The ethylene price recovery in the US, discussed in today's daily report, is again a function of supply disruptions against a backdrop of robust demand. The net effect is to keep ethylene prices well above costs, at margins that justify investment and it is interesting to see the quick return of the CP Chemical project to the front burner. We could make a case that another ethylene facility in the US is likely a bridge too far at this point, despite the compelling current economics. The deep dependence on the export markets makes the US model very vulnerable to cyclical oversupply, and the current tight market is completely obscuring this risk and lulling producers into what we believe will be a misled sense of security. It is likely that the plants already built will prove to be good investments, not least because of the opportunity profits they are making in their early years of operations, but you would need to have a very bullish longer-term view of oil prices relative to natural gas to invest further, as even with an aggressive on-shoring manufacturing program in the US, the net export nature of the polyethylene businesses in the US is unlikely to change much. New capacity means more ethane demand, against a backdrop of lower E&P investment, and while Chevron has access to equity ethane from its US E&P operations, which may guarantee supply, it does not guarantee the price. Separately, while we believe that recycling targets in the US and the rest of the Wold will disappoint, they will still eat into virgin polymer demand. More chemical recycling will mean more “recycled” polyethylene available from heavy crackers – not ethane-based crackers.
Spot prices for ethylene have surged in the US in the last week (chart below) – especially for delivery to Louisiana, where Westlake has a production outage. The price increase has completely removed the brief export arbitrage to Asia that lasted for a few weeks in late May and early June (Exhibit 5 in today's daily report). As we discussed on Sunday, ethylene is in a very wide no-mans-land in the US as it is not in sufficient surplus to drive pricing down to costs, and would likely be supported well above US costs and more by Asia costs in the current market, but if the market becomes short, buyers can pay a lot more for it as derivative prices are so high. If a PVC producer, such as Westlake, is buying, they can afford to pay significant premiums given that ethylene is less than 50% of the PVC molecule.
The charts below focus on ethylene and the significant decline in Asia prices, now to levels that suggest negative cash margins. While we may see some cutbacks in production, especially if ethylene from the US can be secured at prices that are even lower than we see in Asia today, most producers will run until they cannot cover variable costs, and given that some of the imbalance, in China especially, might be short term in nature, it is unlikely that we will see any drastic production decisions yet. While the capacity additions in China have been extreme, demand is subdued domestically as consumer spending has not returned to its pre-pandemic trend and the shipping and port problems are hindering export demand.
The easing of US base chemical spot pricing continues and has now spread, as expected to polymer grade propylene. Supply now appears to be back to levels that do not reflect weather-related interruptions and despite the very strong downstream demand in the US the inevitable monomer surpluses are appearing. The US is a net importer of benzene and consequently, we see a floor being reached pretty quickly here, and while propylene prices could drop much further, PDH economics will provide support, and with a higher propane price, that support will likely be much higher than the price support for ethylene.
Referring back to our daily report today, can polyethylene hold on? Despite the strength in US polyethylene prices and the aggressive attempts by sellers to hold on through the quarter, there are couple of key factors working against them. Local supply may be tight in the US, but as we discussed yesterday, ethylene is moving towards a global surplus that could push US prices even lower than we are seeing this week and as the chart below shows clearly, how large the gap between Asian ethylene prices and those in the US. Unlike ethylene, polyethylene is harder to trade in to the US, partly because it is an unusual movement and the shipping costs are high, as would be the cost of getting from a US port to a consumer, but partly because US consumers serving the higher end of the market are very grade and quality conscious and would concerned about product quality and the risk of sending something to their customers that does not do the job as well.
This headline about China creating petrochemical deflation is largely based on the rate of capacity addition within China and that base chemical pricing in China still sits well above costs – but the argument may be flawed on a couple of levels. First, costs may not fall materially, given the increased thirst for imported naphtha and propane, as well as crude to fill new refining capacity. If crude prices fall, China will see lower costs, but then so will others. The margin issue is also in question because the wave of China’s new base chemical capacity is arriving amid a surge in demand growth, and this is why margins in Asia have not fallen closer to costs yet. China remains a meaningful importer of many base chemicals – less than two years ago for many products, but still meaningful, and it is the surpluses in the US and the Middle East that may drive deflation should supply chains stabilize and production rates remain high.
As we highlighted in yesterday's report, ethylene continues to weaken (see chart below) in the US and it is the one product with a true supply/demand-driven problem today – there is simply more capacity to produce ethylene in the US than there is the capacity to consume it. This is a recent phenomenon and has been clouded by the various storm-related outages, the delay in the Sasol start-up. We began to see the length in the ethylene market lats last year and physical export volumes jumped dramatically – fully loading the terminal in Houston for loadings from November through January. This was based on pricing from October through December that created a significant arbitrage to ship to Asia – partly because a few of the China integrated projects had ethylene derivative projects complete before ethylene units were complete. The risk for US ethylene is that it could go much lower – barring outages – as there is no one left in the US who can take a marginal ton, most likely, and China seems well supplied. For more details please see today's daily.
The relative moves in ethylene and propylene prices are not surprising given the news flow – propylene is likely being influenced by concerns around refinery cutbacks again – this time because of the colonial pipeline issues, while ethylene should continue to see downward pressure as the US oversupply emerges from all of the recent production difficulties. See our Daily Report for more.