US polypropylene imports rise as China aims for self-sufficiency

US propane Jul16

Difficult times lie ahead for global polymer markets, as I note in a new analysis for ICIS Chemical Business.

In the short-term it is clear that downstream users have, once again, been busy building stock in recent weeks as the oil price rose. But now, finance directors are getting calls from their bankers asking about working capital levels. It would be no surprise if demand soon slackened off again ahead of the seasonal summer slowdown, as this excess inventory is unwound.

Unfortunately, however, this is not the main problem facing us as we head into H2. There are more fundamental reasons for concern in the polymer markets themselves, as China starts to ramp up its own production of polymers, in line with the objectives of its new 5 Year Plan. This calls for 93% self-sufficiency in the propylene chain, and 62% in the ethylene chain, by 2020:

  • Polypropylene (PP) highlights the change underway, as China’s capacity expands and its import needs reduce
  • In turn, this is creating a chain reaction, as displaced export producers in NE Asia and the Middle East seek new markets
  • The US market is one obvious target – and it is also starting to receive large volumes from Latin America, as the region’s economy heads into recession following China’s slowdown
  • Europe has seen an even greater change in its trade patterns.  It has now become a net importer, due to the arrival of displaced product from the Middle East and NE Asia, and a 9-fold increase in Latin American imports

These developments highlight the rapid shift that is taking place in demand drivers for the entire petrochemical and polymer industry:

  • Until recently, the industry has operated on the “build it, and buyers will come” principle of Kevin Costner’s 1989 baseball movie ‘Field of Dreams
  • It profited from a 25-year economic SuperCycle, which caused business models to become supply-driven, based on the strength of BabyBoomer demand
  • Today, however, we are going ‘Back to the Future’
  • Feedstock cost advantage remains necessary, but it is no longer enough to guarantee profit in a world where demand growth is slowing sharply, as we describe in Denand – the New Direction for Profit

Unfortunately, the post-Crisis meddling by central banks has increased the potential surpluses, by destroying price discovery in key markets.  High oil prices were never justified by supply constraints.  But, understandably, producers assumed new supply was needed, and rushed to expand production.

Only now are they starting to realise they were fooled.  A new Study by Rystad Energy highlights the extent of the problem – it shows that the US now has larger oil reserves than either Saudi Arabia or Russia.  And as the charts show, the US is also seeing a vast increase in propane production, as the Wall Street Journal describes:

“In a first, U.S. oil-and-gas companies are on track this year to export more propane than the next four largest exporting countries combined—OPEC members Qatar, Saudi Arabia, Algeria and Nigeria, which have long dominated the trade… U.S. exports already account for more than a third of the overall market for waterborne shipment”.

In essence, a chain reaction has developed, which is expanding in scope all the time:

  • The US is exporting low-cost propane to China
  • This means that China can cheaply expand its own propylene and polypropylene capacity via PDH technology
  • It is now 81% self-sufficient in PP, with H1 output up 37% since 2014, dramatically reducing its import need
  • NEA and the Middle East therefore need to send their newly-surplus production to the US
  • This reduces the need for US domestic PP production, freeing up more cheap propane for export to China

And, of course, cheap PP can often replace polyethylene and other polymers in certain applications.  So in turn, this will further pressure all the new PE capacity now about to come online on the US Gulf Coast, by reducing potential demand for the new product.

Please click here to read the ICB article.  And please do contact me at phodges@iec.eu.com if you haven’t yet ordered the Demand Study, and would like further details.

Oil market fundamentals continue to weaken as Glencore buys

Global oil traders are having lots of fun as oil market volatility ramps up.  Earlier this month, for example, Reuters reported that “Glencore have got big positions all over the place” in North Sea oil markets:

  • They spotted that N Sea production would be sharply reduced in June due to maintenance on the Ekofisk field
  • Reportedly, they already own more than a third of the 37 cargoes expected to load during the month
  • In turn, this means they own around 10% of daily world production – enough to have a major influence on other global markets, given Brent’s benchmark status

Yet at the same time, oil storage is filling up all around the world.  The US surplus is so large that a futures market in storage opened last year, with 25 million barrels now being traded.  And 90 million barrels are currently stored on ships, according to the latest report from the International Energy Agency – 48mb are now being stored off Singapore, for example, whilst tankers are waiting a month to discharge oil at Qingdao in China.

And this oil is costing its owners money to store.  On Friday, the Brent one-year ahead price for July 2017 was only $3.15/bbl higher than today’s price, far below the $10/bbl needed to make a profit.  This contango has more than halved since January, despite all the talk about supply disruptions.

Even more telling is the chart above, showing US prices for coal, WTI oil and natural gas – converted to $/MMBtu equivalent.  The excitement over the recent rally has diverted attention from the fierce competition now developing in US energy markets as natural gas and renewables battle for market share:

  • Coal has been the main loser, with publicly traded coal miners losing almost all their value between 2011 – 2016
  • The largest supplier, Peabody Coal, followed the No 2, Arch, into bankruptcy last month
  • But coal still supplies 34% of US electric power versus 31% for gas
  • And its market share is likely to remains stable as power stations cannot easily convert to other fuels
  • Peabody has therefore been able to raise $800m of bankruptcy financing to continue operating its mines

Oil and gas are also losing market share due to climate change pressures.  The US added more renewable power sources to the grid than gas last year, as major users of electric power such as Google  pressured utilities to use solar and other renewable sources.  Thus gas prices at Henry Hub have actually been below coal prices for the past 3 months – despite it being the winter season – as producers became desperate to sell their product.

This tells us that the current oil market rally is living on borrowed time, due to these supply/demand pressures.  The rally’s only support is from pension and hedge funds – seeking a store of value against dollar weakness – and from traders such as Glencore hoping to exploit short-term production outages in a major market.

But in the end, of course, the fundamentals of supply and demand will set the price.  And when the crash happens, it will be painful, due to the massive supply overhang created by the recent rally.  There are also plenty of potential catalysts for the crash:

  • One is the recent rebound in the value of the US$, as currency traders start to bet that the US Federal Reserve might increase interest rates next month
  • $5tn is traded every day in currency markets, so even a minor rally in the US$’s value would have a big impact on the ”store of value” support

Most traders that I speak to therefore believe that anyone holding large inventories today is playing a dangerous game.  Common sense tells us that it is very easy to build a large position in an over-supplied market.  But experience suggests it is much more difficult to then sell these volumes at a profit, when the market is fundamentally over-supplied.

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 53%
Naphtha Europe, down 52%. “Additional naphtha is being blended into gasoline for export to the US”
Benzene Europe, down 55%. “The switch to lighter feedstocks among European cracker operators could also help balance out the marke”
PTA China, down 41%. “The new PX capacities that are due to hit the market in 2017 have led to expectations of longer feedstock supply in the
market for PTA producers”
HDPE US export, down 29%. “China distributors were concerned about the competitively-priced cargoes from Iran and Brazil”
¥:$, down 8%
S&P 500 stock market index, up 5%

Chart of the Year – Oil prices return to natural gas linkage

WTI v natgas Dec15

Last year’s ‘Chart of the Year’ was headlined “China’s auto sales bubble begins to burst“.  Few would disagree with this view today.  Similarly, there is little doubt about 2015′s Chart of the Year.  It has been the focus of industry and analyst attention all year:

  • Those who believed that argument that the world faces an energy supply glut have used it to argue that WTI oil and US natural gas prices were now realigning again
  • Those who decided to invest $150bn of petrochemical industry capital in new gas-based  production, or $1.2tn of their investors’ money in new US energy production, have watched with mounting horror

It shows WTI prices divided by 6 (blue line) to equate to oil’s energy equivalent value versus natural gas (red).  And it highlights oil’s roller-coaster ride since 2009.  Contrary to all logic, oil prices surged from 2009 – 2013, ending far about their relative value versus natgas:

  • But since 2009, there has never been any risk of a shortage of oil, despite the constant analyst forecasts that this was “just  around the corner”
  • The higher prices were instead due to financial players seeking a ‘store of value‘ for US$-based assets, in response to their belief that the US Federal Reserve’s easy money policy would devalue the US$
  • Even China’s stimulus policy failed to create shortages, although it supported the wishful thinking that oil demand was set for long-term increase

But then reality began to return, as the Great Unwinding of stimulus policy began to have its effect from August 2014.

In a perfect world, prices would have simply returned very quickly to their natural level in relation to natural gas.  But as I warned a year ago, it has been a very bumpy road:

  • The problem is that central banks have been destroying markets’ primary role – of price discovery – for 15 years: first with the subprime bubble, and then with Quantitative Easing
  • And so anyone who began work within the past 15 years, has only known a world where market forces could be overwhelmed by central bank stimulus.

This is why the chart of WTI prices versus US natgas prices is so important.  It reminds us there is is a real world out there, where consumers will not continue to pay more for oil than its relative energy value.  And the oil price downturn since August 2014 also reminds us a new era is likely dawning in energy supply itself.

US WTI prices were only decontrolled in 1981 under President Reagan, having previously been set by the Texas Railroad Commission (whose system of “prorating” provided the basis for OPEC’s operation).  Now it seems OPEC’s role is following the Railroad Commission into history.  Saudi Arabia and the GCC countries have recognised this for some time – and it will likely become more apparent to others in 2016 as we move into the New Normal world.

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 65%
Naphtha Europe, down 55%. “OPEC’s new Oil Product Outlook suggests naphtha with be the fastest growing oil product with an average growth of 1.3% per year between 2014 and 2040”
Benzene Europe, down 58%. “The key global development for benzene supply is the new capacity coming online in both India and the Middle East”
PTA China, down 44%. “Chinese demand for polyester end-products and PTA is likely to remain bearish.”
HDPE US export, down 37%. “Ample supplies with little trading activity”
¥:$, down 18%
S&P 500 stock market index, up 5
%

5 Critical Questions every Company and Investor Need to Answer

Chaos Oct15Today’s uncertain economic and oil price  environment has created chaos in petrochemical feedstock and product markets.  This creates major risks for producers, consumers and investors.

ICIS and International eChem have therefore decided to combine our resources to launch a new Study, that will analyse the potential impact of these developments on the olefins, aromatics and polymer value chains over the next 10 years.  It will provide answers to the 5 key questions that arise from this increasingly chaotic environment:

  • Can companies still plan ahead for demand by simply using a relevant multiple for each product in relation to an IMF GDP growth forecast?
  • Can they continue to assume that oil prices will inevitably return to recent highs, or are prices more likely to return to the lower levels seen before 2004?
  • Do China’s New Normal policies mark a complete change of direction from its previous role as the manufacturing capital of the world?
  • Will today’s globally ageing population maintain the same levels of demand for autos, housing, electronics etc as in the past?
  • Should companies focus on new growth areas for demand, in potential megatrend areas such as water, food, shelter, health, mobility and the environment?

Our analysis will therefore explore the critical challenges that confront the industry today.

It is titled How to survive and prosper in today’s chaotic petrochemical markets: 5 Critical Questions every company and investor needs to answer.

Please click here to download a copy of the Prospectus.  And please click here to see an interview with Will Beacham, deputy editor of ICIS Chemical Business, where we discuss the key issues covered in the Study.

 

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 51%
Naphtha Europe, down 47%. “Russian refineries are expected to go on maintenance as usual because of the cold weather”
Benzene Europe, down 59%. “Upward movement on crude oil and US benzene helped European benzene spot pricing push higher midweek”
PTA China, down 40%. “Downstream polyester makers of bottle chips and yarns are still not expecting uplifts in demand for end products. They are presently not seeing seasonal demand from the onset of the winter and year-end festival season.”
HDPE US export, down 36%. “Domestic export prices held steady during the week”
¥:$, down 18%
S&P 500 stock market index, up 3%

“Houston, we have a problem!”

WTI v natgas Jan15Suddenly, far too late, the world is catching up with reality.  Goldman Sachs and others yesterday halved their forecast for Brent oil to $42/bbl from $80/bbl.  But this isn’t forecasting, this is simply catching up with events long after they happened.  Brent, after all, opened at $45/bbl this morning.

As readers will remember, I forecast back in August that Brent oil prices were about to fall to “at least $70/bbl and probably lower“.   I coupled this with a forecast in early September that the US$ was about to see a “strong move upwards“ as the Great Unwinding of stimulus policies began.  Then in October, I published my original forecasts in a Research Note, and also highlighted the key issues in the Financial Times.

Then, when the $70/bbl level was reached in early December, I published a new Research Note highlighting the potential for further major falls:

Astonishingly, most commentators remain in a state of denial about the enormity of the price fall underway. Some, failing to understand the powerful forces now unleashed, even believe prices may quickly recover. Our view is that oil prices are likely to continue falling to $50/bbl and probably lower in H1 2015, in the absence of OPEC cutbacks or other supply disruption. Critically, China’s slowdown under President Xi’s New Normal economic policy means its demand growth will be a fraction of that seen in the past.

“This will create a demand shock equivalent to the supply shock seen in 1973 during the Arab oil boycott. Then the strength of BabyBoomer demand, at a time of weak supply growth, led to a dramatic increase in inflation. By contrast, today’s ageing Boomers mean that demand is weakening at a time when the world faces an energy supply glut. This will effectively reverse the 1973 position and lead to the arrival of a deflationary mindset….

Asian producers and traders now have large inventories of almost every oil-related product. Buyers have simply stopped buying in recent weeks as prices have collapsed. So the question is whether China’s demand will now increase in January, before markets close for Lunar New Year in mid-February. A lot of money is now riding on this issue.

If these hopes prove false, and the West enjoys a mild winter, there would seem little to stop prices heading back towards historical levels of $25/bbl – $40/bbl. This would be good news long-term, as $25/bbl is an ‘affordable’ price for the global economy, at 2.5% of GDP.

But it would be very bad news for investments based on the two myths that (a) oil will remain at $100/bbl forever and (b) China’s demand will increase exponentially as it becomes middle class. Equally important is that a sustained price fall will mean deflation becomes inevitable in the Eurozone and Japan, irrespective of any further QE initiatives.”

That was published a month ago, not yesterday.  Today it is clear there has been no increase in China’s demand ahead of Lunar New Year, and the West is having a mild winter.  So the price is now highly likely to return to historical levels of $25 – $40/bbl.

All these experts who have missed the obvious for so long need to look at themselves in the mirror, and ask the simple question, “How did we get this so wrong“?  And more importantly, “What are we going to do now, to help those who believed our forecast and now face bankruptcy“?

Equally, Western central banks must now give up on the myth that printing money can somehow create demand and inflation.  They are primarily responsible for this looming earthquake by creating the ‘correlation trade’ in the first place.  As the chart shows, this caused oil (red line) and stock market prices (blue) to rise exponentially together.

They too need to look in the mirror, and focus urgently on the real task ahead – “How do we position the global economy to survive the deflation shock that is now about to hit?”

 

US fracking demand creates price volatility for hydrochloric acid

US gas EIA Aug14Fracking has completely changed the outlook for US natural gas supplies, as the above chart from the latest Energy Information Agency 2014 annual report shows:

  • It forecasts a 56% increase in total natural gas production from 2012 to 2040
  • This is largely due to growth in shale gas (green) and tight gas (brown)
  • Shale gas output will double from 9.7 Tcf in 2012 to 19.8 Tcf in 2040
  • Its share of total U.S. natural gas output increases from 40% in 2012 to 53% in 2040
  • Tight gas production increases 73%, but its share stays relatively constant

Changes of this magnitude lead to a vast number of unexpected consequences, some good and some bad.  And even good changes, involving an increase in demand, create major disruption for both producers and consumers.

A blog reader has thus suggested that the adjustment process followed by hydrochloric acid (HCl) could be a useful Case Study.  The idea is to illustrate the opportunities and challenges created by this revolution in energy supply.

THE IMPACT OF FRACKING DEMAND ON HYDROCHLORIC ACID
We all carry HCl inside us, as an essential part of the gastric acid in our digestive system.  It is also a core product for the chloralkali industry, and has a wide range of industrial uses.  More recently, it has become a key part of the fracking process, as the FracFocus website describes:

An acid stage, consisting of several thousand gallons of water mixed with a dilute acid such as hydrochloric or muriatic acid: This serves to clear cement debris in the wellbore and provide an open conduit for other frac fluids by dissolving carbonate minerals and opening fractures near the wellbore.”

As a result, supply/demand fundamentals for HCl are going through major change.

One key issue is that around 75% of all HCl has historically been used internally by companies for PVC and polyurethane production.  Only 25% has gone onto the external market for water/swimming pool disinfection, steel pickling, food processing and other uses.

Nobody had dreamed that shale gas developments would impact HCl, so producers and consumers have been running hard to try and catch up.  Price volatility has thus become a major feature of the market.

Initially prices soared, as it was impossible to create new supply overnight:

  • HCl is often produced as a by-product of other chloralkali processes, with this source often known as ‘fatal’ supply
  • On-purpose production can also take place by combining chlorine with hydrogen in the presence of UV light

More recently, prices collapsed by 40% between December and May, according to ICIS pricing data.  But they have since rallied 40% as the US market then became very tight, as ‘fatal’ supply was reduced by outages at Bayer and DuPont, whilst BASF’s Geismar plant has been on turnaround.

A key part of the problem is that HCl logistics are relatively inefficient, as it is usually transported as a 35% concentration in water.  So it can take a long time to refill supply chains, once they become empty, as an excellent report by Bill Bowen in ICIS news describes.

Further volatility is likely as the year progresses, due to the new capacity due to come online.  This will increase US capacity by around 20%, with most scheduled to start-up between now and year-end.

Will this new capacity now create temporary over-supply, and more price volatility?  Nobody knows.  We are only at the very start of the fracking revolution.  Today’s certainties can easily become irrelevant tomorrow.

What does seem certain is that we all need to learn about what can happen when long-established supply/demand fundamentals are challenged by a major new development like fracking.

The HCl market thus highlights how a company’s ability to manage today’s more volatile world is becoming critical to its current and future profitability.