By John Richardson
THE GREAT US author Mark Twain, pictured on the right, needed to pay off his debts. So in May 1897, he was in London during a round-the-world speaking tour designed to raise the 
money to pay off his debts. People don’t usually turn up to see dead people speak. He was therefore a little disconcerted when rumours that he was gravely ill turned into stories that he was dead. Hence, his famous quote: Reports of my death have been gravely exaggerated.
What we thought we knew
The comparison with the naphtha-cracking business is obvious. Just three years ago, back in February 2014, whilst the industry wasn’t thought to be in danger of dying, the prognosis was that it would remain gravely ill:
- High oil prices meant of course expensive naphtha. So this squeezed the margins of “uncompetitive” naphtha crackers.
- A good number of these crackers were thus expected to be forced to shut down certainly in Europe – and perhaps even in South Korea, Japan and Taiwan as well.
This confirmed the wisdom of the decisions already taken by several US producers to expand their PE capacity. The PE industry is of course based on ethane feedstock, the cost of which is disconnected from oil. Therefore, whilst naphtha cracker margins were squeezed, the US industry enjoyed record profitability, with the consensus view firmly in place that this would carry on and on and on. Crucially, also, the widespread belief that a considerable number of naphtha crackers would have to close down meant that just about everyone thought that there would be ample room for the US PE capacity expansions in global markets.
The ever-onward march of globalisation in early 2014 further underpinned the logic of US ethane-based PE investments. Fewer, rather than more, trade barriers seemed inevitable – meaning that Europe and Asia, crucially including China because of its PE deficits, would be “flooded by cost-advantaged US PE imports”. Not flooded to the point of oversupply, but only flooded to the point where naphtha crackers would have to shut down to make way for these volumes.
What we should have known
But the world was clearly not this straightforward back in February 2014. We knew that because of the local economic imperative of preserving jobs, and keeping refineries associated with the steam crackers open to serve local fuels demand, shutting a cracker in Europe and Northeast Asia (NEA) wasn’t just a straightforward “cost curve economics” decision. Many of the crackers in Europe and NEA were also fully depreciated, and so carried no debt.
The dynamics that led to the collapse in oil prices were also already in motion February 2014. China had started its economic reform programme. And US shale-oil production was on the rise on ever-lower production costs. It thus seemed only a matter of time before crude markets caught up with the realities of demand and supply.
And whilst very few of us expected a Donald Trump White House, it was clear three years ago that something had to eventually give. Popular resentment was building against the failure of the political mainstream. The mainstream had failed to do anything about stagnating middle class and working-class income levels because they didn’t understand, or had simply ignored, the impact of the retirement of the Babyboomers. History teaches us that when the needs of the majority are not met, the policy vacuum is filled by political Populists. So along has come Donald Trump who believes that globalisation is the economic problem for the US, rather than the solution.
Today’s Markets
We now of course know that there are not even any cost curve reasons for naphtha crackers shut down anywhere in the world. The collapse of oil prices has led to much cheaper naphtha. Add to this the advantage that naphtha crackers also make co-product ethylene, propylene, butadiene and aromatics etc. which ethane crackers do not do, and the margin picture looks very different today than it did in February 2014.
The US has so far fallen out with most of the rest of the world in words only. There are thus no new trade barriers, although President Trump has already withdrawn from the Trans-pacific Partnership free-trade deals and is threatening to renegotiate the North America Free Trade Agreement. And crucially for global PE trade, he has yet to fulfil his election promise of declaring China a currency manipulator. This would be the first step towards imposing new tariffs on US imports of Chinese manufactured goods.
Tomorrow’s Markets
Here is one scenario that we will cover in detail in our new Study:
- PE markets become much more regional as a global trade war develops. Local production for local needs will become the priority. This will be supported by government policies and continued strong naphtha cracker margins. Oil prices fall from today’s levels, to around $30/bbl. Meanwhile, co-product credits remain strong (see my post on Monday on the future butadiene co-product credits).
- Satisfying demand on this basis will not be straightforward. China, for instance, will still have to meet big deficits. But it has two options here as an alternative to buying from the US, which are 1.) Buying PE wherever possible from its One Belt One Road partner countries, and 2.) Raising local polypropylene (PP) operating rates. PP can replace PE in some downstream applications, and China is closer to self-sufficiency in PP than in PE.
- US PE producers are thus forced to turn increasingly to their home markets, where growth prospects would have to be transformed from today’s projected levels (see the chart above) to absorb material that was supposed to have been exported.