Market outlook: Europe ethylene heading for oversupply

Source: ECN

2018/12/13

The European ethylene market is in the limelight following a number of new investments announced by some market players.

In a bolt out of the blue, INEOS declared plans for new projects in northern Europe at a value of €2.7bn, comprising an ethane-based cracker and a propane dehydrogenation (PDH) plant.

Not only are greenfield units being considered, but also a few expansions of existing facilities. INEOS has approved an ethylene capacity enlargement at its Grangemouth complex in Scotland, UK.

A new furnace will be fed by ethane and is expected to start commercial production in the fourth quarter of 2020 or early 2021.

Austria’s OMV also aims to expand its cracker unit at Burghausen in Germany by 2021. New investments are a surprise because the European ethylene market is structurally long.

Europe has not invested in any new ethylene plants for more than 20 years due to a number of issues such as energy costs, a lack of cheap raw materials, stricter environmental laws and higher labour costs.

In contrast, cheap feedstocks in the US and a capital-expenditure advantage combined with the need to narrow the supply-demand gap in China are driving construction of new plants in these countries.

However, deeper economic analysis explains why the efficiency of such investments in the ethylene industry might worsen in Europe.

ROI and PCI

Return on investment (ROI) is among the financial tools used to evaluate the quality of a project. The ROI of stand-alone steam cracking, expressed as margin-to-replacement investment ratio, typically increases in line with a growing spread between ethylene price and feedstock costs.

The cost of replacing an investment then increases in line with Plant Cost Index (PCI). This takes into account costs of equipment, construction labour, buildings and engineering and supervision.

ROI

PCI is subject to several factors such as inflation of construction materials, productivity rates and labour costs. PCI has been increasing since 2017, making ROI less attractive compared with previous years.

ROI has been gradually declining because of gloomy ethylene in the US where overcapacity has negatively affected ethylene prices, with higher ethane costs exerting further downward pressure on US cracker margins.

China has been experiencing the highest ROI owing to higher margins and lower PCI compared with the US and Europe.

Europe has recorded healthy gains despite the rise in naphtha costs. Improving cracker flexibility in securing advantaged feedstock (i.e. LPG at the expense of naphtha) and higher ethylene prices have been the main factors behind the snug margins in Europe.

The current backdrop should not last long because, in light of supply and demand fundamentals and raw material costs, European ethylene is undoubtedly overpriced and, clearly, the industry cannot cope with such a high monomer price in the long term. This means that cracker profitability is projected to shrink over the next years, affecting negatively the ROI.

How will the ethylene market evolve in the next couple of years?

A lacklustre market for ethylene is likely on the horizon, given the worries about the projected economic climate and additional polyethylene cargos from the US.

Many economic analysts see the global economy worsening by 2020 following nine consecutive years of good economic growth. Bloomberg published a survey in early October which found that two-thirds of US business economists foresaw a global recession by the end of 2020.

Trade policy, higher US interest rates and a possible stock-market crash might lead to weaker economic growth.

Germany, the major engine of the eurozone economy, announced in mid-November that its economy decelerated in the third quarter of 2018 after three and a half years of expansion. It slashed its GDP projections for 2018 and 2019.

Further disruptions, such as Brexit and the dispute over the Italian budget between Italy and the EU, could also contribute to lower growth.

EUROPE SHORTAGE WORRIES

Concerns about a monomer shortage during 2019 due to scheduled cracker maintenance work appear to be unjustified.

Europe has about 25.6m tonnes/year of cracking capacity, with North-Central Europe accounting for around 18.6m tonnes/year of this total. The rest of Europe makes up the balance.

Capacity

Analysing what occurred in 2017, Europe lost 1.1m tonnes of ethylene production, with planned outages accounting for about 740,000 tonnes.

At the time of writing, 900,000 tonnes of 2018 production had been lost, with 470,000 tonnes of this total the result of scheduled work. Planned and unplanned interruptions in production have been lower in 2018 than in 2017, lengthening the ethylene market throughout the year. In 2019, according to market sources, about 600,000 tonnes of capacity is scheduled to be off line.

The bulk of planned outages will be in Germany and the Netherlands, with the peak production loss expected in May. Actual lost production capacity will surely be higher because of unexpected technical problems. Nevertheless, the regional production capacity will not meaningfully drop compared with the recent past.

The European ethylene market will remain, by and large, long during the year even though limited shortages of material could materialise at some point in 2019.

ETHYLENE GLUT FORECAST

The projected less-than-brilliant macro-economic circumstances, coupled with US overcapacity, might hit future ethylene consumption in Europe. Downward signals for ethylene demand have been picked up for 2018, with preliminary estimations indicating a drop in demand of about 2% on a year-on-year basis. Ethylene supply likely will be more resilient this year, falling less than consumption, with exports supporting cracker production.

According to the latest available partial trade data for 2018 (to July-September, depending on country), European ethylene exports reached about 450,000 tonnes. These volumes are higher than those for full-year 2017.

The majority of the surplus has been sent to Asia, with Italy the largest exporter. Europe’s imports fell to about 50,000 tonnes because of the length of the market, and are significantly lower than imports in 2017. Net exports should be high in 2018 because of advantageous Asian prices, but they are likely to decrease over the next years because of the bearish sentiment.

EUROPE ETHYLENE PRICES

The Europe ethylene contract averaged a higher price in 2018 than the previous year, mostly as a consequence of increased feedstock costs.

Ethylene prices are likely to rise in early 2019, mainly because of pre-buying ahead of turnarounds. In the second half of 2019, we expect monomer prices to decline, mostly because of oversupply and weak demand.

An open arbitrage window from Europe to Asia could alleviate to some extent the length in the ethylene market, although Asia’s import appetite is foreseen to decrease over the next years. To meet soft domestic demand both in 2019 and 2020, less competitive crackers in Europe might cut back their operating rates. This would, though, result in lower gains.

The ability to predict and make operating decisions almost real-time, changing, wherever possible, the raw material slate in response to market volatility, will be fundamental to resisting headwinds. This tells us that feedstock flexibility will continue to play a crucial role for crackers.

Trade

TRADE WAR OPPORTUNITIES

Some opportunities might also arise from the recent tensions between the US and China.

In fact, even though the trade war is generally a source of concern for the petrochemical industry, some players could make gains. European operators might be able to take advantage of the Sino-US trading conflict by obtaining discounts on ethane and LPG cargoes.

About the author:

Paolo Scafetta is a senior analyst at ICIS, covering the olefins market. He is part of the team responsible for the European short-term olefins price forecast. If you would like to discuss feedstock options in today’s volatile climate or other issues, please contact paolo.scafetta@icis.com