By John Richardson
IT has been a fantastic few months for Asia’s naphtha cracker industry as the above chart further illustrates. Even in the case of poor old, very heavily commoditised raffia-grade polypropylene (PP), variable cost margins so far this year for integrated naphtha-based players have averaged $389/tonne.
The story is even better for low-density PE (LDPE) film grade where in 2014 average margins were $321/tonne. In the first five months of this year, they have risen to an average of $576/tonne.
Multiples over naphtha are a useful measure of just how abnormal the market is at the moment. Using LDPE film grade as an example again, the prices for this polymer were at an average of 1.75 times naphtha in 2009-2014. So far this year, LDPE prices have averaged 2.39 times naphtha.
So what has driven all of this? As we discussed last week, there are widespread but unconfirmed reports of gas-supply problems in the Middle East.
In one particular country in the region, major repairs are said to be taking place at gas-processing plants, which are aimed at fixing long-term problems. But meanwhile this has, of course, led to deep operating rate cuts.
I have now been told that feedstock supply constraints are affecting three countries in the Middle East, up from what I had previously thought was only two.
Supply has been tightened even further by this year’s Asian cracker turnaround season, which we think will peak in May with a loss of 13% of total Asian nameplate capacity.
The other big driver of this extraordinary margins upswing is the oil price recovery that began in mid-February. Before then, Asia’s plastic converters were only acquiring resin for their immediate production needs. But more recently, they have been stocking-up on the belief that crude prices will continue to rise.
The big danger here is that positive macroeconomic news is very hard to find.
Apart from the China slowdown, the rest of Asia is struggling. In Thailand, for example, consumer prices have now been falling for five consecutive months.
The Bank of Thailand thinks the answer is cutting interest rates, which it did in both April and March. Now the cost of borrowing is at 1.5%, which was its level at the height of the Global Financial Crisis in 2009.
The problem, though, is that many countries are also busy cutting interest rates or have already reached the point where the cost of lending has actually gone negative – for example, in the case of Sweden.
But this still isn’t working. Why? Because we are at the beginning of a long-term secular decline in demand, which is being driven by demographics in the West and China’s economic reforms.
Let’s return to Thailand. At the end of 2014, household debt had already risen to 80% of GDP. Lower rates might, thus, encourage people to take on even more risky borrowing at a time when both global demand is slowing down and the US seems fairly close to raising interest rates. When US rates eventually do go up, even more foreign money will flow out of emerging markets in general, leaving creditors highly exposed.
How do we relate this back to polyolefins margins? It is in this way: All the above tells us that this year’s strong profitability has been mainly supply rather than demand driven.
The trigger for a retreat in polyolefins prices margins might, of course be a fall in oil prices. I maintain that crude is overpriced, and that Brent could easily decline to $45 a barrel later this year. The reason is years of low interest rates and easy credit that have led to overinvestment in oil capacity, when the demand was never really there to justify these investments.
If oil prices were to come down, we could see plastic converters, who are struggling to afford today’s polyolefins prices, pushing for big discounts.
But what if polyolefins supply remained tight whilst oil prices once again tanked? Sure, this might provide some temporary support.
In the long run, though, we are moving away from markets driven by supply to ones that will be almost entirely dictated by demand.
What polyolefins companies therefore need to do is to invest the money they have made from the great margins of the last few months in creating their own sources of sustainable, long-term demand.