Petrochemical feedstock price rise driven largely by renewable energy gap

2020 was a watershed year in which most industrialized countries eagerly rushed to announce in close succession a united goal of achieving net zero carbon emissions by 2050. US President Biden declared a plan for a “green recovery” at the height of the economic devastation from the COVID pandemic. China was the most notable exception, setting its sights on a 2060 target, partly because its economy is simply more dependent than most on coal, but also because state planners have traditionally erred on the side of caution and probably understood that the 2050 goal is unrealistic, and – at least for now – they happen to be right.

While PR firms were advising companies on the favorable optics of abandoning plastics for paper – even though the carbon footprint from manufacturing paper straws and spoons is greater than for traditional plastic utensils – politicians and activist investors were busy shutting down thermal and nuclear power capacity and clamping down on funding for future investments in fossil fuel production capacity, resulting in the current energy shortage and historically high inflation rates. In effect, economic decisions were made for political reasons. The disconnect between politically popular ideals and economic reality is being felt in today’s markets.

Meanwhile, OPEC was struggling to bring back crude oil production and make up for the shortfall in E&P investments that had built up over the years. Even before the COVID pandemic broke out in late 2019, in 2018 Aramco estimated that over the next 25 years, some USD 20 trillion would be needed to meet the relentless growth in demand as certain oilfields see natural declines in output. Oil E&D investment peaked at USD 800-billion in 2014, according to the IEA.

So when the world’s leading economies started to crawl back from the COVID pandemic and demand for transportation fuels picked up, the result was almost inevitable: energy prices in general – and natural gas, crude oil and coal in particular – surged. Natural gas prices in Europe ballooned by two full orders of magnitude to just Euro 4/MWh in mid-2020 to a peak of almost Euro 210 earlier this year; coal saw a single order of magnitude increase from USD 48/mt FOB Newcastle to a peak of USD 380/mt; and WTI crude witnessed a more than doubling to USD 100/b +/- during the same period.

Almost all of the incremental capacity additions for electric power generation in 2020, 90% according to the IEA, were in fact in the form of renewables. But renewables still account for an insignificant share of the overall energy pie. Moreover, while the increment was impressive, it still lagged behind global demand growth for renewable energy based on the current global decarbonization targets. As a result, the gap between renewable energy supply and demand is actually getting bigger, not smaller. In principle, this is where traditional fossil fuels can help by serving as a bridge to green energy until this gap can be filled, which will take anywhere from five to 10 years, depending on who you talk to. Paradoxically, we need fossil fuels to wean ourselves from fossil fuels.

The immediate effect on petrochemicals of rushing into the energy transition too hastily can be seen in price behavior. If we look into the petrochemical price complex, we can discern a clear trend of increasing volatility as we move up the chain, with the result that margins are getting squeezed further down. For example, while Asian polyethylene prices have shown an impressive doubling over the past year, crude oil prices have almost tripled. Part of the cost push has been absorbed by manufacturers down the chain, but much of it has been passed onto to consumers of final goods, contributing to the current cycle of extreme inflation.

Unlike other heavy industries that produce basic materials like steel, paper, glass and cement, the petrochemical sector relies on petroleum products more for feedstocks than for power generation. So the focus for petrochemical producers seeking to achieve the 2050 target has been mostly on carbon-neutral or carbon-minimal production processes, as well as raising efficiency and managing carbon disposal or processing.

Three scenarios

As petrochemical producers around the world rise to the challenge of going net carbon neutral by 2050, there are primarily three scenarios they are looking at, according to Argus Senior VP for Petrochemicals, Chuck Venezia. “You can (1) close refineries, (2) convert them to biodiesel/fuel production, or (3) promote oil to chemicals (COTC),” he noted. These scenarios are not mutually exclusive and in fact are already being carried out either simultaneously or in staggered stages. As Chuck pointed out, scenarios #2 and #3 are expensive, so scenario #1 is a relatively easy win, especially since the world has a surplus of refining capacity.

However, as integrated producers pursue the 2050 goal, it would be wise to be weary of potential unintended consequences. In particular, while you would expect the price of naphtha relative to crude to go down as the structure of crude demand gradually shifts from transportation fuels to petrochemical feedstocks in tandem with the rise of electric vehicles, in fact this may not be the case. Recall solution #1, shutting in capacity. As this route is pursued over the coming years and global crude oil demand peaks out, probably by 2030, give or take a few years, the sheer volume of naphtha available will shrink. This may drive up prices until alternative feedstocks take over, particularly in Asia.

Japan’s “Dual-Sector, Three-Aspects” approach to carbon net neutrality

Japan can serve as an illustrative example of how a major petrochemical production center is approaching the decarbonization issue. Industry and government are working closely together to create a roadmap for decarbonization since the country’s then Prime Minister Soga announced Japan’s 2050 goal in 2020.

While the Ministry of Economy, Trade and Industry (METI) has announced an impressive number of detailed roadmaps covering a wide range of industries, in point of fact, both the government and many of the affected industries – including petrochemicals – are rushing to back-fill the goals with concrete steps for getting there. “We got the news that 2050 is the decarbonization deadline, so we are very busy trying to work out the details of exactly how we will achieve this goal,” a senior executive at a major petrochemical company said.

To put Japan’s petrochemical industry in context, in 2019 heavy industry accounted for 35% of Japan’s total CO2 emissions of 1 billion tons, according to METI. This was followed by transportation at 19%. Out of the 35% share for heavy industry, chemicals accounted for 15%, or 57 million tons, a distant #2 after steel and metals, which comes in at 42%. Within the 15% share for chemicals, petrochemicals accounts for 48%, or 27 million tons. And within petrochemicals, it is estimated that basic chemicals like olefins and their derivatives account for roughly half this figure.

Although METI does not state this explicitly or attach any special phraseology to its Carbon Net Neutral program, the country’s approach appears to have a dual-sector focus on energy (minimizing the use of coal and oil) and materials (plastics, rubber, and petrochemicals) covering three broad aspects for both sectors: fuel and feedstock choices, process technologies, and carbon disposal measures.

For feedstocks, a combination of low carbon feedstocks, including bio-naphtha, and recovery and utilization of ROG’s (refinery off gases) have been promoted, backed by government funding. A number of trading houses are working with petrochemical producers to start producing and importing bionaphtha. In 2021, Japan’s Mitsui Chemicals Inc and Toyota Tsusho teamed up with Neste to invest in what will become Japan’s first commercial-scale production facility for polyolefins, olefins and aromatics using bio-based hydrocarbons, based on Neste’s proprietary “RE” process technology. Ahead of this project, late last year Mitsui took delivery of its first 3,000-ton cargo of bio-naphtha from Neste. Prime Polymer, in which Mitsui is a major stakeholder, will use bio-naphtha to produce bio-polypropylene, while Mitsui itself has already produced bio-phenol from its earlier purchase of bio-naphtha.

In addition, while CTO and MTO appears to be slowly falling out of favor in China, Japan has included these two processes in its arsenal of technologies to be deployed for bringing down CO2 emissions (see table below).

The main change recommended for in-house heat and power generation has been to shift from coal to biomass, primarily wood pellets, and nitrogen, most likely in the form of ammonia mixed with coal. Japan is also developing a carbon credit trade market to help offset the remaining carbon footprint in its various production processes. Don’t forget, the goal is carbon net neutrality, with the emphasis on “net.”

In fact, the “net” of “carbon net neutral” is often overlooked. Japan’s move away from carbon does not mean that it will completely give up coal and oil in the long term. As long as heavy industry can offset its carbon emissions in the international carbon markets (a domestic carbon market is widely expected to be established later this year or early next year), it will stay within its commitments. The local Toyo Keizai magazine recently reported that Eneos has forecast that Japan’s refined products demand will shrink by roughly half the current level over the next 20 years, or by about 2060. What’s interesting about this estimate is the timing: it implies that Japan will still be burning fossil fuels, albeit much less than now, well past the 2050 carbon net neutrality deadline. This is not a problem, as long as offsets are used.

CCUS (Carbon Capture, Usage and Storage) will also play a significant role for petrochemical producers in Japan. METI’s timetable provides for a gradual buildup toward its 2050 goal during the first phase from 2020 to 2030, followed by an accelerated plan for the remaining two decades to 2050. Specifically, reliance on traditional production technologies would need to be reduced steadily to 88% by 2030, while reliance on processes that involve hydrogen or are used in tandem with CCUS would be about 9% and 11%, respectively. But by 2050, reliance on CCUS would jump to 67%, while legacy technologies would drop to only about 6%. Use of hydrogen would climb to about 13% during this second phase.

In addition to carbon sequestering, Japan is also looking to bolster recycling of plastics and rubber. Currently, 84% of plastics in Japan are recycled, but out of this figure, 57% is simply burned for electric power generation, or “thermal recycling.” The government and industry are seeking to raise the remaining 27% recycling rate to over 50% before 2050, emphasizing both traditional material recycling and chemical recycling to recover usable monomers. The government has allocated Yen 126 billion (rough USD 1 billion) for this purpose.

Refiners and petrochemical producers are seeking to reduce their carbon emissions from power generation. For example, Toa Oil plans to import methyl cyclohexane (MCH) as a carrier of hydrogen, then separate the hydrogen for use in power generation at its complex in Kawasaki. Also in Kawasaki, petrochemical producer Showa Denko, along with refiner Eneos and electric utility giant JERA have consolidated their power generation operations.

In addition, Idemitsu and Eneos have joined the ranks of Japan’s top 30 PPS’s (private power suppliers, or “Shin Denryoku”) to enhance their operational efficiency. Mitsubishi Gas Chemical and Sekisui Chemical have also broken into the PPS space.

Two other measures that will help Japanese petrochemical producers advance toward carbon net neutrality are mergers and vertical integration, although these avenues for improving competitiveness have been in progress for at least a decade, culminating in the consolidation of the refining/petrochemical sector to three main players, Eneos, Idemitsu-Shell, and Cosmo.

The bigger question is, is this enough? Just this week METI came out with its own verdict: no, it’s not enough. Japan needs to triple its annual spending to Yen 17 trillion by 2030 to meet its goals by 2050, according to the Ministry. Although the details of the path to carbon net neutrality are still in the making, one thing is clear: the industry has a firm grasp of the monumental scale of the changes taking place in the global economy, a once-in-a-century upending of the very basis of economic prosperity and way of life. Japan, along with the rest of the world, is slowly but surely turning away from the old world oil-based economy and moving inexorably toward a minimal carbon age.