Outlook for North America’s Polyolefin Industry: Opportunities & Threats

This article complements ChemPMC’s “Outlook for North America’s Polyolefin Industry: Opportunities & Threats” presentation, conducted at Plastic News’ Executive Forum in Naples, Florida on March 7, 2018.

Polyethylene: Steady as She Goes

For the longest time, North America’s polyethylene industry has not seen a lot of capacity changes. The industry became accustomed to a “new normal”, in which capacity and demand were evenly balanced with each other. As you can see in the next chart, between 2006 and 2016 there was virtually no creation of excess capacity in the region.

North America Excess Capacity Growth (KT)

Sources: ACC, ITC, ChemPMC Estimates

This balanced growth in supply and demand, together with non-tariff, logistical barriers that kept imports of polyethylene at bay as well as very low raw material costs for polyethylene produces, resulted in very attractive margins for polyethylene sales.

North America HDPE Prices & Costs (cents per pound)

Sources: ChemOrbis (olefins), TradingView & EIA (Natural Gas & NGL), ChemPMC Estimates

It makes no difference if the companies purchased ethylene on the merchant market for their polyethylene needs, or if they were integrated into ethylene production; the difference between North America’s discounted contract prices (seen in the previous chart) and its cash cost of production, was quite high. Virtually all polyethylene producers in North America are integrated, which means that for every dollar in sales of polyethylene, as much as 66 cents of that revenue was profit.

The actual average margins for producers may be different since not all sales in the region are “contract sales” and not all producers use ethane as the feedstock to produce ethylene. For perspective, in 2016 LyondellBasell reported a 32% EBITDA over revenues for its olefins and polyolefins sales, and Westlake a 29% for its “Olefins” segment (which includes polyethylene and polystyrene).

Nevertheless, the very healthy margins for ethane-to-polyethylene integrated facilities in North America resulted in a rush to invest in polyethylene production in the region. The next table shows the polyethylene projects that have been completed in North America since 2016 or that we expect will be completed in the region in the next five years. The industry has announced it will complete more than 12 million metric tons of new capacity, of which about 3.8 million corresponds to HDPE, 1.8 to LDPE and almost 7 million of LLDPE.

North American Polyethylene Projects (KT)

As we add those projects to our supply & demand forecasts for North America, the “excess capacity” in the region begins to expand. The new additions will far exceed the demand growth in North America, and as a result, most of the new material will need to be exported.

North America Excess Capacity Growth (KT)

Sources: ACC, ITC, ChemPMC Estimates

How much are North American producers going to need to export? A lot. North America, to begin with, exports a great deal of polyethylene. In 2017, polyethylene exports reached almost 5 million metric tons. The issue, if there is going to be one, is that, in a short period of time, our exports will more than double. This duplication in exports will take place both in terms of tons and in terms of share of production. By 2022, exports will increase from 24% of production to 44% of production.  By product, HDPE exports will rise from 22% to 35% of production, LDPE from 22% to 44%, and LLDPE from 28% to 52%.

Exports Share of Production (KT, %)

Sources: ACC, ITC, ChemPMC Estimates

By 2022, total exports out of North America will be very close to the domestic demand in the region. As a result, exports cannot be an afterthought for producers. Historically, most producers have entrusted their exports to third-party companies, with the expectation that those companies will move that material quickly away from the very profitable domestic market. From what we have heard, this will continue to be the case in the near future. However, producers will have to pay more attention to this distribution channel. As we can see in the next chart, in the next 5 years the growth in domestic demand (about 300 KT/year) will be less than 1/5 the growth in exports every year. It only takes 20% of the material intended for exports backing into the domestic market to wreak havoc on prices.

North American Polyethylene Growth in Exports Vs. Growth in Domestic Demand (KT)

Sources: ACC, ITC, ChemPMC Estimates

You may or may not be aware that North American polyethylene prices are typically at a premium over global prices. This premium is due to the relative isolation of this market, with imports being kept at bay by logistical barriers. The other factor that allows for this premium to remain in effect is the efficient exports of any excess production. Excess product is rapidly channeled to the exports market, keeping the supply and demand in the region “tight”. As I explain in a recent article, the logistical barriers in North America are beginning to crumble. As a result, producers will need to efficiently export all this new material out of the region in order to avoid affecting domestic prices. But that’s easier said than done…

As much as 95% of all the additional polyethylene that will be exported out of North America is going to be seaborne. Houston is the largest U.S. port in terms of polymer exports. In 2015, the port of Houston moved about 140 thousand TEUs (twenty-foot equivalent, an inexact unit of cargo capacity often used to describe the capacity of container ships and container terminals). That year, the total plastic exports in TEUs was 522 thousand.

Top 10 U.S. Ports by Plastic Volume, 2015 (TEUs)

Source: US Army Corps of Engineering Navigation Data Center, ChemPMC Estimate

By 2022, we estimate that polyethylene exports will increase by almost 350 thousand TEUs, bringing the total polymer exports to almost 900 thousand TEUs. This is before taking into consideration any increase in exports of other polymers like polypropylene or PVC that may take place.

Increase in Polyethylene Seaborne Exports, TEUs

Source: ChemPMC Estimate

In any given year, the increase in polyethylene traffic will be equal to half the current polymer traffic out of the Port of Houston. It is fair to assume that not all the material will be able to be exported from Houston. Producers will, therefore, have to consider other options. However, as we can see on the next map, those options are located far from where the new investments are planned to take place.

Location – New Polyethylene Investments (blue) and Main Polymer-Exporting Ports (red)

Producers, as well as packaging companies (another important component of the polymer logistical value chain), are considering how to use ports that are away from the USGC to export material. For example, KTN/BNSF and Packwell/UP are investing in resin shipping centers in the Dallas-Fort Worth area, which will bring bulk resin from the USGC and package it for exports in either cost of the U.S. On the other hand, Frontier Logistics is adding capacity in Charleston to support the transloading of plastic pellets for export and Chevron Phillips is building its own transloading & packaging facilities in Ft. Worth and Charleston. In any event, the logistical concerns are multiple and the number of players in the logistics chain that will have to be involved in the development of a long-term solution adds to its complexity.

First, domestic deliveries of polyethylene are made typically by bulk railcar; exports are typically done in 25 kg bags, shipped in 20 or 40 feet containers. The bulk resins will, therefore, need to be transported to packaging facilities, by either truck or rail. This results in increased demand for rail and trucks as well as the need to invest in packaging facilities. Increased demand, as well as limited trucker availability in the case of transportation by road, will likely increase costs. To add insult to injury, roads around ports in the USGC are congested, causing delays, and state legislatures are also being asked to consider increasing the road weight limits currently in place. Finally, there is concern about the availability of empty containers and vessels in the exporting ports.  In other words, the logistical issues to move materials out of the region are multiple and the solutions are multi-pronged and require many actors to participate.

Therefore, it is not clear if the logistical infrastructure is ready to take on this challenge.

Polyethylene: Opportunities & Risks

First, let’s look at how all these changes and potential challenges may impact pricing in the region. As mentioned earlier, North American domestic contract prices enjoy a premium over global prices (see chart below). If the logistical barriers (or other problems like global demand slowdowns) result in material backing into the North American market, producers’ margins and polyethylene prices will suffer.

HDPE Global Prices (cents per pound)

Sources: ChemOrbis (China), ChemPMC Estimates

The other question is whether North American domestic prices can maintain their premium over global prices. If import logistical barriers and efficient exports are helping to keep prices high, what would happen when competition for market share is not external but internal and exports become a much larger component of the North American polyethylene industry?

Next, let’s look at spot prices. As you can see, spot prices don’t precisely align with Asian prices. Now, as Asia becomes a much larger destination for North American exports, replacing Mexico and Latin America as the leading market for exports out of the region, prices will need to adjust to be competitive. Asian prices are typically determined by integrated economics into naphtha cracking, with most of the margin kept in the ethylene chain. In plain English, Asian naphtha prices and margin expectations for ethylene production in Asia will drive spot prices globally. This does not automatically translate into lower prices, but it does translate into spot prices in North America that may be better than contract prices.

In such an environment, converters would have a better competitive position if their resins are priced at the spot level and not at the contract level. The question is whether the “assurance of supply” that contracts bring compensates for the potential higher premium that contract prices come attached with.

Two final considerations related to prices. First, the high concentration of assets in the USGC, and the regional proneness for hurricanes, mean huge weather-related volatility in prices is likely. Second, as we work through the logistical issues to export vast amounts of polyethylene out of the region, there may be short-term distortions (aka product backing up into the region), which may represent purchasing opportunities for converters.

The second set of opportunities and risks are related to feedstocks. The driver for investments in the region is low ethane prices when compared to oil prices. When oil prices crashed in 2014, we observed how producers paused the speed of approvals for new projects. Even though margins were still attractive, the specter of higher relative costs and potential reduced ability to compete globally, came back to take a bite out of producer’s exuberance. Oil prices have staged a recovery, but the risk is there for prices to crash again.

Petrochemical Feedstock Prices

Sources: ChemOrbis (Brent), TradingView & EIA (WTII, Natural Gas & NGLS), ChemPMC Estimates

One key number for you to remember is 6; six is approximately the MM BTU content of a barrel of oil, and the number you would need to divide the oil price in $/BBL to get the oil’s $/MMBTU price equivalent. When you compare the resulting oil price with the price of gas (or ethane, expressed in $/MM BTU) you will see how far or close those two raw materials are in terms of cost to produce ethylene. Right now, oil prices are between 16 and 20 times higher than ethane and natural gas prices – in other words, ethane is still a favored feedstock for ethylene production. If this ratio becomes lower, you may see delays and project cancellations.

Crude to Gas Ratio

Sources: EIA, Trading View

At the current ethane prices (about $4/MMBTU), oil would need to drop to 24 $/BBL to make both feedstocks indifferent for ethylene production. In recent months we have seen how, as oil prices collapse, U.S. production of shale oil reduces, and as oil prices recover, U.S. shale oil production regains steam. As a result, we foresee an oil equilibrium price of around $50/BBL, which would sustain the North American light cracking advantage (at current gas prices).

Alternatively, ethane prices could be the ones to increase, driven up by exports and increased consumption. At current oil prices, ethane would need to increase to over $15/MM BTU to reach the indifference point between naphtha and ethane cracking. Other than short-term spikes in prices in 2006, $15/MM BTU is a gas price we have seldom experienced in the region. We have, however, seen gas prices close to 8 $/MM BTU, which would make natural gas indifferent as a feedstock versus oil at the equilibrium price of $50/BBL stated before. That took place during the 2004-2008, the pre-shale era.

In other words, the scenario of ethane cracking being not competitive versus oil is not on the books currently.

The final risk to explore is the “Chinese Effect”. In 2008 – 2009, a huge increase in polyethylene (and other polymers) imports into China saved the day for producers, that were grappling with the consequences of the global economic crisis and oil prices crash. Since then, China has been actively investing in the domestic production of polyolefins; this would reduce the appetite for imports, becoming a risk for producers that will be looking for markets where to send polyethylene. However, there one factor that may work in the producers’ favor, and that is a new set of environmental measures in China.

These measures impact the industry in two different manners. From one, more direct side, China has banned the imports of plastic scrap to the country. The ban is new, but the country has been reducing imports of scrap materials over the last 5 years. In the case of polyethylene, scrap imports peaked in 2014 and have been retreating ever since. The numbers are still quite high; in 2017, the country imported a little over 2.1 million metric tons of polyethylene scrap. If those imports are replaced with imported virgin resin, it would take care of the increase in North American exports for 2018… Remember that, between 2018 and 2022, North American exports of polyethylene will increase by as much as 8 million metric tons.  So, scraps alone will not cut it.

China Scrap Imports (KT)

Sources: ITC

And here comes the second impact. Many polyethylene projects in China are integrated to Coal to Olefin plants. These plants take Chinese coal and transform it into ethylene. However, due to several environmental factors (fine particulate matter production and high CO2 emissions) as well as reduced CTO cost competitiveness (due to lower oil prices), investment in CTOs has decelerated. This would be a positive for North American producers. Nevertheless, China continues to push for self-sufficiency for some polymers, so the jury is out as to how much producers can count on China as a market where to shed significant amounts of the new polyethylene to be produced in North America.

Polypropylene: A Different Story

The situation for polypropylene differs significantly from polyethylene’s. First, there is a much smaller number of projects announced for polypropylene in the region. The reason is simple; in the case of propylene, there is no slam-dunk, widely accessible cost advantage to produce it. Why that’s the case – that’s not so simple.

You see, propylene is generally a by-product of making something else. When we make ethylene from heavy feedstocks like LPGs or naphthas, we obtain propylene as a by-product. Also, when we are making gasoline we make propylene as well. And you already know that, in North America, cracking ethane to make ethylene is much more attractive than say cracking naphtha or NGLs/LPGs (combinations of ethane, propane, butane and in some cases light naphthas). So, as North American producers transformed their crackers to run lighter feeds, propylene became scarce. Its prices jumped high and were extremely volatile. Converters, more than anyone, know what I am talking about, as polypropylene prices immediately suffered the consequences of high and scarce propylene.

To fix the imbalance, producers focused on so-called on-purpose technologies to make propylene. There are many of those, but in North America the one most generally considered is propane dehydrogenation or PDH. Propane, a natural gas liquid, is transformed to propylene by taking away hydrogen. The high propylene prices and its scarcity made many producers interested in investing in the technology. Dow Chemical, Enterprise, Formosa and Williams announced investments in PDH capacity and got to work. However, as soon as some of those facilities (Dow Chemical’s) started production, they impacted propylene prices immediately. What was an attractive proposition from an economic standpoint (build a PDH to sell propylene), became significantly less so, as propylene price collapsed and PDH margins shrunk. PDH projects got canceled or delayed, and interest in investment in PP capacity waned due to lack of raw material (propylene).

Global PP and North America Propylene Prices (Cents per pound)

Sources: ChemOrbis (PP China, Propylene North America), ChemPMC Estimates

Currently, there are only three polypropylene projects announced in the region, one by Braskem and two by Canadian companies (CKPC & Inter Pipeline, which are taking advantage of stranded propane in Alberta). These projects are not enough to cover the growing demand for polypropylene in the region, which has also seen its exports shrink. There is enough margin in the propane to polypropylene value chain to justify investments in PDH to PP units, but not enough appetite for additional investments, due to the volatile split of margin between propylene and polypropylene. Only integrated projects (propane to PDH to PP) make sense under any scenario. LyondellBasell recently announced it’s considering a PDH to PP project in the USGC, with FID expected by the end of 2018.

The other factor impacting polypropylene is how much more expensive propylene is versus ethylene. As you can see in the chart below, propylene prices in North America are almost two times higher than ethylene prices. However, this has not translated into PP prices twice as higher as PE prices. P/E ratios are extremely high in North America because ethylene is cheap, and propylene is expensive in the region. Nevertheless, PP prices are higher than polyethylene prices in the region, but more like 7 to 8 percent. In prior years, PP was as much as 20% more expensive than polyethylene, which had a negative impact in demand growth. This has moderated, but the fact that PP is still more expensive than alternative materials is another reason producers pause before committing to invest in PP facilities.

Propylene to Ethylene Price Ratios

Source: ChemOrbis

The final, and probably even more definitive issue impacting investment interest in PP, is China’s PP degree of self-sufficiency. After many years of consistent growth in imports, since 2009 the import profile to the country has been flat. This is due to a large number of investments in PP in the country, driven by China’s interest in self-sufficiency as well as by (at the time) competitive CTO costs. The drive for self-sufficiency continues, but CTO cost competitiveness has been lost. That said, in China there are many other sources of propylene, as ethylene production in the country has a higher preponderance of heavier crackers and the country continue to invest in refinery capacity.

China PP Imports (KT)

Source: ITC

What should you be following/checking/keeping up to date with?

After all these many words, what are the leading indicators you should be following/checking or keeping up to date with?

  • North American projects timing, delays & cancellations – they will showcase producers’ expectations
  • Asian projects delays & cancellations – can improve imports into Asia, delaying the impact of new capacity on prices
  • China demand or China imports – how much is that market coming to the rescue?
  • China prices, North American spot prices & your prices – question your contracts… are you getting the best deal possible? Invest in pricing information, particularly overseas data.
  • Who’s moving materials for producers? Become their best friends
  • Check the weather; during active hurricane seasons, inventories will be your best friend. Cover your basic needs, and don’t follow the panic.

These factors all influence whether the predictions we have discussed in this document take place. Find a way to keep up to date with these issues, and in the next few years demonstrate a healthy skepticism towards the prices you are being offered; you want to make sure you are getting the best deal possible, as the last thing you want to do is keep money on the table!

Leave a Reply