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.
To put some perspective around the shipping container costs shown in Exhibit 1 of our daily report today, $20,000 per container equates to roughly 34 cents per pound of cargo assuming that the container is filled to maximum weight. If we also add in loading inefficiencies and assume 500 miles of road transport in the US or Europe, we can add another 5-10 cents per pound. Using ethylene costs in Asia at roughly 43 cents per pound as a basic benchmark (see our most recent weekly catalyst report), we thus estimate that it would cost around 90 cents per pound to get Asia polyethylene into the US. This does not include any working capital cost assumptions around ownership of the cargo from point of production to point of use. US spot PE prices are currently below 80 cents per pound for the more commodity grades of polyethylene, which is the market that could most easily be targeted by imports from Asia. When container rates were closer to $3000 per unit, the all-in import costs would have been roughly 30 cents per pound lower and the arbitrage would have been worth exploring. Of course, if the freight rate was only $3000 per container US polymer prices would likely be lower.
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