Cheap oil & gas: implications for the basic chemicals & plastics industries
The petrochemicals industry, as the name suggests, is intimately linked to the petroleum (oil & gas) industry, as it derives key raw materials from this non-renewable resource. Margins are consequently determined in large part by the price of oil & gas, which is not to say that the industry does not have its own dynamics brought about by supply-demand balances. When oil prices swooned in 2014 and held at low levels through much of the last three years, this industry benefitted both directly and indirectly, as low prices of several commodity chemicals and polymers spurred demand.
Weak outlook for oil
Though oil prices are inching upwards once again, the outlook is still weak and few think prices will soar to the near $150 per barrel levels seen prior to the downward correction in early 2014. A more likely scenario is one where the call on OPEC is replaced by one on American shale oil producers, who will act as swing producers to keep prices in check. The consensus amongst experts is that slowly rising demand and project deferrals, particularly in deepwater exploration & production, will combine to nudge prices upwards over the next three to four years – from about $50 now to about $80. Of course, several factors could alter this outlook – geopolitics, terrorism, breakthroughs in alternate energy, etc.
Whichever way oil & gas prices move, there are lessons to be learnt from the past, in terms of impacts that low (or high) prices have on the chemicals industry in terms of demand, supply, margins and investments, especially on basic chemicals and plastics (BCP).
The products that constitute BCP can be lumped into a few baskets: light olefins (ethylene, and propylene); aromatics (benzene, toluene and xylene); plastics (derived mainly from light olefins); methanol; and chlor-alkali (caustic soda & chlorine). Olefins and plastics together account for about 60% of the volume of BCP produced.
The key feedstock the BCP industry consumed in 2014 included (in descending order of volumes): naphtha, coal, natural gas, ethane, LPG and gas oil. The emergence of coal high up on the list happened solely due its large-scale exploitation in China to make methanol (for propylene and polypropylene), ammonia (for urea), and to a much smaller extent for monoethylene glycol. Much of this was based in indigenous technology, using locally available coal, with several plants located at or near pithead to gain logistical advantage (the products, however, had to be carted, sometimes long distances, to reach consumption centres).
Growth and profits
In 2014, global demand for BCP rose by 3.8% compared to the year before, according to estimates made by IHS, a consultancy – rising from about 670-mt in 2013 to 695-mt in 2015. China accounted for nearly all of this increase, with meagre contributions coming from other countries in Asia, the Middle East and North America.
Profits in the business of BCP in 2014 was dominated by two sets of players: one located in feedstock advantaged regions of the world such as the Middle East and North America; and another in large consumption centres, notably China. In the former, profits were driven by access to low cost gas either due intrinsic economics (North America) or subsidies (Middle East). In the latter, profits were driven by the shrewd exploitation of coal as a feedstock for chemicals – notably olefins and polyolefins. Ethylene, propylene, ammonia and methanol together accounted for nearly all of the $225-bn EBIT earnings of the global BCP industry in that year.
2015 was notable for the beginnings of a perceptible slowdown in the Chinese economy (that was truly entrenched in 2016) and in Latin America (especially Brazil and Argentina), due the collapse in commodity prices (including agri-commodities). Some of the slack was taken up by strong growth in India, parts of South East Asia and the US. But even at the new normal of growth, China still accounted for a big chunk of global incremental demand in BCP in 2015 – though not to the extent of the previous year – which took overall demand for BCP to about 725-mt during the year.
In 2015, profits in basic chemicals such as ethylene, propylene and ammonia, declined from the record high levels of 2014, and shifted downstream to derivatives.
Significant but not uniform impacts
The benefits of low oil prices over the last two years have been significant, but not uniform across the world. Consumer economies – especially developing ones – have gained the most. India, which imports nearly 80% of its hydrocarbon requirements in the wake of near-stagnant crude oil and natural gas production, has benefitted from a smaller foreign exchange outgo, lower subsidy outgo for fuels & fertilisers, and the consequent improvement in the overall fiscal situation.
In the event low prices sustain for a prolonged period, IHS estimates the boost to base GDP growth to 2020 could be as much as 5%, with all regions of the world seeing from faster GDP growth, save the Middle East, with the greatest positive impacts being seen in Europe and North America.
Boost to plastics
From a chemicals perspective, low oil will be positive for base chemical demand, pushing it up by 1.0-1.5% from a base case scenario. Several factors will contribute to raising demand for plastics. Inter-material substitution will play a big role, with plastics penetrating markets served by alternate materials such as glass, metal and paper. In the fibre markets too, synthetics such as polyester could get a boost, at the expense of cotton. The economic incentive to reuse recycled materials, particularly plastics, could also be reduced – especially in the absence of government mandates – giving a further leg-up to demand for virgin material.
These transitions could however be transient and reverse – albeit slowly – if prices begin to inch upward for whatever reason.
Adverse impacts on the Middle East ….
From a geographical perspective, it is no surprise that the implications of sustained low oil are expected to be the worst for the Middle East. Their cost advantage for basic chemicals, such as olefins, is likely to be diminished (though it will still exist) vis-à-vis cracker operators elsewhere cracking cheap naphtha. The adverse impacts on their local economies will imply lower domestic demand for all sorts of derived goods, which will need to be compensated by exports, even at variable costing, to keep operating rates going. These market retention efforts will diminish margins from the enviable levels of the past. As a consequence, potential investors eyeing the BCP space in the region will turn to other investment opportunities, tightening the availability of capital for the industry and even delaying projects that are still to put steel on the ground.
…. And positives for Asia
Conversely, in Asia, where naphtha is the preferred hydrocarbon for ethylene crackers, margins are expected to improve, as the cost curve flattens. New projects, based on conventional feedstock, which were mothballed or put on the backburner, could see a revival. On the other hand, projects based on non-conventional feedstock such as coal are expected to face challenging times. In China, for instance, investments in coal-based projects have levelled off and growth (under the new normal) is expected to come from conventional feedstock after 2017.
For petrochemical players in India, low oil has come as a boon. Naphtha crackers struggling to compete in the onslaught of cheap olefins and polyolefins from shale gas have made a strong comeback and plans to invest in integrated refining-petrochemical projects are being revived. They will be keeping their fingers crossed that the oil & gas outlook remains soft!
- Ravi Raghavan CHWKLY FEB7,2017