Commentary: Energy hurts Europe

07 May 2012 00:00  [Source: ICB]

The disconnect between European and US natural gas prices is hitting profit margins hard

Anyone who follows our weekly feedstocks page will have noticed over the past two to three years how European natural gas prices have disconnected from the US.

Thanks to the US shale gas phenomenon, prices have slumped from over $12/MMBtu to around $2/MMBtu. Yet in Europe gas prices remain tied to oil prices and are therefore at historically high levels.

There has been a lot of focus on ethane from shale gas as a feedstock for chemicals production in the US. This already puts producers there at an advantage over Europe, which cannot access this resource. But Europe faces a second competitiveness challenge from gas through its use as an energy source for chemicals production.

Fuel and power spending for steam, electricity and furnaces amounts to around 10% of sales for chemical producers, according to a paper by analysts at Bernstein Research. It estimates that fuel and power production account for around 35% of the total energy consumed by the chemical industry.

EU gas prices are six times higher than in the US, higher than at any time in the past 20 years, says Bernstein. As a result, the US chemical sector enjoys roughly an 8% cost of goods sold advantage and 50% earnings before interest and tax gain from fuel and power alone. This could rise up to 60% for the US sector if gas prices keep falling and European prices remain elevated, they estimate.

Natural gas contract prices in mainland Europe remain connected to oil prices as this is the preferred pricing regime of two dominant sellers, Russia's Gazprom and Norway's Statoil. There is a lot of pressure from buyers, understandably, to disconnect from oil, and there are a lot of arbitration cases ongoing between the two sides. UK spot prices are shown above.

For now, at least, most European chemical companies will have to endure this competitive disadvantage. Companies and trade groups are campaigning hard against further increases in costs relating to EU carbon controls. The UK's Chemical Industries Association last week called for shale gas exploration to be given greater political consideration. It looks like high fuel and power prices are here to stay for the European market.

By: Will Beacham
+44 20 8652 3214

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