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Europe petrochemicals demand weakness may have bigger impact than any production cuts

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By John Richardson on 05-Apr-2022

By John Richardson

SOME ECONOMISTS MIGHT need to get out a little more rather than spend time poring over data, such as the recent inversion of the yield curve, which is said to be an indicator of a possible global recession (the inversion is when the yield on the two-year US Treasury note rises above that on the benchmark 10-year note).

“Lexie [not her real name] lives in rural north Wales. She is disabled, and her husband recently lost his job in the building trade,” wrote John Harris in this 3 April article in the UK’s Guardian newspaper.

The heating and hot water in the family’s home was oil-fired, and the price of 500 litres of fuel had risen from £235 to £480, Harris added.

“They have also just found out that their annual electricity costs are rising from £1,851.15 to £2,564.33. Their four sons are aged from eight to 18. They have not put their home’s radiators on since last November,” he wrote.

I am afraid that a recession has probably already arrived in the UK and in mainland Europe because of the impact of rising energy costs, not only on the most vulnerable such as Lexie and her family, but also on average earners as well.

The only historic parallel to today’s events seems to be the 1970s, when, as a I child, I remember my mother cutting back on discretionary spending to meet soaring energy bills. Millions of other Britons were in the same situation as energy and food bills soared.

There is a lot of discussion about how polyethylene (PE) demand in developed markets won’t suffer substantially during any recession because most of its end-use demand is in essential food and medical-packaging applications.

But how does one define essential?  Chocolate biscuits don’t fall into the essentials category and biscuits are food.

“I am seeing a drop in grocery spending among my lower-paid customers,” said a friend, who manages a supermarket in the UK’s midlands region. He tracks their income levels through a loyalty-card programme.

This is the reverse of what he saw at the height of the pandemic, when grocery spending among his lower-paid customers went up because of big government stimulus programmes.

Western governments’ abilities to repeat big stimulus is being constrained by the higher interest rates resulting from levels of inflation that we haven’t seen since the 1970s.

One newspaper article, and one comment from a supermarket manager, hardly makes a demand model.

But if you are being told that developed-world PE demand will be pretty much immune from the cost-of- living crisis, I would challenge this assumption.

If I were a senior executive with a polyolefin producer, I would send my sales team out there to discover for themselves what converters and brand owners say about demand.

You should also note that developed-world PE demand was probably going to decline anyway during 2022, even without the Ukraine-Russia conflict.

ICIS data showed that in the EU plus the UK, linear low-density polyethylene PE ((LLDPE) demand performed extremely well at the height of the pandemic despite a big decline in GDP:

  • EU plus UK demand also grew by 1% even though GDP contracted by 6% in 2020 over 2019. This is best compared with 2009, the low point of the EU sovereign debt crisis (the UK was, of course, still an EU member then). Year-on-year LLDPE demand fell by 10% as GDP declined by 5%.

In 2021 over 2020, US LLDPE demand grew by a further 6% as GDP growth returned to a positive 4%. The EU plus the UK saw a 6% LLDPE demand growth and a 6% rise in GDP.

Patterns of demand versus GDP are similar in high-density PE (HDPE) and low-density PE (LDPE).

Assuming the pandemic does become endemic, we should expect less demand in hygiene end-use applications. This was one of the reasons why European demand outperformed GDP in 2020.

The other big reason for the outperformance -– more “surface area” demand as people spent more in supermarkets and less in restaurants at the height of the pandemic -– is more complicated.

Higher costs of living may limit the post-pandemic return to restaurant dining. But if grocery spending is cut back as people struggle to make ends meet, the net result could be less PE demand.

Demand may therefore be the main issues in Europe and not supply

Shortly after the invasion happened, I flagged up that reduced European PE supply that could create a bigger opportunity for exporters.

Before the crisis, the Russian Federation was forecast by ICIS to be a net exporter of around 500,000 tonnes of HDPE in 2022. Most of these tonnes would have gone to Europe (the Russian Federation was expected to be just about balanced on LDPE and LLDPE).

Russian HDPE exports to Europe now look very difficult because of the crisis.

Europe buys some 50% of its naphtha from Russia. ICIS pricing reports that European purchases of Russian naphtha have declined because of the indirect impact of Russian banks being unable to use the Swift financial system.

Europe relies on Russia for around 27% of its oil. Europe depends on Russia for an average 40% of its natural gas, rising to higher levels in individual countries. For example, Germany’s dependence on Russian gas is said to be around 55%.

The last few days have brought very disturbing allegations of Russian atrocities in Ukraine, prompting calls for formal sanctions on Russian energy.

As Chinese PE demand is weak and pricing pretty much pricing flat despite deep operating rate cuts, PE exporters are very keen for scenarios on how energy shortages may affect European PE production.

As the chart below shows, using LLDPE as an example (patterns are similar in LDPE and LLDPE), the big price gulf between Europe and China remains in place. The gulf first opened -up in early 2021.

I will be writing a further post on China later this week where I worry that its economy might even go into recession.

But, sticking to Europe, one can see why this type of chart is drawing a lot of interest in the context of potential European PE production cuts.

And as the second chart below illustrates, northwest Europe LLDPE price premiums over China remain close to record highs. 

But here is a scenario that could play out:

  • Europe introduces direct sanctions on Russian energy, forcing consumers to turn their thermostats down and some industries to cut back production.
  • But lower refinery operating rates on a lack of Russian oil and naphtha -– and reduced electricity supply to refineries and petrochemicals plants -– are more than offset by weaker European petrochemicals demand.
  • Further supply chain problems caused by the Ukraine-Russia conflict and China’s Zero- COVID policy, along with inflation, lead to a collapse in European durable goods consumption. This badly impacts key petrochemical end-use markets such as autos, white goods and electronics.
  • This leaves plenty of spare naphtha available to maintain local PE production at usual levels, regardless of whether European demand into non-durable applications is also negatively affected.

Conclusion: Monitoring all the moving parts

I could be wrong as there are so, so many moving parts. Europe may represent a stronger PE export opportunity during the rest of this year.

Other moving parts I haven’t mentioned -– and where ICIS can also support you -– are levels of US PE exports. If you are a Middle East exporter looking to shift more to Europe, visibility on the US is essential.

There are reports of difficulties with US logistics constraining US PE exports that our excellent CDI team is monitoring.

And as another example of increasing complexity, might higher US liquefied natural gas (LNG) exports to Europe, as the West tries to break its energy links with Russia, lead to cheaper US ethane? Ethane must be extracted from LNG before it is shipped.

Cheaper US ethane may boost US export competitiveness in Europe versus the Middle East -– and especially versus the US’s naphtha-based competitors in Asia.

And perhaps PE and other petrochemicals demand in Europe will be much more resilient than I expect.

Clearly, however, you need to evaluate all the above moving parts -– and probably many more that I haven’t been able to identify.

Every extra tonne of PE sold at good netbacks in today’s highly volatile markets – in not just only Europe, but also in all the other regions – will be of critical importance this year in what I believe will remain a very long global market.