On March 7, Russia and Saudi Arabia fired the first shots in what is an apparent war for crude oil market share. The war’s background, its drivers and the overall consequences for the oil markets are the subject of a multitude of papers and analyses. Today we would like to focus on what impact this war can have on a set of key feedstocks for the North American petrochemical industry – NGLs.
NGLs, and particularly ethane and propane, are key ingredients to produce important petrochemical products. Ethane is mainly used to manufacture ethylene, which is the petrochemical industry’s most consumed intermediate raw material. On the other hand, propane, which is widely used for residential and commercial heating as well as cooking fuel, can be used as a raw material for the production of ethylene as well as propylene. Propylene is the petrochemical industry’s second largest intermediate raw material, used to manufacture plastics and other chemical products. Both ethylene and propylene are members of the olefin family.
Nearly two thirds of the ethane supplied to the ethylene market currently comes from 2 key producing regions, the oilfields of Texas and PADD1, specifically a group of States in the Northeast US where production comes from the Marcellus Shale play. Since 2016, approximately 63% of the ethane supplied to the ethylene market comes from those two regions. This represents a 23% increase from the portion of the total ethane feedstock market that these two regions supported previously, as can be seen in the following chart. Most of the growth has come from increased production in the North East U.S. Ethane demand from that region has grown, primarily for exports to Canada and NW Europe, via pipeline and water respectively. Total ethane delivered to the market rose by 57% or 668 thousand barrels/day from January 2016 to December 2019.
U.S. Ethane Supply Trends (Thousand Barrels Per Day)
Source: Energy Information Administration
The North American ethylene industry has rapidly expanded its capacity to consume the increasingly abundant ethane. Since 2016, the petrochemical industry has added 11 million metric tons of ethylene production capacity in North America. This represents 14.3 million metric tons (or 690 thousand barrels per day) of additional ethane consumption in the last four years.
These investments in ethylene capacity were justified on abundant and low-cost ethane availability. Between 2008 and 2020, ethane production in North America has increased by more than 1 million barrels per day. Since ethane supply increased more than consumption during that period, the NGL industry has had to “reject” excess ethane from the NGL market by selling it as natural gas instead of converting it to a liquid, effectively setting the alternative value of ethane as fuel. This provided the petrochemical industry in North America with access to a very low-cost raw material, compared to other “heavier” feedstocks like naphtha, whose prices are tied to oil.
The industry currently expects this availability of cheap and abundant ethane to continue in the future. In fact, the industry has projects to increase ethylene production capacity in North America by a further 6 million metric tons between now and 2024. This would add another 372 thousand barrels per day of ethane consumption, most of it in Texas and Louisiana. And, fortunately or unfortunately, 4.8 of those 6 million metric tons of new ethylene capacity are already being built, meaning that most of the new capacity is already fully committed and moving forward, regardless of the ethane availability and cost situation.
Ethylene Likely/Firm Projects in North America – Thousand tons Per Year
Propane supply in North America has also increased significantly since 2016. In this case, supply from Texas and the U.S. NE (PADD 1) represents a smaller portion of the total U.S. volume (57%), but again the percentage from these 2 regions has increased in the past 5 years by approximately 5%. Total U.S. propane production in December 2019 was an estimated 1.7 million barrels/day, up 47% from January 2016. The percentage coming from our 2 focus regions grew from 51% in January of 2016 to 57% by December of 2019.
U.S. Propane Supply Trends (Thousand Barrels Per Day)
Source: Energy Information Administration
The long propane position in North America fueled the interest in investments in propane dehydrogenation (PDH) facilities around the world. Propylene availability on a global basis has tightened in the last 10 years for multiple reasons. These include the increased use of light feedstocks for ethylene production, reducing the amount of propylene produced as a co-product, and a lower number of investments in oil refining capacity around the world. In order to feed the growing demand for propylene, companies had to focus on on-purpose propylene production technologies, particularly PDH, to produce the additional propylene the market requires. Many of these new facilities, particularly in China, planned to import U.S. propane as feedstock.
United States Propane Exports – World Total (Million Cubic Meters, RHA) and Share by Region (%, LHA)
Source: International Trade Centre
The key question to explore is how could the assumption of continued growth in ethane and propane supply in North America be affected by the current downturn in crude prices, if this dramatically reduces U.S. crude production?
One important factor to mention is that natural gas production in PADD 3, which includes Texas, is intimately linked to oil production. In fact, ethane and propane production in PADD3 correlates almost perfectly with crude oil production. This is because most natural gas from PADD3 is from wells drilled primarily to produce oil (associated gas). Therefore, any factor that may impact crude oil extraction economics in this region will have an impact on natural gas and NGLs production. On the other hand, natural gas and NGL production in the U.S. NE is independent from oil production; the economics of drilling for natural gas in this region are driven primarily by natural gas prices and markets.
So, what’s the crude oil supply scenario the industry contemplating in this environment of low oil prices? A low case crude production estimate presented by E&P industry commentator David Ramsden Wood shows a potential reduction in U.S. crude production of as much as 3 million barrels a day by year end 2020, if price suppression causes a cessation in most crude based drilling activity during the first part of the year. This could reduce U.S. oil deliveries to the market to under 10 million barrels a day from nearly 13 million currently, essentially rolling back crude supply to late 2017/early 2018 levels.
Assuming natural gas and NGL production rolls back in a similar fashion, NGL supply could decrease to just under 4 million barrels per day (late 2017/early 2018 level), which would mean a potential reduction of 1 million barrels a day of NGLs. Ethane supply was 1.5 million barrels a day during that time, as opposed to 1.84 million barrels a day today.
The near-term impact on the ethane market under this scenario should be minimal. This is because the potential amount of ethane that has been left in the natural gas stream (rejection) has been estimated to be up to 900 thousand barrels per day currently. Extracting this ethane would be more than enough to offset the expected near-term decrease in associated gas production. However, for long term investment scenarios, a question still remains. What happens from this point forward?
Since much of the global oil market is dependent on transportation, which is moving toward electrification, and much of the gas market is targeted toward power generation and other necessary consumer uses such as heating and cooking, it is expected that near and longer term demand for US natural gas will not be impacted as greatly as the demand for oil. The assumption in the market is that a reduction in associated gas supply from a slower pace of oil drilling in the U.S. will be offset by increased gas production from other regions, in particular the NE U.S. This is a key reason why the shares of some gas producers whose assets are in this region have risen recently.
However, this is not a good development for ethylene producers in the U.S. Gulf Coast. The second wave of ethylene production capacity currently in the planning and construction stages relies on increased access to ethane that is currently sourced primarily from producing regions in the oil basins of PADD 2 (North Dakota) and PADD 3 (West Texas and SE New Mexico).
But, under a low oil price scenario, potential expansions in natural gas and NGL supplies may come from the U.S. NE instead. This represents two challenges. The first challenge is the volume of NGLs that can be extracted from each thousand cubic foot (MCF) of gas production. The composition of the NGL barrel sourced from the U.S. NE and the most prolific region of Texas, the Western Delaware Basin, is very similar (see next chart). That said, the average volume of NGLs recovered from gas produced in Texas is about 3.4 gallons per MCF. The NGL yield from the portions of Texas with the highest level of drilling activity is over 5X the volume for the NE U.S. at about 7 gallons per MCF. The current NGL yield in the U.S. NE region averages 1.26 gallons per MCF. Therefore, in order to replace the volume of NGLs lost from the Texas oil fields, the U.S. NE would require a minimum of over twice as much gas to be extracted and sold. This level of expansion could present a challenge over the next few years, given the current oversupply situation in the world gas markets.
NGL Barrel Composition NE U.S. vs Western Delaware Texas at 44% Ethane Recovery Level
Source: US Energy Information Administration, Texas Railroad Commission, Midstream Energy Group
The second challenge to feedstock planners in our hypothetical low oil case is the distance between the U.S. NE and the USGC ethane consumption region. Currently, there is only one pipeline available to transport NGLs from the NE U.S. to the US Gulf Coast. This is the ATEX line, a converted propane system operated by Enterprise Products Partners that transports an estimated 145,000 to170,000 barrels/day of ethane out of the U.S. NE region through Kentucky and down to Louisiana. Several projects have been proposed to move either mixed NGLs, ethane, or propane out of the region, but so far support from producers or end users hasn’t been enough to justify the investment.
All of these factors may result increased ethane price volatility, a higher cost to produce ethylene and derivatives, and lower project profitability for ethylene projects in the U.S. And, all of this would be happening in an environment of low global oil (and naphtha) prices, which make naphtha cracking for ethylene production in Europe and Asia more competitive.
The additional challenge of lower naphtha feedstock costs is another risk factor for North American ethylene and derivatives projects, at least those who are targeting the export market as their outlet for cost competitive production. However, lower ethylene production costs overseas (due to low cost naphtha) mean that producers in export target markets like Asia or Latin America may be better able to defend themselves against North American imports of ethylene and derivatives, especially if the trend toward reduced global oil prices continues.
Just like the case of ethane, propane production in North America increased by almost 900 thousand barrels per day since 2008. Lower propane availability due to the same factors explored before may result in higher propane prices, risking the profitability of PDH projects globally.
This is a fluid situation, which could rapidly move in a positive or negative direction, depending not only on the actions that Russia and Saudi Arabia take in the next few weeks, but on how the global coronavirus crisis affects the world’s economy and consumer demand. We will keep track of these issues; on the meantime, join the conversation by posting your comments here or by sending us an email at email@example.com or firstname.lastname@example.org.