Petrochemicals: Changing Dynamics?

The petrochemical industry has been known for its cyclicality, in which the brief periods of exceptional returns have prompted producers to invest in increased supply - which by its very nature comes on-stream in large lumps - thus causing margins to significantly decline until demand increases to the point where the cycle begins anew. Today, the industry is enjoying the upside of a cycle, which is being supported by strong global economic growth and delays in capacity additions. The latter is, in part, the result of the growing backlog within EPC contractors stemming from the sharp rise in demand for their services and the shortage of resources. This shortage along with the significant increase in raw material costs has led to significant increases in the capital requirements for new capacity - and has resulted in a muted response to the increases in demand and prices.

These developments beg the question of how long this favorable period will last. This question can only be answered by assessing the structural drivers underpinning the industry's competitive landscape and supply/demand dynamics. There are some obvious first-order drivers that need to be considered including the shift of the demand growth towards Asia. For instance, as China's economy continues to develop, so will the indigenous demand for petrochemicals. Currently, there are plans to approximately double the country's steam cracking capacity by 2011 to meet this surge in demand. Another development is the Middle East's aggressive petrochemical expansion plans, which is associated with the leveraging of advantaged feedstock and energy costs, and the desire to capture more of the value-added potential associated with the regions' upstream production. Although the influence of the first-order drivers is important, it is not sufficient for assessing the future industry environment. The required depth of analysis can only be accomplished by having a global perspective coupled with deep local knowledge, which will allow for evaluating the relationships and interconnections across the entire petrochemical value chain.

A key element to establishing a comprehensive understanding is the assessment of the petrochemical feedstock supply/demand dynamics. The first-order drivers will have an influence, which can be illustrated by the fact that the expected growth in Asia capacity will for the most part be based on liquid feedstock. In addition, there are a number of second- and third-order drivers that need to be considered, such as:

• The availability of Middle East feedstock, given the scale of planned gas utilization and the large variability of the ethane/propane yield associated with the gas production;

• The shifts in gasoline demand, including dieselization in Europe and strong growth in the Middle East, and the affect on the naphtha supply/demand balances and flow patterns;

• The growing level of NGL volumes associated with the increased level of investment in gas production and the affect on LPG supply/demand balances and flow patterns - in addition to the naphtha supply/demand balances and flow patterns;

• Although of less significant as a petrochemical feedstock, the supply/demand outlook for VGO, given the addition of refining conversion capacity, as the demand mix shifts towards lighter products;

• The ongoing development of LNG and the affect on ethane/propane prices, including prices in the US.

These second- and third-order drivers will affect the future environment, including the relative operating costs and the location and source of marginal barrels. Furthermore, when considering petrochemical investments it will become increasingly important for companies to identify and assess opportunities to integrate petrochemical facilities with feedstock sources that will be priced favorably because of changes in the supply/demand dynamics.

Key Conclusions:

The petrochemical industry is enjoying an extended up-cycle, as the result of strong demand growth and delays in capacity additions.

An understanding of future conditions requires an assessment of the structural drivers - not just the first-order drivers, but also the second-order and third-order drivers.

The petrochemical feedstock supply/demand dynamics are being affected by a number of drivers, including upstream and refining developments, as well as changes in the demand for refined products.

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John Paisie is a Partner and Head of the PFC Energy’s US Downstream Practice. For further information on this article contact Enews_jpaisie@pfcenergy.com.