Polyethylene markets (PE) are moving into a crisis, with margins in NE Asia already negative, as I have been forecasting. Scenario planning is now a matter of potential life or death for companies likely to be impacted over the next 12-18 months.
The collapse in margins is already quite dramatic as the chart based on ICIS data shows:
- NEA margins were $657/t in January 2017, and are now -$100/t; SE Asian margins have fallen from $909/t to $103/t
- NW Europe margins are down from $739/t to $300/t; US Gulf margins are down from $965/t to $603/t: Middle East margins are down from $1125/t to $833/t
The same pattern is also true for the other main grade, High Density PE (HDPE).
And, of course, today is only the start of the problems. As the second chart shows, there are vast amounts of new product coming online between 2019 – 2021 in both LLDPE and HDPE:
- LLDPE: China is adding 3.4 million tonnes; USA 1.8Mt; Russia and S Korea 800kt each; with India, Oman, Malaysia and Indonesia also adding capacity
- HDPE: China is adding 4.4Mt; USA 1.9Mt, S Korea 900kt, Russia 700kt; with India, Oman, Malaysia, Indonesia, Philippines, Iran and Azerbaijan also adding
The problem is that the fundamental assumptions behind the shale gas investments were simply wrong:
- Oil was most unlikely to always be >$100/bbl, providing a feedstock advantage with shale gas
- China wasn’t likely to be growing at double-digit rates, and always importing more petchems
- Globalisation was already ending, meaning that plants couldn’t be sited half-way across the world from their market
- Plastics will not always be the material of choice for single-use packaging applications
Essentially what happened is that companies stopped planning for themselves and allowed Wall Street to set their strategy, as one CEO told me:
“You may be right, but every time I mention shale on an earnings call, the share price goes up $5.”
It is now too late to wind back the clock. The US product from the integrated players has to go somewhere as their ethane feedstock is essentially a distressed product. If they don’t use the ethane to make ethylene and its derivatives, they cannot produce the shale gas.
The result is shown in the charts above, based on data from Trade Data Monitor
- 2019 has seen vast amounts of new US ethylene-based exports, and more is still to come
- Most of it was exported as PE, where exports have risen 85% so far this year versus 2018
- The trade war means exports to China have actually dropped, so Europe, SEA and NEA have suffered major disruption
- US PE exports to these regions were up 98%, 240% and 246% respectively, causing margins to start their collapse
The world is therefore starting to divide into Winners and Losers, as the chart suggests. Non-integrated ethylene producers around the world are particularly at risk:
- They have to buy their feedstock at market prices, and they will have to sell into an increasingly over-supplied market
- As a result, it is quite likely that their margins will become negative – as they have done before in periods of over-supply
- At this point, integrated producers have the advantage as they are still making money upstream on oil/gas/refining
But there are also wider risks for European and Asian consumers down all the major value chains, as they will be impacted by lower cracker rates.
Scenario analysis must now be a top priority for potential Loser companies. There really is very little time left, as the margins chart confirms.
Europe’s petrochemical sector must prepare now for the trade war, US start-ups, Brexit and the circular economy, as I discuss in this interview with Will Beacham of ICIS news at the European Petrochemical Association Conference.
With higher tariff barriers going up between the US and China, the market in Europe is likely to experience an influx of polymers and other chemicals from exporters looking for a new home for their production, International eChem chairman, Paul Hodges said.
Speaking on the sidelines of the European Petrochemical Association’s annual meeting in Vienna, he said: “The thing we have to watch out for is displaced product which can’t go from the US any more to China and therefore will likely come to Europe.”
In addition to polyethylene, there is an indirect effect as domestic demand in China is also falling, he said, leaving other Asian producers which usually export there to also seek new markets and targeting Europe.
“The US isn’t buying so many consumer goods from China any more – and that seems to be the case because container ships going from China to the US for Thanksgiving and Christmas aren’t full. So NE and SE Asian chemical producers haven’t got the business they expect in China and are exporting to Europe instead. We don’t know how disruptive this will be but it has quite a lot of potential.”
US polymer start-ups
Hodges believes that the new US polymer capacities will go ahead even if the demand is not there for the product. This is because the ethane feedstocks they use need to be extracted by the producers and sellers of natural gas who must remove ethane from the gas stream to make it safe.
For these producers some of the cost advantages have already disappeared because of rising ethane prices.
“The exports of US ethane are adding one or two more crackers to the total. And without sufficient capacity ethane prices have become higher and more volatile.”
Hodges points out that pricing power is being lost as poor demand means producers cannot pass on the effect of rising oil prices. “Margins are being hit with some falling by 50-60%,” he said.
EU targets mean that all plastic packaging must be capable of being recycled, reused or composted in Europe by 2025. For the industry this could be a huge opportunity, but only if it acts fast, said Hodges: “We have to develop the technology that allows that to happen. We will need the [regulatory] approvals and if we don’t get moving in the next 12-18 months we are in trouble.”
According to Hodges: “We are in the end game for Brexit. We talk to senior politicians from both sides who don’t think there is a parliamentary majority for any Brexit option.”
He fears that if no deal can be agreed there is a chance the UK will refuse to pay its £39bn divorce bill.
“Then what happens to chemical regulation and transport? Although the bigger companies have made preparations, only one in seven in the supply chains are getting prepared,” he added. This is why we have launched ReadyforBrexit.
You can listen to the full podcast interview by clicking here.
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Sadly, my July forecast that US-China tariffs could lead to a global polyethylene price war seems to be coming true.
As I have argued since March 2014 (US boom is a dangerous game), it was always going to be difficult for US producers to sell their vastly increased output. The expansions were of course delayed by last year’s terrible hurricanes, but the major plants are all now in the middle of coming online. In total, these shale gas-based expansions will increase ethylene (C2) capacity by a third and polyethylene (PE) capacity by 40% (6 million tonnes).
ICIS pricing reports this weekend confirm my concern, following China’s decision to retaliate in response to President Trump’s $200bn of tariffs on US imports from China:
Even worse, as the chart above confirms, is that US ethane feedstock spreads versus ethylene have collapsed during 2018, from around 20c/lb to 5c/lb today. Ethane averaged 26c/gal as recently as May, but spiked to more than double this level earlier this month (and even higher, momentarily) at 55c/gal.
The issue appears to be that US producers had calculated their ethane supply/demand balances on the basis of the planned US expansions, and never expected large volumes of ethane to be exported. Yet latest EIA data shows exports doubling from an average 95kbd in 2016 to 178kbd last year. And they are still rising, with Q2 exports 62% higher at 290kbd.
The second chart from the latest pH Report adds a further concern to those of over-capacity and weak pricing power.
It focuses attention on the weak state of underlying demand. Even the prospect of higher oil prices only led to modest upturns earlier this year in the core olefins, aromatics and polymers value chains as companies built inventory. Polymers’ weak response is a particularly negative indicator for end-user demand.
This concern is supported by recent analysis of the European market by ICIS C2 expert, Nel Weddle. She notes that PE is used in packaging, the manufacture of household goods, and also in the agricultural industry and adds:
“Demand has been disappointing for many sellers in September, after a fairly weak summer. “I don’t see a big difference between now and August,” said one, “for both demand and pricing. Customers are very very quiet.” All PE grades were available, with no shortage of any in evidence.
“The market is generally quieter than many had expected, and the threat of imports from new capacities in the US looms large – particularly with the current trade spat between the US and China meaning that product may have to find a home in Europe sooner than expected.”
US producers, as would be expected, remain optimistic. Thus LyondellBasell CEO Bob Patel has suggested that:
“Trade patterns are shifting as China sources from other regions and [US producers] are shifting to markets that are vacated. Supply chains are adjusting but there is a bit of inventory volatility as a result. Where product has landed [in China] and has to be redirected, there is price volatility. But we think that is [transitory].”
But the detail of global PE trade suggests a more pessimistic conclusion. Data from Trade Date Monitor shows that China was easily the largest importer, taking a net 11.9 million tonnes. Turkey was the second largest importer but took just 1.7 million tonnes, around 14% of China’s volume. And given Turkey’s economic crisis, it is hard to see even these volumes being sustainable with its interest rates now at 24% and its currency down 60% versus the US$.
As the 3rd chart confirms, the US therefore has relatively few options for exporting its new volumes:
- Total net exports have increased 29% in January-July versus 2016, but were still only 1.8 million tonnes
- Latin America remained the largest export market at 939kt, taking 52% of total volume
- China volume had doubled to 524kt, but was only 29% of the total
- Europe was the next largest market at 369kt, up 40%, but just 20% of the total
- Other markets remain relatively small; S Africa took the largest volume in Africa at just 12kt
China’s US imports will now almost certainly reduce as the new tariffs bite. And the onset of the US trade war is likely to further boost China’s existing aim of increasing its self-sufficiency in key areas such as PE. Its ethylene capacity is already slated to increase by 73% by 2022, double the rate of expansion in 2012-2017 and from a higher base. The majority of this new volume will inevitably go into PE, as it is easily the largest derivative product.
Back in May, I used the chart above to highlight how the coming price war would likely create Winners and Losers in olefin and polymer markets. Unfortunately, developments since then make this conclusion more or less certain. I fear that complacency based on historical performance will confirm my 2014 warning about the dangers that lie ahead.
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I was interviewed on Friday about the likely impact of President Trump’s trade wars on the global chemical industry by Will Beacham, deputy editor of ICIS Chemical Business. His interview is below.
The introduction on Friday of trade tariffs by China and the US is the first step in a trade war that could turn into a global polyethylene (PE) price war as the wave of new US production is sent to new markets, likely Europe.
Paul Hodges, chairman at London-based International eChem, said that around 6m tonnes/year of new US PE capacity has to find a home and, with China largely out of reach, the obvious destination would be Europe, where the surplus production will put downward pressure on prices there and around the world.
“The main hit from a trade war is going to be the US PE expansions – clearly it is being targeted so the opportunity to export to China is sharply reduced,” said Hodges. “But this won’t just be a US problem because they will still want to move their product – it has got to come to Europe as there is no surplus demand in Asia, the Middle East or Latin America.”
He added that this first wave of tariffs were a wake-up call to those who thought globalisation was going to continue as it did in the past. “We have reached a tipping point where we have to expect that trade wars are more rather than less likely”, he said.
“If you assume the US production will come onstream, then where will those 6m tonnes of product go? It can’t go to China, it can’t go to Latin America as that is too small a market, the Middle East is in surplus, Africa is too small – so Europe is the only place,” said Hodges.
US PE producers that are integrated up to the wellhead need to extract ethane in order to monetise their gas production:
- These producers will continue to export happily at whatever price because essentially the ethane is a distressed product and has to be sold
- However, non-integrated players’ margins could come under pressure.
In Europe, there is a parallel to the US, said Hodges, as regional production is generally tied into refineries.
Naphtha is a relatively small part of the product flow from a refinery, so prices can go down quite a long way before you start to think about cutting back on refinery operating rates.
“The risk for the second half of this year and 2019 is that you have two heavyweights in the boxing ring – one integrated back to the gas wellhead in the US and the other refinery-integrated in Europe – and people get squeezed in between,” he added.
EUROPE VALUE CHAINS
Hodges pointed out that if cracker operating rates decline in Europe it will hit all the other product streams such as propylene, butadiene (BD) and pygas. There are tremendous knock-on risks across all the value chains, not just ethylene.
“This won’t happen this year, but if it continues and gets worse over the next 12-18 months, do you start to look at cracker shutdowns in Europe? What will the implications be for people relying on those crackers for feedstocks?” said Hodges. “It’s a hornet’s nest of unintended consequences: people don’t send a ship load of PE to Europe expecting it to shut down a PP plant.”
Hodges urged the industry to make contingency plans now to manage these future risks. European producers will have to think about how they protect feedstock supplies for value chains on a Europe-wide and country basis so that pipelines are not shut down.
“You’d have to focus on a number of core hubs and reinvest in those to give the infrastructure you need for the future. You need to do it now – while there is time to take action,” he said. “You might end up spending money you don’t need to spend, but that’s much better than waking up and realising you don’t have a feedstock supply,” he said.
According to ICIS data, the US is forecast to export a total of 1.37m tonnes of low density polyethylene (LDPE), high density polyethylene (HDPE) and low linear density polyethylene (LLDPE) to China (see LLDPE map above). Although HDPE is not included in the current tariffs, it could be added later, according to Hodges.
He added that a price war in PE would impact other polymers because of inter-polymer competition. It may only be 5-10% that is substituted, but to lose that amount of volume at the margin would be quite significant.
He described the trade war as a paradigm shift for the whole global industry as the era of globalisation switches to regional and nationalism. “I’m worried that a lot of people in this industry have grown up with globalisation and they assume that is how it is,” he said.
Trade policy and geopolitics are like a chess game with lots of moving pieces and the approach is that you give up something in order to gain more, he added. This has been a very successful approach by the US since the Second World War, when it implemented the Marshall Plan or ‘European Recovery Plan’. Almost the equivalent of $110bn in today’s money was invested to rebuild the continent.
“This boosted the European economy in order to make it a bigger import market for US exports. Trade expands opportunities and the overall economy. There may be some short-term successes going into a trade war but ultimately the US economy will lose,” Hodges conclude.
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US ethylene spot prices are tumbling as the major new shale gas expansions come on line, as the chart based on ICIS pricing data confirms:
- They began the year at $617/t, but have since more than halved to $270/t on Friday
- They are only around 10% higher than their all-time low of $240/t in September 1998
- WTI crude oil was then $15/bbl and ethane was $0.15c/gal
- On Friday, WTI closed at $70.5/bbl and ethane was $0.25c/gal
The collapse in margin has been sudden, but is hardly unexpected. It is, of course, true that downstream polyethylene plants associated with the crackers were delayed by the hurricanes. So ethylene prices may recover a little once they come online. But unfortunately, that is likely to simply transfer the problem downstream to the polymer markets.
The issue is shown in the second chart, based on Trade Data Monitor data:
- It shows annual US net exports of polyethylene since 2006
- They peaked in 2009 at 2.6 million tonnes as China’s stimulus programme began
- China’s import demand doubled that year to 1 million tonnes, but then fell back again
- Net exports have actually fallen since 2016 to 1.9 million tonnes last year
The problem, of course, was that companies and investors were fooled by the central bank stimulus programmes. They told everyone that demographics didn’t matter, and that they could always create demand via a mix of money-printing and tax cuts. But this was all wishful thinking, as we described here in the major 2016 Study, ‘Demand – the New Direction for Profit‘, and in articles dating back to March 2014.
Unfortunately, the problems have multiplied since then. President Trump’s seeming desire to launch a trade war with China has led to the threat of retaliation via a 25% tariff on US PE imports. And growing global concern over the damage caused by waste plastics means that recycled plastic is likely to become the growth feedstock for the future.
In addition, of course, today’s high oil price is almost certainly now causing demand destruction down the value chains – just as it has always done before at current price levels. People only have so much money to spend. If gasoline and heating costs rise, they have less to spend on the more discretionary items that drive polymer demand.
COMPANIES HAVE TO REPOSITION FAST TO BECOME WINNERS IN THIS NEW LANDSCAPE As I suggested with the above slide at last month’s ICIS World Polymers Conference, today’s growing over-capacity and political uncertainty will create Winners and Losers:
- Ethylene consumers are already gaining from today’s lower prices
- Middle East producers will gain at the US’s expense due to their close links with China
- Chinese producers will also do well due to the Belt & Road Initiative (BRI)
As John Richardson has discussed, China is in the middle of major new investment which will likely make it a net exporter of many polymers within a few years. And it has a ready market for these exports via the BRI, which has the potential to become the largest free trade area in the world. As a senior Chinese official confirmed to me recently:
“China’s aim in the C2/C3 value chains is to run a balanced to long position. And where China has a long position, the aim will be to export from the West along the Belt & Road links to converters / intermediate processors.”
The Losers will likely be the non-integrated producers who cannot roll-through margins from the well-head or refinery. They need to quickly find a new basis for competition.
Luckily for them, one does exist – namely the opportunity to develop a more service-led business model and work with the brand owners by switching to use recycled plastics as a feedstock. As I noted in March:
“Producers and consumers who want to embrace a more service-based business model therefore have a great opportunity to take a lead in creating the necessary infrastructure, in conjunction with regulators and the brand owners who actually sell the product to the end-consumer.”
Time, however, is not on their side. As US ethylene prices confirm, the market is already reacting to the reality of over-capacity. H2 will likely be difficult under almost any circumstances.
The industry made excellent profits in recent years. It is now time for forward thinking producers – integrated and non-integrated – to reinvest these, and quickly reinvent the business to build new revenue and profit streams for the future.
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Welcome to the New Normal.
The Great Unwinding of policymaker stimulus has led global oil prices to drop back to $50/bbl. Meanwhile China, the major source of demand growth since 2009, is now seeing a major slowdown.
And, of course, this is still only the beginning of the great transformation that is now underway as we enter the New Normal world.
How low will oil prices go? I will look at this in more detail next week. But yesterday saw them reach my long-standing forecast level of $50/bbl. And given the supply build-up since that forecast was made, we will probably now see them fall another $20/bbl and return to historical levels around $30/bbl.
Already, of course, they are now low enough to effectively eliminate the ethane cost advantage that has driven major US ethylene expansion plans. Where will this planned 40% increase in production be sold? This is now a critical question for companies and investors – clearly project cancellations are now becoming inevitable.
Equally important is that China’s economy is already in its New Normal world, as President Xi has recently reminded us. Not only is its demand growth slowing, but it is also on track to become self-sufficient in many major products – and a net exporter of PVC, as well as PTA for the polyester industry, and many others.
COMPANIES NEED TO LOOK IN NEW DIRECTIONS FOR FUTURE GROWTH
But there is another, much more positive side to this story. Yes, we are getting back to reality, and that is set to be a very painful exercise after all the wishful thinking from policymakers.
But it also creates tremendous opportunities for companies and investors who are prepared to ‘think outside of the box’ and develop new ways of working and new business models.
My annual New Year Outlook for ICIS Chemical Business sets out the detail of these opportunities in more detail.
It explains how to become a Winner, and avoid becoming a Loser, in this New Normal world. Please click here to download a free copy.
And please click here to view my interview with Will Beacham, Deputy Editor of the magazine.