INSIGHT: Methanol price gap not wide enough for change

01 July 2013 14:21  [Source: ICIS news]

By Ross Yeo

LONDON (ICIS)--On 28 June the European methanol contract price for the third quarter was confirmed at a rollover from the second quarter.

An initial agreement had been made almost two weeks previously and had received immediate backing from several suppliers. However, consumers, for the most past, initially refused to back the price and, even after it was confirmed, many continued to voice their objections.

This may seem strange, if one looks at the matter purely from a supply and demand point of view.

After all, the average European spot price in the second quarter so far was €17/tonne ($22/tonne) higher than that of the first quarter, and there is a fairly widespread acceptance, even among consumers, that the European market is tighter than it is long.

Looking at the probable supply and demand balance in the third quarter, there is unlikely to be any significant lengthening of the market.

While demand is typically at it weakest in the third quarter, unreliable feedstock gas supply in Egypt and Trinidad is likely to balance this out, at the very least, and could even tighten the market further, many observers believe.

So why did many consumers refuse to back a contract rollover, when market fundamentals would appear to suggest this represents a good deal for them?

The answer is the wide difference in price between Europe and Asia, in particular China. The net European contract price (assuming an average discount of 15%) is $78/tonne higher than the current average spot price in China. (The spot market represents the bulk of methanol trading in China, while in Europe most supplies are contracted.)

European methanol consumers who export derivatives complain this higher price puts them at competitive disadvantage to Asian counterparts, who have access to far cheaper feedstock.

This disadvantage has become so pronounced that some producers of methanol derivatives have been forced to significantly reduce their export volumes, or face operating at zero margins.

One European producer of chloromethanes said it has reduced the operating rate of its plant as a direct result of being unable to compete with Asian counterparts.

A formaldehyde producer said it would increasingly shift operations to its plants in Asia and the US to improve margins.

But why should methanol suppliers care if consumers are performing badly?

Consumers argue that the reduced exports of European methanol derivatives will lead to reduced European methanol consumption, which is, of course, bad for suppliers. The only problem is suppliers are unanimous that contractual off take is stable.

Consumers counter that reduced demand from many traditional chemical produces has been offset by increased demand from the fuels sector, for example methyl tertiary butyl ether (MTBE) production and, furthermore, that the full impact of the demand erosion has not yet been fully felt upstream.

Nevertheless, suppliers point out that European prices have been at a significant premium to Chinese prices since mid-October 2012, and say there has been no discernible impact on European demand.

The suppliers’ main argument is that the contract price should be dictated by market fundamentals alone; on the supply and demand balance and the level of spot prices throughout the preceding quarter.

Whether or not they give much credence to consumers’ claims of difficult downstream conditions, suppliers say this should only be taken in account if and when demand is affected.

But many consumers feel the damage could be done by then, and that suppliers should exercise caution when maximising their profits.

“In 2009, 2010, methanol prices were half of what they are now. Since then natural gas prices went down, not up. [Methanol producers] have been too eager for profits. I understand why, but I think they need to be careful,” said the formaldehyde producer.

Consumers also question why such a wide gap can exist between two regions of a global commodity market in the first place.

One common explanation is that Iranian methanol imports pull Chinese prices down.

Since international trade sanctions against Iran were broadened to include petrochemicals, Iran’s substantial methanol capacity can only realistically be sold into China and India, where most buyers are not affected by the sanctions. Buyers in these countries are therefore able to negotiate lower prices

Other sources have pointed instead to cheaper coal prices in China during 2013, which have made it possible for many of China’s numerous coal-based methanol plants to run at a profit, and so domestic Chinese production has increased.

But why do market participants not act to take advantage of the price?

The most obvious way to do so would be to redirect some Asia Pacific-bound Middle Eastern cargoes to Europe instead.

However, Middle Eastern producers no longer have significant uncommitted ‘swing’ volumes to send to whichever market has the highest prices, sources say.

Instead, the majority of Middle Eastern output is now contracted and so cannot be easily redirected.

A producer added that long-term relationships with customers in China are valued as much as those in Europe, and so a particularly high incentive would be required to alter its distribution flows.

In regards to shipping methanol directly from Asia to Europe, sources say the arbitrage just doesn’t work, even with the current price spread.

What’s more, the costs of shipping from Asia to the US are lower, and US prices have been slightly higher than those in Europe since late-February 2013.

The conclusion, which European buyers and sellers agree on, is that regional price differences in the global methanol market are simply not as easy to balance out as was once assumed.

Even shipments from China to the US in May totalling 40,000 tonnes did little to bridge the price the gap between those markets.

How the situation will be resolved remains unclear. A European consumer admitted its options were limited. A number of producers have said a much larger price differential would be required to elicit a significant change in global trade flows.

Some players are optimistic that the recent election of Hassan Rohani as Iran’s president could lead to a softening of the western-led sanctions, which could eventually eliminate a key source of the global methanol imbalance. However, this is something that is likely to take some time, if it happens at all.

One thing that seems fairly certain – the wide price gap between the Atlantic markets and the Asian markets is going nowhere fast.

($1 = €0.77)

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

By: Ross Yeo
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