INSIGHT: Petchems poised for worst ever downturn

30 May 2008 10:56  [Source: ICIS news]

By John Richardson

 

SINGAPORE (ICIS news)--We are on the verge of perhaps the worst downturn in the history of petrochemicals which will see the closure of an unprecedented amount of capacity in developed and higher-cost Asia, Europe and the US.

 

Some of these shutdowns could be permanent, leaving record numbers of companies asking themselves whether remaining capacities make them meaningful players across a wide range of products.

 

This is one way of viewing the outlook at this week’s eighth Asia Petrochemical Industry Conference  (APIC), which was held  in Singapore.

 

But everything is subjective and how you interpret the words you hear, without wanting to get too philosophical, is down to your particular mindset.

 

Those with a gloomy disposition would have been more likely to see the negatives and come away with the impression that all but the Middle East producers should abandon all short and medium-term hope.

 

Things are never that black and white, as was the case at last year’s seventh APIC conference in Taipei, Taiwan, when top executives were almost declaring the death of cycles. This was based on the theory of a new paradigm of uninterrupted strong emerging-market growth.

 

Still, if you are in polyolefins you may be feeling that it’s “darkness at the break of noon”, to quote Bob Dylan.

 

“Our customers cannot take any more price rises – they are at breaking point and I cannot see any relief for us on naphtha prices. Crude might well go much higher,” said a source with one major global polyolefin producer which has major Middle East and Asian operations.

 

We have heard this for years – the squeeze placed on the converters by polyolefin producers enjoying healthy supply and demand balances and a hugely consolidated retail sector. The same story has been told in other products, especially styrenics.

 

But the recent polyolefin price rises - driven by crude hovering around $130/bbl and Asian naphtha in excess of $1,000 tonnes - have exerted seemingly unbearable pressure on the little guys stuck in the middle.

 

As for the polyolefin producers themselves, they said that they were already at or close to losing money on a cash-cost basis, despite all the recent price hikes.

 

Markets were characterised as quiet with buyers unwilling to commit to purchases because of the daily sharp fluctuations in feedstock costs.

 

Producers also talked of inventories throughout the chain being low and supply remaining tight. This was the result of scheduled and unscheduled operating-rate reductions.

 

Another factor behind tight markets points to the big danger ahead: producers reported that they were sold out for the first half because of pre-marketing ahead of new-capacity start-ups.

 

The well-documented flood of new capacity began with the commissioning of the Advanced Polypropylene PDH-polypropylene (PP) plant in Saudi Arabia in the first quarter. Another PDH-PP plant in Saudi, Natpet, is in the process of coming on stream.

 

This is just the light shower before the storm. Four crackers in Saudi Arabia, one in Qatar and one in Kuwait are due on stream over the next 12 months.

 

The Jam Petrochemical and Arya Sasol crackers in Iran are at last running, albeit at low operating rates and with limited or no downstream consumption.

 

This could result in very liquid Asian spot ethylene markets and high naphtha costs over the next few years. Adjustments might have to be made by Asia’s naphtha-based producers because of the big role that spot pricing plays in Asian ethylene (C2) contract calculations.

 

The ICIS plants and projects database estimates that 57.09m tonnes/year of ethylene capacity will start-up in 2008-12. The Middle East will account for 24.76m tonnes/year of this volume and China 12.865m tonnes/year.

 

This is at a time when we are entering uncharted global - and also emerging market - GDP (gross domestic product) growth territory.

 

Two months ago you would have been hard pressed to find an economist who would have predicted that the world’s economy would expand by less than 3% in 2008-09. This would still have represented a sharp decline from the 3.5% growth we have seen over the past four years.

 

Estimates have since emerged of growth below 3%, perhaps even close to 2%. The maths is in danger of being very simple for petrochemicals: Annual capacity additions greatly in excess of demand and markets remaining long well beyond 2012 - the year that some commentators still believe will signal a return to healthy operating rates.

 

Growth could be lower than recent forecasts because inflation, driven by high crude and food costs, is getting out of control in Asia.

 

The Economist magazine suggests that Asian governments are about to repeat the errors made by their Western counterparts during the 1970s: Central banks that are not truly independent keeping interest rates too low in order to stimulate growth and keep currencies export-competitive in the weaker dollar environment; a lack of confidence in the ability of governments to manage inflation, leading to a wages-prices spiral; price controls and subsidies hiding the true extent of inflation.

 

Asian governments have at least started cutting subsidies on fuel prices - for instance, Indonesia.

 

India has hinted that it might follow suit, although there are as yet no indications that China will shift in this direction. China has huge currency reserves and so can afford to subsidise fuel prices for as long as it feels is necessary to guarantee strong growth.

 

Fuel-subsidy cuts may reduce growth in demand for oil, thereby bringing prices down.

 

But the dilemma for Asian governments is that they need to sustain high levels of growth for social stability reasons. Affordable fuel is the means to guarantee strong expansion of economies.

 

Everywhere in Asia, consumers are complaining about inflation and are moderating their spending habits.

 

For the rich this means less buying of luxury goods made from chemicals.

 

As for the poor, there will be a slowdown in the rate that they substitute goods made from natural products for those manufactured from chemicals.

 

Food accounts for a higher proportion of incomes in emerging economies than in the West. As a result, the World Bank estimates that 105m people in developing countries have been pushed back in to poverty by rising food costs.

 

Let’s pause for breath, though. Markets have a way of finding their equilibrium – they have to find their equilibrium – and so a lot of capacity might be idled in the West and the less competitive parts of Asia. Some 2m tonnes/year of US propylene capacity is expected to be permanently scrapped over the next few years, for example.

 

A much bigger share of the world’s petrochemical assets is in the hands of private owners compared with the last downturn.

 

Perhaps private owners will feel the heat from bond holders more quickly than if they were shareholder-owned, particularly as several companies are highly leveraged.

 

This could lead to hard decisions being taken more quickly than previously. The prediction made at the beginning of this article might, as a result, come true: An unprecedented number of companies exiting products.

 

An additional plus is that state-owned entities have become less state-owned in mentality. Restructuring after the Asian financial crisis has left the Thai industry, for example, more efficient.

 

In China, too, the opening up of the economy has been the driver of an increasing focus on profitability at Sinopec and PetroChina.

 

Further good news is that the majority of petrochemical feedstock remains crude-oil based, meaning that pricing will be driven by the naphtha and other liquids-based producers.

 

A worrying statistic, though, was provided by CMAI in its seminar during this year’s APIC conference. The consultancy estimates that 80% of new basic petrochemicals capacity will be in Middle East and China compared with 20-25% during the previous decade.

 

Middle East plants will run hard in any market conditions because of their cost base.

 

The cynics would also argue that despite the changes in China, the cost of capital remains effectively zero and the government strategy is to substitute imports. Many plants might therefore be run at high operating rates, even if they are bleeding money.

 

In the end it all comes down to the price of oil. A Middle East polyolefin producer conceded that its forecast for the next two years “pretty much ranges from $60/bbl to $200/bbl with various stops on the way”.

 

A world recession might moderate crude prices, making the cost pressures down all the product chains much more bearable. But, of course, this is the last thing anyone wants.

 

The accepted wisdom has become the Goldman Sachs view that crude has further to rise – and could reach as high as $200/bbl by the end of 2009. Because Goldman Sachs was right on $100/bbl, great store is being set in it recent forecasts.

 

Being right once doesn’t mean you will always be right.  Lehman Brothers believes a combination of a stronger dollar leading to a decline in speculation, higher Saudi production and moderating demand will push oil to as low as $70/bbl by next year.

 

Take your pick, and, as the Middle East producer suggests, build in lots of scenarios.

 

Even if you have come away from APIC buoyed with optimism, this is a time of great uncertainty. 

 

We are on the verge of major changes. Something has to give because ever-higher costs combined with lower growth are unsustainable.

 

Let’s hope that what gives is the oil price – but not at the expense of a global recession. 

 

 

 

 

 

 

 

  

 

By: John Richardson
+65 6780 4359

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