Battle Royale

Published at 10:58 4 Feb 2019 by . Last edited 11:18 22 Aug 2019.

Winter finally came for LPG markets as dangerously cold weather settled upon the major consumption regions of the US, northeast Asia and Europe, exacerbating shipping delays in the Mediterranean and tightening up barrels and prices globally. But once the chill abates, a new question will emerge: amid the rush of new supplies and with more product hitting the water, can LPG compete with naphtha to keep its majority share in the global petrochemical feed slate?

Our recent client meetings in Houston brought this question to the fore. There are fresh concerns surrounding the competitiveness of LPG as a petrochemical feedstock, especially in H2 19, in the face of overwhelming bearishness surrounding an already soft naphtha complex.

What has changed? Part of it is the recent price strength in LPG amid the bitter cold and January restocking, which has provided a floor of support that is likely to remain in place through February. The most recent data from China, India and Indonesia point to rising LPG demand in the early part of this year coming from new petrochemical units (China) or looming elections (India and Indonesia), but the continued naphtha oversupply has really been the differentiating factor. The market is already drowning in light sweet crude and is short diesel, but the OPEC+ cuts and the US sanctions on Venezuela will compound tightness in sours ahead of IMO 2020.

To meet the IMO requirements, refiners either keep going with the predominantly light crude slate they have—aggravating the gasoline oversupply and crushing naphtha prices—or cut runs, which still adds to the naphtha length but also aggravates the shortness in distillates. On top of that, heavy cracker maintenance in Q2 19–Q3 19 will push more naphtha barrels into the Med at a time when new production, especially from Turkey, is nearing full operating rates.

As global LPG-naphtha swaps have narrowed considerably over the last few months, Asian values in particular are teetering on the switching threshold. But our soundings from the petrochemical sector indicate they require stable signals from forward values going out three to six months before flipping the switch from LPG to naphtha. We think that switch will get flipped first in Asia in H2 19.

The tipping point could arrive when a slowing global economy collides with the deluge of new olefins and polyethylene units during that time, which is the expectation of many we spoke with in Houston and Asia recently. Should that occur, the petrochemical sector is likely to look at reducing operating rates and/or minimising the production of ethylene and polyethylene while upping that of more premium-priced co-products. At that point, we believe the feedstock choice will come down to butane and naphtha.

The current spike in heating demand and its tightening effect on barrels around the globe is effectively masking significant fundamental softness that lies in wait in H2 19. As such, LPG and naphtha price action from Q2 19 onwards will be dictated by this race to the bottom as excess barrels looking for new homes will price themselves to move.

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