Fitch On: Commodities & Energy Contents

Oil and Gas PAGE 4

Metals & Mining PAGE 11

Chemicals & Fertilizer PAGE 18

Contacts PAGE 23

Fitch On: Commodities & Energy 2 EVENTS About Fitch On: Commodities & Energy

Fitch On: Commodities & Energy is a Contents curated compilation of Fitch Ratings’ in-depth research and commentary. This edition takes a deep dive into the Oil & Gas, Metals & Mining and Chemicals & Fertilisers sectors, and reflects our views on the Commodities & Energy space. Commodity prices are seen as currently being close to peaks. Oil and metals prices are expected to fall back next year as global GDP growth slows, China’s pace of expansion moderates, the impact of US fiscal stimulus fades and supply responds. At Fitch, our seasoned team of analysts collaborate across sectors to provide global, integrated analysis and commentary. We hope this issue, as well as future ones, serve as valued resources to help you make more informed investment decisions. We welcome comments, including suggestions for topical or credit-specific research for future issues. For our latest insights on Commodities & Energy, please visit our Energy & Natural Resources, Metals & Mining, and Chemicals & Fertilisers pages.

3 Fitch On: Commodities & Energy Oil & Gas

Fitch On: Commodities & Energy 4 EVENTS Oil & Gas

Fitch Ratings has increased 2021 and 2022 oil price successful and pandemic-related restrictions are eased. assumptions for the Brent and West Intermediate New breakouts, particularly of new Covid-19 variants, (WTI) benchmarks due to: remain the main risk for the sustained recovery in demand. Output policies of OPEC+ countries are key 1. Stronger year-to-date prices to managing oil supply. OPEC+’s planned production 2. A deficit in the market caused by a recovery in increases, originally agreed in April and confirmed demand in June, will help meet growing demand, but will be 3. Constrained supply from OPEC+ countries insufficient to balance the market in 2H21. 4. Heightened US capital discipline. OPEC+ has spare capacity of about 7 million barrels per We have also raised our 2021 and 2022 Title Transfer day (bpd), which should be sufficient to cover increasing Facility (TTF) gas price assumptions. Increases in spot demand in the short term. There is some uncertainty gas prices are being driven by low gas inventories over how quickly production could ramp up relative to in storage, strong demand in Asia, and recovering the pace of the recovery in demand, which may lead to demand in Europe. All price assumptions from 2023 are price volatility. Furthermore, lifting of sanctions against unchanged. Iran could add about 1.5 million bpd of oil, although we believe that OPEC+ could mitigate the impact of Oil demand has been increasing this year and is likely additional output from Iran by slowing production to continue to grow in 2H21 if vaccination rollouts are increases.

5 Fitch On: Commodities & Energy Oil production in the US, despite the recent rise, is still TTF price rises are supported by strong demand in Asia about 1 million bpd lower than in early 2020. US shale and recovering demand in Europe, reinforced by a cold producers shifted capital allocation priorities towards winter and restocking after the fact. In addition, supply debt reduction and favored shareholder returns over increases have been insufficient to meet recovering growth, which will moderate potential increases of US demand, leading to low gas inventories in storage. shale output, at least in the short term. The number of Surging carbon prices in Europe have also had a positive active US oil rigs is only half the pre-pandemic level, impact on gas prices, contributing to gas price growth. but still about double the number in service in summer 2020. However, despite all of the above, we believe the price rally in 1H21 is temporary. Once gas storage facilities are gradually filled to their normal levels during 2H21 and 2022, demand should subside, leaving the market oversupplied.

What Investors Want to Know: North American Energy (Oil & Gas) and Natural Resources

How Did Ratings Evolve as Commodities Prices and Demand Increased

US and Oil & Gas Rating Actions Through the Pandemic

1H20 Coronavirus-Linked Negative Actions 26/38 Public Issuers

Outlook Revisions Single-Notch Downgrades Multinotch Downgrades Fallen Angels

14 6 6 5

2H20-YTD Negative Actions 2H20-YTD Positive Actions 12 17

Operational Profile Financial Profile DDEs and Bankruptcies Operational Profile Financial Profile

1 5 6 9 8

Source: Fitch Ratings

The table above captures the evolution of ratings across Nearly all the downgrades (11 of 12) were due to North American oil and gas through the pandemic. unfavorable changes to financial profiles linked to the In terms of rating trajectory, several distinct themes pandemic, and only one was downgraded due to an emerged. At the onset, Fitch took rating actions on adverse operational profile. Refinancing was also a key approximately 70% of public credits, mainly through theme. About half the downgrades were deep high-yield sector-wide reviews. Fitch consequently placed 14 names that experienced either bankruptcy or distressed standalone credits on Negative Outlook, with six single- debt exchanges (DDEs). This list includes entities such notch downgrades, six multi-notch downgrades and five as Fieldwood Energy LLC; Extraction Oil and Gas, Inc.; fallen angels. Lonestar Resources America, Inc.; and Nabors Industries, Inc. These ratings were often dominated by weak refinancing prospects and limited institutional support.

Fitch On: Commodities & Energy 6 EVENTS Positive actions taken over this period were primarily What Investors Want to Know: due to upstream M&A, given the rash of announced Outlook for Latin American Energy deals, including Conoco Phillips/ and Utility Issuers Inc.; Pioneer Natural Resources Co./Parsley Energy, Inc.; The coronavirus pandemic, which hit Latin America Corporation/WPX Energy Inc.; Chevron hard in 2020, made for a challenging year for many of Corporation/Noble Corporation; and the region’s oil and gas companies, with crude prices Inc./ Inc. Positive rating actions — and demand both falling due to global lockdowns including the removal of Negative Outlooks — were also before recovering later in the year. Electric generation influenced by rapid improvements in upstream pricing. companies (GenCos) in Latin America also suffered from

falling demand, although government subsidies to end M&A upgrades were often driven by rating equalization users helped mitigate the pain for many of the region’s between a lower rated target and a higher rated acquirer. distribution companies (DisCos). Based on Fitch’s Parent and Subsidiary Linkage Rating Criteria, a robust linkage can result in an equalization Fitch expects improved conditions for both oil and gas of the ratings either based on strong legal ties (for companies and power generators in Latin America example, a debt exchange resulting in the new obligor), during 2021 following last year’s lockdowns and a or on the basis of strong strategic and operational ties. resurgence in regional economic activity. For this year, Equalization is not necessarily a foregone conclusion, Fitch projects global crude prices to increase materially and to the degree ties are considered less robust, linkage compared to the 2020 average, boosting the finances could be limited or non-existent, based entirely on the of regional hydrocarbon producers. Meanwhile, electric standalone ratings of both entities. utilities will benefit from higher cash flows and lower leverage metrics as restrictions on movement and An upgrade for the acquirer was less frequent. One economic activity throughout the region continue to example is Pioneer/Parsley. The company already had loosen. DisCos will also benefit this year as they recoup strong standalone financial metrics, but the transaction revenues that were delayed when governments- with Parsley pushed the combined company into the imposed payment moratoria for vulnerable consumers ‘BBB+’ category based on increased size. early in the pandemic. Fitch expects most of the payment arrears accumulated by DisCos during the There was only one example of a negative rating action pandemic to be paid off in full by end-2021. linked to M&A over this period. Diamondback Energy, Inc. was initially put on Rating Watch Negative. The deal to buy QEP Resources/Guidon Energy Management Services LLC broke the mold as a leveraging transaction with potential execution risk on asset sales for delevering post close. However, as the macro environment for oil prices improved later in the year and the risk around those items dropped, Fitch stabilized the Outlook.

7 Fitch On: Commodities & Energy EMEA Oil Majors to Recover in 2021 on Higher Prices and Volumes

Higher oil and gas prices, increased production volumes and stronger downstream margins in 2021 will help European oil majors to recover from their relatively weak performance in 2020. Financial results in 1Q21 support these expectations as the companies reported a sharp qoq improvement in EBITDA and operating cash flow. The European oil majors’ ratings and Outlooks have remained unchanged during the Covid-19 pandemic. US and Canada Oil & Gas Rating Actions Through the Pandemic

BP Shell TotalEnergies 50 45 40 35 30 25 20 15 10 5 0 2017 2018 2019 2020 2021F 2022F 2023F

Source: Fitch Ratings

Oil and gas prices have increased from the lows during All four companies are likely to generate positive free the pandemic and we expect prices to stay materially cash flow (FCF) for full-year 2021, driven by increased above average 2020 levels in the medium term. Higher profits, only moderately higher capex and lower oil and gas prices and stronger downstream margins in dividends for Shell and BP. FCF before changes in working 1Q21 led to a sharp increase in EBITDA and cash flow for capital increased for the European majors in 1Q21. A European majors after a weak 2Q20-4Q20. BP, Eni and combination of positive FCF and disposal proceeds in TotalEnergies generated increased EBITDA before the 1Q21 resulted in BP and Shell reducing net debt through inventory holding effect in 1Q21 compared to 1Q20. higher cash holdings or early debt repayment. Shell’s 1Q21 EBITDA before the inventory holding gain was weaker yoy, partly due to lower realised liquefied We expect capex to increase moderately in 2021 after natural gas (LNG) prices and restructuring costs. cuts of 25% in 2020 and 12% in 1Q21 (both yoy). However, investment budgets for 2022-2023 will We expect growth in majors’ oil and gas production depend on hydrocarbon prices, and we do not expect in 2021-2022 before the effect of disposals. Global the increase to be significant. The gradual redistribution oil consumption should recover to 2019 levels of investments from oil towards gas and renewable in 1Q22, based on forecasts published by the US segments will continue in 2021-2023, before becoming Energy Information Administration, while natural more material in 2025-2030. gas consumption will exceed 2019 volumes in 2021, according to the International Energy Agency. We believe We believe Shell, BP and Eni will have some headroom OPEC+ will substantially relax its oil production quotas under their leverage guidance in the medium term partly in 2022, potentially accommodating higher Iranian due to dividend reductions during the price downturn, production, if the decline in inventories continues. although the companies are already increasing their shareholder distributions. TotalEnergies remains committed to pre-2020 dividend levels and aims to pay dividends fully in cash, leading to weak leverage headroom for its rating.

Fitch On: Commodities & Energy 8 EVENTS Oil & Gas and Chemicals– Many O&G producers have publicly recognised climate Long-Term ESG Vulnerability Scores concerns and European oil majors have committed to rebuilding their business models to adapt to the ESG Vulnerability Scores (ESG.VS) in Oil & Gas and changing energy mix. Most O&G companies, however, Chemicals O&G companies will be among those most are yet to formulate their response to the energy severely affected by the energy transition: the change in transition. the energy mix, which has been dominated by oil, coal and natural gas for several decades, towards electricity While the pace and scope of the energy transition may generated from low-carbon sources. Many O&G differ from region to region, oil, gas (due to liquefied companies, ranging from large integrated international natural gas, or LNG) and chemicals are globally traded groups (oil “majors”) and national oil companies to commodities. This means that regional differences in smaller producers, rely heavily on debt funding. Their the level of disruption are likely to be less pronounced sustainability in the medium and long term in the compared to those in more domestically focused context of the energy transition is a key area of interest sectors, such as utilities. For this reason, we will assess for investors. ESG.VS and assign scores for the O&G and chemicals sectors on a global basis. We will recognise any Petrochemicals use hydrocarbons as a feedstock and are significant regional differences (for example, those considered a material driver for O&G consumption but due to degrees of proximity to end-markets with more have their own sustainability issues. Also, large integrated stable demand supported by less-punitive policies for O&G companies are often integrated into chemicals. hydrocarbons, or access to non-commercial funding options) when we assign scores to entities and ESG risks have yet to significantly destabilise the sector. transactions through “entity modifiers”. In 2009-2019, before the Covid-19 pandemic, global oil consumption increased on average by around 1.5% a Of the environmental, social and governance factors that year, and natural gas consumption increased by 3% a constitute ESG, we focus on environmentally targeted year. The penetration of electric vehicles (EVs) has so far policy changes as the key driver of vulnerability for been modest. In 2019, according to the International companies in the sectors in the period to 2050. While Energy Agency (IEA), Evs of different types, including governance is frequently cited as a relevant issue for the two-and three-wheel vehicles, displaced consumption O&G sector, we have omitted it from this analysis due of only around 600 thousand barrels of oil per day, or to the difficulty in predicting policy trajectories and its around 0.6% of global demand. smaller impact compared to the energy transition.

However, analysis of regional trends shows that the We have based our central stress scenario around the energy transition should be taken seriously. In Europe, oil UN’s FPS, which we believe provides a realistic basis consumption stagnated in the same period, most likely on which to consider the most significant potential due to the higher efficiency of the internal combustion credit impact from long-term ESG risk factors. The FPS engine (ICE) car fleet. In Norway, which has the highest highlights a range of policies consistent with a scenario penetration of EV globally due to various incentives, the whereby the climate warms by 2°C. consumption of diesel and gasoline decreased by 2% a year in 2016-2019.

9 Fitch On: Commodities & Energy Oil & Gas and Chemicals Long-Term ESG.VS

90 80 70 60 50 40 30 20 10 0 2025 2030 2035 2040 2045 2050 Oil production Liquids transportation oil refining nat ural gas pr oductio n fuel r et ail oilfiel d services petroc hem ica ls other chemicals

Source: Fitch Ratings

Fitch On: Commodities & Energy 10 Metals & Mining Metals & Mining

Rising Prices, Not Runaway Inflation A decomposition of US core inflation into goods and services components helps to explain the outlook for inflation. Pressure on core goods prices has been Supply-chain pressures, rising commodity prices and particularly strong, consistent with commodity price rapid economic recoveries have created a perfect strength and supply-chain pressures. Core goods prices storm for near-term global inflation pressures. The rate rose by nearly 2% both in April and May. Rapid growth of inflation in nearly all of the Fitch 20 countries, apart in used car prices – up by 18% in the past two months from , has risen since the start of this year. as new vehicles became scarcer – was the dominant Some of the biggest increases were in , Brazil factor. However, core goods prices excluding cars have and Turkey following large currency depreciations in also grown at around 0.5% month-on-month for several 2020. Rising food prices are also adding to EM inflation months. pressures given the higher weight of food in consumer spending and CPI baskets. However, the most pertinent Upward pressure on core goods prices will persist for risk of overheating appears to be in the US, given the several months but it seems unlikely to be sustained scale of stimulus and the speed of recovery, which by through next year. Supply responses through higher the end of this year will see GDP move above the level capex will ease shortages in the semiconductor market implied by the pre-pandemic trend. albeit with a lag. In addition, commodity prices are likely to peak in 2021 as production is stepped up and US CPI inflation rose more than anticipated to 5% yoy global growth moderates next year. China’s economy in May. The rate of US inflation was always likely to jump is slowing and infrastructure investment and housing in April given the base effects from price declines at starts are now falling. Fitch’s global metals price the peak of the pandemic in April 2020 and the sharp assumptions show iron ore prices falling to USD 100 a annual increase in energy prices. However, the strength tonne in 2022 from an average of USD 160/tonne this of the sequential month-on-month increases in the year. core CPI (excluding food and energy) at 0.9% in April and 0.7% in May were a surprise. EVENTS

Oil and Metals Prices

(USD/barrel) Oil Brent (LHS) CRB Spot Metal Price Index (Index, 1967=100) 80 1300

70 1200

60 1100

50 1000

40 900

30 800

20 700

10 600 Jan 19 Jul 19 Jan 20 Jul 20 Jan 21 Jul 21 Source: Fitch Ratings, Financial Times, CRB, Haver Analytics

World’s Industrial Production and Metals Prices

(%, yoy) World's Industrial Production (LHS) CRB Spot Metal Price Index (%, yoy) 20 100

15 75

10 50

5 25

0 0

-5 -25

-10 -50

-15 -75 2000 2004 2008 2012 2016 2020 Source: Fitch Ratings, CPB, CRB, Haver Analytics

World Trade and Semiconductor Cycle

(%, yoy) (%, yoy) Wor ld t ra de v olume (L HS) Worldwide semiconductor sales (3mma) 30 90

25 75

20 60

15 45

10 30

5 15

0 0

-5 -15

-10 -30

-15 -45

-20 -60 1993 1997 2001 2005 2009 2013 2017 2021 Source: Fitch Ratings, CPB, SIA, Haver Analytics

13 Fitch On: Commodities & Energy Fitch Ratings Raises Short-Term Global Metals and Mining Price Assumptions

Fitch Ratings has increased most of its short-term metals and mining price assumptions. Many commodity prices have been benefitting from pent-up demand in 2021 and we expect stronger pricing sentiment to spill over into early 2022. Our long-term assumptions remain unchanged. Metals and Mining Price Assumptions

Commodity Long- Long- 2020 2021 2021 2022 2022 2023 2023 2024 2024 (USD per tonne) term term

Actual Old New Old New Old New Old New Old New

Nickel (LME spot) 13789 15000 16500 14000 15000 14000 14000 14000 14000 15000 15000

Copper (LME spot) 6181 7200 9000 6700 7500 6700 6700 6700 6700 6700 6700

Zinc (LME spot) 2376 2500 2800 2200 2400 2100 2100 2100 2100 2100 2100

Aluminium (LME spot) 1701 1950 2200 1850 2000 1850 1900 1900 1900 1900 1900

Gold (USD/oz) 1771 1600 1700 1400 1500 1200 1200 1200 1200 1200 1200

Hard coking coal (Australia 123 135 130 135 135 140 140 140 140 140 140 premium spot, FOB) Thermal coal (Australia Newcastle 6,000 kcal/kg, 61 72 81 66 70 66 68 66 66 63 63 FOB) Thermal coal (Qinhuangdaoo 82 91 106 76 85 76 81 76 76 74 74 5,500 kcal/kh, FOB) Iron ore (China import iron ore 108 125 160 90 100 80 80 70 70 70 70 fines 62%, CFR)

We have increased our copper price assumptions due We also expect incremental supply growth from key iron to exceptionally strong pricing conditions year to date ore producers, which should balance the market in the (YTD), supported by low inventories, economic recovery, medium and long term. stimulus packages and expectations of increased medium-term demand due to energy transition. We Demand for aluminum has been supported by the expect some price correction in 2H21 due to slowing economic recovery and supply restrictions in China. We demand, fewer potential supply disruptions and rising expect China to remain a net aluminum importer due mine output. We expect the market to be largely to its decarbonisation efforts. We have slightly raised balanced in 2021-2022. our 2023 price assumptions as a result, in addition to increases in 2021 and 2022. High iron ore spot prices are driven by strong China’s demand, but we expect some price correction later Zinc inventories are running low, supporting short- in 2021. The Chinese government recently raised term prices that are reflected in our new assumptions. concerns over growing steel and raw materials prices, Nevertheless, we expect mine supply to catch up with which may affect end-markets. Supply has marginally demand in the longer term. increased in 2021 but the market remains in deficit. China’s government also intends to cut emissions from Modest increases in our gold price assumptions reflect most polluting industries, including steelmaking. While stronger prices YTD and the potential for investment this has provided short-term support to steel margins opportunities elsewhere as stimulus subsides. and iron ore demand and prices, reduced Chinese steel output could affect long-term demand for iron ore.

Fitch On: Commodities & Energy 14 EVENTS Strong demand from stainless steel still supports our High EU Carbon Prices to Weigh on revised short-term nickel prices, which we expect to moderate in the medium term. Steelmakers’ Profitability

Coking coal is the only commodity for which we A surge in carbon emission allowance prices could decreased our short-term price assumptions. Australian affect European steelmakers’ profitability once steel spot pricing has underperformed our price levels normalise. In addition, the revision of the EU previous assumptions, driven by China’s ban on Emissions Trading Scheme (ETS) pricing mechanism in Australian supplies. However, we expect the market June is likely to spur further carbon price growth. to somewhat normalise as either China will relax the ban or more non-Australian supply will shift to China Carbon prices in the EU ETS have been rising since as contracts expire. Therefore, we have kept price 4Q20, but their impact on steel producers’ margins has assumptions beyond 2021 unchanged. so far been offset by exceptionally high steel prices, which we expect to moderate in 2H21. Steelmaking We have increased thermal coal prices for both using blast furnaces and basic oxygen furnaces benchmarks for 2021-2023. Higher Qinhuangdao (which represents about 60% of Europe’s production 5,500kcal/kg short-term price assumptions reflect capacity) is carbon-intensive and buying emission strong demand, constrained supply and low allowances is a significant cost for producers. Every inventories at power generation companies. Increased tonne of industrial carbon emissions in the EU must be medium-term assumptions are driven by the Chinese covered by allowances, with about 80% of allowances government’s tolerance of high coal prices. Furthermore, currently allocated for free. Producers have to purchase local governments in coal-producing regions are allowances via the ETS to cover the remainder. motivated to keep supply relatively tight. ETS carbon prices doubled to about EUR50 a tonne Stronger domestic prices in China and supply in early May from an average in 2019-2020 of EUR25 constraints will support export prices in the medium a tonne. The expected tightening of the EU ETS rules, term, including Newcastle 6,000kcal/kg, despite the with fewer free allowances, was the main driver of this ongoing ban of Australian coal imports. We expect the increase, along with increased energy demand due to price to normalise after 2021 on declining transportation cold weather and likely financial investors’ purchases. costs and continuous coal substitution in the energy The share of free allowances was set to decrease to 75% mix. by 2025, but we anticipate it will be cut even more when the European Commission revises the ETS mechanism Our mid-cycle metals and mining price assumptions in June. This is because the EU has recently increased are not intended as price forecasts. We do not expect its emission reduction commitments and now aims to any rating changes due to the revised assumptions. cut emissions by at least 55% by 2030, compared with Some cost increases and exchange-rate fluctuations, a target of 40% previously. This is likely to push carbon including a weaker US dollar and stronger currencies in prices up. many economies with large mining sectors, moderate the positive impact of higher prices on producers’ cash flows. The prices assumptions we use are conservative in nature and typically below consensus levels during periods of rising prices, but remain above market prices during severe market downturns.

15 Fitch On: Commodities & Energy CO2 Prices in EU ETS

(EUR/tonne)

70

60

50

40

30

20

10

0 Jul 09 Jul 10 Jul 11 Jul 12 Jul 13 Jul 14 Jul 15 Jul 16 Jul 17 Jul 18 Jul 19 Jul 20 Jul 21

Source: Fitch Ratings, ICE

Domestic steel prices have increased by 30%-60% For example, ArcelorMittal’s average EBITDA profitability yoy in 2021, which has offset higher carbon costs and (excluding ILVA from the scope of consolidation) was allowed European steel producers to generate healthy only about USD 65 a tonne over the past five years. margins. Increased marginal costs of carbon, which ArcelorMittal and ThyssenKrupp reported that they we assess at EUR95 a tonne of hot rolled coil, will put have partially hedged their carbon emissions until 2030, pressure on steelmakers profits as a result. mitigating rising carbon prices.

European Steelmakers’ Costs and Margins

(EUR/t) EBITDA margin (RHS) M ar ginal cost (LHS) Average cost (LHS) (%)

1,000 40

750 20

500 0

250 -20 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021F 2022F 2023F

Source: CRU

The surge in carbon prices provides extra impetus to EU Further details are due to be published in June, but there policymakers to introduce a carbon border adjustment has been pushback from key trading partners, including mechanism to avoid carbon leakage and ease China and the US. We expect the policy will continue competitive pressures on domestic steelmakers. This to face tough global political hurdles, but in the long would impose a charge on steel imports into the EU term we expect steelmakers, consumers and the public designed to offset carbon costs paid by EU producers. sector to share the pressures of higher CO2 costs.

Fitch On: Commodities & Energy 16 EVENTS China’s Steel Supply-Side Reform Industry top-10 concentration has improved by 3pp since 2015, to reach 37% in 2019. However, this Targets Partially Met, Consolidation remains behind the 13th five-year plan target of 60%. to Accelerate The country’s highly fragmented steel market has a large number of small producers with 1-3 million tonne Fitch Ratings expects the consolidation of China’s capacity plants that are unattractive for large state- steel industry to accelerate and for facility upgrades to owned enterprises as acquisition targets. This makes enhance energy efficiency in the next five years. consolidation harder to achieve than in other industries, such as coal and cement. Industry utilisation rates reached 80% in 2019 and 79% in 2020, up from 70% in 2015 and in line with China’s In the next five years, China’s 14th five-year plan 13th five-year plan target of 80%. This was despite emphasises further consolidation targets. We expect higher documented steel capacity at end-2020, driven consolidation to accelerate with the emergence of by strong demand. China has eliminated more than 150 mega producers. The 14th five-year plan also contains million tonnes of undocumented sub-standard steel more requirements for better technology usage and capacity since the introduction of supply-side reform in higher energy efficiency in the steel production process. 2015.

Fitch Ratings and CRU

In July, Fitch Ratings and CRU Group announced the renewal of their commitment to their existing strategic agreement, under which CRU’s metals, mining and fertilizer market data and analytics will continue to be incorporated into Fitch’s industry research and credit analysis. The combined research applies to all Fitch-rated issuers in the sector.

The partnership between Fitch and CRU commenced in 2017 and has successfully provided investors with enhanced analytical insight into key rating drivers, individual and industry cost dynamics, as well as direct contact with CRU and Fitch’s global team of analysts. The additional insights provided by the combination of Fitch and CRU’s analytics and data has provided investors with a more comprehensive platform on which to price risk and base their investment decisions.

17 Fitch On: Commodities & Energy Chemicals & Fertiliser

Fitch On: Commodities & Energy 18 EVENTS Chemicals & Fertiliser

North American Chemicals - Improving Leverage: We expect median leverage metrics across the chemicals sector will improve toward Peer Review rating tolerance levels through 2021, given solid EBITDA improvement on the back of recoveries across plastics, Sector Highlights non-durables and other end markets. We expect debt repayment to be a priority for companies with leverage Coronavirus Recovery: Improving end-market demand metrics outside stated targets. beginning in 2H20, specifically within automotive, construction, and industrials, drove better than Shifting Capital Deployment: Given the prospects for anticipated rebounds in earnings and leverage for strong earnings and improved cash flow generation in the year. According to Fitch Ratings’ current Global the near term, Fitch anticipates chemical issuers will Economic Outlook, global GDP levels are expected to be revisit deferred capex projects, and opportunistically 2.5% higher in 2021 than in 2019. Chemical demand pursue M&A and shareholder friendly activities. across most end markets will continue to benefit from However, we expect issuers to do so in a credit further recovery in global macroeconomic conditions, conscious manner consistent with current ratings driving continued pricing and volume growth for given demand uncertainty that remains in the medium chemical producers in the near term. and long term. Credit-unfriendly capital allocation policies that prioritize shareholder returns and M&A, where gross leverage levels are sustained above ratings sensitivities, could result in negative ratings actions.

19 Fitch On: Commodities & Energy Ethylene/Polyethylene Supply Expansions: Disciplined weaken as capacity and the wave of polyethylene supply cuts to operating rates during the pandemic, shutdowns comes online. However, virgin plastic demand for food related to Hurricane Laura and freezing weather in packaging and consumer applications benefit from the Gulf Coast, in a period of strong demand, generally above GDP growth, and as we believe there will continue supported robust prices for petrochemical producers to be delays in capacity expansions, markets should since 1H20. While polyolefin margins troughed in remain relatively balanced in the near term. 2020, the current pricing environment could ultimately Rating Headroom by Leverage (As of Dec. 31, 2020)

(x) Negative Sensitivity Threshold Positive Sensitivity Threshold Current Leverage 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0

0.5 0.0 Albemarle Dow Eastman Ecolab Inc. Huntsman International LyondellBasell Westlake Corporation Chemical Chemical Co. Corp. Flavors & Industries N.V. Chemical Company Fragrances Inc. Corporation

Source: Fitch Ratings.

What Investors Want to Know: EMEA Chemicals in 2021

Which Markets Will Remain Oversupplied in 2021?

Fitch believes that petrochemical markets will remain oversupplied in 2021 due to massive capacity additions expected in Asia, (particularly China) coupled with a slow economic recovery in Europe. Demand for polyethylene (PE)and polypropylene (PP), the main polymers produced globally, remained robust in 2020 due to increased demand for packaging and face masks amid the coronavirus pandemic. This mitigated the PP segment’s exposure to the automotive sector. However, prior to the pandemic, we already expected capacity growth in 2020 and 2021 to outpace demand growth. We therefore expect petrochemicals prices and spreads to remain under pressure in 2021, despite current market tightness. China Capacity Additions

70,000 Ethylene PE and PP

60,000

50,000

40,000

30,000

20,000

10,000

0 2018 2019 2020 2021f 2022f 2023f 2024f 2025f f=forecast Source: Fitch Solutions

Fitch On: Commodities & Energy 20 EVENTS Fitch views ESG risks as moderate in the near term Plastic Waste Reduction May Cause given the lack of substitutes for most chemical products despite the potential that tightening regulation will Long-Term Corporate Change increase costs. We expect GDP and population growth in emerging countries, where plastic consumption per Single-use plastics are increasingly being banned capita is lower than in developed countries, to support and restrictions surrounding disposal practices are demand for petrochemical products in the coming tightening, as environmental and public health concerns decades, mitigating the growing use of recycled plastics. around plastic waste mount. Policymakers are looking However, we believe ESG-related legislation will have a to achieve a more “circular” economy, reducing material impact on the sector’s profitability and demand the amount of new resources needed to sustain drivers by 2050. With regards to costs, we expect the economy and minimising the waste produced. carbon-pricing mechanisms to be implemented in all Improving recycling facilities and extending the lifespan regions and to converge to a price of USD 100/tonne of plastic products through repair and refurbishment are of carbon dioxide (tCO2). On the demand side, growing both such investments. recycling rates will slow demand for virgin plastic. However, recycling will not start to materially affect the Importers of plastics, such as China, are beginning to industry until 2040, given the time required to develop restrict or ban such imports and this has disrupted global recycling infrastructure and technologies. We believe recycling practices. Many developed market economies specialty chemical companies are less vulnerable to ESG do not have the infrastructure to recycle the plastic regulation than petrochemical manufacturers, given waste they produce, and so plastic-reduction policies their ability to reposition themselves in product lines that and investment in disposal and recycling capabilities are will be in higher demand following the energy transition. becoming more urgent.

Plastic end-user sectors, such as consumer goods and food services, are most exposed to tightening regulations, and so are driving initiatives to reduce plastic consumption and improve recycling practices. However, the pandemic has highlighted the difficulty of shifting away from plastic usage due to rising demand for food packaging and hygiene products. Fitch Ratings expects plastic demand will continue growing over the next few years, particularly in emerging markets, as there are limited viable alternatives, although demand for paper and pulp packaging has increased.

Fitch expects improvements in recycling technology and infrastructure and the development of viable substitutes to reduce the demand for petrochemicals. Major petrochemical corporates are investing in more sustainable processes in anticipation of further market changes.

21 Fitch On: Commodities & Energy Fitch Ratings Raises Most Short-Term Global Fertiliser Price Assumptions

Fitch Ratings has raised most of its 2021 and 2022 fertiliser price assumptions on strong year-to-date prices, strong agricultural commodity prices and increased feedstock price assumptions. We expect spot prices to moderate in 2H21 and 2022 due to an improved supply and demand balance, and moderating feedstock prices in 2022. Our long-term price assumptions remain unchanged.

Fitch Ratings Global Fertiliser Price Assumptions

Commodity Long- Long- 2021 2021 2022 2022 2023 2023 2024 2024 (USD per tonne) term term

Old New Old New Old New Old New Old New

Ammonia - FOB Black Sea 270 360 260 300 260 260 260 260 260 260

Urea - FOB Black Sea 280 330 260 280 250 250 250 250 250 250

Phosphate Rock - 95 115 90 100 90 90 90 90 90 90 FOB Morocco

DAP - FOB US Gulf Export 430 530 380 400 360 360 360 360 360 360

Potash - FOB Vancouver 230 220 230 230 230 230 230 230 230 230

Increased ammonia short-term price assumptions Revised phosphate rock price assumptions are due reflect lower production volumes because of tighter gas to healthy year-to-date spot pricing, supported by supplies due to the cold winter and high gas prices in strong demand from the phosphate downstream and Europe and the US. The industry was also disrupted in agriculture sectors. 1Q21 by unplanned outages and maintenance, which removed about 1 million tonnes of capacity from the DAP prices reflect higher feedstock prices, including market in 1Q21, not all of which may resume by end- ammonia, phosphate rock and sulphur, as well as 2Q21. Record corn acreage in the US also supports increased shipping costs (OCP, one of the largest ammonia demand. As a result, year-to-date spot producers, imports ammonia by sea). DAP prices are prices have been strong, although we expect prices to also driven by strong demand in all markets, particularly moderate as summer seasons are typically weaker than China. Furthermore, DAP exports from planting seasons. We have recently revised European gas declined in 2021 due to phosphate production issues. price assumptions, leading to higher feedstock prices for ammonia in 2021 and 2022. Potash is the only fertiliser for which we have lowered our 2021 assumptions. This is due to the Increased price assumptions for urea are driven by underperformance of the contract prices compared robust agricultural and recovering industrial demand in to our previous expectations, caused by recent weak China, while production remains flat, leading to lower contract prices, including that in the contract between exports. Chinese coal feedstock prices have increased Belaruskali, one of the largest producers, and . This due to strong demand, constrained supply and low is in contrast with a rally in spot markets in May-June inventories at power generation companies. caused by concerns over Mosaic’s production cuts and the impact of potential sanctions on Belaruskali’s production volumes.

Fitch On: Commodities & Energy 22 EVENTS Contacts

Global Investor Development Team: Analysts:

Aymeric Poizot Brian Coulton Global Head of Investor Development Chief Economist +33 1 44 29 92 76 +44 20 3530 1140 [email protected] [email protected]

Rick Patton Craig Gosnell Head of North America Investment Senior Director Grade Investor Development Business Relationship Manager, +1 646 582 4468 Corporates [email protected] +44 0 20 3530 1322 [email protected] Business & Relationship Management: Alex Griffith Andrei Sandu Managing Director, Head of European Investor Head of Corporate Ratings, EMEA Development +44 20 3530 1709 +44 20 3530 1332 [email protected] [email protected] Dmitry Marinchenko Senior Director, Oil & Gas +44 20 3530 1056 [email protected]

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