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.
In the first Exhibit below we show a 5-year high in chemical rail-car movements. We have noted in research since early October that 4Q production in the US could be very high because of a combination of available capacity – following a year of weather-related delays – and very attractive margins and demand. We have been at the high end of rail car volumes for most of the quarter, and this may be part of the reason why we are seeing some price weakness for polymers in the US. Most of the polyethylene exported from the US moves from the manufacturing site to the export port via rail, so increased exports would also drive higher rail car numbers. As long as pricing and margins remain high and customer demand robust, we would expect these higher volumes to continue. This does not make us any less concerned that somewhere in the chain there is now an inventory build going on and that fortunes could reverse in 2022.
We are seeing some stability in ethylene and propylene pricing in the US to start the week, and with the steady rise in crude prices and the Monday jump in natural gas prices, this is not surprising. As we noted in yesterday’s Weekly Catalyst, there is enough incentive to export ethylene from the US to Asia – most likely Southeast Asia rather than North Asia, and this could offer support for those with surplus ethylene in the US today.
The propylene chart below shows a significant disconnect between spot and contract prices – more than at any point in recent history, and if the US contract price does not fall it will likely be an indicator that either discounts have increased or that more volume is moving against a spot price marker. The pressure is also on to lower ethylene contract prices, but the propylene spread is far more extreme.
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.
As we hinted in yesterday's report, the wheels are wobbling in the US market, especially for polyolefins and this comes at a time when Asia prices are finding some strength because of production and cost issues – it shows how quickly market dynamics can change in this industry and the closing of the gap between Asia and US propylene prices in the first exhibit below is perhaps the most dramatic example. We see a real opportunity for the wheels to stop wobbling and completely fall of the western wagons in the near term, and as the second exhibit below shows propylene continues lower, and with further to fall to hit PDH economics.
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.
The decline in propylene and ethylene values is worth consideration today as it provides proof, along with the feedstock comments in today's daily report, that US commodity chemical producers are on average facing margin pressure WoW. We noted in yesterday's research that China prices were rising amid production cuts, but demand remains a notable concern. As production rises from current levels in 1H22, this will put downward pressure on Asia chemical prices and also translate into lower US export values.
We have a fairly stable week for US olefins so far – no new production disruptions, but the industry is still recovering from the storm-related shutdowns over the last 4 weeks. We still believe that there is a downside to ethylene and propylene in the US as production recovers and as demand normalizes (especially for propylene). With another month of hurricane season to go, however, it probably does not make sense to force surpluses into an export market where prices are much lower – especially for ethylene. As we have noted in the past, the right strategy in 2020 was to store the ethylene at this time rather than sell it. Inventories would likely have to rise further before those with surpluses were willing to take the cut needed to export. At the same time, rising natural gas and NGL prices are another reason to hold on to products as what you have today did not cost that much to make and costs may rise near term. See more in today's daily report.
The major issue with the higher natural gas prices in Europe (and rising prices globally) is the knock-on inflationary impact it will have on products that have natural gas as a feed, rather than those buying it as a fuel. The fuel buyers will take some of the hit, but will also try to pass on some of the hit, as it is generally a small part of overall product or service costs. The focus has been on ammonia/urea production because of the knock-on effect on food-grade CO2. But other products, such as methanol, would also be impacted, although there is not much methanol capacity in Europe. Higher LNG prices in Asia could encourage more coal-based methanol production, which is precisely what the increased use of LNG was supposed to prevent – replacing a high carbon footprint route with a much lower one. In our view, it is imperative that the attendees of COP26 recognize the need for (cleaner) natural gas and LNG, and enact policies to support it. This inflationary lesson is well-timed.