Chemical Surpluses Create Opportunities – and Costs
By Chuck Carr, Global Business Leader of Inorganics, Chemical Market Services, IHS Markit
Chemical demand continues to be robust across most sectors, with growth rates at gross domestic product (GDP) or multiples of GDP around the globe. Manufacturers continue to develop new products using plastics and other chemically derived materials, while growth in existing products remains strong in developing markets with a growing middle class. This robust chemical demand growth must be supplied by new chemical production investments. These investments can be located where there is strong demand growth, where ample low-cost feedstocks are available (such as North America with ethane from shale gas), or where capital cost advantages exist (such as China, where building costs can be 60% of US costs). Because these new production investment decisions generally come in waves – with margins supporting capital outlays – chemical markets tend to have supply-driven surplus cycles. Margins are eventually impacted by surplus capacity, which causes capital investments to slow. Demand growth along with industry consolidation and closures of high-cost assets eventually mop up the surplus capacity. This shift drives margins back above reinvestment levels, triggering a new investment cycle and eventual surplus.
Many chemical value chains are again entering a period of surplus after margin growth in previous years encouraged new investments. In this investment cycle, however, new dynamics are coming into play that could change the landscape over the long term. Although sustainability is top-of-mind for consumers and governments, refinery-scale investments in crude-to-chemicals assets have the potential to create substantial oversupply situations. These investments are being driven by changes in fuel demand and the need for large oil producers to ensure a home for their crude oil. As fuel demand growth slows, strong demand growth in chemicals creates an avenue for refinery assets to diversify their production portfolio. Multiple examples are currently playing out, with announcements from national oil companies and major oil companies such as Saudi Aramco, Reliance Petroleum, and Exxon Mobil. In a recent Chemical Week magazine article, “Shifting Sands: Saudi Arabia Leads Middle East Downstream Push to Add Value Through Chemicals,” Saudi Aramco CEO Amin Nasser says, “The company’s ambition is to integrate up to 30% of its crude output into chemicals.” In another Chemical Week article, Reliance said recently that it has developed a strategy to transform the Jamnagar refinery from a fuels producer to a chemicals producer. The company eventually wants to achieve more than 70% conversion of crude refined at Jamnagar into the key petrochemical building blocks: olefins and aromatics.
These crude-to-chemicals investments are also being driven by large conglomerates looking to ensure production economics for their main feedstocks. Examples in China include large polyester conglomerates building world-scale crude oil refineries, which are equipped to produce paraxylene at production rates that are multiples of current paraxylene annual global demand growth rates. Margins in the polyester chain are forecast to remain under significant pressure for multiple years. Yet three separate companies are building refineries that are in various stages of completion, each with eventual paraxylene capacities near 4 million metric tons per year. Figure 1 compares the size of these production capacities in total aromatics and aromatic derivatives compared with the current production capacities of entire continents. The benzene and benzene derivative markets are forecast to see significant margin pressure from these investments as well.
While these crude-to-chemicals investments are a big part of the aromatics overbuild, ethylene investments into traditional naphtha crackers are forecast to move most chemical and derivative chains into a supply surplus environment over the next few years. Outside of North America, companies have been holding back on ethylene investments as North American investments in shale gas ethane crackers and ethylene derivatives accelerated. However, the pace of these investments has been insufficient to fully supply the global market demand growth. Thus, margins moved to levels that support new China naphtha cracker investments. As these assets start production, margins in nearly all the chemical chains will be under pressure. Unlike ethane crackers that yield minimal co-products, naphtha crackers yield large quantities of co-products.
One area where investment is limited compared to annual demand growth rates is the chlor-alkali chemical chain. The margins in this chemical chain are dependent on many downstream derivatives on both the chlorine and caustic side of the equation. The main derivative for chlorine, polyvinyl chloride (PVC), makes up only about one-third of total chlorine demand. Compare that to the main derivatives for ethylene and propylene, where polyethylene (PE) and polypropylene (PP) make up 60% to 70% of total demand. Chlorine demand is more closely tied to construction, where demand growth has been relatively slow since the global recession a decade ago. Caustic soda demand is even more diverse, with the largest segments being in the alumina and pulp and paper sectors. Together these sectors make up only about 25% of the total global caustic soda demand. The chlor-alkali chemical chain continues to mop up excess capacity. While there are new chlor-alkali-related projects under construction, margins that would catalyze an investment cycle are not forecast to appear until the mid-2020s. Figure 2 shows the trend in chlor-alkali operating rates and cycles over the last two decades.
As mentioned earlier, sustainability is at the forefront of discussion and action from consumers and governments. Single-use plastics bans, mandated recycling rates, carbon-neutral aspirations, and new chemical recycling technologies are just a few ways that sustainability will shape future demand-growth and investment decisions. Looking at the entire supply chain picture, expected low oil and natural gas prices will make these sustainability decisions come at a cost to consumers. Just developing the necessary infrastructure to collect, separate, reprocess, and reuse plastics will require a large capital outlay, which must compete with investments to produce virgin raw materials. Technology and innovation will likely have a major impact on how these investment decisions are made.
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