INSIGHT: LatAm petchems at mercy of global markets as China’s reopening key for prices

SAO PAULO (ICIS)–Latin American petrochemicals companies are dependent on a recovery in global prices to post healthier spreads in 2023 as all eyes are now on China’s economy reopening.

Although Latin American petrochemicals producers and distributors concentrate on domestic consumers, China and other foreign markets are important for the region because they influence margins and stimulate demand for commodity exports.

Meanwhile, Brazil’s petrochemicals association Abiquim is demanding the new government reverses tax exemptions, claimed to favour foreign producers and implemented by the previous Administration, in order to protect their domestic market share.

All in all, the Latin American petrochemicals industry will have to adapt in 2023 to a new environment where still-high feedstocks prices will not match those of the petrochemicals they produce, which are far from the highs of 2022.

ALL EYES ON CHINA
Global petrochemicals posted healthy spreads in 2022 as the world reopened its economy following the ups and downs of 2020 and 2021, when the health emergency brought many economies to a standstill.

Petrochemicals prices in 2022 posted record highs around the world, especially in the first half (H1) of the year, but Russia’s invasion of Ukraine in February changed the picture as crude oil and natural gas prices started to creep up.

For a while, producers across the world were able to pass on those higher costs onto their customers, and prices remained “high and robust”, according to Lincoln Webber, director for Latin America corporates at US credit rating agency Fitch.

However, rocketing inflation brought the counterreaction from central banks, from Brazil to Mexico, which hiked interest rates several times to rein in a runaway inflation.

That, in turn, brought up borrowing costs for dollar-denominated debt, which is predominant for most Latin American petrochemicals companies.

The new economic environment put an end to the party of high spreads, which have been contracting in past quarters for small and large producers alike.

“Those conditions [spreads contracting] should continue into 2023 as prices continue to be under pressure: it doesn’t seem the economy, and therefore demand, is recovering that fast,” said Webber.

“We’ll see prices continuing to go down. Energy and feedstocks are also going to go down, but not as fast as petrochemicals prices will fall. The consensus among industry players, and that is Fitch’s view as well, is that 2023 is going to be a tight year in petrochemicals markets.”

The Fitch analyst said the other key factor to gauge the petrochemicals industry’s health in Latin America – and the wider Americas region – will be the pace in which lockdown-beleaguered, plastics-hungry China reopens its economy.

The Chinese government’s grip on the economy weakened at the end of 2022, when protests across the country due to a beleaguered economy put the Administration up against the ropes.

During 2022, large expansions for several petrochemicals – especially polymers such polyethylene (PE) and polypropylene (PP) – were put on hold as the economy sharply slowed down.

“In 2023, those plants are set to come online, increasing supply, so we may have a reversal of the conditions we saw in 2021, when prices where high and costs low,” said Webber.

“Now we have pressure [for producers coming] from lower demand, and pressure from the supply side. Producers are not enjoying low feedstocks prices, and therefore margins are set to be squeezed in 2023.”

The analyst went on to say, however, that “a couple of wild cards” could drastically improve the outlook for petrochemicals producers’ spreads in 2023: a faster-than-expected China reopening and production cutbacks by large global producers.

“Demand could increase if China reopens its economy faster than expected, which would have a huge impact on petrochemicals as the country is a big consumer of plastics. That, in turn, could have a huge impact on global prices,” he said.

“Secondly, the big players in the Americas such Dow or LyondellBasell, as well as other large companies in Europe, may start to cut back production due to poor demand, supporting prices and margins for companies in Latin America: because companies in the region are smaller in a global scale, they must accept whatever prices the global market offers them.

“Downstream, those two factors could favour them.”

Fitch rates two Brazilian companies, Braskem and Unigel. The former is often considered the bellwether for the region’s petrochemicals industry, and its 2022 financial results and production figures will be looked in detail to assess what the impact of falling prices and spreads has been.

Fitch assumes Braskem sales in 2022 from its domestic assets – which excludes those in the US, Mexico, or Europe – will come in at Brazilian reais (R$) 69bn ($13.2bn), of which R$52bn would come from sales in its domestic market and R$17bn from sales overseas.

Those financial results would correspond to around 6.7m tonnes of petrochemicals sold domestically and 2.1m tonnes sold to foreign markets.

The Brazilian major is due to release its annual results on 8 March.

CALL TO LULA TO PROTECT DOMESTIC PETCHEMS
Brazil has been embroiled in a political crisis since the previous President, Jair Bolsonaro, lost the October presidential election to Luiz Inacio Lula da Silva, who revived to rise to the presidency again after a period in prison on corruption charges, of which he was finally cleared.

His victory, however, was followed by an attempt to reverse the election results in January, when a crowd of Bolsonaro followers stormed the buildings of the so-called Tres Poderes – the Three Powers: executive, legislative, and judiciary – in Brasilia on 8 January.

The failed attempt has had Bolsonaro government’s officials arrested for allowing the crowds to storm official buildings, while Bolsonaro himself remains in exile in Florida, US, since 2022.

For the petrochemicals sector, however, much about they expect from the new Administration comes down to the Special Regime of the Chemical Industry (REIQ).

REIQ lowered the PIS/COFINS tax rates that the chemical industry paid for input within the xylenes chain, including naphtha, benzene, propene, ethene, toluene and cumene, according to Brazil’s chemicals trade group Abiquim.

PIS and COFINS are imposed on the Brazilian entity or individual (the importer of goods or services) and should apply to the import of services at the rates of 1.65% and 7.6%, respectively.

Until now, the PIS/COFINS under REIQ stood at 3.65% overall.

With the suspension of REIQ by Congress in 2022, the PIS/COFINS rate rose to 9.25%, with PIS making up 1.65% and COFINS making up 7.6%.

Abiquim said in 2022 the suspension of REIQ could imply a cost of nearly R$2.0bn for the chemicals sector as well as jeopardising 85,000 jobs and Brazil’s competitiveness in the global chemicals industry.

According to Fitch’s Webber, petrochemicals players in Brazil did not favour the previous Administration’s cuts in some import tariffs for different chemicals.

“They would like those cuts to be reversed, because that gives them more of an advantage to sell in the domestic market,” he added.

“During the electoral campaign, Lula spoke out against those import tariff cuts. Braskem, as well as most other local producers, would welcome those cuts being reversed.”

In a written response to ICIS on 1 March, Abiquim’s executive president, Andre Passos, said the trade group welcomed the new Administration’s aim to keep REIQ, and said it has held several meetings with officials from the new cabinet who sounded inclined to do so.

On 15 December, the Brazilian Congress passed maintaining REIQ but the government still would have to pass regulation to implement it in 2023, said Passos, something yet to occur.

“Fortunately, Congress understood the importance of overthrowing the veto [to REIQ implemented by Bolsonaro in 2022], thus avoiding the negative impacts that would be generated, not only on the chemical industry but on the entire production and consumption chain,” he said.

He went on to say, however, that REIQ “does nothing more than reduce the huge disparity” in costs between Brazilian chemicals producers and their international competitors.

“This is because the sales tax in Brazil is 40-45%, while competitors in the US and Europe pay only 20-25%, and the raw material cost, such as natural gas, is up to three times higher than in other countries,” said Passos.

Overall, the trade group said it sees Lula’s cabinet positively after “it has given clear signs of a promising future” for Brazil’s industrial sectors.

For instance, it pointed to the reestablishment of the Ministry of Development, Industry, Commerce and Services, which before the prior Administration abolished it had acted as an “extremely important” channel of communication between industry and the executive.

BRAZIL GREEN CREDENTIALS – AND ITS PRE-SALT OIL
The Lula cabinet has promised to stop deforestation in the Amazon, which sped up during the prior Administration. The Amazon is key to contain climate change, most scientists agree, as it acts as a global absorber of CO2 emissions.

However, Brazil’s vast natural resources to be still exploited will present a dilemma for Lula’s government; the chemicals industry is adamant the country’s pre-salt oil reserves are exploited to bring domestic production up and costs down.

Pre-salt layer reserves are found in the Atlantic’s African and Brazilian coasts, and pre-salt oil reserves are thought to be a significant fraction of the world’s oil reserves.

According to Brazilian oil and gas company Petrobras, the oil and natural gas reserves lie below an approximately 2,000 metres thick layer of salt, which in turn is beneath more than 2,000 metres of post-salt sediments in places, which in turn is under water depths between 2,000 and 3,000 metres in the south Atlantic.

Because of this, drilling through the rock and salt to extract the pre-salt oil and gas is very expensive.

Within petrochemicals, Braskem is trying to improve its green credentials with the construction of renewable PE plants.

Late in 2022, the company said it was evaluating potential locations globally to produce what it calls Green PE, which it makes by dehydrating ethanol to produce renewable ethylene, then processed through traditional PE plants.

($1 = R$5.22)

Front page picture: Braskem’s facilities in Brazil
Source: Braskem

Insight by Jonathan Lopez

Additional reporting by Al Greenwood