INSIGHT: Europe’s evolving ethylene contract price mechanism

24 July 2013 16:50  [Source: ICIS news]

By Nel Weddle

LONDON (ICIS)--Three years ago, I wrote an article entitled “Olefins contract mechanism – is change afoot?”

Monthly contracts had not been long adopted (after years of debate and spurred on by the devastating demand crash in the fourth quarter of 2008). Questions were being asked about whether the process was viable and relevant for the market? 

It was obvious then that the global market place was changing rapidly and some would say particularly so for the European industry which would have to become more agile.

So roll forward to today. On a structural basis the European industry is under increasing pressure not only from more cost competitive Middle East and Asian capacity but also now from the US shale gas “phenomenon”.

Add the economic woes of the EU and the eurozone and you have a market not at its previous best, caught between a rock and a hard place.

Partly as a consequence there have been some creeping changes to the market. The strategic focus of some olefins market participants has shifted. There have been a couple of new entrants to the contract price process. And least one player has shifted position from a buyer to a seller.

Of primary and increased importance is the care that must be taken to avoid price signalling behaviour and any anti-trust issues.

All these factors have led to more questions being asked about the relevance and viability of the present contract process.

A few seasoned contract participants believe that the mechanism as it stands today has to evolve; it won’t survive.

Other market participants, while firmly in the no change camp, do think that a review of the process is worthwhile to encourage debate and, more importantly, to establish good practice.

Over the past few months, I have been asking the market what it thinks about the current process and, if it needs to change, to suggest alternative mechanisms.

ICIS held a formal general methodology consultation on ethylene and propylene in June and it is clear from all the responses that there are some strong views.

First, a recap of the current process.

The contract price is negotiated between independent merchant sellers and their merchant consumers from a broad spectrum of derivative sectors and is agreed on a gross basis.

The contract price is published only when direct confirmation from two different producers and consumers, ie a ‘2+2’ configuration, has been received from the parties concerned.

The main issues centre on the relevance of the participating parties to the process and then the possibility of the initial agreement being seen as signalling

Who is allowed to play?

Sources have differing views in terms of what constitutes a relevant settling party. For some it should depend on the volume being negotiated, the number of counterparties and whether or not a participant is integrated.

Many sources (and this found the most agreement amongst the responses) think there should be more clarity in terms of net buying and selling positions and that there should be a minimum volume threshold.

For some this means a minimum of 2,000 tonnes sale or purchase per month, while others focus on much larger volumes – 150,000 tonnes/year and above.

Many reckon that a minimum total buy or sell requirement should be 50,000 tonnes/year and that 20% of total volume as a buy or sell position could be enough.

In any case, for this to work effectively it would require participants to declare their volume positions and one source said “contributors should be pre-registered as agreeing to the requirements”.

Personally, I am not sure that I will see many companies keen to disclose such information – even if only on a confidential basis with ICIS.

However, there is little discrepancy when it comes to the number of valid counterparties.

For the majority of respondents only one counterparty is necessary as long as it adheres to the relevant participating party criteria. But some said participants should have a minimum of two relevant contract counterparties.

On the whole, for many monthly contract players the idea is to encourage more companies to participate rather than start to close some off

“Personally I feel that anyone with a contract has the right to discuss and report their agreements,” a source said.

The issue of non-integrated versus integrated settlers has been a key element becasue the European ethylene and propylene markets are by nature increasingly integrated. As one source said, “integration in Europe limits the merchant market [and this] is unavoidable.”

One source suggested that the initial settlement should be by two independent parties, or that deals between integrated parties (net seller or buyer) deals should be supported by two additional independent parties.

Several sources said that settling consumers should come from different sectors – “to avoid bias from a particularly strong or weak sector” according to one of them.

There is sometimes the accusation that polyolefins players often lead the way but many say this is unavoidable too since polyethylene (PE) and polypropylene (PP)  make up such a large proportion of the ethylene and propylene markets.

“We cannot afford to reduce the pool of people [in the olefins world],” a source said.

Many players echoed this view – that it is vital not to restrict participation.

One key player said that buyers and sellers should only agree a number when they have confidence from their discussions and/or confirmation from their counterparty that there are other buyers and sellers willing to engage at that price.

Other key players said they welcomed active participation from players representing all derivative sectors and volume positions and that it should be considered good business practice to consider the wider pool of possible ethylene and propylene sellers and consumers.

“This cannot be legislated or placed in a rule book, but should be encouraged as good business practice,” said one.

There is consensus over the timing of the discussions and the final settlement . Contract participants already adhere to some discipline with regard to settling the contract price prior to the start of the new month in question.

The main fear is of having a retrospective settlement as has become relatively common practice in the US.

But  players also want to be at liberty to discuss the contract price for as long as it takes to find an agreeable number for both sides and several sectors rather than be rushed into a settlement because of timing issues.

Some sources have made suggestions for an evolution of the process. All assume that the relevance of the participating parties has already been established as “more deals won’t improve robustness if other principles aren’t changed.”

The first suggestion is to widen the process to include two more participants, ie have a ‘3+3’ rather than ‘2+2’ configuration.

“’2+2’ is sufficient, ‘3+3’ is desirable but risks slowing down the whole process,” one source said.

“’3+3’ might not work from a propylene perspective [as there is a] more limited pool of contract settlers," said another.

The most radical suggestion, which would really require behavioural change, I have saved until last.

The proposal is that the ‘2+2’ configuration is retained but that the initial number, while reported to ICIS, is kept from the market. This would allow discussions to continue, the thinking goes.

Once a second agreement becomes apparent, both the numbers are made public and then – here views start to differ – either a mathematical average,  a weighted volume average or simply a range is published.

Several sources have pointed out that while this would tick the no-signalling, anti-trust box in theory. In practice it might be more difficult to achieve.

It would require immense discipline on the part of the initial settlers, surrounding market players and, of course, ICIS and other price reporting agencies. For this reason, some sources fail to see how it would work.

For others, the view is that the current process does enough to find the “right” number.

“If your view [regarding a settlement number] is extreme you get disenfranchised and effectively removed from the discussion” a source said.

There have been a couple of instances in the past where initial numbers have not been followed and then eventually rescinded in favour of a second number which has attracted more support from the market.

While appreciative of the need to discuss and debate some of the issues surrounding the contact process, several long-time contract players remain convinced that for all its flaws the process is still the best way to find a level playing field benchmark reference price that the industry can work from.

As one source said: “It might seem like a strange process to others, but its effect is that we moderate prices - moderation is in everyone’s favour.”

It took about  five years of on-off discussion, an alternative bi-monthly process and a global economic crisis to change just the timing of the European ethylene contract price from quarterly to monthly so I am not expecting a radical change any time soon.

Please feel free to direct any comments you may have about the European ethylene and propylene contract price mechanism to

Please see the responses to the Formal Methodology Consultation held in June here

By: Nel Weddle
+44 20 8652 3214

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