Date February 2017
Approximate net recovery on cost
- At the end of 2016, prices for all major commodity resins were higher than the previous year, although there was a decline in pricing for three of the four major grades at the end of the year
- Exports account for an increasing percentage of industry revenue, but growth is hampered by the strengthening dollar
- Total U.S. output of plastics products increased in each of the past three years. Helped by lower resin prices, processors have remained profitable
By the numbers
Resin prices falling: Among the resins and plastics commonly used in industrial manufacturing operations are High Density Polyethylene (“HDPE”), Low Density Polyethylene (“LDPE”), Linear Low Density Polyethylene (“LLDPE”), and Polyethylene Terephthalate (“PET”). During the last three months of 2016 (October 2016 to December 2016), large buyer contract prices for HDPE, LDPE, and LLDPE decreased slightly while prices for PET ticked up. These trends are in line with fluctuating fossil fuels prices during this time period.
Crude oil, coal, and natural gas are used to produce the primary feedstocks for plastics: ethylene, propane, propylene, butadiene, benzene, and xylene. Feedstocks can comprise 60 to 70 percent of petrochemical manufacturing costs, making their cost a significant factor in resin pricing. During the past year, oil and natural gas both posted price increases.
Shale gas creating competitive advantage for U.S. plastics: Perhaps more than any other factor during the last decade, the explosion of fracking has changed the global economics for plastics. Fracking now generates more than half of the U.S. output of natural gas. When liquids from natural gas are refined, ethane comprises approximately one-third of the resulting volume. Ethane is used almost exclusively to make ethylene which, depending on the process used, can be used to produce about 75 percent of all plastic (except polypropylene). Fracking has been so productive that it has created an oversupply of natural gas and ethane. At the same time, falling oil prices have increased the competitiveness of the petroleum-based alternative naphtha. Together, these conditions have pushed ethane prices down to levels not seen for decades to more than 70 percent below their peak. As a result, the U.S. became an exporter of ethane in 2014. Before the shale gas revolution, the Middle East was the low cost plastics producer in the world.
Many investments focus on export opportunities: This shift in global economics of plastic production is shifting investment to the Gulf of Mexico and other U.S. ports where many new, large derivatives production projects are planned. This recent shift to cheap natural gas has attracted billions of dollars in investments to U.S. chemical manufacturing, intensifying production along with the export of plastics and resins. Net U.S. plastic resin exports are expected to triple from 2014 to 2030, increasing from $6.5 billion to $21.5 billion, according to a report from the American Chemistry Council and Nexant Consulting. One place getting ready for the growth is the Port of Houston, which is making massive investments to improve its capabilities. Those efforts are paying off. In September 2016, LyondellBasell, one of the world’s largest plastics, chemical, and refining companies, selected its La Porte, Texas manufacturing complex as the site for a new HDPE plant, located on the Houston Ship Channel.
Resin forecast mixed: In 2017, polyethylene resin prices will continue to mirror those of crude oil, natural gas and other primary inputs, which are expected to increase slightly. Demand for polyethylene resins is expected to grow by an average of 5 percent over the next four years (2017-2020). Furthermore, polyolefin market size is expected to increase from $206.8 billion in 2015 to $297.1 billion by 2021. Exports of both finished plastic resin as well as ethane feedstocks will absorb some of the production volume.
Industry capacity utilization operating rates are forecast to increase to around 94 to 95 percent, which will help the profitability of finished plastic resin. Plastics not impacted by shale gas production, such as polystyrene, PET, and nylon, will be less impacted by oversupply issues, and pricing may be reactive to near-term economic factors. Abnormally low fossil fuel prices mean that polyethylene and polypropylene will likely remain oversupplied for at least the 2016 to 2020 period, restricting pricing but in turn opening up export plays.
While the potential for China to enter the field with increased use of coal to produce methane gas, methanol, ethylene, and polypropylene is a risk, the environmental issues related to coal production and weakness in the Chinese economy overall appear to dampen this possibility. That being said, the current state of the steel market and downsizing of the steel industry in China may leave coal producers with a desire to find alternative uses for their product.
Resin recoveries typically strong with exceptions: While resin inventories typically provide a strong recovery in liquidation, lenders must keep in mind several caveats. Uncolored virgin resins, with no additives, are essentially commodity-like inventories that, in proper quantities, would be readily salable in liquidation at very low levels of discount off market. This type of resin would need a short marketing period to sell.
Once resin is colored, however, its utility to anyone other than the intended customer diminishes precipitously. Likewise, as various additives such as flow inhibitors, UV stabilizers, biocides, and other products are added to resins, the end-use and potential pool of buyers shrinks quickly. Resins such as these are readily marketable, but they may only generate scrap proceeds and would be sold as secondary surplus product to a formulator interested in blending the product with other resins to produce a particular product. Colored resins can typically be mixed to make darker colors but have little other color possibilities.
With the exception of thermoset resin, resin scrap is commonly reprocessed and used again. Many companies stock and reprocess scrap themselves in either flake or pelletized form. The value of these products and their recovery as a percentage of cost will vary tremendously by grade, color, and form. This recovery percentage would also be dependent on the costing methodology applied to these reprocessed inventory items. In addition, lenders should be aware that “resin” inventories may contain non-resin items such as colorants, performance additives, or other non-resin inventory. Thus, while the resin inventory category is something that should indicate a strong recovery on its surface, due care and diligence should be exercised before applying an advance rate for this type of inventory.
Inventory costing and mark-to-market reserves: When a company’s inventory contains commodity-type items, like resins, which are subject to frequent price fluctuations, it is imperative to understand the company’s inventory costing methodology. A standard cost approach includes updating inventory costs periodically and, depending on the frequency of the update, can result in the company’s reported cost varying from the market in an inflationary or deflationary environment. A rolling weighted cost approach utilizes an average weighted cost for each purchased item that equates to a rolling perpetual average. This methodology is useful for commodity-type items as a company’s reported cost will remain closer in line with the market, although it will still trail market prices by a set period. Given the volatility in the resin market, lenders should be aware of the target company’s costing methods and should consider incorporating a mark-to-market or lower of cost or market reserve. This type of reserve will adjust the cost basis to market and ensure that an advance rate based on a percentage of cost remains relevant even in a volatile market.