INDUSTRY INSIGHTThought Leadership

Navigating a world in oversupply

By Matthew Thoelke, Executive Director, Olefins, EMEA, Chemical Market Analytics by OPIS

The global ethylene picture became fragmented during the pandemic. In Asia, new capacity dragged regional operating rates lower and pushed the market longer, with margins for ethylene and most derivatives coming under severe pressure. However, with continued major issues in availability of containers and the ships to move them, the cost to ship products between regions remained high, ensuring extremely high price differentials. The many supply challenges seen in the US and the high level of planned losses in Europe left the western ethylene markets either balanced or tight for much of 2021 and 2022; the situation led Middle Eastern players to redirect exports to these more lucrative markets and ensured the length in Asia only gradually began to be registered in the west, particularly in Europe. A sharp decline in container freights during 2022 changed this picture and European and US markets are now fully impacted by the market pressure seen in Asia for the past two to three years. As the pressure from a long global market began to be felt, the world saw the energy shock of 2022 driving up costs and resulting in inflation for consumers, the resulting demand collapse has been extreme.

The transition from a tight to long market is normally accompanied by a sharp reduction in supply chain inventory. As the overall supply chain sees lower utilization rates, the need to hold inventory in the case of delayed deliveries or supply constraints is reduced, resulting in often moderating their stock levels. The transition from tightness to length during the pandemic has given a vaguer destocking signal than that seen after the financial crisis or following the bubble bursting. However, the destocking push has caused significant shifts in demand in the west during the past 18 months and to varying degrees in Asia over the past 2-3 years. The push to destock is moderating, shrinking supply chains to be as short as possible. This has effectively resulted in an artificially suppressed level of demand. Going forward, that destocking is expected to disappear although any restocking in the current environment is unlikely. Continued lack-lustre demand for the industry is likely.

The current situation greatly differs to previous downturns. The volume of capacity that sits with a structural cost advantage, either due to locally sourced low-priced ethane or due to feedstock flexibility to use imported ethane or LPG leaves around half of the world’s steam cracker supply sitting with a set of economics highly disconnected from the price driving naphtha-based cracker operations in Asia or Europe. Low-cost suppliers enjoy a delivered cost advantage to local suppliers, supported further when crude oil prices are highly elevated as in 2022. This ensures a more secure operating environment for ethane-based operations with many securing strong margins and even maintaining reinvestment level returns. In contrast, the position for marginal producers – naphtha steam crackers, MTO and CTO units – is very challenged. This puts high pressure on these producers in a market that has seen operating rates drop to 80% and even close to 70% utilization rates. The response to long-markets and a need to sharply cut output differs depending on location.

In Asia, we have seen continued competition in the market to secure volume, fighting over the shrinking Chinese import market, and driving petrochemical profits deep into negative territory. In Europe, there is a steady-state approach to the market and more cautious price developments. The willingness of producers to quickly slash output when demand weakens has given support to profitability, though at the cost of market share with imports taking a growing portion of the European market. There is a higher pressure on operations across the low-cost regions. Middle Eastern producers do not have universally advantaged cost positions and for those using LPG or naphtha as a feedstock, the marginal economics on production have, on several occasions over the past two years, been negative and resulted in some cutbacks. In addition, in an exceptionally weak market environment, where it is simply not always possible to sell out your system and the impact of cutting prices too deeply to secure market share may not be worthwhile, we have seen market-based adjustments. That same pressure has been seen in the US, though many of the constraints in the US in the last two to three years have been caused by logistical limitations or weather. Those constraints are lessening, but it is not simply going to be that simple for the US to run at full rates.

These dynamics have left all players affected by the unprecedented  capacity overbuild, though those with the highest costs are most exposed and are facing most risk of closure. Utilization rates are set to remain at very depressed levels for some time, and the industry will need to adjust. There is the chance that higher cost regions will look to trade restrictions as a mechanism to protect their markets. The use of environmental legislation may also be used to limit the import flows into higher cost regions, which is a significant risk for exporters to Europe.

Looking specifically at the Middle East, the outlook which shifted to a more cautious approach during the pandemic, has quickly rebounded with rising oil prices and firmer expectations for demand growth for Gulf sourced hydrocarbons. In 2014 and 2020, drops in crude oil prices both temporarily reversed their low-cost position before leaving them with a much-reduced advantage, far lower than they had become accustomed to.

The crash in 2020 reversed relatively quickly as the OPEC+ efforts to boost oil prices proved successful, the US facing a similar environment. In 2014, the challenge in the Middle East was mostly due to a major reduction in returns and a need to start controlling costs. This resulted in the cancellation of several cracker projects following lower oil prices and pressure on capital expenditure. In addition to the reduction in cost advantage, the limitations in new feedstock availability for the traditional gas-based cracker investments have forced the region to consider mixed or liquid feed steam crackers. This trend has been underway for some time in Saudi Arabia, though other countries’ projects also shifted away from the ethane upgrading philosophy that previously dominated the region’s growth. The second blow of the 2020 oil collapse has been to delay a raft of projects. It is likely that for a 10-year period from the start-up of Sadara’s cracker in 2016, the GCC will only see the new Omani unit at OQ’s Sohar site, which is now operational. However, with a return to strong profitability in the first half of 2021 and some consolidation in the Saudi Arabian industry, a focus on investments has re-emerged and swift progress is once again being seen on several projects. Cracker projects in UAE, Saudi Arabia and Qatar are under construction and forecast to be operational in the next five years.

Across the region, the higher utilization rates set in 2019 have quickly reversed and the feedstock restrictions in 2020 coupled with global markets from 2022 onwards, will keep operating rates lower. Global market weakness and new capacity additions will impact the Middle East and despite an advantaged cost position, producers in the region will not be immune to lack-lustre global demand.