OUTLOOK ’15: Pressure on Europe naphtha prices will continue

By Cuckoo James

LONDON (ICIS)–Deeper penetration of ethane, propane and butane as petrochemical feedstock in the west, Asian condensate capacity additions, US gasoline demand fall and increased global competition for the ‘market of last resort’ – Asia – will keep the pressure on European naphtha prices in 2015.

Prices are already under intense pressure from an erosion in Brent crude oil futures which dropped to the $50s/bbl in mid-December from a June peak of $115/bbl.

By mid-December, northwest European cargoes were trading down sharply too, by more than 50% from its annual peak in June of $976/tonne CIF NWE.

Commodity consultants Natixis Economic Research maintain Brent prices will remain under considerable pressure on bearish fundamentals and OPEC’s inaction: “We expect Brent to average $74/bbl in 2015, although further downside risks exist.”

Oil cartel OPEC during its November Vienna meeting announced it would maintain its 30m barrels per day (bpd) crude output for the next six months, despite the producers’ group forecasting its competitors’ supply to increase to average 57.31m bpd in 2015 and the actual demand for OPEC crude at just 28.9m bpd.

The continuum of bearish factors in the global crude market all highlight a single outcome – a worldwide supply overhang, which is mirrored in the naphtha market.

The sentiment is nicely summed up in one broker’s frustration at matching buyers with sellers in the naphtha open market: “Buyers are more able to dictate price than sellers as supply outstrips demand.”

Ethane, propane and butane (EPB) usage in US and European petrochemical crackers is higher than ever before – and expected to continue as new US petrochemical capacity will likely favour this cheaper alternative – generating more and more unused naphtha in the west.

So much so the US trade balance for naphtha has turned positive and the surplus is landing up on the doorsteps of Europe’s key export destinations in Asia.

In Europe too, the battle between propane, butane and the relatively expensive naphtha for petrochemical market share remains intense.

Trafigura, the world’s third largest private oil and metals trader after Vitol and Glencore, noted in its annual financial statement a drop in its naphtha trades globally, while liquefied petroleum gas (LPG) – propane and butane – trades rose dramatically.

The firm’s naphtha trades dropped from 8.7m tonnes in 2013 to 8.1m tonnes in 2014, while LPG trades went up from 1.7m tonnes to 2.7m tonnes over the same period.

Moreover, the grand entry of ethane in Europe has not displaced naphtha, but made it psychologically no longer indispensable.

In November, INEOS confirmed plans to invest $1bn in UK shale gas exploration and production. It is also in the process of building a large ethane storage tank at Grangemouth for US imports.

Borealis and SABIC are other petrochemical producers courting imports of US ethane for use in European crackers.

But Dow has ruled out ethane imports to its European operations. “According to our math, people should be doing LPG cracking in Europe, versus going to ethane and building large ethane carriers,” said Dow CEO Andrew Liveris, speaking in November at a Dow investor day in Texas.

Cracker rationalisation – especially of smaller, isolated crackers in Europe – is likely to take place in the face of cheaper petrochemicals from the US and the Middle East. This would lead to a further reduction in naphtha demand.

Prolonged cracker outages are not going to help demand in 2015 either. The November IEA Oil Market Report noted: “The extended closure of Shell’s Moerdijk petrochemical plant in the Netherlands from 2 October-through-mid-2015, will keep European naphtha demand under additional downside pressure, as it potentially removes 45 kb/d of naphtha demand.”

The end result of all this activity is, again, surplus naphtha with no home. There is increasing pressure on European traders to arbitrage these extra volumes to the Asian petrochemical sector, especially as European naphtha’s ‘other’ export destination – the US gasoline sector – is suffering from an unprecedented slump.

Light naphtha serves not just as a feedstock for olefins production but also as a ‘blendstock’ during gasoline production.

Europe is structurally long on gasoline and mainly relies on US and west African importers to absorb its excess product.

But US gasoline gross imports have dropped by 8.1% year on year (yoy) in 2014 between January and December. Gross gasoline exports have risen by 11.7% yoy in the same period, says Abhishekh Deshpande, lead oil markets analyst at Natixis Economic Research.

“The increased shale oil and NGLs production in the US has led to increased gasoline and light ends production. Cheap shale oil and increased oil infrastructure to the east and gulf coast of US has led to improved refining margins,” says Deshpande.

The trend of low US imports of European gasoline – and hence, naphtha – is expected to continue into 2015.

“Low oil prices will continue to keep refining margins healthy at least in the near term, which would incentivise refiners to process more crude. This would mean less gasoline and top of the barrel oil products imports from outside of US,” Deshpande maintains.

To reiterate, the increasing displacement of naphtha from the US and European petrochemical sectors and shrinking demand from the US gasoline blending sector has created surplus naphtha in the west.

It’s no small wonder the US is a bigger player in what was traditionally a Middle Eastern and European naphtha outlet, that is, Asia, resulting in Trafigura’s poignant statement: “Europe has ceded its pivotal role in driving naphtha flows.”

“Asian refiners can generally source US naphtha more cost-effectively. Flows between North, Central and South America and the Far East are becoming increasingly important,” Trafigura said in its annual statement.

Meanwhile, Middle East refining capacity is also increasing. In its Middle East Naphtha Market Outlook to 2018, Ken Research said: “It is predicted that naphtha production from the refineries in the top 5 Middle East countries will grow at a gigantic CAGR [compound annual growth rate] of 16.7% during 2014-2018.”

To add to the complexity, new condensate splitter capacity in Asia will turn more condensates into naphtha which can be consumed locally, if its feedstock shortage is met by US condensate exports.

The decision by the US Department of Commerce to allow Pioneer Natural Resources and Enterprise Products to export US condensate this year was a landmark ruling in many ways, and not just for the future of US crude exports, but for naphtha market outlook globally if more and more US condensates head to Asia in the near future.