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Ukraine-Russia: Assessing petrochemical demand losses

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By John Richardson on 25-Feb-2022

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By John Richardson

NOW THAT an invasion has started, the critical issue for petrochemicals companies is whether they can fully pass on rising oil-price costs to their customers.

In the very best of outcomes, passing on the extra costs will take considerable time because of the speed of the oil-price rise, leading to declines in margins for the naphtha-based players. At the very worst, and this seems to be the much more likely outcome, lost end-use demand will make passing on all the extra costs impossible.

In the immediate term, of course, the US, Middle East and Asian ethane-based producers of ethylene derivatives will see their margin advantages over naphtha-based players improve.

But the bigger issue as this crisis unfolds is the extent of lost demand and what this could mean for sales volumes up and down all the value chains. If oil prices were to stay at where they are today, or go even higher, discretionary purchases would very probably take a big hit – and this is likely to be already happening.

So, anyone wanting to work out the prospects for different petrochemicals companies would need to analyse their product portfolios.

The companies heavily focused on making petrochemicals and polymers that go into, say, autos, washing machines, refrigerators and consumer electronics might take a big and immediate hit.

And it is essential to note that while some petrochemicals derivatives can be made from ethane, this is only a small portion of the overall pie. All the aromatics derivatives, many of which go into durable end-use applications, can only be made via crude oi-derived petrochemicals feedstocks.

The companies that make the derivatives of aromatics are therefore confronting the double blow of surging feedstock costs and demand destruction.

The outlook for the biggest ethylene derivative, polyethylene (PE), is a lot more nuanced, as I’ve discussed over the last couple of weeks.

PE consumption does not move in line with GDP. Even if, as seems likely, GDP declines on higher energy costs, this does not necessarily mean that all end-use applications of PE will suffer. People still have to eat, albeit more likely supermarket own-brands rather than brand owner products.

And the pandemic has caused so many distortions to PE demand patterns that is impossible to say whether – as we hopefully emerge from the worst phase of the pandemic – consumption will decline, increase or remain where it is.

But, to some extent, it is still possible for PE industry watchers to grade the risks through analysing the product portfolios of the producers.

Any producer who is heavily focused on making high-density PE (HDPE) pipe grade could be more exposed to demand destruction from a collapse in real-estate contraction versus, say, another producer heavily focused in linear-low density PE (LLDPE) films for wrapping food.

Complicated enough? I am afraid, as is the case with all major conflicts, it gets much more complicated than this, and it can only get more complex. We must also consider:

  • The extent to which petrochemicals production could be affected in Hungary, Slovakia, Czech Republic, Poland and the former East Germany by any Western sanctions on Russia’s Druzhba oil pipeline. The ICIS data forecast that for 2022, 2.79m tonnes of ethylene (11% of total European capacity) and 2.34m tonnes of propylene (12% of total European capacity) are reliant on refineries located along the Druzhba pipeline. While some alternative sources of crude oil could be sourced, it is unlikely normal levels of operations could be maintained.
  • How European production might also be affected by any further interruption in European gas supplies as Russia supplies 40% of Europe’s natural gas. Russia has already cut gas supplies to Europe via Ukraine by two-thirds since January.

It is also important to note that soaring gas prices are also contributing to the inflationary pressure.

Back to the core issue of crude oil.

Modelling the impact of either $100/bbl crude or $150/bbl

“The core reason for the oil price rise is the risk of Russia either choosing to, or being forced to, reduce its oil exports to Europe,” said ICIS senior analyst, Ajay Parmar, in this free-to-view ICIS news article.

“It could choose to reduce these exports in the same way in which it has done with gas, to cause pain to Europe but the more likely scenario is the West imposing strong sanctions on Russia,” he added.

Russia currently exports around 2.3m bbl/day to Europe but if sanctions restrict Russia’s access to Western financial markets, it could make it difficult for Russia to sell its crude on the open market, as oil is sold in US dollars.

“This could reduce Russian oil exports during the exact period where OECD oil inventories are at a seven-year low; if this level of sanctions are applied by the West, oil prices could see a sustained spike well beyond the $100/bbl level,” said Parmar.

Moody’s, in a research note, modelled the impact in global GDP of either crude remaining at its current level of $100/bbl or increasing to $150/bbl.

Under the first scenario, GDP growth in the second quarter would be reduced by 0.1 of a percentage point, by 0.5 of a percentage point in the third quarter and 0.2 in Q4. Crude at $150bbl would lead to Q2 growth being 0.2 percentage points lower, one percentage point lower in Q3 and 0.4 lower in the fourth quarter.

Conclusion: Staying in touch with the micro movements in markets

It is essential that you stay in touch with our excellent news and analytics teams as they provide the micro details, for example, oil, gas, feedstock and product price movements, shifts in margins and any production issues. Please click here for our topic page on the crisis.

I also hope that these few thoughts will offer you some guidance during this rapidly evolving crisis. More will of course follow next week.