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.
China trade data for chemicals and polymers points to a dramatic swing in net imports, partly due to the new capacity added over the last 12 months. Imports are down, and exports are up. Despite the logistic challenges of moving the products and the powerful pull on consumer durables from China driven by US and European demand – much of which consume significant volumes of polymers and chemicals locally. The trade swings talk to the significant capacity additions and the relatively sluggish consumer within China, where spending patterns remain subdued because of the Pandemic. Even with a recovery in domestic spending, China has probably added 2 to 3 years of demand growth in current capacity adds – most notably for polyolefins and PET, but also for styrene, where we believe demand growth could be slowing. If logistics improve and container rates come down, the surpluses in China will have a severe negative impact on international prices. This development will likely be seen in either polymer quantities flowing faster/more freely around the globe or because the export rate of consumer durables will pick up even further at the expense of durable producers in the US and Europe.
The LG Chem announcement may be a hollow victory for a while, and we would use the analogy of being the “best-looking horse in a glue factory”, given the weakness in the Asia ethylene and derivative markets right now. In this case, being the biggest means you lose the most in a down-cycle (see chart below and more on today's daily report). The significant capacity adds in China have collided with lower than anticipated demand growth, and driven prices down to costs (or below in the case of polyethylene in China). However, one thing we have learned over the last few decades is that you should never underestimate China’s ability to grow its way out of oversupply, and to assume that the surplus in Asia is here for the long-term is probably wrong. However, it could last a year or so and this is very unfortunate for LG Chem as making a loss in your first year of operation is very hard to come back from when looking at the project on a DCF basis.
Source: Bloomberg, C-MACC Analysis, June 2021
Referring back to our daily report today, can polyethylene hold on? Despite the strength in US polyethylene prices and the aggressive attempts by sellers to hold on through the quarter, there are couple of key factors working against them. Local supply may be tight in the US, but as we discussed yesterday, ethylene is moving towards a global surplus that could push US prices even lower than we are seeing this week and as the chart below shows clearly, how large the gap between Asian ethylene prices and those in the US. Unlike ethylene, polyethylene is harder to trade in to the US, partly because it is an unusual movement and the shipping costs are high, as would be the cost of getting from a US port to a consumer, but partly because US consumers serving the higher end of the market are very grade and quality conscious and would concerned about product quality and the risk of sending something to their customers that does not do the job as well.
Pessimism in the Asia ethylene market is a bad sign for ethylene vs. other US monomers. Those in the US with ethylene surpluses may need to fight a bit harder to find homes for the excess product in the US. We have not focused on the cost curve for a while as markets have been tight and global costs have not been an influence in the market for some time. The US has plenty of dry powder, in that export prices can fall significantly before they approach ethane-based costs, and can fall below production costs outside the US – especially in Asia – and still generate a margin for the US sellers. But that would mean more downside for US spot pricing and it may be enough to create some surpluses and some downward pressure on US derivative pricing. The caveat, of course, is that we had the same setup last year, albeit with less new capacity in Asia, and the summer hurricane season quickly wiped away any US surplus. A better understanding of the current cost curve and relative regional pricing can be found in our Weekly from Monday.