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.
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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We are living in a New Normal world. Populists such as Nigel Farage, Donald Trump, Marine le Pen and Beppe Grillo are gaining support as economic growth slows and social/political unrest becomes common. My presentation at our annual conference last week in Vienna highlighted some of the key issues, as Jessie Waldheim of ICIS news reports.
VIENNA (ICIS)–Markets face a period of increased volatility as political and demographic changes result in a paradigm shift from globalisation to sustainability as the driver for chemical markets, the chairman of consultancy International eChem said on Tuesday.
“The world is at a tipping point,” said International eChem chairman Paul Hodges. “Everything we’ve known, everything we’ve lived with for the last 50-70 years is now changing.”
In 1987, then US president Ronald Reagan stood in front of the Berlin Wall in Germany and demanded that it be torn down. In 2017, US president-elect Donald Trump is expected to build a wall. In Europe, the Brexit vote for the UK to leave the EU and the upcoming referendum in Italy could cause further turmoil for the EU.
These political changes are being driven by demographic changes which are also going to effect petrochemical and other markets. Essentially, as life expectancies have increased and birth rates have lowered, a larger percentage of populations are older.
For example, as the second chart shows, the number of US households in the 25-54 age bracket has been steady while the number in the 55-and-up age bracket has risen by nearly 50%. The older households tend to spend less money, having already made most major purchases.
This is in contrast to recent decades, when major population growth in the younger age brackets drove global demand. ”We don’t have lots of young people, so you don’t need as much stuff,” Hodges said, speaking at the 15th annual World Aromatics & Derivatives Conference in Vienna, Austria.
According to figures from the American Chemistry Council, we’re seeing a drop-off in capacity utilisation, which is the “best single predictor we have” of global GDP, Hodges said. With the capacity utilisation numbers in September 2016 nearly as low as in 2009, we’re likely to see a global recession next year, he added.
Our economy has not yet adapted to the new demographics. This adaptation will mean uncertainty and political risk. ”We’re seeing the rise of protectionism. Sustainability is replacing globalisation,” Hodges said.
Trump has said he has plans to declare China a currency manipulator and to withdraw from or renegotiate trade deals. The Brexit vote is part of this same paradigm shift. “We need to be planning for this,” Hodges said.
Specifically for aromatics markets, benzene price spreads have already come down. Benzene is a byproduct and refineries don’t increase production when benzene is tight and won’t slow production if less benzene is needed. ”We’ve seen benzene below naphtha before. We could see benzene trading below naphtha again,” Hodges said. “We have to accept the volatility is there.”
Companies will need to consider how trade flows will change with China no longer the major importer and manufacturing capital of the world. And companies will need to consider inter-polymer competition from lower polypropylene prices. Businesses models will have to change and restructuring will be inevitable.
Key chemical hubs will have to be made more robust, and being near customers may become more important, Hodges said. With the change comes opportunities. For instance, businesses could focus on designing solutions with new materials or by repurposing materials already in the market.
“Aging populations are an opportunity. Why are we not developing new services and products for them?” Hodges said.
Capacity Utilisation (CU%) is the best measure we have for the current state of the global chemical industry. It doubles as an excellent proxy for the outlook for the global economy. And as the above chart based on latest American Chemistry Council data shows, recovery still seems a long way off:
- Global CU% was down to 81.4% in November, versus 82% in November 2014 and 82.4% in November 2013
- The only bright spot was in Central/Eastern Europe, up 9.2% versus 2014: Russia was up 14%
- Asia is showing some signs of recovery under the influence of cheaper oil, up 4.9% versus its 7.5% peak
- Middle East is also recovering, up 4.4% versus its 6.1% peak, as countries focus on petchem exports
- W Europe was up 2.8% versus its 4.1% peak, N America was up only 2.2% versus its 5% peak
- Latin America remains in crisis, setting a new low at -3.4%, with Brazil at – 4.3%
Sometimes November can disappoint as companies reduce inventory before year-end, but there was little sign of this happening in 2015. Many companies had in fact been convinced by the analysts that oil prices would rebound, and so there was actually some panic buying. This has no doubt led to some regrets, with oil now back at 2004 lows and still weakening as US and Iranian exports ramp up.
Pressure is also rising in Asia from the increase in China’s oil product exports. November data showed:
- Gasoline exports up 10% so far this year at 5m tonnes; jet kero exports up 17% at 11m tonnes
- Fuel oil was up 12% at 9.3m tonnes; and diesel up 64% at 6.2m tonnes
Naphtha and LPG saw imports rise; naphtha was up 79% at 5.7m tonnes and LPG up 69% at 10.6m tonnes. But these increases effectively meant that China was also boosting its own petchem production – not only reducing its potential need for polymer/PTA imports but also increasing its petchem export potential.
January will be a critical month as Western countries return from the holidays. This will give us some insight into likely demand trends in Q1, which are normally very strong for seasonal reasons. But Asia will, of course, be slowing ahead of Lunar New Year on 8 February.
2013 has seen 3 types of markets develop for the blog’s IeC Downturn Monitor portfolio as the chart above shows:
- Financial assets such as the S&P 500 (purple) have soared, as did the US$ against the yen (orange)
- Crude oil (blue) and naphtha (black) tried to follow, but found it difficult to pass though the higher prices
- Benzene (green) and PTA (red) have struggled with weak demand and high feedstock prices
The anomaly has been US polyethylene (yellow), where prices have stayed relatively strong as producers chose to focus on margin rather than volume.
This might seem a strange decision, given they enjoy a major feedstock cost advantage on ethylene due to shale gas. But it makes perfect sense when seen against the limited potential for selling additional export volumes. As the charts above show, based on trade data from Global Trade Information Services, there is really little scope for selling more PE or PVC (the main derivatives):
- Total PE net volumes are up 16% (blue column) versus 2011 (red) this year due mainly to a 26% increase to Latin America
- This region now takes three quarters of US net exports, as the percentage of sales to Asia has halved
- Total PVC net sales are up just 7% this year versus 2011, and flat versus 2012 (green)
- Exports are focused on Turkey, Mexico, Russia and Egypt: Asian volumes have also dropped versus 2011-12
This message does not yet seem to have got home to investors. They look at the raw data, and see just rising volumes and high margins. So they imagine that the world, and Asia in particular, are just waiting for additional volumes to appear.
What they miss is that Asian and LatAm countries are busy expanding their own production as fast as possible, so as to create jobs. They also forget that China’s slowdown is also now impacting Latin America’s demand. Equally, they overlook the fact that Brazil’s vast increase in PVC imports (double 2011 levels) and in PE (up 34%), is mostly a one-off bonus due to preparations for the soccer World Cup and the Olympics.
The operating managers with whom the blog talks understand all this very well. Some have special grades of PE that currently cannot be supplied by domestic competition in the importing countries. But most appreciate there is little point trying to sell additional volume, as this would merely lead to a price war and lower margins. They also know, unlike investors, that exporting additional volumes – if major new capacity is built – will be very hard indeed.
The chart shows latest portfolio price movements since January 2013 with ICIS pricing comments below:
PTA China, red, down 17%. “Downbeat market outlook for the downstream polyethylene terephthalate (PET) and polyester fibre demand”
Benzene Europe, green, down 14%. “Players are generally in the midst of running down inventories ahead of year-end rather than building stock.”
Brent crude oil, blue, down 1%
Naphtha Europe, black, up 3%. “European arbitrage window to Asia is well and truly shut, but domestic petrochemical demand will continue to prop up prices as crackers minimise the use of the more expensive alternative feedstock propane”
HDPE USA export, yellow, up 13%. “Limited trade in the week shortened by the US Thanksgiving holiday.
US$: yen, orange, up 16%
S&P 500 stock market index, purple, up 23%