INSIGHT: Europe's olefins players wrestle with volatility

30 March 2011 22:33  [Source: ICIS news]

By Nel Weddle

LONDON (ICIS)--Increasing upstream price volatility, over which this industry holds no sway, and the unprecedented decline in demand in the fourth quarter of 2008 led to the move from quarterly to monthly contracts for European ethylene and propylene. More recently, butadiene has followed suit.

A quarterly contract mechanism had been sufficient for most players until the mid-2000s when the calls for a change started to surface. But even then, it took the dramatic events prompted by near global financial meltdown for both buyers and sellers of the most important petrochemical commodities to realise that limited visibility of demand, supply and costs meant there was only one way to go to lessen the burden.

At the end of 2008, the quarterly Europe ethylene contract hit a record €1,228/tonne ($1,731/tonne) FD (free delivered) NWE (northwest Europe), but demand had sunk.

Consumers were declaring force majeure on volumes, reneging on agreed deliveries - one or two producers reported that they were having to come up with ever more creative ways of dealing with the unprecedented situation and to keep the crackers running, albeit it at technical lows not experienced before. The details were not disclosed but were thought to relate to heavy discounts on contract volumes and spot related numbers.

Now, after a reasonably steady 2009-2010 we see the potential for increased upstream volatility in 2011. The price of oil - and subsequently naphtha - has been heavily influenced by civil unrest and political tension across the Middle East and North Africa.

In particular, near civil war in Libya pushed Brent crude oil to a 24-hour peak of $120/bbl, just as March olefins contract negotiations in Europe were getting underway - cue a delay and then more pressure as time disciplinarians wanted a number fixed and fast.

This led some sources to speculate on the possibility of a split settlement, building in some additional flexibility and/or having some way of reopening contract discussions, should upstream and downstream events go beyond expectations

“I openly discussed this idea [of a split settlement] with all my customers” a major olefins producer said at the time.

One of those customers admitted that while it was an interesting possibility, such a key decision surrounding supply contracts could never be taken without several internal and external discussions. The earliest any changes could be seen was for May-June.

In the event, upstream costs later stabilised and settlements were reached for March, although at higher levels than had been originally expected because of the concerns over possible feedstock developments.

But are changes to the contract process feasible, workable, or even under further discussion? And is there a real need for it?

Some contracts already have a re-opener clause, but there may be only allowance to call for a re-opener once per year. In all contracts there is a dispute clause, or hardship clause, if either party really feels hard done by.

One market observer said: “There is always flexibility to the counterparties: they can cause a split contract price by not following the first settlement or they can use re-openers. However, since the move to monthly [contract price (MCP)] there should be less stress even in highly volatile markets because they know they can correct on a monthly basis”.

Others agree. “For the time being, I don’t think so - it was dramatic in Q4 2008 but we dealt with it [through the MCP] no one [buyers nor sellers] suffers for long,” said a major net consumer of ethylene and propylene said

The point has been echoed by another major net consumer of propylene. “The March settlement was stressful, but it shows that the MCP works - we have a system, its stable and it has worked for two years”

The overwhelming view seems to be a case of “if it ain’t broke, don’t fix it”.

As discussions for April contracts swung round - visibility, or rather the lack of it, reared its head once again.

China polyethylene is weak, and the Asian market stagnant despite cracker turnarounds. The Japan disaster on the one hand, and ongoing tensions in Libya, Yemen and elsewhere in Middle East have an influence.

However, the industry settled April contracts comparatively easily. Although with the ever higher prices now causing some concern amongst derivatives players, the olefins industry appeared to be adopting a cautious and more moderate approach.

April ethylene settled at €1,205/tonne FD NWE, up €10/tonne, and propylene at €1,210/tonne FD NWE up by €25/tonne.

“I would not be an advocate for opportunistic reopening around naphtha price escalation/falling within the month - the answer would then be daily pricing like naphtha” the market observer added.

Some have queried whether there could be a shift towards basing contracts partly on spot - although this widely deemed a non-starter due to the illiquidity of the spot market in Europe.

So it seems that it would take another unprecedented world-scale event to change the current contract system.

($1 = €0.71)

By: Nel Weddle
+44 20 8652 3214

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