U.S. Ethane Crackers and Ethylene Derivative Capacity...

www.honfleurllc.com HONFLEUR LLC June 2016 1

The Economics Behind

Monetizing Cost-Advantaged

U.S. Ethane Reserves

by CLAY JONES, TERREL LAROCHE,

and CHERYL GINYARD-JONES

U.S. Ethane Crackers

and Ethylene Derivative

Capacity Additions

Part 3


U.S. Ethane Crackers and

Ethylene Derivative Capacity

Additions - Part 3

In Part 1 of Honfleur LLC’s

continuing series titled U.S. Ethane

Crackers and Ethylene Derivative Capacity Additions, we

addressed the transformative state of the U.S. shale

revolution during the past 10 years.

In Part 2 we explored the sourcing of natural gas liquids -

NGL’s from U.S. reservoirs, the cost advantaged position of

ethane as a feedstock for ethylene production, and the

resulting ethane cracker capital projects currently planned

and under construction that will benefit from abundant

ethane supplies.

In Part 3 we discuss the competitiveness of ethane and

ethylene commodity prices. Additionally, specific focus is

applied to ethane cracker economics and a detailed

discussion of various Honfleur economic model sensitivities

and corresponding IRRs. Finally, we discuss the critical role

of project CAPEX management during the construction

phase in enhancing or destroying a project’s earnings

potential.

This White Paper represents Part 3 of a three-part Series

on this topic.

Honfleur LLC Managing Partners Clay Jones and

Terrel LaRoche, in conjunction with Cheryl Ginyard-Jones, a

chemicals subject matter expert, analyze the commercial

opportunities and economic drivers underpinning one

significant commodity produced from the shale revolution

– Ethane – and its ability as a cost-advantaged, abundant

feedstock in the production of ethylene.

Honfleur’s analysis of this market highlights several key

elements for success. They include:

For the foreseeable future, an abundance of cost-

advantaged ethane will be the key driver for new

ethane steam cracker projects.

Diligent CAPEX management during project

execution will allow efficient operators to have an

economic advantage over their competitors during

periods of ethylene price fluctuations.

A petrochemical company’s diligent utilization of

project execution processes and controls matched

to their specific project will have more impact

upon project IRR than will commodity prices.

Honfleur is a global provider of Independent Consulting

Services on capital projects. Our involvement allows

project operators to secure funding (equity and debt),

maximize project execution efficiencies, and increase the

likelihood of a capital project’s economic success.

Honfleur’s Managing Partners appreciate the opportunity

to bring to you, our Customers, this three-part series.

Part 3

U.S. Ethane Crackers and Ethylene Derivative

Capacity Additions The Economics Behind Monetizing Cost-Advantaged U.S.

Ethane Reserves.

Recent History of Cost-Advantaged Ethane

As of year-end 2015, total U.S. oil production per the

Energy Information Administration (EIA) was approximately

9.3 million barrels per day and natural gas production was

approximately 75 Bcf per day (billion cubic feet). Of these

totals, shale basins contributed total oil production of

5.16 million barrels per day (55%), and total natural gas

production of 35.2 Bcf per day (47%).

In contrast 2005 U.S. oil and gas production totals were at

5.2 million barrels per day and 50 Bcf per day, respectively.

Shale basins have contributed the majority of growth in

U.S. hydrocarbon production. The increase in processed

dry gas production has resulted in an increase in

corresponding NGL volumes, and specifically fractionated

components such as ethane.


Figure 1 reflects the U.S. dry natural gas production and

historical spot prices for crude oil, natural gas, NGL’s

(composite), propane and ethane.

Analyzing the commodity spot prices graphed on an

equivalent U.S. dollars per MMBtu basis, the effect of

surplus NGL’s is clearly shown in Figure 1. Prior to 2012,

ethane prices (orange line) were tied to the NGL composite

prices (purple line) and Mt. Belvieu spot propane prices

(blue line). These commodities each tracked WTI spot

crude oil prices (green line) on a fuel price basis.

Figure 1: U.S. Natural Gas and NGL Price History

This relationship was driven by two factors. First, propane

and NGL’s could be substituted for crude oil as a fuel for

many applications. Second, propane is substituted in place

of ethane in many petrochemical steam cracker

applications.

However, this long term commodity price relationship

between WTI, NGLs, and specifically ethane and propane

diverged from WTI spot crude prices in 2012, as U.S. dry

natural gas production continued to rise, and the quantity

of cryogenic gas processing plant products –methane -C1

and NGLs significantly increased in volume. Demand for

ethane did not rise with increased NGL volumes.

The resulting effect was Mt. Belvieu spot ethane prices

began to trade relatively flat in sync with Henry Hub spot

prices as ethane was “rejected” from the NGL streams and

sold as natural gas on an MMBtu fuel basis. Other NGL’s

including propane maintained their commodity price

discounts to WTI spot crude oil prices, even in the crude oil

price collapse beginning in mid-2014 and continuing today.

Figure 2: U.S. Natural Gas and NGL Price Forecasts

Figure 2 reflects EIA’s forecast through 2040 of U.S. dry

natural gas production and spot prices for composite

NGL’s, ethane and propane. Their long-term forecast

builds upon the current dry natural gas production volume

of 75 Bcf per day, to over 90 Bcf per day within 25 years

(blue dotted line).

Correspondingly, the forecast projects Henry Hub spot

natural gas prices (red line) to increase over the same time

period from less than $3.00/MMBtu to nearly

$8.00/MMBtu, and Mt. Belvieu spot ethane prices (orange

line) to essentially trade in close parity. This would be the

expected outcome as long as ethane remains in an

oversupply situation on the demand side.

Honfleur Ethane Cracker Economics

Prior to reaching a final investment decision – FID,

petrochemical operators must development their ethane

cracker economic models that accurately capture all

variable and fixed inputs based upon project scope, from

which multiple sensitivities can be tested and vetted. A

challenging task, as comparative U.S. greenfield ethane

crackers that may provide economic guidance will not

provide accurate current day results, nor will benchmarking

of “similar” project types constructed globally suffice.

As mentioned in Part 1 of this Series, the last U.S. steam

crackers completed and put into operations were in 2001

and 2002. However, petrochemical companies with

successful operational histories and a record of solid

investment performance will be able to develop the

necessary ethane cracker economic models, methodically


perform economic evaluations of investment alternatives,

and systematically evaluate the relative earnings potential

of these investment alternatives.

With similar rigor, Honfleur has constructed a detailed,

“strawman” greenfield ethane steam cracker economic

model (“Model”). The following summarized items are

included in the Honfleur’s Model assumptions:

Capital Expenditures

Total Installed Cost - TIC: $2.07 billion dollars:

Engineering & Design: $53 million; 3% of TIC

Procurement: $1,105 million; 53% of TIC

Construction & Commissioning: $838 million;

40% of TIC

Owner’s Costs: $75 million; 4% of TIC

Figure 3 reflects a summation graphically of the major

capital expenditures associated with a greenfield ethane

steam cracker developed in the U.S.

Figure 3: Greenfield Ethane Cracker Cost

Other Key Assumptions

O&M expense: $0.04/lb. ethane feed

Operations G&A: 2% of plant revenue

Capital maintenance: 1.5% of TIC per annum

Ad Valorem tax: 1.25% of EBITDA

Plant Capacity

Ethane feedstock: ~90,000 barrels per day

Ethylene produced: ~1.5 mtpa (million tons per

annum)

Plant capacity utilization: 90%

Construction and Start-up

Construction start: July 2016

Ramp-up: 90 days to full capacity

Operations start: January 2019

Ethane Steam Cracker Yields (per lbs. of input lbs.)

Ethylene 0.80

Propylene 0.03

Butylene 0.02

Butadiene 0.01

Fuel Gas 0.13

Py Gasoline 0.01

Gas Oil 0.00

Product Price Assumptions

Ethylene $0.45/lb.; $990/tonne

Propylene $0.50/lb.; $1,100/tonne

Butylene $0.55/lb.; $1,200/tonne

Butadiene $0.59/lb.; $1,300/tonne

Py Gasoline $0.09/lb.; $28/barrel

Gas Oil $0.08/lb.; $24/barrel

Fuel Gas (consumed at plant)

Honfleur Model Results

Future spot ethane prices utilized in Honfleur’s economic

Model were sourced from Petrochemical Update. When

the ethane cracker begins operations in 2019, the

forecasted ethane price utilized in the Model was

US$ 0.305/gallon (US$ 0.111/lb.), increasing to

US$ 0.335/gallon (US$ 0.122/lb.) by 2021, where it was

held flat. The forecasted cash cost of ethylene production

averaged US$ 0.17/lb. (US$ 374 per metric tonne) using the

above assumptions.

Figure 4 reflects ethylene sales dominating accounting for

approximately ninety two (92%) percent of the forecasted

revenue, with the remaining co-products making up

approximately eight (8%) percent combined.

Driven by the ethane steam cracker yields, propylene is the

second largest forecasted revenue stream at nearly four

(4%) percent.


Figure 4: Honfleur Model Revenue

Figure 5 reflects the Model’s forecasted cash flows. The

total CAPEX of $2.07 billion dollars is expended from 2016

through 2018, and includes the three-year construction,

start-up and commissioning periods. In addition to CAPEX,

ethane feedstock, operating and direct G&A expenses are

shown as deductions. Ethane steam cracker revenue

consists of ethylene sales and other co-products sales. The

green line bisecting the figure reflects the undiscounted

cash flow break-even, which occurs approximately six (6)

years after project kick-off in 2021.

Figure 5: Honfleur Model Cashflow

Figure 6 illustrates the critical importance of controlling the

CAPEX budget during the three-year project execution

period. The base Model case is shown at zero (0%)

percent, which implies the $2.07 billion dollar CAPEX

budget was achieved with no cost overruns. Additionally,

the base Model’s cash flow projections generate at

26.8% IRR before federal income tax IRR (blue line).

Several sensitivities were run against the CAPEX

assumptions to determine the IRR destroying potential of

CAPEX - cost overruns against the base Model case.

Sensitivity 1 reflects a cost overrun of approximately

twenty five (25%) percent. In this scenario, a twenty five

(25%) percent CAPEX overrun of approximately

$500 million dollars reduced the project’s IRR downward to

twenty one (21%) percent.

Sensitivity 2 reflects a cost overrun of approximately fifty

(50%) percent. In this scenario, a fifty (50%) percent CAPEX

overrun of approximately $1 billion dollars reduced the

project’s IRR downward to approximately sixteen (16%)

percent. In contrast, strict oversight of CAPEX, diligent

project execution, exceptional communications between

operators and the EPC contractor, thoughtful development

and adherence to project execution processes and controls,

cumulatively, is accretive to the IRR and therefore can

move the economic returns above the base Model case.

Figure 6: CAPEX Effect on IRR

The importance of CAPEX control during project execution

is further illustrated in Figure 7. The graph reflects a range

of ethylene commodity prices in relationship to CAPEX

savings or cost overruns. The base Model’s CAPEX of

$2.07 billion dollars is shown as the blue line. The vertical

shaded bar reflects the base Model case with ethylene

commodity sales at US$ 0.45/lb. and a pre-tax IRR of more

than twenty six (26%) percent (assumptions reflect the


ethane cracker is operational in 2019). Several sensitivities

were run against the base Model CAPEX.

Figure 7: Ethylene Price vs. IRR

Sensitivity 1 against the base Model (blue line) shows a ten

(10%) percent IRR can still be achieved even with ethylene

prices declining to US$ 0.27/lb., a spot price currently

below Mt. Belvieu spot ethylene prices.

Sensitivity 2 (orange line) reflects a twenty five (25%)

percent CAPEX savings generating a sixteen (16%) percent

IRR at a US$ 0.27/lb. ethylene price. Diligent management

of project CAPEX will allow more economic elasticity to

generate a positive IRR in economic environments where

ethylene commodity prices are declining.

However, the inverse is true if project CAPEX is not

managed well during project execution. Poor CAPEX

management will have severe economic repercussions on

the project’s IRR, and be magnified during economic

environments where ethylene commodity prices decline to

the US$ 0.27/lb. price used in the Model sensitivities.

Using this metric, Sensitivity 3 (brown line) reflects a

twenty five (25%) percent CAPEX overrun, and results in a

five (5%) percent IRR.

Sensitivity 4 (green line) reflects a fifty (50%) percent

CAPEX overrun, and a results in a zero (0%) percent IRR.


Conclusions

Part 3 Conclusions

Ethane Feedstock Prices For the foreseeable future, it is

anticipated that Mt. Belvieu spot ethane prices will trade

relatively flat in sync with Henry Hub spot natural gas prices

on an MMBtu basis. Other NGL’s including propane likely

will also maintain their commodity price discounts to WTI

spot crude oil prices. An abundance of cost-advantaged,

oversupplied ethane will be the key driver for new ethane

steam cracker projects.

Commodity Price Flexibility Petrochemical processing

margins are typically very tight, and operators need to

ensure project costs remain under control if they are to

recoup their original ethane steam cracker CAPEX

investment, and have commodity price flexibility should

offtake commodity prices decline.

Project CAPEX versus IRR Petrochemical operators’ focus

on project execution processes and controls must be the

number one strategic initiative during project execution.

Honfleur’s economic Model and associated Model

sensitivities reflect that project CAPEX, and the

management of such, has potentially more impact on IRR

than commodity prices.

Conclusions from Part 2 of this Series

Commodity Prices and Exports Though not intuitive at first

glance, the ethane to ethylene petrochemical industry in

the U.S. should be supportive of natural gas exports and

higher crude oil prices. Ethane cracker investors will find

that LNG exports will support and encourage upstream

producers to sustain and grow the flow of wet natural gas,

which in turn will ensure a steady and growing supply

volume of ethane for the petrochemical industry's use.

Doubly so for ethane steam crackers, a contrarian view on

crude oil will also support the competitiveness of ethane

versus naphtha fed steam crackers, which track crude oil

prices. Also, higher crude oil prices will support more crude

oil production, which will contribute to more associated

wet natural gas production, and therefore more NGL's,

including ethane.

Competition With the expansion in U.S. ethylene capacity

from ethane steam cracker projects in the planning stages

or under construction, there will be a need to supply

competitively priced ethylene. The increased ethylene

supply will force high cost ethylene producers to curtail

operations. Further, given the cost curve of delivered

ethylene globally, it is likely that some naphtha fed steam

crackers may find their ethylene capacity either curtailed or

shut down.

Project Management As only two ethane steam cracker

facilities have been constructed and commissioned in the

U.S. since 2002, there is a gap with any petrochemical

company’s ability to accurately benchmark the current and

proposed ethane steam cracker projects. As such, project

operators must place specific emphasis on project

management skills to provide the necessary oversight of

the EPC contractor and project in general. The form of

contract between project operator and EPC contractor

provides no assurance of timely scope achievement,

anticipated cost metrics, or operational performance.

Conclusions from Part 1 of this Series

Feedstock Sourcing U.S. petrochemical operators

developing ethane crackers must directly source and

contract long-term ethane feedstock supplies for their

specific capital projects. This entrepreneurial feedstock

sourcing effort will entail possible relationships with a)

other petrochemical operators, b) marketing companies

providing trading services tied to company-owned ethane

pipelines, c) fractionation plant operators, and/or d)

cryogenic plant operators (ethane recovery focus).

Strategic Partnerships Unless the petrochemical operator

is selling all ethylene output from their ethane cracker to

third parties (marketers, other petrochemical operators),

monetization of ethylene will be through ethylene

derivative products, sold domestically or through strategic

partnering arrangements allowing access to global offtake

markets. In most cases, strategic partnerships will offer

petrochemical operators greater economic flexibility over

those competitors without partnerships.

Capital Costs In order to achieve anticipated project IRR’s

as approved by Corporate Boards and Financial Credit

Committees, it is imperative that petrochemical operators

enhance their company’s operational expertise with capital

project expertise able to successfully manage multi-billion

dollar capital project budgets. Expertise will have a keen

understanding of the comprehensive project scope (both


operators scope versus EPC contractors scope), detailed

capital project costs (so that peer-to-peer communications

can occur between petrochemical operator and EPC

contractor), and project schedule (tied to productivity, with

best practice processes and controls to drive efforts).

Project Financing Some ethane cracker projects and

ethylene derivative facilities will be financed through

corporate balance sheets. However, many will be project

financed requiring careful consideration of all elements

demanded by equity and debt participants, with particular

focus on feedstock sourcing, strategic partnerships, and

capital costs. A structured project financing may be

required to facilitate a strategic partnership that is

satisfactory to the partners involved.

Authors Clay Jones is a Managing Partner at Honfleur LLC. Contact

him at [email protected] or (832) 282-1164.

Terrel LaRoche is a Managing Partner of Honfleur LLC.

Contact him at [email protected] or

(832) 527-9002.

Cheryl Ginyard-Jones is a petrochemicals subject matter

expert at Honfleur LLC. Contact her at

[email protected] or (703) 576-7847.

About Honfleur Honfleur LLC is a global provider of Independent Consulting

Services on capital projects. Our involvement allows

project operators to secure funding (equity and debt),

maximize project execution efficiencies, and increase the

likelihood of a capital project’s economic success. Visit

Honfleur LLC at www.honfleurllc.com

U.S. Ethane Crackers and Ethylene Derivative Capacity...

Documents

Transcript of U.S. Ethane Crackers and Ethylene Derivative Capacity...