INSIGHT: Omicron variant may further erode US PE margins

HOUSTON (ICIS)–The Omicron variant of the coronavirus could further erode US margins for polyethylene (PE) if travel restrictions imposed to limit the spread of the disease lead to a sustained decline in oil prices.

US polyolefins producers benefit from higher oil prices because most of their ethylene is derived from ethane, giving them a cost advantage against much of the world, which relies on oil-based naphtha. Ethane prices typically rise and fall with natural gas while those for naphtha rise and fall with oil.

When the World Health Organization (WHO)  named the new variant Omicron on 26 November, the Brent futures contract for January fell by $9.50/bbl to settle at $72.72.

Contracts have continued falling since, and the Brent front month settled below $70/bbl on Wednesday.

The concern in oil markets is that countries will start adopting travel restrictions. On 26 November, the US ordered travel restrictions from South Africa and seven nearby countries.

Those restrictions could proliferate as the Omicron variant emerges in more countries.

On 28 November, the Canadian province of Ontario confirmed two cases of the variant.

Two days later, Brazil confirmed two cases in visitors from South Africa.

The US confirmed its first case on 1 December in a traveller who returned from South Africa.

Even without government restrictions, companies and individuals could choose to travel less to avoid contracting the disease.

The European Petrochemical Luncheon (EPL) called off its upcoming event for 2-3 December after more than half of the participants had cancelled.

PEAK SEASON FOR NATGAS
If oil prices remain lower, it will come during the peak demand season for natural gas.

In addition, new liquefied natural gas (LNG) plants are scheduled to start up later in 2021 and into 2022, which will increase demand for natural gas, according to Chemical Data (CDI), part of ICIS. That will provide more support for prices.

Ethane prices are linked to those for natural gas because the material can be burned as fuel instead of used as a petrochemical feedstock. As a result, natural gas sets a price floor for ethane.

A warm winter would depress gas demand and pressure prices. A cold spell would increase demand and support prices.

As a rule of thumb, US chemical producers maintain their cost advantage when oil prices are at least seven times higher than those for natural gas.

The US should maintain its cost advantage, but higher prices for natural gas and lower prices for oil could reduce the size of that advantage.

EXPECTED DECLINE IN POLYMER PRICES
That erosion in the US cost advantage would take place when prices for PE could continue falling.

US October contract prices were assessed lower, the first such decline since April 2020.

The decline in prices and rise in feedstock costs have led Dow to announce that its Q4 earnings before interest, tax, depreciation and amortisation (EBITDA) should be $150m-200m below market consensus.

US contract PE prices for November and December are expected to drop again, according to ICIS.

Inventory levels for PE have been increasing while companies are preparing to start up new units.

In September, a joint venture made up of ExxonMobil and SABIC started commissioning the PE operations at its new complex in Corpus Christi, Texas.

Bayport Polymers should start up a new PE plant in Pasadena, Texas in 2022.

Shell could start up its PE complex in Pennsylvania in 2022.

OMICRON OUTLOOK
The magnitude and duration of any decline in oil prices will depend in part on how quickly Omicron spreads and how it performs against vaccines and natural immunity.

Existing vaccines could struggle against the variant, according to the CEO of Moderna, a US-based company that produces one of the most prominent messenger RNA (mRNA) vaccines against the coronavirus. He made his comments on 30 November in an interview with the Financial Times, a business publication.

Earlier on 26 November, Moderna said it should know the effectiveness of its current vaccine dose against the Omicron variant within weeks.

Moderna is already studying two booster shots that were designed to address many of the mutations in Omicron, the company said.

Moderna could develop a booster shot that is specific to Omicron. Modera did not provide a timeline for an Omicron variant, but it did point to its track record of advancing new vaccine candidates to clinical testing in 60-90 days.

Another option would be a higher dose of Moderna’s existing vaccine, the company said.

LONGER TERM OIL OUTLOOK
If Omicron proves to be mild or if the current COVID-19 vaccines are deemed sufficient to control the variant, then travel restrictions could ease and oil demand could recover. Otherwise, travel restrictions could persist, limiting oil demand and pressuring crude prices.

If this happens, OPEC and its allies, known as OPEC+, may choose to maintain their production cuts for longer than anticipated. That could limit the erosion in oil prices.

Insight by Al Greenwood

Additional reporting by Zachary Moore