Severe global capacity oversupply will characterize the ethylene industry through 2011. This outlook rests on three factors:
1. The collapse in energy prices at the end of 2008 caused destocking in various value chains and a severe contraction in total demand.
2. A global economic recession in 2008-09 hampered overall demand growth.
3. Start-up of large ethylene capacity in the Middle East and Asia is planned. The addition of this capacity has brought surplus ethylene capacity to more than 15% of demand, which would typically lead to a severe decrease in margins for the industry as a whole, especially on the heels of such a deep recession.
Various factors, however, such as falling feedstock prices, plant operating issues, inventory restocking, and strong coproduct pricing, have kept margins much higher than expected for most of 2009 and early 2010. But movements in the market earlier this year indicate that the 18-month delay in trough-cycle conditions may be over.
This article will address exactly how this trough cycle came along, how long it will it last, and when good times might return.
Industry cycles
In the petrochemical business, the industry cycle of building during high-profit periods leads to markets being over supplied, which curtails investments until demand grows enough to catch up to supply when the cycle starts over again. This cycle perpetuates itself repeatedly in the olefins markets, lasting around 7-9 years from trough to trough.
How to manage this cyclicality in the petrochemical business will likely continue to be one of problems facing global olefins producers and consumers. Other factors—including volatility in energy, shifts in demand growth, successful execution of new plant start-ups, and the operating performance of existing assets—also play roles in determining the cycle of the industry and an individual company's performance during that cycle.
Capacity additions
During 2000-10, ethylene capacity added in the Middle East brought the region's share of global capacity to 17% from 7% (Fig. 1). This capacity was added as regional governments worked to reduce their dependence on crude oil exports, maximize the returns on all hydrocarbons, and diversify their industrial bases.
Much of this capacity was brought on as the governments were offering low ethane prices to steam crackers. With a fixed ethane price between 5 and 10¢/gal (compared with a US price that changes daily and averaged roughly 50¢/gal in 2009), the cost for the producing of ethylene and ethylene derivatives is among the lowest in the world. The capacity built in the region was to support exports of ethylene derivatives, particularly polyethylene.
Expansion projects currently under discussion or in the planning stages in the Middle East indicate that the build in ethylene capacity is far from over. In fact, the construction pace over the next 5-7 years is accelerating. This wave of additions will increase the region's share to 23% of global ethylene capacity, making it the largest ethylene producing region in the world.
As the buildup of capacity in the Middle East has been going on, a large amount of capacity has been added in Northeast Asia as well during 2000-10, bringing the region's share of global capacity to 24% from 19%.
The additions in Northeast Asia, particularly China, are different from those being made in the Middle East in two main ways:
1. They are not being built to take advantage of large local hydrocarbon resources. In fact, the crackers in China are largely run on naphtha from refineries produced from imported crude oil.
2. The units in China, unlike the crackers in the Middle East, are being built to meet growing domestic demand for polyethylene and other ethylene derivatives. The finished goods, such as plastic bags from the polyethylene, are still often shipped to other locations including the US, but the country is working to eliminate some of its dependence on imported materials.
Sufficiency, capacity analyses
Although China has improved its self sufficiency by adding a large amount of capacity (Fig. 2), it will remain a large net importer of ethylene and ethylene derivatives.
CMAI's self-sufficiency analysis, shown in Fig. 2, determines the degree to which a country meets its own ethylene demand with domestically produced product. The self-sufficiency number is calculated as the portion (%) of demand met by domestic production.
A number below 100% indicates that a country imports material to make up for excess demand. A number above 100% means the country is more than self sufficient and exports material to balance supply and demand.
CMAI's surplus-capacity analysis (shown in Fig. 3) forecasts future trends in supply and demand by forecasting the level of capacity-surplus or capacity-shortfall in a market.
The analysis calculates the difference between capacity growth/year and demand growth/year (which by definition is the amount of product surplus or shortfall each year) over a given time and measures the absolute level of surplus capacity, depicted as a percentage of total demand in any given year.
Fig. 3 provides a view of the cycles in the global ethylene industry from 2000 through our current forecast to 2014. A build of surplus capacity can be seen 2001–03. In 2002, the global ethylene capacity surplus peaked, representing 7% of global demand. The forecast calls for a build-up of surplus capacity about 18% of global demand in 2010.
This level greatly exceeds the previous surplus period on an absolute basis as well as a percentage basis.
As a result, CMAI is forecasting a severe decline in sector margins for ethylene and major ethylene-derivative markets through 2012. Even as the market begins to recover, the amount of surplus capacity will remain large by historical standards on a percentage basis, indicating that the recovery will be uneven across the world.
Some regions such as Northeast Asia (outside of China) and West Europe may continue to struggle to recover as other, lower cost regions such as North America and the Middle East will begin to enjoy healthy margins.
In fact, the recovery in ethylene margins is predicated on there being widespread additional plant shutdowns globally. Among North America, Europe, and Asia, CMAI projects as much as 6 million tons of capacity will be taken out of service during the downturn and remain off-line through 2014. Some portion of this capacity will likely be shut down permanently.
As a result of the anticipated closures in the analysis, the level of surplus capacity declines by 2014 to about 8% of forecast demand. This also suggests that the next period of peak-of-cycle profitability for the industry is beyond the current 5-year forecast period.
Demand trends
The rate of recovery in global ethylene markets depends not only on capacity start-ups and shutdowns, but also on continued growth in demand. The largest demand segment for ethylene is polyethylene, accounting for more than 60% of the total ethylene market in 2010. The major end uses for the other demand sectors are plastics as well.
Ethylene oxide is used to produce polyethylene terephthalate, which is used to make plastic water and soda bottles. Ethyl benzene is used to produce styrene, which is converted to polystyrene and used to make Styrofoam and other plastics. Finally, ethylene dichloride is used in the production of polyvinyl chloride, which is used to make pipe.
The percentage of ethylene going into each derivative has changed little since 2000 (Fig. 4), but the overall size of the market has grown considerably. During 2000-07, global ethylene demand expanded by 33%. 2008 marked the first year that ethylene global demand actually decreased year-on-year. In 2009, however, global ethylene demand increased once again, led by strong demand in China. As the recovery progresses, the distribution of demand among the ethylene derivatives is unlikely to shift drastically 2010-14.
Roughly 60% of ethylene demand is into nondurable goods with the balance into durable goods. During a typical recession, demand for ethylene into durable goods (PVC into housing construction) decreases as consumers are more anxious about the economy and less likely to make large purchases.
In previous recessions, however, demand for nondurable goods (plastic bottles and bags) have not gone down. During this recession, however, demand for nondurable goods actually decreased. One reason has to do with the depth and severity of the downturn, which perhaps led people to purchase fewer goods overall.
Another factor was down-gauging of packaging. Plastic bottles and bags have been made thinner, bottle caps have fewer turns, and package sizes have been made smaller. This adjustment is likely permanent.
By region, the demand growth has been dramatically different (Fig. 5).
In 2000, North America was the largest demand region, accounting for 33% of global demand. Europe and Northeast Asia were the next largest demand regions. These top three regions accounted for 77% of demand.
Since then, the major story has been the increase in demand in China. With demand growing 2000-10, the entire Northeast Asia region has become the largest demand region in the world, accounting for 25% of global demand in 2010.
Demand in the Middle East has also changed rapidly with the region increasing to 16% of demand from 7%. By 2014, Chinese demand for ethylene will be 26% of global demand and demand in the Middle East will account for 19% of global demand.
It must be noted that, in this case, demand for ethylene is demand for ethylene into the production of derivatives not the demand for finished goods. The strong growth in Chinese demand for ethylene results from the large amount of finished goods produced by China and then exported to other countries.
Only in the last several years has growth in Chinese domestic demand for finished goods played a large role. Development of the Chinese middle class will make Chinese domestic demand for finished goods grow rapidly. India is growing at a similar pace in terms of demand for finished goods but from a much smaller base. As a result, healthy demand growth, especially in developing nations, will help alleviate the global ethylene margin trough and oversupply situation.
Exports
Global trade is a helpful way to understand the growth of demand for ethylene and ethylene derivatives. Net equivalent exports (Fig. 6) reflect the amount of ethylene exported from a country as monomer and contained in derivatives less the amount of ethylene imported as monomer and in the form of derivatives.
In China, ethylene production grew quickly 2000-10. At the same time, net imports of ethylene and ethylene derivatives also grew quickly. The increase in ethylene and ethylene-derivative imports was required in order to meet growing demand for finished-goods production.
On the other side of the trade flow, Middle East exports of ethylene and ethylene derivatives have increased rapidly. During the last 5 years alone, exports from the region have more than doubled. Just as China has emerged as a global consumption region for ethylene and ethylene derivatives, the Middle East has positioned itself as the global incremental supplier.
The other large global supplier is North America, which has historically supplied ethylene and derivatives to South America and Asia. Over the coming years, however, North America's net export position is likely to shrink due to a combination of competition from lower cost materials and growing domestic demand.
What prompts ethylene and ethylene derivatives to be traded on the global market? In the short term, it is availability of product. If one country needs 5,000 tons of polyethylene and another has them, trade will meet that demand. In the medium to long term, however, if a country decides that it will continually need to import polyethylene, it will look for supply from the lowest cost supplier.
There are many reasons to import ethylene derivatives rather than make them. One of the largest is access to ethylene and ethylene feed slates. Unless there is a refinery nearby to feed the steam cracker or access to other natural resources, it is unlikely that an ethylene production unit will be built.
Importing ethylene monomer to make the plastics in the country is also expensive, given hefty shipping and logistics costs for ethylene. On the other hand, importing most plastics and finished goods is relatively inexpensive, so that countries could set up more permanent import structures. Ideally, these imports will come from the lowest cost producer.
Cracker capacities
Middle Eastern producers have built up their cracker capacity precisely for this reason. There are ample cracker feedstocks including ethane, propane, and butane being produced from associated gas. As the region had few other uses for much of these liquids, lower feedstock prices were offered as an incentive to build petrochemical plants.
The cost advantage in the Middle East is substantial. Production cash costs for purity ethane crackers in the region can be as low as six times below the US (Fig. 7). Even costs at crackers in Western Canada, which have historically been at an advantage, are substantially higher than in the Middle East.
In coming years, more mixed-feed crackers are likely to start up in the Middle East. These units have smaller, though still substantial, cost advantage that will leave the Middle East in a position to export additional material.
What this means to global ethylene markets is that material from the Middle East will generally be the least expensive and will be able to find a home. The demand for imports, however, will remain larger than the amount of ethylene being exported from the Middle East.
This additional material has traditionally come from and is expected to continue coming from North America. In fact, fears that the US may switch from a net exporting country to a net importing country now seem unfounded. US ethylene has gone from being some of the highest-cost material to the lowest-cost material outside of the Middle East and Western Canada and remains competitive for export economics.
Naphtha steam crackers in Asia and West Europe are among the highest cost in the world and will remain so for the forecast period. These crackers, which largely rely on refinery-produced naphtha, will not see any advantage in their current configuration. In some of these crackers, propane and butane feedstocks are used during summer, when the lower cost is advantageous. The ability to substitute is limited, however, by logistics or cracker operating constraints.
US perspective
The shift of the US to a lower cost region from a high cost occurred for two reasons.
The first has to do with the dramatic increase in crude oil prices. In 2008, as crude oil prices increased sharply, natural gas prices did not follow. Although natural gas prices increased, they did so more slowly, causing the relationship between natural gas and crude oil prices to shift much lower.
In 2004, gas was valued at 86% of crude oil on a btu basis; in 2009, that value shifted to 37%. As a result, prices for propane, butane, and ethane have remained lower than the crude oil-based feedstocks.
The second factor has to do with natural gas supply. As both crude oil and natural gas prices fell in 2008-09, it became clear that a revolution was occurring in the natural gas markets with the widely available commercially viable shale gas technology.
With this technology, the amount of gas estimated to be in the US has increased dramatically, meaning long-term supply of natural gas is no longer a concern for the US. In addition, large reserves of liquids have been discovered in these shale basins.
As a result, supply of liquids to feed steam crackers also appears no longer to be a problem. The current market dynamic of drastically reduced values for natural gas compared to crude oil will continue. The large amount of ethane, propane, and butane that is likely to be available will keep those prices lower.
With the changes in relative feedstock prices, the US has moved from one of the higher-cost regions in the world to one of the lowest-cost regions. This movement will allow the US to remain competitive in the global export market and leaves the US a net exporter of ethylene and ethylene derivatives. The export position is expected to decrease, however, but this will be due to decreased availability of material for export as domestic demand grows.
Domestic demand is not expected to surge or grow very rapidly, but neither is it expected to contract further, and it will experience moderate growth. As this growth occurs, there are no additional ethylene or derivative units expected to be built, making less material available for export.
The reaction of US steam cracker operators to lower-cost ethane, propane, and butane has been to shift feedstocks lighter (Fig. 8). In 2003, nearly 35% of US ethylene was produced from crude oil-based naphtha and gas oil with the remainder coming from NGLs. During 2006-08, there was a steady increase in the amount of light feedstocks being used, especially ethane. This occurred as cracker operators shifted to lighter feedstocks in order to take advantage of the lower costs.
In 2009, as it became clear that the favorability of the lighter feedstocks was here to stay, there was a large jump in the amount of ethane going into steam crackers. This was due to investments made at several ethylene production units to shift away from crude oil-based feedstocks to purity ethane.
In the coming years, crackers will continue shifting to lighter feedstocks either by adding ethane into existing crackers, restarting some idled crackers, or making investments to switch over to lighter feedstocks. This will allow US ethylene and derivatives to remain competitive globally and will keep exports flowing, consequently helping the US recover from the margin downturn.
Recovery
The recovery from the current trough to the next market peak will be different in different regions. For example, because the US rationalized a large amount of capacity at the start of the market trough and due to the favorability of light feedstocks, the US ethylene market may recover from the trough by 2011.
In the Middle East, margins may be somewhat lower than expected but will still be large and positive, so that the "trough" of this cycle will be easier to ride through.
Regions such as Asia and West Europe may take longer to recover, especially given the reluctance in those regions to close older and inefficient units. As this occurs, the market will be setting itself up for the next cycle peak with slow investment.
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