EPCA ’22: Long markets, falling margins could prompt more Europe production cuts – EPCA president

BERLIN (ICIS)–Weaker market conditions, narrower margins and easing supply chain issues could open Europe up to cheaper imports, forcing more producers to cut operating rates, according to the president of the European Petrochemicals Association (EPCA).

With institutions such the IMF, the OECD and the European Commission itself all continuing to slash GDP growth expectations in an economic environment that is deteriorating faster and more deeply than expected, many chemicals markets are expected to remain long into next year, according to EPCA’s president Hartwig Michels, who is also the president of BASF’s petrochemicals division.

The economic chill currently taking root in Europe and beyond is likely to offset the normalisation of supply for petrochemicals players after the outages seen in the first half of the year, according to Michels.

“I expect a supply normalisation during the second half of 2022 following the end of planned and unplanned outages we have seen during the first half of the year. On the other hand, consumer confidence in the eurozone has fallen to a record low,” he said.

“Markets are turning long during the second half of 2022 and, consequently, extending into 2023, resulting in reduced margins in comparison to the healthy levels reached in the first half of this year. Depending on how pronounced and fast the demand reduction will materialise, producers may be forced to reduce operating rates,” he added.

There has already been a spate of shutdowns in the European chemical and fertilizer sectors as a result of surging energy prices rendering production of some materials uneconomic.

European players have also benefited to an extent from supply chain issues representing a shield as well as a hurdle, insulating producers from lower-cost competition elsewhere.

“The extreme shortage in interregional transport capacities did limit arbitrage business from Asia and the US into Europe, allowing European producers to pass on rising raw material cost nearly fully. This is changing now. More imported volumes of lower cost products into Europe put substantial pressure on prices,” Michels said.

“Like no other region, Europe is depending on access to feedstocks from other regions and access to markets globally. Nevertheless, we do see and will see in some cases homeshoring of value generation taking place – especially for key intermediates which are important for domestic value chains,” he added.

Despite the shutdowns, the increasingly bearish macroeconomic environment is keeping markets for building block chemicals such as naphtha and olefins long as end market demand continues to weaken in an inflationary, high cost-of-living environment.

European policymakers have moved to build up gas stocks ahead of the winter, with the success of those steps underlined by the lack of market impact from alleged sabotage arresting the flow of gas once more along the Nord Stream 1 pipeline from Russia to Europe in late September.

Nevertheless, a cold winter could push gas reserves to dangerous lows, meaning the prospect of rationing has not yet been eliminated, with a lot also riding on the alternative supplies that governments have sourced all being delivered.

For example, BASF has set out plans to cut production of lower-margin, energy-intensive chemicals such as ammonia if gas supplies are limited.

The need to build up gas reserves has also seen some countries, including Germany, revive mothballed coal-fired power plants, which has resulted in some erosion of the gains chemicals firms have made on reducing carbon dioxide (CO2) emissions.

Levels for the industry have increased this year, according to Moody’s, and could stand to increase in 2023, which has prompted concerns about progress on publicly stated emissions reduction targets.

Policymakers have set out set durations for those plants to be used, and increased CO2 emissions at present are unlikely to represent a long-term threat to progress, according to Michels.

“Granted, there will be the need to include more coal in a countries energy mix, but this will be a temporary measure to cover the energy gap for a few years perhaps, which will not result a serious departure from the EU’s climate path with a fixed ETS [emissions trading system] emissions cap,” he said.

With no end in sight to the Russia-Ukraine war and little prospect of Europe returning to pre-invasion gas flows from Russia, a more systemic issue with the energy transition is the prospect of prices staying higher well into the future.

The focus at present is on securing sufficient reserves to keep houses heated and industry producing during the winter, but none of the current issues are likely to have gone away when spring 2023 comes into view.

This makes the political calculus of how to address the sustainability challenge even more delicate, Michels said, considering the potential for energy costs to make up a more substantial portion of European household budgets for years into the future.

“We need to consider that this is an energy crisis of global scale. Affordable energy will be a key challenge to prevent social unrest. The sustainability transformation will require gigantic investments in a relatively short period of time,” said Michels.

“And it will result in higher costs, which at the end of the day will have to be borne by the consumer. So, the fact that we are currently entering a period of a weakening economy, higher inflation, and geopolitical tensions will make this transition even more challenging,” he added.

Some governments such as the UK have moved to introduce ceilings on how much of the energy cost rises will be borne by households and businesses – albeit with a far shorter timeline for companies than consumers – but, with the cost of those measures running into hundreds of billions across Europe, it is unlikely that those measures will last forever.

“We have to take the people along on this transformation journey. However, we will realize that we cannot compensate all negative impacts on rising living cost via state subsidies,” Michels said.

The EPCA annual meeting runs on 4-6 October in Berlin.

Interview article by Tom Brown

The conversation with the EPCA president took place in the run-up to the event; the second part of ICIS’ conversation with Michels, covering the role of fossil fuels and EU chemicals legislation, will be published on 4 October.