The Revival of Previous Up-cycle Unlikely
The author is an analyst of Shinhan Investment Corp. He can be reached at jinmyung.lee93@shinhan.com. -- Ed.
Oil refining and chemicals are typically cyclical industries. The two sectors experienced an up-cycle in 2014-1H18 led by low prices, and have now entered a down-cycle due to the global economic slowdown triggered by US-China trade disputes. Global oil prices have recently tumbled by more than 50% from the peak. Despite the oil price drop, we are unlikely to see the revival of the previous up-cycle. Ultra-low oil prices (USD20-30/bbl) should not be sustained for long. We recommend SKC and S-Oil as our sector top picks.
SKC should see earnings growth pick up steam, driven by: 1) strong earnings growth at KCF Technologies thanks to tight supply of copper foil and capacity additions; and 2) growth of industrial/semiconductor materials businesses on increasing sales share of high value-added IT products, such as MLCC-use films and CMP (chemical mechanical polishing) pads. SKC shares are now down 40% from the peak due to concerns over the global economic slowdown and disruptions in the EV value chain. Earnings momentum remains intact, supported by copper foil and semiconductor materials. We see strong growth potential despite tough market conditions.
S-Oil, being the biggest beneficiary of Saudi Arabia’s OSP cut, is set to deliver steep earnings improvement in 2H20 despite plunging oil prices. Its refining margin is projected to rise USD2.3/bbl YoY in 2020 on the recovery in oil demand, oil price increase, and OSP reduction in 2H20. The decline in HSFO prices should boost lube base oil spread and lift profitability of RUC/ODC operations.
Refining: Refining margin to rebound from 2H20
We forecast oil prices to bounce back from 2H20, on forecasts for: 1) recovery of oil demand once the COVID-19 outbreak subsides; 2) Saudi Arabia and Russia returning to the negotiation table under growing economic burden; and 3) natural reduction in US shale oil production. The effect of the implementation of IMO 2020 rules (low sulfur regulation) should be felt in earnest along with the industries returning to normal operations. We expect refining margin to increase USD2.6/bbl HoH in 2H20and USD1.0/bbl YoY for the whole year. Under IMO’s sulfur cap, the price of HSFO (feedstock for lube base oil) is forecast to slide. The lube base oil spread should also rise with domestic refiners largely focusing on Group II/III base oils that are in high demand.
Chemicals: Caught between hope and fear
Chemical market conditions are expected to remain stagnant, weighed down by falling demand and capacity additions. For 2020, global ethylene demand is projected to grow 1% YoY, while production capacity increases 6% YoY. However, as the steep drop in oil prices leads to lower naphtha prices, domestic NCCs should find opportunities to strengthen their cost competitiveness. In 2019, when oil price stood at USD64/bbl and natural gas at USD2.5/MMBtu, the cost to produce ethylene at NCCs was roughly USD300 higher per ton vs. ECCs. With Brent oil at USD30/bbl, costs to produce ethylene at NCCs should fall to the levels of ethane-cracking centers (ECCs). Amid sluggish demand and supply burden, NCCs should sharpen their edge vs. ECCs as greater cost competitiveness leads to higher capacity utilization rates.