INSIGHT: Petchem concerns clouded by uncertainty

01 August 2008 15:48  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS news)--The world’s oil majors stick with chemicals because they provide growth.

If you have the technology and engineering expertise, then the sector is not a bad place to be. The world wants upstream chemical intermediates to drive its industries and help oil the wheels of commerce.

True, you have to have put steel on the ground in the right place at the right time - hardly an easy task to predict. And you need to be particularly adept at running complex processing and marketing systems. But the rewards are substantial.

The past three to four years have proved to be a boom time for petchems makers. The sector, along with most of the broader chemicals business, has been able to provide what some have called a "plateau" of earnings.

But those good, or better times, have juddered to a halt with the rapid increase in the cost of raw materials and energy.

The second quarter was difficult in the upstream (chemicals) business to say the least. Liquids cracking margins were under severe pressure. Gas crackers too felt the squeeze, but hardly to the same extent.

But you don’t analyse this business on a quarterly basis, often not on annual returns.

Companies aim for a sustainable, base level of performance but push hard for more. Working within legacy constraints - the plants and the businesses on which they are built - most seek to broaden the envelope in terms of influence and performance.

The trouble now is that performance is coming under severe pressure and beginning to look a bit thin. The chemicals cycle is starting to bite.

Just this past week, consultants ChemSystems called the supply-driven olefins downturn for 2010-2011, a bit later than most, so the suggestion is that we are only a short way below the crest on the down slope.

Managing through this period of volume and, subsequently, price pressure is going to be tricky and there are considerable uncertainties in terms of operating costs and product demand.

Those uncertainties now are uppermost in minds of many industry executives.

Olefins margins were hard hit in Q2. Look at the industry data Shell collects on regional naphtha and ethane-based returns. But producers have recovered some ground with more recent ethylene price increases.

The big question is how petrochemical companies manage prices in the second half as crude comes off recent highs and the wind is taken out of their sails as regards product price hikes.

French oil giant Total put it in a nutshell on Friday when it said that Q2 petrochemical margins were weak, “reflecting the squeeze of rapidly rising naphtha prices and weakening demand in the Atlantic Basin”.

Its base chemicals businesses slumped into loss in the quarter and the going was clearly hard for the more specialised products in the Total chemicals portfolio.

The company’s base chemicals include ethylene and propylene (from crackers and oil refining), styrene, polyethylene (PE), polypropylene (PP) and fertilizers. Specialties include rubber, resins, composites, electroplating and adhesives.

This sort of performance reflects the dilemma for the oil companies. Stick with chemicals and you are stuck with fluctuating and hardly sparkling returns.

And those returns have trended down markedly over the past year let alone in the most recent quarter.

Total says its return on average capital employed (ROACE) in chemicals dropped to 7.7% in the year to the end of June 2008.

For all of 2007 the chemicals ROACE was 12.1%. Admittedly, the oil companies are also feeling the pinch in their downstream businesses while making the real money upstream, but chemicals is suffering disproportionately.

All is by no means doom and gloom. June was dreadful for any company wedded to naphtha cracking and that includes most olefins makers in Europe and Asia. But the cost situation has improved. Questions now must be asked about the rate of demand growth.

Downstream, customers still appear willing to accept significant price increases. If they contiue to be able to pass on, or absorb, cost increases then upsream producers retain some market strenght.

ExxonMobil called the petrochemicals environment “robust” overall after itssecond-quarter results.

“Long term, we see the chemical business as growing,” said Henry Hubble, vice-president of investor relations. The oil giant was hit hardest in the second quarter by feedstock cost increases in its aromatics businesses.

But the results shed some light on the demand slowdown in North America that is linked most importantly as far as chemicals makers are concerned to the downturn in housing construction and automobiles.

The firm’s US profits from chemicals were just $102m (€65.6m) in the latest period compared with $204m in the second quarter of 2007.

Non-US second-quarter net profits from chemicals were down 28%, at $585m. That number will have included profits from strong joint ventures, including those in the Middle East.

Petrochemical makers are faced in Europe with the third-quarter summer lull. We don’t as yet know what impact government clampdowns ahead of and during the Olympic Games will have on China demand.

Uncertainty generates the sort of operating environment that few companies relish no matter how confident they are in their ability to handle the worsening times as well as the good.

($1 = €0.64)

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By: Nigel Davis
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