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A fundamental shift in thinking on petrochemical plant closures

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By John Richardson on 07-Nov-2023

In the third part of my series on the New Petrochemical Landscape (here is the Executive Summary and part two on crude-oil-to-chemicals) I examine a fundamental shift in thinking that could lead to a signifcant wave of capacity closures.

By John Richardson

I AM TOLD IT IS never easy to close a plant down. There are the environmental clean-up and redundancy costs to meet, and it might also be that a loss-making petrochemicals plant must continue to operate in order to support a refinery.

The scale of refining revenues is always far greater than in petrochemicals. The bigger-dollar refining business is the dog that wags the tail.

Plus, there’s long been the argument that security of supply of local transportation fuels needs to be maintained, especially in remote geographical locations.

Another argument against closing petrochemical plants is the history of price fly-ups.

Pricing and more importantly margins have in the past reached positive tipping points after the obscure forces of supply and demand worked their mysterious magic. Sentiment added to the momentum, and, whoosh, producers made more money in a few months than they had lost in several years.

Given the prospect of fly-ups, why would anyone, even someone operating a petrochemical plant far to the right of the cost curve, want to shut down? Especially so when you add the other reasons not to close that I’ve detailed above.

Then there are the social and political factors to consider that can in any location (this is not just a China story) outweigh the economic factors.

Job losses are social and political. Governments intervened when they were made to understand that one job lost in a petrochemicals plant equalled half a dozen or so other jobs downstream, from the converters to the young couple who ran the lunchtime restaurant just outside the gates of the plant.

What if the petrochemical plant was part of a big industrial conglomerate? The insurance company in the same conglomerate might have agreed to fund the plant during bad times on the promise of a return favour later on.

In China, security of local petrochemicals supply has always been a critical factor in decisions to shut plants down. Better to keep the workers employed in the downstream washing machine factory even if the upstream petrochemicals business was losing money.

Perhaps a new way of thinking in Europe

But in Europe, petrochemicals producers operate assets that are sometimes old and small in scale. The assets have become relatively smaller than four years ago because of the big wave of new capacity that’s come onstream.

Some of the refineries which supply them with feedstocks will have to shut down because of the rapid pace of electrification of gasoline vehicles in Europe, which, of course, is weakening the demand for gasoline.

But what about the demand for diesel and jet fuel that could justify the continued operation of European refineries?

What about, though, the ultra-low sulphur diesel that will be produced at very low production costs in some new crude oil-to-chemicals (COTC) plants?

And what about the very competitive base oils that will also be made in the COTC plants in a lubricants market that looks set to decline in size because of electrification? This may further undermine the logic of maintaining refinery operations in Europe.

The costs of decarbonisation in Europe, essential under EU regulations, are also said to be another factor in favour of plant closures.

These costs are reported to above those in the Middle East, in North America and possibly in China when you factor in state support.

When and if the carbon border adjustment mechanism (CBAM) is applied to polymers, European producers could face increased import competition from more efficient and lower carbon emitting overseas plants.

Security of local fuels supply may also be less of an issue as demand for gasoline declines on electrification and if there is ample low-cost diesel and jet fuel available from overseas.

Sure, the costs of environmental clean-ups and redundancies haven’t gone away. But when you balance these against all the other factors, it feels as if a fundamental shift is underway in Europe.

The challenges for northeast Asia ex-China and southeast Asia

The scale and age of some assets in northeast Asia ex-China and southeast Asia are also factors behind potential consolidation in these regions, whereas the pressure on refineries to close due to electrification of transport seems to be much less than in Europe.

But these two regions confront their own, separate monster challenge: The fall in China’s demand for imports.

China keeps adding to products in which it has shifted from being the world’s biggest net importer to being a net exporter – in some cases, the world’s biggest net exporter. In other products, net imports have been greatly diminished.

China used to be the world’s biggest net importer of polyester fibres and polyethylene terephthalate (PET) bottle and film grades. Now it is the biggest net exporter.

In styrene monomer (SM), China has moved to close to a balanced position as there are no big export markets that it can target. China, until it moved much closer to self-sufficiency, had dominated global trade flows in SM.

Returning to the synthetic fibres chain, China has moved close to a balanced position in purified terephthalic acid (PTA) from being the world’s biggest net importer just a few years ago. As with SM, now that China is largely out of the picture, there are no other big PTA importers.

The next shoe to drop might be polypropylene (PP) where China could become a net exporter over the next few years from being the world’s biggest net importer as recently as 2021. This position is now occupied by Turkey.

PP is very different from SM, as the size of Turkey, Europe, Africa and the other regions’ PP import demand tells us.

So, as China seeks to add value to its manufacturing industries as it tries to escape its middle-income trap, there is a scenario where China much more aggressively exports PP, including in higher-value grades. Right now, China’s exports are mainly in the commodity injection grade.

I had thought that China’s polyethylene (PE) imports would remain very big for the foreseeable future. Now I am not sure, having heard the opposite from several industry sources, but have yet to re-crunch the data.

A major global producer of monoethylene glycol (MEG) has a scenario where China moves much closer to self-sufficiency over the next 10 years. I’ve also heard reports, although I have again yet to back this up with any data, that paraxylene (PX) could be heading in the same direction.

Returning to PP as an example, our excellent ICIS Supply & Demand Database allows us to track the percentage exposure of exporters in Asia and in the Middle East to the China import market.

In 2022, 29% of South Korea’s total PP exports went to China. It was 21% in the case of Thailand, 34% for Singapore, 64% for Taiwan and 61% for Japan.

In comparison, Saudi Arabia only exported 6% of its PP to China in 2022. Its main export markets included Africa, Turkey, South Asia and Egypt.

We need to put these exports into the context of total exports as percentages of production, which is the function of the chart below.

As you can see, Japan is the least exposed as just 22% of its PP production in 2022 was accounted for by its total exports. This was because of the size of Japan’s domestic market.

But producers in other locations face major risks. Singapore, South Korea, Taiwan and Thailand could struggle to maintain acceptable operating rates if China were to become a PP net exporter.

And for everyone in every region the scale of oversupply – the result both of China’s greater self-sufficiency and because of growth that’s much lower than had been expected – is exerting pressure for consolidation.

This again comes back to China. The main reason for the chart below is that as recently as three years ago, China’s petrochemicals demand was expected to grow by 6-8% per year, but 1-3% now seems more likely. China dominates global demand.

Because China’s demand looks set to grow by only 1-3%, and because as I shall hint in a moment the scale of necessary capacity closures will be huge, I see little prospect of a sudden “fly up” in margins.

I suspect that we will instead see a prolonged trough as the business reshapes itself.

Conclusion: We are in uncharted territory

“We are in uncharted territory” can be an inappropriately used cliche. Not in this case, though, as the above chart tells us that:

  • Global ethylene operating rates are forecast to average 80% in 2022-2030 and propylene 72%. This would compare with ethylene at 88% in 2000-2021 and propylene at 81%.

In a later post, I shall examine the scale of lower capacities in global ethylene and propylene versus our base case that would have to happen between 2022 and 2030 to get back to the historically healthy operating rates.

In short here, and given I see little upside for demand, the scale of these necessary reductions in capacity versus the base cases will be huge.

I believe a new petrochemicals landscape is emerging. The commodity end of the business will, I think, be increasingly shaped by the oil and gas companies. A few non-oil and gas companies in North America could also win because of shale gas, as could the regional “national champions” with strong government support.

For the rest, sustainability appears to be the way forward. But this means consolidation and a switch to smaller, niche and more complex markets. In other words, these companies will need very different business models.