INSIGHT: Cracker and profit margins expected to moderate through 2012

06 July 2011 16:44  [Source: ICIS news]

By Nigel Davis

LONDON (ICIS)--We are looking down from dizzying heights, and the multi-million dollar question is whether the slope ahead is gentle or steep.

Analysts with Bernstein Research, part of Hong Kong-based AllianceBernstein, expect naphtha cracker margins – and ultimately petrochemical producers’ operating profit margins – to moderate over the next 12 months or more. Ethylene cash margins in western Europe were at 10-year highs in June; in the top quartile in the US and the second quartile in Asia.

“With key petrochemicals prices rolling over and margins near historical peak levels, we believe cracker margins will likely gradually decrease from here. In June, prices of basic petrochemicals have started rolling over with crude oil prices, and we are expecting less unplanned downtime and more debottlenecking. Therefore, we expect margins to gradually decrease through 2011 and 2012,” they said in a research note issued on Wednesday.

The negative impact of upstream chemical producers, however, is likely to benefit those further down certain product value chains, by providing welcome relief from higher feedstock costs.

Bernstein Research says, for example, that it expects BASF’s chemicals segment operating profit (EBIT – earnings before interest and tax) margin to fall by 200 basis points between now and the end of 2012. But because about 30% of the company’s cracker products are the raw materials used in other parts of its business, it is likely to make gains that will compensate for the weaker upstream position.

Overall, Bernstein is positive on the Germany-headquartered global chemicals giant. Its earnings estimates are 18% above consensus EBIT before exceptional items in 2011, and 8% above consensus for 2012.

Of particular note is the fact that it is some 25% above consensus for the second half of this year, because it believes that BASF will be affected less than other cracker operators because of its position in plastics, so-called performance products and ‘functional solutions’. Pricing power can be gained in these businesses, even though there are near-term challenges.

Both petrochemical and some polymer prices have rolled over, and most recently declined as the negative sentiment has spread from China.

“In June we saw prices for key petrochemicals starting to roll-over. For example in western Europe, prices for ethylene in June decreased by 3%, propylene prices decreased by 3%, benzene prices decreased by 5%. The only prices that increased were butadiene and C4 which increased by 14% and 4% in June,” Bernstein Research notes.

The suggestion is, however, that gradual re-investment in “under-maintained” assets will mean more supply coming on-line in the short term, “and a measurable decrease in forces majeures. Debottlenecking in the medium term should help alleviate the pockets of (temporarily) tight supply, although as new cracking capacity comes on-line in China and the Middle East, nameplate capacity operating rates could remain as low as 80% over the next five years.

Margins for naphtha cracker co-products, particularly propylene and butadiene, have been strong thus far in 2011, although propylene prices have declined in recent weeks. The returns from these businesses could help underpin (naphtha) cracker margins in the second half. But propylene prices have begun to fall, although butadiene has remained strong.

Bernstein Research believes that the contribution to cracker operator profitability of the margins from these products is currently above the historical average – at around 60%, compared with a 2000–2009 average of 50%. It suggests, however, that the contribution will “normalise” to around mid-cycle levels over the next two years.

That normalisation process has begun, as ICIS cracker margin analysis (which takes into account co-product values) shows.

European contract cracker margins

European contract naphtha cracker margins have fallen by almost a quarter on higher naphtha costs, but lower ethylene and propylene prices.

In the week ending 1 July, contract cracker margins fell by €162/tonne ($235/tonne) to €579/tonne from a post-2008 crisis margin peak in June of €667/tonne.

The July ethylene contract dropped by €95/tonne to settle at €1,090/tonne free delivered (FD) northwest Europe (NWE), while July propylene settled down by €75/tonne at €1,130/tonne on the same basis.

(€1 = $1.4)

By: Nigel Davis
+44 20 8652 3214

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