Commodity Chemicals – It’s Not Just About Crude – It’s a Gas!

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For the last 12 months – since the significant slide in crude oil – several US commodity chemical companies have effectively traded as a proxy to crude. For months, if crude has gone up then so has LYB, and to a lesser extent DOW, WLK and EMN. If crude has gone down, then the stocks have gone down also.

But it is not crude oil that gives the US its competitive advantage in ethylene, it is the difference between crude oil and US natural gas pricing that matters. Yesterday crude prices were down just over 2% and LYB was down just under 2%. US natural gas was down just under 10% and this is by far the more important driver of profitability for LYB, WLK and DOW as it drives down power prices and ethane feedstock prices. Natural gas has been relatively stable for most of 2015, hovering in the $3.00 per MMBTU range from January through August – today it is hovering just over $2.00 per MMBTU and looks very weak, given the mild weather and the very high inventories. The harsh winter of 2013/2014 hid the increase in US natural gas production from 2013 to 2014 as inventories were so low coming out of the winter that the rapid accumulation of inventories in 2014 only restored summer inventories to a “normal level”. Since that time, and despite much stronger demand in the US, gas inventories have crept up to historic norms and above – today at a 5 year seasonally adjusted high – see exhibit.

More mild weather could drive inventories higher and prices a lot lower over the next few weeks (especially if we run out of cavern space) and provide a possible November/December boost for US ethylene producers focused on ethane feed.

Fourth quarter estimates have started to slide for LYB and DOW following recent earnings announcements and guidance. Recent weakness in LYB could provide an interesting trading entry point if natural gas prices take another step down as we believe that guidance and estimates reflect the recent negative slope in the chart below, not the very recent bounce back. Ethane could drop by 25-40% (depending on the level of oversupply), adding as much as 2-4 cents per pound to ethylene margins – roughly 10-15 cents per share for LYB and WLK in Q4 2015 (assuming a 2 month benefit).

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