By John Richardson
THE demand was simply never going to be there to support anywhere close to the number of US cracker and derivatives projects listed in the table above. There long been two reasons for this:
- The US is a mature market with no demand growth since 2000 in ethylene and the biggest-volume derivative being planned downstream of all of the crackers – polyethylene (PE). This is the result of down gauging – i.e. PE technology that enables converters to use ever-smaller volumes off resin to produce plastic films that are just as good or even better than when they were using more resin. PE demand growth is also flat because of the long-term decline in the US economy.
- Overseas markets would never have been able to absorb all of the volumes from these plants. This was firstly because the only game in town in terms of the capability of buying this tonnage was China and secondly, it was clear from November 2013 onwards that China was heading for a major economic slowdown.
So last year I was predicting the possible cancellation of some of these projects, even though the margins on existing cracker and derivatives operations suggested that there was a great opportunity to make profits in the future. But my point here was this: Money on a spreadsheet is fine, but it is only real money when you can actually sell enough of your product to make a decent return on your investment.
For so many quarters, though, the financial results of US petrochemicals companies have been fantastic, thanks to the shale gas advantage. As a result, investments seemed to have gained an irreversible momentum based on these two alternative arguments:
- Ethane prices are going to remain low for a very long time in the US, and so this is indeed just too good an opportunity to be missed.
- And because our margins will stay very strong global economic growth doesn’t really matter, as we will have the pricing power to force lots of higher-cost naphtha cracker operators to shut down. This will enable us to create enough global space for all our extra production, no matter how bad the macroeconomics. And, anyway, there is a very good chance that the gloomy predictions about China are wrong.
What kept US cracker margins so incredibly high, though, was not just lots of cheap gas, but also expensive oil that of course eroded the cost position of the naphtha-cracker players.
And why was oil until very recently so expensive? Because most people had yet to realise that China was heading for a prolonged and very severe economic downturn.
Now, though, the penny has dropped on China, pushing oil prices into deep bear-market territory.
The return of the oil price to its historical levels means that relative feedstock prices between oil and natural gas will return to normal. This trend has been underway since last August (see the chart below).
US WTI oil has an intrinsic energy value of around 6 times that of natural gas, and in addition oil has logistic advantages versus gas, meaning that it has typically traded at around 10 times natural gas prices.
Thus $25 barrel oil [Paul’s long-term forecast price for crude – subscribe to his report for his explanations] will mark a return to the traditional relationship with natural gas, assuming its prices remain around $2.50 million British thermal units.
There is at least some good news in all of this: US companies now have even more justification to re-examine and possibly cancel projects. No matter how painful this process is likely to be, it will be a lot better than losing an awful lot of money.