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US Polyethylene’s Weak Pricing Power

Business, China, Company Strategy, Economics, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins, US
By John Richardson on 26-Nov-2014


By John Richardson

HERE is the thing: Petrochemicals pricing for just about every product in every region is usually pretty much set by crude oil and yet in the US, the correlation between polyethylene (PE) pricing and oil has been just 32% since 2010, according to Wells Fargo analyst Frank Mitsch.

An ICIS analysis for the same timeframe between Brent crude and US contract  high-density PE yielded an r-squared value of 19.0%. The value using WTI crude was 40.0% – both not meaningful correlations.

What does this tell us?

It tells us that US converters have successfully pushed back against oil-driven price rises because they know that US producers have become just about 100% based on very low cost ethane.

But this push back would not have happened to such a big extent (and as little as a 32% correlation with crude is, surely, a big extent) if there had been a genuine economic revival in the US. The US PE industry would have achieved much better results than even their stellar financial performances of late if such a revival had really happened.

Instead, though, the local plastics processing industry is facing its own form of push back – from big retailers such as Wa-lMart, who need greater cost savings on the plastic films, plastic trays and plastic pallets that they buy from the converters.

Wal-Mart failed to grow its sales for six consecutive quarters up until Q2 this year. These are the explanations it gave for this failure:

•It was facing intense competition from discount ‘dollar stores’ as many working families have little spare cash.

•Major cuts to the food stamps programme were impacting the 20% of sales from this area.

•Consumer preferences had shifted away from big-box stores to small local convenience stores.

The reality is that majority of Americans, who, of course don’t own shares, have seen anaemic income growth over the last decade as a result of demographics. This explains the poor Wal-Mart results.

And as the S&P 500 continues to defy gravity (more on this subject later), the gap between the relatively small number of people who own equities and everyone else has widened.

What the weak correlation between crude prices and PE prices also tells us that the US plastics processing industry faces strong import competition from low labour cost countries.

Despite rising labour costs in China, finished plastic goods are still a lot cheaper to make in China than the US.

Most of the rest of the “developing world” has  even greater labour cost advantages over the US.

If the US PE market had been genuinely strong since 2010, US producers could have offered pricing on a “take it or leave it” basis to their customers.

“Sure, you can import PE as an alternative to buying from us, but if you do so you will have to pay all the high logistics costs that come with buying from overseas,” PE producers could have, in effect, said to their customers

(In the US polymers are moved by railcar and stored by plastic processors in giant hoppers. Imports arrive by container, either loose in the containers or in plastic bags. Thus, labour costs are incurred in unloading the polymers from the containers and into railcars).

The converters would then have happily paid whatever was offered by the PE producers, even if this was a lot closer to parity with international PE prices – which do correlate more closely with the costs of crude.

What is remarkable is that what seems to be a weakness in the market has occurred despite no major capacity additions over the last decade.

If you don’t buy of my above arguments, understood of course. As always – this is a debate.

But how do you then explain the data on US demand? The above chart, from fellow blogger Paul Hodges’ new PH report, shows that the US PE production peaked in 2007. As you can also see from the chart, production of other petrochemicals peaked even earlier.

“The reality is the US from a chemical standpoint is a very mature market. We have some demand growth domestically in the US but it’s a percent or two, it’s not strong demand growth. PE hardly grew in the US in a decade. That is not going to change,” said Stephen Pryor, president of ExxonMobil Chemical in January 2014.

So the obvious next question is: What will be the impact on the US and global PE industries once all the new US capacities start coming on-stream? As many as 17 new PE plants could eventually be built in the US with total capacity of 8.1m tonnes/year.

We know that the US market cannot take anywhere near close to all this material, for the reasons we have just outlined.

And you can also forget about export markets easily absorbing all of this capacity.

So what will be the impact on the global PE industry all of this new capacity, then?

This will be the subject of a later blog post.