Dow Chemical (NYSE:DOW) recently restarted its St. Charles Olefins 2 plant in Louisiana after four years to accelerate investment in the U.S. Gulf Coast region. The company expects this move, which comes on the back of lower gas prices in the region, to help lower costs and strengthen its competitiveness.
The applications of hydraulic fracturing technology and horizontal drilling of shale rock formations have helped unlock the previously inaccessible sources of shale gas, which has caused a glut of gas supplies. This has led to a significant reduction in the prices of some essential chemical inputs, particularly ethane. Dow plans to invest $4 billion into the U.S. Gulf Coast to increase ethylene and propylene capacity through 2017.
The Louisiana plant produces ethylene (the simplest olefin or alkene) by cracking ethane that is used as feedstock for almost all of the company’s operating segments. It is used to make elastomers like EPDM, which is most commonly used in door seals and window seals in vehicles. Ethylene is also used as a primary feedstock in the production of polyethylene (commonly known as polythene). Polyethylene has a variety of uses in electrical and telecommunication, hygiene and medical, and performance packaging segments like insulation of power cables and packaging of food articles for preservation. Ethylene oxide (also derived from ethylene by oxidation) is used in the agro-science segment, and so the extension of backward integration in producing ethylene helps Dow drive better margins on its products.
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The performance plastics and materials segment uses most of the ethylene produced by the company. This makes the segment the foremost beneficiary of increased production of ethylene. The wide range of product applications in this segment from packaging adhesives, disposable diaper components, sporting goods and housewares to automotive interiors and exteriors, carpeting, home furnishings and personal care products contribute to the huge $450 billion plus and growing market size. This division makes up more than 55% of our price estimate for Dow’s stock.
We have currently factored in fairly stable EBITDA margins in this segment because of lower gas prices being offset by lower margins on naphtha-based plants in Europe and soft pricing due to weak demand going forward. However, with huge expansion plans in the U.S. Gulf Coast region, the company expects to drive EBITDA higher by around $2 billion per year by 2017. This could potentially imply upside to our current price estimate for Dow.