By John Richardson
FOR most of the time from 2009 until the end of H1 2014, understanding what was going on in petrochemicals markets was pretty easy.
The price of oil was stable in the region of $100 a barrel and so upstream costs were very predictable. This meant that you only really had to focus on how many plants in any particular petrochemicals product were shut down, as the upstream supply-side story of oil was usually summarised in just one word: Tight.
And demand for everything – from oil to consumer goods – seemed equally easy to read, thanks to the illusion of global economic health created by central bank stimulus.
But we are in a very different world today. Oil prices could trade as low as $20-30 a barrel in Q2 on rising supply and weak demand resulting from the withdrawal of central bank stimulus. Alternatively, geopolitics might cause a sharp spike in prices. But any big rebound would be very fragile because of today’s very different world.
Tight supply in Asian ethylene and polyethylene (PE) was said by market players to be the cause of further price rises last week. But what was happening in crude was the bigger background story as the risks increased another oil-driven destocking process.
In propylene and its derivatives, destocking had already started to happen.
“Chinese importers are taking time to purchase April-arrival [propylene] cargoes amid concerns that the weak oil market will likely hurt downstream demand,” wrote Pei Lin Yeow, the ICIS pricing olefins editor Asia, in another of her excellent reports.
“Signs of destocking are already appearing in the domestic propylene and derivatives market in China. Transaction volumes are down in the first half of the week,” added Pei Lin, who said that downstream 2-ethylhexanol and acrylic prices had fallen. However, polypropylene was stable-to-firm.
What’s going to happen during the rest of this year? Here are some thoughts.
Assume, first of all, that demand can only get weaker until or unless China sorts out its macroeconomic problems. Please don’t be distracted by the notion that this will be a quick or easy process.
As for oil supply, the above chart is further evidence that despite the big reduction in the overall number of oil rigs operating in the US, the rigs that are running have become much more efficient.
This greater efficiency is, I think, connected to debt. When you have big debts to pay back it makes sense to improve efficiency as this reduces production costs – and thus gives you more dollars to service your borrowings.
So expect further efficiency gains as production continues to surprise on the upside, confounding the analysts who expected exactly the opposite: That debt would curtail output.
Another reason to think that crude might weaken is the amount being stored in tanks in the US, which is close to maxing-out.
Oil is also, in effect, being stored in the shale-oil wells themselves.
“From North Dakota to Texas, there are more than 3,000 wells that have been drilled but not tapped,” wrote Bloomberg in this article.
Here is how this “fracklog” works:
- Once a horizontal shale-oil well tunnel has been drilled by one crew, a second crew then blasts it with a mixture of water, sand and chemicals to crack the rock and retrieve the oil.
- This second crew can be put on standby, waiting for oil prices to recover. So these untapped tunnels have become the extra storage space.
“Fracklog” could amount to as much as 3 million barrels a day of untapped production, according to the experts who spoke to Bloomberg.
There is also the story of Russian “teapot” or basic oil-conversion refineries and how their economics might drive oil supply even higher. These refineries, because they are so basic, depend on government subsidies in order to make money from producing fuel oil. The higher the price of crude, the bigger these subsidies – and so, of course, the subsidies have fallen since the collapse of oil prices.
Falling subsidies means that it makes more sense to export Russian crude rather than process the oil through the refineries. Russia’s “teapot” refineries processed 800,000 barrels of oil last year, some of which could now end up being exported directly as oil.
Here is some more data consider: Russian crude exports averaged 4.84 million barrels a day last year, a 6.1% drop compared with 2013; the biggest annual increase Russian production over the past decade was 3.6% in 2009.
Might this increase now be equalled, or even surpassed, because of government policy?
I suspect that governments of oil-producing countries will in general insist that state-owned energy companies pump more rather less crude.
Why? Because as is the case with the US shale-oil producers, a few dollars above the variable costs of production are better than no dollars at all.
Last but certainly not least in this post is the role of US dollar.
US Fed chairwoman Janet Yellen promised last week that no longer being “patient” on US interest-rate rises did not mean the Fed had become “impatient”.
This led to stronger equities and a weaker dollar. A weaker dollar makes oil more affordable for other countries, and so can drive prices higher
But in my view, there is every chance that the dollar will get stronger during the rest of this year as the global economy weakens. A stronger dollar makes oil more expensive for non-dollar denominated economies, and so places downward pressure on the price.
Greater complexity is the nature of the New Normal. Do you have the resources in place to cope with this?