Make or break

25 April 2005 00:01  [Source: ACN]

THE world’s eyes have been so firmly focused on China that many may have failed to notice or give due importance to the solid growth recorded by the North American petrochemicals market last year.

As one Asian participant at the International Petrochemical Conference (IPC) held in early April in San Antonio, Texas, US, put it: ‘A major contributor to last year’s petrochemicals boom was the US, where demand and production grew by an average 10%. The US industry, with an ethylene capacity of about 25m tonne/year, is the largest in the world, so this growth rate had huge implications.

‘The US saw an unusually good year with some of the highest prices in the world. The strength in the market also helped absorb some of the surpluses from the Middle East, and this in turn helped maintain the Asian demand and supply balance.’

North American cracker operating rates averaged 95.7% in 2004 compared with 88.8% in the previous year. The average contract ethylene price was 18% higher in 2004 at 33.8 cents/lb, while the spot price was 47% higher at 31.6 cents/lb. Average cash margins improved from 8.1 cents/lb in 2003 to 10.1 cents/lb in 2004.

At DeWitt & Co’s World Petrochemical Review, Pat Duke of DeWitt pointed out that US polyethylene (PE) demand and margins improved in the second half of 2004, recovering from a period of extended weakness dating back to the first quarter of 2000. Even polypropylene (PP) margins improved after being weak since Q4 1997, said Duke.

After a lacklustre 2003 for some products, North American demand growth was certainly impressive. PE demand was up by about 10%; PP rose by around 4%, while the vinyls chain posted a growth of 20%. Overall, ethylene grew by about 11%, while propylene was up by 8%.

Needless to say, the robust growth was supported by a strong economy, with the US posting a GDP (gross domestic product) growth of 4% last year. Industrial production was higher by 4.1%, and thankfully the all-important US consumer was willing to keep using his numerous credit cards. Consumer confidence was up 21.7% year-on-year. The housing industry remained strong as new-home sales rose by 10.6% while sales of existing homes grew by 8.7%.

Even a decline in demand and pricing in the first quarter of this year has failed to dampen optimism.

But Sergey Vasnetsov of Lehman Brothers pointed out in an April report on the US market that North American PE demand in 2005 has been weaker than expected by the market.

High operating rates and a slowing down of the export market have seen US PE inventories rise to the highest level in two years. ‘We believe that in the next six months ethylene/PE chain profit momentum will reverse from the previous eight months of an upward trend,’ said Vasnetsov in his report.

‘We have seen some softness in the ethylene chain,’ conceded Ed Dineen, senior vice-president, chemicals and polymers, for Lyondell Chemical Co

‘New capacity coming onstream in Asia needs to be absorbed. But the market is likely to stabilise by the middle of this year and get tight again,’ he added.

On the economic front, the news has been mixed, with recent indicators suggesting a steady weakening in consumer confidence.

According to the American Chemistry Council (ACC), economic reports have been generally disappointing lately, suggesting that the US economy is reaching another soft patch as higher energy prices work their way through the supply chain. The reports on weak retail sales and the rising trade deficit have dampened confidence in the US economy. But the ACC continues to post a green banner for the chemical industry.

And these figures had not dampened the mood at San Antonio. But behind many of the optimistic faces, there were a few concerns - some new and others familiar from IPCs of previous years.

Gridlock woes

The strength of the domestic economy in 2004 magnified a logistics problem that had been building up over the last few years. Timely availability of rail freight services has become a major headache for chemical industry executives, forcing them to compare it to the 1997-98 rail crisis. That crisis, which followed the merger of Union Pacific (UP) and Southern Pacific in 1996, was resolved only after the US Surface Transportation Board intervened with an emergency service order that opened UP lines to competitor railroads for nine months to ease congestions.

According to UP, chemical shipments have grown progressively. In November 2003, shipments were down 5% when compared with November 2002, but they rose by 5% in the following month and have climbed steadily since then. In addition to this, overall demand for rail freight is at an all-time high.

At the IPC, UP chairman James Young attempted to reassure worried industry players that, although his company was raising freight rates, it was committed to making capital investments to improve rail services.

Congestion is a real problem in the US, be it highways, rail, or ports. But Young said UP would be investing 20 cents of every revenue dollar in capital work, more than in any other industry.

UP has already announced that it will spend more than US$2bn throughout its 33 000-mile system this year on track improvements and new rail lines to increase service speed.

A familiar tale

But the mother of all problems – and an extremely familiar one – remains the erosion in competitiveness as a result of high natural-gas costs – an issue that threatens to bring the US chemical industry to its knees.

According to the ACC, the industry’s natural-gas bill has increased by US$10bn in the last two years. It has lost US$50bn in business to overseas facilities, and more than 900 000 jobs have disappeared. The chemical industry is running a US$4bn trade deficit, while in the 1990s it had posted a record surplus of over US$20bn.

The struggle to make the government understand the serious implications of this issue has been running for over three years now.

At last year’s IPC, officials from the National Petrochemical & Refiners Association (NPRA) had expressed optimism that the government would finally pass the energy bill. But the bill, which has been in the making for four years, is still in the US Congress and officials once again expressed hopes that the bill would be passed this year.

‘There are positive signs that the bill will be passed,’ said Robert Brown, business manager and petrochemical director of NPRA.

Given the threat of US companies moving offshore, Brown stressed that natural-gas pricing was a serious issue, with the NPRA doing everything that it could to ease the burden for its members. ‘We are reasonably optimistic as the president has indicated that something must be done [on the energy issue]. We are working hard on it.’

The hope stems from the US president’s recent State of the Union address in which he said: ‘Four years of debate is enough: I urge Congress to pass legislation that makes America more secure and less dependent on foreign energy.’

Earlier this month, the Energy and Commerce Committee approved the Republican-crafted Energy Policy Act of 2005 after overcoming attempts by the Democrats to reshape the policy. The bill will now be combined with a separate measure that would open the Arctic National Wildlife Refuge in Alaska to oil-and-gas drilling.

For a country that prides itself on forward and rational thinking, the contradictions evident in the policies introduced so far are difficult to comprehend. The government’s focus, perhaps justifiably, has been on the environment, with the emphasis being on promoting clean fuels, as in the use of natural gas for power generation. But there has been little action to ensure a corresponding increase in supply.

Demand has soared, pushing prices to unprecedented highs. The cost of natural gas was 26% higher year-on-year in March this year reaching an average of above US$7/mmbtu for the Henry Hub spot price.

According to the Energy Information Administration (EIA), although natural-gas storage remains adequate, high world oil prices and a continued strong economy will keep upward pricing pressure on North American natural gas. Henry Hub prices are expected to average about US$6.95/mmbtu this year and US$6.90/mmbtu in 2006.

The average price in 2004 was US$5.5/mmbtu.

US gas demand is expected to increase by 1.7% in 2005, but production is likely to rise by only 0.7% despite an expected 8% increase in gas-directed drilling. Demand in 2006 is projected to increase by 3.2%, largely because of weather-related factors and continued strength in gas-intensive industrial production.

Meanwhile, the NPRA has been urging Congress to include incentives to promote domestic refinery and petrochemical capacity in the energy bill. No new refinery has been built in the US since 1976. It is also pushing for more access to onshore and offshore gas reserves, extra facilities for liquefied natural gas (LNG) and completion of a pipeline that will bring in gas from Alaska.

At the IPC, Frank Murkowski , the governor of Alaska, indicated that the US$20bn trans-Canada pipeline was likely to bring Alaskan natural gas to the Lower 48 states only by 2012-14. The mammoth project would be a ‘difficult task’ with significant economic challenges, he said.

A major hurdle is the six-month delay in the planned US$6bn Mackenzie pipeline project in Canada that would transport 1.2bn ft³ of gas/day through a 20-inch diameter pipeline from Canada’s Arctic region some 800 miles south to Alberta. The delay is because of disputes over the environmental impact of the project.

The Mackenzie pipeline was to be completed before the trans-Canada line, so if there was a delay in this project, it would affect the trans-Canada pipeline, warned Murkowski.

Alaska has plenty of gas, but it will only partly meet growing US demand. The rest will have to be met through LNG imports, which the EIA projects will reach 6400bn ft³, up from 400bn ft³ in 2003.

One LNG industry player believes that the 8-10 import terminals are likely to be built in the US over the next 15 years despite opposition by communities living in the coastal areas. Spurred by the record high natural-gas prices, proposals for 40-50 terminals are at various stages of the approvals process, but all are unlikely to go through.

A major task confronting the interested parties is convincing local communities that LNG terminals are for the greater good.

This challenge is true for other gas ventures too. Even if an energy bill allowing access to unexplored gas reserves is passed, companies will struggle to obtain local permits. Communities in the US, and increasingly in most of the developed world, are not keen to house LNG terminals – or, for that matter, even refineries – in their backyards. Until the industry overcomes environmental and safety concerns, it is quite safe to bet that natural gas will continue to figure high on the agenda of forthcoming IPCs.

What the industry can certainly do without is volatility of prices. Huntsman has been at the forefront of the battle to curb market speculation in natural gas. During the IPC, Peter Huntsman, president and chief executive of the company, yet again stressed that volatility was driven by unrestrained speculation in financial markets and not ‘the simple of laws of supply and demand’. But he was optimistic that a bill, introduced in the House of Representatives by Sam Graves and John Barrow to increase transparency and stability in gas trading, would be passed.

The bill, formally titled the Commodities Exchange Improvements Act of 2005, proposes several changes in the operation and regulation of market exchanges and instruments to make the trading of natural-gas contracts more transparent and subject to limitations on price fluctuations. This includes putting natural-gas trading under the regulation of the Commodity Exchange Act and requiring the Commodity Futures Trading Commission to review and approve rules applicable to transactions involving natural gas.

Another proposed piece of legislation introduced in April by Senator Lamar Alexander also holds promise. The bill is described as balanced and thoughtful by the ACC. It seeks to lower and stabilise natural-gas prices, curb consumption by aggressively implementing a number of energy-efficient measures, promote investment in development and implementation of new technologies such as coal gasification, and create greater access to US reserves of natural gas.

Competing in the world

Ever since the US lost its advantage in natural gas, questions have been raised on the ability of the chemical industry to compete globally and also on its future role.

It needs to be asked whether the mature industry in the US has a future.

Cracker operating rates were at extremely high levels last year and would have to rise higher in the coming two years to meet a projected growth in demand.

The only new cracker that has been announced is by Shintech, which is mainly to meet the needs of expansions in its vinyls chain. And although Shintech has selected Louisiana as the site for its cracker and vinyls project, sceptical industry players still think that the announcement is more a negotiating ploy on the part of the company to secure a better price for its current ethylene purchase contracts.

Among the few other projects, BP will be adding 295 000 tonne/year in Chocolate Bayou, Texas, this year. But the US has plenty of idle capacity and it will be interesting to see if any of these will be restarted if demand continues to grow.

Other new cracker activity in the region is mainly outside the US. There is the 1.2m tonne/year Phoenix project in Mexico, but its future depends on whether its proponents are successful in striking a long-term contract with Pemex for feedstock supply.

Most of the other big investments in crackers and derivative projects are taking place outside North America. Cheaper feedstocks and faster-growing markets have lured most US companies to turn to the Middle East and Asia. These regions promise better returns with perhaps fewer or more manageable complexities.

‘Our focus will be on the Middle East in the C2 chain. We plan to be there, potentially ten years later. It is still in the idea stage,’ said Lyondell’s Dineen. As for propylene oxide (PO), the company is interested in China in the longer term. It is also discussing a possible offtake arrangement with a PO project that Sumitomo Chemical and Saudi Aramco are jointly studying in Rabigh, Saudi Arabia. The offtake would be through Nihon Oxirane Co (NOC), a joint venture with Sumitomo. This would allow Lyondell, through NOC, to maintain ownership or marketing rights for 20-25% of Asian PO capacity.

Dineen is not too perturbed by the lack of major investments in the US. He expects that, over a period of time, the US exports of PE, styrene, and polyvinyl chloride will gradually decline to take care of the needs of the home market.

Among the other US companies, ExxonMobil is carrying out a feasibility study on a cracker project in Qatar. Work is already under way for its project in Fujian, China, with the cracker slated for completion in the first half of 2008.

Dow Chemical recently broke ground for a new olefins and derivatives complex in Shuaiba, Kuwait, its second investment at the site. Besides this, it is searching for an investment opportunity in China.

Speaking to ACN’s sister news service CNI on the sidelines of the IPC, Dow’s chairman, William Stavropoulos, said the company would continue to seek production asset expansion in growth markets worldwide, including Eastern Europe and Russia

Market forces to the rescue?

So does this mean that predictions of chemicals becoming a rust-belt industry in the US are coming true?

Will the US demand eventually be met by cheap imports from neighbouring countries or from as far as the Middle East?

The president and chief executive officer of Lyondell Chemical, Dan Smith, is not convinced this will happen.

He had this to say at the IPC: ‘Yes, the industry is well established here and growth is more rapid in Asia than in Europe and the US. But does this mean that business is bad, that there are limited opportunities for our industry, or that the future is bleak? No. In fact, I believe exactly the opposite. It is all a matter of your perspective and your goals.’

Smith pointed out that the region’s reliance on chemicals would not diminish in the years to come. The industry, he said, would continue to find ways to improve.

Flexibility and speed were the critical factors that would separate the winners from the losers in the years ahead.

He also believed that market forces would eventually work to provide cheaper gas to the US industry.

‘The market, which increasingly is a global market, coupled with our industry’s skills in problem solving, ultimately will provide the solution.

‘Technology already exists and investments are being made that will, I expect, by the end of the decade make gas a more global commodity, much like oil.

‘If enough natural gas is brought into the US from overseas, I believe the price will moderate. And if industry follows the typical cyclical trend and overbuilds LNG capacity, it could moderate even more.

‘Through a combination of market forces, company creativity, and productivity, I expect we’re going to have the answer to the natural-gas question within a decade,’ he said.

Federal Reserve chief Alan Greenspan had a similar message to convey at the IPC. Increased demand, he said, had absorbed most of the spare capacity that helped contain energy prices between 1985 and 2000.

But he was optimistic that the current high prices would result in increased production and encourage the use of technology to improve recovery from existing gas fields.

However, all one can say with any degree of certainty is that the current high oil-price environment and firm economic growth have helped US companies overcome the disadvantages of high natural-gas costs.

The pain will be less evident as long as the current upcycle lasts. But beyond that, marginal players will once again be under pressure unless market forces come into play faster than predicted. 

Natural-gas costs around the world

	US$/mmbtu
Canada	5.50
US	6.30
Trinidad	1.60
Bolivia	1.60
Argentina	1.50
UK	5.15
Belgium	5.25
North Africa	0.80
Oman	1.00
Saudi Arabia	0.75
Qatar	0.65
Kuwait	1.25
Iran	1.25
Turkey	2.65
Ukraine	1.70
Belarus	1.20
Russia	0.95
India	3.10
Singapore	3.20
Indonesia	2.70
China	4.50
South Korea	4.50
Japan	4.50
Taiwan	4.65
Australia	3.75
Source: American Chemistry Council

Polyethylene demand performance, % demand change

	2000	2001	2002	2003	2004	2005	2000-05
North America	1.9	-3.6	4.0	-0.6	10.5	4.8	1.7
South America	7.6	0.8	-1.2	0.9	6.0	8.7	3.0
Western Europe	2.2	1.5	-0.6	1.8	3.4	2.0	1.6
Eastern Europe	5.8	10.7	8.7	14.0	3.0	7.2	8.7
Africa & Middle East	11.8	0.8	18.4	1.9	16.3	9.5	9.1
Northeast Asia	4.7	13.2	4.8	6.1	3.2	9.9	7.4
China	10.3	21.4	12.0	9.3	4.2	10.0	11.2
Southeast Asia	4.4	8.0	10.7	6.1	14.5	4.5	8.7
Asia-Pacific	4.6	12.0	6.2	6.1	5.9	8.5	7.7
World	3.8	2.2	5.3	3.3	8.0	5.7	4.9
Source: DeWitt & Co

Global ethylene capacity by region, m tonne/year

	2004	2010	% change
Americas	38.469	41.415	8
Europe	21.803	31.990	6
Middle East/Africa	12.180	32.677	53
Asia Pacific	31.091	43.890	33
Total	111.543	149.972	34
Source: CMAI

Polypropylene demand performance, % demand change

	2000	2001	2002	2003	2004	2005	2000-05
North America	1.9	-1.2	8.0	3.5	3.9	6.5	4.1
South America	10.9	2.9	7.8	6.4	9.5	7.6	6.8
Western Europe	2.2	6.5	6.0	1.8	7.4	5.6	5.5
Eastern Europe	17.1	8.2	8.9	6.2	8.1	9.3	8.2
Africa & Middle East	10.8	11.0	1.1	14.1	12.0	11.2	9.8
Northeast Asia	12.5	6.6	8.9	8.8	7.7	6.7	7.7
China	18.0	10.0	14.4	13.8	9.8	8.8	11.3
Southeast Asia	15.6	-4.3	11.9	15.4	0.6	3.8	5.2
Asia-Pacific	13.3	3.5	9.7	10.6	5.7	5.9	7.1
World	7.9	3.6	7.9	7.0	6.3	6.5	6.2
Source: DeWitt & Co

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