Commentary: US ethane uncertainty

A supply of cheap ethane has been a core assumption in the decision-making process for the wave of new US crackers and expansions, which start to come on stream this year.

This feedstock advantage, so the theory goes, will allow the current bonanza in ethane-based polymers production economics to continue for years. However, as the new capacity comes on stream, demand for ethane will increase. Ethane exports to Europe and Asia have begun and will ramp up. There is currently a surplus of the product, much of which is wasted through flaring or left in the natural gas stream. On paper, increasing demand will be met by rising supply, as shale gas and oil production increases and pipeline infrastructure is developed to move stranded natural gas liquids, including ethane, to chemical production sites.

But a debate is now developing about these assumptions. A new report by investment bank Cowen & Co suggest otherwise, though some of its conclusions have been questioned by ICIS consultants.

There will be big increases in ethane prices as demand exceeds supply from the second half of 2018, according to Cowen’s publication, “NGL Bubble Bursts: Chemical Earnings At Risk”. As the current wave of new chemical production capacity comes on stream from 2017-2019, demand will steadily outstrip supply, leading to hikes in ethane prices from current levels of around 20-25 cents/gal to reach as much as 55 cents/gal or more, it says.

Cowen forecasts that a deficit of 200,000 bbl/day of ethane by 2019 could lead to ethane prices breaking their link to natural gas and becoming more aligned to naphtha. This could create significant earnings headwinds for US chemical producers in terms of volumes as well as export economics. With the new wave of US production, competing with capacity increases in the Middle East and China, earnings before interest, tax, depreciation and amortisation (EBITDA) margins for US polyethylene (PE) production could shrink to below 20 cents/lb ($441/tonne) from current levels of over 35 cents/lb. This margin compression will begin to take shape in early 2018 and reach its apex in the second half of 2019, the report said.

Companies most negatively affected would be Dow Chemical, LyondellBasell and Westlake. However, some upstream integrated oil, gas and chemical majors might stand to have chemicals losses offset by higher natural gas liquid (NGL) prices.

According to Cowen, there is a misconception that $60/bbl crude pricing will stimulate enough NGL production growth to sustain a high level of surplus ethane rejection through 2019, with only gentle price rises. Their analysis suggests the low price of oil over the last 12-18 months has slowed growth in drilling activity, NGL supply growth below its original trajectory. “Much of the focus of today’s drilling activity is on oil, which is not as ethane-rich. As a result, drilling is not adding as much NGLs to the pool,” adds the report.

Cowen analysts also believe that lack of infrastructure development will stop recovery of much stranded ethane. “Because of the locations of the ethane, we find that there will not be enough pipeline capacity to get all of these rejected barrels to the US Gulf Coast, where they are needed.”

The report points out that when the new wave of US ethane-based projects were first proposed in 2012-2013, the price differential between oil and natural gas was at its highest levels, giving the US a massive cost advantage over oil-based production prevalent in Asia and Europe.However, as the new wave of US ethylene and PE supply comes on stream, domestic overcapacity will force producers to export more, pushing global prices downwards.

“At the same time costs will rise on the tightening supply/demand environment for the consumed feedstocks, leaving a situation where margin could compress sharply as ethylene capacity comes online,” says the report.

ICIS CONSULTANTS’ VIEWPOINT

According to one ICIS consultant, the Cowen report assumes that the first ethane crackers do not benefit from special contract prices, much like the Middle East legacy ethane crackers.

“I believe some of them have long-term formula prices that may not follow what we publish as the ‘Market Price’, but rather be much lower,” says ICIS senior consultant James Ray. He argues that if shale drilling resumes, associated gas supply is likely to increase to a degree – not initially perhaps, as the focus is not on gas, but it will at some point.

Ray says, even if margins do decrease, US polymer producers will still be making a lot of money. Integrated polyethylene (PE) margins are currently 210% (22.5 cent/lb cost vs 47.5cent/lb margin). Even if they fall to 150%, production economics will still be healthy.

Chris Hedge, Americas lead for analytics and consulting for ICIS, calculates that ethane supply and demand will be essentially balanced from the first wave of new expansions. The second wave of expansions – on stream from around 2020 – could face shortages, however.

According to Hedge, there may be extra capacity built into the pipeline network that is not publically stated: “The pipeline companies are not incentivized to advertise the true capacity as it takes away their ability to negotiate more advantageous take or pay agreements.”

ICIS expects ethane prices to rise from the natural gas floor to the ceiling level of propane cracking parity once the new crackers come on line. As propane is crude/naphtha linked, the link to naphtha is expected.

“Even at propane parity, the US crackers will remain advantaged over the marginal naphtha cracker in Asia, just not as advantaged as what they were earlier in the cycle,” adds Hedge.