Could what we are seeing in metals happen in chemicals and polymers? Over the last few weeks, we have seen already high metals pricing spike even further, both because of production shortfalls and because of expectation of higher demand, especially in the renewables space, as conventional energy prices have spiked. We show a lithium example below, but note that after chaotic nickel trading last week and a halt to trading, the market has made some attempts to reopen this morning with renewed problems.
As noted in Exhibit 1 from today's daily report, the jump in oil prices has plunged the European polyethylene producers into the red and pushed Asian polyethylene producers further into the red. This will inevitably result in price increases as basic chemical and polymer producers will shut down at negative margins, and these price rises offer an opportunity for the US, Middle East, and select other producers.
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.
More confirmation from Covestro that global demand growth is strong, supporting reports that we have seen from most companies over the last few weeks. Some have struggled with raw material cost squeezes and either late attempts to raise prices or pricing lags in contract agreements, but almost all have pointed to very strong demand outside of auto OEM. We have questioned how much of this strong demand is inflation-driven, but it is very hard to tell as the last time we had significant inflation we did not have such an interwoven global supply chain as we have today, and consequently, it is harder to assess how much pre-buying may be going on, not because of fear of higher prices but because of fear of supply. Note that we have at least two European automakers (VW and Renault) shutting down facilities this week because they cannot key parts from Ukraine. This adds to the already problematic path for parts from China as well as the semiconductor shortage. If everyone is looking for a little bit more it would explain the very high 1Q 2022 demand that all are talking about and it likely means that inflationary pressures will continue as chemical and polymer makers try to make more, against a backdrop of higher raw materials and find it easier to increase their prices because their customers are as concerned about availability as they are prices.
While it has been a long time coming, and it is unclear whether COVID hindered or helped, the DuPont materials exit is not a surprise and we noted after the IFF deal that we believed that Ed Breen was not done. During his time at Tyco, Mr. Breen showed a very clear ability to identify better owners for businesses that were lost in a conglomerate structure. We had always anticipated the same with DuPont and the business that is moving to Celanese is one we had expected to move and we had discussed previously. This should be a win for both companies as DuPont begins to look much more like a stable margin specialty chemical company with a portfolio that is becoming more ESG centric – see today's daily – while Celanese now has a large and comprehensive portfolio of polymers that are critical to the transport sector and should be able to drive both revenue and cost synergies if the company manages the integration well.
Part of our confidence/concern that prices can continue to rise in the chemical space in general stems from what seems to be very strong demand – again confirmed in earnings reports overnight, as well as in the rail data from today's daily report, as well as inventory data that suggest we are below recent ratios to shipment trends. The inventory piece is the great unknown here because the supply chain shocks of the last 20 months will have reset expectations around “safe” levels of inventory and it is hard to judge whether the new “comfort” normal will be back to the trend in the chart or 50% higher! If the new comfort level is materially higher than in the past, demand growth will remain strong and price momentum could continue through 2022. Our expectations for a mega-cycle in basic chemicals and polymers – targeting late 2023 and 2024 could be dragged forward because of higher apparent demand the time to buy the equities could be now, on that basis.
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.
In a recent report, we discussed the relative demand strength in the US, as well as the high costs of importing chemicals and polymers into the US and suggested that higher energy and feedstock costs could arrest price declines in the US at levels that still drive significant profitability for US producers. With that in mind, it is interesting to note the upward move in propylene spot prices in reaction to higher propane prices and the resulting flat settlement in propylene contract prices.
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.
The jump in expected US chemical production in 2022 versus 2021 and the more anemic growth in 2021, is in part due to new capacity in the US but is likely more a function of lost production in the US in 2021 because of the February freeze and the hurricane that hit the New Orleans area. These two weather events, especially the freeze, cause significant production cutbacks, and not only would production have looked better in 2021 without them, but the inventory decline shown in Exhibit 1 in today's daily might have been less severe. IF we assume that climate change is causing more severe weather, then perhaps it would be prudent to build more unplanned downtime into forecasting models and on that basis perhaps the production growth forecast in the exhibit below is too hopeful. However, if you model more unplanned downtime you are inevitably going to end up with a more volatile market as available capacity will swing around the forecast average by a larger amplitude, which would make production and inventory planning more complicated.