A lesson in crude economics

05 September 2005 00:01  [Source: ACN]

WHENEVER CRUDE oil hits a record high, Asian naphtha prices tend to follow suit. And if analyst projections are to be believed, the recent price spikes are likely to be the rule rather than the exception until the end of this decade.

So is this bad news for petrochemicals? Not necessarily but, as always in these situations, there will be clear winners and losers. Asian naphtha cracker operators could be among the latter group; especially for the remainder of this year if feedstock costs surge further and producers continue to struggle to pass costs down the chain by raising olefins prices.

If the shock of oil breaking through US$70/bbl isn’t enough, Goldman Sachs and Merrill Lynch both recently revised upwards their price forecasts for this year. Goldman Sachs predicts US light crude to weigh in at US$67/bbl this year, up US$13.50/bbl on its last forecast, while Merrill Lynch sees oil averaging US$56/bbl, up US$6 from its earlier forecast. Tellingly, Goldman Sachs says it expects US light to still be hovering around US$60/bbl at the end of the decade.

Of course, for those Asian petrochemical companies who have really done their homework, these projections are hardly a wake-up call. Key issues affecting crude supply/demand are not exactly rocket science, and nor are they a secret: with the notable exception of Saudi Arabia, Opec simply doesn’t have spare capacity to pump more oil; the security and political situation in Saudi Arabia is uncertain at best; and in Iraq it is downright dire. Throw in a major hurricane in the US and you have the ingredients for the perfect storm.

If we are to believe the economists, Asia is as thirsty as ever for the black stuff, and that usually means being vulnerable. Asia consumes 30% of the world’s oil (a figure that’s growing) but produces only a tenth of it. Region governments pay a heavy price, literally as well as figuratively, for the privilege of importing nearly all of their energy needs. The Thai government, for instance, has spent a whopping US$2.2bn on petrol and diesel subsidies since January 2004 in an attempt to keep a lid on consumer spending and inflation.

BEARING UP WELL

But in a recent report, Goldman Sachs claims most Asian economies are bearing up reasonably well against the current oil price surge, and are certainly in better shape than they were during the 1970s oil shock. The reason, they say, is that today’s high prices are as much the result of stronger demand as they are of real, or potential, supply disruptions.

But try telling that to governments in southeast Asia.

The Central Bank of Thailand cut its 2005 gross domestic product (GDP) growth forecast at the end of July to 3.5%, from 6.1% last year, blaming rising oil prices. In response, the government – which imports 90% of Thai energy needs - scrapped crippling fuel subsidies altogether in mid-July.

It has been a similar picture in Indonesia, where vice president Jusuf Kalla says fuel subsidies could cost Rp150 000bn (US$15.3bn) this year, more than double last year’s US$7.4bn.

Since subsidies have been a useful tool for governments in stabilising consumer spending and generally appeasing the masses, one regional analyst warns that any subsidy removal now could be serious.

‘We can’t discount the possibility of social unrest in places like Indonesia and the Philippines,’ he says.

GDP growth in Indonesia slowed to 5.5% in Q2 2005, from 6.2% in Q1, and higher prices have already hit consumer spending. Inflation rose to 7.8% in July. The rupiah has been falling in value against the US dollar, too, breaking through the psychologically-important 10,000 to the US dollar mark.

Feeling the heat on its finances, Jakarta recently cut fuel subsidies for industrial facilities which buy more than 500 kilolitres/month of diesel fuel. The move follows state oil major Pertamina’s decision to increase industrial grade diesel prices by 135% to US53 cents/litre in August, up from July’s US23 cents/litre. Sources say this was the first significant increase seen this year, and producers add that they expect September diesel prices to jump 15% to US60 cents/litre.

 

 

 

 

 

HITTING WHERE IT HURTS

‘Our fuel costs have doubled but we cannot reduce operating rates because of our contracts,’ says a source at Polytama, Indonesia’s second-largest polypropylene (PP) maker. Chlor-alkali producer Satomo Indovyl Monomer, meanwhile, says it relies on fuel for its boilers and furnaces, though a company source also adds that there are no plans, as yet, to slash operating rates.

However, Styrindo Mono Indonesia shut indefinitely a 120 000 tonne/year styrene monomer line on 1 September as a result of rising ethylene and benzene feedstock costs. However, it’s 250 000 tonne/year No 2 line in Merak will continue running as normal for the time being, the company says.

Chlor-alkali and polyvinyl chloride (PVC) producer Asahimas Chemicals admits it cannot continue to absorb higher costs indefinitely, warning that it may have to pass some costs on to customers.

Aaron Yap, an analyst at CLSA in Taiwan, points out that the ability of petrochemical companies to transfer costs down the product chain is key to addressing eroding margins.

‘This isn’t easy because the market is not responding, at the moment, to the high prices offered by the companies. Downstream, buyers are simply staying away,’ he explains. ‘Eventually, petrochemical companies will have to drop their prices, which will inevitably erode margins.’

A Hong Kong-based analyst at a major investment bank admits that the ability of companies to pass on costs depends on the product. ‘Speciality chemicals, for example, are doing better at the moment while commodities is still a buyers’ market,’ he says.

Asahi Kasei, Japan’s second largest petrochemical producer, says it will raise polyethylene resin prices by about 6% in October, the first increase in six months, according to newspaper reports. Japanese chemical companies raised prices of commodity-grade resins last year, but have, so far at least, avoided doing so in 2005.

Key raw material prices, especially for synthetic, water-soluble polymer production, have increased significantly over the past three years, say chemical industry experts. The sharpest increase in the last year has been due to escalating oil and natural gas prices as well as capacity limitations for key petrochemicals. This, combined with increased competition and demand for the same raw materials from China, will keep prices and shortages increasing well into 2006, one chemical official predicts.

HIGH FEEDSTOCK PRICES

Forced into a corner by the high feedstock prices, and at the sharper end of consumer price sensitivity, Asian refiners have had little choice but to hike prices or cut output. Taiwan’s Chinese Petroleum Corp and Formosa Petrochemical Corp raised wholesale gasoline prices by 7.64% and 7.39% respectively in recent weeks, a move which adds ammunition to those who warn the island’s GDP growth will fall by 0.25% this year if oil averages US$60/barrel, a scenario which looks very possible.

Refiners in China and Japan have simply been turning off the taps to limit the losses. Chinese motorists have been stalled by government-enforced fuel rationing. Japanese refiners Nippon Oil Corp and Cosmo Oil Co are apparently reducing throughput due to forecasts for slower gasoline demand this year.

The inability to pass on costs has had an inevitable impact on the bottom line. China’s Jilin Chemical and Industrial Co (JCIC), which runs a 530 000 tonne/year cracker, reports that its H1 2005 net profit plunged 80% to Rmb124m (US$15.3m) compared to the corresponding period of 2004, lower than it’s expectation of a 50% drop. JCIC attributes this to what it says was a ‘substantial increase in crude oil prices which have driven the price of refined oil upwards.’ The company says it expects profits to fall 50% for the first nine months of 2005, largely due to the increased cost of running its refinery.

However, its H1 2005 sales revenue increased 28% year-on-year to Rmb16.1bn on higher revenue from a wider petrochemical portfolio and an increase in petrochemical prices, JCIC says.

Back in May, Madoka Tashiro, chairman and chief executive officer of Japan’s Tosoh Corp, said he expected net profit to decline to Yen23bn (US$209m) in 2005-06 due partly to rising naphtha costs, a strong currency and concerns about a slowdown in Chinese markets.

Does this imply that those companies with a broader business portfolio will come out of this in better shape?

Maybe. Tosoh’s Tashiro emphasised the need to have a mix of products in order to weather the volatility that is a trademark of the chemicals business.

CLSA’s Yap, meanwhile, says the clear winners in all of this will be companies like ExxonMobil who are integrated right up to the wellhead.

‘Those integrated up to the refineries, such as BP, Shell and Chevron, will be borderline, while the losers will definitely be non-integrated steam crackers,’ he says.

‘Many people still think oil prices are volatile, despite projections that high prices could be around until the end of this decade. The concept of perpetually high oil prices probably hasn’t sunk in for many operators, and won’t until their mindset changes,’ says Yap.

There are signs it has sunk in for some, though. Paraxylene and benzene producer Aromatics Thailand Co (ATC) says it was hit hard by higher expenses caused by higher oil prices in Q2, leading to a 38.5% plunge in operating profit. Analysts warn that it will continue to suffer from high oil prices into Q3.

But ATC is now involved in high profile merger talks with the Petroleum Authority of Thailand, whose upstream interests would provide logical integration benefits.

At least one petrochemical company in the Philippines also appears to have taken the hint about integration as it seeks security in the volatile naphtha market. State-owned Philippine National Oil Co and refiner Petron are said to be eyeing a new joint-venture cracker in Bataan, which would be integrated with Petron’s existing refinery and may use liquefied petroleum gas and gasoil as an alternative to naphtha feedstock.

Cost pressures aren’t exclusive to products at the top of the chain. In South Korea, the Korean Federation of Plastic Industry Cooperatives says more than 50 small plastic manufacturers have been driven out of business this year alone due to higher petrochemical prices. Propylene and compound xylene prices rose 20.4% and 13.5% respectively in June, according to reports.

‘It is very difficult to make a business plan for next year due to the unpredictability of fluctuating oil prices,’ says a spokesman from LG Chem. The company’s subsidiary LG Petrochemical says its profitability declined slightly in Q2 on higher naphtha prices, which it says were at US$448/tonne in Q2 against US$362/tonne in the same period 2004. The company says it raised propylene prices to US$870/tonne in Q2 2005, against US$697/tonne in Q2 2004, though it adds that it had not passed on higher ethylene prices, which were at US$735 for Q2 2005, against US$788 in the same period last year.

NOT EVERYONE IS CONVINCED

Not everyone is convinced, however, that high oil prices necessarily spell trouble for regional economies. After all, the euro and yen have been performing well against the US dollar, providing a welcome cushion for higher oil prices on European and Japanese economies.

And importantly, some analysts point out that oil demand shows little sign of falling, indicating there’s still enough drive in the economies to offset inflationary concerns. How long this will last, though, is quite another question.

Mixed messages coming out of South Korea sum up how difficult things are to predict. The government said at the end of last month that it was pessimistic about the country’s H2 economic outlook, while the Bank of Korea simultaneously announced that the rising value of the Korean won against the US dollar had helped reduce the fuel import bill nicely.

The messages coming from companies and analysts are no less confusing. Some South Korean companies are expected to post a Q2 loss in fiscal 2005-06, thanks to high naphtha prices and low product prices, after months of profitable operations.

But the Hong Kong-based analyst says that ethylene crackers in Korea, such as Honam and LG Petrochemicals, are expecting better Q2 results.

‘It has to get better. Q1 was beset by weak product demand and ongoing speculation about the revaluation of the remnimbi in China which hit results,’ he explains. ‘There is a feeling that high oil prices are now a reality: that they’re here to stay. Buyers do seem to be returning to the market reluctantly in search of inventories for the peakproduction season running up to Christmas.’

MISSING THE BOAT

Whether they have missed the peak season boat is another matter.

Interestingly, a maintenance contractor whose clients include refining and petrochemical companies throughout Asia, says there has been no noticeable downturn in his business, suggesting that plants can still afford planned shutdowns even if their operating costs are high.

‘Some companies are, however, looking at extending the time between shutdowns due to the current price environment,’ he says.

Yap believes that companies in Asia will have to hold on to their hats for ‘at least the next six months, after which we hope to see things pick up.’

At least most projections now consistently come with a health warning – high oil prices are here to stay. It may be wise for companies to prepare for the long haul.-

WHAT'S IN A NAME?

Rick Coles looks at why petrochemivals are so named, and explains the often cosy relationship they have with oil

Market talk often, and rightly, concentrates on supply, demand and trading. New capacity, unexpected outages, buyers’ withdrawals from the marketplace, the latest cargo fixtures: these are the bread and butter of market reporting.

But what is sometimes overlooked is the reason why petrochemicals are called PETROchemicals. Behind every petrochemical stands good old oil.

In the aromatics chain the linkages are obvious. Naphtha and reformate and the alternative uses for BTX in gasoline all ensure that the relationship between refiner and chemical producer is a particularly cosy one. Price relationships between oil, benzene, toluene and xylenes (BTX) and aromatics derivatives are particularly strong and robust. Not for nothing did a senior executive of the old Amoco call PTA ‘white powdered gasoline’.

However, an executive of BP, ExxonMobil, Borouge, Sabic or any other polyethylene (PE) producer might, with justification, call PE ‘white granular oil’.

A look at a scatter graph of oil and Chinese cfr polyethylene prices over the period since January 2003 tells the story. Up to oil prices of around US$55/bbl the price relationship between the outer ends of the PE chain have been strong and it is only at very high (and very recent) oil prices that PE hasn’t been able to keep up.

Yet, ultimately, this is no surprise. In Asia, naphtha and other refinery and petroleum feeds (gas oil, condensate and heavy refinery streams) are used to produce more than 90% of the region’s ethylene. Small wonder that there is a close relationship between oil prices and ethylene price via the intermediate linkage of naphtha price. Regular readers of ACN will be aware that this has been illustrated in a number of my regular columns in the magazine.

As around two-thirds of all ethylene goes to make polyethylene, a close relationship between ethylene and polyethylene pricing is also not surprising.

Of course other factors are also at play, particularly in the short term. The current market situation provides an example. Downstream converters of PE have not been able to absorb the costs that would have been associated with oil above US$60/bbl and, today, we find PE significantly below its historical price relationship to oil.

Nevertheless, what is particularly interesting in the enduring price relationship between oil and Chinese PE prices is the vast differences in price risks that are so intimately intertwined.

At one end of the spectrum is oil, perhaps the most volatile of all commodities, whose price varies literally by the minute. At the other end of the spectrum is the converter buying PE and selling end products into markets that may well insist on fixed prices for months or even a year. Just consider for a moment how much price risk is being absorbed down the PE chain.

Given that ethylene and PE pricing in Asia is virtually 100% spot, one of the ironies of this pricing relationship is that the lion’s share of price risk is absorbed by the converter, the party least equipped to absorb it!

So, as you read your market reports and consider supply, demand, plant performance and trading, never, ever lose sight of the underlying effects of the cost of good old oil. Remember, they aren’t called PETROchemicals for nothing.

< previous article(ICIS Chemical Business podcast November 2, 2009)

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