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Supply-Driven Petrochemicals Success Under Threat

Business, China, Company Strategy, Economics, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins, US
By John Richardson on 01-Mar-2017

By John Richardson

THE OLD joke goes like this: “If oil and gas exploration is the gorilla, refining the dog and petrochemicals the tail on the dog, what does the gorilla say when he looks at the dog? He says, “I can’t even see the tail on the dog’ ”.

The history

So events upstream from petrochemicals, where far-greater investment and operating-cost dollars are required, can have side effects that the petrochemicals business has absolutely no control over. Hence, my first chart for today from Paul Hodges’ blog post last Friday:

OECD2

It shows:

  • European and Asian refineries have been running well below pre-2009 levels due to lack of demand.
  • They have therefore been producing less naphtha as a feedstock for petrochemical plants
  • Only North America has seen good refinery rates – and, of course, most of its olefin production is gas-based, so the higher rates do not translate directly into more petrochemicals production.

So we have lack of naphtha supply restraining global petrochemicals production, which of course the petrochemicals business can do absolutely nothing about because of its dependence on the bigger-dollar upstream refinery business.

And in Europe, the high number of force majeures, due to what Hodges say has been lack of spending on maintenance, has further constrained petrochemicals production by steam crackers.

Putting this all together, the second chart below shows how this has affected the growth of polyethylene (PE) production in Europe between 2008 and 2016 – PE being of course the most-important steam cracker derivative volume-wise. As you can see, production has fallen as demand has crept up over the last eight years:

Europeanpeaproduction

Breaking this down to the three major commodity grades of PE:

  • High-density PE consumption grew by 17% as production fell by 8%.
  • Linear-low density demand (LLDPE) was 11% higher as output fell by 4%.
  • In low-density PE, consumption declined by 6% as it was replaced by LLDPE. However, production was also down by 9%.

European PE markets have thus been tight since 2009 on the high number of force majeures and lack of naphtha, with global market also tight on lack of naphtha availability.

The next phase of history began in September 2014. Oil prices collapsed, making naphtha a lot cheaper for those PE producers which could get hold of naphtha from refineries. So tight global PE markets combined with cheap naphtha to result in the rise in PE margins to record highs.

Then came events peculiar to China in 2016. Its state-owned refineries, already facing fuels-product oversupply, found their economics further undermined by changes to rules governing privately owned, or “teapot”, refineries in China. This further reduced naphtha availability and so China’s PE production. So did ahead-of-target cutbacks in coal production that raised coal prices to the point where China’s coal-based PE plants had to cut back on their output.

The future

Petrochemical company CEOs talk at investor meetings of “the rise of the Asian middle classes” as a reason for strong margins not just in PE, but across several other petrochemicals and polymer products. They also talk of how their innovation is powering growth in for example lightweight but strong packaging materials that reduce carbon footprints.

On innovation, this is to some extent true thanks to the hard work of many people in the petrochemicals industry. But to what degree have we also seen long-term demand destruction over the last two-and-a-half years as petrochemicals end-users have cut back on consumption due to lack of affordability? Has, for instance, expensive virgin PE led to greater use of recycled PE and other replacement materials? This is an area worthy of further study.

And the supply story is I think probably more important to the success of the petchems business since late 2014 than demand, with global PE supply tightness now set to unwind as a result of:

What will remain unchanged is the state of the global refinery business because we have gone past, or are close to reaching, peak demand growth for crude.

But on balance, we are heading for much-greater length in global PE markets with the potential for this oversupply to be greatly exacerbated by a collapse in global demand. On Friday, I will begin a series of blog posts on how the threat of a collapse in demand has developed over the last month.