A return to lower oil prices is good news for the global economy. But it is bad news for all those who have invested in expanding ethylene production on the assumption that US gas prices would maintain the temporary advantage of recent years. As the chart shows:
- Oil (blue line) has around 6x the energy value of gas (red)
- US oil and gas prices have historically tracked each other on the basis of relative energy values
- Prices have only recently diverged, due to the Federal Reserve’s Quantitative Easing (QE) policy
- Now the two lines are reconnecting very fast, with the gas advantage already nearly halved since the summer
Logic always dictated this would happen, once the Great Unwinding of central bank stimulus policies began.
Energy values are not like paintings, where someone may naturally prefer to value a work by Rembrandt or van Gogh at a higher price. If gas is cheaper than oil, a normally-functioning market will soon arbitrage prices back to reality.
The problem is that euphoria over shale gas has also blinded companies and investors to the real issue:
- The ethane surplus driving the US ethylene expansions is just a side effect of shale gas expansion
- This is a relatively small volume compared to the natgas volume, but has to be sold on a distressed basis
- This creates a need to find a home for the ethane on a lowest-cost basis
A number of potential options exist to do this. Usually the cheapest option is simply to blend the ethane with gas from another field. Another is to ship it overseas for use as feedstock in other regions.
Ethane can easily replace LPG as a cracker feedstock, and ethane terminals are relatively cheap to build by comparison with the cost of building ethane cracker complexes to process it to polyethylene.
In addition, the distressed ethane can then simply replace existing feedstock. There is no need to develop new markets for the derivatives, such as polyethylene, in an already over-supplied global market.
Today’s problem, however, is that companies and investors appear to have been blind-sided by the impact of the Fed’s QE policy. They came to believe that a “new paradigm” had developed in energy markets where oil would always be valued at more than its energy value.
Now, as I have long feared, we will all end up paying the bill for the Fed’s policy mistake.