RECOVERY, what recovery? Talk of a sustained economic recovery is premature. Even in the US, where the recovery seems reasonably robust, the benefits are only just starting to trickle down to the petrochemicals industry.
The strong US economic growth registered in the fourth quarter of last year has stretched into 1994, albeit at a reduced pace, and, in February, the index of US manufacturing production increased to a record high of 116.3. But, as the April economic profile from the US Chemical Manufacturers Association notes: ‘The chemical industry, however, didn’t share in the manufacturing sector’s improved activity. The index of chemical production decreased 0.4 per cent – to 119.3 in February. Nonetheless, production is up 3.4 per cent over a year ago and, despite the lower February figure, output in the past several months appears to be recovering.’
That news is hopeful but it is only part of the picture. In the US, as elsewhere, prices for industrial inorganic and organic chemicals remain soft because of global oversupply in many products. In January, attempts to push up key petrochemical product prices either failed or were postponed. These efforts included the polymers family of polyethylenes: high density polyethylene (HDPE), low density polyethylene (LDPE), linear low density polyethylene (LLDPE), polypropylene and polystyrene.
A second attempt to raise prices in March and April was more successful. As the petrochemical service of the Houston-based Pace reported at the end of April: ‘Producers’ attempts at a three cents a pound increase in polypropylene prices were partially successful, and prices rose two cents to 28-30 cents at the first of April.’ Pace continues: ‘The proposed three cents price increase for HDPE to 32-33 cents appears to have been completely achieved in early April. The planned five cents price increase for LDPE and LLDPE also went into effect at the beginning of April.’
Some of the large US diversified chemical companies reported improved first quarter earnings but much of the improvement was due to restructuring and other cost-cutting measures. Only in recent weeks has revived domestic demand, coupled with increased offtake from Far East and Latin American customers, resulted in improved margins.
This is small comfort to European and Japanese producers. Opinion is divided about whether the European recession has reached bottom, although most economists assume it has. The London-based industry consultant Trichem estimates that 45 per cent of West Europe’s olefin industry operated below cash cost break-even in early 1993. The trend has improved since then and now only about six operators are still failing to cover cash costs. But the improvement is relative. Trichem reports that only five of Europe’s 53 ethylene crackers made a positive return on investment during the last quarter of 1993. At the end of April, return on investment levels were ‘still a disaster’.
Margins may be poor or negative but volume sales have been reasonable. Export volumes are growing in strength although analysts say that Europe is exporting because there is nowhere else to place product. Within Europe, polyethylene prices have slipped further, though polypropylene and polyvinyl chloride (PVC) levels have nudged ahead. Petrochemical price watchers see the market staying flat, with producers desperate to lift price levels.
At a Dubai planning seminar in April, oil and gas consultant Chem Systems reported that its index of European petrochemical profitability is now 112. This looks reasonable if it is recalled that the index, based on 100 in 1978 dollars, registered an all-time low of minus six in the second quarter of 1981. Feedstock naphtha prices in Europe fell by $43 a tonne in the 12 months since the first quarter of 1993, reducing industry costs by about $2,000 million. That has narrowed the cost gap between Europe’s predominantly naphtha-based operators and ethane-based producers in the Middle East and elsewhere.
But Europe is still a high-cost region for petrochemical production. Chem Systems estimates that the lowest ethylene cash cost for any European producer was $236 a tonne in the first quarter of 1994. This compares with $180-220 a tonne for the various feedstocks in the US and $104 for ethane crackers in the Middle East.
The inescapable fact, as Chem Systems reiterates, is that global oversupply continues to result in aggressive pricing, forcing down margins in all regions. Rationalisation is needed not just in Europe but in Japan, South Korea and elsewhere to reduce the surplus producers, capacity and costs.
Chaos theory, according to which a butterfly fluttering its wings on one side of the world can cause a storm on the other side, apparently applies to petro-chemicals too. Since the 1970s and 1980s, the emergence of the Far East as a market for petrochemicals has had a dramatic impact on the flow of polymers and petrochemical intermediates. The rise of Southeast Asia, the Indian subcontinent and China has transformed the significance of the region in petrochemical terms within those 20 years. It now accounts for more than half the world’s inter-regional movements of all the principal traded petrochemicals and polymers.
By the mid to late 1980s, a flurry of Far East petrochemical projects had moved from drawing board to construction site. Between 1989-92, 14 ethylene plants were either commissioned or expanded in the region. Coupled with the range of derivatives plants that accompanied them, these new plants have frozen import volumes. And there is more capacity on the way (see table). This time the overcapacity that overshadows the global petrochemical market is not due only to reinvestment in the developed world but also to substantial capacity additions elsewhere, particularly in Asia.
Developments in Asia will be an important factor in the evolution of the global petrochemicals industry for the rest of the decade and well into the next century. Indeed, over the next 10 years, more growth in production and consumption of petrochemicals is projected for Asia than for the rest of the world put together. East Asia is emerging as an outstanding petrochemical power.
In South Korea alone, 2 million tonnes of ethylene capacity has already come on stream and the country has become a major net exporter. It has been argued that this capacity build-up has lengthened the global petrochemical downturn by a year. One of Korea’s weaker producers, KPIC, is already under protection from its creditors. However, other operators appear to be producing flat out despite early-April rumours of a pact to trim overcapacity in Korean ethylene output by an estimated 30-40 per cent .
Figures released recently by the Korean Petrochemical Industry Association (KPIA) highlight the impact the country has made within the past couple of years. Ethylene production hit 3.31 million tonnes in 1993, double 1991’s production. Ethylene exports quadrupled last year to 235,000 tonnes, polypropylene exports rose by 27 per cent to 764,000 tonnes, while HDPE and polystyrene exports rose by 13 and 19 per cent, respectively.
The impact of Korea’s entry into the petrochemicals business could have been even more dramatic if China had not bought considerable volumes. In 1992, polymer imports to China were about 3 million tonnes, though this figure slipped last year. But how long will China soak up surplus capacity? Even though it has scaled back its petrochemical plans, 12 complexes are included in the current five-year plan and a number of other projects have been proposed. It is more than likely that China will bring about 2 million tonnes of ethylene capacity on stream by 2000, doubling current capacity.
What are the prospects for the petrochemical industry? Global ethylene operating rates may weaken in 1994-95 as capacity additions continue to exceed projected demand growth. This is likely to slow the progress of a price recovery in Europe and, to a lesser extent, in North America, as inter-regional competitive pressures continue.
In its annual review and five-year forecast, published in February, Trichem predicted that the European industry, based on naphtha cracking, could remain at a competitive disadvantage compared with the economics of ethane cracking in the Middle East and the US Gulf Coast. Beyond 1995, Trichem sees a gradual and significant recovery in the European industry’s profitability, though the levels will remain weak compared with those seen in the late 1980s.
Set in a historical context, this prospect is less alarming. Since the mid-1960s, the petrochemical business has achieved high margins only three times. The first two periods of exceptionally good results, in 1973-74 and 1979-80, were triggered by the oil price ‘shocks’. Those shocks were accompanied by high margins as the price of feedstock, bought on low-price contracts, doubled and tripled. Amid all the uncertainty, demand rose as converters and fabricators built up inventories and the industry worked round-the-clock to meet it.
During the most recent cyclical high, in the late 1980s, the industry enjoyed historically high margins. Even in Europe in 1989, every single derivative sector and every ethylene producer was effectively minting money.
But as the recession bruised the economies of the industrialised world and petrochemical projects came on stream in the Far East, the emerging fourth power bloc of the industry, margins suffered once again. They seem fated to remain very fine for a very long time to come.