Two major challenges face petrochemical and polymer producers and consumers in 2018:
- The likely disruption created by the arrival of the ethylene/polyethylene expansions in the US
- The growth of the circular economy and the need to dramatically increase recycling capacity
My new interview with Will Beacham, deputy editor of ICIS Chemical Business, focuses on both these key issues and suggests they will create Winners and Losers.
The new US product will likely change the global market. Its ethane feedstock is essentially a distressed product, which has to be removed to enable the shale gas to be sold. It is also clear that this 40% expansion of USA polyethylene capacity, around 6 million tonnes, cannot be sold into the US domestic market, which is already very mature:
- US net exports have actually been in decline in recent years, so it will also be a challenge to export the volumes
- President Trump’s apparent wish to start a trade war with China will make that market difficult to access
- It is likely, therefore, that a significant volume will end up arriving in Europe, causing a price war
We have seen price wars before, and the “Winners” are usually the integrated producers, who can roll through margins from the well-head or the refinery into ethylene and polyethylene sales.
The economics of this are relatively simple. In the US, producers will have to absorb lower margins on the small percentage of shale gas that is used as ethane feed into the cracker. Similarly in Europe, refinery-integrated producers will have to absorb lower margins on the small percentage of oil that is used as naphtha feed into the cracker.
As the chart shows, this development will be good news for ethylene consumers. As Huntsman CEO, Peter Huntsman noted a year ago:
“There is a wave of ethylene that is going to be hitting the North American markets quite substantially over the next couple of years. I’d rather be a spot buyer than a contract buyer. I can’t imagine with all of the ethylene that is going to be coming to the market that it’s not going to be a buying opportunity.”
In turn, of course, this will pressure other plastics via inter-polymer competition
Non-integrated producers clearly face more difficult times. And like the integrated producers, they share the challenge being posed by the rise of sustainability concerns, particularly over the 8 million tonnes of plastic that currently finds its way into the oceans every year.
This issue has been building for years, and clearly consumers are now starting to demand action from brand owners and governments.
In turn, this opens up major new opportunities for companies who are prepared to realign their business models with the New Plastics Economy concepts set out by the Ellen MacArthur Foundation and the World Economic Forum.
The New Plastics Economy is a collaborative initiative involving leading participants from across the global plastic packaging value chain, as the second chart illustrates. It has already prompted action from the European Union, which has now set out its EU Strategy for Plastics in the Circular Economy. This aims to:
“Transform the way plastics and plastics products are designed, produced, used and recycled. By 2030, all plastics packaging should be recyclable. The Strategy also highlights the need for specific measures, possibly a legislative instrument, to reduce the impact of single-use plastics, particularly in our seas and oceans.”
Clearly this represents a paradigm shift for the industry, both producers and consumers.
It may seem easier to do nothing, and to hope the whole problem will go ahead. But the coincidence of the arrival of all the new US shale gas capacity makes this an unlikely outcome. Companies who do nothing are likely instead to become Losers in this rapidly changing environment.
But as I discuss in the interview, companies who are prepared to rethink their business models, and to adapt to changing consumer needs, have a potentially very bright future ahead of them. Please click here to view it.
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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.
The Brexit vote, and Donald Trump’s election, confirm that we are in a New Normal world. In the interview below with Will Beacham, Deputy editor of ICIS Chemical Business, I highlight some ideas about how industry needs to adapt.
BARCELONA (ICIS)–The global chemical sector needs to stimulate demand for innovative products and services in mature economies so that the benefits of globalisation are felt by people who have been left behind, a leading consultant says.
Globalisation is a very efficient method of production, but it shifts manufacturing to low-cost areas, leaving workers in mature economies at risk of under-employment. The chemical sector should adopt more service and solution-oriented business models which will boost demand and employment in high-cost regions, says International eChem chairman.
This innovative approach is particularly important for a country like the US where the election of Donald Trump has highlighted anger among voters about falling incomes and hostility to the effects of globalisation.
On 21 November, Trump confirmed that he plans to exit the proposed Trans-Pacific Partnership as soon as he is inaugurated. This indicates he does intend to follow through with a protectionist agenda which could result in higher tariffs against US-made chemicals and polymers if a trade war develops.
Hodges says the US industry can harness unmet domestic polymer demand to help swallow up the wave of new shale-based capacity due onstream over the next 2-3 years.
“It’s highly likely that all the new capacity will come onstream at a time when the US is pushing towards protectionism. This makes it critical for the US industry to move away from wishful thinking about selling all the new PE capacity into Asia and other foreign markets. They will have to refocus on creating domestic demand.”
Hodges believes it is critical to look at new opportunities in areas such as water and food; otherwise the industry will not be able to sell these new volumes. “Companies will move towards being designers of materials and solutions. There are opportunities as well as threats for people who can revise their business models. It’s critical for people to take decisions now.”
He highlights the example of California which has been in drought for the last five years. “Why not sell more PE pipes as we know that 40% of water is lost before it reaches the consumer. Why waste capital on new reservoirs when you are going to lose 40%?”
He also suggests developing materials for intelligent packaging to tell people when food is really out of date because 35% of food is currently thrown away.
“There must be a big focus on being efficient: these are enormous markets and the industry needs to become more demand-focused. Some of the new [wave of ethane-based] plants will struggle but in principal there is a lot of new demand that could be generated by taking a demand-orientated approach.”
Looking globally, a new political and trading power block will develop as a result of China’s “One Belt One Road” policy which includes countries representing 40% of global GDP, says Hodges. This strategy aims to boost cooperation and trade between China and around 60 countries including Russia, much of eastern Europe, Asia including India and Indonesia, and parts of North Africa and the Middle East.
Hodges also believes the chemical industry should adopt the use of smaller, leaner and more efficient manufacturing systems.
“In an uncertain world the biggest risk is that you can’t sell product: this was always the risk before and it is today. We need smaller, more flexible, cheaper production with units located next to customers, as well as a greater focus on sustainability in the plastics chain.”
“We won’t return to a world of unbridled production – services and solutions are the way smart companies will make money in the future.”
Imagine your government decided to shutdown most of the industry in two major cities for 2 weeks or more? Say Detroit and Chicago in the US, or Milan and Turin in Italy, or Leeds and Manchester in the UK. Now you will have some idea of the scale of the shutdowns being mandated in China for Shanghai and Ningbo ahead of the G20 Summit in Hangzhou on September 4-5.
The reason is the need to improve air quality during the summit, as I noted last month.
Hangzhou itself is China’s 4th largest city, with a population of 21m. And as the map shows, it is bordered by Shanghai (with 24m people), and Ningbo (8m people). Together, they are one of the biggest industrial conurbations in the world.
Now, as ICIS news reports, more details are starting to emerge of the scale of the likely disruption:
“Hangzhou is home to major polyester producers, which are expected to implement the prescribed temporary measures to curb pollution until after the summit, market sources said.
“For Shanghai, the production cuts and shutdowns will take effect from 24 August to 6 September, according to a document published on the Shanghai Environment Protection Bureau website. Other industries such as steel, coking and cement sectors in Shanghai are also being required to restrict production for a prescribed period, based on the document.
“In Ningbo City, a number of industries were likewise given orders to help out in the efforts to reduce pollution in preparation for the G20 summit. Cement, non-ferrous metal, chemical fibre companies are due to shut down their plants during the summit, while refining and chemical companies must reduce operation more than 50%, according an official statement obtained by ICIS.”
More information will obviously follow in the next few weeks. But already details have begun to emerge on the scale of the planned shutdowns in Ningbo:
- In the polyester sector, Yisheng Petrochemical will shut 5 million tonnes of PTA capacity
- In polyurethanes, Wanhua Chemical will shut 1.2 million tonnes of MDI capacity
- There will also be 1.2 million tonnes of propylene capacity shutdown
- In addition, production of at least 16 major petrochemicals will be disrupted including PVC, ethylene, styrene. ethylene glycol, acrylic acid and polypropylene
- CNOOC’s Ningbo Daxie refinery complex will also be operating at reduced rates
These closures/cutbacks will obviously have a very disruptive impact on a whole range of supply chains. Some companies will lose their raw material supplies – others will lose their customers for finished product. So there will be no easy answers for managements – and even if their immediate suppliers or customers are still operating, there may well be closures or disruption in another part of the value chain.
Companies outside China, whether suppliers or customers, will clearly also be impacted, given the importance of this region in global markets. My suggestion would be that you need to check as soon as possible with your business partners to gain their insights into the likely outcome, now that details of the plans are becoming clear. Then you will have time to work out alternative options.
One other important conclusion is clear. No government would lightly create this level of disruption, particularly at a time when the domestic economy is already under pressure. The fact that President Xi Jinping is taking these major steps, is a sign of the severity of China’s pollution problems. The country simply cannot go back to the Old Normal way of doing things – the New Normal policies are here to stay.
Difficult times lie ahead for global polymer markets. It would be bad enough that downstream users have been busy building stock in recent weeks as the oil price rose, as Linda Naylor reports on polypropylene (PP) for ICIS:
“PP demand is slow, slower than many expected, and the strong growth of recent months is now considered to be partially down to stock building. “The market appears to have gone long quickly,” said one buyer. Some sources thought that inventories along the chain were higher, and concerns over working capital were leading to destocking.”
Now these stocks are likely to be unwound, as oil prices return to more normal levels with Iran and Iraq (and probably others) ramping up production just as demand weakens seasonally.
But there are more fundamental reasons for concern in the polymer markets themselves. As the chart above shows:
- China’s PP production is up 38% in January-April versus 2014 levels, and its imports are down 28%
- NE Asia and the Middle East have been badly hit, with their volumes down 10% and 38%
In turn, this is now starting to pressure the US market, as these producers seek to replace lost volumes. US imports from both regions have jumped to 25kt this year from 9kt in January-March 2015 (US Customs data is a month later than China’s). There are likely to be further increases through the year as China’s imports continue to reduce.
A further problem was a further 25kt of PP imports from Latin America – up from just 1kt in 2015 – as China’s slowdown forces LatAm producers to seek new markets. Unfortunately, US demand is also slowing, and so US inventories are now back at April 2013 highs.
As suggested 3 months ago, a major battle for market share is now developing, with US prices for PP starting to tumble. Contract prices fell 4c/lb ($88/t) in May after a 3c/lb fall in April, and ExxonMobil have told customers its prices will reduce by 3c – 5c/lb in June.
Europe is seeing a similar reversal of trade patterns, with Middle Eastern and NE Asian imports each up 20kt in January-February versus 2015 (Europe’s trade stats are even slower to appear than the US). And worryingly, many market players have failed to understand the extent of the downward pressures, with respondents to the latest ICIS sentiment index expecting a “sustained period of bullishness”. I fear they have a nasty shock ahead of them.
The problem goes far deeper than just PP, of course, as the second chart shows. European contract propylene prices have fallen sharply in H1 versus ethylene, averaging just 69% of the C2 price – a level last seen nearly 20 years ago. Already, as I found when giving the keynote presentation at last month’s World Polyolefins Conference, convertors are starting to think about switching from other polymers to PP in certain applications.
This is bound to put further pressure on polyethylene (PE), where China’s import volume has also fallen so far this year. It was down 3% versus 2015, whilst China’s production was up 6% – and overall demand up just 1%. The slowdown couldn’t be worse timed, as the first of the major new US capacities will be online in less than a year.
Unfortunately all my warnings have been lost in the recent euphoria – understandably, everyone wanted to instead believe that demand was returning to pre-2008 SuperCycle levels. But hope is not a strategy.
The good news is that our new Study, Demand – the New Direction for Profit, is now available to guide you through the difficult times that likely lie ahead. I honestly believe that buying it could be the best decision you make all year.
Who would have believed, a few years ago, that European cracker operators would see an operating rate of 84% as something to celebrate? It would have been thought a disaster prior to 2008, when rates typically ranged around 90%.
But whilst nobody is flying flags, last year was the best year since 2007. And as the chart shows, based on APPE data, it was a major improvement from the 78% level seen in 2013.
Even better news, of course, was the collapse in oil prices, which started to restore the balance with gas-based plants in N America and the Middle East:
- European producers had managed the situation by keeping their operating rates low to support margins
- This had supported prices for co-products such as propylene and butadiene, as well as pygas
- They also invested in technology to enable them to operate successfully at these lower levels
- An operating rate of 85% would have been thought a minimum level before 2008
However, high oil prices have been only half of the problem. If we assume they will continue to fall back to historical levels, the industry will still be faced with the challenge of changing demand patterns – caused by Europe’s ageing population.
Countries with median ages of 46 years, such as Germany and Italy, are not suddenly going to start buying new houses and cars at the Supercycle levels seen when Europe’s BabyBoomers were in their prime consumption years.
Instead, companies are going to have to come up with new, more service-based, business models targeted at meeting the currently ignored needs of Europe’s rising numbers of those aged over-55.
That is the real challenge for the next few years, to reinvent the industry. It needs to move away from the focus on supply issues, and instead focus on understanding the changes underway in demand patterns. The return of lower feedstock prices provides a golden opportunity to meet the need for more affordable products, suitable for those living on low incomes and pensions.
The industry has been through many such reinventions in the past, and it has a talented pool of employees able to help drive the transition. There is no reason to believe it cannot succeed.