Naphtha and octane are feedstocks for production of aromatics, but are also important gasoline blendstocks. In 2012-13 demand for naphtha and octane was high, but presently octane and specially naphtha are well- to over-supplied. Higher gasoline demand can make a difference between wellsupplied and balanced naphtha market. With increase in shale gas and tight oil production, the market became well-supplied with crude, naphtha and NGLs. Increase in ethane and propane supply has significantly impacted strategy of olefins producers, but has so far been considered less important for aromatics business. As we have seen in US in 2012, rejection of naphtha from steam crackers can significantly increase octane prices, and this impact should be monitored by the Asian aromatics producers. Naphtha and NGL balances can be significantly affected by: the amount of naphtha replacement with ethane and LPG in Northeast Asia, gasoline demand in Asia, weather, as well as commercial and residential consumption of propane in China and India. Prices of naphtha are in general expected to remain weak relative to crude prices until at least 2019-20. Implementation of more stringent gasoline standards in China as well as decrease in marine fuel oil sulfur content have potential to make gasoline, naphtha and octane more expensive starting in 2020. The largest impact of increase in Asia demand for polyester fiber and cleaner gasoline will be the need for a) larger capacity of reforming units to make reformate for gasoline blending and benzene, toluene and xylene production, as well as b) heavy naphtha supply. Increase in demand for heavy naphtha will require significant additional hydrocracking capacity. With robust reforming margins in North America and Asia, the ability to operate at high reforming rates will be important for gasoline and aromatics producers. With over-supply of cheap feedstocks, operation on most economical 1
feedstock will be paramount. Olefins production will be optimizing between ethane, propane and naphtha feedstock; while aromatics producers will be substituting heavy naphtha with gas oil and condensate. 1
- Shale renaissance increase in US production created global oversupply and fall in crude oil prices - OPEC had finally decided to cut the production, which increased prices - Higher crude prices have stimulated growth of the US production and some deinventoring - Increase in crude supply is limiting growth of crude oil prices - OPEC doesn t have much room to cut more of production and loose additional market share Result is lower for longer crude oil prices, as IHS doesn t expect crude oil to hit nominal price of $80/bbl before 2023. 2
Primary driving factor for most everything that is happening in refining and petrochemical market today can be one way or the other related to shale gas and tight oil renaissance in US. Red, green and orange dots on this plot from IHS Markit N. America Performance Tool are the new unconventional wells that have been drilled across the US. Clearly this is a large expansion in drilling activity that has stimulated production of crude oil and natural gas, but also NGL. Competition between naphtha and NGL as well as competition of gasoline and aromatics for octane will be the main topics of this presentation. 3
At today s low crude oil prices and state of developed trade, regional supply/demand and prices are much more interdependent. Oversupply of ethane and LPG pushed naphtha out of steam crackers into gasoline and en route has increased octane value. Long list of gasoline regulations from RFS, Euro V, China V, MSAT 2, Tier 3, China VI, have comingled interaction between aromatics and refining. Companies can no longer survive by understanding isolate impacts observed within their industry segment, but need to understand much broader integrated impact of changes that are and will be happening in the near future across aromatics, olefins, NGL production and refinery operations. 4
Overwhelming market sentiment is that recovery led by rebound in crude prices is to be expected. The biggest questions are how soon and how high will petrochemical prices and margins increase. Propane and naphtha are so oversupplied that regional prices are at recent minimums, and arbitrages are closed. Still strong US gasoline demand supported blending of Europe naphtha and US butane, and their prices. Asia gasoline demand seems to be robust (much larger 2016 sales of small-engine vehicles in China also helped), but at the moment even gasoline prices are relatively low. Cautiously optimistic economic sentiment supports rebound, but much will depend on the scale of expected US legislative stimulus, extent of US interest rate increases, as well as world ability to dodge impacts of several existing risks. 5
Let us first focus on utilization of lighter NGL feedstocks in steam crackers for production of olefins. A lot has been said, written and discussed about ethane crackers in US and West Europe as well as investing in propane flexi-cracking capability in West Europe and Northeast Asia that until recently have been used to using naphtha as the main steam cracking feedstock. But NGL have displaced refined naphtha also from gasoline (with butane and natural gasoline) and from crude oil blending (with butane, natural gasoline and condensate). 6
Spread between crude and US natural gas prices will increase. Crude prices will increase slower than producers would hope, but faster than the prices of natural gas that is pressured by very low coal prices, and soon discounted high sulfur fuel oil. Spread between prices of Northeast Asia naphtha and US ethane is good indication of US ethane cracking margins. We expect prices of ethane to increase faster than prices of natural gas, creating a narrower differential between with Asia naphtha. But in spite of increased demand for new ethane crackers in US, Europe and India; because of delayed startups, slower ethane penetration in Northeast Asia and significantly larger Marcellus production, increase in ethane prices will be slow leaving enough profit for few new ethane crackers in US. 7
Increase in US shale production created large price differentials between Asia and US propane prices between 2012 and 2015, opening opportunity for significant increase in US exports. In the last 5 years exports have been limited only by US marine terminal capacity and number of large LPG ships. As US production became so large that Asia became the last significant import growth region in 2014, investments in very large gas carries (VLGC) started, increasing the VLGC fleet size 70%. With opening of expanded Panama canal, further growth in US export volume, as well as investments in marine export terminals and VLGCs, will be limited only by Asia ability to accept and distribute significantly increasing import volumes. 8
Limited growth of olefins production in Europe implies limited growth of ethane and LPG demand. Competition between naphtha and propane is fierce, and many crackers are utilizing small differences in prices to optimize feedstocks. Olefins production in Asia is expected to continue to grow, with naphtha remaining primary feedstock. But in spite of excess, US ethane and LPG exports to Asia will be limited by Asia capability to offload, distribute and process larger volumes of ethane and LPG. Significant new midstream and flexible steam cracking investments will be needed. Therefore US prices of ethane and propane will be heavily influenced by amount of Asia demand. IHS is with a lot of interest monitoring any rumors about any potential projects that can increase Asia imports of US feedstocks. 9
The most significant difference between naphtha and ethane or propane cracking is production of coproducts: benzene, butadiene and propylene. In the long term very large ongoing capital investments in paraxylene and benzene production, PDH based propylene production and BDH based butadiene production is expected to limit increase in relative prices of benzene, butadiene and propylene. Therefore coproduct prices will not provide sufficient incentive for continuing naphtha cracking. However, due to large amount of interregional trade, as well as temporary spikes in vehicles and tire sales, particularly benzene and butadiene prices could widely swing as a product of temporary supply disruptions. This means that olefin producers will need to remain nimble and switch between naphtha and propane or ethane cracking depending on prices of coproducts. 10
Naphtha prices are fundamentally limited by prices of gasoline on the up side and crude oil on the low side. Plotting US naphtha relative to the prices of crude and gasoline shows that in 2010-11 naphtha was strong with prices close to the prices of gasoline. This was before US shale renaissance, which gradually from 2012 decreased prices of naphtha very close to the prices of crude oil. Comparing Europe and Asia naphtha prices with the US, shows that due to demand in Asia, Europe and Asia naphtha prices will remain much stronger, relative to crude oil. MARPOL induced higher Asia gasoline prices will additionally pull Asia naphtha prices between 2020-23. We also expect that MARPOL regulations will have much less impact on prices of LPG, impacting rate of substitution of naphtha in steam crackers. 11
To summarize this part of the presentation, naphtha and LPG have found the balance. As both are oversupplied till at least 2025, the present balance is at low prices. Question is what kind of increases in demand can we expect that could increase prices of naphtha and LPG. Increase in cracking of LPG in Asia, as well as increase in residential and commercial LPG demand, can have a significant impact on its prices. With substitutions out of steam crackers, naphtha will be looking to gasoline demand. With new China VI and MARPOL regulations after 2019 gasoline will provide stronger support to naphtha prices. Finally, temporary disruptions in prices of coproducts will make processing of naphtha on steam crackers economical at times. 12
What we noticed in the first part of the presentation that it is not possible to talk about competition between NGL and naphtha without gasoline. Now let us shift to the main interest and talk more about aromatics and the battle of gasoline and aromatics for octane. Aromatics need reformate as the feedstock. With onset of China VI standards gasoline will need increasing amount of reformate and naphtha in the gasoline pool. 13
Comparing naphtha prices relative to the prices of gasoline and crude is very helpful but it masks how wide is the window between crude and gasoline prices. It doesn t show how strong is gasoline relative to the prices of crude oil. US gasoline had very strong periods in 2012 (shale) and 2015 (drop in crude oil prices), but with limited growth in the future we expect that US gasoline will remain around 1.2 multiple. Comparing US with Asia gasoline prices shows that the prices at the two regions have connected starting in 2014, but with China VI and MARPOL in 2020 the prices will diverge where Asia gasoline prices will be significantly stronger. Hence, not only that Asia naphtha will be at 50% between prices of crude and gasoline, but also gasoline prices will be quite strong. 14
Starting Beijing in 2019, China will initiate gradual transition to most strict gasoline regulations in the world. With ongoing implementation of China V, two largest cities are already using 10 ppm sulfur gasoline. For comparison 10ppm gasoline is being implemented in US in 2017. After 2020 China gasoline will increasingly resemble Euro V specifications. After 2024 China gasoline will have most strict specifications with large additional reductions in olefins and benzene specifications. In general, the transition to China VI will result in less aromatics and olefins rich FCC gasoline blending. FCC gasoline will be replaced by a blend of naphtha and reformate. While in 2020 light naphtha is expected to remain well-supplied, increase in octane demand will likely result in increase in blending of MTBE and alkylate, as well as higher octane values. 15
In November 2014, crude prices tumbled. With crude prices gasoline prices also fell, losing support from higher crude oil prices. However, in relative terms, gasoline spread vs. crude oil prices remained quite high. Until late 2016, US gasoline was keeping Europe naphtha from larger price declines. In spite of record inventories throughout 2016 and highest ever US gasoline inventories in 1Q 2017, US prices are still relatively strong, partly because of Tier 3 10 ppm sulfur specification, that limits direct blending of high sulfur virgin naphtha. Comparing to regular gasoline, US premium gasoline has lost even less in value. Due to record high reforming operating rates in 2016 premium spread decreased to recent low values, but the premium spread is expected to increase in 2017 due to Tier 3 gasoline specification. That effect has been assessed as equal to deficiency of roughly 0.5 0.7 octane numbers, or ~2 3 cpg rise in premium regular spread. 16
Both gasoline and octane are presently well supplied. The world is in a trough following large impact of US shale renaissance, and shortage of gasoline in China that was resulted by insufficient crude import quotas. World is awaiting higher octane values, that will be in US driven by Tier 3 specifications. In spite of recent decline from historically high levels, US octane will remain above Europe and Asia octane values. We expect another trough with low octane values in 2019, before much tougher environmental China VI gasoline and MARPOL marine fuel oil specifications cause an increase in octane values. Octane values will increase as we don t expect that all of the needed reforming capacity, or oxygenate supply, will become available. 17
Toluene is aromatics product, paraxylene feedstock and gasoline blendstock. As such, difference between price and blend value of toluene (represented by vertical bars) is an important indicator of relative aromatics demand. From very strong aromatics demand in 2010-12, the world has evolved to minimal differentials and relatively weak US aromatics STDP demand that are not expected to return to 2010-12 levels soon. The reason is slow aromatics growth in US. Only occasionally benzene prices are so high that they quickly incentives very high STDP operating rates and cause a jump in toluene prices. Toluene prices will get a boost from gasoline demand in Asia, and still reasonable gasoline demand in US, but we expect that integrated East Asia will have sufficient amount of regional toluene. 18
US refining margins (proxy by reformate crude price) have been stronger than the US aromatics margins (proxy by paraxylene reformate price). In Asia, in spite of higher cost of energy refining margins are only slightly lower than the US refining margins. However, aromatics margins in Asia are significantly higher than in the US. But notice that in Asia aromatics are made from heavy naphtha, not reformate. Hence, the primary reason for the flip in refining and aromatics margins is the reforming margin, or more simply, price difference between reformate and naphtha prices. Therefore, regardless if you are in refining or aromatics business you will want to operate reforming. US aromatics could benefit from using heavy naphtha as feedstock, but heavy naphtha is not much traded in United States and additional production capacity is not supported by slow regional growth in aromatics demand. 19
Most of growth in reforming capacity additions has been driven by polyester growth, and not by China VI and MARPOL regulations. Similarly, most of hydrocracking capacity additions have been driven by diesel production and presently to less extent aromatics need for heavy naphtha (by integrated polyester producers). One could postulate that in not too distant future gasoline will need to buy reformate that was intended for production of paraxylene. Due to faster growth of polyester compared to diesel fuel, more heavy naphtha hydrocracking is to be expected to be added to make heavy naphtha, likely from discounted vacuum gas oil. 20
Aromatics are essentially buying high octane toluene and xylene feedstocks out of the gasoline pool. Presently both aromatics and octane are well supplied, with relatively low prices. Aromatics have ongoing large capacity additions along the whole xylenes derivative chain, while octane demand was moderated with significant penetration of ethanol in US, MTBE in Europe and methanol in China gasoline. In order for octane to increase in value, larger demand from aromatics and gasoline (post 2019) is needed. Additionally, economics (as LPG substitutes naphtha in steam crackers) and regulatory (due to China VI reduction in blending of FCC gasoline) increase in naphtha blending will also increase demand for octane. Aromatics on the other hand need increase in demand for polyester, mainly in China. Although polyester is still the faster growing fiber and plastic its growth has slowed down in the last several years, closer to the growth of GDP. 21
Crude import quotas have made a large difference in gasoline availability in China, between shortages in 2H 2015 to the well supplied market in 2016. Gradually more stringent gasoline specification so far have not mad a large impact on prices and margins, but starting in 2019 we will likely see a stronger impact, depending on speed of China VI and MARPOL implementation. Large xylene chain capacity additions in 2013-14 and 2017-18 have oversupplied market and created environment for rationalizations. Rate of capacity additions and rationalizations as well as imports will have major impact on margins. Finally something that probably most people in aromatics / refining business don t worry much is potential for start of large scale imports of ethane into NE Asia. Although not significant to impact gasoline prices will impact naphtha prices and margins of naphtha crackers in Asia as well as octane prices. 22
During last 10 years we have all witnessed that world has become more flat and markets significantly more interconnected. Trade between regions has been increasing for many products. That implied that plant operations depend on import of feedstocks (like NE Asia) as well as exports (like Middle East) to place the product where the demand is. As we frequently witness that interdependency brings also supply volatility that can significantly change prices within a single day. Hence, interdependency brings benefits, more future opportunities but also significant risks that should be considered and mitigated. Continue to make sure that you have access to several feedstocks that you can switch depending on prices, supply and demand. Similarly you should consider having options and variability on your product delivery contracts. Particularly for aromatics producers, that may imply for example ability to sell toluene and xylene (Paraxylene feedstocks) into gasoline, when octane is poorly supplied. 23