Alembic Global Advisors

Chemical Industry Reports

US Chemicals: Ethylene exposed names may be oversold

12/08/14 -

US Chemicals – Ethylene exposed names may be oversold

  • Valuations baking in as much a 15c/lb y-o-y ethylene margin compression in 2015
  • Co-products, regression analysis, and ethane point to at most declines of 0.5-12c/lb
  • US ethylene exposed names oversold; we rate DOW, LYB and WLK Overweight

Summary

The recent USD30 per bbl selloff in crude oil prices has resulted in industry participants looking for as much as a 15c/lb y-o-y margin compression for US ethane based ethylene in 2015 with valuations for US ethylene exposed names already discounting such a move down in margins. Our analysis suggests that this figure may prove to be too high and we expect at most a 12c/lb y-o-y margin compression and as little as a 0.5c/lb compression in 2015.

First and foremost we believe market participants looking for a 15c/lb y-o-y margin compression are ignoring the fact that ethylene prices have averaged 49c/lb year-to-date in 2014 while ethane prices have averaged 27c/gal. If the current ethylene and ethane price regime were to persist through 2015 the y-o-y margin compression would be an insignificant 0.5c/lb – lower ethylene prices being a 3.5c/lb headwind while lower ethane costs a 3c/lb tailwind. Additionally analyzing the Brent crude oil-US contract ethylene price regression equation over 24 years of monthly history points to ethylene prices declining by 8c/lb from 2014 averages in a USD70 per bbl Brent crude oil price environment. This in-turn would imply a 5c/lb y-o-y ethylene margin compression once one factors in a 3c/lb lower ethane cost related margin tailwind. Finally factoring in a decline in co-product credits in-line with the recent decline in crude oil prices would imply a 5c/lb decline in ethylene prices from 2014 averages or a 2c/lb y-o-y ethylene margin compression when again factoring in the margin tailwind provided by lower ethane costs.  

Barring another leg down in oil prices we believe valuations for US ethylene exposed names are already baking in a worst case margin scenario suggesting limited downside and significant upside.  

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