Additional Inventory Valuation Losses Possible
The author is an analyst of NH Investment & Securities. He can be reached at ys.hwang@nhqv.com. -- Ed.
Due to the plunge in international oil prices, large-scale oil inventory valuation losses were likely booked in 1Q20. In 2Q20, sluggish demand is to place pressure on refining and petrochemical firms’ earnings. Looking at the petrochemical industry, however, if low oil prices continue, cost competitiveness should come to the fore, with structural competitiveness strengthening on a likely decline in supply expansion projects.
Expect inventory valuation losses for 1Q20 and weak demand in 2Q20
Affected by the March plunge in international oil prices, refineries likely recognized large-scale inventory valuation losses in 1Q20. If the average WTI oil price in 2Q20 comes in below US$30/bbl, additional inventory valuation losses are possible. We note that: 1) inventory valuation losses at petrochemical companies should be relatively limited; and 2) spreads have expanded on the input of low-priced raw materials. However, amid weak global demand for oil refining and petrochemical products, cost reduction effects are to be limited in 2Q20.
Although the industrial environment is changing rapidly, as LG Chemical (LG Chem), Lotte Chemical (Lotte Chem), and SKC boast prospects for both long-term business growth and improved competitiveness (thanks to low oil prices), they stand as our top picks. As shale gas/oil production becomes difficult amid weak oil prices, the cost competitiveness of petrochemical products is likely to rise, and many global expansion projects may be delayed. In the case of EV rechargeable batteries, while market growth may slow, expansion is ongoing, and the sector’s long-term growth trajectory appears to remain intact thanks to the global top-tier production competitiveness of industry players.
Petrochemical firms’ competitiveness to rise if oil prices remain low
In terms of 2Q20 raw material input costs, both the refining and petrochemical industries should see positive effects. With the OSP having been cut by US$6/bbl (m-m) in April, refining margins should have room to expand. However, due to contractions in both short- and long-term demand, we suggest a Neutral rating for the refining industry. But, we offer a Positive rating on the Petrochemical industry, as: 1) spreads should improve on a significant drop in the price of naphtha (NCCs) versus that of ethane (ECCs) gas; and 2) improved structural competitiveness looks possible thanks to likely widespread delays in global expansion projects.