The financial crisis began a decade ago, yet production of the key “building block products” for the European petrochemical industry has still not recovered to its pre-Crisis peak, as the chart shows (based on new APPE data):
Combined production of ethylene, propylene and butadiene (olefins) peaked at 39.7 million tonnes in 2007
A decade later, 2016 olefin volume was 4% lower at 38.1MT, and lower than in the 2004 – 2007 subprime period
Olefins are used in a very wide variety of applications including plastics, detergents, textiles and paints across the European economy. The data therefore highlights the slow and halting timeline of the recovery – despite all the trillions of money-printing by the European and other central banks, and all the government stimulus programmes.
Worryingly, new data from the American Chemistry Council suggests that a new downturn may be underway in W Europe, as the second chart shows:
Output had been growing steadily at around 3%/year from 2014 to early-2016
But then it began to slide. It was just 0.5% in May, and only recovered to 2% in January – normally one of the seasonally strongest months in the year
This report is confirmed by Q1 results from BASF, the world’s largest chemical company. It cautioned that volumes were only slightly up compared to Q1 2016, despite “a sharp increase in prices for raw materials” due to the rise in oil prices. This is particularly worrying as demand was artificially inflated in Q1, due to many companies building inventory as the oil price rose following November’s OPEC/non-OPEC deal.
The issue is that oil prices are a critical factor along the entire value chain. Even retailers follow the oil price very closely, and every purchasing department aims to second-guess its direction, whether upwards or downwards. They buy ahead when they believe prices are rising, and leave purchases as late as possible when prices are falling.
This behaviour has a counter-intuitive impact on the market. Instead of demand reducing when prices rise, it actually appears to be increasing as companies build inventory. Thus producers are lulled into a false sense of security as price increases appear to have no impact on demand. But when oil prices are thought to have stabilised, volume then starts to reduce as buyers reduce their inventory to more normal levels.
The impact over a full cycle is, of course, neutral. But on the way up, apparent demand can often increase by around 10% and then fall by a similar amount on the downside, accentuating the basic economic cycle.
The European economy already faces a number of major headwinds due to the rise of the Populists and the UK’s Brexit decision to leave the European Union. Now the APPE and ACC data suggests that overall demand has actually been slowing for the past 9 months. And it is likely that underlying demand today is now slowing even more as companies along the value chain destock again as the oil price weakens.
Prudent CEOs and investors will no doubt already be preparing for a potentially difficult time in H2 this year.
An ageing population and record annual levels of oil prices create massive headwinds for Europe’s petrochemical producers. One means demand growth is much reduced from the SuperCycle. The other means these lower volumes cost more to produce.
What a pity, you might say, that the industry is not part of the financial sector. Then it would have been the sweetheart of the last European Commission, and received massive bailouts as well as special treatment on regulatory matters.
But instead petrochemicals, which are the building block for most of today’s consumer products, see their costs rising to support the banking sector – whilst their regulatory burdens are increased. Its a funny old world.
The hard facts are in the chart above, based on new APPE data for Q1:
- Operating rates in what should have been the seasonally strongest quarter of the year were just 82%
- This was better than the 79% seen last year, but only equalled 2012 levels
- It was nowhere near the 90%+ level that was normal in the pre-2008 SuperCycle
The only good news is that the US and Middle East move into ethane feedstocks has helped keep propylene and butadiene prices higher than usual. So European producers, like those in Asia, have been benefiting from higher overall netbacks than would otherwise have been expected. But, of course, this also helps to destroy downstream demand, as end-consumers find it harder to afford the products being produced.
Thus whilst ethylene production at 4.9MT was back at 1999 levels, propylene volume at 3.7MT was still only equal to 2004 levels, as was butadiene volume at 0.5MT.
One hopeful sign, as the blog discussed yesterday, is that growing crude oil gluts in the US and elsewhere may well be the catalyst for a return of oil prices to a more normal historical relationship to gas prices. That would cause major short-term dislocation in terms of destocking and working capital. But it would be very good news longer-term.
However, today’s lack of demand growth will not get better, as Europe continues to age. Equally, its exports to China are now being reduced as China bursts its property bubble. This has a double impact, as China is not only buying less, but also exporting more. It is now becoming a PVC exporter rather than importer, for example.
Similar woes are impacting Europe’s refining sector, which has lost its gasoline export market in the US, and is configured to supply gasoline rather than the diesel that now drives Europe’s transport fleet. At some point, probably not far away, someone is going to have to start to address these problems.
The modern European economy could live without ‘too big to fail’ banking monoliths. But it can’t live without the products provided by the petrochemical industry. The new European Commission will hopefully recognise this fact early in its term of office. It cannot afford to repeat the mistakes of its predecessors,
Nobody was expecting very much from Q4 ethylene production in Europe, as several plants had been taken offline in December due to lack of demand. And yet it is still possible to be disappointed by the actual outcome as reported by APPE. As the chart above shows:
- Q4 production at 4.4MT was the lowest since the terrible results of Q4 2008 (purple)
- H2 output at 9.2MT was almost exactly the same as in 2012, and only just above 2008
- Total 2013 output at 18.5MT was the lowest since 1996, when volumes were still climbing year-by-year
In fact, the chart gives a clear indication that European ethylene production is now in steady decline. Operating rates were just 78% in 2013, worryingly close to the 77% seen in 2009. That might have been seen as a one-off post-Crisis problem. But data since then suggests a long-term trend is now underway.
Propylene data confirm the miserable picture. It was the highest since 2010 at 14.6MT, due to changes in severity to maximise output. But Q4 was weak at 3.4MT, and lower than 2012 as propylene prices came under pressure.
Butadiene was the same story, with output at 1.9MT in 2013 also the lowest since 2009, and otherwise the lowest since 1996. The lack of recovery in the European car market continues to take its toll, as the blog will discuss later this week in relation to the problems at Lanxess.
The latest EU olefin operating rates (OR%) were very disappointing, even though they were not a surprise. As the chart shows, ethylene rates were just 81% (based on APPE data). They were far below the 90%+ rates that were normal before the crisis began.
These rates would normally have left the industry in crisis mode as regards profitability. But they were “rescued” by the parallel collapse in refinery runs, and the shortage of propylene/butadiene caused by the major shift to ethane feeds in the USA.
The second chart, from the International Energy Agency, highlights the truly startling change in German refinery runs since the financial crisis. Germany is the EU’s largest and most prosperous country. Its refinery runs hardly ever fell below 2.1mbd before 2008. Since then, they have never reached this level, and were just 1.8mbd in February.
This average 18% fall in refinery runs gave major support to effective olefin OR%, as almost all EU crackers are based on refineries – either for naphtha or LPG. The high co-product values for propylene/butadiene were also critical in enabling the industry to deliver strong profitability.
The above chart would have seemed unbelievable at any time in the past 30 years. It shows the performance of propylene and butadiene relative to ethylene.
Not because it shows butadiene prices racing ahead relative to ethylene (green line). This happens routinely during a downturn, as tyre demand is more robust than for polymers. If people are not buying new cars, they still have to buy new tyres for existing cars – for legal and safety reasons.
But the record level of the butadiene premium to ethylene, an average of 170% in 2011, does give a clue to the dramatic nature of the disruption that has taken place.
The real shock, however, is that propylene sold at parallel prices to ethylene through the year (blue line). Not only has this never happened before. But it is also contrary to the main rationale for propylene sales, as this developed during the 1980’s.
The blog discussed this emerging trend back in July 2010, in a major series of posts that anticipated recent developments. They were also summarised in its ICB analysis of September 2010. New readers may like to refer to these for background detail by clicking the links:
• Major changes underway on relative olefin pricing
• Propylene prices reach parity with ethylene
• Benzene develops security of supply issues
• Lower Western gasoline demand helps paraxylene
• Major changes underway in chemicals markets
The key is that markets have become supply-driven. Oil production and refinery output have been reduced due to lack of demand. This has reduced ethane availability in the Middle East, and naphtha availability in the West.
Equally, the dramatic increase in the price of crude oil versus natural gas in the USA, due to financial speculation, has prompted a major switch from liquid to ethane feeds on the crackers.
Propylene supply has therefore been reduced both by lower refinery runs, and by the switch to ethane feeds, as these produce virtually no propylene or butadiene. Lower cracker operating rates have also helped to tighten markets, particularly for butadiene.
The question ahead is now twofold:
• Will buyers still be interested in using propylene for its commodity applications such as packaging, if it is no longer price competitive?
• Can crude oil really maintain its current premium to natural gas?
The answers to these questions are really a zero-sum game. Those who get them right, stand to make a lot of money. Those who get their analysis wrong, will likely lose a lot of money.
The blog itself would be extremely cautious about ignoring affordability issues, and simply assuming current trends will automatically continue.