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Crude oil price surge helps U.S. chemical makers

Cheap natural gas is giving U.S. chemical companies an edge over European rivals, many of which are increasingly anxious about soaring crude oil prices resulting from uprisings in the Middle East.

That edge should lift 2011 margins and earnings at Dow Chemical Co., Westlake Chemical Corp., LyondellBasell Industries NV and other American-based commodity chemical producers.

Large-scale exploitation of shale formations in the United States has driven down natural gas prices by 12 percent in the past year, highlighting the growing disconnect between the costs of crude oil and natural gas.

Both natural gas and crude are used to make ethylene, propylene and other basic chemicals. They in turn are used to produce swimming pool liners, pantyhose, diapers and other common products.

Brent crude prices have jumped 46 percent in the same time period—and 17 percent in the last month alone—as democratic revolts have rippled across the Middle East, causing supply concerns among Europe's chemical leaders, including Lanxess AG and BASF AG.

Europe has not developed its natural gas shale formations, partly because of regulatory and environmental resistance, effectively handing U.S. chemical producers a global advantage. Most of Europe's chemical producers use crude oil-derived naphtha to make the building blocks for common plastics.

Chemical prices are set globally by naphtha-based producers. That lets Dow and its peers charge the higher industry price and bank the margins from using cheap natural gas.

The consensus among industry executives, academics and many on Wall Street is that North American natural gas will stay cheap for some time, largely due to a supply glut.

That should help Dow, LyondellBasell and Westlake beat Wall Street's first-quarter earnings estimates by at least 3 percent, according to StarMine SmartEstimates.

Natural gas prices were sitting near $3.90 US per million British thermal units this week. A year ago natural gas cost $4.40 per mmBtu.

Prices for Brent, a crude oil popular in Europe, were trading around $113 per barrel on Friday.

"Rising crude oil prices mean the cost of production will rise for the 60 percent of the global chemical market that relies on crude oil as a raw material, while the U.S. guys will not" see that kind of increase, Alembic Global Advisors analyst Hassan Ahmed said.

"This scenario could also lead to higher earnings, and in turn, share price performance for the U.S.-based commodity chemical producers."

Even with the natural gas cost advantage, Dow, LyondellBasell and Westlake are not immune to the Middle East turmoil. All three are also heavy crude users, and Dow and LyondellBasell have large European footprints.

Dow, which has long been concerned by the fluctuations in natural gas prices, is also looking to get out of the commodity plastics business to focus exclusively on specialty chemicals, which tend to have more stable pricing.

Yet the immense North American networks all three currently have give them a distinct advantage over global rivals. Commodity chemical demand is moving from a trough in 2008 to an expected peak around 2013.

That explains Wall Street's heightened interest in North American commodity chemical makers. The cheap natural gas and Middle East uncertainty only help.

During the fourth quarter, LyondellBasell was the No. 2 new holding by dollar value among large equity hedge funds, behind only General Motors Co.

Styron, a plastics maker that Dow sold last year to Bain Capital, is considering an initial public offering, partly to take advantage of the commodity chemical sector improvement and cheap natural gas.


Inside chemical plants, natural gas is stripped down into ethane, which can be used to make ethylene.

Roughly 65 percent of the ethylene produced in the United States is made from natural gas and related products, according to the American Chemistry Council.

By comparison, European and Asian rivals use naphtha to make 70 percent of their ethylene, according to council data.

The U.S. petrochemical industry becomes more competitive versus its peers when the price ratio between crude oil and natural gas is greater than 7 to 1, according to the council.

Currently, the ratio is 27 to 1.

"We expect a growing abundance of natural gas and natural gas liquids from shale gas drilling in North America to sustain the cost advantage that ethane-based ethylene production has over naphtha-based ethylene production," Westlake Chemical Chief Executive Albert Chao told investors last month.

Alembic Global's Ahmed estimates that for every $10 per barrel rise in the price of crude, U.S. ethylene margins increase by about $120 per ton, roughly 5 cents per pound.

That's money the chemical industry can take to the bank, or pass on to their shareholders.

In the past year, shares of LyondellBasell are up 49 percent, shares of Dow have risen 27 percent and shares of Westlake have more than doubled.

"I think that dynamic is a new dynamic," Dow Chief Executive Andrew Liveris said of North American shale gas last month. "It will unfold." CTV Two CTV News CTV News Channel BNN - Business News Network CP24