While it is always tempting to upgrade a stock or a sector when ones competitors are finally throwing in the towel, it is too early to call for US ethylene. The two most exposed ethylene stocks, LYB and WLK, have had a terrible run and are now both trading below our normalized value, but we are still not ready to change our bearish view.
All things being equal, at $70 Brent, European ethylene economics should normalize at around $930 per metric ton cash cost of ethylene (which is around 42 cents per pound) – see Exhibit. To move US ethylene into Europe as derivatives, we would need a US price lower than that – by 4-5 cents for PVC and by 7-8 cents for polyethylene. If US ethylene settles at 40 cents on average and derivatives fall in line we would be looking at a 15 cents per pound decline in margins versus 2014. This is roughly a $3.25 per share drop in earnings for LYB and $3.50 for WLK, versus 2014 with LYB possibly getting some offset from Europe. LYB looks fairly valued on this basis today and WLK still looks expensive.
But…the world is short of propylene and butadiene. These are major co-products for European ethylene producers and much less so for US producers these days given the strong ethane feedstock bias. If propylene and butadiene prices remain robust – well above ethylene prices, these will provide a more significant cost offset in Europe and Asia as oil/naphtha prices fall, reducing the effective cost of making ethylene. For every $100 per ton propylene and butadiene remain above “normal”, the cost of making ethylene falls by $70 per ton on a standard naphtha unit.
The risk to buying LYB and WLK today is that the markets for propylene and butadiene globally remain strong, increasing the co-product credits for both and lowering the cost of making ethylene in Europe and Asia further. This lowers break-even pricing and US margins further.
This is a complex subject – please contact us directly for more details.