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Margin Upswings Will Be Shorter And Shorter

Business, China, Company Strategy, Economics, Environment, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins
By John Richardson on 02-Jul-2015


By John Richardson

A GOOD chart can quite often by worth many thousands of words with the above chart serving as an excellent example.

You can see how in June, scheduled and unscheduled shutdowns of Asia-Pacific ethylene capacity exceeded 6.3m tonnes – the biggest total by far since at least 2011. Markets have been further tightened by production losses in three Middle East countries which are, of course, not documented in this chart. This goes a long way to explaining why cracker operators integrated through to polyethylene (PE) have enjoyed excellent margins so far this year.

When naphtha cracker operators lose ethylene production they, of course, also lose propylene, crude C4s and aromatics output.

In the case of propylene, however, production losses from reduced output at naphtha crackers have been more than offset by increases in production China. This the result of the start-up of new propane dehydrogenation units.

Propylene’s main derivative – polypropylene (PP) – is also oversupplied as a result of start-ups in China. The oversupply is so bad that I have heard unconfirmed reports of China exporting homopolymer grades to Latin America.

But the story for butadiene, the most valuable component of the crude C4s stream, is very different. From mid-May until 26 June, pricing had surged by 30% to 1,360-1,420/tonne CFR Northeast Asia (NEA).  And this week butadiene rose to $1,500/tonne CFR NEA, which was the price paid by traders following tenders conducted by Asian producers.

There has been another factor behind the tremendous margins enjoyed by Asia’s cracker operators so far in 2015, which is oil prices. When crude is strengthening, olefins and derivatives prices have to also go higher. So, in order to hedge against this cost inflation, buyers of PE, PP and butadiene etc. stock-up on their raw materials. This has occurred since around mid-February of this year.

As you can also see from this chart, however, ethylene supply is set to lengthen from July onwards. This is good news for buyers of PE and butadiene as they are struggling to cope with a slowdown in GDP growth across much of Asia.

And here’s the thing: Today’s oil prices simply don’t make sense when you look at the underlying supply and demand fundamentals. This became even more apparent when it was announced on Tuesday that US oil production rose in April of this year at its fastest pace since the same month in 1971.

There is also, of course,, the Greek crisis which could on Monday cause widespread financial and oil-market panic if there is a “No” vote over the European Union rescue package.

I think that there is also something much more significant happening here. As we move further into the New Normal, sure, we will have other periods of strong margins on supply volatility. But as downstream demand grows ever weaker, the length of these upswings in margins will become shorter and shorter.

So what should petrochemicals companies do to boost their long-term profitability? It is to engage in the type of “demand management” that I have been discussing over the last few weeks. If you don’t engage in demand management, you will end up losing access to markets.