Market outlook: The future for China acetylene PVC is grim

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The US is a key part of the world vinyl industry, as is China and other countries. The US has clear cost advantages – in salt cost, power supply, ethylene costs, scale, infrastructure and integration. But those advantages have no doubt been diminished by the fall in oil prices, which levelled the playing field to some unknown extent.

We at Probe Economics wanted to know how much the playing field had changed, and how competitive Chinese polyvinyl chloride (PVC) production is – considering the high capital and environmental costs of the carbide-based (also known as acetylene) PVC process used predominantly in China.

The answer: Naphtha-based PVC is competitive at $40/bbl oil; the US and Middle East still have the best cost positions; and the competitive position of Chinese carbide-based vinyl is questionable.

To reach these conclusions, we extended our global chemical cost model to include vinyl from two PVC chains – ethylene to PVC, and calcium carbide to PVC – in six areas of the world: US Gulf Coast (USGC), western Europe, the Middle East, eastern China, western China and India.

THE SCENARIOS

Oil prices are the key drivers of changes in vinyl competition. We made the assumption that US non-conventional oil will be the marginal source of world oil, with a cost of production about equal to the price of oil. Our Path A scenario assumes OPEC is dead and non-OPEC production declines only slowly in response to low oil prices, so that oil prices are under $40/bbl (WTI) in 2018. In Path B, OPEC retains some power and low oil prices restrain supply more than in Path A, so that oil prices exceed $60/bbl in 2018.

Not everyone will agree with the assumptions we made, especially for China. The main rub is with capital costs. China can build things cheaply, and we made adjustments to account for this, but China has also been able to ignore capital costs once its plants are built. Ignoring these costs is a competitive advantage for anyone who can get away with it.

Given China’s sky high debt levels and problems with non-performing loans, especially to its state-owned enterprises (SOEs), it will not be able to keep doing this very much longer – certainly not the next time someone asks for money to build another carbide-based PVC facility. Return of capital will likely have to be promised, and even some kind of return on capital.

CONDITIONS IN 2015

We priced out the vinyl supply chains for two polar cases: (1) everything that is produced in the chain, other than electricity, is priced at cash cost; and (2) everything that is produced in the chain is priced at full cost, including overheads, depreciation and return on capital. The calculations showed that, under 2015 conditions, USGC ethane-based PVC was the least expensive, followed by the Middle East. Naphtha-based PVC in Western Europe, India and Eastern China looked reasonably competitive. Chinese acetylene-based PVC was in a disadvantaged position, and looked really bad when we tried to account for fixed costs. Putting it another way, raw material and other cash costs matter a lot in determining petrochemical competition, but it also matters how you treat fixed costs, especially return on capital.

Based on these economics, it is difficult to see why the western Chinese carbide-based PVC industry is so large. This is without even considering the sizeable environmental costs associated with the carbide route to PVC.

CHANGES OVER TIME

The competitive positions we just described have changed a lot since 2012, when oil prices were around $100/bbl per barrel, and will change in the future as oil prices change. We ran the economics forward and backward in time using the oil price scenarios.

Naphtha-based PVC was the most expensive at first – even more expensive than Chinese carbide-based PVC on a cash cost basis. But then oil prices started falling in 2014. As oil prices fell, naphtha became more competitive in all the geographies studied. Chinese acetylene-based PVC looked terrible, especially in Eastern China where rationalisations are already underway. As oil prices rise, especially in Path B, naphtha-based PVC becomes less competitive, about equivalent to carbide-based costs in 2018. The US and the Middle East look like clear winners again.

In the full cost case for Path B, everything along the vinyl chain is priced at full cost, with full accountability for capital and overhead costs (but not environmental costs). In this case, Chinese carbide-based PVC is about equivalent to naphtha-based PVC when oil prices are around $100/bbl.

When oil prices fall, the carbide material is completely out of the running. And it never fully recovers, even when oil goes back above $60 per barrel. Like we said, China is ignoring the cost of capital now, but we don’t see how it can continue the practice.

If our assumptions are half-way correct, this analysis suggests that in the low oil price environment that is likely to exist for years, China cannot justify building more acetylene-based capacity – unless it is going to throw away capital once again and/or base its decisions on something other than economics.