The US chemical rail volumes should be considered in the context of some of the slowing demand that has been indicated by companies downstream of chemicals, and we see this as further evidence for possible inventory build through the chain. Earlier in the year these builds would have been justified by supply chain issues that have plagued all segments of retail and manufacturing for close to two years, but today we should be at or above inventory comfort levels. We are calling for weakness in demand and some margin erosion in US chemicals and polymers in 2H 2022, before a strong rebound as early as 2024, but if buyers of polymers and chemicals and their customers look to reduce inventories more quickly, the landscape could change quickly. While this is possible, with the threat of higher energy prices very real, we would be surprised in anyone was interesting in dramatically lowering inventories today.
In our Sunday Thematic to be published this weekend we are focused on business lines that will still look good in an economic turndown versus those that are more vulnerable, and ASIX may find itself spread across both buckets. The momentum in agriculture is very strong and even with a quick resolution in Ukraine, we could see high prices for crops and farm inputs for years as it will take a long time to correct recent imbalances and the Ag markets were already tightening before Russia invaded Ukraine. This and natural gas shortages (see today's daily report) should keep upward pressure on ammonia and ammonia derivatives pricing. On the other hand, any slowdown in consumer durable/discretionary spending will likely negatively impact nylon. A faster resolution in Ukraine would likely be negative for the Ag names as even if it takes a while to correct crop and fuel imbalances, the stock market will likely look through that and start focusing on eventual more normalized markets.
While Alpek shows a decline in the polypropylene to propylene spread in the exhibit below, it is important to note how high margins remain in the US. It is also important to note that the company points to high freight costs from Asia as one of the key drivers. China has significant polypropylene surpluses, and the price delta with the US is very high and, on paper, looks high enough to encourage imports into the US. But it is not that simple. The freight rates for containers from Asia are just one of many roadblocks, including wait time – on the water and the docks – and product quality. A US converter will likely not risk buying a few spot containers from China if focused on a product spec for a US customer. One way to get more material into the US would be for the end-user to buy the product – durable manufacturer or packager – and then ask its supplier to effectively toll-process. That way the product quality and logistic risk sit with the end consumer rather than the converter in the middle. The longer US domestic polypropylene prices remain inflated versus Asia, the more end-users may look at this option.
US ethylene prices have bounced off a low this week largely, in our view on the steep rise in natural gas and ethane. The drop in ethylene prices over the last couple of weeks signals an imbalance whereby production is more than enough to satisfy domestic demand and export demand. Export demand is limited by terminal capacity, and we have seen some domestic demand issues for polyethylene, not because of demand weakness, but because of export logistic bottlenecks, that are resulting in product (with homes to go to) backing up in the US ports. Given the timing of this build-up, we may see some higher end-quarter working capital from some of the chemical companies with sizeable export footprints for 1Q 2022. The sharp increase in US natural gas prices and the catch up that ethane has made to natural gas, should keep some upward pressure on spot ethylene prices if gas prices remain high. Propylene remains very supported by high propane prices.
We are seeing some monomer price weakness in the US, despite the rising costs. For ethylene, this is likely because of increased supplies (new capacity and turnarounds ending) and all capacity to consume running at full rates, including the export terminals. There is plenty of margin in exporting ethylene today and US prices are not falling because they need to find another buyer internationally. We could see some opportunistic buying for inventory at these prices, especially if you believe that the conflict in Ukraine is not ending soon and also if you are concerned about more extreme weather as we move through the summer in the south of the US.
It is interesting to note the rapid rise in US propylene (and benzene) values as they follow propane and crude prices (propane is following crude because of its heating value and export opportunities). Ethylene is not moving as US natural gas is in surplus and is not following international natural gas prices. The US is surplus ethylene and derivatives, but we would expect to see ethylene and ethylene derivative prices jump up in the US if Europe is physically unable to make ethylene and derivatives or if the costs in Europe become so high that supplying incremental volumes from the US becomes even more compelling. For more see today's report titled "Into The Mystic – Ex-US Energy Price Surge Favors US Producers; Low Visibility Keeps Capex In Check".
In a recent report, we discussed the relative demand strength in the US, as well as the high costs of importing chemicals and polymers into the US and suggested that higher energy and feedstock costs could arrest price declines in the US at levels that still drive significant profitability for US producers. With that in mind, it is interesting to note the upward move in propylene spot prices in reaction to higher propane prices and the resulting flat settlement in propylene contract prices.
The CP Chem propylene splitter announcement linked suggests that CP Chem expects surplus refinery propylene to be around for the long-term, and likely has supply lined up from the parent companies. However, this is still a bit of a gamble unless both parents see a scenario where they would change catalysts on FCC units longer-term and run at higher severity for more propylene and more hydrogen. This project looked a lot better only a few weeks ago than it does today – based on the spread in the Exhibit below, but propylene demand continues to grow faster than ethylene demand in the US and with all incremental ethylene capacity based on ethane, propylene consumers either have to choose the path from refineries or invest in on purpose PDH. PDH is an energy-intensive process with a large carbon footprint, and splitting refinery propylene likely looks far less problematic from an emissions perspective, especially if there is surplus process heat on-site. In our ESG report today we talk about polymer recycling into new end markets, but polypropylene may see more direct substitution, especially if we see consumables related polypropylene recycled into durable polypropylene markets. This might dent demand growth for polypropylene going forward, but probably not meaningfully.
Following on from the LyondellBasell commentary in today's daily report, we would make one further, but very important point. With its refinery (granted the company is exploring opportunities to exit) and its huge commodity polyethylene, polypropylene, and propylene oxide business, any attempt to pursue a “specialty” strategy that encompasses the whole portfolio will be seen (crudely) as trying to put some lipstick on a pig! This rarely works in the chemical sector and the real transformation stories involve wholesale portfolio shifts, many of which have taken notable periods of time to develop. We still believe that the right path for LyondellBasell is to spin off the good piece – recycling, licensing, and compounding, or even better, find someone they can sell the business to through a Reverse Morris Trust. This strategy would likely allow the company to pay down (or shift) a significant amount of debt. The commodity business can then focus on the best strategy for a commodity polymer business in the face of energy transition, which might involve taking the business private or merging with another.
The drop in US benzene pricing is likely a function of lower crude oil pricing and the overall impact this is having on oil product values. As the US has moved to much lighter ethylene feedstocks, the proportion of benzene that is coming from refining is overwhelming and alternative values for benzene or reformate in the gasoline pool are a strong driver of US and international pricing. Lower naphtha pricing for ethylene units outside the US will also hurt benzene values. By contrast, the stronger natural gas market – through the end of last week - supported ethane pricing in the US and we saw a step up in propane pricing – which have provided support for ethylene and propylene – also note that the analysis we published yesterday in the weekly catalyst suggests that the US can export ethylene to Asia at current prices – delivering ethylene into the region below current local costs. This should keep a floor under US ethylene pricing although any further decline in crude oil prices relative to US natural gas and NGLs will close this arbitrage.