Sector Top Pick: Hanwha Solutions
The author is an analyst of NH Securities and Investment. He can be reached at yk.choi@nhqv.com. -- Ed.
Amid the arising of supply issues, oil refining/chemical industry trends this year have been differing by region. Northeast Asia has been experiencing oversupply due to both large-scale expansion of petrochemical facilities and China’s increasing of its petroleum product exports. Meanwhile, the US and Europe have been suffering product supply disruptions due to energy shortages caused by the Russia-Ukraine war. As a result, the gaps between refining margins and petrochemical product prices have widened between the US, Europe, and Asia.
In 2023, with Chinese demand expected to rise gradually, the demand-supply balance in Northeast Asia's oil refining/chemical industry (which has been worsened due to China-induced oversupply) should improve step by step. However, with demand uncertainties in play as China could alter its policy stance, we suggest an investment strategy for 2023 which focuses upon companies with large new growth businesses portions. Such players should see valuations re-rating once solid demand is confirmed.
We present Hanwha Solutions as our top pick for the sector, drawing attention to the widening renewable energy business portion among its overall sales. Moving ahead, we expect the firm to benefit from the mid/long-term growth of the US solar market, backed by policy support (including the IRA bill). Based upon likely further solid demand, regional differentiation in solar module prices is expected to continue in 2023.
I. Refining: Supply-demand balance to remain tight in 2023
With a tight supply-demand balance likely to continue in 2023, oil prices should remain lofty. Compared to the higher oil price level, investment by oil companies has not upped significantly, and US control over oil prices appears to be weakening. Continued efforts to limit the extent of oil price hikes are expected to act as a factor that strengthens downward rigidity in oil prices. In 2023, since oil demand growth and refinery expansion volume are similar, supply is unlikely to grow notably. Inventory shortages, especially for kerosene/diesel, remain in play.
II. Refining: See factors that should help improve supply-demand balance in Asia
As China’s oil product exports have pushed up supply in the region, refining margins in Asia are particularly low compared to refining margins in the US and Europe. However, the breakout of the Russia-Ukraine war has altered oil import and export routes between countries. Europe needs to diversify its energy sources away from Russia. The urgency of such is expected to be further strengthened by import regulations on Russian oil products this winter. With energy dependence upon Asia amplifying, we believe that the supply burden issues which have been suppressing refining margins in the region will ease going forward.
III. Petrochemicals: Time to bottom out
We expect the petrochemical industry to bottom out in 2023. As demand is slowing, especially in the US and Europe, the current global supply-demand balance is likely to remain unchanged for the most part. But, given likely higher demand from China (the country which has the strongest influence upon demand), we forecast that the supply-demand balance in Northeast Asia will come to show signs of a gradual recovery. However, considering predictions that oil prices will stay high in 2023, demand is vulnerable to fluctuating according to Chinese policy changes, and supply issue burdens remain a factor. Given this backdrop, the extent of improvement in the industry will likely be limited next year.
IV. Top picks
We maintain a Positive stance toward the refining and petrochemical industry. In 2023, the Northeast Asia demand-supply balance (which has been suppressed by China-induced oversupply) is expected to show a gradual improvement trend. However, rather than focus on limited spread improvement due to differentiated supply-demand balance among regions, we draw investor attention to players that have new businesses with clear market growth potential, believing that they will come to enjoy valuation re-ratings. We present Hanwha Solutions as our sector top pick, anticipating that its EV will strengthen in line with higher operating profit contributions from its renewable energy business.