Commentary: China may see a shortfall in ethylene

Joseph Chang

22-May-2015

Investment bank UBS projects that China’s ethylene capacity additions through 2019 will fall short of expectations as CTO/MTO projects are delayed or cancelled on poor economics

One of the big variables in the global petrochemicals outlook is how much new capacity will come from China CTO/MTO (coal-to-olefins/methanol-to-olefins). Indeed this was one of the key topics at the recent Asia Petrochemical Industry Conference (APIC).

 

The big decline in crude oil prices since Q4 2014 changes the equation for China CTO/MTO, making the economics far less attractive, as naphtha-based production becomes more competitive, and ethylene and propylene and derivatives prices are pressured.

If China CTO/MTO projects are cancelled or delayed on a large scale, China may need to boost its imports in the coming years – contrary to some forecasts of increasing self-sufficiency.

Investment bank UBS points out that non-oil-based new capacity (CTO/MTO, PDH (propane dehydrogenation)) in China will likely fall short of expectations. “We believe the economics of non-oil-based chemical projects look poor below $90/bbl [crude oil], particularly for CTO and MTO,” said UBS analyst Benson Chen in a report on oil disrupting China’s chemical supply.

UBS has lowered its projection of China ethylene capacity additions from 2015-2019 to a total of 8.07m tonnes/year. Its new forecast of total China ethylene capacity of 26.93m tonnes/year by 2019 is 13% lower than its previous estimate.

Unless expectations from the Brent crude oil futures market show a higher oil price scenario than the current $70/bbl in 2017-2018, “delays look inevitable, in our view,” said Chen.

While the UBS forecast is for Brent to rise to $80-90/bbl by 2017-2018, the distinction between forecasts and the futures strip price (the implied price from Brent crude oil futures contracts) is important, “given that our checks with the chemical industry in China indicate that project developers are conservatively focusing on either spot or futures prices when considering whether to invest in new projects”, the analyst noted.

At $50-90/bbl for Brent, UBS estimates the internal rate of return (IRR) for China CTO/MTO projects range from 5-10% – mostly too low to justify investment.

“We believe potential investors – large chemical and coal SOEs (state owned enterprises) – will not go ahead given their already high gearing (debt levels) and a low normalised oil price based on the current spot price,” said Chen. Given the cost of capital of around 7-8% for SOEs, an IRR of about 9% for CTO plants would be required to account for project risks, UBS noted.

For China MTO projects largely developed by private companies, an IRR of “at least 10-11%” would be attractive given their higher cost of capital and more volatile cash flows associated with MTO, according to UBS. For MTO projects, methanol feedstock would be largely imported.

“Failure to commit could lead to significant capex (capital spending) cuts and supply shortfalls, which we estimate would cause ethylene imports to China to rise 29% from 2014-2019 and the polyethylene (PE) spread to remain near $600/tonne for a longer period,” said Chen.

PROPYLENE FORECAST TAKES DIFFERENT PATH
On the propylene side, the picture is different. UBS projects propylene capacity additions in China from 2015-2019 to total 14.32m tonnes/year (around 38% from PDH). Overall estimated China propylene capacity of 34.60m tonnes/year by 2019 is 4% higher than its previous forecast.

“While the increase in propylene capacity looks large, we note that PDH plant operating rates are typically unreliable,” noted Chen.

Much lower than expected China ethylene capacity and somewhat higher than anticipated propylene capacity could mean the good times for certain global petrochemical producers could be better and last longer than expected.

There are positive implications in this scenario for companies such as ethylene and derivatives producers Thailand-based Siam Cement and PPT Global Chemical, China-based Sinopec and Sanjiang Chemical, and US-based Dow Chemical, said UBS. On the propylene side, a buyer such as France’s Arkema could benefit from a looser market.

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