Petrochemical margins across almost all global product supply chains are in dire straits, a concerning indicator for LPG and naphtha markets since the sector accounts for a fifth of world LPG demand and more than three-quarters of naphtha demand. The second quarter of the year is typically a period of recovery given that it coincides with petrochemical plant turnaround season, which tightens downstream supplies, and the seasonal demand lull for feedstocks.
That has not been the case in Q2 19. Most notably, in Asia, naphtha cracking margins for ethylene and polyethylene (PE) have hit 2009 recession levels, as have benzene-naphtha spreads. Our market soundings indicate that Q3 19 will not look much better, as the historical run-up to consumer goods manufacturing season ahead of bulk Christmas orders is threatened by waning consumer sentiment due to the escalating US–China tariff war. Demand is the culprit and looks weak worldwide. The European economy has slowed significantly since 2018, and any growth through year’s end will be tepid at best. Asia, under a cloud of uncertainty since the beginning of the US–China trade war last year, has seen very few green shoots. As new petrochemical capacity comes onstream worldwide all along the value chain, dwarfing demand growth, the market is in serious jeopardy. Neither the US nor China are giving way in their ongoing game of chicken, which does not help matters.
We have been pointing out the weakness in the polyethylene chain due to global overbuild of ethylene and polymers capacity and previously suggested that some margin reprieve could be had by maximising output of heavier co-products, such as aromatics. But now the weakness has spread to aromatics derivatives from those heavier co-products that constitute the building blocks of consumer electronics, car parts, tyres, and even clothing. Any activity surrounding talks between the US and China in the next few months will be closely watched. In July, another round of tariff hikes (from 10% to 25%) could go into effect on $300 billion of Chinese goods, including smartphones, toys and musical instruments. These are effectively back-to-school items and Christmas gifts that might never receive shipment orders or even get made in the first place.
We posit that should meagre margins persist, petrochemical producers are likely to throttle back on output, but not from newly-minted facilities. We expect plants tending toward the higher end of the cost curve will be the first to fall, namely ones that are older and more inefficient, as well as non-integrated units largely dependent on waterborne barrels. While there are already announcements of lower output in Japan and Germany, we also see the possibility of operating rate cuts at the older, non-integrated units in South Korea and Taiwan, which could back out as much as 14 thousand b/d of LPG and 0.17 mb/d of naphtha. Turning to the older, standalone olefins plants in Europe, we see as much as 70 thousand b/d of LPG and 0.1 mb/d of naphtha at risk should cuts or outright shutdowns occur.
Naphtha balances are therefore most liable to bloat y/y in this scenario, impairing prices as a result and rekindling the race to the bottom with LPG. But even with feedstock prices doing the heavy lifting to expand petrochemical margins, given the worrying signs of dragging demand that could worsen should US–China relations sour further, the emerging threat is from declining downstream prices.