Special Issue: Global macros line up on cusp of US petrochemical capacity wave

24 August 2017 19:31 Source:ICIS Chemical Business

Global macroeconomic dynamics are steady or on the upswing as the US petrochemical capacity wave kicks into gear, providing a tailwind as companies attempt to place massive volumes of downstream polymers.

For the global economy, the International Monetary Fund (IMF) maintained its forecast of 3.5% GDP growth in 2017 and 3.6% in 2018 – not a barnburner but a benign and stable backdrop. And the manufacturing sector is chugging along, with the big three regional purchasing managers’ indexes (PMIs) for the US, eurozone and China in expansion mode (above 50), with particular robust activity in the eurozone and the US. China’s PMI has been hugging the edge of expansion and contraction, warranting close attention in the coming months.

Overall economic activity in the US is actually now stuck in a 2% GDP growth world as tax reform and infrastructure spending are wishful concepts amid a storm of political controversy and a failed healthcare reform push. The US automotive sector is particularly weak with a downcycle firmly under way.

The IMF now expects US GDP to rise by just 2.1% in both 2017 and 2018, down from 2.3% and 2.5%, respectively, from its previous forecast in April.

However, on the manufacturing front, the PMI readings have been robust, with the US ISM Manufacturing PMI clocking in at 56.3 in July, down 1.5 points from June, but still firmly in expansion mode. Any reading over 50 indicates expansion in manufacturing activity while under 50 denotes contraction. In the July US manufacturing PMI report, released on 1 August, the Plastics & Rubber Products sector was at the top of the list of 18 manufacturing industries in terms of growth while Chemicals came in sixth. The US economy is not without risk, but growing at a slow and steady pace in spite of the political dysfunction, with earnings gains across most sectors.

Trade policy is a prominent risk, as the North American Free Trade Agreement (NAFTA) is being renegotiated and the US administration is considering other protectionist measures on products such as steel and aluminium. A measure of relief came with the Republicans in both the House and Senate abandoning the controversial border adjustment tax (BAT) in upcoming tax reform.

Trade is vital to the US chemical sector, as petrochemical and polymers capacity expansions ramp up on an unprecedented scale based on cheap shale gas.

US ETHYLENE AND PE WAVE

From 2017-2018, eight new ethane crackers are expected to start up, featuring a total of 9.2m tonnes/year of ethylene capacity. There is also another 1m tonnes/year of ethylene coming on through expansions and restarts in this timeframe. Overall, a massive 36% expansion in the existing US capacity base is on tap. Downstream, it is primarily polyethylene (PE) that will be produced, and much of it for export. Key destinations will be Latin America, Asia, Europe and Africa, according to chemical executives and sources.

US PE capacity is set to rise by 6.5m tonnes/year through 2019, accounting for plants already completed in 2017 or under construction, plus a planned 650,000 tonne/year unit by ExxonMobil Chemical where a final investment decision (FID) has yet to be made. Going out to 2020, tack on another 625,000 tonnes/year of PE from the Total/Borealis/NOVA joint venture (FID yet to be made) for a total of 7.1m tonnes/year, according to an analysis by ICIS.

Through 2020, the US alone will account for about 42% of global PE capacity expansion, according to the ICIS analysis. Other countries with notable PE projects include China, India, Saudi Arabia and Russia.

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And that is just the first wave in the US with many more PE projects in the works.

If all the planned projects in the US and one in Canada (NOVA’s planned 450,000 tonne/year LLDPE project in Sarnia) are built as scheduled, PE capacity would jump by 12.1m tonnes/year through 2022, according to the analysis.

As one chemical CEO put it, the US is essentially aiming to export its cheap shale gas all over the world in the guise of PE pellets.The impact on US chemical company earnings from all these expansions has yet to be felt as the bulk of the capacity will start up in Q4 2017 through all of 2018. PE margins have held up well through Q2 ahead of the onslaught.

LyondellBasell’s Olefins & Polyolefins (O&P) – Americas segment generated earnings before interest, tax, depreciation and amortisation (EBITDA) of $859m in Q2 2017 – up by 14% from the year-ago period on 15% higher sales of $2.55bn.

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The segment’s EBITDA margin came in at 33.7%, slightly lower versus 34.1% in the year-ago quarter but still an incredibly robust margin for a commodity business. The company’s O&P operations include PE as well as polypropylene (PP).

LyondellBasell also saw a major improvement in its European operations, as reflected in its O&P – Europe, Asia, International (EAI) segment, where EBITDA rose by 21% to $699m on 11% higher sales of $3.0bn. The O&P – EAI segment’s EBITDA margin widened to 23.2% versus 21.2% in the year-ago period. While chemical company executives do expect a downturn in the cycle as a direct result of the significant new capacity, they are rather optimistic on the magnitude and duration.

On LyondellBasell’s Q2 earnings conference call, CEO Bob Patel said he expects a “shallow and narrow” downcycle in the global PE and ethylene markets, as he anticipates US producers will be able to successfully export volumes amid healthy global demand.

Dow Chemical expects to grow EBITDA in its performance plastics segment, even through a potential industry downturn in 2018 caused by the wave of capacity.

“Demand has been solid for all of those products, and as we noted through the first half of this year, price has been up. Packaging and specialty plastics, for example, is up 5% year over year. If you look at both North America and Europe, both pricing and margins have been up,” said Dow president and chief operating officer Jim Fitterling on the company’s Q2 earnings conference call.

Dow would benefit from its new Texas cracker and derivative units starting up in Q3 2017 and through the end of the year, along with full benefits from its Sadara joint venture in Saudi Arabia, where 25 of 26 units have started up.

Dow’s performance plastics EBITDA fell by 14.8% year on year to $1.06bn, on 8.2% higher sales of $5.08bn in Q2 as start-up costs and higher raw material costs offset 7% higher prices and volume growth of 1%.

The segment’s EBITDA margin fell to 20.9% versus 26.6% in the year-ago period. Dow’s performance plastics segment, while US heavy, includes international operations as well as elastomers.

THE NEXT WAVE

Meanwhile, companies completing major ethylene and PE expansions in 2017 are already planning the next wave.

Dow, which is ramping up its 1.5m tonne/year ethane cracker in Freeport, Texas, and a number of derivative plants in the area, has already laid out a $4bn US expansion plan over the next five years. This will entail several projects starting up in phases beginning in 2020. These include a 500,000 tonne/year expansion of its recently completed Texas-9 cracker in Freeport, a new 600,000 tonne/year PE unit on the US Gulf Coast and 350,000 tonnes/year of incremental PE capacity through various debottlenecks. ExxonMobil Chemical, which is set to start-up its 1.5m tonne/year cracker in Baytown, Texas, along with two 650,000 tonne/year PE units in nearby Mont Belvieu, by the end of 2017, is loading up another US cracker project.

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Its next one would be a joint venture with Saudi Arabia’s SABIC in Corpus Christi, Texas and the largest cracker in the world at 1.8m tonnes/year (depending on when Dow’s Texas-9 expansion takes it to 2m tonnes/year). However, a final investment decision has yet to be made.

Chevron Phillips Chemical is also bringing on its 1.5m tonne/year cracker in Cedar Bayou, Texas with 1m tonnes/year of PE capacity in nearby Sweeny in Q4 2017.

It should surprise no one if the company announces another worldscale US project.

TRADE DEVELOPMENTS

Trade is obviously critical to the US mega project business model, as a significant portion of the new PE capacity is targeted for export.

In overall chemicals (all trade figures exclude pharmaceuticals), the US exported $121bn of product in 2016. Canada and Mexico were the #1 and #2 destinations, receiving $20.4bn, and $19.2bn in US chemical imports, respectively, with China at #3 receiving $10.6bn in chemicals from the US.

The US ran a massive chemical trade surplus to the tune of $28.2bn in 2016. Trade with Mexico accounted for $14.6bn, or more than half of the total. The US chemical industry is actively engaged with the US administration on its priorities for the renegotiation of NAFTA. Major chemical trade groups in the US, Mexico and Canada are aligned in their priorities for NAFTA.

In March, the American Chemistry Council (ACC) along with ANIQ (Mexican Chemical Industry National Association) and the CIAC (Chemistry Industry Association of Canada) issued a joint statement highlighting NAFTA’s benefits for the regional chemical industries and manufacturing economies, as well as opportunities to harmonise regulations and practices, and promote digital data flows.

While certain changes to NAFTA could benefit all parties, at the top of the priority list is to “maintain duty-free trade for all qualifying chemical products”, said Greg Skelton, senior director of regulatory and technical affairs of the ACC, in June.

While the free trade of chemicals between the US, Canada and Mexico is not likely to be a flashpoint in the negotiations, the risk is that other areas of contention could endanger the entire agreement.

CHINA OUTLOOK

For China, which is expected to absorb a good chunk of US PE exports, the IMF raised its 2017 GDP growth forecast to 6.7% from 6.6%, reflecting a strong 6.9% expansion in the first half. The IMF also upped its 2018 China GDP forecast to 6.4% from 6.2% as it expects the government to “delay the needed fiscal adjustment (especially by maintaining high public investment) to meet their target of doubling 2010 real GDP by 2020”.

However, the IMF noted this delay comes at the cost of increasing debt and overall risk to the economy. The official People’s Bank of China data shows that Total Social Financing (TSF) more than tripled from $7.8tr in 2007 to $26.4tr in 2016, points out Paul Hodges, chairman of International eChem.

“Most remarkable was the growth of shadow banking loans within the TSF. This lending was primarily focused on the housing market and rose four-fold from $3.1tr in 2007 to $14.4tr in 2016. By comparison, the IMF reports China’s GDP was just $11.2tr last year,” said Hodges.

The risk is the impact on the economy, as China eventually takes major steps to restrict the rampant growth in credit. It has already taken measures to tighten credit growth this year through more stringent regulations on the unofficial (shadow) banking sector and removing liquidity in the financial markets.

“If China continues to withdraw stimulus at the current rate, then commodity prices and inflation will continue to fall – just at the moment when Western central banks are busy declaring victory over deflation and preparing to finally unwind their own swollen balance sheets,” said Hodges.

It is hard to imagine falling commodity prices in China not impacting crude oil and chemicals. Even as the IMF raises its GDP forecasts for 2017 and 2018, the situation in China bears watching. This is especially because while China’s manufacturing PMI leading indicator shows expansion, it is severely lagging manufacturing activity in the US and Europe.

The China Caixin Manufacturing PMI rose to 51.1 in July, up from 50.4 in June and ahead of expectations. It was the highest reading in 4 months as output and new orders accelerated. However, optimism on the 12-month business outlook fell to an 11-month low.

“Operating conditions in the manufacturing sector improved further in July, suggesting the economy’s growth momentum will be sustained. That said, it’s unlikely that financial regulatory tightening will be relaxed,” said Zhengsheng Zhong, director of macroeconomic analysis at research firm CEBM Group.

EUROZONE COMING TO LIFE

The eurozone is coming to life, with expected 1.9% GDP growth in 2017 and 1.7% in 2018, upward revisions from 1.7% and 1.6% in the IMF’s previous forecast. While these numbers hardly look robust, they are leaps and bounds ahead of several years ago.

European economies have demonstrated resilience following the shocks of the Greek debt crisis and near-exit of the eurozone, and the UK Brexit vote of 2016. The IHS Markit Eurozone Manufacturing PMI came in at 56.6 for July, down from 57.4 in June. While the eurozone PMI declined along with the US PMI, both areas are showing strength.

“Eurozone factories were buzzing with activity again in July. The PMI came in slightly below the earlier flash estimate, slipping to a four-month low, but this is still an encouragingly buoyant reading,” said Chris Williamson, chief business economist at IHS Markit.

“The survey indicates that manufacturing output was growing at an annual rate of approximately 4% at the start of the third quarter, sustaining the best growth spell that the region has seen for six years,” he added.

In Germany, the heart of Europe’s chemical industry, trade group VCI in July raised its chemical volume production forecast for 2017 to 1.5% from its previous 1%. It expects overall sales to gain 5% to €194bn.

“The current situation is positive,” said BASF chairman Kurt Bock, who is also president of the VCI. “We continue to expect good business in Germany and abroad for the second half of the year.” Companies expect stable economic growth in all foreign markets important for German chemicals, he added.

“This is true not only for Europe, but also for our most important trading partner, the USA,” said Bock. However, Bock expressed concerns about structural issues in Germany’s energy, research and development (R&D), infrastructure and education systems that could impact long-term competitiveness.

US PROPYLENE CHAIN PROJECTS

Getting back to the US petrochemical expansion, LyondellBasell in late July made an FID to proceed with its $2.4bn propylene oxide/tertiary butyl alcohol (PO/TBA) project in Channelview, Texas.

The 470,000 tonne/year PO, and 1m tonne/year TBA plant would be the largest of its kind and yield the most PO of any plant in the world when it starts up in mid-2021. Construction is slated for the second half of 2018.

The main feedstocks for LyondellBasell’s PO/TBA process is propylene and butane, both of which the company expects to be in sufficient supply.

“Our investment in this plant combines the best of both worlds – our leading PO/TBA process technology with proximity to low-cost feedstocks, which gives LyondellBasell a competitive advantage in the global marketplace for these products,” said LyondellBasell CEO Bob Patel.

On the feedstock front, propylene supply should be “adequate” with a number of propane dehydrogenation (PDH) projects in North America, said Jim Guilfoyle, senior vice president – Global Intermediates & Derivatives, Global Supply Chain at LyondellBasell.

LyondellBasell also has metathesis capability in Channelview, Texas, which converts ethylene to propylene, while on-purpose propylene production via PDH could also be considered in the future, he noted. The other key feedstock, natural gas liquid (NGL) butane, should continue to be abundant with US shale gas production, said Guilfoyle.

LyondellBasell sees a greater feedstock advantage in the PO/TBA process versus the PO/SM (PO/styrene monomer) process as the latter is based on benzene as well as ethylene. Benzene is produced from crude oil rather than cheaper natural gas, and the US is a major importer of the aromatic.

On the downstream demand side, the LyondellBasell sees steady global demand growth in polyurethanes (PU), the key end market for PO, on the order of 3-4%/year – at or above GDP. Asia should have a faster rate of 5-6%/year, according to Guilfoyle.

LyondellBasell plans to sell PO and derivatives from the new plant to customers in the US and abroad, with a significant portion of the PO likely going to derivatives it produces such as propylene glycol (PG) or P-series glycol ethers. Some merchant PO would also be exported, primarily to Asia. But most would be placed in the US market.

The LyondellBasell PO/TBA final investment decision was a long time coming, as was Braskem’s decision announced in June to build a new 450,000 tonne/year polypropylene (PP) plant in La Porte, Texas. Construction is set to start in the summer of 2017, with completion by Q1 2020. The Braskem PP project is the only one of consequence going forward. Others have announced their interest in new PP plants, but have not moved forward. The propylene advantage from US shale gas (mainly from propane but also another technology using methane) is simply not as pronounced as it is for ethylene from ethane. It is a more capital intensive process for propylene on a per volume basis, and downstream PP margins tend to be thinner than for PE.

There are much more PP projects being planned in the rest of the world, especially in China as that country marches toward self-sufficiency in the polymer, and thus more competition for now. In contrast, China remains and will remain a huge net importer of PE for the foreseeable future.

For propylene itself, US on-purpose projects have also been slow to come by. The only new arrival through 2020 will be Enterprise Products’ PDH plant in Mont Belvieu, Texas with 750,000 tonnes/year of propylene capacity which was expected to start up in Q3 2017.

Other PDH projects by Inter Pipeline (Alberta, Canada) and Formosa Plastics (Point Comfort, Texas) are not expected to start up until 2020-2021.

BASF put on hold its 475,000 tonne/year methane-to-methanol-to-propylene project in February 2016, and has not made any decision to revive it. There are signs of life in the US propylene chain, but any revival looks to be a far cry from the massive boom in ethylene and derivatives.

Joe ChangJoseph Chang is Global Editor of ICIS Chemical Business, a weekly publication focused on making sense of chemical prices worldwide. This includes macro factors and trends impacting the supply chain such as global trade and arbitrage, project activity, and mergers and acquisitions. He has been with ICIS and one of its predecessor publications for over 20 years, specialising in financial developments. Joseph has a BS degree in Finance and International Business from New York University’s Stern School of Business.

 

By Joseph Chang