PTT Global Chemical

PTT Global Chemical Plc

 

Investment thesis

We recently accompanied PTTGC chief financial officer Patiparn Sukorndhaman on a non-deal roadshow to the United Kingdom. In all, the investors we met seemed to rate the O&G space underweight, but we sensed that they were starting to look at downstream plays again relative to E&P counters, as oil prices are expected to move sideways for some time. However, investors expressed concerns over China’s macroeconomic slowdown, which may have a negative impact on chemical demand and the economic viability of PTTGC’s US petrochemicals complex. Nevertheless, we think that the improving chemical spreads brought about by high seasonal demand should be a share price catalyst going forward. We have summarized below the key issues raised during roadshow discussions. 

Issue #1: Concerns on slowing chemical demand from China  

The low seasonal demand for chemicals and the weak Chinese economic data in early 3Q15 were blamed for the recent chemical spread weakness. However, chemical spreads have gradually rebounded over the past few weeks, driven by the high season. Management cited that chemical demand from China remains strong, however, Chinese buying behavior has changed to purchases of smaller volume but greater frequency, as they want to keep their stocks lean. Moreover, PTTGC sells its products to China through traders, of which 50% of total volume is under long-term obligations. As such, the traders should be able to switch the volume to other markets in the case of a Chinese demand slowdown. 

Looking ahead, management expressed that the current demand-supply of olefins products, which had already taken into account the new supply from shale gas crackers, had reached equilibrium—the additional demand was around 6-7mt/year against the additional supply of 5mt/year. Given that, the HDPE spread over Naphtha is expected to sustain at least US$700/t for the next 2-3 years.  

Issue #2: Will the low crude prices diminish PTTGC’s cost competitiveness over Naphtha?   

Management said that PTTGC gas cracker’s cost was still more competitive over Naphtha cracker, even in the period of low crude prices due to: 1) gas-based cracker yields being higher Ethylene output (78% against 31% for Naphtha-based cracker), 2) gas-based cracker yielding byproducts amounting to only 22%, of which the current selling prices have considerably declined, minimizing their premiums over Naphtha, and 3) that the conversion cost of Naphtha-based cracker is higher than gas-based cracker. 

Despite that, the EBITDA margin of gas cracker has declined to 32% (from 33% previously), while the EBITDA margin of Naphtha cracker has expanded to 23% (from 16%). In summary, the profitability of gas cracker is still higher than that of Naphtha cracker.

The falling current crude prices also raised questions about the possibility of changes to the pricing formula (the profit-sharing regime between the two parties [the concept of equal IRR]) for the purchase agreements for wet gas feedstocks between the firm and PTT, as the current formula is based on Dubai price range of $70-130/bbl. Management said that if the pros and cons of the changes in parameters have yet to be quantified, it did not expect any changes to be made in the pricing formula in the near future.  

Issue #3: PTTGC’s future growth prospects 

Management explained that the petrochemical complex in Indonesia had been postponed along an indefinite timeline, as the new government there had prioritized the refinery project while it had put the petrochemical project on hold. This is positive for PTTGC, as it will reduce the firm’s investment burden. Despite that, PTTGC is seeking long-term growth opportunities and has set an investment CAPEX of $4.5bn for 2015-19. The firm is currently studying three major projects, which will be decided upon within 2016. These projects comprise: 1) the Map Ta Phut retrofit project, 2) the PO/Polyols project and 3) the US petrochemical complex. 

For the Map Ta Phut retrofit (which will create feedstock flexibility and lengthen the value chain [CAPEX ~US$1bn]), the configuration will be finalized by YE15 and will take one year for front-end engineering design (FEED). The final investment decision (FID) is expected to be within YE16. For the PO/Polyols project (CAPEX ~US$1bn), PTTGC will partner with Japanese firms and will hold an approximate 60-70% stake. This project will take nine months from now for FEED and will start construction in 3Q16. The commercial commencement is expected in 2Q19. 

For the US petrochemical complex, the firm is undertaking the FEED and the FID is expected in 4Q16. The commercial start-up is expected in 2021. The preliminary estimate for the investment cost of this project is US$5.7bn. However, management said that the actual investment cost was likely to be lower, as the current EPC cost should be cheaper than a few years ago, due to postponement of several projects. In addition, PTTGC is negotiating with potential ethane suppliers to set an indicative cap ceiling and floor price to mitigate the risk of ethane price volatility. On the marketing front, PTTGC will co-invest with Marubeni, a prominent global trading firm, to penetrate the US market. Management reaffirmed that these conditions needed to be met before the FID date to ensure that the project would be economically viable and that its internal rate of return (IRR) would not be less than 14%.

Issue #4: What would be the impact of weak crude prices on PTTGC’s profitability?

Weak crude prices will affect PTTGC in two ways: 1) lower profitability of gas cracker and 2) inventory loss. Management admitted that low crude prices had diminished the profitability of its gas cracker—the EBITDA margin had declined as mentioned earlier. However, PTTGC has adopted the mitigation plan of realigning its feedstock usage—by increasing the ethane portion while reducing the LPG portion, as the LPG cost is more expensive than that of the ethane. In addition, the current Dubai price of US$44/bbl against US$61/bbl as of end-June would cause an expected inventory loss of around Bt3bn in 3Q15. However, PTTGC has hedged 60% of total crude inventory at US$60/bbl, so the firm should be able to mark gain on oil hedging in 4Q15 if the crude prices sustain at the current level. More interestingly, the 3Q15 inventory loss may be less than the market expectation, as Baht depreciation will ease the inventory loss effect by almost 30%, given that the inventory cost is booked in Baht terms.