By John Richardson
EVERYTHING started going very well for the global polyethylene (PE) business from the end of 2014/early 2015 if you look at the spreads, or differentials, between naphtha costs and PE pricing.
Spreads are only a blunt instrument to measure real profits. But both spreads and integrated naphtha-based margins have reached historic highs since this turning point – the highest in Europe and Northeast Asia (NEA) since at least 2000 when our records begin. US margins have also been record-breaking – although, of course, they are based on ethane as this is the dominant US feedstock.
What happened from late 2014 is that oil prices fell off a cliff. Over the same edge went the cost of naphtha, which is the main raw material to make PE globally. Meanwhile, PE demand growth remained robust for several reasons, including the following:
- Political stability. This predated the rise of the populists, most importantly of course Donald Trump.
- China’s reforms started and then stopped. The dip in credit growth in 2014-2015 was sharply reversed in 2016. Meanwhile, PE consumption has been bolstered by a.) Strong demand growth for pre-packaged food on food-safety concerns b.) Booming internet sales as China develops its “mobile internet economy”.
Lack of new capacity to meet this demand further benefited the global PE business, enabling it to hold on to pricing very well compared with the collapse in its costs of production. ICIS Consulting estimates that this led to global average PE operating rates climbing to 85% in 2016 from 84% in 2015 and 83% in 2014.
In some regions and in some grades of PE operating rates have been much higher than this. For example in 2016, linear low-density PE (LLDPE) rates reached 98% in the US and 91% in NEA.
What Happens Next
The new US president is trying to something altogether different to reenergise the US economy. No matter what your politics, you have to accept that his approach carries enormous risks.
Events of the first week of his presidency have revealed to everyone the extent of these risks – and have confirmed my view since November that he will govern exactly the way he promised to govern during his election campaign.
The biggest single global risk is the US-China relationship. In the event of a US-China trade war the pace of economic reforms in China and booming internet sales etc. would become almost irrelevant. What would instead matter would be the resulting global recession.
In Europe, Brexit could be followed by the election of populists in polls due to take place in Holland and France this year – and possibly Italy. A breakup of the European Union is a possibility.
Lots of new capacity is also due to be added this year. Our January Asia PE price forecast report details how many tonnes of LLDPE we think will actually hit global markets in 2017 versus nameplate capacities. We will look at low-density PE in February and high-density PE in March.
Let’s assume that 2017 ends up as “business as usual” – a repeat of the benign economic environmental described above.
The above chart on the left, which is from this month’s Asia PE price forecast report, shows my estimates of what this would mean for LLDPE pricing and spreads. This is based on an average 2017 Brent price of approximately $60/bbl with very little month-by-month volatility around this price level.
The recovery in spreads from February reflects the end of the Lunar New Year holidays, with a contraction in March indicating the impact of new start-ups.
Spreads then level-off in May-July and recover in August on maintenance shutdowns and China’s peak manufacturing season – when manufacturers of finished goods ramp-up production time to meet Christmas orders in the West.
Next comes a decline in spreads as new capacities kick-in. But for the year as a whole, both spreads and margins remain close to recent record highs.
But this is a one-dimensional view of the world that by itself is not good enough for sensible business planning. Hence the second chart on the right, which I built around an average 2017 Brent price of $35/bbl and big month-by-month volatility in crude and so naphtha.
In such an environment, measuring new capacities would become of minor importance because of the extent of demand destruction. Pricing – and more importantly spreads and so profitability – collapse in this scenario as the year progresses.