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We are living in extraordinary and challenging times. Within
basic petrochemicals, these extraordinary times have led to
previously 4th quartile naphtha cracker complexes becoming 1st
quartile in their own domestic markets.
The global basic chemicals industry has always been cyclical.
From 2013 to 2018 it experienced an extended up-cycle with
above-reinvestment-level profitability. In 2019, economic headwinds
slowed global economic growth, especially in China which impacted
the demand for basic chemicals. Other trends such as oil
volatility; currency fluctuations; protectionist trade tariffs;
reduction in the use of single-use plastics; geopolitical
uncertainties such as US-China trade; Brexit; and political turmoil
in Europe, the Middle East, South America, and the US all created
uncertainties that caused businesses and consumers to become more
conservative with their investments and spending. This was all as
new capacity start-ups across basic chemicals value chains impacted
the market. In the most extreme case, the huge capacity expansions
of paraxylene in Asia overwhelmed demand growth despite strong
market growth over many years. This resulting oversupply had
already decreased industry operating rates and profitability with
several producers announced declining financial performance.
Just 6 months later, all of the above has been overshadowed by
the Covid-19 pandemic; governments trying to flatten the curve of
infection and an oil market-share battle between Saudi Arabia and
Russia just as demand collapsed. In April, the benchmark WTI
dropped to just $13/bbl. In such an environment it is critical that
producers understand their own competitive cost positions relative
to their competitors. IHS Markit Chemicals develops cost and margin
curves for over 40 petrochemical products. Within each product,
every plant is modelled individually considering its nameplate
capacity, technology, country-specific feedstock and unit utility
costs, country-specific by-product value, country-specific labor
costs and shift patterns, maintenance, and other fixed costs. We
combine this data with our World Analysis country-by-country
capacity, supply and demand balances, and operating rates to show
production cost curves, rather than just capacity curves.
Production cost curves offer a more realistic view of how the
industry operates. The resulting cash-cost-at-plant-gate for all
plants can be modified so it can be shown on an integrated or
non-integrated basis. It can also include delivery costs,
depreciation, corporate overhead, and even an ROI for this year and
for 10 years into the future. With the IHS Markit product price
forecasts, these cost curves can be turned into margin curves to
forecast EBITDA per producer for the next decade. Oil or product
price forecast scenarios can be performed, and hypothetical new
plants can be put on the curve.
Naphtha and LPG costs drop in proportion with
oil
An example of the ethylene plant gate cost curve for 2020 is
shown in Figure 1. The full line is at the 2020 annual average WTI
oil price forecasted in January ($52/bbl). It is characterized by a
plateau of higher-cost producers in the third and fourth quartiles.
The producers are mainly naphtha crackers primarily based in Europe
and Asia, as shown by the weighted averages. In the first and
second quartile are the advantaged NGL crackers in the US and
Middle East. There is, of course, a wide range of capacities and
technologies that contribute to the weighted averages. Hence it is
essential to model each plant individually. The dotted line shows
the curve if the WTI oil price averages $20/bbl in 2020. As
expected, the curve is much flatter as naphtha and LPG costs drop
in proportion with oil. Whilst Europe and Asia crackers are
expected to remain 4th quartile, US crackers become much less
competitive due to the expected ethane supply squeeze and resulting
price rise as oil, and associated NGLs, production is cut back.
Figure 1: World Cost Curve for Ethylene (Plant Gate)
However, this view can be misleading to the overall
competitiveness of olefin derivatives complexes. Of course, very
little ethylene is sold as monomer; rather as derivative be it
polyethylene, ethylene glycol, polystyrene, etc. and preferably in
domestic markets that yield a better netback. An example of the
HDPE delivered West Europe cost curve for 2020 is shown in Figure
2. The full line is at the 2020 annual average WTI oil price
forecasted in January ($52/bbl) and majority of West European
producers are still 3rd and 4th quartile. However, the dotted line
shows the curve if the WTI oil price averages $20/bbl in 2020. In
this scenario, some of these polyolefin complexes move to 1st
quartile and over half are now in the upper 2 quartiles. Most of
these polyethylene plants consume ethylene from naphtha feedstock
steam crackers that, in the past have always been 3rd or 4th
quartile.
Figure 2: World Cost Curve for Polyethylene - HDPE (Delivered
West Europe)
How do previously 4th quartile complexes become 1st quartile?
Apart from the reduction in naphtha and LPG feedstock costs for the
domestic producers, the cost of freight and duties becomes a much
larger proportion of total delivered cost at this low oil price for
exporters to that region. If the above is switched to delivered to
China, a similar picture emerges for Chinese polyethylene producers
consuming ethylene from naphtha feedstock steam crackers that, in
the past have always been 3rd or 4th quartile.
Impact on producers
What does all of this mean to producers? Even before the
decrease in oil prices, higher cost producers were struggling to
make margins as the overbuild in certain chemical chains such as
polyolefins and MEG and perhaps were likely to mothball or shutdown
permanently. At the time of writing IHS Markit forecasts that Brent
oil prices will remain under $40/bbl for the duration of 2020.
Hence this is the opportunity for previously higher cost producers
to maintain or even gain market share in their domestic markets.
Given the longer-term trend for oil to move upwards only gradually,
this provides time for previously higher cost producers to assess
their options. For example, a company might look to switch to more
premium polymer grades; speed up initiatives to decrease feedstock
or utility consumption; enhance process control to increase
existing production tons; debottleneck to make a step change in
production tons to decrease fixed costs per ton; delay turnarounds
if possible or feasible; rationalize the number of customers with a
low volume or high cost-to-serve; or even divest the plant before
margins deteriorate even further.
For producers in exporting regions such as the Middle East that
were previously able to deliver to market at a lower cost that
their competitors in that market, this situation means that they
will need to look at their entire production and logistics costs to
maintain competitiveness and market share. They may look to simply
move more volumes to regions of a lower cost-to-serve and/or lower
duties. On a production plant, a subtle shift in feedstock mix,
minor modifications to reduce costs by just a few $/ton or pushing
the plant to a slightly higher production would substantially move
the competitive position due to the flat curve. This would, of
course, set the plant up for an even better competitive position as
oil prices rise.
In summary, the current very low oil price has created an
opportunity for olefins and polyolefins complexes that have naphtha
and LPG feedstocks. This opportunity may also allow time for
projects and initiatives to improve longer term competitiveness.
Cost and margin curves are essential for insight into a product
chain and developing strategies in the immediate months and coming
years. As such, this information should be part of the workflow for
every producer.
Dr. Richard Charlesworth is an Executive Director supporting the
global IHS Markit Technology & Analytics team as a Technical
Subject Matter Expert for Chemicals & Refining. If you would
like a demonstration of any of the IHS Markit Technology products,
please contact him at richard.charlesworth@ihsmarkit.com