Market intelligence: European olefins players wrestle with volatility

11 April 2011 00:00  [Source: ICB]

As buyers and sellers struggle with rapidly changing prices, could split settlements emerge? It may take another crisis to change the current system

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 (BD) 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 realize 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 high of €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 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 uprising and political tension across the Middle East and North Africa.

In particular, near civil war in Libya pushed Brent crude oil to a 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.

SPLIT SETTLEMENTS POSSIBLE
Some sources speculated on the possibility of a split settlement, building in some extra 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 stabilized 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 reopener clause, but it may only be allowed to call for a reopener once a year. In all contracts, there is a dispute clause, or hardship clause, if either party really feels it has been wronged.

One market observer says: "There is always flexibility to the counterparties: they can cause a split contract price by not following the first settlement or they can use reopeners. 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 [there will be split settlements]. 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.

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, it's 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 around, visibility - or rather the lack of it - reared its head once again.

China polyethylene (PE) is weak and the Asian market stagnant, despite cracker turnarounds. The Japan disaster, coupled with ongoing tensions in Libya, Yemen and elsewhere in the Middle East have an influence.

APRIL CONTRACTS 'EASY'
However, the industry settled April contracts comparatively easily. April ethylene settled at €1,205/tonne FD NWE, up €10/tonne, and propylene at €1,210/tonne FD NWE, up by €25/tonne.

The month-on-month increases of €10/tonne for ethylene and €25/tonne for propylene were in line with market expectations and based on strong demand and firm upstream values.

A major propylene producer said that, compared with the March settlement, the April settlement "was easy." The initial April settlements were agreed on March 28.

The ethylene contract price was first agreed between a major olefins producer and one of its customers, which is a key nonintegrated ethylene consumer. To date, two producers and two consumers have confirmed the settlement.

The major olefins producer was also the first to settle the propylene contract, which has risen above the ethylene price for the fifth time since April 2010. The producer first settled with a major net consumer, and then with a major nonintegrated consumer.

To date, three producers and three consumers have agreed to the April propylene price, but confirmation from one of the consumers is still pending.

Sources say there are still a lot of uncertainties going forward, particularly in view of the ongoing turmoil in the Middle East and the impact of the earthquake and tsunami in Japan.

With ever higher prices now causing some concern among derivatives players, the olefins industry appears to be adopting a cautious and more moderate approach.

"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 questioned whether there could be a shift toward basing contracts partly on spot - although this was widely deemed a non-starter because of the illiquidity of the spot market in Europe.

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

By: Nel Weddle
+44 20 8652 3214

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