End user market outlook and its impact on petrochemical demand
By Andy Nicholson, Business Development Manager, Petrochemicals for Argus
Economic downturns are a cyclical phenomenon, typically occurring every 8-10 years. The petrochemical industry follows a similar pattern, with periods of investment followed by consolidation as the supply/demand balance shifts. An economic downturn generally has a trigger — sometimes political, sometimes financial, sometimes from an unexpected source, such as the coronavirus. The petrochemical cycle tends to move a little ahead of the economic cycle and can be a harbinger of developments to come.
The suddenness and depth of the collapse in business caused by COVID-19 could not be predicted, but signs of a coming downturn were already present in the petrochemical value chain. The industry’s reaction to the current crisis will necessarily reflect the economic and social impact of COVID-19 and will – to a significant degree – presage the pattern of recovery. Petrochemical producers in the Middle East are affected like others and will need to adapt their strategies to position themselves correctly to benefit from the upturn in the next cycle.
“The industry’s reaction to the current crisis will necessarily reflect the economic and social impact of COVID-19 and will – to a significant degree – presage the pattern of recovery.”
“Vehicle production in China rose from 9.3 million units in 2008 to a peak of 29 million units in 2017, before declines of 4.2% and 7.5% in 2018 and 2019, respectively.”
Impact on petrochemical demand from end user industries
The impact of the coronavirus and resulting lockdowns has varied according to market. Demand for petrochemicals for packaging, medical supplies and surfactants has been strong. Products such as polycarbonate and acrylic sheet have seen new demand for protective screens. Demand for electronics has been mixed, with the move to home working generating extra demand for personal computers and screens, but mobile phone sales declining.
The construction industry has continued to function in many countries, but with constraints on operations because of social distancing. In areas heavily dependent on migrant labor, such as the Middle East, where workers are often lodged in dormitories, construction activity has been greatly reduced. The lockdown coinciding with Ramadan deepened the fall in April and May. Petrochemical demand for industrial applications, particularly related to the automotive and aeronautical industries, collapsed from mid-March to mid-May and is only returning slowly.
The automotive industry was already running into problems before the impact of the virus. The cyclical peak in passenger vehicle production coincided with that of the petrochemical industry in 2016-17, with declines in 2018 and 2019. According to figures from the Organisation of Motor Vehicle Manufacturers (OICA), production of passenger and commercial vehicles grew by an average of 6% a year between 2010 and 2017, to reach 97 million units. Vehicle production in China rose from 9.3 million units in 2008 to a peak of 29 million units in 2017, before declines of 4.2% and 7.5% in 2018 and 2019, respectively. Globally, production declined by 1.2% in 2018 and 5.2% in 2019.
Following the last financial crisis, global vehicle production declined by 3.5% in 2008 and 12% in 2009. The decline in 2008 was largely concentrated in the fourth quarter of the year. There was a sharp rebound in 2010, when production grew by 26%.
Petrochemical producers will be hoping for a similar rebound after the current crisis, but there are good reasons to doubt that this will be the case. Worries about particulate pollution from diesel engines and wider concerns about fossil fuel use generally were partly behind the declines in vehicle production in 2018 and 2019. These concerns will not go away, particularly as in many cities the improvement in air quality during lockdowns has been a revelation for many. In 2009, countries supported the ailing car industry with “cash for clunkers” scrappage schemes, replacing ageing vehicles with less polluting models. This time around the reaction is likely to be more nuanced, particularly in Europe, where France is offering incentives closely linked to the purchase of electric vehicles. And China is unlikely to move sharply away from its aim to electrify the vehicle fleet. That said, it is difficult to envisage the US moving rapidly away from its addiction to gasoline.
Shift towards electric vehicles
The shift towards alternative energy vehicles is important for the petrochemical industry because although there will be strong demand for lightweight body parts, demand for engineering plastics used for engine parts will decline. Argus estimates that in Europe more than 40% of the benzene consumed is used in engineering plastics for the automotive and electrical industries. Butadiene demand is closely linked to synthetic rubber for automotive use. Imbalances apparent in benzene and butadiene markets in the short term will persist if there are longer-term changes in automotive use and technology. In any case, the outlook for the next four or five years is weak for both benzene and butadiene consumption. Following the crisis of 2008-2009, global benzene demand did not return to 2007 levels until 2010, and was then static for a further three years, only starting to grow again from 2014. It is to be feared that this pattern will be repeated between 2019 and 2026.
“Imbalances apparent in benzene and butadiene markets in the short term will persist if there are longer-term changes in automotive use and technology.”
“Middle Eastern and other Asia-Pacific producers will lose PX sales to China, which in 2019 imported one third of global production.”
Weakness in one product has repercussions for other monomers, particularly in markets where strong growth and profitability have led to over-investment. This is true for benzene co-product paraxylene (PX). The growth rate in PX consumption over the past 35 years has been on average about twice that of benzene. In the mid-late 1980s the market for PX was a quarter the size of the benzene market. In 2020, production of PX will exceed that of benzene for the first time. Massive new investments in PX capacity in China will keep prices low for some years to come in a reduced growth environment. A weak benzene market will put further pressure on aromatics margins.
Middle Eastern and other Asia-Pacific producers will lose PX sales to China, which in 2019 imported one third of global production. Aromatics producers will need to be patient while waiting for a return to previous levels of profitability. On one level, the greater the pain in the short term, the better it may be for large integrated aromatics producers. Negative margins will drive rationalization of less efficient capacity. This will help rebalance the benzene and PX markets since modern plants generally produce less benzene per ton of PX than older units. PX contracted during the crisis of 2008-2009, but growth picked up much more quickly than for benzene afterwards. Polyester fibre demand will continue to increase with population growth, and polyethylene terephthalate (PET) resin demand will be supported by its relatively easy recyclability.
Impact on naphtha-based crackers
Weak benzene and butadiene demand will weigh on naphtha-based cracker operations. There has been extensive co-cracking of C4s in Europe in the second quarter, while benzene has fallen close to the naphtha price, leading producers to cut extraction of benzene heart-cut from reformate and direct pygas towards the gasoline pool. Lower crude oil prices have kept naphtha cracking competitive with ethane and LPG crackers and may continue to do so for some time as oil markets rebalance. The advantages of low-cost gas feedstocks will return in time, but probably at lower levels than previously as weaker demand growth and the threat of more shale production keep oil prices closer to the levels seen between 2015 and 2017, at or below $60/bl.
Polymer demand has generally held up better through the COVID-19 crisis than chemical demand, largely because of a stronger orientation to consumer markets, particularly in packaging. Lower raw material prices and financial constraints may slow moves towards more recycling, but the broader hit to economic output will be felt in consumer demand for all products. Now is not the time to be looking at major new investments. New olefins and polymer capacity in China and the US will take time to absorb. As in the refining industry, there will need to be rationalization before new projects are initiated. Middle Eastern companies should concentrate on their existing strengths and assets and proceed cautiously with diversification into new markets. The dip in global demand can be expected to last at least three years. Arguments for greater self-sufficiency, already present for some time in China and the US, are likely to spread and could easily fall into protectionism. Middle Eastern countries will need to be sensitive to the widespread sense of insecurity that the coronavirus has created.