Asian Polyethylene: The Butadiene “War Chest”

By John Richardson

HERE we go again. The above chart shows how the spread between CFR Japan naphtha costs and CFR Northeast Asian (NEA) butadiene prices has been steadily climbing over the last few months. In January of this year it reached $2,277/tonne – historically very high but still some distance from the all-time high of $2,861/tonne in August 2011.

The history

Here are the five reasons why this has happened:

1. A sales tax reduction for cars up to 1.6 litres in engine size in China from 10% in 2015 to 5% in 2016. This contributed to a 13.7% rise in China car sales in 2016 to 28.03m (butadiene is of course used to make synthetic rubber, with synthetic rubber then used to produce automobile tyres).
2. New height and weight restrictions on transporting goods by road in China. These were introduced in 2016 to improve road safety, forcing hauliers to buy more trucks.
3. A shortage of natural rubber. This resulted in natural rubber futures prices recently hitting a four-year high on the Tokyo Commodities Exchange. Natural rubber competes with synthetic rubber in end-use applications, including tyres.
4. A switch to lighter cracker feedstocks in Asia during 2016 because of strong naphtha-ethylene-PE margins. Lighter feedstocks make more ethylene and PE, but less butadiene.
5. A shortage of naphtha in China that resulted in lower-than-expected cracker operating rates in 2016. This was the result of the increased competitive pressure that the country’s “teapot” refineries exerted on state-owned refiners Sinopec and PetroChina.

And now we are into the Asian cracker turnaround season during which maintenance work will tighten olefins and derivatives markets in general. This might offer further support to butadiene spreads and prices up until around May/June, when the turnaround season is scheduled to come to an end.

Spreads of course don’t equal. But strong butadiene prices are a major factor behind the surge in NEA PE integrated naphtha-based variable cost margins.

Whilst the spread between naphtha costs and PE prices have remained virtually changed since November of last year, as I said, butadiene spreads have risen to the point where they are approaching their all-time.

This helps to explain the second chart below – the rise in NEA PE margins since November. Remember, integrated margins take into account costs of production, PE margins over the costs production – and also co-product credits from selling propylene, butadiene and aromatics etc.

The Future 

My base case is that NEA butadiene spreads over naphtha will start to fall from April.

This decline would be the result of a fall in sales of cars in China because the sales tax on vehicles up to 1.6 litres in size has this year been raised to 7.5%.

I also expect Asia’s cracker operators to switch to heavier feedstocks in order to boost butadiene output. Plus, by May/June the Asian cracker turnaround season should be over. Availability of naphtha in China is also set to rise on changes to government regulations governing the teapot refineries.

A further reason for my base case is that synthetic rubber producers are losing money because of high butadiene costs. They are locked into supply contracts with their downstream tyre-manufacturing customers for the first few months of this year, which is forcing them to buy high-priced butadiene. But once these supply contracts run out they should start pushing back against expensive butadiene.

But what if history repeats itself and butadiene remains incredibly tight throughout this year? We are only just over three months into this rally, and the last time that butadiene prices and spreads rallied in this way the upturn lasted from January 2010 until September 2012. Last week, NEA butadiene prices did fall by $50/tonne to $2,800-3,000/tonne CFR NEA on downstream affordability issues, but one week doesn’t make a long-term trend.

If history does repeat itself, then of course PE margins will receive further strong support from butadiene. This would further fill the Asian PE industry’s “war chest” as it confronts a big new wave of supply from the US and the Middle East due on-stream in 2017.

But even if history doesn’t repeat itself, the extra profits earned from butadiene over the last four months cannot be taken away. And before the rally in butadiene, Asian PE margins were already at record highs because of the collapse in oil prices and so naphtha costs from September 2014 onwards.

PE in 2017: Putting the Whole Story Together 

Summarising my posts on PE over the last few weeks:

• Greater naphtha availability in China might well increase the country’s PE production in 2017. This would raise naphtha cracker operating rates and so reduce demand for PE imports.
• Cheaper coal – resulting from a slowdown in coal-production cuts and declining coal demand from the steel industry – may boost the profitability and so operating rates of China’s coal-to-PE producers. This might further depress PE imports.
• Naphtha may also stay historically very cheap on low oil prices. And I’ve just explained, co-product credits from selling butadiene could provide further support to margins. This would enable Asian PE producers to discount their PE prices quite heavily in order to maintain market share as the new US and Middle East volumes hit the market.
• But this is assuming that the US can export to the key China market. If a global trade war develops, then the US industry would have to fall back on a domestic market where growth is forecast to be minimal up until 2020. This would be further good news for the Asian PE industry.