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.
With the rapid jump in international natural gas and oil prices, we would see very concerted efforts to raise basic chemicals and polymer prices in Europe and Asia and will have a positive knock-on effect for the US. In our weekly catalyst report on Monday, we showed that ethylene producers outside the US were all losing money, especially in Europe and Asia. Some European demand will already be lower, because of curtailed product exports to Russia and Ukraine, but producers will want to cover costs at a very minimum and consequently, will be trying to match price increases with cost increases and if possible do a bit better than that. All of this will create a greater margin umbrella for the US, and US exporters selling directly into international markets will see export margins step up and may see incremental opportunities to export more, assuming that the freight rates are not too onerous for incremental containers.
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.
We have been asked a couple of times in the last week how US polymer (polyethylene in particular) pricing can remain so robust in a market where there is an inventory build going on. The PMI numbers are part of the answer. While we may be in the seasonally weaker part of the year, customers are still looking for more material than a year ago, and this makes the “we need a lower price” argument much harder, especially when the memory of 1H 2021 acute shortages is still fresh in the memory and when, more than likely, they are getting signals from their customers of a further step up in demand in 2022. We have done some traveling recently and the incremental demand for packaging polymers is very evident in the travel and leisure business, even if the number of travelers is still down. There is more packaging on airline and airport food and hotels are offering pre-packaged food for breakfast that would previously have not been individually packed. The reasons are obvious – safety and hygiene from the consumers' end and costs from the providers' end, as prepackaged food, can be bought in bulk and more cost-effectively and they likely have a longer shelf life.
Our latest Sunday Thematic research report titled, "Reshoring Should Remain Supportive of Chemicals in ’22" studied the investment in US enterprise zones, near and medium-term, and the broad-based benefits for domestic supply chains.
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 ACC May production data shows the very strong year on year production growth globally, with the US gains more muted than the rest of the world as the COVID production impact in May of 2020 was less severe in the US than in many other parts of the world, and the China growth has been further assisted by significant capacity additions since this time last year. It is interesting to note that on a year to date basis the US is still down year-on-year, which is the lingering impact of the winter storm on production and it reflects that there is not much space capacity in the US, given both the strong demand and the export economic advantage of lower feedstock costs. Despite the collapse in prices in Asia – very well reflected in Exhibit 1 in today's daily report – the US has enough margin to continue its derivative and ethylene exports.
The Dow announcement yesterday speaks to a much larger issue within the investment community in our view, which is that research fees have come down so much over the last ten years that the sell-side gets paid very little for doing any real research. We talked about the upside in 2Q for the commodity polymer producers for months. Still, we know that we cannot get paid for maintaining the models needed to get to the numbers with enough confidence to publish estimates. The buy-side does not have the budget. In the past, as sell-side analysts, we would subscribe and talk to price discovery consultants, such as the predecessor companies of IHS (now in the middle of an acquisition by S&P) and CDI (in the middle of a merger with ICIS). This data and these dialogues would allow us to adjust earnings estimates during the quarter and keep up alongside our other work (e.g. corporate marketing/roadshows, etc.) as analysts. There is enough data in our weekly report – published each Monday to do this for many companies. (See an example in the chart below). Today, IHS has made its service so expensive that it is difficult for sell-side analysts to justify the cost when they are not getting paid by clients for real, fundamental research. The JP Morgan alleged base fee for research for an entire platform would not cover 25% of the IHS subscription cost for olefins and polyolefins data alone, per our estimate. Plus, all the merger activity at the data providers is causing some to question quality. The result is limited mid-quarter analysis from the sell-side and moves like Dow’s so that they can have realistic conversations with investors. In the case of Dow, it was to get the message out ahead of the Bernstein Conference.