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Asian Ethylene Markets: What We Definitely Know

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Asianethlyenespreads

By John Richardson

FORECASTING the absolute future price of any petrochemical has always been difficult and if you are ever exactly right this will be down more to good luck than good judgement.

And the problem is that when you have been right once, and you make a big song and dance about it, everyone expects you to be right all the time – which, of course, is impossible. Anyway, if you were right all the time you wouldn’t be forecasting, but would instead by trading, would keep your methodology secret, and would make an absolute fortune.

Today, though, life for petrochemicals corporate planners is even harder because of the extreme volatility in crude prices. Even if you classify day-to-day or even week-by-week price movements as mere noise that needs to be ignored, and instead try to come up with a sensible 12-month forecast for oil, this doesn’t really help. The reason is that over the next year all of these three scenarios are perfectly possible:

  1. No more major Western central bank stimulus and you are looking at prices returning to their long term average of around $30 a barrel.
  2. More major Fed etc. stimulus and we could be back to $100 a barrel.
  3. Or around $50 a barrel in a world of perhaps some stimulus, but still weak underlying demand.

There also are  numerous potential price points in between these three extremes, which is why you need a wide range of scenarios to stress test your business. This will be the subject of a new multi-client study by ICIS Consulting and the UK-based chemicals consultancy International eChem. Details soon.

Meanwhile, here are a few things we can be sure about:

  • There will be a very weak “peak manufacturing season” in China this year. Normally, between around July and October, Chinese manufacturers ramp-up production of finished goods for export to the West in time for Christmas. But the 14.3% fall in Chinese imports in August (a big percentage of Chinese imports are raw materials that are processed for re-exports) suggests a weak peak season. So this is a downside for spreads – and more importantly margins – up and down all the petrochemical value chains.
  • The macroeconomic fundamentals are not going to get any better, and can only get worse, until or unless Western policymakers wise-up about where they have gone wrong. In the US, new and sensible policy initiatives will be pretty much on hold next year because of the presidential elections. And in Europe, talk of more ECB stimulus entirely misses the point.
  • Meanwhile, the weakness I have just detailed in China can only get worse as economic reforms continue. These reforms simply have to continue. And even if you wrongly assume that they will be scrapped, no amount of new government stimulus can return China to the growth pattern that it saw in 2008-2013. The maths simply do not add up.

So let’s next drill down and consider what this means for one of the six petrochemicals building blocks – ethylene (for anyone new to the industry, click here to find out more about ethylene –and the five other building blocks).

The spread between CFR Japan naphtha costs and CFR Northeast Asian (NEA) ethylene prices was historically very high at an average of $644/tonne in January-August of this year. This compares with an average of $356/tonne for 2009-2014.

Why? Because the thinly traded Asian ethylene spot market was very tight earlier this year due to a large number of production losses. This was great for integrated naphtha and ethane-based polyethylene (PE) producers, as the Asian spot ethylene price largely sets Asian PE prices.

So I see the spread between CFR Japan naphtha costs and CFR NEA ethylene prices returning towards that $356/tonne long-term average over the next year – and possibly lower – now that these production losses are at an end – and because of the macroeconomic fundamentals. The only reason why I think this might not happen are lots more unexpected shutdowns.

More importantly, also, I see ethylene and and high-density and low-density PE margins declining as spreads are,not a measure of profitability.  Margins have again been well above their historic averages so far this year. So I also see them returning towards their historic averages, possibly lower, over the next 12 months.

For more details on margin forecasts, contact me at john.richardson@icis.com