LyondellBasell Industries N.V. (LYB) Earnings Call Transcript & Summary

Good afternoon, everybody. This is Bob Koort at Goldman Sachs. Welcome to day 3 of our Industrials & Materials Conference. I'm joined with my teammate, Dylan Campbell, who helps me cover LyondellBasell. And we're pleased to have from Lyondell, Bob Patel, the CEO; Michael McMurray, who's the EVP and CFO; and Dave Kinney, who runs Investor Relations. As with most of the presentations today, Dylan and I will pepper Bob and Michael with questions. But we'd encourage our clients to submit questions. We always like to put yours first and get those prioritized. There is a window in the chat box on the webcast where you can submit those, and then we'd be happy to ask them to Bob and Michael.

So maybe starting off, Bob, I got a few speakers today give us a little appraisal. Obviously, very unfortunate times and very uncertain. But maybe you could just give us a little taste of how you've seen recent trends around the world and how that's affected your business.

All right. Bob, good to hear from you. And thanks for having us. So I'll talk a little bit about kind of what we're seeing in China, Europe, U.S. work, follow the sun, if you will, and how the virus progress as well, and then talk a little bit about how that translates into demand. So in China, we are seeing a reasonably good return to activity. We have about 1,000 employees in China, and 90% of them are back to work. As you know, we have compounding plants that we own in China. Those are ramping up to pretty good rates. We're not running full, but they're running at decent rates now. And so we do see a gradual return of base demand in China. Now having said that, what we hear from our team anecdotally is that discretionary activity is still kind of limited. People are doing shopping and going to grocery stores and things, but more entertainment-related activities or whatever are not really coming back as much. So that's translating into decent demand for polyethylene in China. We see spreads -- our PDs and naphtha are holding up well. We sense that inventories are at reasonable levels at the ports. So now the next phase of demand improvement for -- in China will come from reopening of other economies around the world where exports from China goes. So that will be the next phase. In Europe, we're seeing partial reopening in different countries, and it varies very much country by country. So we have great visibility into all of the big countries in Europe. Germany, reopening; Netherlands, we're starting to see some of that as well. We're starting to see more activity. Now our offices, we've not really returned yet. We're still a couple of weeks away from having employees return to our office, but we understand that there's partial reopening happening. On the demand side in Europe, demand has been decent for packaging and medical applications. Automotive, on the other end of the spectrum, has essentially been shut down. So we've slowed down -- or shut down some of our compounding assets that serve automotive. For the rest of our large assets, we continue to run 80% to 85% in the crackers and polymer assets and do not plan to idle any assets there for a longer period of time. In the U.S., reopening is starting to happen, Bob, as you and I are both based here in Texas. In Houston, especially, we're starting to see more traffic out on the roads. Restaurants are opening partially. And for us, our office, we're going to start to reintegrate a small part of our population back into the downtown office here in Houston starting Monday. And we'll take a very measured, slow-paced, phased approach in bringing people back. So -- and operating rates for our assets in the U.S. are in this 75% range, as I had mentioned during our earnings call. We're running our crackers at pretty good rates, working through feedstock flexibility where we can with the limitation on disposition of butadiene, and I'm sure we'll come to that later. So that's a bit of a view on demand. Bob, what I thought I'd also do, while we're talking about demand, is help maybe characterize how demand for our company is sort of segmented. So I think about demand in 3 buckets for our company. About 50% to 60% of our revenue or demand goes into packaging and medical-type applications. So that's, of course, been very resilient in this downturn. And in fact, we saw a boost in demand in many packaging sort of applications, especially for food packaging and also for cleaning supplies and things like that. So that part of demand for our company continues to do well and, we think, has potentially some incremental upside from a seasonality perspective. Next, about 25% -- 20% to 25% of our demand goes into fuels. So refining, oxyfuels in I&D, those are the 2 big areas in fuels. Of course, during the lockdown, demand was significantly impaired in April and March and even into May. But we think that, as we go into the end of Q2 and into Q3, that the fuels part of the end use that we serve will see some recovery, and we'll be able to participate in early recovery in earnings from the fuels part of our business. And then the last bucket of demand is automotive and durable goods, which is maybe about 20% or so of our total demand, and that will probably be a little bit later in terms of recovery. We'll see partial recovery as auto plants reopen, and then more probably into next year. So think about it as a little more than half from packaging, which has been consistent and good; fuels, we should benefit from recovery late Q2 into Q3; and then later on with automotive and durables. So I'll stop there.

Great. Why don't we get into some of the businesses? I think the most prominent questions we've been getting from clients have revolved around the flattening of the cost curve. So we've been in the news flattening curves. It appears the polyolefins world has seen something similar. Can you talk about what's changed to date, how you've reacted or the industry has reacted and then maybe what the path is into the second half of the year?

Yes. So Bob, I mean, absolutely, this has been a very prominent topic as it should be. So the way I think about cost curve and feedstocks is I think we've got to think through different time horizons, so near term, medium term and long term. And the answer is a little bit different in each one of those time frames. So I'll start with near term, near term I would define as now through end of year. I think we're going to continue to see volatility in feedstock prices. The recent run-up in ethane was somewhat unexpected and mysterious in some ways, but we think that the reason ethane has run up is because there were some basins who were producing ethane, which eventually shut down oil production because the economics around the oil production were not good. So ethane that was being produced got shut in, and ethane that was being rejected wasn't recovered fast enough. So it didn't go into recovery mode fast enough and, therefore, there was a bit of dislocation in specific basins, and certain midstream producers were even potentially cut short and had to buy ethane to cover demand. So I think this is -- this volatility in what we've recently experienced in ethane is really indicative of getting to a different equilibrium in a low oil price environment and timing of shut-in of ethane that was being recovered and recovery of ethane that was being rejected and the timing of all of that being dislocated in the near term. So I think that there's enough ethane. First of all, our view is that if you go back to Q4 2019, we believe that about 400,000 barrels per day of ethane was being rejected. After demand declined in March, we think that as much as maybe 1 million barrels per day was being rejected. And now with the shut-ins, perhaps 400,000 barrels per day of ethane won't come to market because there's less associated gas. So in that, I think what we're left with is still excess ethane, but we've got a transit there through this period of some wells being shut in. Some are going to go back into recovery mode. And today, the frac margin is something like $0.07 or so, so it's quite attractive for ethane producers. Now today, as we sit here, naphtha is actually favored, but the limit on our ability to crack naphtha is butadiene disposition. So butadiene demand is off significantly because of the shut-in of auto manufacturers, but we think that will ease as the year progresses. A company like ours in the period that lies ahead, we think that we're really well positioned with our significant feedstock flexibility to be able to maximize value in a period of higher feedstock price volatility that we're likely to experience for the rest of this year. For example, our 2 crackers at Channelview can theoretically crack maximum all liquids, so all naphtha, gas, oil and very little LPG, so no ethane. Now of course, that's going to be limited by our ability to move butadiene, so we have a lot of flexibility. So in the near term, I would characterize the situation as feedstock volatility. There's enough ethane. We've got to get to a new normal with whichever wells are going to be running and implications on ethane supply. Medium term, we think that there's enough ethane available to meet the needs at higher operating rates than where we are today. And in periods where ethane price does rise, we think that the feedstock flexibility in the industry and, perhaps, curtailment of exports could ease any sort of a run-up on ethane. And long term, so 2-plus years out, we believe there's enough ethane here in the U.S. and that there will be enough incentive in terms of frac margin to get that ethane to market. And we think that there's still cost advantage in the U.S. long term.

So Bob, I'm curious, some of the recent pressure in the polyolefin space and for North America has been demand weakness and an oil drop. Is the recovery to more reasonable margins for you, is it an and or an or? Can you have either the economy come back or oil goes up? Or do you need both to happen to get back to a healthy state for the industry?

I think the demand is probably more important than oil going back to where it was. So today at $35 oil, and gas where it is, if ethane were to trade closer to fuel value, then U.S. has advantage, even though it's marginal. I think the improvement in demand will be beneficial globally. So it's not and.

Sorry. It looked like last fall and the beginning of this year, we saw some very compromised naphtha cracking economics, particularly in Asia, as the industry sort of softened a bit, and then this has provided a bit of a lifeline. And we heard from one of your competitors yesterday that they thought there was quite a bit of capacity at risk if the world remains on a pretty compromised position. So what do you expect to happen in Asia and with China, which is adding all the capacity that's got people a little bit anxious? And then maybe around the rest of the world, expansion plans, what do you think happens going forward?

Yes. So Bob, in China, I mean, I think maybe some delays, like a quarter or so, because of the virus on existing projects. But I think existing projects probably do complete. That would be our base case. We don't think there will be significant cancellations. But let's see. I mean it's early, and we don't have enough data yet. In terms of more projects being built in China, I think it's going to depend on how financing will work in China. So for example, it could be the very large companies like Sinopec have financial wherewithal to continue to build. But entrepreneurial companies who are more family-owned or very, very regional or local in China, they have more difficulty attracting financing, and that slows down the pace of build. I still think China continues to be a significant importer of polyethylene for quite some time. So let's take the announcement at face value for China and assume that will ahead because we don't know anything different today. Rest of world, I do think that, for different reasons, we are going to see less supply in the future. So let's take the U.S., for example. Given the relative flattening of the cost curve and some of the other headwinds in terms of demand, it's not unreasonable to think that the new projects that have not reached FID will be pushed out. And I think some of those companies have already announced delays. And I would expect that, that would continue. In the Middle East, perhaps also, we could see delays because of the low oil price and ability to finance some of these projects and to back them. And in terms of rationalization, if this is more of a prolonged downturn, then, certainly, I think assets that are in the fourth quartile in Asia ex China could be at risk. And in Europe, you could see some rationalization. I don't think we'll see significant rationalization in the U.S. because we still think U.S. has advantage long term.

Bob, this is Dylan Campbell on the team here. I'd be curious, just going back to your -- some of your initial comments talking about U.S. operating rates at 75%; and Europe, 80%, 85%. Is that lower operating rate in the U.S.? How do you decipher how much of that is driven by the flattening of the global cost curve versus the impacts we're currently seeing in terms of demand in the U.S. relative to Europe and Asia?

Well, I think it's more about demand than it is about cost curve. And going back to my earlier comments, what's missing today is the -- is sort of our ability to export more to China because China is limited on their re-export of finished goods because the rest of the economy in the world is not operating at significantly better than lockdown kind of levels. And so I do think, as the year progresses and as lockdowns ease and trade flows start to resume, I don't think they'll get back to where they were in 2019, but any improvement should increase the flow of exports out of the U.S. of polyethylene and, therefore, then the export of finished goods out of China. I think that's what's missing. It's not so much the cost curve.

Got it. And I guess in China specifically, can you walk us through kind of what their polyethylene balance -- net export-import balance is and what their need is to import going forward given kind of the expansions that they're undergoing?

Well, I think the expansions, and Dave, correct me if I'm wrong here, but the expansions that were planned on paper before sort of the crisis, so let's assume that demand were to be as we thought back in '19, then really, the new case supply additions were meeting the demand growth and that the import in absolute terms was really unchanged.

Yes. We think that China is short about 14 million tonnes out of their total demand of a little bit over 30 million tonnes.

And guys, we'll interrupt some of the business questions we have there because we've got several from clients around the same topic, and I'm sure you've been asked this a bunch today, Bob. But can we talk about balance sheet, credit ratings, dividend coverage, capital allocation, sort of give us how you've adapted to the current environment and how your priorities may have shifted, if at all?

Sure. Let me start with kind of philosophically how we think about capital allocation. So our over umbrella sort of philosophy is that we want to maintain a strong investment-grade rating. So BBB would be characterized, in our view, as a very good investment-grade rating. We still have a notch of cushion left, right? Then we believe that our dividend is an important part of the shareholder return proposition, and it's a very high priority for our company. It's the highest priority in terms of capital allocation. So as we think about those 2 things and we think about the actions that we've taken, so first of all, we entered this downturn from a position of strength. We've had very good -- very low cost position, good scale assets, incredible feedstock flexibility in the U.S., feedstock flexibility in Europe. European position helps low oil price environment. In fact, margins have been better in Europe than they've been in the U.S. recently. So all of that, we enter into this downturn with a position of strength. We've reduced -- we have a plan to reduce working capital, where we'll benefit this year, in terms of cash flow, by about $500 million is our estimate. We've reduced CapEx by $500 million versus our base case. And we've accelerated some cost initiatives, which are not people related. They're more -- if there's other productivity improvements in procurement, in manufacturing, in maintenance, in how we spend our capital, that we think will accrue another $150 million to $200 million of cash this year, so call it $1.1 billion to $1.2 billion of cash improvement. So as we think about that and we think about our outlook, Q2, we think, will be lower than Q1 in terms of earnings. And then Q3, Q4 maybe similar or slightly better than Q2 because of the oxyfuel's contribution and refining getting a little better as we work through the year. But with that as a setup, we think that our dividend is pretty well covered for the rest of this year. So those would be our priorities and how we're thinking about liquidity and cash flow. Today, we have total liquidity of $5.4 billion and about $3 billion of cash on balance sheet. So we're really, I think, well positioned to support the dividend for quite some time.

And we have another question here from an investor, I guess, on that comment on the CapEx. You had lowered CapEx by $500 million, you just mentioned. They're just curious kind of how you think about CapEx and facility maintenance spend during slower times. And let's say, slower times continue into 2021, how will kind of CapEx look relative to these 2020 levels?

Yes. So our base case is that we would finish our PO/TBA project in the second half of 2022. So we would reaccelerate spending next year and into 2022 and finish the project. That's certainly a lever that we can pull. If the downturn is prolonged, we could stop the PO project, for example, as an additional source of cash flow. But -- so our CapEx, we're aiming for about $2 billion in CapEx in '21 and '22, but that assumes finishing the PO/TBA project, which is a large part of our growth capital in '21 and '22. And again, if we needed to, we could revisit that later this year.

Got it. And then I guess on inorganic M&A type of opportunities, given the distressed valuations in the industry, we have an investor asking kind of how you think about being more opportunistic here, particularly for, let's say, downstream assets such as polyurethanes.

Yes. So as I mentioned earlier, if you think about our priorities in terms of capital deployment and balance sheet, investment-grade rating, so BBB, where we are. Strong dividend, that's really well covered, and then visibility around the downturn. And I think the depth, for now, we assume that we're kind of at bottom. And now it's about the trajectory of how we come out. And so until we have more visibility, our view is that we would be reserved in terms of inorganic because our -- because we want to satisfy those first 2 priorities without question: strong investment-grade rating; dividend well covered.

Bob, it's Bob again. You guys have done a remarkable job of highlighting my ignorance and the ability to predict your refining earnings. Can you maybe talk about what's going on in that asset today, what the path forward is and to the extent, whatever happened to the IMO 2020 opportunity?

Yes. Well, it's certainly been a challenging couple of years in the -- for our refinery. And so if you think about the performance of our refinery, there's kind of 4 things that are really important. First, of course, is operating at maximum rates based on demand, and I think we've been operating very well. We did have an FCC issue earlier this year. But other than that, we've been running pretty well. So having an upset every now was not unusual. Then when we get to the margin side, there are 3 components of margin that are really important: light-heavy differential; diesel cracks; and gasoline cracks, in that order. If you think about light-heavy differential, we process about 95 million barrels per day through our -- per year, sorry, through our refinery. So $1 change in light-heavy differential is worth $95 million in a year. Light-heavy differential has been crushed. I mean we've gone from mid-teens a few years back to single digits last year because both sides of that equation have gone against us. We've had more supply of light crude because of the Permian last year, and sour crude values have come up because Venezuela has been out of the market. Now we've seen that get a little bit wider recently into the high single digits. We need that to be in -- firmly in the double digits for us to be profitable. And then diesel cracks were pretty good in March, and they've kind of collapsed starting mid-April, while gasoline cracks came up some later. So there's been a ton of volatility. So it's not just you. It's really difficult right now to kind of model the refinery. But if I were to put it simply, for Q2, we're thinking somewhere between where we printed in Q1 and breakeven, and I'm hoping that we can get closer to the breakeven in Q2.

Bob, can you talk -- we have a question here just on the $0.04 per pound polyethylene price increase on the table into summer months. A question here from just a skeptical investor given kind of the current supply and demand conditions of your ability to get that price through.

Well, look, I mean, I said this during the earnings call as well that costs have come up a good bit. And so this increase, at least in our view, is not so much about the fact that markets are tight or something. It's just that costs have come up a lot. And we do see -- we're going into the summer months. Relatively speaking, we should see demand improve. We don't see a lot of inventory across the value chain, and we see firmness in Asia. So it's kind of mostly in response to this run-up in costs.

Got it. And I guess on the back of that, I mean, where do you see integrated margins for Asia producers today? And kind of what have you seen in terms of their competitive dynamics given the shift in the global cost curve?

Yes. So PE-naphtha spreads are around $500, give or take, depending on the day. We would -- if you took the U.S. export price for high-density polyethylene at $0.25, that's the latest posted number that I've seen. And you add kind of packaging and freight and some local costs, you get to about $700 per ton. So $500 is a reasonable level. And I think that it's somewhere between trough and mid-cycle for China spreads. I mean I think it's reflective of a demand environment in China that's somewhat constructive, and not a lot of inventory at the ports.

Got it. That's helpful. And I guess on that comment, Hyperzone, a lot of that project -- production was slated to go into the export market. I think a lot of that marketing was done towards the end of last year, but what receptivity do you have from customers to buy the Hyperzone project given it came online during the midst of a lot of this pressure?

Yes. No, indeed. So we've been -- frankly, we've been up and down as we work through getting that unit up to full rates. We've made a few products. We're exporting some of the product, so too early to really comment on receptivity of the grades. We're still working through the product wheel. But our intention is to continue to prove out the capability during this period because what I'd like to see us be in a position to have proven out the capacity and the grade range as we had envisioned so that when the market does improve, we can hit the ground running. So now is the time to kind of shake down the unit, get it -- get all the bugs out and improve them in terms of capacity and grade sling. And that's what we aim to do over the next 90 to 120 days. And we'll export probably most of what we produce.

Bob, it's Bob again. Do you have any expectation? Earlier, you talked about sort of the near, mid and long term around feedstocks and such. What would be your sense of a sustainable or longer-term oil-to-gas ratio? And I think you've mentioned you expected ethane to again become a preferred feedstock at some point. But what do you think on a long-term basis that should look like?

Yes. Bob, on the gas side, certainly, one of the concerns is that with associated gas declining, and in terms of supply, could gas price rise? Everything that we read and the conversations I've had with midstream and upstream CEOs, my impression is that at $3 gas, there's a lot of supply. So I would kind of put -- get long-term gas price at something south of that, maybe $2.50 or something like that. And on oil price, so it's hard to predict when we get there, but it seems to me a reasonable scenario of -- is to peg oil price at $50, plus or minus. So take that -- take $50 and $2.50, then you have an oil-to-gas ratio of 20. And I think with parity at something like 7 or 8, U.S. still has advantage. And I think there's enough ethane available that it will be plentiful for the assets that are on the ground and the ones that are under construction. And so now the question is, is there enough slope on the cost curve to incent new investment in the U.S., and I don't have an answer for you for that today.

I guess one last one for me here. I guess on our Intermediates & Derivatives business, obviously, you talked a little bit about oxyfuels and the relationship to gasoline. Another area that -- I don't know if that does get as much attention as your styrene and acetyls business that has benefited from cost advantage dynamic. How do you expect those businesses to trend here towards the end of the year now that oil prices have declined?

Yes. So in the past, we always took for granted that there was a floor level of earnings because we never envisioned essentially a global lockdown where people just stop driving, right? So the way to think about oxyfuels is that the earnings recovery has 2 components; one is volume, which we think that will improve directionally as we work through the end of Q2 into Q3 and lockdowns are eased; and then oil price because, as you very rightly said, part of the value proposition on oxyfuels, at least here in the U.S., has been cheap butane converted to oxyfuels that are priced off of oil. So I think about earnings recovery for oxyfuels as being 2 phased: one is the volume side; and one is, directionally, with improvement in oil price. So oil price has already moved from $25 to $35. We're not expecting more dramatic improvement in oil price between now and year-end. So I think the oil price part has already come off the really kind of difficult lows. And now with some improvement in demand, we ought to see price -- some margin improvement and some earnings contribution. And as I said in my early remarks, if I think about our recovery from lows, the first phase of recovery in earnings is going to come from the fuel side normalizing some.

That's terrific, Bob. Unfortunately, we've run out of time there. But thanks to you, Michael, Dave. Appreciate your time in participating in the conference. Everybody, stay safe. Thanks.

Thanks for having us, Bob. Good to hear from you. Take care.