Tight times

Last month also saw a widely reported warning from analyst Goldman Sachs that crude may hit between US $150-$200 a barrel within two years, because growth in supply will fail to keep pace with increased demand from developing nations.

This analyst also said that OPEC’s recent argument that much of the increase was due to “market speculation” was erroneous and that the price was being supported by a new era of fundamentals.

Even OPEC itself has admitted that there has been a shift in the dynamics of the market and its president, Saudi oil minister Ali Al-Naimi, recently went on the record as saying he doubted prices would ever again dip back below US $60 a barrel.

High oil prices are already having a serious impact on the petrochemical sector and could bring about a major change in the industry’s structure and economics.

The most tangible impact at present is the sharp rise in feedstock prices, due to refiners having to pass on high crude costs to consumers. There is also tightened demand as refiners switch capacity to gasoline production, away from naphtha. Dow Chemical’s first-quarter 2008 earnings amply illustrate the point.

In April it said its raw material costs during the first three months of this year had risen by 42% or US $2.2 billion year on year. This was the largest quarterly increase in the company’s history, and nearly equal to the increase it experienced for all of 2007.

The pressure on petrochemical producers is less marked of course in major oil producing areas, where in fact high crude prices are enabling countries like Saudi Arabia to increase investment in new feedstock, as part of a general shift into petrochemicals and economic diversification away from oil and gas.

But for those countries that lack indigenous feedstock supplies or only have a limited amount, rising costs are forcing a change of strategy.

It is often said that the problem with feedstocks is that although they are true commodities, their markets are run on an industrial basis rather than via an exchange, meaning that rapid changes in prices are much less easy to absorb.

Feedstock producers will endeavour to pass on price increases to the converters, but they themselves cannot pass these costs on as they are more often than not tied into long-term contracts with their customers.

According to a recent report by Wood Mackenzie and International eChem, the future availability and cost of cracker and reformer feedstocks is about to become a critical success factor for olefin and aromatics producers, in particular in all major petrochemical producing regions.

Today’s high-priced, and volatile, crude oil environment already presents the petrochemical industry with a huge challenge.

This is a global issue, where seemingly minor developments in one region can easily have a major ‘knock-on’ impact around the world.” In particular, aromatics producers are already finding themselves having to compete for feedstock supplies with growing global gasoline demand, the report said.

It predicted that ethylene capacity was expected to grow by around 30 million tonnes over the next five years, and propylene capacity by 24 million tonnes.

This additional olefin capacity will require an incremental 80 million tonnes of cracker feedstock. At the same time, demand for gasoline is expected to be strong, particularly in Asia.

This has the potential to create strong competition for feedstock, particularly as the availability of new gas supplies appears to be reducing. Feedstock selection and availability will therefore become even more critical for new, and existing, cracker and reformer operators.

The report’s authors believe that these developments will lead to a major shortage of naphtha, even while a surplus of gasoline develops. In turn, this will pressure naphtha-gasoline differentials and also cause cracker feedstock prices to rise.

Already, the usual seasonal advantage of LPG for flexible crackers appears to be becoming deeper and more sustained, while naphtha supply is tightening. This may cause a structural shift to take place in the relative values of naphtha and LPG, the report predicts.

Margins are under pressure around the world (with the exception of the Middle East). Analyst Nexant’s Global Petrochemical Industry Cash Margin Index, which assesses average profitability of producers in Western Europe, the US and Asia Pacific, has slipped to its lowest level in five years.

Aromatics have been especially hard hit – margins for paraxylene collapsed to an all time low in Western Europe in January, while acrylonitrile producers were facing an unprecedented 60% increase in the cost of ammonia during the first quarter of 2008.

In the US, high feedstock costs exacerbated by concerns over gasoline demand for the critical US summer driving season have already been felt by producers. These higher production costs have increased existing downward pressure, from weaker markets linked to US economic woes depressing the profitability of many producers, to well below average levels seen in the past five years.

According to the US National Petrochemical & Refiners Association, petrochemical demand growth eased at the start of 2008 with slower consumption across all industry sectors.

Producers who were already reluctant to buy large inventory due to high feedstock prices are now facing even greater raw material costs due to the inexorable rise in oil prices.

In Latin America unreliable feedstock supplies are expected to hold back what would otherwise have been a strong year. According to analyst PFC Energy, the main challenge facing this region’s producers now is to secure a stable source of supply.

Several projects have been shelved or postponed including Chile’s Methanex.

Dow Chemical was forced to halve production at its Bahia Blanca operation in Argentina during the winter due to a shortage of natural gas, while Brazil’s Braskem announced in late 2007 it was suspending plans to build a new ethylene and polyethylene plant in Bolivia.

Braskem reported a 35% fall in first-quarter 2008 net income in April from a year ago in part due to higher naphtha costs.

In Venezuela, the government is persisting with plans to triple output at plastic resin producer Peguiven by 2013, but could face an initial feedstock shortage as it will have to import supplies.

Indian producers are also struggling. The Indian government launched a major petrochemical strategy in 2007 which contains a strategy to provide feedstock “at globally competitive prices” as well as a Taskforce on Petrochemical Feedstock.

In May the government and backers of the Assam Gas Cracker Project Gas Authority of India Limited (GAIL) announced the project begun last September was on schedule and that all feedstock requirements had been agreed from domestic suppliers.

In an apparent recognition however of India’s limited supplies, GAIL has also signed a memorandum of understanding with Reliance Industries to explore opportunities for setting up petrochemical complexes outside of India in non-specified “feedstock-rich” countries.

Throughout Asia, petrochemical producers are resorting to alternative feedstocks in a switch away from naphtha and a focus on ethylene, which in May was reportedly commanding around a US $400 premium.

South Korean producers have announced this year plans to use more LPG; a move triggered in part in South Korea by the government’s decision in April to scrap an import tax on the product. They and other regional producers have also been looking to source cheaper naphtha from outside Asia.

While high oil prices will continue to exert pressure on feedstocks, more capacity is due on stream over the next 10 years, mainly in the Middle East and this is expected, over time, to ease the current supply constraints.

The Middle East is expected to see high levels of investment in new ethylene capacity over the next decade. According to the World Bank, capacity is expected to grow from around the current 20 million tonnes by around 150% to over 32 million tonnes from the start of the next decade.

The Bank has said that by 2012 the Middle East will have nearly the same amount of ethylene capacity as North America and around one fifth more than that in Western Europe.

But while this does offer the prospect of more feedstock supplies for export to Asia, Europe and North America in the medium-term, in the short-term it means investment in capacity will not be made in these areas further exacerbating the current shortages.

For European producers however there is some good news. Having been one of the worst off regions in relation to raw material costs, the weakening of the competitiveness of the US petrochemical sector, and more expensive feedstocks in Asia, are making Western Europe’s costs the lowest of the three.

This is being reflected in investment in new capacity such as BASF’s announcement last August to expand capacity at its naphtha cracker at Antwerp, Belgium to over 1 million tonnes from the current 800,000 tonnes a year.

Even though expanding capacity will ease supply constraints, expanding global demand – especially in emerging economies – will continue to make price volatility a reality for years to come.

A recent report from business advisers Deloitte suggested petrochemical producers would have to get use to a new reality of feedstock issues and adopt “integrated commodity strategies based on clear, forward-view price forecasting models, with an arsenal of tactics to manage shifting supply-demand exposure tied tightly to a company’s core business strategy.”

The Deloitte report suggested options available to producers included: copying Asian producers recent strategy of switching to LPG as naphtha gets pricier; shopping around for new supply sources; and looking at employing new technology to increase cracker yields.