Commentary: Oil puts chemicals over a barrel

Joseph Chang

17-Oct-2014

The sharp decline in crude oil prices should lead to lower petrochemical prices. Even as oil-based feedstocks become cheaper, the price impact will outweigh any cost relief

The collapse in crude oil prices will cause pain for petrochemical companies. One might think that lower oil prices would result in lower feedstock costs, boosting margins. This dynamic may work to some extent, but is far outweighed by the impact on prices.

Chemical prices move with crude oil, and the impact on margins tends to be more favourable on the upside versus the downside. Why? Because when oil prices are moving higher, producers dictate the conversation on pricing. Conversely, on the downside, the pricing discussions are dominated by buyers.

 

The coming impact of rapidly falling crude oil prices is being signalled by the sharp declines in chemical stock prices. As of the close of 15 October, LyondellBasell is down 25% from its high of $114.59 reached on 5 September 2014. Westlake Chemical fell 29% from its high of $97.96 on 2 September. A more diversified Dow Chemical is off by 20% from its $54.80 high reached on 5 September.

It’s not hard to understand why. Chemical companies with significant assets in the US have been getting a double benefit – not only do they use mainly low natural gas based feedstocks, but also reap the benefit of high chemical prices which are based on crude oil.

Although around 80% of US cracker feedstocks are derived from natural gas liquids (NGLs) – ethane (58%) and propane and butane (22%) based on 2013 statistics from ICIS – US chemical prices follow crude oil.

An ICIS analysis of the relationship since 2000 between US chemical prices as measured by the US ICIS Petrochemical Index (IPEX), Brent crude oil and Henry Hub natural gas, reveals that the US IPEX and Brent crude oil have an R2 (r-squared) of 86.6%. This is a significant degree of correlation.

In stark contrast, even as 80% of cracker feedstocks are based on natural gas, the R2 between the US IPEX and natural gas is just 2.0% – essentially there has been no correlation.

Big beneficiaries of the dynamic of using feedstocks based on low US natural gas costs and selling prices based on high crude oil have been the commodity petrochemicals and polymers companies LyondellBasell and Westlake – they’ve been the biggest gainers in the past two years, and have fallen the hardest as crude oil collapsed.

“Oil’s rapid fall forces a reset of expectations. Falling feedstocks could help downstream margins for a while, but volumes in petrochemical value chains and energy-efficiency applications could be challenged,” said Laurence Alexander, analyst with investment bank Jefferies.

“The bridge to 17% consensus earnings per share (EPS) growth in the [US chemical] sector in 2015 appears fraught. Aggregate chemical EBITDA [earnings before interest, tax, depreciation and amortisation] has benefited from wide arbitrages. Can the sector decouple the way it did in the 1990s?” he added.

In the 1990s, crude oil prices fell and were relatively low, but US chemical companies enjoyed solid though varying levels of profitability.

But the impact of lower crude oil prices should also be felt in Europe – and not in a positive way, even as the petrochemical sector there uses primarily oil-based naphtha for feedstock.

BASF’s share price, as of 14 October, is down 17% from its interim high of €79.50 reached on 26 August, and down 25% since its 20 June high of €87.36. Of course the Germany-based company does have major assets in the US, along with direct exposure to oil through its Wintershall oil and gas production subsidiary. Other Europe-based chemical companies Solvay, LANXESS and Arkema, have also seen their stock prices clipped since early September, though with less severity than US commodity players.

If crude oil price weakness persists or worsens, expect financial analysts to start slashing 2015 profit estimates across the board and worldwide.

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