As Avient and the linked paint article remind us, there are sectors of the US chemical industry that rely on imported products – in these cases pigments, and the supply chain challenges and logistic delays have caused production problems in the US and price increases in 2021. The automotive segment of the paint industry has seen lower demand because of the auto OEM production slowdown, and pigment shortages and price spikes would likely have been worse if automakers had been running at full rates. There is no sense of impending relief in the logistic issues as we go through 4Q earnings reports and we could continue to see issues for a while. This should be good for US-based pigment suppliers, but while Chemours, Venator, and Tronox all have capacity in the US, they also have capacity outside the US which likely faces some supply chain challenges.
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.
The theme of our Sunday report (to be found here) will be inflation this week and the signs that we are seeing across multiple industries which suggest it could be more problematic and worsen in 2022. One of the focuses is energy and how the pressures to be seen as good citizens is lowering investment in oil and natural gas production, while the world is not far enough advanced on energy transition to be able to substitute for the missing hydrocarbons. We would agree with many of the recent comments from some segments of congress, which is that the answer is not to curtail exports of LNG and crude, as by doing so we will starve the rest of the world of hydrocarbons and create worse shortages than Europe and China are seeing today. The better solution would be to support “clean” US production of the lowest emission fuels possible – especially for natural gas. As we have noted in prior research, with a global solutions hat on, the relatively low costs of natural gas F&D costs in the US, when combined with what we expect to be relatively low costs of emission abatement in the US, should drive more investment in the US, creating jobs and export income.
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 decline in US and global chemical pricing this week (as discussed in today's daily) is a function of oversupply in the US and lower costs in the rest of the world. The US has had an incentive to produce everything for most of the year and has had essentially full capacity to do so since the beginning of the 4th quarter. This will have collided with seasonally weaker incremental demand in December and the recent abrupt drop in oil and gas prices to swing momentum very much in favor of buyers. Polymer prices have to date been more stubborn in the US, but we expect continued weakness here also through the end of the year.
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.
We should probably link the message in the exhibit below with the write-ups in both today's daily report and today's ESG and Climate report. The drop in E&P spending relative to cash flows and the shortage signals that are evident from the current oil and natural gas prices is likely to bump into rising hydrocarbon demand for the next several years, while the rate of renewable investment tires to catch up with energy growth before it can focus on energy substitution as meaningfully as the climate agenda would like. We also cannot look at the chart below and say that it does not matter because oil is less important in energy transition than natural gas. The oil-based investments in the Permian and Eagleford plays, in particular, have significant volumes of associated gas, and much of the natural gas supply growth in the US has come from these oil-centric investments. As they slow down, natural gas supply and NGL supply will be impacted, and while we are seeing increased rig counts in the natural gas biased regions, such as the Marcellus, the potential declines from the other fields will be hard to make up for.
We remain concerned that natural gas E&P investment in the US remains too low to meet expected demand increases, especially for natural gas-fired power stations and LNG, but also possibly for NGLs, especially ethane, given new ethylene capacity and a fresh export market in Mexico. Near-term, natural gas prices are showing some easing relative to crude, albeit a very volatile trend – Exhibit below – but we see medium and longer-term shortages unless E&P spending increases. The new power facilities shown in the bottom Exhibit will all need incremental natural gas, and the international LNG market is so tight that as new capacity comes online in the US we would expect it to run as hard as is possible. This sets up for a market where the clearing price of natural gas in the US is at risk of being set by the marginal exporter. The price jump for domestic consumers would be dramatic and it would cause all sorts of headaches in Washington and probably intervention. We showed the incremental natural gas price in the Netherlands in our Daily Report on November 18th, and if the US price were to reflect the netback from this level, they would rise close to $30 per MMBTU. The natural gas industry needs some sort of global blessing to continue to operate as what will likely be the core transition fuel. It will be necessary to clean up the emissions footprint of natural gas, but the industry should be encouraged to invest on this basis. For those who doubt whether the US natural gas price can rise to $30/MMBTU – note that the Europeans did not think $30 was possible either.
With ExxonMobil and Baystar’s ethylene plants in start-up and Shell expected to come online in Pennsylvania in 1H 2022, the news that Braskem wants to double its ethane imports from the US in 2022, adds to concern that the US may struggle to meet ethane needs at peak demand rates in 2022. We would be less concerned if we saw natural gas production rising, which is unclear for 2022, despite the expected new LNG capacity. Ethane is likely to follow any upward movement in natural gas pricing as there will be a need to bid the product away from heating alternatives. The increment suggested by Braskem in the Exhibit below is not larger in the overall scheme of US ethane demand, but every gallon may matter in 2022. See today's daily report for more.
While we will talk more about the Dow project in Alberta on Sunday, one of the problems that the stock faces in the light of the announcement is largely unrelated, which is the growing expectation that margins in 2022 will be significantly lower than in 2021. This is the view coming out of the recent EPCA meeting and as the ethylene/propylene chart below shows, monomer pricing is already weakening in the US as production ramps back up following the recent storms – we note in Exhibit 1 from today's daily report the squeeze on ethylene margins as prices fall, while costs rise. But it is also worth noting that margins remain quite healthy, while well below their highs. Those companies who built new ethylene capacity in the US over the last 5 years would have had a margin similar to the current level shown in Exhibit 1 in an optimistic capital case.