Crude oil crash flattens global ethylene cost curve
ICIS analysts share some interim results from new modelling which shows how the previous ethane cost advantage has disappeared with falling oil and naphtha prices
By James Wilson, Jonathan Scelle and Ciarán Healy, ICIS Analytics
Since the start of March the twin pressures of slumping industrial demand and collapsing crude oil prices have, with remarkable speed, reshaped the structure of global ethylene supply.
These changes to industry cost curves have persisted for the last month and come with significant implications for producers of different types in different places.
The lower crude pricing means that crackers using liquid feedstocks derived from oil, especially naphtha, have benefitted significantly while the costs of olefin producers using alternative feedstocks like ethane or methanol have remained stable or even increased in some cases.
Put together these changes mean that, at present, it is hard to identify clearly ‘advantaged’ crackers resulting in a much more even competitive landscape.
The shape of the new cost curve also suggests that pricing will become much more sensitive to changes in the balance of supply and demand with the possible price floor collapsing as the economy enters what seems to be a period of weaker chemicals consumption.
At present, it is hard to identify clearly ‘advantaged’ crackers resulting in a much more even competitive landscape. This means that the returns achievable by gas-based export-focussed operations, especially in the Middle East and US Gulf are likely to be substantially lower than expected, even assuming high operating rates can be maintained.
ICIS Analytics are developing new detailed plant-level modelling tools to provide an integrated view of the petrochemical industry. Below are some of the interim results from this work in progress to highlight and better understand some of the changes that have taken place in the last two months.
“The lower crude pricing means that crackers using liquid feedstocks derived from oil, especially naphtha, have benefitted significantly.”
Restructuring the curve
Coming into 2020, olefins producers were bracing themselves for some difficult market conditions. The US “first wave” of ethane crackers was reaching its culmination and a large number of new crackers were due on stream in Asia. There was evidence that the industry was entering into a down cycle and ICIS analysis pointed to Asian and European olefins producers being the most exposed.
That situation has now changed. ICIS margins analysis indicates that on a generic basis naphtha-based producers in northwest Europe and northeast Asia currently have about the same variable cost of production as an ethane cracker in the US Gulf.
This convergence exemplifies the new, flatter competitive landscape amongst crackers. Chinese methanol-to-olefins (MTO) producers are now in a vulnerable position. Their variable costs have changed little in recent weeks and are now significantly higher than for crackers. They typically must also bear higher fixed costs.
Since the 2014 collapse in oil price, MTO units have tended to act as a swing producer, often setting an effective floor for northeast Asia ethylene pricing. However, through 2019, methanol prices reduced significantly. This enabled MTO operations to have a lower cost of production than either European or Asian naphtha crackers during the second half of the year.
In the last month, ethylene prices have fallen below the estimated cash costs for a generic MTO unit. If this continues it would suggest that the ethylene price in Asia should be bounded. This wide spread between MTO and relatively equal cracker operators means that the cost curve has taken an unusual shape.
A flat world?
The ethylene cost curve in early 2020 showed a familiar shape which, by-and-large, did not change significantly for most of the preceding half decade. The world’s producers were arrayed in three broad bands. At the bottom of the cost curve, a long flat run equivalent about 70m tonnes of annual capacity reflected the advantaged gas crackers of the US Gulf and the Middle East.
The floor price for the market, where not enough producers will be able to operate to balance demand, is likely to be very sensitive to demand.
This was followed by a large, and more varied, ‘middle class’ of about 100m tonnes worth of cracking capacity, by and large based on liquid crackers around the world. In general, greater ability to crack liquified petroleum gas (LPG) gives a better cost position and plants in locations with better access to major sources of feedstock appear lower in the curve.
The shape of the curve is now much less like the smoothly increasing ramp seen in the early part of the year. Instead, almost the whole length of the curve is remarkably flat, with a sharp climb at the end, comprising mainly of coal to olefins (CTO) and MTO plants.
The flat section is made up of a varied mixture of crackers, although NEA units are still found at the more expensive end of this section, the spread is much smaller than previously.
It is hard to identify any generalizable set of significantly advantaged crackers in this arrangement. The current situation differs from other recent periods of low oil prices such as early 2016 and Q4 2018, where the tripartite structure of the cost curve did not totally break down.
In both these periods, a generic Middle Eastern or US Gulf ethane cracker typically retained a variable cost advantage of around $300/tonne over naphtha cracking in other regions and considerably more compared over Chinese MTO producers. That is not the case now. The modelled production costs of these generic units have converged to about the same variable costs of production as one another.
“The floor price for the market, where not enough producers will be able to operate to balance demand, is likely to be very sensitive to demand.”
“Middle Eastern plants of this type have been around long enough that they
have become more established elements of the industry and are unlikely
to need to be so aggressive in searching for market share as those newer US plants.”
New supply landscape
Two major, general conclusions can be drawn from this redrawn curve. The floor price for the market, where not enough producers will be able to operate to balance demand, is likely to be very sensitive to demand. This seems to have been reflected in the extraordinarily low ethylene prices recorded in various parts of the world in recent weeks.
We estimate that demand for polyolefins is likely to be significantly lower for the year, even in the most optimistic scenarios. This combined with the implied demand-sensitivity of the price floor means that there is a major possible downside for olefin and derivative pricing.
US producers who have made major recent investments based on low costs of production and the ability to export will likely face challenges. Local producers in other regions will be in a much stronger position to resist imports and this could have a profound impact on the netback achievable to the US or the Middle East on exported cargoes.
In fact, this comes at a time when the role of exports has become particularly essential to the US industry, with in excess of 50% of all ethylene produced in the US eventually being exported in petrochemical form. If something like the present situation persists, it will likely produce a major headache for some export-focussed operations.
A sustained period of low crude oil prices could create another problem for US ethane-based producers. If oil prices stay low long enough to dramatically reduce the amount of drilling going on in the US, then ethane availability is likely to fall.
Whether this would be significant enough to result in an ethane shortage is far from clear; however, it seems possible that a situation could arise where US ethane and ethylene prices became interdependent, with changes in the supply/demand situation of one having an important impact on the other (analogous to the current situation with northeast Asian methanol and olefins. Because of a combination of the drive to export putting pressure on all producers, the fact that methanol values are typically sensitive to the operating rates of MTO producers and the continuing instability in crude oil pricing: the situation we see now is likely inherently unstable.
While still challenging, the situation is not quite so difficult for the Middle Eastern counterparts of these export-focussed gas crackers. Middle Eastern plants of this type have been around long enough that they have become more established elements of the industry and are unlikely to need to be so aggressive in searching for market share as those newer US plants. Nor do they face the same degree of threat about the long-term availability of cheap feedstock.
Precisely what this transition state will evolve into is unclear, with so much uncertainty around so many of the main drivers even weeks or months into the future. What does seem fairly certain is that, barring a sudden recovery of economic activity and the higher oil prices and demand that we would expect to follow that, the medium term outlook is for highly competitive markets in ethylene and its derivatives with the potential for low price floors across several regions.