INSIGHT: Record natgas prices are raising costs for US chemical producers

HOUSTON (ICIS)–Prices for natural gas are hitting highs not seen since 2008, raising feedstock and energy costs for petrochemical producers.

• Natgas forward month contracts remain above $7/MMBtu.
• Oil prices forecast to stay above $100/bbl.
• Supplies of ethane remain adequate.

If prices for natural gas rise faster than those for crude oil, then it could erode the high margins that US chemical producers have enjoyed for nearly two years.

Early in 2022, that run of high margins was expected to continue. In late January, Dow said gas prices could fall below $3/MMBtu.

Instead, Russia’s invasion of Ukraine has upended those forecasts. On Monday, natural gas futures for May delivery broke $8/MMBtu before settling at $7.82/MMBtu. Barring the Texas winter storm of February 2021, prices have not been so high since 2008.

The forward months for natural-gas futures contracts remain above $7/MMBtu through March 2023.

While ethane prices have risen, the increase reflects the rise in natural gas prices. Ethane supplies should be adequate to meet demand, even with exports and this year’s start-up of new ethylene plants.

ETHANE
The US relies predominantly on ethane as its chemical feedstock, and its price tends to rise and fall with that for natural gas. Sales prices for petrochemicals tend to rise and fall with those for oil.

When oil prices are high and natural gas prices are low, US chemical producers benefit from higher profit margins. When those trends reverse, US margins shrink.

Up until the war, the US petrochemical industry enjoyed relatively low prices for natural gas and high ones for crude oil.

The following chart shows the premium that Brent oil usually holds over Henry Hub natural gas. Figures are in dollars per million British thermal units (MMBtu).

Source: Energy Information Administration (EIA)

Up until the war, the size of Brent’s premium over natural gas had been rising, which translated into higher margins for US chemical producers.

ICIS keeps track of US contract margins for ethylene, the world’s most widely produced petrochemical. Figures are in dollars per tonne.

Source: ICIS

Since the invasion, Brent’s price premium over natural gas has declined and US contract ethylene margins have followed.

The following shows the Brent premium since the 24 February invasion. Figures are in dollars per MMBtu.

Source: EIA

The following shows ethylene contract margins since the invasion. Figures are in dollars per tonne.

Source: ICIS

RUSSIA, UKRAINE WAR
The opprobrium unleashed by Russia’s invasion of Ukraine has caused companies to adopt self-sanctions that go well beyond the official ones imposed by governments.

While Russia is honouring existing natural-gas contracts, European countries are scrambling to find spot volumes to replenish their stocks and to prepare for any future cuts in Russian shipments of natural gas.

In mid-March, gas prices in Europe and Asia started hitting record highs as they competed against each other to attract spot cargoes of liquefied natural gas (LNG).

That bidding war and lower than typical inventories are supporting natural gas prices in the US, which would typically decline this time of year because of warmer weather and seasonally lower demand.

“Natural gas prices continue to defy expectations this month as concerns over supply adequacy dominate market psychology,” said Barin Wise, vice president of feedstocks and fuels Americas at Chemical Data (CDI), a part of ICIS.

Wise expects demand for LNG to keep US liquefaction capacity running at full tilt though the rest of 2022. That outlook takes into account the new Calcasieu Pass plant that Venture Global is commissioning in Louisiana.

At the same time, the US will need to replenish stocks before the next heating season, Wise said.

US natural gas inventories as of 8 April were just under 1.4 trillion cubic feet (tcf), nearly 24% lower than the year-ago level and almost 18% lower than the five-year historical average, according to the US Energy Information Administration (EIA).

SUPPLY SQUEEZE
Many factors are holding back attempts to increase more gas production.

Energy producers are dealing with labour shortages. Costs for tubular steel, fracking sand and other inputs for energy production are skyrocketing, Wise said.

Oil and gas companies are reluctant to expand production too rapidly because of promises to boost shareholder returns and to reduce debt.

Investors want oil and gas producers to exercise more capital discipline so they have cash available for share buybacks and dividends. That has restrained the companies’ response to the surge in prices.

The policies and rhetoric of President Joe Biden have further discouraged production. He cancelled the Keystone XL oil pipeline, warned the industry about price gouging and issued a moratorium on new federal leases.

The administration lifted the moratorium on Friday, but it limited the sale to just 173 parcels on 144,000 acres (58,000 ha). That represents a reduction of 80% from the acreage originally nominated. At the same time, the administration increased the federal royalty rate to 18.75%.

Markets were underwhelmed, and energy prices rose following the announcement.

OIL
Nearly all of the trends affecting natural gas markets are also affecting oil.

In addition, OPEC and its allies, known as OPEC+, have stuck to their schedule of gradual production increases despite the Russian war and the run-up in prices. Several members lack the capacity to raise production and are failing to meet their quotas.

CDI is expecting oil prices to remain above $100/bbl, peaking in August due to the loss of Russian supplies to the market, Wise said. Only a portion of those losses will be offset by coordinated releases from the strategic petroleum reserves by the US and other major oil-consuming countries.

Later in the year, more supply will come from higher production in the US, Brazil, Canada, Guyana, Norway and other countries that are not part of OPEC+, Wise said. Russia could find ways to skirt the sanctions as Iran has done for several years.

Demand destruction and slower economic growth could bring more balance to energy markets.

OUTLOOK
Already, the International Monetary Fund (IMF) has cut its forecast for global economic growth. The world’s GDP should grow by 3.6%, down 0.8 point from its forecast in January.

For the US, GDP is forecast to expand by 3.7%, down 0.3 point from the IMF’s forecast in January. Slower growth should lower the rise in demand for oil and gas.

Countering this is the upcoming travel season in the US, which traditionally begins on Memorial Day at the end of May. If the coronavirus does not flare up, oil demand should increase with the start of the travel season.

The US hurricane season starts at about the same time, and a busy one could disrupt oil and gas production along the Gulf of Mexico.

Meteorologists at Colorado State University expect an active season, with 19 tropical storms and hurricanes, versus an average of 14.4. Out of those, 9 should be hurricanes and 4 should be major hurricanes. That compares with an average of 7.2 hurricanes and 3.2 major hurricanes.

Regarding the outlook for LNG demand, Calcasieu Pass will be the last US plant to begin operations in the next couple of years.

Golden Pass in Sabine, Texas is the next LNG plant to start up, in 2024. It will have a capacity of 15.6m tonnes/year (15.6mtpa).

Venture Global’s proposed 20mtpa Plaquemines LNG in Plaquemines Parish, Louisiana, is next in line to make a final investment decision (FID). After that, several years would pass before construction could start.

Additional reporting by Alex Froley and Ruth Liao

Insight by Al Greenwood

Thumbnail shows gas. Image by Shutterstock

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