INSIGHT: Making the most of a mini-price bubble

13 February 2009 14:48  [Source: ICIS news]

By John Richardson

SINGAPORE--A polyethylene (PE) buyer says there has been an “almost perfect” correlation between the recent rise in the costs of naphtha and resin, reflecting his belief that the price recovery is mainly feedstock-driven. The graph from ICIS pricing appears to support his view.

Demand has also recovered, though on modest restocking. Converters were holding several weeks of inventory in the first half of 2008, says a Hong Kong-based trader.

“This fell to as low as one day in Q4 but is now back up at one week. From naphtha through to resin, prices fell too far – an overreaction as everyone panicked. A recovery was inevitable but the question now is whether the recovery has been overcooked.”

Increased liquidity in China seems to have turned up the heat beneath the pot. More loans are reported to have been issued by local Chinese banks in January than in the whole of the first half of 2008 as the government, perhaps in desperation, tries to shore up GDP (gross domestic product) growth.

Approval processes for loans have been simplified and there are reports that recently beefed-up labour and environmental rules can be ignored.

“Some of the extra cash is flowing into fixed-asset investments, but a lot of it is also ending up in trade finance and with the traders who have bought petrochemical cargoes in the hope of making a killing,” said a Singapore-based trader.

“If it all goes pear-shaped and they have to liquidate their inventories at a loss, will they have to repay their loans? This is an interesting question, as this would counteract the boost that the extra lending has given to the economy. I suspect that the answer could, in some cases, be no.”

So there you have it: if any of the traders are aware that their lending has no strings attached, they can afford to take a risk-reduced punt.

But for producers of petrochemicals, the danger is, of course, that the not-always-entirely-visible quantities of traders’ inventory could suddenly flood the market and cause a downward price correction.

Producer sentiment has definitely improved relative to the fourth quarter of 2008, and there is no disputing that there has been a real and tangible improvement in demand from some end-users.

However, it doesn’t take a rocket scientist to note the vulnerability of some downstream sectors compared with others.

A lot of PE goes into packaging. Even in the midst of what is perhaps the worst economic crisis since the Great Depression people are not suddenly going to switch back to paper to wrap food.

But while PE’s price rally continued after the Lunar New Year, the phenol chain continued its decline as most of the consumer spending at the end of this chain is non-essential or discretionary.

For instance, why rush out and buy new CDs and DVDs if you might be about to lose your job? Some polycarbonate (PC) also goes into construction as does phenolic resins.

Upstream aromatics values have improved as a whole. Yet benzene is awful. It has traded at or below naphtha since November 2008, reflecting the need to run reformers for other reasons – and weakness in some benzene derivatives.

Five weeks ago, toluene was at $470-480/tonne FOB (free on board) Korea. At the end of last week, prices had risen to $578-585/tonne FOB, with a $35/tonne increase following the Lunar New Year holiday, according to an assessment by ICIS pricing.

The rise in isomer-grade xylenes began earlier and has led to even healthier spreads over naphtha. Prices were at $690-710/tonne FOB Korea last week, an increase of $55/tonne from the previous week.

“We’ve seen, as a result, several toluene disproportionation (TDP) units (which take toluene and convert it into xylenes) restart in Thailand, South Korea and Taiwan,” said an experienced industry observer.

But there are reports of Japanese TDP operators being a little more cautious.

The surge in isomer-grade values is obviously being driven by the polyester chain.

Paraxylene (PX) had risen to $890-910 FOB Korea by the end of last week from $740-760/tonne FOB Korea four weeks earlier. Prices for purified terephthalic acid (PTA) had gained $90/tonne in just one week to stand at $740-750/tonne CFR (cost and freight) CMP (China Main Port).

But again, there you have it: Some polyester plants are reported to be running at only 50% of capacity in China. Ninety per cent of textiles and garments in the US are imported, and guess where most of those imports come from?

The huge Chinese economic stimulus packages are going to help, but some commentators say that domestic polyester demand grew too quickly and was going to level off anyway – even without the economic crisis.

The blunt fact is that no matter what the government does to boost the economy, in the short term it cannot replace all the lost demand in the West for finished goods, from shirts to plastic toys to shoes and electronics.

With the consumer-demand outlook at the very least uncertain – and probably set to get even weaker – are we therefore in the midst of a mini petrochemical-pricing bubble?

Some support for aromatics will be offered by improving gasoline demand. There are already reports of a greater requirement for toluene and xylenes as octane boosters.

The US driving season is imminent. Although it’s likely to be anaemic compared with the boom years, low gasoline prices might at least lead to some kind of demand recovery.

Asian gasoline demand is also set to continue growing, even if at lower rates.

The fate of poor old benzene, therefore (which you obviously have to always take out of reformate) might be grim. How far could it fall below naphtha prices as reformers keep operating for gasoline, xylenes and toluene values – and to produce hydrogen for hydrocrackers?

And what of the support from naphtha, which has, as was previously mentioned, been a big driver behind recent petrochemical price gains?

“I am bearish on naphtha in the second half of this year,” said N Ravivenkatesh, a Singapore-based consultant with international energy consultancy Purvin & Gertz.

“A reason is weaker petrochemical demand. For example, Northeast Asian naphtha demand (excluding China) is forecast to fall to 2.8m tonnes this year from over 3m tonnes in 2008.”

He sees the overall Asian deficit slipping to well below its 2008 level of 3m tonnes.

Big capacity build-ups in the Middle East of ethane-based ethylene (C2) and derivatives will hurt naphtha consumption – along with weaker petrochemical demand – added Ravivenkatesh.

More than 5m tonnes/year of C2 capacity alone is due on stream in the Middle East this year. There will also be the impact on markets of capacity that started up in the second half of 2008.

Naphtha, as with petrochemicals, had to rebound as prices had fallen too far.

Refiners were caught unawares by the fourth-quarter crisis and made big operating cutbacks, along with their petrochemical customers.

Crack spreads for gasoline, naphtha and other refinery products fell into deep negative territory in October-December, but have since rebounded very strongly, said Ravivenkatesh.

The improvement in naphtha is the result of the refinery rate cuts, better demand from petrochemicals and reduced exports from India as naphtha has become a more attractive fuel for power and fertilizer plants than natural gas.

Term naphtha requirements have been reduced by northeast Asian cracker operators because of the uncertain demand outlook. Spot premiums have, as a result, increased as the spot market has become more active.

And because of deep operating rate cuts at Chinese refineries, China has swung from being a slight net exporter of naphtha to an importer in February.

“Now, though, the refinery and petrochemical players are trying to communicate better in order to better coordinate operating rates,” Ravivenkatesh said.

What of crude prices? They might firm a little on likely further OPEC cut backs next month, but you cannot see a big upsurge in pricing without obvious signs of a sustained global economic recovery.

Second-half March naphtha cargoes were at $464.50-$465.50/tonne CFR Japan, first-half April shipments were at $454-$455.50/tonne CFR Japan, with second-half April at $443.50-$445.50/tonne CFR Japan.

Take away the argument of rising or firm feedstock costs and petrochemical producers will have one less reason for maintaining price increases.

It’s all about the economy. But even when the world is eventually sure that the worst is over, the petrochemical industry will still have to confront its big supply overhang.

We could see several more mini-pricing bubbles before the industry is out of the woods.

At least, though, there will be some people making money out of entering and exiting these bubbles at the right time.

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By: John Richardson
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