Cowen breaks consensus, expects rough second-half for US chems

Author: Al Greenwood

2019/02/08

HOUSTON (ICIS)--The investment bank Cowen expects petrochemical companies will continue to face challenges in the second half of this year, breaking from the consensus that the market will stage a recovery from the slowdown in the fourth quarter.

Companies warned about slowing demand for their chemical products during their third- and fourth-quarter earnings announcements. However, several CEOs said a rebound will take place by the second half.

Cowen disagreed, saying that the challenges are too widespread.

"It has been 11-12 years since we were so universally ambivalent about owning chemical shares," the investment bank said in a research note.

CHALLENGES IN H2 2019
Cowen warned about several trends working against a rebound in the second half.

- Companies will start up even more plants in 2019, causing supply to grow faster than demand. This is on top of all of the new plants that the industry added in 2017-2018.

- New ethylene plants will start up in quick succession to one another, causing a sudden spike in demand for ethane. That sudden spike will increase raw material costs – all while supply is increasing.

- Lower oil prices will reduce the feedstock advantage that US producers have over foreign competitors, especially given the expected rise in ethane costs.

- New players are entering the US polyethylene (PE) market, a phenomena that is typically disruptive since these new entrants are eager to build market share.

- Companies are starting up new plants in the US at a time of rising trade tensions with China. The result is causing US producers to lower prices to gain market share in alternative markets.

- Slower growth in the global economy will make it more difficult for foreign markets to absorb new US supplies. Slower growth could also drag down demand within the US.

- Given the decline in prices, producers will confront a dilemma. They can lower production rates and contend with the resulting rise in production costs. Or they can maintain production rates and further expose themselves to lower prices. Companies lose in either scenario.

Cowen's report paints a gloomy scenario for US chemical producers.

A scramble to place product during the recent contract season likely led to better terms for buyers, Cowen said. The fallout from these terms will likely linger into 2020, since these contracts typically last one to three years.

During the fourth quarter, producers likely lowered prices to a much greater extent than what was reported, Cowen said.

For PE, prices likely fell by an average of 7-9 cents/lb ($154-198/tonne) after November and December price concessions, Cowen said. In some isolated one-time deals, those reductions exceeded 10 cents/lb.

That compares with the 6 cents/lb that was reported, Cowen said.

So far, there is little sign of prices rebounding, according to the bank. "We believe it could take much of Q1 2019 to get pricing to settle and that price gains typically seen in Q2 may be dampened by the macro/oil/capacity environment."

Overall, the second half will be challenging, and expectations of a recovery are underestimating the difficulties being faced by the chemical industry, Cowen said.

'NOT TAKING A WIDE ENOUGH VIEW'
This is a sharp break from the outlook that companies shared during the earnings season. Many CEOs said that the industry will start to bounce back after the Lunar New Year, and a recovery will being in earnest by the second half of the year.

Cowen disagrees. Companies are only recognising the direct challenges that could disrupt their business, it said. They are not digging deeper into secondary and tertiary threats to their businesses.

"This is the heart of our disagreement with the broader view of a H2 2019 recovery," Cowen said. "We believe that the industry is not taking a wide enough view of the hurdles it faces to move to recovery."

These indirect effects are not readily apparent. For example, the oversupply of ethylene and PE will also affect demand for methanol, given its use as feedstock for methanol-to-olefin (MTO) plants, Cowen said. Worsening MTO economics will lower demand for methanol, caused prices to fall.

Lower methanol would then work its way through the acetyls chain, affecting prices for acetic acid and downstream products.

Cowen is breaking from consensus in other significant ways. Unlike many chemical companies, Cowen is not blaming the slowdown in China solely on trade.

Yes, the trade dispute between the US and China hurt growth, but the situation was already deteriorating before tariffs became an issue, Cowen said.

Rising demand in the US could offset some of these challenges. However, US ethylene demand has already increased by 7.8% in 2017 and 13.8% in 2018, Cowen said. Given the rise in output, demand growth in 2019 will have to exceed that in 2018 in order to maintain operating rates. Likewise, demand in 2020 will have to exceed that in 2017, Cowen said.

It is doubtful that the US can continue to repeat its strong performance from 2017 and 2018 in what will likely be a weaker economy, Cowen said.

More problems could pop up beyond the challenges specified by Cowen, the bank said. Company-specific issues could force them to reduce capacity.

"The situation does not seem to lend itself to a H2 2019 recovery," Cowen said. "In our view the best we can hope for is that the market is stabilising by Q4 2019, though it is far from assured."