Day of reckoning approaches for US polyethylene expansions, and the European industry

Planning for future demand in petrochemicals and polymers used to be relatively easy during the BabyBoomer SuperCycle. The team would consult the latest IMF forecast for global and regional growth, and then debate the right ratio to use to calculate product demand.

For polyethylene (PE), the ratio was generally just above GDP at around 1.1x, on the basis that relatively more plastic was likely to be needed as the economy grew.

So when the US shale gas opportunity came along, producers were very confident that it would provide them with major cost advantage over most other Regions. And they were under major pressure to use the ethane that might be produced from the new natural gas production, as it is explosive when mixed with air in concentrations between 3% – 12.4%.

Essentially this meant the ethane was a distressed product, and had to be used in ethylene production, as there are no other major applications.

Since those early days, the US polyethylene expansions have been “an accident waiting to happen”, as I first argued when the plans were still being finalised in March 2014:

“US ethylene producers need to work out where all the new ethylene production is going to be sold before embarking on the planned frenzy of cracker construction”.

Unfortunately, the pressures from Wall Street to exploit the apparent opportunity were too great. One by one, companies gave in to peer pressure and announced expansion plans, as shown in the ICIS graphic – and were rewarded by sharp increases in their share price. As one CEO said to me at the time:

“You may be right, but every time I mention shale on an earnings call, the share price goes up $5.”

Our major Study, ‘Demand – the New Direction for Profit’, jointly produced with ICIS, took the analysis a stage further in March 2016, warning that:

“The supply-led business model – build capacity and wait for demand to catch up – will no longer work in today’s low- or-no-growth marketplace.”

And it really did seem obvious then that the key assumptions behind the expansions were wrong:

  • Oil prices were no longer above $100/bbl and so US gas-based producers didn’t have a major cost advantage
  • Global growth hadn’t returned to SuperCycle levels; China was starting to move towards self-sufficiency and would not longer need need vast import volumes
  • Globalisation was being replaced by protectionism, and plants could no longer be sited half-way across the world from their markets

But companies went ahead anyway, due to the pressure from upstream gas producers to dispose of the product, and the enthusiastic support provided by investors.

The terrible hurricanes in 2017 postponed the moment of reckoning, as plants were delayed for months due to the damage.  But then, construction picked up again and most of the new capacity is now in place – and linked to new polyethylene capacity.

Polyethylene is the largest volume polymer, and the expansions are adding 40% (6.5 million tonnes) to US capacity between 2017 – 2019.  Other Regions are of course also expanding – particularly China, as it seeks to become more self-sufficient as a result of President Trump’s trade war. The ICIS price charts therefore show a depressing picture:

  • Asian HDPE CFR prices have fallen from $1350/t to $900/t over the past year
  • US HDPE prices have fallen from 64c/lb to 53c/lb over the same period
  • And European HDPE prices have started to tumble, down from $1150/t in June to $950/t today

The reason is not hard to find, as the charts from Trade Data Monitor confirm.   Total H1 ethylene exports in the shape of PE, PVC, styrene, EDC, ethylene and other derivatives almost doubled to 4 million tonnes. And suddenly, Europe has become the main importer, with volume up from 420kt in 2018 to 1.05MT.  Most of the volume is in PE, which doubled to 3MT on a global basis.

And there is still more volume to come, with ExxonMobil now starting its new 650kt plant and LyondellBasell starting its new 500kt plant in Q4. That’s more than 1MT of new  PE output which will have to be exported into an already over-supplied market.

In addition, it is clear that public opinion and the new EU Circular Economy directive are already starting to have a major impact on demand for single use plastics. Unfortunately, over 50% of  PE output goes into this application, along with nearly a third of polypropylene.

Volume is already disappearing as consumers make the shift to more sustainable forms of packaging. It is clear that recycled material now has the potential to replace virgin product as the feedstock of choice in the future.

In turn, these paradigm shifts are creating Winners and Losers.  Next year is likely to prove very difficult for US PE exporters, as they face up to the fact that export demand has not grown as expected, and they do not have a major cost advantage.

As the picture of Fido the dog illustrates, polymer producers are the ‘flea on the tail of the oil/gas markets’:

  • Producers integrated into US natural gas production, or EU refineries, will be able to ‘roll through’ margins to the wellhead and refinery as prices go lower
  • But non-integrated European players have much less protection. Their margins will get squeezed, at the same time as demand patterns shift away from the use of virgin product

Now is therefore the time for these producers to start accelerating moves to using recycled feedstock for their production.  In another 12-18 months, if prices and margins keep on falling at current rates, it may well be too late.

Stormy weather ahead for chemicals

Four serious challenges are on the horizon for the global petrochemical industry as I describe in my latest analysis for ICIS Chemical Business and in a podcast interview with Will Beacham of ICIS.

The first is the growing risk of recession, with key markets such as autos, electronics and housing all showing signs of major weakness. Central banks are already talking up the potential for further stimulus, less than a year after they had tried to claim victory for their post-Crisis policies.

Second is oil market volatility, where prices raced up in the first half of last year, only to then collapse from $85/bbl to $50/bbl by Christmas, before rallying again this year. The issue is that major structural change is now underway, with US and Russian production increasing at Saudi Arabia’s expense.

Third, there is the unsettling impact of geo-politics and trade wars. The US-China trade war has set alarm bells ringing around the world, whilst the Brexit arguments between the UK and European Union are another sign that the age of globalisation is behind us, with potentially major implications for today’s supply chains.

And then there is the industry’s own, very specific challenge, shown in the chart. Based on innovative trade data analysis by Trade Data Monitor, it highlights the dramatic impact of the new US shale gas-based cracker investments on global trade in petrochemicals.

The idea is to capture the full effect of the new ethylene production across the key derivatives – polyethylene, PVC, styrene, EDC, vinyl acetate, ethyl benzene, ethylene glycol – based on their ethylene content. Even with next year’s planned new US ethylene terminal, the derivatives will still be the cheapest and easiest way to export the new ethylene molecules.

The cracker start-ups were inevitably delayed by the hurricanes in 2017. But if one compares 2018 with 2016 (to avoid the distortions these caused), there was still a net increase of 1.7 million tonnes in US ethylene-equivalent trade flows.

This was more than 40% of the total production increase over the period, as reported by the American Chemistry Council. And 2019 will see further major increases in volume with 4.25 million tonnes of new ethylene capacity due to start-up, alongside full-year output from last year’s start-ups.

The problem is two-fold. As discussed here in 2014 (ICB, US boom is a dangerous game, 24-30 March), it was never likely that central bank stimulus policies could actually return demand growth to the levels seen in the Boomer-led SuperCycle from 1983-2000:

“Shale gas thus provides a high-profile example of how today’s unprecedented demographic changes are creating major changes in business models. Low-cost supply is no longer a guarantee of future profitability.”

This was not a popular message at the time, when oil was still riding high at over $100/bbl and the economic impact of globally ageing populations and collapsing fertility rates were still not widely understood. But it has borne the test of time, and sums up the challenge now facing the industry.

Please click to download the full analysis and my podcast interview with Will Beacham.

$60bn opportunity opens up for plastics industry as need to eliminate single-use packaging grows

150 businesses representing over 20% of the global plastic packaging market have now agreed to start building a circular economy for plastics with the Ellen MacArthur Foundation.

As a first step, Coca-Cola has revealed that it produced 3MT of plastic packaging in 2017 – equivalent to 200k bottles/minute, around 20% of the 500bn PET bottles used every year.  Altogether, Coke, Mars, Nestlé and Danone currently produce 8MT/year of plastic packaging and have now committed to:

  • Eliminate unnecessary plastic packaging and move from single-use to reusable packaging
  • Innovate to ensure 100% of plastic packaging can be easily and safely reused, recycled, or composted by 2025
  • Create a circular economy in plastic by significantly increasing the volumes of plastic reused or recycled into new packaging.

The drive behind the Foundation’s initiative is two-fold:

  • To eliminate plastic waste and pollution at its source
  • To capture the $60bn opportunity to replace fossil fuels with recycled material

Encouragingly, over 100 companies in the consumer packaging and retail sector have now committed to making 100% of their plastic packaging reusable, recyclable, or compostable by 2025.

Perhaps even more importantly, they plan to actually use an average of 25% recycled content in plastic packaging by 2025 – 10x today’s global average.  This will create a 5MT/year demand for recycled plastic by 2025.  And clearly, many more companies are likely to join them. As I noted a year ago (Goodbye to “business as usual” model for plastics):

“The impact of the sustainability agenda and the drive towards the circular economy is becoming ever-stronger. The initial catalyst for this demand was the World Economic Forum’s 2016 report on ‘The New Plastics Economy’, which warned that on current trends, the oceans would contain more plastics than fish (by weight) by 2050 – a clearly unacceptable outcome. 2017’s BBC documentary Blue Planet 2, narrated by the legendary Sir David Attenborough, then catalysed public concern over the impact of single use plastic in packaging and other applications.”

PLASTICS INDUSTRY NOW HAS TO SOLVE THE TECHNICAL CHALLENGES

The issue now is around making this happen. It’s relatively easy for the consuming companies to issue declarations of intent. But as we note in the latest pH Report, it’s much harder for plastics producers to come up with the necessary solutions:

“The problem is that technical solutions to the issue do not currently exist. It is possible to imagine that new single-layer polymers can be developed to replace multi-layer polymer packaging, and hence become suitable for mechanical recycling. It is also possible to believe that pyrolysis technologies can be adapted to enable the introduction of chemical recycling. But the timescale for moving through the development stage in both key areas into even a phased European roll-out is very short.”

Already, however, Borealis and Indorama have begun to set targets for using recycled content. Indorama plans to increase its processing of recycled PET from 100kt today to 750kt by 2025.  And as Dow CEO Jim Fitterling said last week:

“The industry needs to tackle this ocean waste and develop ways to reuse plastics. There are no deniers out there that we have a plastics-waste issue. The challenge is that the plastics industry has developed around a linear value-chain. A line connects the hydrocarbons from the wellhead to either the environment or to landfills once consumers discard them. The discarded plastic does not re-enter the chain.

“The industry needs to adopt a circular value-chain, in which the waste is reused. For this to be successful, some kind of value needs to be attached to plastic waste. Without this, consumers have little incentive to recover plastic waste in a form that would be useful to manufacturers.”

As McKinsey’s chart shows, this is potentially a $60bn opportunity for the industry.  It is also likely, as I noted back in June, that the ‘Plastics recycling paradigm shift will create Winners and Losers‘:

“For 30 years, plastics producers have primarily focused upstream on securing cost-competitive feedstock supply. Now, almost overnight, they find themselves being forced by consumers, legislators and brand owners to refocus downstream on the sustainability agenda. It is a dramatic shift, and one which is likely to create Winners and Losers over a relatively short space of time.”

The Winners will be those companies who focus on the emerging opportunity to eliminate the physical and financial waste created by single use packaging. As the European Commission has noted, it is absurd that only 5% of the value of plastic packaging is currently retained in the EU economy after a single use, at a cost of €70bn-€105bn annually.

On a global scale, this waste is simply unaffordable, as the UN Environment Assembly confirmed on Friday when voting to “significantly reduce” the volume of single-use plastics by 2030.

The plastics industry now finds itself in the position of the chlorine industry 30 years’ ago, over the impact of CFCs on the ozone layer. The Winners will grasp the opportunity to start building a more circular economy.  The Losers will risk going out of business as their licence to operate is challenged.

Asian downturn worsens, bringing global recession nearer

The chemical industry is the best leading indicator for the global economy.  And my visit to Singapore last week confirmed that the downturn underway in the Asian market creates major risks for developed and emerging economies alike.

The problem is focused on China’s likely move into recession, now its stimulus policies are finally being unwound.  And the result is shown in the above chart from The pH Report, updated to Friday:

  • It confirms that the downturn began before oil prices peaked at the beginning of October, confirming that companies were responding to a downturn in end-user demand
  • Since then, of course, the oil price has – rather dramatically – entered a bear market, with prices down by nearly a third

The question now is whether finance directors will choose to aggressively destock ahead of year-end results, to mitigate the volume decline with a decline in working capital. This would be a bold move given continuing geo-political uncertainty in the Middle East, and would also conflict with the more upbeat guidance that was given earlier with Q3 results.

But a review of ICIS news headlines over the past few days suggests they may have little choice.  Inventories are described as “piling up” in a wide range of major products, including polyethylene – the biggest volume polymer.  Indian producers are even offering “price protection” packages on polypropylene, to safeguard customers from losses if prices fall further.

Asian countries and their major partners (eg Argentina, S Africa, Turkey) were, of course, the first to be hit by China’s downturn.  But Q3’s fall in German GDP shows the downturn has now spread to the Western economy that most benefited from China’s post-2008 stimulus bubble.  As The Guardian noted:

“Goods exports make up 40% of German GDP – a much bigger proportion than for the next two biggest eurozone economies, France and Italy.”

OIL MARKETS CONFIRM THE RECESSION RISK

Of course, consensus opinion still believes that the US economy is sailing along, regardless of any problems elsewhere.  But the chart of oil prices relative to recession tells a different story:

  • The problem is that oil prices have been rising since 2016, with the summer proving the final blow-off peak.  As always, this meant consumers had to cut back on discretionary spending as costs of transport and heating rose
  • The cost of oil as a percentage of GDP reached 3.1% in Q3 – a level which has always led to recession in the past, with the exception of the post-2008 stimulus period when governments and central banks were pouring $tns of stimulus money into the global economy
  • In turn, this means a downturn is now beginning in US end-user demand in critical areas such as housing, autos and electronics

Oil markets have therefore provided a classic example of the trading maxim for weak markets – “Buy on the rumour, sell on the news”.

  • Prices had risen by 75% since June on supply shortage fears, following President Trump’s decision to exit the Iran nuclear deal on November 4
  • As always, this created “apparent demand” as buyers in the US and around the world bought ahead to minimise the impact of higher prices
  • But the higher prices also negated the benefit of the earlier tax cuts for his core supporters just ahead of the mid-term elections, causing Trump to undertake a policy u-turn
  • He is now pushing Saudi Arabia and Russia to maintain production, and has announced 180-day exemptions for Iran’s 8 largest customers – China, India, S Korea, Japan, Italy, Greece, Taiwan and Turkey.

Understandably, oil traders have now decided that his “bark is worse than his bite“.  And with the downturn spreading from Asia to the West, markets are now refocusing on supply/demand balances, with the International Energy Agency suggesting stocks will build by 2mb/d in H1 2019. In response, OPEC are reportedly discussing potential cuts of up to 1.4mb/d from December.

CHINA’S SHADOW BANKING COLLAPSE IS CREATING A NEW FINANCIAL CRISIS

Unfortunately, as in 2008, the collapse in oil prices is coinciding with the end of stimulus policies, particularly in China, as the chart of its shadow bank lending confirms.  This has hit demand in two ways, as I discussed earlier this month in the Financial Times:

  • Just 3 years ago, it was pumping out an average $140bn/month in mainly property-related lending *
  • This created enormous demand for EM commodity exports
  • It also boosted global property prices as wealthy Chinese rushed to get their money out of the country
  • But during 2018, lending has collapsed by more than 80% to average just $23bn in October

China’s post-2008 stimulus programme was the growth engine for the global economy – with the efforts of the Western central banks very much a sideshow in comparison.  It was more than half of the total $33tn lending to date.  But now it is unwinding, prompting the Minsky Moment forecast a year ago by China’s central bank governor:

China’s financial sector is and will be in a period with high risks that are easily triggered. Under pressure from multiple factors at home and abroad, the risks are multiple, broad, hidden, complex, sudden, contagious, and hazardous.”

As I warned then:

“Companies and investors should not ignore the warnings now coming out from Beijing about the change of strategy. China’s lending bubble – particularly in property – is likely coming to an end. In turn, this will lead to a bumpy ride for the global economy.

The bumps are getting bigger and bigger as we head into recession.  Asia’s downturn is now spreading to the rest of the world, and is a major wake-up call for anyone still planning for “business as usual”.

 

* Lending has major seasonal peaks in Q1, so I use rolling 12 month averages to avoid distortions 

Petrochemicals must face up to multiple challenges

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.

Circular economy
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.”

Brexit beckons
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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Ethane price hikes, China tariffs, hit US PE producers as global market weakens

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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