EUROPEAN PETROCHEMICAL SURGE: A RECOVERY OR TEMPORARY BLIP?

European petrochemical producers during the last few years have often complained that their market is in the doldrums.

While saying something must be done to revive the market, they have been reluctant to close money losing plants. Instead, they have chosen to hang on to production capacity and try to reduce operating costs.

Now, during the last 3 months, demand for European petrochemicals has shot up and producers are working flat out.

While manufacturers try to work out whether recent price increases represent a recovery or a temporary "blip," they will be considering:

Failure of an industry-wide campaign to help fund closure of uncompetitive plants.
Giant mergers that have realigned major players.
Plant closures coinciding with high operating rates throughout the industry, which have helped trigger price revival.
Recent production at record levels.
Additions to production capacity.
When and how former Soviet Union (FSU) petrochemical capacity will affect western producers.

RESTRUCTURING

Last year the Association of Petrochemicals Producers in Europe (APPE), Brussels, developed a plan-later aborted-for closure of uneconomic plants.

This was to be an industry financed restructuring fund to help shut down excess capacity, given that the cost of permanent closure of uneconomic plants is higher than the cost of continued operation.

APPE said, "It was clear from the outset there was no prospect of obtaining funding from European Commission authorities. Therefore, the onus fell on members of APPE to develop a proposal which could attract industry support, in accordance with European competition law."

An APPE task force proposed that each company owning a European petrochemical cracker should contribute toward a fund of 500 million deutschemarks ($340 million).

APPE said, "The contribution of each company would be in proportion to their declared cracker capacity for 1994 so that, with a total capacity then estimated at about 19.4 million metric tons/year, the contribution would have been about 26 deutschemarks ($17.30)/metric ton."

Plant operators wishing to shut down production were invited to apply for a grant from the fund, setting out what contribution per metric ton of closed capacity they required.

The fund would have been dispensed by an independent panel, giving preference to the applications having the lowest cost per metric ton, until the money was spent.

The association set two conditions for the fund to proceed:

All member companies with interests in western European crackers must contribute.
At least 1.5 million metric tons of capacity must be earmarked for closure.

"From a confidential survey carried out by APPE's external auditors towards the end of 1993," said APPE, "it was established that the required minimum tonnage would not be achieved. For this reason the steering committee of APPE decided in December 1993 not to go ahead with the proposal."

When the committee met again last February it decided not to try to find an alternative industry-wide solution to surplus capacity. Instead, decisions on plant closures are to be left to individual companies.

British Petroleum Co. plc was one of the main forces behind the APPE restructuring proposal. Disappointed by the response of other companies, BP has withdrawn from the debate.

"BP feels it has shouted loud and long for restructuring," said a BP Chemicals official. "Having campaigned through APPE for closure of ethylene capacity in Europe and having seen the proposal fail, we are keeping a low profile and leaving it up to the rest."

MERGERS

Roger Longley, director of Chem systems Ltd., London, reckons the European petrochemicals sector by itself has not done a great deal to solve its problem of surplus capacity.

He cites recent mergers of assets between Royal Dutch/Shell and Montedison SpA, Neste Oy and Den norske stats oljeselskap AS (Statoil), and Union Carbide Corp. and Enichem SpA. None of these has so far resulted in shutdowns of capacity, Longley points out.

Shell and Montedison announced a merger of most of their polyolefins assets only a week after failure of the APPE restructuring plan was disclosed.

Montell, as the merged company later became known, will have $3 billion/year revenues and worldwide capacity to produce 3.3 million metric tons/year of polypropylene and 700,060 metric tons/year of polyethylene (OGJ, Jan 10, p. 34).

Chem Systems' Longley said the Montell venture might have sparked major changes in the market but for conditions set by the European Commission before it would approve the merger.

Longley said the EC prevented Montell from taking over the Montedison license for Spheripol technology, which is used in plants producing 60% of the world's polypropylene. This was to be one of the companies' major benefits from the merger (OGJ, July 25, p. 40).

Borealis Holding AS was created Mar. 1 by a merger of the petrochemicals businesses of Finland's Neste and Norway's Statoil. The merger was said to have created the world's fifth largest polyolefins producer and the largest in Europe.

Borealis is reckoned to have capacity to produce 1.5 million metric tons/year of polyethylene and 650,000 metric tons/year of polypropylene.

Union Carbide and Italy's Enichem also plan a 50-50 venture to produce and market polyethylene in Europe starting in first quarter 1995.

The venture's combined low density, linear tow density, and high density polyethylene production capacity will be 1.3 million metric tons/year.

A 400,000 metric ton/year plant is planned by the venture at Enichem's Brindisi plant, using Union Carbide's Unipol polyethylene process. Further units will be added.

PLANT SHUTDOWNS

BP Chemicals was the only European company to close an ethylene plant in the wake of failure of APPE's restructuring plan.

Early this year BP announced plans to close its 335,000 metric ton/year ethylene plant at Baglan Bay, South Wales, because of industry overcapacity and recession in Europe.

In January, BP said the plant had been producing only 185,000 metric tons/year since October 1993. Closure also ended production of propylene, butadiene, butane, gasoline, ethyl benzene, and benzene concentrate at the site.

However, the Baglan Bay plant closure was made for economic reasons, not for the general well-being of the industry.

In 1992, BP placed a new cracker on stream at its Grangemouth plant in Scotland, boosting ethylene capacity at the site to 600,000 metric tons/year.

The Grangemouth plant used natural gas feedstock and so had an economic advantage that made it among the most competitive ethylene plants in Europe. The Baglan Bay plant had relied on naphtha feedstock, which is relatively expensive.

BP Chemicals early this month decided to review options for its Antwerp plant, which can produce 127,000 metric tons/year of ethylene oxide and 130,000 metric tons/year of ethylene glycol.

The BP Chemicals official said the company had been approached by a group proposing a management buyout of the Antwerp plant. The company was said to have given approval for the group's proposal to be presented to the BP board, but this did not count as a decision to get rid of the plant.

"BP is also looking at other options for the Antwerp plant," said the official, "including retention and sale in parts. All the proposal shows is that BP Chemicals is prepared to review all its options."

PRODUCTION BOOM

Despite the industry's lack of willingness to close plants, Chem Systems' Longley sees a significant change in the outlook for petrochemicals during the past year.

Longley said that about a year ago the industry could blame a number of factors for poor returns:

Surplus capacity in Europe, which was expected to work itself out of the system-but slowly.
World overcapacity, which encouraged exports to Europe.
Lifting of the Iron Curtain followed by recession in Russia and Central Europe, which led to an influx of petrochemical imports in western Europe's markets.

However, Longley believes that behind these contemporaneous trends lay an even bigger problem: high costs of European production.

Longley, said the top echelon of Europe's petrochemicals plants is competitive with production anywhere, but there is a long tail of subeconomic capacity.

He said, "The attitude last year was that producers should use the current period of overcapacity to close down uneconomic plants and reshuffle assets so that only the companies which are good at the petrochemicals business would remain."

But plant closures, the difficult part of making Europe's petrochemicals industry competitive, have not occurred. Instead, a number of factors have combined to let European petrochemicals producers off the hook-temporarily, at least.

Longley cites the healthier than expected state of the U.S. economy as one factor behind a recent improvement in European petrochemical prices. U.S. producers have stopped exporting to Europe because of higher demand at home.

Also, Longley says, there have been three significant ethylene plant closures which, coupled with closures of some smaller plants in Europe, have helped lift the market.

Exxon Corp. closed its Baton Rouge, La., plant, which has 850,000 metric tons/year capacity, until yearend. Enichem closed its 740,000 metric tons/year plant at Priolo, Italy, although it is expected back on stream within a few weeks. And Thai Petrochemical Industry Co. was prevented from starting up a 350,000 metric ton/year plant after an explosion in a furnace.

These closures came at a time, Chem Systems says, when Europe's ethylene crackers have been operating at about 90% utilization. Although loss of a cracker is not noticeable under slack market conditions, the analyst reckons every plant closure becomes significant when producers are running flat out.

"These factors precipitated a tighter supply/demand balance in July," said Longley. "Suddenly, everything started to move rapidly."

From July to September Longley saw a complete change of attitude in Europe's petrochemicals sector.

Chem Systems' third quarter analysis reported polymer prices had risen 30% since the beginning of the year.

In July, producers were said to have received 1.35-1.45 deutschemarks (90-97cts/kg for LDPE and PVC, with prices for polypropylene, HDPE, and Lldpe reaching 1.20-1.30 deutschemarks (80-87cts)/kg.

Profitability in all basics products has shot up, Longley says, raising the question of whether this is the start of a genuine petrochemical recovery or just a short term market movement.

The full effect of price increases on margins is expected to show in September and fourth quarter results, Chem Systems predicts.

"The answer seems to be that market fundamentals are improving," Longley said. "Demand has increased in the U.S. and is beginning to improve in Europe. Expected economic recovery in Germany and Japan will increase demand still further."

Chem Systems reported European ethylene production for the first 7 months of the year was 10% higher than in the same period last year (Table 1). Europe's ethylene producers set a record rate in July, equal to 17.5 million metric tons/year.

High production levels raised the average industry operating rate close to 90%, giving an average return on investment of 3.4%.

"In practice, this level of profitability is still well below that which could be expected for such a high level of operation," reported Chem Systems, "and points to a continued upward drive on prices and margins while the supply/demand balance remains so tight."

Also, Longley said, eastern Europe's petrochemical producers are no longer dumping products in the West. They now have to buy crude oil feedstock with dollars, so their costs have rocketed.

However, a string of debottlenecking projects at plants around the world may put an end to the boom before it has become established.

"My own view is that expectations of further recovery are premature," Longley said. "The rate of recovery will not continue as sharply as over the last 3 months."

Longley expects petrochemicals producers to have 2-3 years of profitability ahead so long as they do not start to act on expectations of recovery too quickly.

"The danger is that new construction can be completed within the 2-3 year period," he said. "The industry is already loading the gun, ready to shoot itself in the foot."

BP Chemicals sees improving profit margins at present, but the official warned that the industry must not be over optimistic.

"Even with a recovery in petrochemicals prices," said the official, "the structural problems within the industry remain."

NEW CAPACITY

Shell last March announced a $53 million project to install a propene splitter and expand an isopropyl alcohol plant at its Pernis petrochemical plant near Rotterdam.

The unit is slated to begin production by the end of 1995. It will increase propene production capacity at the plant to 230,000 metric tons/year from 140,000 metric tons/year.

In April, BASF Aktiengesellschaft placed on stream a new steam cracker at its Antwerp site at a cost of 1.3 billion deutschemarks ($870 million). The new cracker can produce 600,000 metric tons/year of ethylene and 400,000 metric tons/year of propylene. The Antwerp plant also can produce 240,000 metric tons/year of C4 cut products and 530,000 metric tons/year of benzene.

BASF's other petrochemical plant at Ludwigshaven can produce 560,000 metric tons/year of ethylene, 310,000 metric tons/year of propylene, 195,000 metric tons/year of C4 cut products, and 450,000 metric tons/year of benzene.

BASF Chairman Jurgen Strube said, "The new steam cracker brings major advantages on an international scale in feedstock flexibility, and logistic optimization of feedstock supply and product distribution."

Although the plant added to European capacity, Strube said it will fit in with BASF's integrated production strategy. He added BASF does not operate plants that lose money.

"It is our principle to keep capacities in our major bulk products so far below our own actual requirements that we can operate at full stretch even in economically leaner periods," Strube said. "Only in transport sensitive products do we aim at a high degree of captive supply."

Borealis decided to complete construction of a new polyethylene plant at Porvoo, Finland, which had been put on hold by parent company Neste.

The 120,000 metric ton/year plant is slated to go on stream in fourth quarter 1995, having originally been expected in production this year. A depressed polyolefins market and overcapacity in European polyethylene were blamed for the postponement.

"We are now cautiously optimistic about the polyolefins market," said a Borealis official, "but the main reason the project was revived is to increase Borealis' competitiveness in polyethylene."

The plant is designed to produce a high proportion of specialty products by means of proprietary technology. Total investment in the plant is estimated at $110 million.

"We do not intend to add to overcapacity problems in the market," said the Borealis official. "We have just started a feasibility study on conversion of a PE plant in Beringen, Belgium, to polypropylene production."

Lionel Chambers, director of Stone & Webster Engineering Ltd., Milton Keynes, U.K., said inquiries for petrochemicals construction work suddenly started coming in again about the end of last month.

"Ethylene plants had been building production volumes in recent months, although they were not making a profit," Chambers said. "Suddenly they found they had both volumes and profits. They were making money overnight.

"A number of forced shutdowns around the world at about the same time have banged the ethylene price up. When the plants come back on line, though, this may change the market outlook."

Chambers reckons at least four plants around the world either went down in the third quarter or were due to go on stream and slipped behind schedule.

Although all the new inquiries were for debottlenecking only, Chambers believes companies must be feeling increasingly confident in Europe's petrochemicals market to be putting out feelers.

EASTERN EUROPE

Of increasing concern for western European producers is likely to be a change of attitude in the FSU's petrochemical industry seen by Chambers.

Like refinery managers before them, FSU petrochemical plant managers are being given authority to run their plants without control from central government, Chambers said.

"Next year Stone & Webster will start putting down markers in the FSU petrochemical sector," he said. "Little has been going on there of late, but soon it will be time to start to push."

Chambers' discussions over FSU petrochemical projects involve less and less time with Moscow ministry officials and more time with plant managers.

So far, said Chambers, only one new FSU petrochemical project has received the go-ahead. This is a 320,000 metric ton/year ethylene plant to be built in Urengoi field to make use of natural gas feedstock from the field.

Chambers expects a consumer led rise in plastics demand in the FSU-but not soon.

"FSU will need new petrochemical plants to supply its own market," Chambers said. "However, we see FSU projects as long term prospects."

The most ambitious move by a western company into the former Communist bloc has been by Dow Chemical Co. this month.

Dow moved to secure a production plant in the former East Germany by signing a letter of intent for evaluation of three state owned companies with a view to acquiring a majority shareholding. The agreement is with Treuhand Anstalt, the agency charged with privatizing state concerns of the former East Germany.

By yearend Dow expects to have determined the expansion potential for the three plants and to have decided the share it hopes to hold in each.

The plants involved are a steam cracker in Bohlen owned by Sachsische Olefinwerke GmbH, electrochemical units and derivatives plant at Schkopau run by Buna GmbH, and polyolefin and intermediate chemicals plants in Merseburg operated by Leuna-Werke GmbH and at Schkopau operated by Buna.

"From a long term perspective, these assets could provide potential for Dow to strengthen its manufacturing base for meeting growth opportunities in the local economy and throughout a dynamic and changing Europe," said Elmar Deutsch, vice-president of Dow Europe.

The three plants reportedly were the backbone of East Germany's petrochemical industry under the Communist regime. Total plant staff of 68,500 before 1990 are said to have been reduced to 12,300 by this year.

London's Financial Times said Treuhand plans to invest 2.9 billion deutschemarks ($1.87 billion) in modernizing the polyolefins plants at Buna and laying a gas pipeline from the German port of Rostock to Buna to enable imports of Russian gas.

OUTLOOK

APPE sees recent mergers, along with ethylene plant closure at Baglan Bay in South Wales and capacity reduction by Enichem in Italy, as evidence that things are happening in the European petrochemical industry.

APPE adds that more could be done to improve the situation. Companies are trying to improve plant efficiency and raw material flexibility while lowering raw material and fixed costs. There is no rush toward plant closures.

The association sees current ethylene production of 10% more than last year's average as a phenomenal performance, aided by improved demand in the European and export markets.

This performance is seen as unsustainably high. An APPE official said a downturn will follow as surely as night follows day. And when the downturn comes, the industry's structural problems will still be in place.

APPE sees eastern European capacity as a big influence on Europe's petrochemical markets: "The question is when and how the influence will be felt. Western Europe's petrochemical sector has problems already. Addition of eastern European capacity will make them bigger."