The US chemical rail volumes should be considered in the context of some of the slowing demand that has been indicated by companies downstream of chemicals, and we see this as further evidence for possible inventory build through the chain. Earlier in the year these builds would have been justified by supply chain issues that have plagued all segments of retail and manufacturing for close to two years, but today we should be at or above inventory comfort levels. We are calling for weakness in demand and some margin erosion in US chemicals and polymers in 2H 2022, before a strong rebound as early as 2024, but if buyers of polymers and chemicals and their customers look to reduce inventories more quickly, the landscape could change quickly. While this is possible, with the threat of higher energy prices very real, we would be surprised in anyone was interesting in dramatically lowering inventories today.
In our Sunday Thematic to be published this weekend we are focused on business lines that will still look good in an economic turndown versus those that are more vulnerable, and ASIX may find itself spread across both buckets. The momentum in agriculture is very strong and even with a quick resolution in Ukraine, we could see high prices for crops and farm inputs for years as it will take a long time to correct recent imbalances and the Ag markets were already tightening before Russia invaded Ukraine. This and natural gas shortages (see today's daily report) should keep upward pressure on ammonia and ammonia derivatives pricing. On the other hand, any slowdown in consumer durable/discretionary spending will likely negatively impact nylon. A faster resolution in Ukraine would likely be negative for the Ag names as even if it takes a while to correct crop and fuel imbalances, the stock market will likely look through that and start focusing on eventual more normalized markets.
We note the polyethylene price nominations in the US, timed by some to coincide with earnings releases this week and next, and would remind clients that there is always price momentum in commodities, one way or another. In our view, the price increase moves aim to maintain directional momentum (upwards) while giving the polymer producers some cover should natural gas prices spike further. US ethane prices are now tracking natural gas more closely and have moved up meaningfully over the last few weeks, and US ethane-based ethylene margins have fallen around 80% since the start of the year, with at least half of that coming from cost increases. All polyethylene producers are integrated back to ethylene, and the price nominations will be attempts to recoup some of the cost increases. This is against a backdrop of still very strong polyethylene margins in the US, which although way off their 2021 highs remain much higher than in 2019 and 2020 and the longer-term average. This is covered in our Weekly Catalyst report each Monday. Ethylene margins are summarized in exhibit below and the chart shows the impact of higher costs in the US and falling spot ethylene prices as the US now has more surplus ethylene capacity and is looking for export homes for ethylene and easy to ship derivatives. As we have noted before, the jump in margins in Europe and Asia is because of extreme volatility in naphtha markets over the last couple of weeks. We would expect margins to be lower next week based on naphtha moves this week.
US ethylene prices have bounced off a low this week largely, in our view on the steep rise in natural gas and ethane. The drop in ethylene prices over the last couple of weeks signals an imbalance whereby production is more than enough to satisfy domestic demand and export demand. Export demand is limited by terminal capacity, and we have seen some domestic demand issues for polyethylene, not because of demand weakness, but because of export logistic bottlenecks, that are resulting in product (with homes to go to) backing up in the US ports. Given the timing of this build-up, we may see some higher end-quarter working capital from some of the chemical companies with sizeable export footprints for 1Q 2022. The sharp increase in US natural gas prices and the catch up that ethane has made to natural gas, should keep some upward pressure on spot ethylene prices if gas prices remain high. Propylene remains very supported by high propane prices.
While we remain advocates of “stronger for longer” with respect to chemical demand and pricing in the US, the auto data does suggest that the US consumer may be cooling off a bit in reaction to higher prices and higher borrowing rates. Historically, the chemical industry has a habit of running headlong into a downturn while waving an “everything is great” flag, and the RPM results and outlook have a vague “deja vu” feel to them. We also note some surprise at the robustness of the MDI market in the chart below, and it would be wrong not to admit that our cautionary antennas are rising. The auto exposed products should still see some upside from higher auto production in the second half of the year, but otherwise, a possible consumer pullback to take the wind out of the sector sales, especially if the US is constrained moving out products because of container and shipping issues. The significant cost advantage remains in the US but the ethylene market over the last week is a reminder of what can happen when you struggle to find someone who can take the last pound. Given infrastructure, energy, and clean energy investment, as well as reshoring, many materials could see significant offsets to consumer spending pullbacks and our focus would remain on PVC and building products, as most of the hit would be in consumer durables. Metals demand should remain strong regardless. For more see today's daily report.
It's back to 2012/2013 for polyethylene, but with a potential twist. As we noted in today's daily report, international prices for polyethylene are being pushed up by oil prices, and even with higher prices in Asia, margins are still negative locally, which suggests that they will go higher. This margin umbrella is what generated windfall profits for US and Middle East producers in 2012, 2013, and half of 2014. The upward pressure remains high for international polyethylene prices because producers are not covering costs locally and in theory, the US should continue to benefit and we see domestic polyethylene prices rising again, both contract and spot. The risk for the US is local overcapacity of polyethylene and potential export challenges. The pricing arbitrage to export US polyethylene is huge and rising, but we are in a constrained trade world and we understand that export terminals are at capacity and warehouses are full. It is possible that the sharply lower US ethylene price is not just a function of new ethylene capacity, but also a function of integrated polyethylene producers choosing to limit production and looking for homes for the extra ethylene. If the polyethylene producers in the US try to push more volume domestically we could see local prices fall well below their export alternative – this is possible, but unlikely, in our view. Polypropylene does not have the same significant net export and the two plant closure in the US are likely enough to drive the price support that we are seeing this week.
The BASF commentary about the impact of gas cuts in Europe should not be read as specific to BASF, but as we move out of the winter in Europe it is less likely that countries will directly restrict industry in favor of retail customers should gas supplies become limited. While many European countries will try to protect retail customers from hyperinflation in energy costs, their ability to do that for the industry might be more limited as they cannot find the additional gas, and subsidizing everything would be fiscally irresponsible. We expect to see more basic chemicals and derivatives moving from the US and the Middle East to Europe to displace uneconomic local production, but we understand that all shipping capacity is now constrained – liquids, gases, and containers – limiting the volumes that can move. The high end of the cost curve that Europe has occupied for decades in chemicals means that exports from Europe have been very limited and reducing exports is not a balancing act tool that Europe has to play with. We continue to see significant upward pressure on prices in Europe and the jump in inflation in the region, reported today, was dramatic but could accelerate as there are very few corrective levers that Europe can pull right now.
We are seeing some monomer price weakness in the US, despite the rising costs. For ethylene, this is likely because of increased supplies (new capacity and turnarounds ending) and all capacity to consume running at full rates, including the export terminals. There is plenty of margin in exporting ethylene today and US prices are not falling because they need to find another buyer internationally. We could see some opportunistic buying for inventory at these prices, especially if you believe that the conflict in Ukraine is not ending soon and also if you are concerned about more extreme weather as we move through the summer in the south of the US.
We have talked at length in today's daily and recent Sunday recaps about our expectation for a mega-cycle in chemicals because of an unwillingness to deploy capital as uncertainty rises. The exception is likely to be large oil producers looking at long-term downstream integration plans, with the primary objective of consuming captive crude oil. The Aramco ambitions in China bear some similarities to the ExxonMobil investment announced for China last year. While the crude oil market may be tight and prices may be high today, few oil producers believe that demand will not ultimately be hurt by renewable penetration and EV and hydrogen growth as transport fuels. Looking for captive crude oil demand is a logical step for the major and it is likely that the Aramco ambitions include refining as well as chemicals in China.
The Lanxess guidance below is likely the right way to go for now. The medium-term effects of the Russia/Ukraine crisis are unknowable today and all companies can monitor is the immediate impact on their businesses. Most had entered 2022 seeing very strong demand growth and the promise of a much better year as COVID restrictions were lifted and economic activity picked up generally. Now all bets are off, as it is not just the primary impacts that matter – such as a companies’ direct exposure to Russia or Ukraine – note McDonald's is suggesting that pulling out of Russia will cost the company $50 million a month, for example – but also the secondary impacts of what the conflict is doing for supply-chains and pricing. Higher hydrocarbon pricing in Europe, for example, will impact the economics of all production, not just the products sold to Russia or Ukraine. There will also be some demand adjustments directly related to the conflict – disaster relief for example – more PPE – more spending on defense and defense-related materials – DuPont’s kevlar business should be seeing a benefit for example.