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The North America investment wave hits landfall – what about the second wave?

14 November 2017 Dewey Johnson

The first extended wave of new capacity is arriving now in North America. Total petrochemicals capacity arriving from 2016 through 2020 is approximately 3.8 million metric tons per year. Incremental ethylene capacity alone during this timeframe will average 2.4 million metric tons per year. This comes after an initial surge in total capacity of nearly 2 million metric tons in 2015.

While demand for petrochemicals grows at a multiple above GDP growth rates, North America will experience a large share of the global capacity expansion. With global petrochemical capacity in 2017 at 610 million metric tons, North America's installed capacity is 90 million metric tons, representing 15 percent of the world's capacity. On the horizon of the next decade, North America will construct 25 percent of the new capacity needed worldwide.

The North American base chemical total capacity growth in 2021-2030, will continue to experience a surge of 2.6 million metric tons per year, with ethylene growing at 1 million metric tons per year, propylene at 0.6 million metric tons per year, and methanol at 1 million metric tons per year, respectively.

A vital market condition for North America's investment is its advantaged feedstock, position. Gas to Liquids differentials also create significant advantages for North American investment. The Northeast Asia naphtha (often the marginal price setting region) spread overethane is $5.50 per MMBTU in 2017, and over $6 per MMBTU in 2021 and beyond, providing significant headroom for investment. The crude to U.S. natural gas spread of $5 per MMBTU in 2017,expands to over $8.50 per MMBTU in 2021. The risk in the gas to liquids differentials is expected to be driven by crude price uncertainty with North American natural gas and natural gas liquids in extended surplus.

Financial performance in petrochemicals continues to see healthy earnings. While 2014-2015 brought exceptional margins to North American petrochemicals with high crude prices and low gas prices, the plunge in crude prices in 2015 amid political and economic uncertainty created a pause in new project decision-making. Global financial performance in petrochemicals for 2017 is the best in a decade, averaging $200 per metric ton on a weighted average cash earnings basis, with North America averaging nearly $300 per metric ton. However, the pause in new projects decision-making in the 2015-2017 timeframe will exhibit itself in near term higher operating rates as demand continues to grow and excess capacity is consumed. In the olefins market, for example, a cycle peak is likely in the early 2020's followed by a potential down-cycle as significant new capacity decisions are under consideration with lags of five to seven years before the results of those decisions are reflected in the market.

The second wave

North America's second wave of new capacity expansions is faced with a number of uncertainties and challenges ranging from relative competitiveness of energy and feedstock costs, competitiveness of global supply, to economic and political forces.

The crude -to -gas spread is the most critical competitive lever for North America. Ethane is expected to remain advantaged relative to naphtha with sufficient incremental supply to support an additional 10 million metric tons of ethylene production. However, North American ethane export volumes, especially to China, creates the largest uncertainty for North American ethane-based investment. North America's advantage in propane has higher certainty with a significant excess supply, as North America becomes the largest global exporter of propane. Finally, US natural gas remains in significant excess and is geographically stranded, providing significant advantaged costs for decades in the horizon.

Global competitiveness of supply is also determined by the relative capital cost of construction. With the US Gulf Coast at a capital cost index of 1.0, China is achieving a capital cost index below 0.7 and in some cases as low as 0.5. China's productivity of capacity execution with proximity to a large hub of demand growth creates a significant advantage versus North American exports. In addition, much of China's next wave of chemicals consists of large scale integrated refinery-petrochemical complexes creating scale and flow-through refinery economics. Further, North America's challenge in the next wave of capacity expansion is a significant improvement over the most recent performance where many projects experienced delays and project cost overruns.

North America's next wave of capacity exceeds domestic demand requirements, requiring producers to export incremental supply. This export position exposes producers to not only the economic uncertainty of their home market but also to the health and stability of economies in their target export markets, including South America, India, and China. As North America becomes a large net exporter of petrochemicals, unrestricted trade is critical. This is in the face of increasing protectionism in a number of petrochemical markets.

While much uncertainty exists, North America has many robust advantages and opportunities. The US is especially resource rich with low cost abundant gas (natural gas and natural gas liquids), crude, and coal, creating a diversified feedstock mix and low power costs for petrochemical production throughout its value chains. North America remains a hub for innovation throughout the value chains from wellhead to consumers. This is demonstrated in the emergence and continued cost productivity advances in U.S. tight oil and shale gas in the upstream. Process innovation continues in areas such as on-purpose propylene production and refinery unit process designs (High severity-FCC units producing increased propylene). North American chemical value chains are also well positioned to address major shifts in downstream markets, such as changes in mobility (hybrid and electrical vehicles and user habits) and digitisation of retail channels (Amazon's penetration into food, pharmaceuticals, etc. and FedEx expansions in logistics). North America shows robust operational flexibility with a highly developed infrastructure with integrated and optimized logistics systems (marine,pipeline, rail, trucking). The region also has efficient financial and capital markets providing access to competitive capital and enabling efficient product trade in liquid markets. Finally, the region exhibits low political and security risks, creating a safe environment for long term asset performance.

A second wave of significant investment in North America petrochemicals is expected with strategic decisions needed in 2017-2019. Winners will leverage the full benefits of the region with advantaged feedstocks and energy, a critical mass of well-developed infrastructure, a balanced portfolio of customer markets, and integrated scale. Operational flexibility is the critical element as producers embrace across their enterprises abundant and diversified feedstocks from gas to liquids on the upstream with diversified customers and market access across consuming derivatives and downstream uses. The large scale complex North American refineries will also provide another avenue of diverse competitive feedstock supplies for petrochemicals. Finally, winners continue integration throughout their value chains to achieve low cost and baseload demand for their production units. The extensive diversity on petrochemical feedstock supplies and well developed large end-use markets along with North America's proven innovation engine creates a market that enables high flexibility in an ongoing uncertain environment.

Visit Chemical Market Advisory Services for more information.

Dewey Johnson is Vice President, Base Chemicals, IHS Markit
Posted 14 November 2017



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