By John Richardson
AS crude heads to perhaps as little as $10-15/bbl, you have evaluate the immediate, or first order, effects on the petrochemicals industry and then move to stage two – what it means in the longer term.
Right now, you have to worry about the potential for raw material inventory losses up and down all the hydrocarbon value chains. Late last year, if you were, say, a steam cracker operator, you might have been tempted to stock-up on your raw materials of naphtha in the belief that oil prices had bottomed out. The problem was that too many analysts were making this call.
Now, of course, the naphtha you bought yesterday would have been cheaper today. And the polyolefins you attempt to sell today will be at lower prices than those of last month. This was same problem, on a bigger scale, that threatened the bankruptcy of companies in late 2008, when oil prices also defied the conventional wisdom and collapsed to around $30/bbl.
I strongly suspect that the bigger companies are in general much better at inventory management than in late 2008. But what about the smaller companies? Might they be soon fielding calls from bankers unwilling to further extend working capital? Managing working capital will thus be King today, whatever cash you can get your hands on, and so a sale will be sale, even if it just delivers a few dollars above variable costs. This will drive product prices lower, creating even more difficulties for producers with weaker economies of scale, and, as I said, raw-material inventory losses.
This moves onto our second order effect – what happens to making contributions to everything above the variable cost line. Because of the new global economic realities, demand will simply not be there to justify the capital costs of many of the new recent petrochemicals investments.
In China, of course, paying back debt has never been an issue because of the importance of recent investments to local governments. Nothing has changed. They still need the tax revenues from these plants, and so the plants will be kept running via soft loans. The central government, anxious to minimise job losses, could well also provide support to producers, particularly if they are operating very new and so world-scale plants. Why shut down modern capacity, when the focus is on getting rid of older, and so less efficient, plants across all industrial sectors? Big oversupply in products such as purified terphthalic acid will thus not go away.
The West is obviously entirely different. Failure to meet debt repayments will result in bankruptcies, with some countries and regions better placed than others to help companies through this process. The Chapter 11 procedure in the US stands out as giving producers there a pretty good chance of survival. Debt will clearly thus be written off, with investors only receiving a few cents in the dollar.
As I said, some Western companies will survive, whilst others will not. This will provide private equity companies opportunities to acquire often brand new, and so again world-scale, assets at discounted prices. These private equity investors will then be in a position to run plants very hard in just about any market conditions, as they will little or even no capital costs to pay back. This will add to deflationary pressures.
I suspect that, in a couple of years, the landscape of the business could look a lot different, with more private ownership. The bigger companies will not only be forced to exit some product chains because of debt, but will also face increasing investor pressure to streamline operations