Feast or famine: Factors that impact volatility in petrochemical pricing

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1 Feast or famine: Factors that impact volatility in petrochemical pricing Kevin Allen Managing Editor - Petrochemicals Platts McGraw Hill Financial June 5, 2013 Mexico City, Mexico 2013 Platts, McGraw Hill Financial. All rights reserved.

2 Agenda: Factors impacting volatility in petrochemical prices. GDP growth impacts pricing. Weak growth means less demand What 2008 taught us: Inventory control becomes ever more important Imbalance between light and heavy products in North America Shift to lighter feeds: the case of US and ethylene and derivatives Shift to lighter feeds: case of US propylene and derivatives Shift to lighter feeds: case of butadiene and aromatics Crude production and its impact petrochemicals Conclusion and what this means for Mexico

3 Volatility more pronounced following 2008 Following the economic crisis in 2008, the global petrochemical industry has seen regular intervals of volatility. Volatility in the shortterm can be influenced by a number of factors but generally supply disruptions, and trader speculation are the primary factors. Long-term, price swings are impacted by fundamentals, macroeconomic factors, and socio political turmoil. 3

4 Volatility: Renewed focus on Inventory control The economic downturn in 2008 caught a number of people off guard. Prior to the crisis, we can see higher operating rates with an average of just under 93% between Between , the average operating rate was 87.75%. US producers have been more diligent about inventory balance in the last 3-4 years but inventory overhang in China remains an issue. 4

5 GDP growth and it s impact on pricing GDP growth driven by disposable income, consumer spending. When GDP growth is strong, i.e. consumer spending is strong, demand for petrochemicals remains healthy. GDP growth has been mixed in recent years. The US and Europe continue to stagnate while regions such as Latin America are expected to post GDP growth of 3.5-4% in This is significant given that US GDP growth has not breached the 3% mark since The one to watch is China however. The country anticipates a 7.7% growth in 2013 however this is markedly slower than expected. Slower GDP growth in China spells bad news for chemical demand. Region/Country KG per year North America 90 Western Europe 65 Gulf/Middle East 33 Latin America 18 China 12 Eastern Europe 10 Southeast Asia 10 India 5 Per capita, Latin Americans consume an estimated 18 kilograms/year of plastics. That s 20% of annual plastics consumption in the US and is just over 27.5% of European plastics consumption. Latin American plastics consumption is roughly 54.5% of consumption levels in the Gulf/Middle East. Source: Al Fajer Information and Services Arabplast

6 Volatility: The impact of manufacturing growth Volatility in petrochemical pricing is also correlated to growth in manufacturing by virtue of chemical use in everyday products such as automobiles, refrigerators, furniture, toys etc. Weak manufacturing growth, such as that seen by France, Greece, Spain and the Netherlands, have a ripple effect across the region and result in softened demand. The best indicators per region are the US in North America, China in Asia, Germany in Europe, and Mexico and Brazil in Latin America. 6

7 Production imbalance also fosters long-term volatility Shifts in production can also result in long-term volatility. For instance, prices for chemicals produced en masse are likely to face downward pressure. One example would be to look to olefins and polyolefins production and pending capacities coming online over the next 5-7 years. Conversely heavy products such as propylene, C4, butadiene and aromatics will see pricing supported by a short market. Any disruption in production for heavy products will generally result in a price spike. Heavy Products Light products 7

8 Feast or famine: Ethylene in the US The US petrochemical industry has been revived due to the discovery of vast amounts of shale gas. More specifically the low-cost NGLs associated with shale gas has given producers a cost advantage and led to increased investment in green and brownfield projects. If all projects are fully realized, the US can expect some 10 million metric tons of new ethylene capacity by New builds Company Location MM mt/yr ETA Aither Chemical/RMG TBD/USNE ExxonMobil Chemical Texas Formosa Plastics CUSA Texas ChevronPhillips Chemical Texas Dow Chemical Texas Sasol Louisiana Occidental/Mexichem Texas Shell Chemical Pennsylvania Expansions Company Location MM mt/yr ETA BASF-Total Texas Dow Chemical (restart) Louisiana Westlake Chemical Louisiana Williams Louisiana Ineos Texas Westlake Chemical Kentucky BASF-Total Texas Westlake Chemical Louisiana LyondellBasell Texas (3) Dow Chemical TX/LA (2)

9 Feast or famine: Asia olefins supply MTO projects in China are expected to increase the country s olefins output by over 4.4 million metric tons by 2015 with the potential for an additional 3.4 million metric tons in the planning stages. Company Location Capacity (kt/year) ETA Shenhua Baotuo Baotou Sinpoec Zhongyuan Hebi Datang Int Duolun Shenhua Ningmei Yinchuan Pucheng Clean Energy Weinan 680 Mid-2013 Yankuang Group Ordos 600 Mid-2014 China Power/Total Ordos Sinopec Sichuan Vinylon Zhijin 600 Planning Shandong Energy Xinwen Yili 600 Planning China Shenhua/Dow Yulin 1000 Planning China National Coal Group Yulin 1200 Planning 9

10 Feast or famine: China and CTO projects In addition China has announced a number of coalto-olefins projects and is expected to bring on some 6 million metric tons of olefins via 18 new projects. Add that to the MTO projects and the country could see over 20 million metric tons of additional capacity come online by 2017 (if all are realized and run at full rates). Add in the anticipated 10 million metric tons from the US and global olefins capacity could increase by over 30 million mt/year by 2017.

11 Feast or Famine: Polyethylene production in the US Given the logistical constraints and costs associated with ethylene exports, the logical progression is polymerization. The US could see up to 6.9 million metric tons of new PE capacity come online by Company Location MM mt/yr ETA Sasol Louisiana.42 (LDPE) 2016 Sasol Louisana.45 (HD/LLDPE) 2016 Formosa Plastics USA Texas (1) 0.3 (LDPE) 2016 ExxonMobil Chemical Texas (2) 1.3 (TBD) 2017 ChevronPhillips Chemical Texas (2) 1.0 (TBD) 2017 NOVA Chemicals Joffre, Canada 1.0 (LLDPE) 2017 NOVA Chemicals Sarnia, Canada World scale 2017 Dow Chemical USG TBD 2017 Shell Chemical Pennsylvania 1.0 (TBD)

12 Feast or Famine: Asian & Gulf PE production surges Company Location Product KT/Year Status/ETA Wuhan Petrochemical China LLDPE/HDPE Fushun China LLDPE/HDPE Sinchuan China LLDPE/HDPE Opal India PE 1,100 October 2013 Gail India PE 900 Expansion Q4, 2013 Reliance Jamnagar LDPE 400 Planned, by 2014 PetroVietnam Long Son PE 800 Under Construction/Completed by 2014 PetroVietnam Long Son PE 800 Under Construction/Completed by 2014 Reliance Jamnagar LLDPE 500 Planned, by 2014 Qapco LDPE 3 Mesaieed LDPE 300 Start up in June 2012 Ethydco Alexandria PE 400 Planned Q UZ-Korea Gas Ustyurt HDPE/PP 400/100 Construction starts in 2012 Borouge 3 Ruwais HDPE/LLDPE 1008 Borouge 3 Ruwais LDPE 350 Under Construction/Start up in mid Under Construction/Start up in mid Carbon Holdings Ain Sokhna PE 1,350 Start up in Q Sipchem Saudi Arabia HDPE 400 Start up in 2013

13 Feast or famine: Where will all of this new capacity go? It s unlikely the US will be able to absorb new PE capacities. Sellers will look to export and will target Latin America given its proximity and higher prices. US sellers could also look to place material in Northwest Europe and Africa, albeit to a lesser extent. 13

14 More feast than famine for polyethylene Polyethylene supply in the Mid-East and Asia to increase by nearly 10 million metric tons by Sellers will need to find an outlet and will also look to Latin America to offload volumes.

15 What could go wrong for ethylene and derivative producers Ethylene and polyethylene prices likely to face downward pressure in the near term but there are several factors that could prevent this from happening and ultimately influence pricing: Costs: New steam cracker and derivative units can cost anywhere between $1-5 billion. Brownfield projects are substantially cheaper at under $500 million. Timing: Those late to the game could miss out on the cost advantage. Brownfield projects advantaged in this area. Permitting: Environmental groups likely to protest new projects and that could delay progress. Time is money. Craft Availability: If all announced projects in the US are realized, there will not be enough skilled labor to build and operate these plants. Engineering firm Fluor anticipates that 40,000-50,000 skilled resources will be needed at the building peak in Overbuilding: Overbuilding supplies to lengthen and depresses prices. The additional capacity also tends to coincide with an economic downturn, resulting in reduced demand. 15

16 Feast or famine: the case of US propylene Switching to NGLs, specifically ethane and propane, increases ethylene output to between 66-78% but cuts propylene and C4 output by 50% or more. Between the years of 2000 and 2011, the percentage of propylene coming off the steam cracker fell by roughly 40%. In 2011, propylene yields off steam crackers were roughly 34% while refinery yields grew by over 30%, accounting for 65% of total production in At the end of 2012, propylene output from steam crackers in December shrank 7.3% from the previous month, to million lbs/day while the P/E (propylene/ethylene) ratio sank to %. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Ethane Propane EP Mix Normal Butane Light Naphtha Ethylene Propylene Crude C4s Butadiene Refinery Cracker

17 More famine than feast: C3 volatility and the impact on polypropylene

18 More famine than feast: US PP export prices not competitive globally US polypropylene prices are often much higher than prices in Asia and the Middle East as a direct result of spikes in monomer pricing. It is difficult to stay in business when prices are among the highest globally for periods of 4-6 months at a time.

19 US polypropylene exports fall sharply 2,500,000 2,000,000 1,998,633 1,500,000 1,564,342 1,530,651 1,600,054 1,231,368 1,195,139 1,083,800 1,000, , Source: ITC 19

20 Higher PP prices open the door for HDPE substitutions Large spreads between polypropylene and HDPE opens the door with large spreads seen between H and Q4, During most of 2011, PP premium to HDPE breached the $500/mt mark on several occasions, peaking at $616/mt on January

21 PDH units: An end to the famine? Company Location Capacity (mt/year) ETA Dow Chemical Freeport, TX 750, Enterprise Mont Belvieu, TX 750,000 Q3, 2015 C3 Petrochemicals Alvin, TX 1,200,000 H2, 2015 Formosa Point Comfort, TX 600, Williams Redwater, Alberta 500, *Dow Chemical TBD TBD 2018 *Enterprise Mont Belvieu, TX TBD TBD PDH announcements continue to increase with several companies announcing new capacities with at least two projects under study. Total increase in production expected at 3.8 million mt/year by 2016, assuming all projects a realized.

22 Anticipated North American PP consumption Metric Tons 8,700,000 8,553,000 8,338,000 8,200,000 8,133,000 7,940,000 7,758,000 7,700,000 7,200, Source: Townsend Solutions

23 Expected capacity increase from crackers and PDH units Total propylene output from steam crackers in the US in 2012 was just under 4.4 million mt. Additional output from new steam cracker projects expected to be about 392,500 mt. 4,400, , ,800, ,592,500 mt If all on purpose PDH units, not currently under study but including Williams Alberta unit, come to fruition, propylene supply in the US will increase 3.8 million mt. This raises the question: Is million mt of new propylene capacity enough? 23

24 C3 from crackers will not meet expected US PP demand To meet anticipated polypropylene demand in the North America in 2015, monomer supplies would need to be just under million mt. Factor in continued growth in PP consumption at 2.5% per year and North American demand for propylene in 2016 would be 8,942,161 mt. In 2017, presuming consumption levels in the region hold steady, total propylene demand needed for PP would be just under million mt. (Total US production ) 8,592,500 (PP demand in 2017) 9,165, (573,220) 24

25 Estimations do not account for other derivatives Heavy focus on polypropylene as it accounts at least 50% of propylene demand however these estimations do not consider derivative demand from other sectors. Following polypropylene, propylene oxide and acrylonitrile are the two largest segments at accounting for a combined 19% of propylene demand. 5% 7% 9% 9% 10% 50% Polypropylene Propylene Oxyde Acrylonitrile Cumene Oxo-alcohols Acrylic Acid Others Cumene accounts for another 9% while the oxo-alcohols segment accounts for 5% of propylene demand. 10% 25

26 More famine than feast: C3 s impact on acrylonitrile 26

27 More famine than feast: the case of butadiene 2,000,000 1,800,000 1,600,000 1,400,000 1,200,000 1,000, , , , , *2013 US butadiene supply has shrunk by just over 29% since This again is the direct result of lower yields as steam cracker operators shift to lighter feedslates. New cracker capacities should add nearly 366,000 mt/year by Sources: Eastman, EIA, Hodson Report 27

28 More famine than feast: the case of aromatics The shift to lighter feedslates in US steam crackers has reduced the output of pygas, benzene, toluene, and xylenes. This is on top of pre-existing constraints by refiners in the US and Caribbean in recent years. Sunoco announced the closure of its Marcus Hook refinery at the end of 2011, taking an estimated 19,000 b/d of benzene, toluene and xylenes out of the market.. Co-product yields from ethane Pygas Benzene Toluene Xylene Other Aromatics Gas Oil (6 oil) Hydrogen/Fuel As well HOVENSA shuttered its St. Croix refinery which had an estimated production capacity of 5,800 b/d of toluene, 4,500 b/d of benzene, and 4,000 b/d of mixed xylenes.

29 More famine than feast: the case of benzene The shift to lighter feedslates has cut benzene and pygas production significantly. Pygas production from US steam crackers could fall by as much as 120,000 mt/year by Benzene output from steam crackers could decline by as much as 400,000 mt/year by This is bad news for countries such as the US which are net short benzene and are forced to import between kt/month depending on fundamentals. 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000, ,

30 Benzene prices prone to volatility 30

31 Benzene volatility tied to exports from South Korea, demand in China 170, , , , , , , , , , , , , , ,385128, , , , , , , , , ,484 99,376 99,450 90,000 80,000 Aug 2011 Sep 2011 Oct 2011 Nov 2011 Dec 2011 Jan 2012 Feb 2012 Mar 2012 Apr 2012 May 2012 Jun 2012 Jul 2012 Sep 2012 Nov 2012 Oct 2012 Dec 2012 Jan 2013 Feb 2013 Mar 2013

32 More famine than feast: Toluene and MX output from steam crackers Mixed xylenes and toluene are expected to suffer a similar fate as lighter feeds curb production. Toluene, shown in blue, is expected to fall from near 425,000 mt in 2011 to just over 362,000 mt in Similar declines can be seen in MX production from steam crackers with output falling by over 30% during the same period to near 148,000 mt/year

33 More famine than feast: What this means for Asian aromatics Tighter supply has led to higher mixed xylene prices which means higher paraxylene prices. Paraxylene is a feedstock for PTA. PTA, along with MEG, are the feedstocks for PET. The end use for PET in North America is from bottled beverages though PET fiber constitutes a larger chunk of demand in Asia. Higher mixed and paraxylene prices also make US exports less attractive to buyers in Asia, which is significant as demand for xylenes in the region is expected to be strong amid a surge of new PTA production. China alone is expected to see 10.9 million mt of capacity come online by the first half of this year. Asian PTA capacity is expected to increase by near 19 million mt by Volatility further exacerbated as PTA producers began to cut rates at the end of 2012 on weak derivative demand. 33

34 More famine than feast: tight oil impacts aromatic prices Aromatics production in the US has been constrained, not only by the shift to lighter feeds at the cracker, but also at the refinery due to increased production of unconventional tight oil. Crude from the Eagle Ford play is set to surge in the coming years with production slated to increase more than three-fold between Prior to the shale boom, refiners were utilizing crude which had an estimated 40% naphthene and aromatic cut. The naphthene and aromatic cut from unconventional tight oil is estimated at near 35%. The reduction of aromatics as a result of shale plays is difficult to quantify though as many US refiners cannot run straight Eagle Ford crude and are most likely to blend with heavier crudes. Trend shows that refiners in the Northeast and Gulf Coast are utilizing lighter crudes with a higher API. 34

35 Petrochemical prices impacted by crude production MBPD US Production US Imports We ve begun to see a shift in crude production in the US and are beginning to see a convergence in US production versus imports. The gulf between US production and imports is expected to narrow going forward as production from shale plays increases.

36 US crude production up almost 2 mm b/d since 2007 million b/d Jan 2013 Canada United States Saudi Arabia Lineal (United States) 36

37 Crude production increasing, likely to pressure prices lower This graph shows anticipated crude production from the Eagle Ford shale play. The expectation is that output will nearly triple from 2012 to MBPD 2,200 2,000 1,800 1,600 1,400 If we include anticipated unconventional tight oil production from Williston (Bakken), the expectation is for an additional 1.6 million barrels/day by Combined US crude output from the two shale plays could reach near 3.8 million barrels/day. 1,200 1,

38 Looking at it differently There has been a fundamental shift in rig counts in the North America since H2, 2011 with the oil rig count surpassing the number of gas rigs. Looking back to 2009, the oil rig count has increased by roughly 700%. This is a trend that will likely continue in the near term and increased supply will push naphtha costs down, all at a time when ethane-based chemical production faces potential increases in feedstock costs, shrinking margins and the threat of overbuilding. 1,800 1,600 1,400 1,200 1, /01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/2013 Source: Baker Hughes 38

39 Increased production but limited processing capacity The US could produce as much as 11 million b/d of crude in 2020 thanks to shale, according to the International Energy Agency, surpassing Saudi Arabia. US crude oil production breaches 7 million b/d, levels not seen since the 1990 s, while imports fall to the lowest levels in 12 years. US refiners Valero, Marathon, and Phillips 66 announce shifts to domestic shale crudes at many of their refineries; US Atlantic Coast refiners begin to shift to Bakken and eschew imports. However the US still could face a bottleneck in the US Gulf and an investment in processing capacity would be necessary to take full advantage of the increased crude production.

40 Why is this important? Because petrochemical prices historically track crude values 40

41 In conclusion There are number of factors that influence petrochemical price volatility starting with GDP growth and manufacturing. Long-term volatility most heavily impacted by fundamentals. The petrochemical landscape is ever changing and there is no guarantee that the shale gas discoveries which have revived the US petrochemical industry will not be found in places like Mexico, Argentina, China or Saudi Arabia. The fact is that the industry tends to follow an 8 year cycle of profitability where overbuilding is prevalent in peak times. Looking at the US and Asia, it is clear that were are in the middle of one such cycle. 41

42 What does this mean for Mexico: Winning Mexico is in a prime position to benefit from changes in the global petrochemical landscape. The country has a strong manufacturing base for everything from computers, appliances, aerospace, automobiles, textiles and packaging. The pending startup of Etileno XXI will reduce dependence on US imports and pending capacity increases in the US will reduce costs of imports for manufacturers and converters. Strong GDP growth and the benefits of free trade via NAFTA will only help to bolster the country s position as manufacturing growth in 2013 is expected to be near 3%. 42

43 Thank you Kevin Allen Managing Editor - Petrochemicals Platts McGraw Hill Financial kevin_allen@platts.com 2013 Platts, McGraw Hill Financial. All rights reserved.