Ethylene is and has been the bellwether of the health of the global petrochemical markets as it is the largest by volume basic chemical used in the manufacture of many durable and non-durable goods. The near term additions of North American ethylene capacity is perceived as a flood of ethylene to the global market. The emerging dynamics would indicate otherwise. Coming off two high margins years, 2015 and 2016, the world ethylene supply capability does not appear to be keeping up with demand growth. Ethylene operating rates for steam crackers are used to indicate the fundamentals (supply and demand) of the ethylene market, with the ethylene producers primarily concerned about adequate surplus ethylene production capacity to manage supply during upsets, whether their own or one of their peers. Operating rates reached the top of sustainable levels in 2015 and 2016. The strong margin realized around the world during the last two years would have an operator making more ethylene if he could have so he would capture that margin. We saw limited if any spare ethylene production capacity around the world. Ethylene could very likely become the constraint in this value chain as operating drivers shift around the globe with limited spare capacity to absorb any disruptions in ethylene supply and demand. 1
A constraint synonymous with bottleneck. We have all experienced a traffic hold up when we were in a hurry to get somewhere, just sitting in traffic. We finally get to the point in the road causing the hold up: an accident, construction or just simply not enough traffic lanes. Once we get passed that hold up, the road opens up and traffic can freely move, often asking ourselves, why is the road so free here and backed up back there? This is what the theory of constraints is and how the limiting part of the flow (the hold up) caused a back up before the hold up and unused highway down the road. 2
The world is flush with oil, natural gas, and natural gas liquids. The world has resources under ground and assets to bring that material to market from oil and gas wells, to pipelines to fractionation and recovery equipment. Feedstocks, Natural Gas Liquids and naphtha, are plentiful around the world and often looking for a home for upstream players to monetize these resources. The produced ethylene feeds a much larger pool of derivative assets: Polyethylene, the Vinyls Chain ultimately producing polyvinyl Chloride, Ethylene Oxide chain producing monoethylene gylcol, styrene, etc. The production of derivatives is often limited by end use demand, In the coming few years, ethylene production could be the limiting factor in the chain causing a bidding war for this key building block amongst the derivatives. 3
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Ethylene crackers have two primary sources of feedstock: natural gas liquids (NGL) from oil and gas production and co products from refining of crude oil. As the feed slate shifts from ethane to heavier feeds, the coproduct production becomes an important variable. These co products have to be separated before they can be marketed. A move to heavier feeds slates increases the steam cracker site complexity and more importantly investment cost. Chemistry from Coal or natural gas (NG) to methanol has gained in share of ethylene supply over the last few years driven by lower cost coal and NG relative to crude oil. The methanol is used to produce ethylene as well as some co products via the methanol to olefins (MTO) chemistry. Coal to olefins (CTO) and MTO capacity is being added predominantly in China, but other regions with stranded gas are announcing new projects, namely Iran. Not shown in the picture above, some new ethylene production disruptor technologies are sitting on the horizon. At the moment no commercialized units exist, but the technology developers continue on an aggressive path to commercialize. 6
Ethylene capacity continues to ramp up in the forecast period approaching 200 MMTA. World ethylene derivative capacity additions continue to outpace ethylene production capacity additions and the global net short position grew by 20% to 9 MMTA. The three polyethylenes (HD, LLD, LD) continue as the work horse derivatives of the ethylene chain. Ethylene oxide, ethylene di-chloride (PVC precursor) and ethylbenzene (styrene precursor) follow at a distant 2 nd, 3 rd, and 4 th versus the combined PE production. The balance of ethylene derivatives, though important in balancing ethylene offtake, are small relative to the first four. Demand elasticity trends between 1.1 and 1.2 relative to GDP in the coming years coming off two very strong demand years. 7
Ethylene supply continues to be sourced mainly from steam crackers with the work horse feeds being naphtha and ethane. The primary shift in the coming years is from naphtha to ethane driven by the wave of NAM crackers. LPG s and heavier feeds remain in the feed mix and increase in absolute volume, but reduce as a percent of ethylene production. Non steam cracker production capacity and supply growth continues, predominant CTO and MTO, but CTO/MTO on purpose supply remains a small piece of the global ethylene supply pie and in the longer run we expect to peak at 6% of global ethylene supply and the balance of other coming from refinery offgas recovery and other less traditional routes.. 8
Capacity Does Not Equal Supply, inferring margins via these trends is risky. Year on year capacity additions in 2017 and 2018, per the IHS Markit forecast, outpaces ethylene demand growth. For the period 2019 2021, global ethylene capacity under construction, may not be sufficient to satisfy demand. In the five year time horizon IHS Markit demand forecast is strong, driven by the IHS Markit global economic forecast. In this five year window demand growth begins to outpace production capacity additions, which could stress the global systems capability to supply ethylene demand needs. It is important to recognize that capacity is not supply. History has shown that sustainable operating rates on steam crackers does not exceed 89% on a global basis (for short periods the system can run higher operating rates but this is not sustainable), so it would be expected 10% more ethylene production capacity is needed over time to stay ahead of demand growth. 9
2015/16 Peaks Not Seen Since Early 2000 s. To summarize the fundamental picture over the next five years: Based on IHS economic forecasts demand should be strong, no global recession. Operating rates dip in 2018 based on an optimistic construction and start up schedule for new assets globally. Timing of startup of new ethylene assets is not certain and any shifts into 2019 will raise rates well above 2014 levels. For the next five years, the operating rates do not dip much below the 2014 levels which was a period of strong European margins and rising Asian margins. The operating rate story is the most critical issue facing ethylene supply globally. At the high global operating rates seen in 2015 and 2016, when looking at Asia and Europe, disruptions to supply caused a spike in ethylene pricing and near record margins in both of those regions. The message is that any demand gain or supply disruption over the next five years will push the global ethylene supply system into a volatile market at a minimum and possibly into an infeasible situation. 10
With little spare global ethylene production capacity, an analysis on the new capacity production capability becomes essential. Steel on the ground and feed in does not mean design rate ethylene production and this analysis is an attempt to adjust the nameplate capacity for what is the effective production capacity of the new assets. Using 2018 capacity as the starting point as shown from the prior graph for operating rate calculation, three adjustments were made to capacity availability: First adjustment is Ramp up timing of the new assets which is more relevant in the current market than in prior big capacity addition waves. The lack of spare global capacity means this lost production becomes more relevant. In this case we assume ramping up from 50% to design capacity happens over 6 months. This has a large impact on available capacity. Secondly, in the forecast capacity, some new crackers are starved for feed, so this capacity cannot run at design rates which creates an available capacity production bias. Lastly, the new MTO/CTO assets have lower operating rates than steam crackers which gives an additional adjustment downward. Impact of these estimates is a 22% decrease in capacity coming on stream in 2018, the low point operating year. 11
Applying this adjusted capacity to the demand, global operating rates shift up 1% in 2017 and 2018 to 88%. Spare capacity in the low point year is cut by 2/3 s. 12
The ethylene forecast is becoming much more complex. On the supply side: Feed switching on existing naphtha crackers (shift to LPG s) does come at a cost, either in ethylene production or investments to debottleneck. Gas and coal to methanol and methanol to ethylene is having a major supply impact in China balancing. How this capacity runs will have a large impact on steam crackers, which ultimately close the ethylene supply balance. Catalytic conversion of Natural Gas to ethylene is looking to fit into the mix as well but on a longer term horizon on significant volumes. Co product chemistry for propylene is adding its own impact as cash cost for ethylene production in steam crackers and MTO units. More and more on purpose propylene production is changing the dynamics of the ethylene and propylene monomers versus when propylene was primarily a co product from ethylene production (steam cracking) or refining (FCC units making gasoline). On the demand side: Shift in and out of recycling plastics due to economics or policy can have a large impact on virgin resin demand and ethylene requirements Chemistry that has been commercialized over the last few years, coal directly to VCM and MEG, can impact ethylene needs dramatically. Economic, environmental and quality issues plague this chemistry which exist mostly in 13
China, but it is a supply alternative for PVC and MEG that needs to be tracked. product substitution is always a concern as technology and end use applications evolve. 13
With dramatic shifts in the NGL supply picture, the trend will be for NGL s to price lower to encourage steam crackers to shift from naphtha to a lower cost feed. This switch from naphtha to NGL does not come without a cost. Recycles within the unit from feed switching can become a major constraint unless investments in the hardware are made. Many recent feed flex projects around the world have resulted in an ethylene capacity de rate. Over time, the operators may spend money to eliminate some constraints, but some conversion may not be reversible in case feed cost trends shift back, making the investment more risky. In the US, crackers were incented to convert to ethane feed; as a consequence, the US crackers de rated capacity. This de rate is also being experienced in Europe as more LPG is being processed. Asia has a high percentage of ethylene production from naphtha fed crackers. The Asian market could experience some ethylene production de rating, as was the case in the US and Europe, if they choose to switch feeds with limited investment. Ethylene cash cost on flex crackers feeding propane and butane (LPG) are keys to be watched with the glut of LPG molecules coming to the market. The annual average cash costs are not as good as ethane in NAM or naphtha in WEP/Asia. But propane and butane have high levels of seasonal pricing with high winter values and low summer values. This makes them ideal for swing or price sensitive feed to steam crackers. 1% higher effective operating rate pushes 2018 back into to questionable territory for 14
sustained operations. Also limiting spare capacity. 14
Coal/methanol economics also play an interesting role over the next few years in respect to ethylene and ethylene derivative supply. Positive margins for all of the coal to olefins units will incent these assets to continue to run. For those China assets buying merchant methanol to operate their methanol to olefins (MTO) plants, the economics become less obvious with other, more profitable outlets available for methanol producers. The current forecast for methanol price and MTO derivative pricing pulls the integrated MTO based production into the red. With these assets being owned and operated by non traditional Chinese petrochemical producers, this negative profit operating mode may not be acceptable and slowdowns/shutdowns could be inevitable. The lost ethylene production from idling these assets would have to come from some other source because demand has not been eliminated, just a source of supply. The fallback source of ethylene is the steam crackers. But, we already have the steam crackers pushing the limit, meaning a tighter ethylene market once again. For example, if half of the existing MTO units shutdown due to negative economics, 1.5 MMTA more would have to be produced on an already stressed steam cracker system. This would reduce spare capacity by that much more. 15
Poly ethylene and poly propylene, based on MTO integration, co serve as a good proxy for integrated margins and operations. The Merchant portion of the ethylene derivatives are linked directly to third party derivative asset owners for PE, EB SM and EO MEG, so no spot sales of ethylene. The merchant portion of the propylene derivatives are to a large extent not linked to derivatives. So this excess propylene has to find a way to market which can be costly. 16
4/25/2016 A very key impact on ethylene demand is the use of recycle PE. Over the last ten years as absolute PE price increased, the level of imported recycle PE has increased from 0 to 5 MMTA (double this if considering domestically recovered recyclable PE), all in China. Two key issues are changing the recycle usage: With pricing of prime/virgin PE resin coming down with energy, the consumers are shifting back to the prime material. Policy changes in China may impact its availability as existing recycle plants are required to move from community/residential areas to industrial zones, which are more capable of handling truck traffic, water treatment, odors, etc.; with low margins on recycle operations today and little economic incentive to move these operations, recycle may have to convert to prime resin Key point being, prime resin needs ethylene, ethylene is already tight; adding 1 2% more demand on prime resin from reductions in recycle use, to an already stressed ethylene supply picture, will likely cause price increases on ethylene. This dynamic will reduce spare ethylene production capacity. A drop in recycle usage may not be one to one with virgin PE needs as some recycle PE applications may disappear, but directionally a pull on virgin/prime resin. 17
China, can swing ethylene demand and pressure ethylene operating rates: Two molecules are in the sights of Coal chemistry: a) the production of Vinyl Chloride monomer (VCM) used to make PVC, and b) mono ethylene Glycol (MEG) to make polyester. MEG from coal continues in the scale up and commercializing mode, but this move continues slowly due to technical challenges, so at the moment not much of a threat, but something to be watched. Coal based VCM production is China s main route to PVC, but this chemistry has issues of scale, cost, and pollution. In a lower energy market, the cost competitiveness of the VCM from coal chemistry may shift to ethylene chemistry. This shift will have the effect of more ethylene demand. In an already tight ethylene market, the story continues, where do I get the ethylene I need with little or no spare capacity. 18
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3/17/2017 The most common metric to compare ethylene production economics is cash cost. This analysis can be done regionally and for varying feedstock. Each region that has ethylene production typically has a dominate feed. In NAM and the Middle East (MDE) this is ethane. In Europe and Asia it is predominantly Naphtha. But each region has some flexibility on feed types. In China, in addition to steam cracker based ethylene production, they have CTO, which is integrated with the coal mines, and MTO plants which on the margin have to buy incremental imported methanol. Due to the many applications for methanol, the pricing affordability to those options drive up methanol prices to push MTO to the highest cost producer of ethylene globally. US advantage drops in our short term outlook relative to naphtha (2019), due to rising North American ethane prices. As energy prices recover (crude oil / naphtha) 2020/21, US advantage does return as ethane prices rise only as much as the marginal ethane supply source to USGC. The MDE will retain its low cost advantaged position even with new Kingdom of Saudi Arabia pricing adjustments for NG and NGL s. 20
3/17/2017 7:32 AM WEP contract prices have some discounts associated with sales so net sales prices are lower than shown. Discount levels vary and are influenced by current market fundamentals, volume of sales, etc. US prices for ethylene are the lowest globally. The average acquisition price is a proxy for the average of all the merchant buyers and is an average of the spot price and the Net Transaction (NT) contract price. Our forecast is for the spot and NT differential to close which reduces the gap for US relative to WEP and SEA in our forecast. The US monomer exports are limited. So, the differential region to region is driven by the affordability of ethylene to the various derviatives in NAM. Affordability is the price a consumer of ethylene can pay for US ethylene, convert to a derivative, and ship that derivative to an importing region. Net back prices of derivatives to the USGC becomes a key driver for US ethylene pricing. 21
3/17/2017 7:32 AM Trends are for stronger margins versus early to mid 2000 s. US ethane based margins drop from peak years of 2012 14, the years of high crude oil and low ethane pricing. WEP based margins remain on the higher side, with much of the integrated margins (feed to PE) remaining with the crackers. Asia is the market to watch. As margins remain strong due to the capacity additions / demand forecast balance, we could see a renewed interest in adding capacity in the Asian markets. Announcements are trickling in, but we are still in a wait and see pattern on demand health longer term versus capacity under construction. 22
Trend continues for exporters and importers. Exports, grow out existing export regions as these regions continue to invest in more ethylene and derivative capacity driven by low cost feed and strong returns on investments. Some regions will add capacity as their: net imports of ethylene, propylene and aromatics derivatives grow Need for job creation grows Labor costs are low relative to other regions of the world Imports, grow into existing import regions as importers move further down the continuum of standard of living development and the appetite grows for petrochemicals. China for ethylene trends at about 60% self sufficiency for ethylene and derivatives. 23
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NAM ethylene equivalent balance not such a cut and dry picture!! In Alberta Canada new PE capacity was added in 2016. From current ethylene capacity levels, the ethylene production capability is not there to close the Alberta ethylene balance. In the longer run it is likely some debottlenecks will take place on ethylene production. Feed availability issues were solved by new pipeline connectivity to the North Dakota Bakken oil and gas plays. In the short run though which derivative loses out? On paper Alberta is 350 kta short ethylene capacity. So which derivative will be starved for feed? PE? MEG? One of the other derivatives? This allocation of ethylene will be an important element for assessing PE and or MEG supply, demand and trade for NAM. In Mexico new ethylene and PE capacity were added by the Braskem/Idesa joint venture. In the Mexican case it is a story of insufficient ethane to feed the entire ethylene system (legacy crackers base and the new asset). So similar to the Canadian story, which derivative loses out? Market indication have the Mexican ethylene system short 400 kta of ethylene equivalents short due to ethane supply issues. For the United States, on paper we have added much more ethylene supply than derivative demand capacity. What this assessment does not reflect is the baseline shortage of ethylene, based on capacity, in the US. In the US we see three dynamics, filling of existing derivative assets, capacity creep on derivative assets, and exporting of 26
ethylene via and existing asset and talk of multiple new export facilities under evaluation. 26
Ethylene capacity globally we come up short on additions in 2019 21. Ethylene capacity US wave will have its challenge from the production side. Derivatives projects should be available first and ready to consume ethylene once it becomes available. Stress on global Ethylene as supply could be challenged via feed switching and MTO negative economics. Demand up with more virgin resin demand and coal chemistry challenges. Nameplate capacity operating rates remain at elevated levels. Global Margins remain strong ethylene integrated margins remain high with a question on what does it take to encourage the next Asian capacity wave? 27