Too Good To Last for Asian Petchems? Yes

By John Richardson

IT has been a fantastic few months for the integrated Asian polyethylene (PE) producers as the above chart illustrates.

You can see that the average price for naphtha was $533/tonne CFR Japan in April. This compared with an average high-density PE (HDPE) price of $1,271/tonne CFR Northeast Asia and an average low-density PE (LDPE) price of $1,389/tonne CFR Northeast Asia for the same month.  These spreads were, as the chart above shows, the healthiest they have been for integrated producers since at least January 2009.

This is also, obviously, reflected in margins. For example, integrated naphtha-based variable cost Asian HDPE margins rose to an average of $735/tonne in April. This compares with just $150/tonne for the same month last year.

Why? Two reasons, essentially. The first is crude where I think the following happened:

1. During the H2 2014-early 2015 collapse in oil markets, the world became a very shaky, nervous place. It felt a bit like 2008 all over again, and  plastic converters in China were obviously not immune to this feeling. They thus kept their purchases to an absolute minimum in order to avoid heavy losses on their raw-material inventories.
2. So when crude, instead of collapsing to $30 a barrel (its real long term price) as some feared, began to recover to around $60 a barrel from mid-February, this gave processors everywhere the confidence to stock-up a little on raw materials.

What has also been behind the recovery in PE profitability has been tight supply, whether it has been actual tight supply or more just the perception that supply has been really, really tight.

“My own calculations indicate that in Northeast Asia cracker and derivatives production losses due to scheduled and unscheduled shutdowns  in January-April totalled about the same  as last year,” said a major Asian-based propylene and ethylene buyer.

But our initial assessment of lost cracker capacity for Asia a whole tells a different story. The monthly average of cracker capacity lost to production issues in January-April 2015 was 6.25%, we think. This compares with a 5% average monthly loss for the same four months of last year.

So, what about the future?

HERE are five things you should know about oil markets as you plan for the second half of this year:

1. The latest data shows that paper-market speculators now control 510 million barrels of oil – equivalent to five days of global physical demand. This is the same amount of crude that Saudi Arabia, Iraq and Iran together produce in one month.
2. This increased paper-market activity has enabled oil producers to hedge against lower prices in H2. So, in the event of physical markets weakening, they can still afford to “pump and be damned” – in others words sell almost as much volume as they like, regardless of how far prices fall.
3. The ability of shale-oil producers to do the above, even if they didn’t have the luxury of well-hedged positions, improves almost by the day as the cost efficiencies of the fracking process improve. These constant improvements are being driven by heavy debt burdens which make maintaining production vital because, of course, if you shut down you make no contribution whatsoever to your debt repayments.
4. “Global crude supply was up by a staggering 3.2 million barrels a day in April year-on-year, extending the first quarter’s massive gains,” wrote the International Energy Agency in its latest monthly report.
5. Saudi Arabia’s oil exports hit a 10-year high in March as it continues to lead OPEC in the battle to regain market share. This week’s Economist argues that Saudi could withstand today’s oil prices for as long as a decade.

What does this tell us? That crude can go a lot lower in H2, which would once again create the concern amongst PE buyers about inventory losses. This would lead to another destocking process.

Ethylene and PE supply is also set to lengthen in the second half of 2014. We estimate that May will see this year’s peak month for lost cracker Asian production with a very steep decline from June onwards.

Then you have to think about China’s macroeconomic environment. The second half of this year does not look good at all as Beijing accelerates its “industrial shakeout”.

For me the key to the health of the PE sector, and, of course, the health of all other chemicals and polymers, is the likely availability and cost of credit in China during the rest of 2014.