Crunch time for crackers

24 August 1998 00:00  [Source: ACN]

Asian cracker operators face having to close down crackers to halt the price slide. Players say the gloomy outlook is not expected to improve before the turn of the century. John Richardson reports

ASIAN petrochemical companies are searching for the strategies which will enable them to survive a crisis which has seen the repeated collapse of product prices and margins to new record lows.

As Q3 works towards a conclusion more desperate than that which could have been imagined even a couple of months ago, the prospects for Q4 appear to be daunting.

Few players envisage much improvement in markets before the turn of the century - the consequence of the sharp loss of demand that has accompanied the economic crisis across the region.

It is clear that major operating-rate cutbacks are inevitable. At least one South Korean cracker operator admits that its recent sale of ethylene at US$215/tonne fob Korea failed to cover its variable costs, with many other Asian producers believed to be already selling at or below variable costs.

Cracker operators appear to be adopting measures other than major operating-rate cutbacks in an effort to improve their economics. One such measure was the recent switch in naphtha buying patterns.

Ethylene has traditionally always enjoyed a premium over both propylene and aromatics, resulting in most cracker operators meeting the vast majority of their spot market feedstock needs through the acquisition of light grades of naphtha which have a high ethylene yield.

However, huge reductions in demand for PE and subsequently for ethylene has eradicated these premiums. As ACN went to press, both ethylene and propylene were trading at within the same US$10/tonne price range.

And there is the isssue of the decline in margins. To put this decline in perspective, in early November 1994, during the last upcycle, the MoPJ (Mean of Platt's Japan) was at US$180/tonne cfr Japan while propylene was trading at US$650-660/tonne cfr SEA and PP at US$1010-1050/tonne cfr SEA/ NEA (ACN 7 Nov 1994, p28-29).

As ACN went to press, the MoPJ stood at US$130.5/tonne cfr Japan, propylene ranged between US$260/tonne and US$270/tonne cfr SEA and PP had fallen to as low as US$390-400/tonne cif Hong Kong.

Cracker operators in an effort to reduce raw-material costs are therefore increasingly buying cheaper open-spec spot naphtha cargoes which often contain more heavy-grade material and therefore have a lower ethylene yield than lighter-grade shipments.

Heavy-grade material yields more butadiene and benzene, toluene and xylenes. Producers which have derivatives fed by C4s and C9s, such as Hyundai Petrochemical, have the option of reducing spot naphtha purchasing costs by switching to open-spec. Hyundai told ACN that, at present, it is buying entirely open-spec cargoes whereas previously, its spot purchases were predominantly of A-180.

An industry source says that for those ethylene producers who do not run downstream plants which require C4s and C9s - many of whom are based in Southeast Asia - they have no option but to continue buying more expensive lighter-grade material.

However, any competitive edge which more diversified ethylene players are enjoying as a result of increasing open-spec aqui-sition is rapidly diminishing and may soon disappear.

The surge in demand for open-spec material, the supply of which has always been limited, has resulted in an increase in its price and a sharp reduction in the differential between it and spot cargoes of A-180.

A Hyundai source says: 'Before the crisis, spot A-180 was as much as US$6-7/tonne more expensive than open-spec. The gap has now narrowed to US$0.5-1.0/tonne.'

But even if the differential does vanish entirely, Hyundai adds that it will only make economic sense for it to resume the buying of spot A-180 when, or perhaps even if, the premium for ethylene is restored.

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A much bigger feedstock issue for Hyundai and all Asian ethylene producers is the premiums being charged for Saudi Aramco A-180 and Jubail full-range naphtha. Despite the adjustments in spot buying patterns, Asian ethylene players still source the vast bulk of their naphtha needs through these contracts.

In May this year, buyers tried but failed to obtain premiums of below US$10/tonne for Saudi Aramco A-180 and US$3-4/tonne for Jubail full-range naphtha for H2 supplies.

At the time of the H2 contract talks, the position of buyers was weakened by market anticipation of the startup of the Rayong Olefins 600 000 tonne/year cracker in Q1 1999 and the then scheduled June startup of the Formosa Group's 450 000 tonne/year cracker. The Formosa startup has since been delayed until year-end.

This surge in demand promised to reduce availability in what has long been an under-supplied market. Therefore, the Middle East naphtha producers were able to achieve premiums of US$11/tonne for A-180 and a premium of US$6.50/tonne for full-range naphtha.

Each of these prices represented reductions of only US$1/tonne on the premiums charged in H1 1998, which, say the cracker operators, are insufficient to compensate them for the sharp falls in product prices and demand.

Changes in naphtha buying patterns have clearly only resulted in marginal and pro-bably short-term gains for Asia's cracker operators.

The only gain which will make a difference to the fundamentally flawed economics of selling below variable costs are operating-rate cutbacks sufficient in both size and duration to achieve a reversal of the slide in product prices.

At the end of H1 1998, South Korean and Japanese producers announced that they would cut operating rates at both ethylene and downstream plants by 15-20%. Many observers doubt that these reductions have been fully implemented.

Some naphtha traders are among those who doubt that the cuts have been made, arguing that naphtha pricing and demand is stronger than would be the case if output had been cut by 15-20%.

Here, this discussion comes full circle. The traders add that if capacity utilisation had been reduced by the amount announced at the end of H1, the fall in demand for naphtha and therefore naphtha prices would have provided far greater long-term savings than the short-term benefits derived from switching to open-spec material.

For instance, oil prices recently fell by US$0.5-1.0/bbl. However, the decline in the MoPJ, because of strong naphtha buying interest, was only 50% of what it should have been if it had responded in tandem with crude.

Other naphtha traders say that the strength of naphtha is merely the result of high demand for prompt cargoes and are uncertain as to whether the operating cuts have been fully implemented. They add that this high demand is the result of buyers waiting until their inventory is empty in the hope of reductions in naphtha prices which often fail to materialise because of a shortage of sellers.

Hyundai, SK Corp and Samsung General Chemicals in mid-August said that their respective crackers were running at 80% of capacity with similar reductions downstream.

Daelim Industrial adds that between the beginning of July and 1 August this year, its 420 000 tonne/year No1 cracker had been operating at 87% and the capacity utilisation of its 310 000 tonne/year No2 plant had been 83%. Operating rates at both facilities were from 1 August increased to 100% ahead of a turnaround.

However, an industry source says that a recent independent survey conducted into all South Korean cracker operating rates during July and early August concluded that the country's average capacity utilisation was 96%.

In Japan, Ministry of Trade and Industry statistics indicate that ethylene production was 607 900 tonne in July, a 12.7% reduction compared with the previous month and a 4% drop when measured against July 1997.

Whatever the reality of reductions in total output by South Korea and Japan, one observer says that the only means by which the slide in product prices will be halted will be a 40% reduction in Northeast Asian ethylene production. Such a huge cutback would require the closure of some crackers, a tough call for any producer to make.

'Every ethylene operator in Northeast Asia is aware that if it puts its head above the parapet first and decides to temporarily suspend production, it will clearly not be in the market to take advantage of any recovery in prices,' says a source.

His view, therefore, appears to indicate that short of a magnanimous gesture on behalf of the Northeast Asian industry, a South Korean or Japanese cracker shutdown for market reasons is unlikely to occur.

There are also other factors at play which may have kept average cracker operating rates in Northeast Asia near to 100%.

Suspended debt repayments and the competitive edge provided by the devaluation of certain currencies faster than others have clearly given many producers the short-term opportunity to crank out even more product than before the crisis, regardless of the long-term impact on prices. There is also the strategy of increasing exports to compensate for sharp declines in domestic demand.

These appear to be the reasons that ethylene operating cuts at many Southeast Asia plants have yet to be even publicly discussed.

National Petrochemical Co (NPC) says it is running its 528 000 tonne/year plant at an operating rate of 110% due to record-high demand from customers such as HMC Polymer and Bangkok Polyethylene.

NPC's domestic competitor, Thai Petrochemical Industry, says its cracker is operating at about 95% as part of its export drive.

Petrochemical Corp of Singapore (PCS) is also running both its crackers at 100%, a policy motivated by sufficient downstream demand and a desire to remain balanced.

Occasionally, when PCS considers that market conditions are appropriate, it will run at a lower operating rate and purchase cargoes of ethylene.

For Ethylene Malaysia, which recently experienced a two-week outage, an issue this year has been attempting to resolve diffficulties with its gas separation unit. Industry sources say these difficulties have prevented Petronas from running its cracker at more than 80% during a period when it would have hoped to achieve maximum capacity utilisation in order to increase export sales.

The one Southeast Asian cracker operator contacted by ACN which professes to a reduction in its operating rate is Chandra Asri.

The 510 000 tonne/year producer is running its plant at 70-75% of capacity because of reduced demand from downstreamers, and a decision not to export spot cargoes of ethylene because of what it regards as unworkable prices.

Conditions in Indonesia are worse than anywhere else in Asia, principally because the rupiah has depreciated more than any of the other currencies in the region. Demand for monomers and polymers has fallen by more than 60% so far this year compared with the same period in 1997.

Chandra Asri cannot reduce its operating rate any further without shutting down. If it wishes to shut down, it faces the complication of being Indonesia's only cracker operator during a period when letters of credit for many of its customers are either unavailalbe or prohibitively expensive.

If Chandra Asri ceased production, many of its customers would therefore have no option but to follow suit because trade financing difficulties rule out the option of importing feedstocks.

But the most pressing issue for Chandra Asri does not differ from that which confronts all of Asia's cracker operators.

'Producers cannot continue selling at or below variable costs or building inventory of unsold products,' says a senior executive at an Asian chemical company.

Which producer is therefore going to be the first to stick its head above the parapet?

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