History will surely repeat itself

The mood at the recent NPRA International Petrochemical Conference in San Antonio, Texas, was mixed, despite all the economic gloom.

Some producers said they were still making money – especially those selling into manufacturing sectors benefiting from a rise in exports due to the weak dollar.

What’s certain, of course, though is that things will get worse regardless of the health of the global economy. The down cycle is just around the corner.

But we could quite easily see, as this extended article below speculates, another period of under-investment following all the over-investment that markets will need to absorb over the next 3-4 years.

Plus ca change, plus c’est la meme chose.
02 April 2008 11:10 [Source: ICIS news]

HOUSTON (ICIS news)–If you are too young to remember what a real recession feels like you might be clinging onto the hope that this downturn will be short-lived. Or perhaps it is just a question of perception.

“Americans tend to react to what they see on TV and are very sentiment-driven. The sentiment is very negative, but that could quickly change,” said Stacy Methvin, president and CEO of Shell Chemical LP.

She was speaking on the sidelines of this week’s 33rd National Petrochemical and Refiners Association (NPRA) conference in San Antonio, Texas.

The mood of the event in general was one of looking at the evidence down all the product chains and concluding that things are not universally bad in the US.

Liquid cracker margins are chronically squeezed, whereas some gas-cracker margins are good because of the relatively cheap price of natural gas. Several of the downstream markets are also showing resilience.

The weak dollar is obviously creating advantages for some of these markets for either direct or indirect chemicals exports. The US exported 15-17% of its polyethylene (PE) production in 2007 compared with 10-12% in 2006, said Earl Armstrong, consultant with DeWitt.

This led to the hope that exports alone would be sufficient to tide the industry over until the overall economic cycle recovers – a theory that Joe Zidle, economist with Merrill Lynch dismissed.

Speaking at last week’s DeWitt World Petrochemical Conference in Houston, he said that other weaknesses in the US export position, such as uncompetitive labour costs, meant that an export-led rescue was impossible. In addition, exports remain a relatively small part of the economy.

And so it comes back to the level of consumer confidence which is reflected, or maybe created, by universally gloomy press coverage. As most people get their news from the TV, and TV tends to be sensationalist and short term in perspective to get the ratings up, this is a worry.

But drive through rural Texas and you will see remote rural communities that must be suffering from high gasoline and diesel prices. This is much more media-driven panic.

If you had asked any two people during the NPRA what their views were on the direction of crude prices, you would get at least three opinions.

Perhaps crude is the biggest single factor that could determine whether the recovery is V-shaped or the dreaded hockey stick – a long, drawn-out bumping along the bottom for maybe two or three years.

If high crude persists, inflation will continue to eat into the crucially important confidence of the consumer.

Recent benzene prices reflected both the high price of crude and weak consumer spending.

Pricing in the US and Asia was close to the historic highs of 2004 but margins had almost vanished because of weaker derivatives demand.

The strength of the US driving season will lead to some recovery in aromatics pricing with the extent of the recovery under close scrutiny and no doubt subject to numerous interpretations. The driving season is seen as key barometer of how the overall economy is doing.

But if gasoline prices remain above $3/gallon, consumer confidence could remain weak and the political pressure will mount in election year for punitive taxes on the big oil companies.

Opinions on the direction of crude pricing at the NPRA varied from as low as $75/bbl by the end of 2008 to as high as $150/bbl. The majority view was that crude could not fall below $80/bbl because of the strength of emerging markets demand.

Andy Nicholson, consultant with DeWitt, caustically remarked that if there was a full-blown Wall Street collapse, the trader’s premium on crude, which he estimated at $45/bbl, would disappear.

A collapse of the financial system would make the length of the flat line at the bottom of the hockey stick-shaped recession almost as long as the distance between Houston and San Antonio.

The US and developed Asia also faces pressure from the capacity surge.

In early March, the sentiment in China’s polypropylene (PP) market was immensely gloomy because of a range of factors including imminent new capacities, a shift in export-tax credits for re-exporters and higher labour costs.

At that time, pricing seemed likely to weaken. However, it promptly recovered and for many grades rose well above $1,500 tonne CFR China.

“I am afraid this is the last big push to make some money before things turn bad. Producers are taking advantage of temporarily tight market conditions to maximise their returns,” said an Asian polyolefins producer.

The reality is that the approximately 6.5m tonne/year of Middle East and Asian capacity, which is due on stream between now and early 2009, will reduce export opportunities for the US. Closer to home, new capacity in Mexico will also hurt the US.

The strength of China’s demand across all the products will be critical in determining how quickly the new capacity is absorbed.

GDP growth is likely to be lower this year – at 8-9% compared with 11.4% in 2007 – and everyone is worried about the post Beijing Olympics demand-growth slump.

The major structural changes the Chinese government is making in its export industries will have a negative effect on import volumes in the short term, even if the long-term prospects remain good.

A huge readjustment is also set to take place in styrene trade patterns because of big new capacities in the Middle and Asia. No longer will as much benzene be sucked into the US from Asia before being re-exported back to Asia as styrene.

Further restructuring in the North American styrenics industry seems inevitable with perhaps the equivalent of as many as 3-4 world scale styrene plants in need of closure.

The implications for Asian benzene balances are severe as a result of both a weaker US styrene industry and gasoline demand that slumped into negative territory in the fourth quarter of 2007 and again in February this year.

Asia has traditionally used the US as a sink for its surplus benzene production.

Aromatics margins were at chronically low levels in Asia during the first quarter of this year with all the margin gain being made in the olefins-polyolefin chain.

As a result, even pygas was shipped from Asia to the US as the Asian cracker operators were keen to maintain cracker operating rates in order to supply the olefins needed for strong polyolefins markets.

The more traditional benzene trade surged. The South Koreans, for example, shipped 220,000 tonnes to the US in the first quarter compared with 150,000 tonnes in the first quarter of 2007. South Korea shipped a total of 480,000 tonnes to the US in 2007.

South Korea and Japan are going to bear the brunt of the big capacity surges taking place in the Middle East, China, Thailand and Singapore across many products.

Remaining with benzene as an example, more than 1m tonnes/year of highly competitive coal-based capacity could come on stream in China over the next few years. Reformer-based benzene might have to be shuttered, particularly if the oil price stays high.

A further problem for the global benzene trade are new gasoline regulations in the US – MSAT II – which come into force on 1 January 2011. This could lead to a great deal more extraction taking place.

“It is not a question of whether we have to further restructure our petrochemical industry, it is only a question of when and I expect some announcements this year. I expect more consolidation across several sectors,” said a senior Japanese industry executive.

But assuming that the world does not enter into a 1970s recession, the petrochemicals industry could recover – and potentially very quickly.

Those that cannot remember the 1970s might even be too young – or too panicky because of what they have seen on CNN or Fox News – to realise that there could be a repeat of the under-investment and over-investment cycle.

Very few producers are likely to be able to firm-up projects over the next 12-18 months because of the state of financial markets and earnings.

Gas supplies are also at higher premiums and in tighter supply in the Gulf Co-operation Council (GCC) region of the Middle East.

Capacity shortages are quite possible beyond 2012 – meaning that the US producers with understanding shareholders or perhaps no shareholders at all, have an opportunity to invest.

Gas-based production outside the GCC and coal-to-chemicals are being talked about a great deal – often connected with methanol-to-olefins technologies.

By: John Richardson
+65 6780 4359

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