Plastic prices have crashed. How could investors cash in?
While demand for plastic remains strong, resin prices are now at the lowest since 2009. Dragged by unexpected factors, low prices could last another 3–5 years. We dive into Malaysia’s petrochemical sector to identify which company could thrive in this new era
A booming industry…
Plastic production is seen rising 4x between 2020–2050, amid a gold rush into petrochemicals. Despite rising pressure from environmental activists, the world is making more and more plastic. Demand for plastic is growing faster than that for all other major materials, whether it’s steel, aluminum, or cement. Global oil majors from China to the U.S. are building new petrochemical plants, hoping to profit from the world’s growing need for plastic.
…but prices have crashed
While one may think such healthy demand translates to a rosy outlook for plastic, unexpected events have dragged prices to 2009 lows. We think low plastic resin(PE) prices will be “the new normal,” at least for another 3–5 years. In this report, we outline why, and examine the potential impact on Malaysia’s listed PE producers, Lotte Chemical Titan Holding and Petronas Chemicals Group.
In this report, we take a deep dive into:
- An overview of the global market for plastic resins
- Why we think PE prices will stay low
- The impact of falling prices on Malaysia’s listed PE space
Why the world wants more plastic
Described by the United Nations as “a miracle material,” plastic does not rust, is very light, and very durable. Modern plastic was designed to last for hundreds of years without decomposing, and is much cheaper to produce compared to other materials. It is no wonder then that plastic makes up over 15% of today’s cars and 20% of our mobile phones. In fact, 50% of the Boeing Dreamliner is made up of plastic.
The basic form of plastic is a resin, which is processed with colors and additives, then melted, extruded(squeezed) or molded into consumer products.
Polyethylene, also known as PE, is the most popular type of plastic resin. PE itself comes in many forms, but the most common ones are HDPE(High Density Polyethylene), LDPE(Low Density Polyethylene) and LLDPE(Linear Low Density Polyethylene).
Demand for PE is strong…
Due to its irreplaceable features, despite being a relatively new material, plastic has become a critical component of everyday life.
In an earlier report, we highlighted an estimate that shows replacing plastic in consumer products and packaging with other materials — such as paper or glass — would create an additional $400 billion in environmental costs.
Nearly half of all plastic has been made since the year 2000. By 2050, global plastic production is expected to rise 4x.
“Although substantial increases in recycling and efforts to curb single-use plastics take place, especially led by Europe, Japan and Korea, these efforts will be far outweighed by the sharp increase in developing economies of plastic consumption,” according to the International Energy Agency.
..but supply has already gone ahead of demand
Strong demand for plastic should be good news for PE producers. According to news reports, oil companies such as Exxon Mobil and Royal Dutch Shell plan to invest in new petrochemical plants in the coming decades, betting on rising demand for plastics in emerging economies.
In fact, global demand for PE resin has risen at 4% every year and reached about 99 million tons in 2018.
But PE producers have already run ahead of demand, and this has created an oversupply of resin in the market. By 2021, ICIS projects there will be an additional capacity of 19.69 million tons, which will exceed demand by 9 million tons. Most of this capacity growth will be driven by new China-based plants.
Understanding the link between PE and the oil-and-gas industry
Plastics and other petrochemicals are becoming the main driver of oil-and-gas demand growth
By 2020, petrochemicals will be the main driver of oil demand growth. Most of us think oil and gas are mainly used for transport — in petrol or LNG, for example. But because plastic is such a big part of our lives, petrochemicals are now the second-biggest market for oil and gas. In fact, the global petrochemical industry took up 12% of all oil demand in 2017.
The PE industry is heavily tied to the oil-and-gas industry. Some PE manufacturers, like Petronas Chemicals Group, are also linked to oil producers on the group level (Petroliam Nasional).
Petrochemical ethylene is the base ingredient for PE
The base ingredient of PE resin is ethylene, a petrochemical. (Recall that PE stands for polyethylene). Ethylene is made from either naphtha, a crude oil-based product, or ethane, a natural gas liquid.
Some ethylene plants can process ethane, some can only process naphtha, and some can process both.
For ethylene producers, the price of either naphtha and ethane is very important. This is because feedstock makes up 60%-70% of the cost to manufacture petrochemicals.
Ethane is typically cheaper than naphtha as it is made from natural gas, and natural gas is cheaper than crude oil. Why?
Natural gas is a by-product of an oil production facility. In the past, oil companies would even burn off natural gas in a process known as flaring, as building an additional storage and processing facility would incur additional capital expenditure costs. At other times, natural gas would be used to power turbines on the facility, creating energy. Hence, oil companies view natural gas as a byproduct of the production process, and tend to sell it cheaply.
Two wars: why PE prices will stay low
A series of unexpected events
It takes up to five years to take a new petrochemical plant from planning to construction, to start-up. Constructing a new petrochemical plant is a big decision to make, as a plant is very expensive to build. Industry players usually base their planning and decisions on long-term forecasts of supply and demand — not on market volatility or geopolitical events, such as the U.S.-China trade war, which are very hard to predict. Hence, it’s possible that major and unexpected events can seriously affect the outlook for PE prices — and they have.
Unexpected event 1: price war sparked by the shale revolution
By injecting water, sand and chemicals into the ground, shale rock can be cracked and fractured to release oil and gas. This technology is known as “fracking”: a combination of “crack” and “fracture.”
Fracking shale created a whole new industry in the U.S. as many companies rushed to find — and found — huge gas reserves across the country. Some players became concerned that with so much gas in the market, the price of gas would drop.
By 2009, the industry had shifted its attention to finding and extracting shale oil. As more and more shale oil reserves were found, U.S. oil production shot up.
The U.S. became the world’s biggest oil producer in 2012. With so much additional oil in the market, oil prices have fallen by almost 50% since then.
In the early 2000s, ethane-based ethylene was preferred as a feedstock for plastic resin, because gas was much cheaper than crude oil. This, in turn, was due to new technology in the shale gas industry which made it cheap to produce gas from shale rock. Hence, there was a lot of gas in the market.
In 2014–2015, the boom in US shale oil production caused oil prices to crash. As a result, the price of naphtha-based ethylene fell.
Suddenly, naphtha-based ethylene became an attractive alternative to ethane-based ethylene. Since then, the gap between the price of ethane and naphtha has narrowed a lot.
At the same time, due to the boom in US oil-and-gas production, there was now an oversupply of PE feedstock. Recall that a lot of oil and gas production actually flows to PE producers.
As there is now an oversupply of PE feedstock, it is cheaper to produce PE. Producers that sell the cheapest PE will win more market share.
Many PE manufacturers are part of oil-and-gas companies, and they will make and sell their products even if PE prices drop more. This has created a price war in the global PE market, as manufacturers race to win market share.
Unexpected event 2: The U.S.-China trade war has disrupted the global PE market
As part of China’s strategy to improve its self-sufficiency, it has been growing its local PE manufacturing capacity. Globally, China is the biggest consumer of PE. But it is buying less and less PE from other countries.
Both China’s private and state-controlled companies are building up large, new PE factories around the country. That takes out an important source of demand for international PE producers.
Amid the trade war and potential 30% tariffs on U.S. imports into China, Chinese companies are buying less PE from the U.S. To make up for the loss, U.S. producers are shipping their PE to other export markets.
Recall that there are other global PE producers that have already built additional capacity, or are in the process of building additional capacity. With all these factors at play, there will be an oversupply of PE resin in the international market.
Lotte Chemical Titan Holding: falling PE prices pose a big risk
Company makes almost all its revenue from sales of PP and PE
Lotte Chemical Titan Holding makes most of its revenue from sales of polyolefins(PP and PE). In 2018, 88.5% of Lotte’s revenue came from sales of polyolefins.
This means Lotte is heavily exposed to the drop in PE prices. This is important to note, as PE overcapacity will reach even higher levels in 2020 and 2021.
Lotte’s dependence on naphtha exposes it to rising crude oil prices
Lotte’s Malaysian operations currently rely heavily on naphtha, which exposes it to any rise in crude oil prices. Remember, naphtha is based on crude oil, and higher crude oil prices result in higher naphtha prices.
Lotte has not provided a detailed breakdown on its usage of naphtha vs ethane feedstock in its other plants. However, the group has repeatedly highlighted naphtha-based feedstock as a key cost and risk.
To mitigate this risk, Lotte is building new plants in Malaysia and the U.S. that will use ethane feedstock.
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Petronas Chemicals: better-positioned for era of low PE prices
Petronas Chemicals has a more diversified revenue stream
Compared to Lotte, Petronas Chemicals Group is less exposed to the drop in plastic resin prices, as it is also involved in the Fertilisers and Methanol(F&M) business. This gives it a distinct advantage over petrochemical players focused entirely on PE and Olefins and Derivatives(O&D), the product segment for plastic resins.
In 2018, Petronas Chemicals earned 62% of its revenue from O&D, while the remaining 38% was from F&M. Every year, Petronas Chemicals produces 3.9 million tonnes of O&D and 6.5 million tonnes of F&M.
Petronas Chemicals’ acquisition of Netherlands-based Da Vinci Group B.V. in May 2019 has given it an additional foothold in the derivatives and specialty chemicals business. It also opens up end-markets such as personal care, construction, paints & coatings, electronics, automotive and healthcare.
As the PE price war rages on, Petronas Chemicals will likely focus on F&M
The global F&M market is expected to grow at 3.8% CAGR between 2019 to 2024, according to research firm Mordor Intelligence. This, in turn, is driven by rising demand for food products, as well as declining area of “arable” land — land that can be used to grow crops.
Over the past 40 years, the world has lost over 33% of high-quality food-producing land, due to erosion and pollution. At the same time, demand for food is expected to grow 50% between 2019 and 2050, driven by the growth of developing countries. Fertilizers will be a critical part of our future as they play an important role in helping raise the output of arable land.
Petronas Chemicals enjoys higher profitability in the F&M segment. While there is an RM4.9 billion gap between revenue generated in the O&D and F&M segment, the EBITDA between both segments only differs by about RM1 billion. Given the higher profitability of F&M, Petronas is likely to focus in this segment, waiting out the PE mismatch in demand and supply.
Petronas Chemicals has very little exposure to naphtha
Petronas Chemicals’ main source of feedstock is methane, which is derived from natural gas(obtained from sister company Petronas Gas Berhad and other suppliers). 97% of Petronas Chemicals’ feedstock is methane — and the remaining 3% is made up of ethane, propane, butane and heavy naphtha.
This makes Petronas Chemicals pretty well insulated in event of rising oil prices, compared to any other petrochemical manufacturer that relies heavily on naphtha feedstock — such as Lotte.
A direct link to the gas well
Gas is normally sold in long-term contracts, which locks prices for a much longer period of time — often 15–25 years. This compares to spot and futures contracts for crude oil, which can expire in a matter of months.
Petronas Chemical’s upcoming plant in the Pengerang Integrated Complex — also its largest — will allow it to tap into the nearby LNG regasification facility(partly owned by sister company Petronas Gas). With this, Petronas Chemical can secure long-term prices and feedstock for its new plant.
In contrast, Lotte Chemical Titan’s Tanjung Langsat plant does not have a regasification terminal. Even if Lotte decides to reconfigure its plant to process ethane or methane, it would still be at a disadvantage.
In the era of low PE prices, investors should go beyond plastic
Both Lotte Chemical Titan and Petronas Chemicals can’t escape the era of low PE prices. But investors can easily assess which company is better-positioned to ride out the storm.
Amid the gloomy outlook for PE, investors should look for petrochemical players with exposure to other end-markets. With applications ranging from clothing, foams, paints, to dyes, petrochemicals are far more than just plastic feedstock, and demand continues to grow.
While Lotte Chemical Titan is heavily reliant on the polyolefins and O&D markets, Petronas Chemicals has the distinct advantage of being involved in the F&M business. This more diversified revenue stream acts as a hedge against falling PE prices, in our view.
If it maintains its high plant utilization rates and strategic feedstock supply, Petronas Chemicals could thrive even before PE markets rebalance.∎