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SPECIAL REPORT: PETROCHEMICALS

Production restarts threaten to spoil bumper year for Europe’s crackers

August 2014

by Daved Chohan

plAtts speCiAl RepoRt: petRoCHeMiCAls | 2

Production restarts threatens to spoil bumper year for Europe’s crackers

PROduCTIOn RESTARTS THREATEnS TO SPOIL buMPER yEAR fOR EuROPE’S CRACkERSAfter years of bad news and rationalization, olefin and polyolefin producers have enjoyed six months of improved margins and increased run rates so far this year. This was largely driven by cracking liquefied petroleum gas (LPG), which is trading at record discounts below naphtha – Europe’s traditional feedstock.

The onslaught of LPG cracking has given Europe a peek into the future of a world where gas becomes more dominant as a feedstock. Lower ethylene prices, higher propylene prices, unexpected exports to Asia and a converter-driven shift away from polypropylene-based products to polyethylene has been the impact.

The short term boost in operating rates has been welcomed by Europe’s battered crackers, but it has not changed the overall picture, which is one where Europe’s chemical companies will have to specialize or import gas in order to survive in a world of cheap U.S. gas and Middle Eastern petrochemical expansions.

The shale expansion has provided European cracker operators food for thought, with some refitting plants to maximize use of gas, while others invest tens of millions of dollars in building infrastructure to bring in ethane from the U.S.

For coastal crackers, having the flexibility to crack gas or liquids is vital as they need to compete with cheap polyolefin imports from the Middle East.

But for inland plants the economics are different and transporting ethane provides enormous challenges. Leaving those inland to hope that the benefits of having a captive market outweigh what will likely be more expensive liquid feedstock.

A good startAs the first quarter of 2014 came to a close, European cracker operators toasted what was a remarkable three months. Operating rates hit a two-year high of 83% pushing quarterly production of the two main olefins to a two-and-a-half year high. According to data released by Petrochemicals Europe, European crackers produced 4.9 million mt of ethylene and 3.7 million mt of propylene, more than any quarter since Q3 2011.

The reason for the improved production margins was due to a global transition to cracking cheaper, lighter feedstocks, which boosted production margins and operating rates.

A rule of thumb for crackers is that once butane and propane falls 10% below naphtha, the production economics favor cracking gas over liquids, a price phenomenon that has been evident all of 2014.

Indeed the economic condition was particularly favorable for butane, which collapsed to a record 23% discount to the price of naphtha. Propane also remained at a reasonable discount to naphtha, widening to a 16 month high of $187.75/mt on July 21.

LPG on the riseSo what caused the LPG price fall and will it last? At 3C over historical averages, the European winter in 2013-2014 was exceptionally mild which reduced demand for LPG, as propane is used as a heating fuel. This came on the back of a record year of LPG exports to Europe from the U.S.

0

200

400

600

800

1000

Q1 14Q4 13Q3 13Q2 13Q1 13Q4 12Q3 12Q2 12Q1 1260

68

76

84

92

100

Source: Petrochemicals Europe, Platts

($/mt) (%)

Variable Margins/ Cracker Operating Rates

Naphtha Propane Butane Operating rates

70

75

80

85

90

Q1 14Q4 13Q3 13Q2 13Q1 13Q4 12Q3 12Q2 12Q1 12

Source: Platts

($/mt)

Cracker operating rates

Ethylene Propylene Butadiene

800

1000

1200

1400

1600

1800

May-14May-13May-12May-11

Source: Platts

($/mt)

Global ethylene prices

CIF NWE FD USG CFR NE Asia



According to the EIA, LPG exports from the US surged to 281,000 b/d in 2013, an annual rise of 44%. Of that, 44,000 b/d came to Europe in 2013, up 63% on a year earlier and hammering down the relative price to naphtha. But while the winter may be a temporary phenomenon, increased supply of LPG may not be.

According to the EIA, US exports of LPG reached an all-time high in April, as the U.S. transported across the Atlantic 15.2 million barrels of LPG, 50% up on 2013’s monthly average.

Over at least the short term, it is hard to see where LPG will find a home and some analysts even talk of the U.S. exporting propane to China for its on-purpose propylene plants.

Over the longer term some cracker operators see the same picture, with Repsol last year retrofitting its Tarragona plant to maximize flexibility and take in more gas, a huge outlay that would unlikely be made without confidence that LPG would remain at a discount to naphtha for some time.

And the transition towards lighter feedstocks will not end at LPG. Major European crackers are looking west to buy U.S. ethane, which will make the European feedstock slate even lighter.

Ineos will import the first molecules into Europe next year for its Rafnes and Grangemouth facilities and Sabic has applied to convert storage terminals at its Wilton plant in the UK from liquids to gas.

Adding to that, in February this year, Borealis renewed its long term agreement to source ethane from Norwegian state-controlled Statoil’s gas plant at Karsto, Norway for its steam cracker in Stenungsund Sweden for seven years starting October 2015.

DivergedThe impact of a shift to light feeds has been stark. Ethylene collapsed to an 11-month low of Eur855/mt on April 25, and propylene in May touched a high of Eur1,173/mt FD NWE - levels not seen for more than 2 years.

That price divergence has pushed European ethylene into Asia and sucked in propylene from the Middle East. Ethylene exports to Asia in

the first 4 months of the year hit 85,148 mt, treble the levels seen in the same corresponding period a year earlier, according to Eurostat.

But the rise in exports to Asia was not solely due to a switch in feed, meaning rising exports east are unlikely to be a permanent feature. The cracking of gas coincided with a heavy turnaround season in Asia and congestion in the port of Ruwais, which saw Asia prices spike at the same time that Europe’s slumped.

The divergence in ethylene and propylene prices diminished towards the end of the first half of the year as a number of production issues downstream led to propylene prices falling and these are key issues to watch out for.

Another outcome is the growing trend towards substitution. There is a growing body of anecdotal evidence that many converters are now seeking to replace polypropylene products with cheaper polyethylene alternatives. Several of Europe’s largest converters have told Platts they are looking into reducing purchases of polypropylene due to the growing belief of lower ethylene prices over the long-term.

Three main factorsLooking ahead there are three main factors to watch out for, which together could mean depressed ethylene prices for the remainder of the year. For propylene the picture is more mixed.

The first key issue is when the POSM plant at Shell and BASF’s Moerdijk facility will return. On June 4, an explosion at the plant, which consumes propylene to make propylene oxide, took it offline and raised the availability of propylene in the market. Any return, now expected in the next 2-3 months, could take propylene tons out of the European market, with the unit having a propylene oxide capacity of 250,000 mt/year. It would have no impact on ethylene.

Key events to watch out for

Ellba POSM unit to restart Bullish propylene, neutral ethylene

Versalis Porto Marghera (Q3) to restart Bearish propylene

Borouge (Q2) due to restart Bearish ethylene

Ethylene variable cost curve and cumulative capacity additions

Source: Platts

*No capacity additions; **All additional Chinese capacity projects Cumulative ethylene capacity additions (’000 mt)

($/mt)

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300

400

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700

0 10000 20000 30000 40000 50000

Middle East ethaneUS E/PUS ethaneCTO (max ethylene)WE naphtha*SE Asia naphthaNE Asia naphtha**US full range naphtha*



The second issue concerns Versalis’ Porto Marghera cracker. In February, Versalis announced that it was to “pause” its cracker and aromatics units for six months in Porto Marghera, Italy to absorb the prevailing downturn in the market and prepare the site for investment. When the cracker does return, it is clearly bearish for both ethylene and propylene.

The final issue concerns the UAE’s Borouge. Borouge 3’s 1.5m mt/year ethane cracker started last month in Ruwais, UAE. Whilst it has had a limited impact on the ethylene market thus far, this has been primarily due to the congestion in Ruwais, rather than any longer lasting trends. The belief remains that it will become an important exporter of ethylene and when that takes place it is expected to have a globally bearish effect on ethylene prices.

Rising poolOver the longer term, and in spite of the improvement in margins and the rise in operating rates, it is clear that Europe is still suffering. The economic benefits gained from cracking lighter feeds have proved instrumental in steam cracker margins reaching a 16 week high in July.

However the seasonality of LPG, combined with the continued rationalizations, is indicative of a more permanent trend permeating the European olefins industry.

Europe still remains at a significant cost disadvantage when considering the cheap ethane used in both the US and the Middle East. And if China is anywhere near as successful as it intends to be with its coal-to-olefin technology, more Middle Eastern product than ever before will be heading west.

Several large producers, both in the Middle East and in Europe, have expressed skepticism over whether China will indeed meet its goal to become more self-sufficient in plastics and can deliver the huge capacity additions due to the massive technical challenges that persist in the technology.

These include whether there is enough clean water available, the high energy and emission costs and the yawning distance between the location of CTO projects in the west and demand centers in the east.

Regardless, as one large olefin producer told Platts earlier this month in relation to more rationalizations in Europe: “The aim (for European crackers) is to be the tallest main in a rising swimming pool.”

LeviesFurther downstream, as well as the switch to lighter feeds, the polyolefin markets are still being impacted from political issues such as a hike in duty on imports from nations, such as those in the Middle East.

At the start of the year, the EU revised its General System of Preferences – with custom tariffs for both polyethylene and polypropylene increasing from 3% to 6.5% for all imports from Gulf Cooperation Council countries such as Saudi Arabia.

Europe is a net importer of both products; however the impact of the revision was far greater from some grades of PE, because it’s a larger net importer of polyethylene.

In fact more than two-thirds of some grades of PE come from the GCC.

The threat of the 3.5% rise in duty had a strong impact. Chart on the left clearly shows a slump in imports from Q4 2013 to Q1 2014, the latest data available, as buyers stockpiled product in Q4 and eroded that inventory throughout Q1.

It is unclear so far what the long-term impact of the protectionist measure will be, but anecdotally sources say that imports from the Middle East are expected to be lower this year than they were before.

The fall in imports and a gradual improvement in Europe’s economy have driven European polyethylene prices up, which is best evidenced by the premium that low density material trades in Europe relative to Asia.

Coal field

Additions – delay riskAdditions on trackBase capacity (’000 mt)Project with delay riskProject on track

Chinese CTO/MTO/MTP projects

Source: USGS, Platts

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202320182013

ETHYLENE

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202320182013

PROPYLENE

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Q1 2014Q4 2013Q3 2013Q2 2013Q1 2013

Source: Platts

(mt)

Polymer imports

LDPE HDPE LLDPE PP



And the rise in this premium is even more startling when viewed in the light that this year has seen a particularly heavy maintenance period in Asia, which has driven Asian prices up. Furthermore, there has been a fall in European ethylene prices which in a typical market would actually reduce downstream prices as buyers demand monomer-driven cuts.

The second major influencer of price has been the European rationalization that has occurred over the past two years and is expected to occur over the next three years. From 2012 through 2017 about 1.2 million mt of polyethylene capacity will have been taken offline in Europe,

That amounts to a 5% cut in total capacity as Europe’s naphtha crackers come under pressure from cheap U.S. and Middle East imports. For Western Europe the picture looks even bleaker as industry says high environmental charges and feedstock costs as crippling, cutting capacity by 900,000 mt or 6%.

While there have been no new closures announced in 2014, Figure on the right shows a projected closure of Total’s HDPE line in Antwerp, and Borealis’ HDPE plant in Burghausen; both of which are expected to cause upward price pressure in the HDPE market, according to sources.

The effect of the rationalizations is expected to increase Western Europe’s deficit of polyethylene over the next decade. When combined with the lack of expansions, the regional deficit will reach approximately 4 million mt by 2025, according to Platts Petrochemical Analytics, and this will need to be compensated by higher imports.

Due to the shale gas revolution in the US, and the cheaper feedstock access in the Middle East, both regions are expected to play a part in filling the deficit expected in 2025.

Although Asia is not expected to play as prominent a role, the region will continue to export specialty grades such as metallocene from Korea. Essentially, Europe will become a price taker and a reliance on imports will make it more volatile due to the effect of plant closures overseas.

PP ticked upPolypropylene ticked up this year following polyethylene’s rise, albeit for different reasons. A string of production issues at several plants has seen prices from Eur1,247.5/mt on January 2, to Eur1,330/mt on July 22.

Four production issues, in particular, played a role in the price hike. Namely, force majeures at LBI’s Brindisi plant, ExxonMobil’s Lillebonne plant, LBI’s Plock plant, and finally Total’s Feluy plant. Lyondell Basell, one of the biggest producers of PP has had four force majeures this year.

Brindisi and Lillebonne have both restarted; Total lifted the FM at Feluy on July 23, and Carrington and Plock both remain in force majeure. When they come online, sources expect prices to soften.

Europe PE plant closuresCompany Location Product Capacity Status (mt/year)

Dow Chemical Tessenderlo, BE HDPE 190,000 Closed end-2012

LyondellBasell Wesseling, DE HDPE 100,000 To close end-2013

Versalis Prilo, IT LLDPE 150,000 Closed Sep 2013

Total Petrochemical Antwerp, BE HDPE 70,000 To close end 2014

Versalis/Eni Gela, IT LDPE 150,000 Possible close 2014

Borealis Burghausen, DE HDPE 175,000 To close end 2014

Slovnaft SK LDPE 180,000 2016

Unipetrol Litvinov, CZ HDPE 120,000 2017

Source: Platts

1200

1250

1300

1350

1400

11-Jul11-Jun09-May04-Apr05-Mar03-Feb02-Jan

Source: Platts

(Eur/mt)

Convergence of PP and LDPE prices over 2014

PELDPE

1200

1250

1300

1350

1400

29-Jul09-Jun14-Apr21-Feb02-Jan

Source: Platts

Carrington FM

Lillebonne

Carrington FM

Feluy FM

Brindisi FM

(Eur/mt)

PP prices over 2014

One reason for some of these production issues has been due to a lack of feedstock availability. This is crucial as it underlines the impact of the transition to lighter feeds. The cracking of LPG yields less propylene than naphtha and this reduction in propylene availability has led to force majeures. Brindisi is an example of this.

The production issues driven by reduced propylene availability have accelerated the rise of PP prices to such an extent that they converged with low density polyethylene prices this year.



The average premium of LDPE over PP for 2013 was Eur93/mt and this premium has now collapsed, with both grades pricing at a similar level. Again, the cracking of lighter feedstock is behind

this, and the convergence between PE and PP prices will only encourage converters to continue to substitute between grades where possible.

Middle East

Africa

Europe

Central & South America

USA

202520182014 202520182014

202520182014

202520182014

202520182014

202520182014

Asia Pacific

Surplus

Deficit

Trade flows

286

107215

-239 -155

-732

494

-1,922

912

3,5614,2444,211

-3,462

-20,158

-3,095

-127-936

-374

Regional polypropylene net trade for 2014, 2018 and 2025 (’000 mt)

Source: Platts

Middle East

Africa

Europe

Central & South America

USA

202520182014 202520182014

202520182014

202520182014

202520182014

202520182014

Asia Pacific

Surplus

Deficit

Trade flows

2,402 2,369

4,581

-1,769

-4,769

-2,678

-1,169

-4,338

-1,992 11,71712,66010,008

-4,684

-25,292

-4,955

-1,995

-4,183

-2,006

Regional polyethylenenet trade for 2014, 2018 and 2025 (’000 mt)

Source: Platts


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Maps on the left Illustrate the trade flows, expected for 2014, 2018, and 2025, for PE and PP respectively and Europe and Asia unsurprisingly will remain the price taker.

There is forecasted to be a jump in the US surplus of PE from 2.4m mt to 4.9m mt from 2014-2018. While this surplus will diminish to just under 2.4m mt in 2025, the crux is that the US will boost its production driven by low cost ethane feedstock which is expected to remain correlated with a historically depressed US natural gas price.

Looking at the Middle East, the surplus will climb from 10m mt in 2014, to 12.6m mt in 2018. This production will be driven by gas and mixed feed based crackers. The majority of these petrochemical projects will occur in Iran and Qatar, but the region will also have heavier feedstock additions as Saudi Arabia moves to diversify its petrochemicals industry away from relatively lower valued cracker outputs.

For PE, it is projected that the European, Asian, Central and South American, and African deficits will all jump. This deficit will elevate the importance of the cheaper feedstock access of both the US and Middle East, and the roles that both regions will play in balancing the global polyethylene supply.

For PP, the trade dynamics are identical. The US and the Middle East will both maintain a dominant role in global exports, as deficits in Europe, Central and South America, Africa, and the Asia Pacific grow. Following the rise of ethane based capacity coming on stream in the US, the reduced co product output has sparked a wave of potential on purpose propylene production. Furthermore, China has vast coal reserves and the prospect of CTO/MTO based propylene additions had added an intriguing dynamic to the landscape of the polyolefin markets.

In the short term it means that European prices could be subject to volatility due to a reliance on imports.

The main elephant in the room remains what will happen to naphtha. Ever tightening low carbon fuel standards in the U.S. and the ongoing dieselization of Europe paints a bleak picture for naphtha cracks. Added to this is the slowdown in demand growth for naphtha and what this will do to the barrel.

Should naphtha fall too far and co-products rise high enough it may well kick up the margins of some naphtha crackers in Europe, but it remains to be seen whether it will be enough to prop up the balance sheet.

Additional reporting by Andrew Allan and Hetain Mistry

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