Q for the commodity polymer producers for months. Still, we know that we cannot get paid for maintaining the models needed to get to the numbers with enough confidence to publish estimates. The buy-side does not have the budget. In the past, as sell-side analysts, we would subscribe and talk to price discovery consultants, such as the predecessor companies of IHS (now in the middle of an acquisition by S&P) and CDI (in the middle of a merger with ICIS). This data and these dialogues would allow us to adjust earnings estimates during the quarter and keep up alongside our other work (e.g. corporate marketing/roadshows, etc.) as analysts. There is enough data in our weekly report – published each Monday to do this for many companies. (See an example in the chart below). Today, IHS has made its service so expensive that it is difficult for sell-side analysts to justify the cost when they are not getting paid by clients for real, fundamental research. The JP Morgan alleged base fee for research for an entire platform would not cover 25% of the IHS subscription cost for olefins and polyolefins data alone, per our estimate. Plus, all the merger activity at the data providers is causing some to question quality. The result is limited mid-quarter analysis from the sell-side and moves like Dow’s so that they can have realistic conversations with investors. In the case of Dow, it was to get the message out ahead of the Bernstein Conference.
The propylene moves, highlighted in our report today, show just how fragile some of the commodity markets can be and how supply/demand imbalances can change very quickly. In this case, there are likely some significant restart timing issues associated with the freeze, compounding the return of propylene production from PDH units that had been shut down for maintenance. It is also possible that the spot market was overly influenced in the early part of this year by propylene producers purchasing to cover contractual shortfalls than propylene consumers paying up, only to lose money on their incremental sales.