The Asian petrochemical industry is likely heading for a better 2024. High oil prices and weak Chinese orders sent spreads on benchmark products to multidecade lows last year. However, this is a highly cyclical sector, and supply and demand eventually come into balance. S&P Global Ratings expects global utilization rates of ethylene to recover, slowly increasing spreads this year.

Moreover, while global firms have flagged heavy capacity expansion, entities typically overstate their intentions. This likely will prove the case in 2024, with producers bringing less new capacity online than previously projected. This reduction may partly help the market recuperate.

Even if the downturn persists deep into this year, most of the rated Asian petrochemical operators should be able to navigate difficult conditions, though with rating buffers narrowing from 2023. The rated firms typically are larger than peers and benefit from more diversified product mix and business segments, which is especially helpful during downcycles. Such entities often have access to lower-cost feedstock from sister firms, and can rely on parent support if needed. Several of the entities have also expanded into specialty chemicals, where spreads are more resilient.

Chart 1

High Oil Price Caps Petrochemical Spreads

Petrochemical products are intermediate goods, which means they are used in the production of other products. For example, acrylonitrile butadiene styrene (ABS) is used as a plastic resin to be molded as an exterior component of mobile phones. Many of the petrochemicals are ultimately derived from crude oil or gas (ethane and propane).

In an environment where inflationary risk is absent, petrochemical product spreads are based on supply-demand fundamentals, in which global utilization rates drive the product spreads (see chart 2).

Chart 2

However, in an environment of rising oil prices, petrochemical spreads are squeezed. Producers can struggle to pass on rising raw material costs to their buyers, especially when product demand is subdued. This is most apparent among high-cost producers, typically naphtha-based petrochemical companies, based mostly in Asia.

Scatter graph analysis of key petrochemical products, such as ethylene, high-density polyethylene (HDPE), mono-ethylene glycol (MEG), and polyvinyl chloride (PVC) indicate a negative correlation between the spread and the price of crude oil, in which a rising oil price results in squeezed spreads (see chart 3).

Chart 3

The current inflationary environment poses challenges to petrochemical makers in the region.

Producers are unable to fully pass on product price increases that fully reflect the hikes in raw material costs (for example, for naphtha) when crude oil prices rise and product demand softens. This explains currently weak margin trends for the chemical producers, with the price of crude oil hovering around US$80 per barrel. The Brent oil price to average US$85 per barrel over the next two to three years, in our view.

Having said that, some chemical companies are less hit by the spread compression, given their access to low-cost feedstock and diversified product mix. PTT Global Chemical Public Co. Ltd. (GC; BBB/Stable/--) for example, has a lower-cost profile than many naphtha-based petrochemical producers in the region. This is thanks to GC's ethane gas supply arrangement with its sister company, PTT Exploration and Production Public Co. Ltd., and half of GC's olefins feedstock will likely be ethane in 2024.

LG Chem Ltd. and Chang Chun Group companies offer diversified products, which somewhat offsets volatility in petrochemical spreads.

Expansion Plans May Prove Aspirational

Petrochemical companies typically indicate significant capacity expansion plans for their products that reflect robust long-term demand growth. However, when the capacity comes online, we often see the plans were overstated.

S&P Global Commodity Insights estimated in August 2021 that 2022 capacity expansion plans globally for ethylene was 15.7mtpa (million tons per annum). The actual capacity that came onstream was 12.2mtpa or 3.5mtpa less. In 2022, S&P Global Commodity Insights forecast expansion of 9.2mtpa for 2024. However, its August 2023 report expected a mere 4.9mtpa expansion. In other words, the closer we get to the date of capacity launch, the lower our estimates, with the actual capacity usually undershooting projections.

Construction delays, financing, and the complex logistics of launching expansions usually explain the reductions in actual new capacity. Several ethane-based petrochemical complexes launched during 2005 in the Middle East, and coal-to-chemicals complexes launched in the 2010s in China, encountered significant delays and start-up issues. The resulting loss of capacity tightened the supply of petrochemicals. Expansion delays and project cancellations will remain part of this complicated and imperfect process, in our opinion.

Chart 4

Referencing S&P Global Commodity Insights assumptions, global incremental ethylene demand is likely to outpace supply in 2024, the first time since 2018. After bottoming in 2023 at 78.7%, global ethylene utilization rates will likely rebound to 81% in 2024. While incremental ethylene supply should outpace demand from 2025, squeezing global utilization rates, we cannot rule out further delays to capacity expansions, or shifts in global demand.

Having said that, the industry's capacity expansion should still remain sizable over the next two to three years, constraining a material industry recovery absent a notable demand rebound.

Chart 5

Players' Strategies To Mitigate The Downturn

Companies in Asia have taken different strategies to address the cyclicality and inflationary risk associated with their commodity chemicals business. The firms are aiming to minimize volatility in earnings and cash flow, or to diversify their product mix and markets.

China

Chinese chemical companies are continuously investing to increase their focus on higher-end products.

Producers are continuously improving their operational efficiency and treasury management, while staying disciplined on spending. To maximize profits, entities are adjusting facilities' utilization rates and product mix according to market conditions.

Many also focus on cash management, including receivables collection. And to optimize spending, some just focus on existing projects under construction and may delay projects in response to soft market conditions. They will only cautiously commit to new investments.

In five years and beyond, players should gradually reap the benefits of industry upgrades following an expansion cycle. Chinese companies have been investing in the past years to gradually move to higher value-added products and eco-friendlier goods.

Companies successfully executing this strategy will be better positioned amid the downturn, as they move toward higher growth products that are less affected by the overcapacity weighing on commodity chemicals. Some firms that are following this strategy include Wanhua Chemical Group Co. Ltd. (BBB/Stable/--) and Sinochem International Corp. (SIC; BBB+/Stable/--).

The technological strengths of new products, such as aramid fibre, polyolefin elastomers (POE), high-end polypropylene (PP), and ethylene vinyl acetate (EVA), will not only build entities' competitive strengths but also earnings resilience. More integrated production will offer them greater flexibility on product optimization and cost synergies.

The credit profiles of most rated entities should stay stable over the next two years. The downturn will hit most companies amid overcapacity, lukewarm demand, and sticky input costs, in our view. However, their profitability will likely bottom out in 2023 and rebound thereafter as demand gradually recovers. The ramping up of new projects will also support earnings growth in 2024.

Parent support is another pillar bolstering our ratings on some companies, despite weakened stand-alone credit metrics. As an example, we anticipate the group credit profile of Sinochem Holdings Corp. Ltd. will remain stable in the following two years, which will underpin the ratings on its key subsidiaries, such as SIC, Syngenta Group Co. Ltd. (BBB+/Stable/--), and China National Chemical Corp. Ltd. (A-/Stable/--).

Wanhua Chemical's globally leading sales position in methylene diphenyl diisocyanate (MDI) will continue to underpin its competitiveness and credit standing. The MDI market has a high barrier to entry. New projects to make petrochemicals and fine chemicals will also expand the firm's product offerings and improve synergies. It is the only rated Chinese company that will likely see earnings growth in 2023, driven by the resilient profitability of its polyurethane products and the contribution from new projects.

Wanhua Chemical's key risks are its high capital expenditure on new projects, which constrains deleveraging, and its reliance on MDI and polyurethane sales, on which it derives concentrated earnings.

Korea

Korean chemical companies have pursued diversification over the past couple decades. LG Chem (BBB+/Stable/--), for example, is one of the most diversified petrochemical companies in Asia. Since the 1990s, the company has heavily invested into nonchemical segments, including its electronics materials business, and batteries for electric vehicles. With a sizable order backlog and partnerships in non-chemical enterprises, LG Chem's revenue from the chemicals segment declined to 38% of total revenues in 2022, from 76% in 2012. This percentage will likely drop to about 30% by 2024.

Companies such as Hanwha Totalenergies Petrochemical Co. Ltd. (BBB/Stable/--) have focused on their core energy and petrochemical expansions over the past few years. This has helped entities achieve a more balanced and vertically integrated portfolio of energy businesses. The strategy has specifically enabled Hanwha Totalenergies to diversify its products while decreasing its reliance on commodity chemical goods. We have a stable rating outlook on the firm, reflecting a recent earnings recovery. Normalized earnings and a disciplined investment policy will enable the company to improve its ratio of debt to EBITDA to about 2.5x in 2024, from 3.5x in 2023 (our estimate).

LG Chem has a material presence in the Asian chemical industry, and it is also a global producer of the fast-growing electric vehicle (EV) battery market through its subsidiary LG Energy Solution Ltd. (BBB+/Stable/--). LG Chem will likely sustain its steady operating performance, backed by a rising contribution from its EV battery and advanced materials divisions. LG Chem's key risk concerns the significant finances and execution involved in expanding capacity for its EV battery initiatives. This will likely result in negative free cash flows and increased debt over the next two to three years. We have a stable ratings outlook on LG Chem, since the company's ratio of debt to EBITDA will range 2.0x-2.5x over the next 12-24 months, in our view.

SK Innovation Co. Ltd. (BBB-/Negative/--) is one of the largest oil refining companies in Asia. The company has businesses in the refining and petrochemical sectors, including SK Geo Centric Co. Ltd. (BBB-/Negative/--).

SK Innovation has also diversified into the EV battery market. As a latecomer, the company has invested aggressively. This could increase execution risk, in our view. We have a negative outlook on SK Innovation, given the ratings headroom on the firm will likely remain narrow in the next 12-24 months.

Taiwan

Taiwanese chemical companies will remain strained by regional overcapacity, particularly in mainland China. Rated Taiwanese companies have taken measures to diversify their end-markets to various countries, and have made efforts to improve cost competitiveness through process enhancements. The firms

• Four Formosa Plastics group companies: Formosa Plastics Corp., Nan Ya Plastics Corp., Formosa Chemicals & Fibre Corp., and Formosa Petrochemical Corp. (all rated BBB+/Negative/--);
• Two Chang Chun group companies: Chang Chun Petrochemical Co. Ltd. and Chang Chun Plastics Co. Ltd. (both rated BBB+/Stable/--)
• CHIMEI Corp. (twAA-/Stable/twA-1+); and
• USI Corp. (twA/Stable/twA-1).

Further diversification is happening and could accelerate, as companies are looking to shift their product mix away from commodity chemicals and toward specialized or recycled chemicals, such as recycled polyester, chemicals for the manufacturing of lithium-ion batteries, carbon fibers, or fine chemicals used for the fabrication of semiconductors.

Market and product diversification won't likely mitigate business volatility quickly. Rated companies also remain cautious in diversification into new areas. This includes the four Formosa companies' investments in a battery manufacturing and energy management company in Taiwan, totaling new Taiwan dollar 6.65 billion.

The size of the investment underscores a need to shift to specialty chemicals, in our view, which will weigh on the profitability of rated Taiwanese chemical companies, heightening the risks of price volatility in the commodity chemicals market over the next two to three years.

Most rated Taiwanese chemical companies have sufficient financial buffers to withstand the current downturn, after building robust capital structures during 2020-2022. For example, the Chang Chun group companies will likely maintain a net cash position even with sharply reduced profits and cash flows in 2023 and 2024.

On the other hand, it will be more challenging for the four rated Formosa group companies to maintain their credit strengths during the current downturn, in our opinion. High cash dividends payments significantly increased their debt levels in 2022. Our base case holds that the four companies' ratio of debt to EBITDA could improve to about 2x over the next 12-24 months, from about 3x in 2023.

Japan

Major Japanese chemical manufacturers are likely to curtail or rationalize their petrochemical business. They are focusing on specialty products with high margins and high growth, such as semiconductors, automotive batteries, and health care. In so doing, entities are reducing their focus on more generic, low-margin goods. For example, Japanese firms produce 6 million tons of ethylene each year--vast output on which they make slim profits, due to aging facilities and stagnant demand.

Given decarbonization pressures, major Japanese chemical companies are reforming their business structure. For example, Sumitomo Chemical Co. Ltd. is considering rationalizing its domestic ethylene production through joint operations with other companies. Mitsubishi Chemical Holdings Corp., Sumitomo Chemical Co. Ltd., and Mitsui Chemicals Inc. are the major chemical companies in Japan. We do not rate these entities.

South And Southeast Asia

South and Southeast Asian chemical companies will continuously invest in ways to make their earnings more resilient to the volatile chemical sector, in our view. PTT Global Chemical Public Co. Ltd. (GC; BBB/Stable/--) has made efforts to secure low-cost feedstock, as mentioned. Other South and Southeast Asian companies are implementing measures to increase their exposure to the non-commodity chemicals segment.

One strategy is to expand into specialty chemicals, as GC and a Petronas subsidiary have recently done. GC acquired a German coating resins maker, Allnex Holding GmbH, in 2021, to expand its foothold into specialty chemicals segment. The Allnex purchase also increases GC's geographical diversification. The asset will likely generate 20%-25% of GC's EBITDA by 2024.

Our rated companies such as Reliance Industries Ltd. (RIL; BBB+/Stable/--) and Thai Oil Public Co. Ltd. (TOP; BBB/Stable/--) have fairly resilient chemicals segments. RIL, being one of the largest and most complex refiners globally, has a record of more stable and higher profitability in its oil to chemicals (O2C) segment compared with peers. TOP controls almost one-third of the domestic refining market. Its strong position in this segment will continue to mitigate its exposure to petrochemical spreads through their respective cycles.

RIL's resilience will strengthen as its domestic consumer business grows and its reliance on earnings from the chemicals segment declines accordingly. The company's retail and digital services segments will likely constitute more than half of its EBITDA by fiscal 2024 (ending March 31). Ten years ago, the firm derived most of its EBITDA from oil & gas and petrochemicals.

The stable outlook that we have on RIL reflect the aforementioned strategy, which will likely keep the company's earnings resilient. For TOP and GC, our stable rating outlooks reflect their strong ties and operational linkages with parent PTT Public Co. Ltd.

Editor: Jasper Moiseiwitsch

Digital Design: Evy Cheung

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