AFPM 2013: US ramps up cracker project slate on shale boom

22 March 2013 15:54  [Source: ICB]

Plans to build seven new crackers and expand existing plants could add almost 10m tonnes/year of ethylene capacity, or 37% of the total today

Get ready for an unprecedented wave of new cracker construction in the US. The nation has moved further down the global cost curve in petrochemical production on the back of the shale gas boom, leading to the launch of seven new worldscale cracker projects and more expansions. This could ultimately add as much as 37% to existing US ethylene capacity by the end of the decade and significantly boost the US footprint in the global petrochemical arena.


 Copyright: Rex Features

Meanwhile, US producers are enjoying record profit margins as feedstock natural gas liquids (NGL) ethane and propane have fallen, conditions that Wall Street analysts expect to extend into a peak in 2014-2016. The outlook is no doubt very positive for the coming years. Yet the massive projects set to come on stream in 2016-2017 are likely to lead eventually to overcapacity and a downturn in the cycle.

"Looking at the revised cost curves and what we expect to be a capacity addition vacuum in the 2012-2017 time period, we expect to see a long duration and high amplitude peak in the commodity chemical cycle as early as 2015-2016," says Hassan Ahmed, analyst at Alembic Global Advisors. "This suggests that there may still be substantial room for positive earnings revisions and in turn, a further share price rally for US ethylene exposed names."

Vincent Andrews, analyst at US-based investment bank Morgan Stanley, also sees the "potential for an ethylene super-cycle in the 2014-2016 timeframe".

US-based Dow Chemical CEO Andrew Liveris expects the US ethylene cycle to hit a "double peak" in the coming years - not in the traditional sense where a peak is followed by a dip and then another peak, but rather a "doubly good" peak in the form of higher margins from low NGL feedstock costs, coupled with higher operating rates.

"Wet shale gas dynamics are fundamentally changing the game for integrated North American-based producers like Dow," said Liveris on the company's fourth-quarter conference call in February. "This is clearly evidenced by operating rates in the US and Canada being in the 90s [%] while Asia and Europe have been in the 70%s.

"Further, as global demand outstrips supply in the next few years and world GDP gains further traction, we anticipate operating rates higher than 90%, leading to substantial margin expansion - a double peak, so to speak," Liveris said.

In 2012, US petrochemical producers benefited mightily from falling ethane feedstock costs. They also benefited on the price side as chemical prices remained high along with oil prices. Even though around 85% of US chemical production is based on natural gas, US petrochemical prices as measured by the US ICIS Petrochemical Index (IPEX) follow crude oil prices rather than those of natural gas.

The r-squared (R2) or significance of correlation between the US IPEX and West Texas Intermediate (WTI) crude oil prices going back to 2000 is 84.4%, according to an ICIS analysis, indicating a high degree of correlation. The R2 between the US IPEX and Henry Hub natural gas prices was an insignificant 5.8%.

This gives US producers a double edge - lower natural gas-based feedstock costs and higher chemical prices based on high crude oil prices.

Companies most leveraged to US ethylene production were among the top performing stocks in 2012. Shares of LyondellBasell surged by 76% to $57.09 by the end of 2012, while Westlake Chemical jumped by 97% to $79.30, even after paying a special dividend of $3.94 in November. More diversified players such as Dow Chemical fared less well. Its stock price rose 12% to $32.33.

Companies flush with cash and encouraged by low US ethane prices are rushing to bring on new ethylene capacity.

Right now, there are seven worldscale crackers planned in the US, along with seven planned expansions of existing facilities that together amount to the capacity of almost one more worldscale cracker. We define a worldscale cracker at between 1m-1.5m tonnes/year of capacity.

The companies proceeding with plans to build new crackers include Dow Chemical, ExxonMobil Chemical, Chevron Phillips Chemical, Formosa Plastics, Sasol, Shell Chemicals and Occidental Chemical/Mexichem. All but one of the planned seven new crackers are based in the US Gulf Coast - the exception is Shell's in Monaco, Pennsylvania, in the heart of the Marcellus shale region in the northeast US. That cracker will likely come on line in 2019-2020 if it proceeds, while all the rest are scheduled to come on line between 2016-2017.

The total planned ethylene capacity additions amount to 9.78m tonnes/year, or a stunning 37% of existing US capacity. This excludes Dow's restart of its 380,000 tonne/year St Charles, Louisiana cracker in December 2012.

And there are more companies that have said they are exploring the potential of building a new cracker in the US. These include Thailand-based Indorama Ventures, Thailand's PTT Global Chemical, Brazil's Braskem, Saudi Arabia's SABIC and US-based Axiall (former Georgia Gulf).

US start-up Aither Chemicals has also announced a small 272,000 tonne/year cracker in the northeast US. An official at South Korea-based Hanwha Chemical was also quoted in a local media report in February that it is involved in talks concerning the building of a cracker in the US.

The low-cost position of US petrochemical producers relative to their counterparts in Europe and Asia, which primarily use oil-based naphtha feedstock, has led to an increasing volume of US chemical exports.

US chemical exports totalled $190.7bn in 2012, up by 1.8% from 2011, and are projected to rise by 4.7% to $199.7bn in 2013, and another 6.2% to 209.6bn in 2014, according to the American Chemistry Council (ACC). The US chemical industry swung back to a net export position in 2012, and is expected to maintain a trade surplus for the foreseeable future.

"Renewed competitiveness from shale gas - and the resulting disconnect between US natural gas prices and global oil prices - will boost US exports in the years ahead," says ACC chief economist Kevin Swift. "New investments to take advantage of this competitive position will begin to supply export markets in the coming years."

US chemical production volumes are poised to surge between 5-6%/year from 2014-2017, driven by the shale gas boom.

"Most forecast models are demand-driven, but the US shale gas phenomenon is a supply-side shock - a positive shock that will have a knock-on effect on chemical production and GDP for the next 10 years," says Swift.

"Models don't capture the supply side. While the consensus outlook calls for production growth in the 2-5%/year range, we think the growth profile will be much higher," he adds For the coming years, he sees US chemical production volumes, excluding pharmaceuticals, rising by 2.9% in 2013, followed by a 5.4% surge in 2014 and another 6.0% jump in 2015.

Already there have been over 50 chemical projects requiring capital investment of more than $40bn announced in the US to capitalise on the shale gas advantage, says ACC economist Martha Moore.

"We see shale gas fuelling the US manufacturing sector, which will also pull on chemical demand. But also some of the surplus will be going to exports because of renewed US competitiveness," Moore says.

"US chemical exports have continued to find a home, in part displacing local production primarily in Asia and to some extent Latin America. This has helped support pricing and margins by maintaining high operating rates," says Charles Nievert, analyst at US-based investment bank Dahlman Rose.

"Clearly, low-cost nat gas is directly translating to a low-cost position for US plastics producers. This competitive advantage has created a global market opportunity, which is a nice offset during times of lacklustre domestic demand," notes Frank Mitsch, analyst with US-based investment bank Wells Fargo.

"In 2011 and 2012, we estimate that polyvinyl chloride [PVC] exports accounted for 39% and 37% of North America production, respectively. Polyethylene [PE] exports have not risen as dramatically, but have stepped into the 20%+ range after averaging in the mid-teens from 2000-2006," he adds.

Many believe US ethane and propane prices will remain low for years to come, allowing US petrochemical producers to sustain their cost advantage. Ethane prices have fallen from almost 80 cents/gal in January 2012, to the mid-20 cents/gal range as of late February.

Dow CEO Liveris expects the US ethane market will remain long for the next four-to-five years. "One would expect we're going to benefit from this 20-something number for a few years to come. If it goes into the 30s, it will be due to aberrations," said Liveris on the company's fourth quarter conference call on 31 January.

Dow has a $25bn asset base in the US that will benefit from low ethane prices, Liveris said. Dow also expects to take advantage of low propane prices, as it uses both ethane and propane feedstock at its crackers.

"We are especially bullish on propane. In fact, going forward, we see structurally long propane creating a ceiling on ethane pricing," Liveris said. "And you can be sure Dow's feedstock flexibility will allow us to continue to pivot, so we continue to take advantage of our uniquely advantaged feedstock slate."

Gregg Goodnight, analyst at global investment bank UBS, also sees low ethane prices for the next four years.

"We believe that ethane will be oversupplied until the first grassroots cracker expansions are seen in 2016-2017," says Goodnight. "Low ethane prices should assure that LyondellBasell's light feed crackers will achieve outstanding EBITDA [earnings before interest, tax, depreciation and amortisation] margins near $0.30/gal."

Before 2008, US ethane supply and demand had been in relative balance at around 900,000-1m bbl/day. But after the rapid acceleration of shale gas production, which tends to be rich in NGL, today's ethane supply of around 1.1m bbl/day has outpaced US crackers' ability to consume ethane of about 1m bbl/day, notes Goodnight. This has led to ethane "rejection" of between 100,000-200,000 bbl/day, where this excess ethane is added back to gas streams to be sold as fuel.

While the US moves down the global ethylene cost curve on the back of cheap ethane costs, the Middle East is moving up, according to Alembic Global Advisors' Ahmed.

Middle East ethane crackers still enjoy the lowest costs in the world, with a 46% cost advantage relative to US ethane crackers, but Middle East mixed feed crackers have a 24% cost disadvantage to US ethane crackers, says the analyst.

"NGL production in Saudi Arabia has remained relatively flat over the last few years while ethylene capacity has increased considerably," says Ahmed. "Saudi Arabia has been running short of NGL since 2009 and, not surprisingly, is considering heavier feeds like naphtha for further chemical expansions."

The analyst adds that state oil and gas company Saudi Aramco has not made any new ethane allocations to the chemical sector in Saudi Arabia since 2006, because it is likely that it foresaw ethane shortages.

New projects, such as Saudi Aramco's Sadara joint venture with Dow Chemical and its Petro Rabigh venture with Japan's Sumitomo Chemical, involve mixed feed crackers.

In Qatar, a moratorium on additional gas development projects in its massive offshore North Field through 2014 will limit new supplies. "This has clear ramifications on petrochemical supply in Qatar. Even if the very day the moratorium were lifted, the decision to add a new cracker was announced, it would still take four years to bring it on stream," says Ahmed.

In Iran, aside from the global trade sanctions led by the US, which is severely limiting its petrochemical and derivative exports, the government plans to eventually set natural gas prices to market prices, noted the analyst.

"Industrial projects, including the petrochemical projects, now have to pay around $2/MMBtu for natural gas for the first year of the reform plan, which is considerably higher than the past price of $0.53/MMbtu in early 2010," says Ahmed.

Looking ahead, Iran plans to increase gas prices to 65% of the average export gas price within 10 years, suggesting gas prices of $5.20-6.50/MMBtu, the analyst adds.

Ultimately, all these changing cost factors are worth another look when considering the Middle East's position on the global ethylene cost curve.

"Our view of an imminent peak in the commodity chemical cycle is primarily predicated on what we consider to be a capacity vacuum arising between 2012 and 2017 as Middle Eastern producers exit the capacity game and US capacity additions are still years out," Ahmed says.

Yet taking the longer view, many things have to go right for the US market to absorb a 37% increase in ethylene capacity over a relatively short period of time. Methanol capacity is also set to rise dramatically, as is propylene, with seven propane dehydrogenation plants being planned in North America.

Meanwhile, it is important to realise that the US chemical sector is not the only group seeking to take advantage of low natural gas prices.

In the coming years, there will be increasing demand draws on natural gas, including new electric power plants, fertilizer plants, and liquefied natural gas (LNG) exports. The debate on the latter issue is heating up with a number of US chemical CEOs lining up against unrestricted LNG exports, fearing that this would diminish the industry's competitive edge, along with lower energy prices enjoyed by the wider manufacturing sector.

Already Switzerland-headquarted INEOS plans to ship ethane from Pennsylvania to its cracker in Norway by 2015. What could be next?

The debate on US liquefied natural gas (LNG) exports is heating up, with oil and gas companies lined up on one side and the chemical sector on the other.

 Cheniere Energy has LNG export facilities under construction at its Sabine Pass terminal

Copyright: Cheneire Energyy

More than 20 companies have applied for approvals with the US Department of Energy (DOE) to export LNG. The combined planned LNG export capacity amounts to around 200m tonnes/year - or about 40% of US natural gas consumption, according to an ICIS analysis.

For those US LNG export projects with disclosed completion dates - all between 2015 and 2018 - the capacity amounts to 129m tonnes, which is still a substantial amount.

This has caused concern among a number of US chemical company CEOs, who fear that unlimited LNG exports could take away the US competitive advantage - both in cheap natural gas liquids (NGL) feedstock for chemical production, as well as cheap energy for overall manufacturing.

If you look over the impressive list of planned projects for US LNG exports, it's hard not to see a parallel in the heavy project slate for planned new world scale crackers in the US. Both are being driven by the US shale gas boom.

Unlimited US LNG exports could create volatility in natural gas and NGL prices, contends US-based Dow Chemical.

While LNG exports for fuel would consist primarily of dry gas, with NGL stripped out in the process, LNG containing ethane and propane could be shipped out as well, according to the company.

"It is not a given that NGL will always be stripped out prior to shipping," says Kevin Kolevar, vice president of government affairs and public policy at Dow. "For example, Japan has specs for wet gas concentrate in LNG. And to what extent would other countries look to use wet gas? We have not heard assurances from the oil and gas community that they would strip out the NGL."

This is an important aspect for the chemical sector. There's another argument that LNG exports could actually increase NGL supplies, precisely because it is stripped out.

Dow estimates that over a 10-year timeframe, the US could export up to between 5 billion cubic feet (bcf)/day - or 141.5 million cubic metres (mcm)/day - and 6bcf/day (169.8mcm/day) of natural gas through LNG without disrupting the market, if that capacity comes on in a linear fashion.

That would amount to 38m-46m tonnes/year of LNG. Yet, there is a total of 200m tonnes/year of LNG export capacity being planned in the US. While not all that capacity would be built, if the LNG projects get full approvals to proceed, there is virtually no chance they would come on in a disciplined, linear fashion - neither will the wave of new worldscale ethane crackers.

The battleground is now set over DOE approvals of US LNG exports to countries that do not have free trade agreements (FTAs) with the US. As of the end of January, the DOE has granted 20 approvals for LNG exports to FTA countries, but only one to non-FTA countries - that of Cheniere Energy's Sabine Pass project.

Exports to non-FTA countries is the big game, as these nations include Japan, China and all of Europe - major target markets. Japan is a huge importer of LNG for its fuel needs. In 2012, Japan's LNG imports jumped by 11.2% to a record 87.3m tonnes.

The DOE notes on its website that for non-FTA countries, it "is required to grant applications for export authorisations unless the Department finds that the proposed exports 'will not be consistent with the public interest'. Factors for consideration include economic, energy, security and environmental impacts."

That's where chemical companies are bringing the fight - citing the "public interest" provision in the DOE's remit, and claiming unchecked LNG exports will erode US manufacturing competitiveness.

By: Joseph Chang
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