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European polypropylene: Supply chain demand destruction and the need for a new business model

China, Company Strategy, Environment, Europe, European economy, European petrochemicals, India, Middle East, Naphtha & other feedstocks, Oil & Gas, Olefins, Polyolefins, Singapore, South Korea, Thailand, US
By John Richardson on 24-May-2022

By John Richardson

EFFICIENT SUPPLY CHAINS were something that we used to take for granted. They hummed away in the background, making petrochemicals just one of many globalised industries where products and services flowed almost seamlessly across borders. We didn’t have to think about supply chains because they worked so well.

But with the wonderful benefit of hindsight, stresses were building long before the pandemic and the Ukraine-Russia conflict happened.

The geopolitical relationship between the US and China became a threat due the landmark Mike Pence speech in 2018. The speech by the then- US Vice President highlighted the shift in US policy towards treating China as a geopolitical competitor rather than a partner. There was and still is bipartisan support for this changed approach.

Other stresses include a shortage of US truck drivers that first became apparent in 2018 and precision scheduled railroading in the US that was first developed way back in 1993. This has reduced spare capacity on US railroads. Tight railcar supply is one of the reasons why US polyethylene (PE) exports may not be as big this year as had been expected.

The container shipping industry underwent major consolidation after years of heavy losses. This left us very vulnerable to disruptions in the delicate balance of enough containers in the right places at the right time, and the containers moving in and out of all the major ports on schedule.

As the rest of this post is mostly about Europe, overreliance on Russia for oil, naphtha and natural gas was another problem that was building for many years –- with the benefit of hindsight again.

Because of disrupted supply chains, with no immediate relief in sight, we are into the realm of petrochemical demand destruction, as I shall now discuss using European polypropylene (PP) as an example.

Nice netbacks if you can get them

 In the Old Normal, when international and domestic logistics worked very smoothly, the above chart would have by itself been very actionable.

The surge in northwest Europe (NWE) PP injection grade price premiums over CFR China PP injection grade prices in February 2021 would have led to the big exporters – the Middle East, South Korea, Singapore, Thailand and India etc – easily switching more volumes to Europe. This would have closed the window very quicky, bringing the NWE spread premiums back down to their historic levels.

But this didn’t happen partly because of the tight container market – and also because of the slowdown in Chinese growth and a lot of new capacity in China and South Korea.

European PP imports in 2021 did increase by 9% over the previous year as the tough got going. The overseas producers that managed difficult supply chains were able to compensate for the weaker China growth – and Europe remains a key destination this year.

But 2021’s higher PP imports should be put into the context of a 5% rebound in growth following the pandemic-related 6% contraction in consumption in 2020 over 2019. The growth in imports, in this context, seems to me quite modest.

The Ukraine-Russia conflict left thousands of truck drivers stranded. Semi-conductors were already in tight supply before the conflict because of the surge in demand resulting from the pandemic. Supply has since become tighter.

“Ukrainian companies, Ingas and Cryoin, account for about half the world’s neon production, which is critical for lasers used in chipmaking. Both Ingas, based in the beleaguered town of Mariupol, and Cryoin, based in the port town of Odesa, have shuttered operations due to the conflict,” wrote the IPS Journal in this late April article.

Ukraine also has a thriving car parts industry, including the crucial production of wire harnesses.

“Europe’s new-vehicle sales shrank for a 10th month in a row [in April) as the industry remains mired in supply-chain crises that are stoking record inflation and threatening to put off car buyers,” said Automotive News Europe in this 18 May article.

New-vehicle registrations in the EU, Britain and the European Free Trade Association fell 20% year-on-year in April, the steepest decline this year, according to the European Automobile Manufacturers’ Association.

Rail freight between Europe and Asia has been disrupted by the conflict. Three weeks ago, BMW and Audi suspended auto shipments by rail to China and switched to alternative routes.

“Europe’s high-cost position relative to the rest of the world has already been damaging for some export derivatives [of propylene] for a good while and other derivative production is constrained through materials shortages either brought about by logistics challenges or the Ukraine conflict,” wrote Nel Weddle, Senior Editor Olefins for ICIS Pricing in Europe in her latest price assessment report.

Specifically in European PP, our pricing editors Vicky Ellis, Ben Lake, Linda Naylor and Samantha Wright, wrote in their latest price assessment report that the automotive industry remained a “big hole” in demand with durable goods consumption in general weak.

Even packaging demand was said by market participants to be in decline, supporting my anecdote from a supermarket manager in the UK’s midlands region.

Earlier this, he reported weak sales of a “two-for-one-offer” for-one-offer” of brand owner-made chocolate biscuits. Cheaper single packets of supermarket own-brand, or white-label biscuits, were selling better – the opposite than at the height of the pandemic when confectionary sales volumes boomed.

If single-use PP packaging demand is being negatively affected by record-high inflation –- mainly the result of rising energy costs because of Europe’s dependence on Russia –- Europe’s PP business could be in a lot of trouble.

Some 30% of global PP demand is said to be accounted for by flexible and rigid packaging applications, with 10% into the autos sector and 10% into household goods.

There may be other factors behind the latest European PP import data other than just demand. But take note that year- on- year in Q1 2022, Europe’s PP imports were down by 12% at 2.2m tonnes.

Supply chain disruptions look set to continue

Pat Gelsinger, the Intel CEO, told CNBC on 29 April that he expected the global semiconductor shortage would last until 2024.

“The European Union has unveiled a €210bn ($221bn) plan to wean itself off Russian oil and gas,” reported CNN on 18 May.

“Presenting its “REPowerEU” plan on Wednesday, the European Commission said it would attempt to slash consumption of Russian gas across the bloc by 66% by the end of this year — and break its dependence completely before 2027 — by saving energy, finding alternate sources and speeding up the transition to renewables,’” CNN added.

In other words, disruptions to European energy supply, along with high costs, could last for several more years.

A quick resolution of the Ukraine-Russia conflict seems unlikely. Even when the conflict is finally settled, deep divisions between Russia and Europe may continue. The return to the old geopolitical status quo seems unlikely.

Focusing just on 2022, our base case for European PP demand in 2022 involves 5% growth over 2021. See the chart below which also details consumption since 2019.

If, for argument’s sake, 2020 demand fell by 6% – – the same as in 2020 over 2019 – this year’s consumption would be 1.1m tonnes lower than our base case.

As always, this is not a proper alternative scenario, but it does provide an estimation of the scale of the risks in the world’s second-biggest PP market, behind China.

“Supply chain challenges arising from the COVID-19 pandemic and Russia’s invasion of Ukraine could result in a potential €920bn cumulative loss to gross domestic product (GDP) across the Eurozone by 2023,” wrote Accenture in a report published yesterday, at the World Economic Forum in Davos, Switzerland.

Supply chain disruptions caused by the pandemic cost the Eurozone €112.7bn in lost GDP in 2021, the report continued.

“Before the war, the lack of material supplies, breakdowns in logistics and inflationary pressures were already undermining the economic rebound in Europe, with resurging demand and precautionary hoarding overwhelming supply chains,” said Accenture.

Russia’s invasion of Ukraine had aggravated the situation, with a protracted war potentially costing a further loss to GDP of up to €318bn in 2022 and €602bn 2023, with inflation as high as 7.8% in 2022 before declining in 2023, said the management consultancy.

Conclusion: Making supply chains more local and sustainable

The chances of the world reverting to the old fully globalised supply chains seem slim to me. Europe and every other region must, as a result, focus on localisation. We are already seeing this through, for example, construction of new semiconductor capacity in the West.

In the case of Europe’s petrochemicals industry, the answer is environmental sustainability as the public and legislative carbon abatement and plastic recycling pressures build.  Greater environmental sustainability could result in greater economic sustainability through lower reliance on imports.

Moving hydrocarbons across borders carries great geopolitical risk, as we’ve discovered since late February. Plastic recycling can be a domestic or regional industry because of the negative environmental impact of moving plastic waste across long distances.

If chemicals recycling can be significantly scaled-up, the processes could consume a lot of local European plastic waste, thereby replacing resins imports. Pyrolysis oil from the chemicals recycling plants could be upgraded in big volumes to the right quality feedstock for Europe’s naphtha crackers.

It must be stressed, though, that high quality recycled polyethylene terephthalate (PET) plastic pellet production is increasingly moving across borders.

The short – to medium-term challenges for European petrochemicals are big, I am afraid, as we go through a very difficult period of adjustment. But in the long term, the future looks bright for the producers able to reinvent their business models.