29 November 2012 18:47 [Source: ICB]
Shale gas will have significant long-term effects on the global petrochemical industry. Those impacts, and the associated strategic decisions needed to manage them, vary based on a company's position, ambition, and what will happen to the shale gas ecosystem in the long term.
We will walk through these issues and strategic decisions, using the results of a comprehensive, integrated study by A.T. Kearney, starting by examining the future of shale gas, then showing how those developments will affect petrochemical markets, and identifying the key strategic questions that each type of company needs to answer.
FUTURE OF SHALE GAS
The development of shale and associated natural gas liquids (NGLs) has shifted the US from a net importer to exporter of gas and sent natural gas prices to profoundly low levels of $2.00-3.75/MMBtu (€1.56-2.92/MMBtu) over 2012.
While attractive for end-users industries, these prices are not economically sustainable for the producers. They reflect a market that is out of balance and result from a lack of coordination among the many players in the natural gas ecosystem - upstream exploration and production companies; midstream pipeline, processing, and fractionation companies; and downstream users, including the chemical industry but also power generators, industrial and transportation users, and exporters of liquefied natural gas (LNG).
To account for all these players and understand how the market might balance, we developed an integrated econometric model for the natural gas ecosystem. We modelled the impact of five drivers - global GDP, oil price, energy policy, global shale gas supply, and technology developments − using five scenarios to capture a range of pessimistic to optimistic states for the market in the year 2020.
We also show the price of natural gas under each scenario. Across all the scenarios, we predict a 2020 natural gas price from a low of about $4 to a high of about $8/MMBtu. Our Reference Free Markets scenario, which represents a future most similar to the prevailing conditions in 2012, predicts an equilibrium price in the range of $6-7 by 2020.
IMPLICATIONS FOR CHEMICALS
This has implications for chemical companies, but the specific implications depend on the type of company and where it plays.
To simplify the implications for the more than 220 chemical companies globally with sales of $1bn or more, we focus on three types of chemical companies: 1) North America-based petrochemical companies, 2) global petrochemical companies, and 3) non-integrated specialty chemical players.
We also focus on the primary areas of impact from shale gas and associated NGLs: 1) its potential for feedstock advantage, 2) its potential to drive growth in select North American end-use markets, and 3) its potential impact on global supply and demand balances for select chemical chains. We map these three groups of companies to the three impact areas and identify the relevant strategic questions for each.
Many North American petrochemical players who are interested in feedstock advantage have already placed a bet.
As of November 2012, 13 companies, all of whom have current operations in North America, have announced shale-related investments here. The question for them is: Is this level of bet appropriate?
If one believes the Global Gas Competition scenario, in which the rest of the world would catch up to the US advantage, the bet may be too large. However, in the other scenarios, the other regions are at least 10 years behind the US in their efforts to characterise shale formations, adapt technology, and build midstream infrastructure - so the bet is justified and may even be too small.
Our model predicts that, in the Free Markets scenario, North American petrochemical companies can maintain meaningful cost advantage over Europe and Asia, assuming close supply integration with midstream ethane suppliers. Thus doubling down on the bet, and securing long-term supply, could have huge implications for these companies.
The availability of shale gas is likely to trigger a reconfiguration of global value chains, so another important question becomes: How big of an end market growth opportunity does this create?
Chemical companies have several potential growth opportunities - selling into the shale gas ecosystem, selling to export industries such as metals and materials, and selling to "re-shoring" industries.
On the last point, we foresee potential re-shoring of a portion of the $600bn-800bn of goods currently imported by the US, especially products with a high proportion of costs in hydrocarbon feedstock, energy, or shipping, as well as products with a close trade-off between value chain risks and labour costs.
Finally, as these companies consider potential future US demand, they must also consider how shale gas will affect global chemical markets, and what this means for where they place export capacities.
Several global petrochemical companies are conspicuous by their absence to date from the shale investment list. As they consider the potential sustainability of the North American feedstock advantage, they need to ask if there is still room to enter the game.
Although the question is still "How much do we bet on shale?," the fact that these companies have no current US presence may change the way to answer it. If these companies decide not to enter, the second question, of how to serve the North American market, is irrelevant.
But for these companies, the most important strategic question comes in assessing global impacts on supply and demand. As North America becomes a major exporter of chemicals, with its ethylene capacity growing by up to 40% by 2020, what happens to facilities elsewhere?
If all global ethylene projects planned between now and 2016 get built, capacity will far outpace demand, even assuming optimistic, rather than historic demand growth.
In such a situation, the global market will seek balance. This will lead to the potential shutdown of naptha-based production in Europe and Asia. It may also lead to a delay or cutback in new projects announced for North America and Asia. So the question for global players is: Which assets will be forced to exit in this competition?
EFFECT ON SPECIALTIES
For producers of specialty chemicals that are not already integrated with larger players, the question of a sustainable US feedstock advantage may point to opportunities for partnerships to reduce their production costs.
On the revenue side, these companies may be in a good position to refocus their growth efforts on North America, given the new markets resulting from the build-out of the shale gas ecosystem and the re-shoring trend.
Shale gas presents tremendous opportunities for the global chemical industry and will challenge company strategies. It is up to each company to answer these questions for its individual situation in ways that will ensure long-term profitability during a time of market disruption.
Coming up with those answers will involve rigorous strategic planning, relying on the capabilities listed across the bottom of the chart above. Chemical firms need to do scenario planning and war gaming to construct different views of the future under varying conditions and competitor responses, and rely on robust risk-management capabilities to test the potency of their strategies. They need to design for supply chain flexibility to ensure speed to market.
By paying attention to capital project management, they should streamline approvals, reduce cost and project timing, and ensure the availability of resources. Finally, these companies need to manage their relationships with partners in the shale ecosystem to ensure that they can maximise feedstock cost advantages well into the future, even as market conditions evolve.
Andrew Walberer is a partner and co-leader of A.T. Kearney's Chemicals Practice for the Americas. His work with clients addresses strategic and performance improvement issues with petchem and specialty chemical firms.
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