To understand the global chemicals industry, look to energy markets

Jun 30, 2015

To understand the petrochemicals industry, we must put it in the context of energy markets.  Most chemicals come from oil and gas, usually from naphtha (or other refinery streams) or natural gas liquids—NGLs—such as ethane or propane separated from methane in gas treatment plants. These feedstocks represent the vast majority of petrochemicals sources around the world.  There are some exceptions; notably in China, where there is increasing interest in making chemicals from coal, and in Brazil, where some polyethylene is produced from sugar cane (albeit in small volumes). But for most petrochemicals producers in the world, it’s all about oil and gas. Changes in the supply and demand of oil and gas, and their relative values in energy terms, does influence chemicals industry economics. 

From the perspective of oil and gas producers, the chemicals industry represents a very small portion of demand. Calculating from International Energy Agency (IEA) numbers, the chemicals industry represents about 6% of the global demand for oil and gas. This is a rough global average as the numbers vary by region, but even in the Middle East, where more gas is directed to chemicals production, the number is still below 20% of that region’s demand. For some oil majors though, downstream integration into chemicals is a desirable way to add value to hydrocarbons, though it’s still a relatively small portion compared to the much larger volumes destined to supply the world with energy.

I know this may be disappointing from our perspective in the chemicals industry. We like to think we are important, but when it comes to volumes, it is sobering to see that we are the smallest slice of the pie. The majority of oil and gas (and coal) is used to produce power, transportation fuels and heating for residential, commercial and industrial use.

 

Shifts in energy markets will inevitably have an impact on the chemicals industry. Changes in the supply and demand of oil, gas and coal, and their relative values in energy terms, will influence chemicals industry economics.  The recent decline of oil prices from around $110 per barrel in mid-2014 to approximately $60 per barrel currently impacts the chemicals industry on several fronts: 

1) The fall in oil prices will provide an improvement in margins for petrochemicals producers that rely on naphtha as a feedstock, at least in the short term. 

The price of naphtha has fallen in line with crude oil.  Chemicals producers that use naphtha as feedstocks, especially in Europe and Asia, are enjoying lower raw material costs.  Chemicals prices have declined as well but not as much as naphtha (indeed, recent production issues and reasonable demand have propped prices to higher levels than otherwise expected), so even if absolute revenues are smaller, margins are swelling.  This will not be permanent of course, and as in previous cycles, chemicals prices will decline following lower feedstock prices and any upturn in oil and naphtha prices will quickly erode petrochemicals margins.  Supply and demand of chemicals will also play a role—even if demand remains healthy, new supply will come on-stream soon, dampening prices in the future.  However, current naphtha prices and the time lag provide a windfall to many chemicals producers.

2) The difference in cost-competitiveness between producers using naphtha versus gas feedstocks has narrowed.

For producers in North America and the Middle East using NGLs as feedstocks for chemicals, the situation is less favourable. For most of the recent past, it has been more economical to crack ethane than naphtha to make ethylene, which explains why companies like Ineos, SABIC and Borealis have struck deals to ship ethane from the U.S. to feed crackers in Europe.  This situation was forecast to continue as North American oil and gas producers (from shale or otherwise) were expected to continue pumping NGLs into the system, maintaining prices well below naphtha while chemicals producers in North America were announcing projects to build new ethylene or propylene capacity. Now that naphtha is less expensive in relation to gas, these projects look less attractive than before, and some are being reviewed, delayed or even possibly cancelled.  For producers with fixed feedstock prices (such as the Middle East), the fall in naphtha prices actually shrinks the margins since lower naphtha effectively makes the cost curve flatter. 

3)   The energy markets are still in flux.

The story is not finished yet.  One year ago crude oil was selling at about $18 per million BTU (assuming an energy equivalent of 5.8 mm BTU per barrel), while now the price is around $10 per mm BTU (~$60 per barrel). In the U.S., the Henry Hub gas prices are significantly lower (around $3 or $4 per mm BTU), but in the UK the price is around $7-8. In Japan, the average price is still around $15 (some of the Japanese contracts are linked to crude and will be adjusted downward in the coming months as they reflect lower oil prices).  The chart below shows the fall in oil prices and narrowing gap with gas prices.  Suddenly, oil and gas prices look closer together, much as they did 15 years ago. 

 

With this information, several questions arise:  Will lower oil prices reduce production in North America?  How will Liquefied Natural Gas (LNG) trade and new pipelines facilitate the convergence of gas prices between regions?  How much share of the market will gas take from oil and coal if policy on global warming and greenhouse gases gets serious?  What will happen with oil prices if Iran increases exports?  The answers to these questions can push prices up or down.  We’ll continue this discussion in future posts, but whatever the case, the economics of the chemicals industry will be affected.

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Nexant Training offers a range of training courses around the world on the commercial, technical and strategic aspects of the petrochemicals value chain from refinery to consumers, discussing oil and gas, chemicals, petrochemicals, polymers, plastics and renewables.