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Q4 2016 / Q1 2017 Market Update

1/12/2017

Import and export trends have shifted dramatically over the past two to three years, narrowing the supply/demand balance here in the US. Record exports from the US gulf, coupled with decreased imports from Europe and China, has allowed the domestic producer to push pricing higher here in the US. One of the key reasons US producers are able to export upwards of 30% of caustic soda production is because of the “energy play.” For example, natural gas priced at $3.00/ MMBtu multiplied by a set constant of approximately (6) yields the equivalent oil price which in this case is $18.00 / barrel oil. With oil at $45-$60 per barrel globally (equivalent to $7.5 – 10 per mmbtu natural gas using the algorithm above in reverse), and with most Asian and European producers of chlor-alkali using oil derivatives such as naphtha and/or coal for energy, the U.S. has the ability to compete on a worldwide basis.

China, Europe and the Middle East all produce chlorine derivatives for domestic consumption and/or export and they must weigh their energy cost against the U.S. when contemplating production rates. When a producer exports a given derivative they are fundamentally exporting energy. Simply put, we’re able to compete and ship low cost derivatives and play in markets historically supplied by closer geographical regions than in the past decade. Do the math --- a $4.50 to $7.00 per mmbtu energy advantage equates to $135 to $210 per ECU energy advantage. And this doesn’t even take into account the other part of the “energy play,” ethylene. Ethane (which is a coproduct found in natural gas) is in abundance in the US. With ethylene in the US being nearly 80% ethane-based, and with new ethylene cracking coming online in the next twelve months, the US will be lowest cost producer on numerous fronts related to ECU’s and ethylene derivatives i.e. EDC, VCM, and PVC. We are exporting derivatives to regions we have 'ignored' for years due to the freight disadvantage. We don’t want to make the mistake of looking strictly at caustic soda, we must look at chlorine derivatives as well.

Historically, commodity caustic soda on a domestic market basis once witnessed in ‘simple’ terms about 1,000,000/dst imported collectively to the East and West Coasts. In the past, U.S. exports would total about 2,000,000/ dst to favorable regions (South America) based on freight costs around the world. This pattern no longer holds true. The U.S is now on pace to export close to 3,500,000/ dst annually and import as ‘little’ as 500,000/ dst per year. Both price and volume of Asian imports to the west coast have been stable for last 6-12 months’ but recently, due to lack of availability ex-China, the price is now beginning to rise quickly and numerous distributors have price nominations on the table for Q1 2017. China has all but disappeared from supplying this geography as their domestic demand has grown due to Chinese alumina demand. Korea and South American countries have been filling the Chinese void but at much higher prices. It’s entirely possible U.S. Chlor-alkali producers are considering supplying a portion of west coast demand as increasing market prices make the fob USGC prices reasonable.

A similar phenomenon is occurring on the US East coast which historically has been supplied by the Europeans. So far, in 2016, volume imported to the USEC has fallen from historical annual levels of ~ 500,000/ dst annually to a pace which may conclude at less than half that volume for 2016 when all is said and done. The downturn in European imports can be attributed to higher energy costs (petroleum / as outlined earlier in this post) as well as a concerted effort to shut down aging Mercury Cell technology due to the BREF document. Not all producers will convert mercury cell plants to membrane caustic plants, some will elect to shut down capacity entirely or switch to Potassium Hydroxide production. Total Mercury Cell production capacity that will be rationalized or converted to KOH could be as high as 1,500,000 dst annually.

So, with U.S. producers stepping up to replace the European supply shortfall, increased exports as explained above and with U.S. producer capacity shut downs of about 400-500,000/ dst in the past twelve months, the supply/demand balance in the USGC has tightened considerably and forced caustic soda prices up. Most if not all producers supplying the East Coast supply it from the gulf with net backs which exceed current export prices. Exports will not dry up by any means but the delta between export and domestic barge prices will be much smaller than in the past. Currently, Formosa is the largest shipper of USGC material to the East Coast from a producer stand point followed by Olin.

It is my belief that “CONSOLIDATION” of producers has dramatically changed the dynamics of the chlor-alkali market and pricing momentum has clearly swung their way. The ability to balance excess inventory with export parcels due to the USGC energy advantage has given the USGC producer a strong “outlet" away from domestic only sales. I would argue that the market performance over the period 2013 through early 2015 proves my point. If you would have told me that the following were to occur:

  • Sluggish economic growth for at least 2 of 4 quarters each year
  • Major producer divesting its chlor-alkali enterprise (and keeping market share high to dress up the business)
  • Disruptive change to distribution landscape with several distributors attempting to grab vacated share
  • Several new chunks of capacity coming online (Oxy, Westlake, Dow-Mitsui)

I would have told you that the caustic market would have descended to double digits. The fact is, it declined but not in a cataclysmic fashion. Why? Because the low-cost US industry was able to export what it couldn’t move domestically.

That was then and we are now transitioning into a new phase. We’ve seen PPG and Georgia Gulf become Axiall and eventually become Westlake. Dow and Olin are now Olin. BCS became Univar and KA Steel became Olin. These changes are massive and quite dynamic.

Bullet Points (4th Qtr)

Today, we are down to (5) major producers all with the ability to export. ALL WITH OPTIONS!

  • Overall production in the US is higher than in 2015 but export demand is greater and imports have decreased dramatically.   This means that inventory imbalances have declined dramatically.
  • Westlake had a Force Majeure outage in Calvert City, Ky. but is now up to full capacity.  However, that downtime had a large negative impact on inventories.
  • Currently export prices are moving upward well above the $360/ dst fob USG with many nominations as high as $370-$380/dst.
  • Chlorine rates should continue to decline in December due to seasonality of some products such as bleach, further curtailing production rates.
  • Exports will continue at record rates giving domestic producers price discipline with shipping options.
  • The 4th quarter domestic maintenance issues [planned and unplanned] have equated to close to 150,000 tons, or 10% of capacity.  This involves Olin-Plaquemine, La., Oxy- Geismar, La., Westlake- Natrium, WV., Bayer- Baytown, Tx., Formosa-Point Comfort, Tx., Olin-Charleston, Tn, as well as Olin-St. Gabriel, La.
  • Rationalization of capacity may continue into 2017 further tightening the market- this could be anywhere from 500,000 to 650,000 tons.

Today going in to 2017

RFQ Season has concluded and operating rates will be ticking up faster than most are forecasting in Q1 2017. Most outages have ended and minor issues still exist with a couple producers. We are entering into what appears to be a strong recovery in housing and therefore vinyl demand should improve as we head into Q1. Bleach season will begin in April for several geographic regions. Most producers seem to be poised to continue to export incremental supply primarily due to the strong export market demand (alumina). One very large domestic producer has shown strong aggression with the domestic market RFQ season and in some instances has taken business at sub-export economics. It’s not often this phenomenon occurs where export prices are considerably higher than the domestic market. Typically, the export market is your ‘dumping’ ground to stabilize your backyard or domestic market.

If producers can maintain the edge on energy costs, the U.S. will continue to grow exports. We believe there is a sense of stability to the market or at least a temporary ‘peaking’ but after (28) quarters in a row of attempted increases it is not easy to forecast, as there are many puts and takes in the equation

  • Shintech -coming on with new capacity estimated 100,000 dst
  • Bleach season? Higher rates?
  • Housing strength-seasonal uptick for Cl2
  • Consolidation synergies- will producers see the benefits?
  • Plant closure(s)-possibility
  • Supply West Coast from gulf or the traditional Asian producer?
  • Indexing-always a crap shoot

Because of the complexity, a buyer’s best bet is to align with a winning producer and/or its channel partner of choice. OWI will be here…