In an important, but inevitable, change in tone, it is worth noting that the Borouge ethylene expansion announcement includes the idea that the complex will explore the possibility of a major carbon capture facility that will take much of the CO2 from the existing complex as well as the new plant. We have stated previously that the mood has changed sufficiently such that large industrial investments without a carbon abatement plan will not get approval from stakeholders and this is a prime example of what we expect. Locations with low-cost CCS will see disproportionate investment in our view and Abu Dhabi already has CCS in place as Adnoc is selling blue ammonia already to Japan. As we noted in a recent Sunday Piece, we expect carbon abatement challenges to slow expansions in basic chemicals and, despite this announcement by Borealis, see a market shortage in 2024/25 as a consequence.
While we are beginning to see some easing in US polyolefin prices we note in today's daily that prices are not falling in step with monomers and so spreads are widening. Because of the very integrated nature of the polyethylene market, we see swings in where the margin is being captured based on relative tightness and today it is squarely biased towards polyethylene in the US. Despite the polymer price declines in the US we maintain a level of pricing that is well above Asia – Exhibit below, but not high enough to attract imports, given the high container rates and the long lead times on shipping. The same is not true for polypropylene, which maintains a spread versus Asia that can cover the very high current costs of transport (bottom exhibit).
The US propylene to propane spread finished this week within the 5-year range, as opposed to setting the high end of the 5-year range, for the first time since December 2020. It still has a long way to go to reach seasonal 5-year averages and even further to reach seasonal lows, and there is plenty of margin left in PDH production in the US, even if the returns are now much lower than they were only a couple of months ago. Propylene pricing in the US is now low enough to encourage all derivative units to operate at high rates and we expect derivative price declines to follow – perhaps as steeply as propylene in the spot markets but more slowly in the contract markets.
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.
Even with the inflated container rates, the vast price difference between US and Asia polypropylene prices makes the opportunity too great to ignore. Even at their highest levels, container rates, and inland transport costs likely total no more than 35 cents per pound today, and as shown in the Exhibit below, you have plenty of room to maneuver. This is not the case with polyethylene or other polymers where the price delta between the regions, while high, does not cover the costs and the added risk of delays to sourcing. For more see today's daily.
US polyethylene producers are pushing for September price increases and their arguments center around lost production, because of Ida and Nicholas, and rising costs because of the much firmer natural gas and ethane markets. Working against them are the very high margins and what appears to be a stubborn spot market, both covered in the charts below. A contract increase in September would maintain an unprecedented gap between US contract and spot pricing, and while it is likely that the spot market is very thin, it is a very strong push back against producers for a contract hike.
The crack in US polypropylene prices is probably worth some comments as the polymer has shown extraordinary strength since the middle of last year, in the face of new capacity that was expected to push the US market into surplus. In the chart below we show that the spread over propylene has not fallen, but this is because propylene is falling lock-step with polypropylene for the most part. Those companies integrated back to PDH economics will see a significant margins squeeze as polymer prices fall while propane prices increase. We have written recently about a concern that lower auto production rates in the US will back up into parts and that this will impact materials. In the early days of the auto cutbacks, we assumed that the automakers and their suppliers would simply build inventory, with the expectation of a bounce-back in demand once the chip shortage was over. As the chip shortage has dragged on and become more significant, we have likely hit any limit of inventory build, and we are concerned that polypropylene pricing could collapse if auto-related demand does not recover quickly. While autos are not a dominant demand category for polypropylene the sector is certainly large enough to swing the polymer market from shortage to surplus. With the rise in propane prices and other ethylene feedstocks, polypropylene profits could fall meaningfully. See today's daily for more comments on the propane markets.
The gap between the US contract and spot price for polyethylene in the exhibit below looks wrong, and it could be wrong in absolute terms but the trend alone makes a statement. In the past, we have seen a couple of instances where reported contract settlements have drifted further from net transaction prices, either because of larger agreed discounts or because of contract formulae that reflect spot pricing to a greater degree. This tends to work for a while, but ultimately smaller buyers with more limited purchasing power become more disadvantaged and there is a breaking point at which the “contract” price is adjusted downwards by the price reporting services to better reflect what is really going on. The current market feels like the times in the past when an adjustment has been needed.
The chasm between US and Asia polyolefins prices remains wide, close to a 5-year high for polyethylene and setting new highs for polypropylene. The polyethylene arbitrage is not large enough to encourage US imports – first Exhibit below – largely because of the very high container rates from China.
The ICIS polypropylene analysis in the linked headline is interesting in that it shows the vulnerability of the traditional exporters of polypropylene to China if China goes ahead with the longer-term capacity announcements that local producers have made to date. The analysis suggests that this development will move China moves from deficit to surplus in PP.. Where the analysis may be wrong in our view is that the current high price of propane, low ethylene margins, and low local polypropylene margins could put portions of the planned capacity on hold, and while it may come eventually, the phasing of additions may be different. Current economics make any ethylene (and associated propylene) investments hard to justify and the same with PDH. In the past, we have seen China pull back investments when economics have not worked – most notably in the early part of the last decade when oil prices were very high. At that time China moved to projects based on coal, and while that may re-emerge, local oversupply, in general, will slow things down in our view, and pushing back towards coal may not fit with whatever carbon emission targets China will set ahead of the COP26 meeting.