Fettered flexibility

Published at 14:25 1 Apr 2019 by . Last edited 11:18 22 Aug 2019.

The market is waking up to the cold reality that the ever-lightening global crude slate will result in oversupplied gasoline and naphtha markets. The assumption then becomes that naphtha will decline sufficiently to price itself back into the petchem cracking pool from Q2 19. On paper that might seem like a sound assumption. The global olefins fleet is heavily weighted toward naphtha as it comprises the bulk—54%—of the world’s cracking feed slate. But in practice, other factors come into play, such as upstream captive feedstock and on-site downstream commitments.

Our analysis indicates that though 51.8% (91.21 Mtpy) of the world’s cracking fleet can process more than one feedstock, only 9.4% (16.49 Mtpy) has a high probability of doing so. Regionally speaking, Europe has the most flexible fleet and has demonstrated its price sensitivity time and again. We determined 42.9% (7.84 Mtpy) of Europe’s flexi-crackers could flick the switch, followed by Asia excluding China (17.8%, 4.58 Mtpy). Should European and Asian crackers find naphtha to be the more favourable feedstock and the units we have pinpointed in this report do make the switch, incremental naphtha demand could total 0.56 mb/d, or 7.2% of total naphtha demand, and 0.37 mb/d of LPG demand (3.7% of total demand) would then be at risk.

Other regions show less promise. Having heavily weighted itself toward ethane cracking thanks to robust shale production, North America has severely restricted its flexibility to 3.5% (0.98 Mtpy). China is in a similar situation but with naphtha, with little flexibility and probability of switching away from that feedstock. This will change a touch when two new ethane-fed crackers come online this year and next. Finally, although the Middle East’s ethylene plants appear to have a fair amount of flexibility, these units and the region itself are self-sufficient in terms of feedstock and are unlikely to draw on international supplies.

We see significant downside risk in H2 19 for plastics pricing as a slowing global economy meets a rush of new olefins/polymers capacity. As such, narrowing global polyethylene (PE) margins suggest operators will likely turn to heavier liquids as a way of dialling back ethylene output when PE unit operating rates are reduced. We saw early indications of this expected decline from some petchem producers’ downward revisions of Q1 19 revenue guidance. Additionally, Asian and Northwest European PE margins have begun weakening since mid-March on slowing demand and robust stocks. European margins are in the same boat, with a recovery after the crude price slump in Q4 18 stymied by the onslaught of US PE exports and an economic downturn.

But those expecting the overabundance of naphtha to be remedied by placing the excess barrels into the petchems cracking pool will be disappointed given the maximum uptick in demand is relatively minor. The flexibility of most crackers that have some design capacity to burn more than one feedstock is something of a misnomer once geography and long-term upstream and downstream commitments are layered on. Furthermore, we do not expect to see the full potential of the naphtha switching we identified to materialise as forward cash cost estimates change over time and propane-naphtha spreads fluctuate regionally. It will ultimately be left to prices to do the heavy lifting, either falling in the upstream to stem the gush of supplies, or falling in the downstream, which would be more of a longer-term remedy to rejuvenate demand. 

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