By John Richardson
CHINA hugely increased its propylene and derivatives capacity to the point where by 2011, it became the first region or country where downstream propylene consumption surpassed that of ethylene.
This didn’t mean booming actual demand for propylene and what it is used to make. Instead, it meant that lots of “empty factories” had been built during the 2008-2013 economic stimulus programme, where supply of propylene derivatives such as acrylic acid and phenol was way ahead of demand.
In the process, the Asian spot propylene market also became very long. Because this market is thinly traded, it only takes a mild increase or decrease in supply to send prices crashing down or surging up. So today propylene prices have collapsed.
A similar dynamic has played out in propane, which is of course part of the natural gas business. Global propane supply has lengthened – and prices has thus also collapsed – primarily due to over-production via the shale gas route in the US. Two things have happened here.
- Shale gas technology has greatly improved, and so production costs have fallen. This obviously makes the “breakeven” price of natural gas a lot lower for US producers than was the case a few years ago. So they have the incentive to keep on producing large volumes, even in weak markets.
- And the propane market is weak because, as with all other commodities, including oil, most people got China wrong. Despite all the long-standing evidence to the contrary, they thought that China’s 2008-2013 economic boom was permanent. They, as a result, built vast new capacities in natural gas, oil and iron ore to serve demand growth that will not happen.
If you are a standalone polypropylene (PP) producer, who buys merchant propylene to make your PP, you are therefore enjoying great profitability. The same applies to propane dehydrogenation (PDH)-based PP producers, who buy propane to make PP. As you can see from the chart above, both these set of producers in Asia are enjoying record variable cost margins. And in our latest Asia PP Price Forecasting Report, I expect this excellent profitability to continue for the next 12 months.
This represents a fantastic opportunity for these two segments of the PP industry. Buoyed by continuing strong profitability, they can attack the polyethylene (PE) market and win greater market share.
This second chart below explains why.
This chart shows the price premium/discount for PP homopolymer CFR China injection grade versus high-density CFR injection grade, from shortly after we began this PP injection grade assessment until February of this year.
Premiums versus discounts matter between these two grades, as one can replace the other in many end-use applications, such as household and kitchenware, furniture and toys etc. The same applies to some other PP and PE grades.
From January 2003 until December 2014, PP injection traded at an average premium of $53/tonne over HDPE injection grade.
But from January 2015 until February this year, this has turned into an average discount of $91/tonne.
For each of the months from July of last year until February 2016, the discount has exceeded $100/tonne. In no single month between January 2003 until December did the discount go above $100/tonne. In fact, its record high during that period was just $46/tonne.
The same pattern applies to some other grades of PP that can replace PE. I see these discounts continuing – in fact, they might even widen – over the next 1-2 years.
Why PE has become so much more expensive than PP is a subject that I shall address in a later post.
But here, what this story tells us that in an overall deflationary world – and the propylene value chain is great example of these wider deflationary trends – there is still great money to be made.
This, though, requires a change in mind set. Previously, success was achieved by worrying only about supply. Now, however, because of all the uncertainties associated with economic growth, you have to spend much more time managing the growth of your demand.
For the PP business this might, for instance, mean more actively engaging with converters in order to provide them with the technical knowledge and confidence that they need to switch to PP from PE.
Or for investors, there could even be an opportunity to add more standalone PP or PDH-based PP capacity.
Crazy, given the recent growth in PP supply that helps explain the fall in PP pricing relative to PE?
Not necessarily, if you see potential strong growth in a particular regional PP market anywhere in the world, given that petrochemicals markets are in general set to become more regional.
Or you are an investor based in China. There is, as I said, plenty of surplus propylene around. So why not add a standalone PP plant to add value to this very cheap propylene? You might be further incentivised to do this by government officials keen to create new jobs that compensate for the overall slowdown in the economy.