Volumes holding up in Q4

15 December 2003 00:00  [Source: ACN]

Despite year-end inventory reductions, the market remained confident. But US ethylene prices remained unsettled. Report by Sergey Vasnetsov

DEMAND for many chemicals picked up in the third quarter, as all boats were lifted by the rising economic wave.

Volumes remain fairly strong thus far in Q4 03, despite some weakness due to year-end inventory reductions. However, most chemical markets continue to suffer from excess capacity, which we expect will slow the recovery in chemical margins in 2004.

Although US manufacturing trends appeared to be improving in November, with higher durable-goods orders in Q4 03, this was being slightly offset by the apparent slowdown in the housing market. Consumers continued to provide strong support for the economy, as confidence picked up ahead of the holiday shopping season.

The S&P Chemical Index rose by 4.9% in November, outperforming the overall S&P 500 Index for the second consecutive month. Both the overall market and the chemicals sector continued to benefit from the flurry of positive economic data, which followed the strong Q3 GDP (gross domestic product) growth. Furthermore, energy prices continued to hold flat, heading into the winter heating season. These two factors helped raise investors’ hopes of a strong 2004 recovery in chemical earnings.

Although volumes and demand appeared to be up last month, we expect chemical cash margins will lag this recovery in demand because of the continued overcapacity in most commodity chemical markets, and because of increased competition from imported finished goods.

September, October, and November contract US ethylene prices remained unsettled, although September negotiations neared a settlement, with pricing declining 0.75 cents/lb versus August. Meanwhile, October price negotiations centred on a range of flat to up by 0.75 cents/lb.

As a result of these ongoing negotiations and the uncertainty surrounding near-term energy prices, a few ethylene producers announced a 2-3 cents/lb increase for November and a 2 cents/lb increase for December. However, we believe the main purpose of these increases was to prevent price erosion during the winter heating season, when energy prices could spike.

Overall, US ethylene market fundamentals were mixed last month. Although demand was fairly strong in Q3 03 (thanks to the surge in industrial production), volume trends appeared to be softening, since some of the strength appeared to have been based on some pre-buying in the polyethylene (PE) market.

Moreover, although overall industrial production appeared to be stronger, the apparent demand for US-made non-durable goods (a major end-market for PE) was lagging.

We estimate the current industry average nominal operating rate at 84%, with effective rates slightly above 90%. While the improvement in effective operating rates is encouraging, we feel supply/demand fundamentals remain far too weak for producers to have sustainable pricing power.

Producers need customers to fear a potential shortage of ethylene before industry cash margins are likely to experience a significant and sustainable improvement. That is far from the case now, given the large surplus of ethylene capacity available in the US market (note: November production losses were almost 600m lb, or about 11% of nameplate capacity).

North American PE demand remained weak in November. Domestic demand continued to struggle, due to weak apparent demand for US-made non-durable goods, but export demand improved by about 10%. Most of this supply was just being shipped to Mexico, but there was also a temporary pickup in exports to China, as downstream producers there restocked inventories.

Overall, we believe US PE demand could be down 2-3% in 2003, due to a lacklustre economy and the increased pressure of imported finished goods.

Despite these weak supply/demand conditions, PE producers continued to push for a 4 cents/lb price increase for December. However, we do not believe this increase will go through in the next few months, if at all, since operating rates are so low.

Furthermore, producers had not completed implementing the September-October 5 cents/lb increase; therefore, we expect customers to take a hard stance against this increase. Only a sharp energy spike would help the implementation of price increases.

The US propylene market stabilised last month, as demand declined versus September-October levels. Overall supply/demand conditions were fairly balanced, which helped producers settle November prices up 0.5 cents/lb versus October. Although demand from acrylonitrile producers remained strong in November, volumes to the polypropylene (PP) market levelled off, due to the year-end slowdown.

On the supply side, propylene production decreased versus October, as light (lower propylene-yielding) feedstocks cracking became more attractive, with oil prices rising relative to the natural-gas market.

After two months of decent demand, US PP volumes slowed in November, as the year-end approached and producers tried to bring down their inventories. Given this slowdown in demand, we do not expect producers will be able to implement the 3 cents/lb October price increase. Nevertheless, a new 3-4 cents/lb increase has been announced for December, as producers seemed to be hedging against another energy spike (as was the case in 2001 and 2003).

Although US styrene demand was slightly better recently, the market remained lacklustre overall. However, producers were running in the high 80% range (with effective rates in the mid-90s, mostly because of lost capacity at Nova’s Bayport plant).

Although producers did not want inventories to skyrocket, they were preparing for extensive planned maintenance in H1 04 (about 18% of North American capacity is scheduled to be lost in January and February).

US styrene prices are expected to get a boost from these multiple outages, as was the case for US ethylene prices in H1 03, when about 10% of North American capacity was undergoing maintenance.

Spot demand for styrene picked up last month, as Asian styrene prices increased. However, US styrene producers were not able to take full advantage of this export demand, because of the high freight rates to China (due to limited space).

Although US polystyrene (PS) demand remained fairly soft in November, producers successfully removed a 2 cents/lb discount, effectively raising PS prices. Despite weak supply/demand conditions, producers appeared quite determined to improve their profitability by being much more disciplined, which has not always been the case in the US PS market.

November PVC market conditions were better than expected, as demand remained flat month-on-month. Mild weather trends allowed US construction markets to remain active into late 2003, which kept up PVC volumes into the pipe, siding, and windows market compared with the same period last year. Based on the continued strength in the PVC market, we expect US PVC producers will announce a 2 cents/lb price increase for the beginning of 2004.

US chlorine prices settled flat in November, as producers held prices steady despite the availability of spot chlorine supplies. While chlorine demand is typically slower at the end of the year, Q4 03 sales volume has picked up, thanks to better demand in the vinyls sector. Additionally, we believe some demand could be attributed to pre-buying in anticipation of price increases in Q1 04.

US caustic soda prices also remained flat in November. Increased production levels and a surge in imports were the main reasons contract prices were lower in October, and November pricing trends were quiet, as expected, since buyers and sellers were negotiating alumina contract prices for H1 04.

Moderate natural gas prices helped the US offset lower electrochemical unit (ECU) values (relative to Q3 03). Thus, although ECU cash margins were slightly lower quarter-on-quarter, the chlor-alkali market remained in much better shape than most of its commodity peers. This strength is largely attributable to the 13% of permanent capacity shutdowns in the US chlor-alkali market, which improved industry operating rates significantly.

The painful downtrend in the US polyethylene terephthalate (PET) market continued in November, despite some modest decline in raw-material costs. Asian PET supplies continued to pressure the US market, and US industry operating rates were near 80%. Given these low rates, customers were able to reject the 5 cents/lb increase, which was originally scheduled for September but delayed until October.

Operating rates are the key driver of sustainable cash margins growth. Unfortunately, operating rates for most chemicals remain very low, recovering to the point of the last chemical trough (in 1991) only recently.

Thus, we expect it will take at least a few more quarters of solid demand growth before producers are able to return their cash margins to acceptable levels.

Chemical prices and margins outlook

Product prices (cent/lb)	Peak	Trough	2002	Q1 2003	Q2 2003	Q3 2003	Q4 2003
Ethylene	30.2	17.7	22.2	28.4	30.3	27.3	27.8
HdPE*	44.3	28.8	38.5	46.0	49.0	47.0	48.3
LdPE film	46.4	30.7	41.9	50.0	53.0	51.7	52.3
LldPE film	41.9	26.7	33.9	42.0	45.0	43.7	44.3
Propylene**	22.6	12.2	18.0	22.7	23.5	19.3	19.8
PP	42.0	25.7	33.8	39.7	43.7	39.7	39.0
ECU***	440.0	223.0	284.0	391.0	462.0	399.0	372.0
VCM	25.3	13.7	19.9	24.8	26.8	25.3	26.2
PVC	37.3	23.1	34.4	40.5	43.8	42.2	43.5
Styrene	33.8	20.5	27.2	36.8	33.9	33.0	32.0
PS	47.8	31.8	36.8	42.7	49.3	47.8	47.6
Cash margins (cent/lb)
Ethylene	16.0	4.2	7.2	6.0	13.0	8.4	7.6
HdPE*	8.0	(1.3)	4.7	4.7	6.2	7.4	8.3
LdPE film	8.0	(1.6)	5.3	5.0	6.7	8.8	9.1
LldPE film	6.5	(3.5)	0.4	1.2	3.0	4.6	5.0
Propylene**	15.6	7.6	14.9	15.3	15.2	18.5	13.6
PP	12.0	1.8	5.5	6.3	9.9	9.8	9.2
ECU***	266.0	29.0	72.0	106.0	201.0	146.0	130.0
VCM	2.4	(2.3)	(1.2)	(4.4)	(3.3)	(0.7)	0.3
PVC	5.7	(0.1)	3.1	0.5	1.3	1.7	1.8
Styrene	11.1	3.0	5.2	4.7	5.9	6.5	5.7
PS	8.1	0.1	0.9	(3.0)	6.7	6.2	6.2
* blow-moulding grade	** chemical grade			*** electro chemical unit (US$/short ton)
Source: Lehman Brothers

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