Return of NCCs after 20 Years
The author is an analyst of NH Investment & Securities. He can be reached at ys.hwang@nhqv.com. -- Ed.
WTI drops below US$15/bbl
Falling oil prices mean more than just cost savings for Korean petrochemical players. Specifically, as NCCs now boast higher cost competitiveness than ECCs, their valuations are set to recover and their structural competitiveness should strengthen on a decline in capacity expansion projects.
WTI price at lowest level since 1999
WTI futures prices for May fell below US$15/bbl yesterday, the lowest level since 1999, while Saudi Aramco’s May official selling price (OSP) came in at -US$7.2/bbl, the lowest level ever. Such developments demonstrate the seriousness of the global oil oversupply situation, despite the recent output reduction agreement made by OPEC+. Volatility in oil prices and capacity utilization will likely hinge upon oil storage capacity by region and the size of product storage tanks at refineries.
Petrochemical companies’ structural competitiveness to strengthen
The benefits being experienced by NCCs are exceeding those felt during the low oil price trend in 2015. In 2015, an expansion of shale gas/oil production in the US led to a drop in oil prices, and the cost competitiveness of ECCs fell. The only benefit experienced by NCC players was a reduction in the cost gap with ECCs. However, regarding the recent fall in oil prices, shale gas/oil production is projected to decrease, which should significantly improve NCC’s cost competitiveness.
When shale gas/oil production declines, ethane gas production also falls, a development that causes the cost of raw materials for gas crackers (ECCs) to skyrocket. If naphtha prices remain below US$200/ton, a surge in ethane gas prices is likely to lead to an unprecedented situation where productions costs are lower at NCCs than at US gas crackers.
Return of NCCs after 20 years
Utilization rates at chemical facilities have fallen due to a sharp drop in global demand, and there is no evidence of an ethane supply shortage. However, if demand for products normalizes and ethane supply continues to slide, the price of ethane will rise sharply, and spreads for domestic petrochemical products will expand. In this case, NCC players’ share prices should enjoy re-rating and their valuation gap with ECC firms will narrow.
With NCC’s competitiveness set to strengthen on a naphtha price plunge, we recommend paying attention to the growth potential of companies that own or plan to expand their NCC capacity. LG Chemical and Lotte Chemical are constructing NCC facilities of 800,000 tons and 750,000 tons, respectively, with both planning to start operations in 2021. On the other hand, the construction of global gas crackers is likely to be postponed or canceled. Accordingly, capacity expansion for ethylene is expected to decrease significantly (vs initial plans). We present LG Chemical, Lotte Chemical, and SKC as our top picks, and we also recommend KPIC as NCC-related beneficiaries.