It is interesting to note the rapid rise in US propylene (and benzene) values as they follow propane and crude prices (propane is following crude because of its heating value and export opportunities). Ethylene is not moving as US natural gas is in surplus and is not following international natural gas prices. The US is surplus ethylene and derivatives, but we would expect to see ethylene and ethylene derivative prices jump up in the US if Europe is physically unable to make ethylene and derivatives or if the costs in Europe become so high that supplying incremental volumes from the US becomes even more compelling. For more see today's report titled "Into The Mystic – Ex-US Energy Price Surge Favors US Producers; Low Visibility Keeps Capex In Check".
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.
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.
2022 has started very strongly for US chemical and polymer producers, in part because demand growth remains very robust based on early reads from those that have reported earnings, and in part because of the ever-increasing competitive edge that the US is enjoying over Asia – see exhibit below. US producers can maintain strong margins in the US, while easily pushing any surpluses into export markets where local suppliers cannot compete. At the same time, higher production costs and very high logistic costs make it almost impossible for those regions with capacity surpluses to move products into the US, and it is challenging also to move products into Europe. If this production and logistic cost environment persist, not only should US prices stabilize, but for select companies – those with a strong US production bias – we should see estimates for 2022 start to rise.
While it might be tempting (and perhaps easier) to focus on the negatives in the Dow earnings release – such as price declines in polyethylene and higher costs in Asia, we think it is much more interesting to focus on the positives. For a while now we have been suggesting that the industry is gearing up for a mega-cycle of profitability, perhaps as early as 2024 – see report – and we see nothing in the current macro environment or in Dow’s release to suggest we might be wrong. Demand growth is very robust across the industry, with consumer spending driving some quite impressive GDP growth numbers in the US in 4Q 2021, as an example. We often see companies suggest improving global operating rates in earnings calls, and while it is mostly hopeful and self-serving, the chart below, from Dow’s report may be conservative. The very high ratio of Asia costs versus US costs in the 2012 to 2014 period (second image below), because of high oil prices, effectively shutdown new naphtha based ethylene investment in Asia for several years and it is what prompted China’s move into coal-based and methanol chemicals (China has almost no ethylene capacity from methanol or coal in 2011, but close to 6 million tons by 2016). As the price of oil rises and the cost curve works against China and the rest of Asia again, the move to more coal is less attractive because of the environmental footprint – coal gasification creates a lot of CO2 emissions and elaborates CCS investment would be needed to justify further expansions, which increases the cost of ethylene production.
Ethylene producers in Asia are cutting back production because of the negative margins that some are seeing for much of their production. This will initially lead to higher losses as lower rates will impact plant efficiencies and raise unit costs. Cutting operating rates only works if prices rise as a consequence and if other producers choose not to cut back and seek to gain share, things get worse before they get better. The margins we show in the exhibit below are exceptionally low for Asia and are certainly at levels that would have caused many shutdowns in the past, but there are so many new players in Asia, especially in China that it may either take time or government intervention to get enough of a cutback to move prices. But if ethylene prices do improve in the region the arbitrage for moving ethylene in from the US goes up, so the US may gain more than the local producers. Also, as prices rise, someone in the region could look at marginal economics and start increasing rates. See more in today's daily report.
We have seen relative stability in US spot ethylene and propylene prices for several weeks now, despite some volatility in feedstock markets. Ethylene likely has significant export support in that there are complexes in Asia that are net short of ethylene and where derivative production can be increased if ethylene is available at the right price. There are also displacement opportunities if US ethylene can be delivered to importers in Asia at lower prices than local production costs. This is broadly the case today and there may even be select opportunities in Europe. In Asia it is likely easier, as the buyer would be replacing an alternate supplier. In Europe, most potential buyers would be looking at cutting back their own local production and that is a more marginal decision given the impact on unit economics of lower operating rates. US propylene demand remains high, but prices are now settling closer to PDH costs, although not close enough to encourage anyone to slow production. See more in today's daily report!
Following on from the Enterprise comments covered in our daily report, the company is more likely to acquire something in chemicals than build it in our view, especially if a move into ethylene or polymers is on the table. Today, building capacity will come with all sorts of emission-related restrictions most likely, and many of the new build announcements we have seen since COP26 have come with a carbon plan (Dow, Air Product, and Borouge). While it is not obvious today that any Gulf Coast ethylene capacity is up for sale, we would imagine that most companies are reviewing strategy and evaluating whether they have assets of entire businesses that may have a better owner. This would be especially true if a basic chemical business is holding back the valuation of a more interesting core. In the recent past, we have talked about the relative value arbitrage open to LyondellBasell from separating its compounding, licensing, and recycling business from the core. Maybe the core would fit well with Enterprise? As the chart below shows, there is money in buying ethylene for export, but there is more money in the US in making ethylene, as discussed in our daily report.
The ACC forecasts below leave us a little confused as the implication for specialty chemicals is that production declines in the US by an average of 2.0% per annum from 2019 to 2023. Given the demand that we are seeing for US manufacturing, as covered in our most recent Sunday Report, we would expect demand for all inputs to rise and it is unlikely that the gap would be filled by a swing in net imports. The lower demand from the Auto industry in 2020 and 2021 and broader manufacturing shutdowns in 2020 explains the 2020 and 2021 numbers to a degree, but it is not clear why there would not be a rebound as auto rates increase. We would also expect to see a stronger rebound in polymer production in 2022, assuming weather events are less impactful than in 2021, given substantial new capacity for polyethylene from ExxonMobil/SABIC, BayStar, and Shell.
The Navigator Gas announcement should not be a surprise as the ethylene export arbitrage reopened in the US in September (Exhibit below) and since the terminal opened there has been a demand for ethylene exports each time the numbers have made sense. There are ethylene consumers in Asia that are net short and will buy incremental volumes from the US when the price is right relative to local suppliers and there is incremental demand in countries and regions that appear to be in surplus, including Europe, where a buyer can leverage an import to try to push local prices lower. In China, some of the facilities that require either propane or ethane imports might be better off buying ethylene versus making it today, and this is certainly the case for naphtha importers, as we highlighted in our Weekly Catalyst report on Monday. Today a US exporter can buy spot ethylene in the US and deliver it to China for less than the cost of manufacture in China, before the cost of getting the local ethylene to any consumer that is not on site.