LONDON (ICIS)--Analysis of the ethylene margin cycle suggests challenging conditions for producers in 2020, as new capacity and poor demand forces the cancellation of new projects and global rationalisation of assets.
It is easy to forget that in the pre-coronavirus world the chemical industry was already under a lot of pressure. New waves of capacity were coming on stream just as the US-China trade war was dampening growth around the world.
There were multiple profit warnings in 2019 as conditions worsened during the year.
Into 2020, profitability is likely to be even more challenged as a vast amount of new ethylene capacity is due on stream from now into 2021. As the current shale gas-related capacity boom peters out, attention shifts to China. Here around 10m tonnes of new projects are forecast to come on stream during 2019-2021, according to the ICIS Supply and Demand database.
Throw that into the mix with a global economy devastated by the coronavirus from the second quarter and a worsening supply-demand imbalance looks increasingly likely.
This is likely to lead to delays or cancellations of projects where a final investment decision has not yet been made. Closure of older, smaller and more costly sites is also looking increasingly likely.
Although the pandemic did not really affect Europe and the US heavily until March, the impact of that plus a general slowdown in first-quarter earnings was already startling.
There were double-digit declines in earnings before interest, tax, depreciation and amortisation (EBITDA) for many of Europe’s biggest chemical companies.
BASF, for example, saw EBITDA fall by 12% to €2.4bn. The unquantifiable shock of the pandemic made the company abandon any earnings guidance for the full year. It also raised the possibility of negative earnings for the second quarter.
The biggest impact on earnings was the collapse in automotive sector demand, BASF’s largest customer industry, with products from materials, industrial solutions and coatings feeding into vehicle production.
Global automotive production fell 24% in the first quarter of the year, according to BASF, compared to a 5.6% drop for 2019 as a whole.
With the most intense period of lockdown in the US and Europe lasting from March until June or July, the second quarter is likely to be even tougher for earnings.
EXPECT TOUGH REST OF
The Organisation for Economic Co-operation and Development (OECD) said on Wednesday it expects, assuming no second wave of infections, a 6% contraction in global GDP for 2020. OECD unemployment is forecast to climb to 9.2% from 5.4% in 2019. With a second wave of infections global GDP would fall by 7.6% this year.
Negative chemicals demand growth seems almost inevitable in these scenarios, yet companies are pushing ahead with expansions.
In a podcast broadcast on Monday, ICIS senior analyst James Wilson pointed out that from 2019 into 2020 there were already big dips in margins, especially in Europe. This year was already looking like quite a hard year even before the pandemic hit.
From 2017 to today 11m tonnes/year of new capacity has come on stream in the US. Over the next couple of years another 4m tonnes/year can be expected from projects with steel already in the ground, though some of these could be delayed.
He said: “Coming into this year we were already talking about a need for rationalisation, but we are still seeing a lot of capacity coming on line. The big source is China, with over 10m tonnes/year due from 2019-2021.”
Wilson believes there will be a need for project cancellations and rationalisation of existing facilities. But as the US ethane advantage has waned it is not so obvious where the at-risk units are located.
“We are looking at fixed and variable costs, location for access to markets, how integrated they are. The other big one is government support and social factors.”
Social factors and government targets mean China is not likely to cut chemical production or projects this year.
ICIS's senior consultant for Asia, John Richardson, said: “It’s the last year of the 13th five-year plan and I’m told that people who are behind on their production targets will run hard this year – a lot of that new capacity will run very hard.”
He believes that in polypropylene (PP) it is very easy to picture China moving towards independence, even becoming a net exporter. It will remain a net importer of polyethylene (PE), though imports could fall from 17m tonnes in 2019 to 15m tonnes this year.
Neither are the US operators likely to cut production, as the new facilities have to be paid for even if returns are small.
The ICIS Supply & Demand Database shows that in Q1 US linear low density polyethylene (LLDPE) exports were up 30% while high density polyethylene (HDPE) exports rose by 40%.
Richardson said: “They are running these new plants hard, despite losing their cost position, just to get rid of waste ethane.”
Ethane is still holding its place at the bottom of the cost curve, according to Wilson, but the advantage has reduced. In January US ethane crackers versus northeast Asia naphtha crackers had a cost of production advantage of around $750/tonne of ethylene. Today it’s just $150/tonne.
“The premise on which many of these units was built was the ability to export and still make good money. It’s a more challenging environment now,” he said.
OIL PRICE EXPECTATIONS
International eChem chairman Paul Hodges expects to see crude oil settling back to its long-term median of around $25/bbl, but with considerable volatility.
“We assume we have seen peak oil demand because of the rise of electric vehicles and US shale oil production is coming back very strongly at $40/bbl.”
He believes a second-quarter demand pull from restocking as the oil price rose has now died away. In the third quarter he expects companies to run stocks down again.
Richardson adds: “You have to look at sales volumes, not just margins. The best we can hope for is a return to previous levels in two to three years - we have lost a lot of demand.”
LICENCE TO OPERATE
Hodges believes the public has moved from denial about the impact of the pandemic, to anger about it.
He said: “We need to be very thoughtful about our relationships with our customers and with the wider public and should put resources into this area to maintain our licence to operate. Things could get quite rough in a year or two if this anger continues to develop – we want to ensure it is not directed at us.”
Focus article by Will Beacham
Additional reporting by Tom Brown