INSIGHT: Shifting margins help translate petchem fundamentals

LONDON (ICIS)–Looking at margins is a useful way of making sense of changes in the fundamentals of the petrochemical industry. An example of such a shift is the one that took place in the price of crude oil in the final quarter of 2018.

CRUDE PRICES AND THEIR RELATIONSHIP WITH PETCHEM MARGINS
Brent crude prices briefly spiked to $86/bbl in early October 2018 before falling precipitously to $50/bbl at the turn of the year. While prices have subsequently recovered to between $65 and $70/bbl, such abrupt movements are naturally reflected in significant changes in margins for olefin and polyolefin producers.

In general, a collapse of this magnitude in the cost of oil is associated with an improvement in margins for many petrochemical producers – especially those who crack liquid feedstocks such as naphtha. This is typically at the expense of producers using feedstocks not directly derived from oil, like those who crack ethane or use methanol-to-olefins (MTO) technology.

SHARP 2014 CRUDE DECREASE
Previously when oil prices fell so spectacularly, during the second half of 2014, margins for high density polyethylene (HDPE) producers based on cracking naphtha rocketed in both northwest Europe and the US Gulf.

In Europe, they increased by about $500/tonne, to $1,000/tonne in the second half of the year. In the US Gulf, equivalent margins more than doubled, increasing from about $500/tonne to just below $1,250/tonne.

In both cases the full gains proved somewhat short lived, melting away in the new year as oil prices rebounded slightly and olefin and polyolefin pricing finally caught up with the falls in oil.

Generally speaking, there is a slight delay in passing price changes down production chains. This means that margins are typically inflated in a falling market and compressed during a rising market.

IMPACT OF CHEAPER OIL
Nevertheless, the pattern of the pace of falls in liquid feedstock costs outpacing, at least initially, falls in product pricing is familiar.

Conversely, for those producers whose feedstock costs do not correlate with oil prices in the same way, falls in the price of oil generally have a negative effect on margins. Margins for US ethane crackers and for MTO producers in China – a section of the industry in 2014 still in its infancy – tumbled by $125/tonne and $900/tonne respectively.

This had predictable effects on the relative competitiveness of such processes. In the US, the spread between ethane and naphtha-based producers narrowed from more than $1,100/tonne to just over $250/tonne in half a year.

The spread between MTO producers and naphtha crackers in China went from $900/tonne in favour of MTO producers to $250/tonne in favour of naphtha-based producers.

These changes were in line with what might be expected as a result of such a large fall in the crude oil price.

What is striking in the case of the 2018 fall is that, in one of these cases, a similar change in inputs did not produce a similar impact on margins. This helps to reveal striking changes in the global structure of the olefin and polyolefin sector that have taken place in the past four years.

Unsurprisingly, the collapse in oil prices in the final quarter of last year resulted in an increase in naphtha and LPG based margins in the same period. This is because naphtha prices declined much more quickly than petrochemical prices.

METHANOL-TO-OLEFINS COMPETITIVENESS
In contrast, margins for MTO producers in China slumped at the end of last year as oil prices began to fall. Olefin and polyolefin prices declined in response to the falls in crude while methanol costs actually rose in response to supply constraints.

What happened next was different to the pattern seen in 2014. Methanol costs dropped by about 30% between mid-October and the end of the year provoking a remarkable spike in MTO margins. From their 26 October nadir of more than $300/tonne below zero, margins increased by in excess of $400/tonne in only two months.

This meant that instead of the more than $1,100/tonne gain relative to calculated MTO margins that naphtha producers experienced in the second half of 2014, naphtha producers saw a $20/tonne fall in their relative margins during Q4 2018.

This remarkable turnaround in outcomes is the result of the growth and consequent influence of MTO producers in the petrochemical industry as a whole.

Roughly four times as much ethylene is produced using methanol in China now compared with 2014. This means that these producers now play an important role in determining the price of methanol.

As MTO margins plummeted to extremely low levels during October 2018, operating rates declined substantially and some plants shut temporarily on economic grounds. This, combined with the easing of some of the earlier supply constraints generated the fall in methanol prices previously referenced.

A significant drop in MTO profitability leads to a substantial drop in methanol demand, driving down prices. This mechanism serves to limit how poor MTO margins can become.

Methanol margins have remained relatively stable in 2019 so far. It is possible that methanol prices will rebound somewhat in the medium term, depressing margins. Nevertheless, the development of margins in recent months illustrates how quickly MTO producers have become an established part of the supply landscape.

IMPLICATIONS OF CHEAPER CRUDE FOR US PE EXPORTERS
In the US, ethane crackers saw largely flat margins during Q4 2018 while naphtha margins climbed dramatically in Europe and the US. This significantly eroded the competitive position of US PE producers in comparison to their European counterparts.

At the start of the quarter, the cost of producing one tonne of HDPE by cracking ethane (taking into account co-product credits) was about $90/tonne lower than the cost for a European naphtha cracker, by the end it was $90/tonne higher. If such a situation continues, it will make exports from the US relatively uncompetitive even before taking into account transportation costs.

ICIS launches its new Margin Analytics solution to customers this week. For further margins analysis and data click here

By Ciaran Healy