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.

  • 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.

Petrochemicals are everywhere — not just in plastic bottles..

, which is processed with colors and additives, then melted, extruded(squeezed) or molded into consumer products.

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.

“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.

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.

At the time of investment, Shell’s Eastern Petrochemicals Complex was the company’s largest-ever downstream investment.

In fact, global demand for PE resin has risen at 4% every year and reached about 99 million tons in 2018.

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

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).

(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.

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?

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

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. — 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.

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 : 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 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.

Source: IHS Markit

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.

Source: Braskem

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.

Producers that sell the cheapest PE will win more market share.

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

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.

Amid the trade war and potential 30% tariffs on U.S. imports into China, Chinese companies are buying less PE from the U.S.

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

In 2018, 88.5% of Lotte’s revenue came from sales of polyolefins.

This is important to note, as PE overcapacity will reach even higher levels in 2020 and 2021.

Source: Lotte corporate presentations and filings

Remember, naphtha is based on crude oil, and higher crude oil prices result in higher naphtha prices.

Source: Macrotrends

Lotte has not provided a detailed breakdown on its usage of naphtha vs ethane feedstock in its other plants.

To mitigate this risk, Lotte is building new plants in Malaysia and the U.S. that will use ethane feedstock.

Source: Lotte corporate presentations and filings
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Petronas Chemicals: better-positioned for era of low PE prices

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.

It also opens up end-markets such as personal care, construction, paints & coatings, electronics, automotive and healthcare.

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.

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.

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.

(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.

The upcoming LNG regasification facility in Pengerang, Pengerang LNG2(Source: Dialog Group corporate presentation)

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 — (partly owned by sister company Petronas Gas). With this, Petronas Chemical can secure long-term prices and feedstock for its new plant.

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

But investors can easily assess which company is better-positioned to ride out the storm.

With applications ranging from clothing, foams, paints, to dyes, petrochemicals are far more than just plastic feedstock, and demand continues to grow.

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.∎

EquitiesTracker is a pioneer in providing technology-driven financial intelligence to Malaysian, Singaporean, and Australian investors.

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