With oil price volatility complicating investment planning for petrochemicals companies, IHS cautions that an extended period of low crude oil prices could create 1980s-style economic conditions.
Falling crude oil prices have significantly affected the petrochemical industry since the November 2014 OPEC meeting, creating challenges for chemical companies that are planning investments. Yet the volatile crude oil market could have longer, even more dramatic effects on petrochemical feedstock choices, trade patterns, capital spending plans, new plant locations, operating rates, and production technologies.
What happens next will depend on what recovery path the market takes. In a recent report, “Crude Oil Turmoil and the Global Impact on Petrochemicals,” IHS assessed the potential market and economic implications of three possible recovery trajectories for crude oil prices:
- V-shape recovery: Short-term return to normal pricing, where supply and demand quickly come back into balance, thanks to one quick turning point for crude oil prices
- U-shape recovery: Medium-term return to normal pricing, with a few years of low prices before recovery, with turning points at the lowest-price trough and during recovery
- L-shape recovery: Long-term low prices for crude oil, where oversupply continues for five or more years, and the industry experiences fundamental changes to petrochemical feedstocks, similar to the late 1980s.
The speed of the oil-price recovery will influence what technologies, feedstocks, chemical products, and regions can create the most cost-effective offerings. As the petrochemicals industry plans for low-price oil environments, new risks will emerge, and business and investment decisions will differ depending on the type of recovery.
The long-term L-shaped recovery case has the most significant implications for the petrochemicals market. Since oil dynamics drive marginal production cost and price-setting mechanisms for many chemicals, plastics, and fibers, a prolonged oil-price recovery of more than five years could somewhat shift the feedstock advantage from ethane back to more cost-competitive naphtha. Much like the DeLorean time machine from the 1985 film “Back to the Future,” naphtha would be the conduit taking some petrochemicals companies and regions back to a market similar to that of the late 1980s—starring overproduction, reduced demand, and depressed oil prices.
Continuing oil glut
Current economic and political conditions set the stage for any of the three potential recovery scenarios. In the near term, IHS energy experts believe economic and geopolitical risks will continue to challenge oversupplied oil markets, as crude oil prices are posed to drop or at least remain low.
Oil producers are not yet taking action that will help speed the recovery of crude prices. In late July, IHS Energy noted that since the oil-price collapse that began in mid-2014, global oil production has actually gone up, not down. Indeed, since November 2014, when OPEC oil ministers agreed to let the market determine prices, aggregate production from the United States, Saudi Arabia, and Iraq has increased 2 million barrels per day—far more than global demand. As a result, oil markets are glutted.
Last November was also when the United States became the swing oil producer. Prices have not yet fallen far enough or for long enough for the United States to appreciably adjust supply. But this shift may not be far off, especially if oil prices fall further as the lifting of economic sanctions frees Iran to add even more product to the market. Oil prices will be under downward pressure until the evidence clearly demonstrates that the glut is shrinking. This will not happen quickly, unless prices fall even further from recent levels. In fact, continued global oversupply of crude oil could keep prices from recovering for more than 10 years.
Impact on ethylene
Let us now assume that the glut begins to shrink, but that the industry still enters into a long-term oil-price recovery. In this case, IHS economists would expect moderate economic growth to continue for several years, along with slower oil demand growth. At the same time, technology would continue to reduce oil production costs and increase supply, even at lower oil prices. With these conditions in mind, how would a long-term recovery impact petrochemicals?
The first major impact would be on the production of natural gas liquids (NGLs) and ethylene in the United States. In this market, prolonged lower oil prices would slow NGL production and ethane cracker capacity expansions, potentially creating a tight market. Because ethylene is the basic building block for many downstream chemicals, plastics, and synthetic fibers, it is the largest-volume and perhaps most market-indicative petrochemical. A tighter ethylene market would not only push operating rates higher, but would also increase prices and introduce more market volatility.
Because the next wave of ethylene capacity additions is not expected to come online until after 2020, and since global ethylene demand growth will be strong, a tighter ethylene market would drive ethylene cracker operating rates to near-record highs. In the long-term recovery case, IHS forecasts that ethylene demand will grow at an annual rate of 4.5% and nearly 4.0% during 2015–20 and 2020–25, respectively. Nameplate capacity is forecast to grow at an annual rate of more than 3% and less than 1%, respectively, during those corresponding time periods. Ethylene demand is expected to grow at a higher pace than supply during 2015–20, which will lead to severe supply shortages similar to those experienced by the industry in the late 1980s.
A second macro trend would be seen in Europe and Asia. With naphtha back in economic favor as a cost-competitive feedstock, the regions’ petrochemical producers would be the winners, with their naphtha crackers running at high-capacity rates and margins moving back into positive territory. In response, China could be expected to build more naphtha-based crackers while other emerging countries would build a petrochemical base.
The additional ethylene production from naphtha would yield more co-production of propylene and butadiene, impacting global on-purpose producers of these substances. These companies would see their profits erode quickly because conventional production would be able to meet market demand, reducing the need for higher-cost production options.
>One of the most intriguing revelations from the IHS analysis is the impact of the long-term price recovery on the plastics industry, particularly plastics demand and the implications for plastics recycling. IHS found that low oil prices stimulate demand for virgin plastics by reducing the economic incentives to recycle plastics. As less plastic is recycled, demand for ethylene further increases, which leads to more coproduction of propylene and butadiene.
A prolonged oil-price recovery would also dramatically impact future investment plans, as chemical producers adjust to shifting feedstock dynamics. In North America, US ethane would remain “stranded” and advantaged in the long term, as oil prices cycle and infrastructure for liquefied natural gas and ethane export and shipping is added.
In China, however, coal is an inland “stranded” feedstock. With a long-term recovery scenario, coal and methanol routes would lose most of their advantage, since low oil prices will keep naphtha prices depressed and coal prices are already near the break-even levels needed to overcome high investment costs. IHS anticipates that the tighter spread between oil and coal prices would cause coal-based petrochemical investments to lose favor in China.
Winners and losers
The methanol value chain would also be affected by a long-term oil-price recovery. For example, methanol projects with advantaged feedstocks, such as those in North America and the Middle East, would fare better than higher-cost, coal-based units in China. Methanol projects targeting energy applications, such as gasoline and dimethyl ether (DME), would also be the losers in this outcome, along with North American methanol projects that target methanol-to-olefins (MTO) and methanol-to-propylene (MTP) processes. While IHS expects methanol capacity additions to occur in locations with advantaged feedstocks, the pace of these additions would be significantly delayed, and rationalizations would also be likely.
A long-term oil-price recovery would also have a profound impact on both global polyethylene and polypropylene markets. IHS anticipates that polyethylene production rates would grow, as demand expands by more than 54 million metric tons (MMT) from 2014 to 2025. This growth would be supported by a higher GDP in developed countries; improved price competitiveness that would displace conventional materials such as metal, paper, and glass; and the aforementioned replacement of recycled material by virgin material.
Western Europe and Asia would benefit greatly from more competitive feedstock and buoyant demand, while North America would experience lower integrated margins. A prolonged period of low oil prices would also put new Russian polyethylene projects in jeopardy because of the poor investment climate, leaving Russia as a net importer of the chemical. Changes in the global oil market due to persistent low prices would continue to impact regional capacity additions, creating significant implications for global petrochemical producers and maritime operations.
European and Asian naphtha-based producers would be the winners in a long-term recovery scenario because of their conventional cracker investments. South American polyethylene projects also would move forward, and additional Asian capacity would come online. North America would lose in this equation, since the North American export position would be negatively impacted as its economic advantage shrinks.
While the implications for the chlor-alkali and vinyls chains under the long-term oil-price recovery are not as severe as for other chemicals, lower oil prices through 2017 or later would likely drive a break-even point between acetylene-based polyvinyl chloride (PVC) and ethylene-based PVC. If this ratio between oil and coal is reached, Asian producers may realize an opportunity to develop more ethylene-based PVC. IHS expects that North American ethylene-based PVC producer margins will shrink under the long-term recovery scenario, whereas naphtha-based Western European PVC producers’ margins will improve.
Short-term and medium-term scenarios
In addition to assessing the impacts of a long-term oil-price recovery on petrochemicals, IHS forecasts the potential impacts of both a short-term, V-shaped, and a medium-term U-shaped oil-price recovery.
Short-term recovery would help petrochemical margins and volumes remain close to the base case. Faster price recovery would create little impact on US and Middle East capacity builds, other than slight delays due to uncertainty on projects not yet under way. Europe and Asian naphtha crackers would run at high rates and experience good margins. In China, short-term low oil prices could accelerate some naphtha cracker builds, potentially leading to excess global cracker capacity.
A medium-term oil-price recovery would likely slow US oil production, according to IHS, but oil production outside the United States would offset any US decline. Low oil prices would also hold back NGL production and reduce US ethane cracker builds, preventing a second wave of ethane production from coming online until 2025. European and Asian naphtha crackers would run at high rates and experience high margins, with China adding new naphtha crackers.
Also in the medium-term scenario, IHS anticipates that refineries would run at high rates, with additional refineries built in the Middle East, thereby increasing the production of refinery-grade propylene. Low oil prices would increase the elasticity of plastics demand and reduce recycle rates in this case as well. A medium-term oil-price recovery will also slow MTO plant builds in China and the United States. PVC projects in China will move toward ethylene-based processes and away from coal.
Planning wise investments
Understanding the potential impact of various scenarios for an oil-market recovery is essential for petrochemical producers. In the midst of significant market volatility and a high degree of uncertainty regarding the role of OPEC in managing the global supply of crude oil, business and investment decisions must consider each type of recovery. Only with this insight can petrochemicals companies maximize profit and minimize risk, avoiding the fallout of a potential 1980s-caliber market.
Don Bari is vice president, technology and analytics group, IHS Chemical