INSIGHT: Profits lifted and the cycle smoothed by cracker co-products

15 November 2012 16:34  [Source: ICIS news]

By Nigel Davis

A naphtha crackerLONDON (ICIS)--Purely on a cost basis, naphtha or liquids cracking hardly appears attractive when set against the much technically simpler cracking of gases like ethane.

Gas crackers are easier and cheaper to build. So the availability of higher volumes of ethane in North America from the exploitation of shale gas and shale oil, as well as projected relatively low prices, makes the decision to crack more gas an easy one.

Not so the cracking of liquids. Which is rather the opposite.

Petrochemical producers in the US have moved sharply to crack more ethane. Elsewhere, the situation in which those producers find themselves, is viewed with some envy.

Taken together, feedstock and energy costs are by far the greatest cost element of the cracker. And if those costs are related to cheap ethane and natural gas rather than expensive naphtha and oil then so much the better.

Yet you wouldn’t build a naphtha cracker to produce solely ethylene, although ethylene is the primary product from the plant.

The value of co-products, primarily propylene, C4s such as butadiene, and aromatics such as benzene and the xylenes, is immense.

Taking the value of these products into account when assessing the profitability, or the value generated, from these competing petrochemical processes, sometimes sheds a very different light on the picture.

Financial analysts Bernstein, for instance have this week assessed the cracking process and the fact that profit margins from naphtha cracking remain, in its words “surprisingly high”.

They are surprisingly high simply because the co-products produce so much value for the operator, even though C3 and C4 prices have declined from 2011 highs.

“Naphtha cracker owners have surprisingly benefited from low-cost gas,” Bernstein Research says in a note to investment clients. "The shift towards ethane cracking has boosted global naphtha margins to mid-cycle levels when operating rates imply margins should be at trough levels.”

Bernstein reckons that cracker operating rates globally are around 88%. And because of the shift in value from oversupplied ethylene to relatively tight co-products, we are in a situation not seen in the past 20 years.

“The shift in feedstock mix is smoothing the naphtha cracker cycle – it has made the current trough shallower and could smooth the next peak,” the analysts say.

“We estimate several naphtha cracker owners (eg, BASF, Sinopec, Reliance) are earning an additional 10-25% EBIT [earnings before interest and tax] in their chemicals businesses and 3-7% of group EBIT due to co-product scarcity. Other companies outside our coverage (eg, LyondellBasell and Dow) have group EBITs that have been boosted by about 10%. We also expect smoother earnings over the cycle.

Over the longer term, ethylene demand is expected to improve, tightening the supply demand balance and providing some upside to cracker operator’s earnings. Naphtha cracker margins are expected to remain stable because of the balance provided by co-product values.

Bernstein’s profit model for BASF’s chemicals segment EBIT before exceptional charges and gains suggests that margins will increase from 13% in 2012 to 16% in 2015. “We are now more confident that margins will remain well above BASF Chemicals’ trough of about 9%.”

The analysts believe that there is some upside risk too, and that the company’s chemicals segment margins (EBIT to sales) might not now reach their prior peak of 20%.

The overall impact is, however, positive with expected higher ethylene margins feeding into the equation and lifting Bernstein’s adjusted earnings per share (EPS) 2015 estimate for BASF by 4%.

Chemical companies cracking naphtha and other liquids fully recognise the value of the co-products they produce although there is the constant battle with costs so closely related to the volatile price of oil.

Understandably, Bernstein sees the value of co-products, and the smoothing out of the profit cycle, apply to other operators, including to a greater or lesser extent the petrochemical operations of the downstream integrated oil majors.

The company says that it is seeing signs of a bottoming out and even an improvement in chemical margins, which have been under pressure for most of 2012. Given a continuation of China’s economic recovery, it expects demand to pick up and margins to improve with Sinopec being levered the strongest to this in Asia.

“Longer term, while there is concern on more cost competitive exports of ethylene from the US, the increase in value of co-products may mean that some of the concerns are overdone, it says.

ICIS analysis of cracker margins – naphtha-based, taking into account co-product credits, as well as ethane margins in the US – show that year-to-date they have held up remarkably well.

Europe naphtha feed ex works cash margins were particularly high in May and June and have recovered from a low point in July. Naphtha cracker cash margins in Asia have been much lower to date in 2012 because of higher naphtha costs and have reflected weakness in local regional demand and lower cracker co-product prices.

Contract margins on an ethane fed cracker in the US so far in 2012 are more than 40% higher than the 2011 average.

Read Paul Hodges’ Chemicals and the Economy blog
Bookmark John Richardson and Malini Hariharan’s Asian Chemical Connections blog

By: Nigel Davis
+44 20 8652 3214

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