Alembic Global Advisors

Chemical Industry Reports

US Chemicals: Co-product value declines may buoy pricing

11/10/14 -

US Chemicals – Co-product value declines may buoy pricing

  • History and co-product dynamics not supportive of cited Brent-Ethylene sensitivity
  • We see at most 5c/lb ethylene price declines – not valuation implied 10-15c/lb
  • We rate US ethylene exposed names – DOW, LYB and WLK - Overweight

Summary

An over 20% recent decline in Brent crude oil and naphtha prices has made investors jittery about an equivalent decline in contract ethylene prices with a perception that ethylene prices may decline by 10-15c/lb from current levels. The often cited sensitivity by industry consultants and investors is that a USD10 per bbl decline in Brent crude oil may reduce ethylene pricing by 5c/lb thereby implying a 10c/lb ethylene price decline – something valuations have already baked in according to our analysis. We contend that this sensitivity is overstated and neither finds support in history nor factors in the role of co-product credits in determining ethylene pricing.

From a historical perspective we point to 2006 and 2010 - periods when Brent prices were below current levels but contract US ethylene prices were 6-8c/lb below where they are currently.

In terms of co-product credits we highlight that co-product credits over the last thirty years have accounted for around 70% of naphtha based ethylene raw material and other production costs. Additionally the correlation between Brent oil and co-product prices is very tight (R-squared of 0.82). In the current environment while naphtha based ethylene raw material costs are down 30% from their October 2013 highs co-product credits are actually up 5% for the same time period suggesting an imminent crack in these values. If these values were to decline at the same rate as raw material costs, which have declined by 27c/lb, that would imply co-product credits declining by 22c/lb thereby implying marginal ethylene producer cost of production declining by 5c/lb contrary to the extreme 10-15c/lb decline suggested by industry consultants and investors and baked into current valuation, in our view.  We see limited downside and significant upside to valuations of US ethylene exposed names.

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