Where will all the new US ethylene capacity be sold?

Consumer demand

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US C2 Nov14I worry about the $100bn+ investment that it currently being made in new US chemical output.  On paper, it seems a ‘slam dunk’ as a US College basketball player might say:

  • Shale gas has created a massive surplus of ethane feedstocks that can provide low-cost production for export
  • Oil prices are very high, and so all this new production has a ‘price umbrella’ compared to alternative production routes from oil

What could possibly go wrong?

The problem that keeps me awake at nights, as I documented back in March, is that neither of these statements stand up to proper examination.

1.  The US cannot sell existing production.  The first issue is highlighted in the left-hand chart (which annualises 2014 data using Q1 – Q3 output).  It shows that the US is producing less ethylene today than a decade ago, well before the Great Recession began.  So it seems most unlikely that companies can suddenly start to sell another 10 million tonnes of production over the next few years, as the new capacity comes online

2.  Oil prices are beginning to return to historical levels.  Oil markets lost their role of price discovery over the past decade, as discussed last week.  Instead the ‘correlation trade’ meant pension funds bought oil market futures as a hedge against the US$’s decline.  And the algorithms of the high-frequency traders told them that the S&P 500 Index and oil price futures always moved together.  But today’s oil market collapse tells us this period is now ending.

3.  The US will not be able to export its vast surplus.  The right-hand chart tells another key part of the story.  US exports of polyethylene, the main derivative, have been in steady decline since 2009.  Even worse is that China is building vast new capacity at a time when its own demand growth is slowing sharply.  It is already exporting major volumes of PVC and PTA for the first time in history.  It may well end up exporting surplus PE as well

4.  Asian producers have to find new markets.  Asian companies have continued to open new capacity in recent years, often expecting at least half of the output to be exported to China.  Already they are having to compete against cost-advantaged Middle East production.  But governments are unlikely to allow them to shutdown, due to the social impact.  Instead, we are likely to see duty barriers and other protectionist measures

Outside of Asia, other Regions such as Latin America and Africa are simply too small to make a difference.

These are urgent questions that have been ignored in the general excitement over the shale gas revolution.  But the good news is that Board members and investors still have time to start the debate.  They may be unpopular at first.  But temporary unpopularity today is better than living with a ‘white elephant’ for years to come.

 

 

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