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BUSINESS
March 19, 2001
Volume 79, Number12
CENEAR 79 12 pp.18-24
ISSN 0010-2347
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PETROCHEMICALS
Markets for ethylene and propylene were battered in 2000 by an unexpected leap in oil and natural gas prices

ALEXANDER H. TULLO, C&EN NORTHEAST NEWS BUREAU

It might be tempting to say that profitability in the petrochemical industry will steadily improve until it peaks again in 2003, and that thereafter the petrochemical cycle will move on like clockwork, unimpeded by unknown factors. However, the markets for the petrochemical industry's building blocks--ethylene and propylene--are much more complex than their simple chemical structures may suggest. Unforeseen events dragged down the petrochemical industry toward the end of 2000. Energy prices surged and have since remained higher than normal, increasing the cost of making ethylene and propylene around the world. The year also raised the specter of an economic slowdown. But there is good news: Consolidation may dampen the volatility of future petrochemical cycles.

7912-C18710
MORE ETHYLENE Nova Chemicals and Union Carbide's--now Dow's--1.3 million-metric-ton-per-year Joffre, Alberta, ethylene facility is part of a string of large North American expansions that started to come onstream last year.
North American ethylene makers are facing these and yet additional problems. Natural gas prices in North America hit unprecedented levels in 2000, even higher on an energy content basis than petroleum. This demolished profit margins at the end of the year and made some observers question the competitiveness of the North American ethylene industry. Moreover, a series of gigantic expansions started to come onstream in 2000, and North American makers of polyethylene, ethylene glycol, polyvinyl chloride, and other derivatives will need until well into 2002 to absorb all this capacity.

As a whole, though, 2000 wasn't a bad year for ethylene makers, according to Mark Eramo, business director of light olefins at CMAI, a Houston-based consulting firm. The average profit margin in North America was about 10.5 cents per lb last year, he says, compared with 8.3 cents in 1999.

"Prices were high and energy subsided somewhat, so there were tremendous margin expansions through the first half of the year," Eramo says. "But during the second half of the year, gas started to get out of control, leading to very low margins."

PRODUCERS AGREE with Eramo's assessment. "For the past two years in a row, we predicted low-margin years for ethylene," says Bruce Bush, manager of natural gas liquids and olefins for Chevron Phillips Chemical. "And for the past two years, we exceeded our budgets. It wasn't until the last quarter of 2000 that we saw a complete unraveling of the industry."

About 50% of the ethylene capacity on the Gulf Coast and all the ethylene capacity in Alberta, the two main North American production areas, use ethane as feedstock. Because ethane is originally extracted from natural gas and is sometimes used for its energy value, the natural gas market usually drives the ethane price.

After starting 2000 at around $2.00 per million Btu, the price of natural gas quadrupled by January this year. As a result, ethane-based ethylene producers throttled back production. Meanwhile, naphtha-based ethylene crackers ran at high operating rates because naphtha, which is driven by oil prices, enjoyed an advantage. For example, Chevron Phillips took down two smaller ethane-based units at its Sweeny, Texas, complex in early December.

Equistar, because two-thirds of its capacity is based on heavy feedstock, wasn't hurt as much as most companies. However, the company idled its Lake Charles, La., cracker, where it has light feedstocks for ethylene production.

Dan Boivin, president of the olefins/polyolefins business for Canada's Nova Chemicals, notes that ethane-based producers on the Gulf Coast reduced production by about 30% on average, while Nova cut back production by only 25%, including at its 1.3 million-metric-ton Joffre, Alberta, ethylene cracker, a joint venture with Union Carbide that it completed last fall.

Dow obtained Carbide's share when it merged with Union Carbide last month.

Europe, which had no natural gas spike, had a reasonably good year, according to Scott Roberts, vice president of lower olefins for Shell Chemicals. "Naphtha was high for part of the year, and that made life a little bit difficult. But by and large, even though demand didn't grow much in Europe and things were a little tough on the downstream environment, profitability was reasonable for crackers," he says.

Asia, however, was less healthy last year, Roberts says. The first half of the year was profitable and demand grew, he notes. "But the second half of the year was difficult, as naphtha moved up and demand slowed down in China."

7912bus2.ce Besides the capacity expansion in Joffre and from a couple of other smaller projects that came onstream in 2000, more new capacity this year may weaken the North American market. BASF and Atofina are starting up the world's largest naphtha-based cracker, representing about 900,000 metric tons of ethylene per year. Formosa is completing an ethylene cracker that will have capacity in excess of 800,000 metric tons.

"This is going to be a difficult year," says Theo Walthie, Dow Chemical's president of hydrocarbons and energy and ethylene oxide and glycol, who notes that the capacity that is coming onstream this year, mostly in the U.S. and the Middle East, will reduce plant operating rates by 4 to 5% globally.

Walthie says Europe, on the other hand, has been building capacity more conservatively. In fact, he points out that the only major capacity coming onstream in the region is Dow's own 600,000-metric-ton expansion in Terneuzen, the Netherlands. "Europe realized that it could not grow its export position competing with the Middle East, and therefore it became kind of a huge market on its own. Investments were made accordingly, even to the tune of being a little too low," he says.

NORTH AMERICAN ethylene margins are expected to drop down to about 8 cents per lb again in 2001, CMAI's Eramo says, improving each subsequent year. "After BASF and Formosa, there's nothing of any great significance on the drawing board, so second-half 2002 and 2003 are going to be really strong," he says.

Eramo forecasts a global annual growth rate for ethylene of about 5% through 2005. Growth in North America will be about 3.5%, with about 2.5% growth in Western Europe.

Eramo stresses that these figures do not account for a major economic slowdown or recession. However, he notes such events would not affect the forecasts dramatically. He explains that about 75% of ethylene is sold into nondurable markets, such as polyethylene shopping bags and milk jugs. The rest is mostly polyvinyl chloride applications, such as pipe.

The next petrochemical cycle will probably be tempered by the round of consolidation that the industry has just been through. Consolidation like the Dow/Carbide merger and the formation of Chevron Phillips prevents overbuilding by allowing companies to team up on new capacity rather than having to build separate world-scale plants on their own.

For example, Nova's Boivin says that was the case with the new Canadian cracker. "While the cracker may be a big one, it's probably smaller than the amount of capacity that would have been added by separate companies. The same thing, no doubt, is happening in the U.S.," he says, noting the BASF-Atofina unit.

It is also happening in Asia. Exxon and Mobil each had plans for a cracker in Singapore. Now that ExxonMobil has built one of them, the company will likely expand it instead of building another one.

REGIONALLY, the health of the ethylene industry might change. Since the spike, natural gas prices have eased to about $5.00 per million Btu, roughly in line with oil prices on an energy content basis, but still much higher than usual.

Ethylene producers fear that during the next two years natural gas will stay relatively high, undermining the competitive advantage that North America has enjoyed in global markets for ethylene derivatives. In addition, Eramo says the recent natural gas crisis may have caused ethylene suppliers on the Gulf Coast to rethink their feedstock requirements for future expansions and new ethylene crackers.

Normally, Eramo says, when naphtha-based cracker coproducts such as propylene and butadiene are taken into account and natural gas trades at around $2.00 per million Btu, ethylene producers on the Gulf Coast enjoy a 2- to 3-cent-per-lb advantage, on a cash cost basis, over ethane-based ethylene.

With gas prices between $3.00 and $4.00, Eramo says, ethylene makers dependent on ethane may look for more flexibility and will build more naphtha-based crackers. "The difficulty is that naphtha crackers require more capital because they generate a significant amount of coproducts," he explains.

Eramo points out that spikes in feedstock prices won't be the norm, but gas could become more costly because of the increasing reliance on it for energy. "There are changing fundamentals in natural gas supply and demand," he notes.

Nova's Boivin warns that high prices for natural gas threaten North American petrochemical makers. "The price of natural gas has gone up a lot more than the price of oil, and if that remains the case then we're not going to be able to export the way that we used to and the industry is not going to grow the way it has historically," he says.

"We just had one blip, but it was a very significant blip," Shell's Roberts says. "The U.S. is a major exporter of petrochemicals, and if they are overpriced because of natural gas, it could significantly change the outlook for the U.S."

The natural gas situation in Alberta has improved, but over the long run, Alberta faces a partial erosion of its "Alberta advantage," its low-cost position in natural gas and ethane extraction.

7912bus3aerial
REDUCED RATE Dow's Fort Saskatchewan, Alberta, ethylene unit is one of many North American ethane-based crackers that felt the impact of high energy prices in the past year.
The huge natural gas reserves in Canada, because of limited pipeline capacity, used to be isolated from the lucrative energy markets in the U.S., according to Eramo. As a result, natural gas and thus ethane have been cheaper in Alberta than on the Gulf Coast, creating an incentive to use them as petrochemical feedstocks. "In 1999 and 2000, the Alberta advantage was as high as 10 cents per lb," Eramo points out.

THE FEEDSTOCK ADVANTAGE is being diminished by newly constructed pipelines, such as the Alliance Pipeline completed last year from British Columbia to the Chicago area. "There's a straw in the glass of the Alberta ethane supply," says Mark Noetzel, BP Chemicals' group vice president of olefins and polymers in the Americas and Asia, who estimates that the Alliance Pipeline can carry about 70,000 barrels of natural gas liquids--ethane, propane, and heavier hydrocarbons--out of Canada each day.

"Now the gas in Canada has access to a higher value market, and we expect that price to be higher than it was in the past," Eramo notes.

Boivin has already observed this effect. "The price of natural gas in Alberta is essentially the price of the U.S. market less the transportation costs to get it there," he says.

Most observers agree that it may be many years before there is another major ethylene expansion in Alberta. The region already has its hands full with the Joffre unit, Eramo says. "Theoretically, the Joffre cracker took the last easy increment of ethane that was available to the petrochemical industry," he says.

"There's going to be a wave in the future, but it's probably a few years off," Boivin says. "Most likely, it is dependent upon the next round of getting natural gas supplies and the development that comes out of the north, whether it is the Canadian Northwest Territories or Alaska."

In the U.S., new air quality standards, such as those being proposed by the Texas Natural Resource Conservation Commission, might also affect the long-term competitive advantage of ethylene makers, particularly near Houston. The standards are meant to reduce pollution in the nonattainment area--the eight counties around Houston where pollution levels chronically exceed national standards.

According to the proposal, point sources of nitrogen oxides (NOx), such as furnaces for ethylene crackers, must reduce NOx emissions by 90%. Plants will be required to achieve 44% of this reduction by April 2004, 89% by April 2005, and the rest by April 2007. The proposal also includes a trading system for emissions credits.

Though these regulations are more lenient than those originally proposed, some ethylene producers say they will be very expensive. For example, Chevron Phillips' Bush speculates it could cost his company as much as several hundred million dollars.

Bush says these restrictions could damage the competitiveness of the U.S. petrochemical industry. "Regulations like these will basically force people to go to the Middle East or somewhere where you can still get a permit to produce these products," he says.

BUT NOT EVERY chemical company is against the regulations. BP says it can work with the rules and remain vital at the same time. The company plans to build cogeneration plants that will reduce NOx emissions at its Chocolate Bayou, Texas, refinery and chemical complex by 34%. Furthermore, BP plans to expand ethylene capacity at Chocolate Bayou by 270,000 metric tons, an action that will also reduce NOx emissions, on an average basis, according to BP's Noetzel. "Those projects plus a number of smaller projects at the refinery and the chemical plants can get us a fair way toward the 90%," he says.

Although Asia rarely has feedstock advantages, it is an enticing market for petrochemical makers because of its high growth. According to Eramo, demand in Northeast Asia--which includes China, Korea, and Japan--is forecast to grow at 4% annually through 2005. Southeast Asia is forecast to grow at 10.5% per year. Last year and the beginning of 2001 saw significant progress in the region on ethylene projects, especially in China.

BP, China Petroleum & Chemical Corp. (Sinopec), and Sinopec subsidiary Shanghai Petrochemical Co. have completed a feasibility study on a $2.7 billion ethylene project in Shanghai. The proposed naphtha-based cracker will have ethylene capacity of about 900,000 metric tons per year, with about 450,000 metric tons of propylene capacity, plus derivatives for each. Start-up is slated for 2005. "The degree of alignment we have with Sinopec and the authorities in Shanghai is quite remarkable," Noetzel says.

Five other ethylene cracker joint ventures are scheduled for China, with varying degrees of progress. Last fall, Shell signed a joint-venture agreement with China National Offshore Oil Corp. for an 800,000-metric-ton ethylene cracker in Daya Bay slated for completion in 2005.

BASF is believed to be ahead of the pack with its 600,000-metric-ton integrated chemical complex in Nanjing, expected to be operational by 2005. BASF and Sinopec have awarded Stone & Webster the construction contract. Dow, Chevron Phillips, and ExxonMobil are planning projects that will come onstream much later.

Noetzel says that, after an initial round of foreign investment, it will actually become more difficult for new greenfield chemical complexes to be approved in China. "When they have the world-scale assets, expanding and debottlenecking those facilities are actually the most cost-effective routes for China to grow," he says.

The Middle East is also being developed for the huge Asian market. It is the lowest cost region in the world in which to produce ethane-based ethylene because of its own reserves, which are not tied to overseas fuel markets. As a result, ethane can be sold at a fixed price in Saudi Arabia that is about one-quarter of the price on the Gulf Coast, according to CMAI's Eramo.

THIS EDGE has led to a flood of players in the region eager to upgrade ethane into products for export. "The region has gone from burning the ethane to running it through a steam cracker and selling polyethylene and ethylene glycol around the world," Eramo says. He estimates that in 1990 the Middle East had about 5% of global ethylene capacity. In 2000, it was at 7%. He forecasts its market share will jump to 10% by 2010.

Global petrochemical makers have been eager to invest in the Middle East. ExxonMobil has completed two integrated cracker complexes with Saudi Basic Industries Corp. (SABIC) over the past year. One is the 700,000-metric-ton Kemya plant in Al Jubail, and the other is the 800,000-metric-ton Yanpet partnership in Yanbu.

"The Middle East has become a very important supplier to the other regions of the world since the mid-1980s," says Goran Martinsson, olefins product executive at ExxonMobil Chemical. "It is important to be a low-cost producer in the truly global light olefins and derivatives businesses, and some of the world's most competitive plants are located in the Middle East."

Chevron Phillips and joint-venture partner Qatar General Petroleum Corp. are building a 500,000-metric-ton ethylene unit in Qatar. Chevron Phillips' Bush says the deal isn't quite as lucrative as those found in Saudi Arabia, but it is close. "Ethane prices have been our nemesis for the past couple of years on the Gulf Coast. Our Middle East deal has a great advantage over the Gulf Coast," he says.

Dow obtained a Kuwaiti ethylene joint venture through the Union Carbide merger. This asset is a key pickup for Dow, one that it would like to leverage. "The plants are stretched, running at over 800,000 metric tons. So it is already running more than was expected," Walthie says. "An expansion is up to our partner in Kuwait, and we are encouraging them to be bold."

Propylene's year was mixed. Demand for polypropylene, which normally drives propylene growth, slowed significantly. "The propylene chain has struggled mightily as of late, and a lot of propylene derivatives--polypropylene foremost among them--are in difficult shape right now," says BP's Noetzel, adding that he doesn't expect improvement this year.

Steve Zinger, director of propylene for CMAI, forecasts global growth of about 4 to 4.5% over the next two years, a little slower than normal. "Polypropylene is propylene's biggest derivative, and it goes into a lot of durable end uses, like automotive applications and carpeting. Those are the sectors that tend to get hit by an economic slowdown," he explains. Propylene oxide, which is used in polyurethanes, can also be hit somewhat by an economic downturn, he adds.

On the supply side, a number of factors have come into play. Naphtha-based crackers produce propylene that is used for chemicals and polymers. Refiners, however, have a number of uses for the propylene generated as a coproduct while making gasoline in fluidized catalytic crackers. Propylene can be purified and sold to chemical markets, alkylated for incorporation back to the motor gasoline stream, or used as fuel at the refinery itself.

In 2000, even with a booming energy market, rising propylene prices made it profitable for refiners to sell propylene on chemical markets, Zinger says. The margin of recovering propylene compared to leaving it at the refinery was 5 to 6 cents per lb. In the two previous years, the difference was less than 2 cents.

However, as natural gas peaked at the beginning of the year, this situation started to change. "There were many refineries that were burning the refinery-grade propylene as a means to replace expensive purchases of natural gas," Zinger says.

Bush says ethylene producers added some propylene to the North American market during the second half of 2000 by using heavier feedstocks. "But there wasn't a lot of overburden because the refiners pretty much took it off the market. If you had the ability, when gas was $10 per million Btu and propylene was 20 to 21 cents per lb, it made sense to burn it. It was worth quite a bit more in fuel than it was in the marketplace," he says.

THE PROPYLENE SUPPLY this year can still be influenced by two factors. The newly completed Formosa and BASF-Atofina crackers will add propylene to the marketplace by the end of the year and into 2002. On the other hand, alternative uses remain unpredictable. "This summer, it depends on where alkylation and motor gasoline values go," Zinger says. "That's a repeating event of last year, and it's possible that propylene prices could stay strong through the summer."

However, because there haven't been many projects in propylene coming onstream in North America over the past year, Zinger forecasts a fairly profitable year for propylene makers. "In 2001, there will be some incentive to extract propylene again. But 2002, because of all the projects coming on at the end of this year, will probably be somewhat depressed," he says.

In the longer term, Zinger expects growth in propylene derivatives to bounce back, creating global growth of about 5.5% per year on average over the next five years. He believes the North American market will tighten by the end of 2002. The European and Asian markets will have to wait longer. Projects due to go onstream in both regions next year will weaken markets through 2002.

7912bus3.ce Derivatives will strengthen as well. "Polypropylene is growing at 7 to 8% per year," one propylene observer notes. "Of all the polymers, polypropylene has the greatest growth potential. As a result, I see propylene demand at least as strong as ethylene, if not stronger."

But companies build ethylene crackers because of ethylene, not propylene. As propylene demand outstrips ethylene supply, the chemical industry will need more propylene from refineries and other sources. "There is a potential inherent shortfall of propylene from heavy crackers, which implies propylene is going to have to come from somewhere else, and you have to turn to the refineries," the observer says.

In North America, this is a pretty straightforward problem because there is plenty of untapped propylene in the region's vast refinery infrastructure. "Whenever the price of propylene stays high enough for a while, more propylene recovery takes place," Dow's Walthie explains.

EUROPE, HOWEVER, is different, Walthie points out. "The European scene will hardly change. It is already a naphtha-cracking region, and new fluidized catalytic cracker projects are relatively nonexistent," he says. "Most of the propylene is already being recovered. The propylene supply will grow, but only in line with ethylene production," he says.

BP's Noetzel believes there could be some available propylene in the refining infrastructure in Europe. "A lot of European propylene comes out of crackers rather than refineries, but people are waking up to the refinery's potential," he says.

On the other hand, Noetzel says there are fewer refinery propylene possibilities in Asia, where Asian refineries tend to be small. Even when there is refinery propylene, there isn't usually enough to warrant integrating it with derivatives plants. "Propylene supply in Asia is going to remain an issue," he notes.

There has been more investment in another propylene source, propane dehydrogenation, where propane is converted directly into propylene. This process is usually thought of as uneconomical and relegated to places where propylene is needed but no ethylene crackers or refineries are available.

However, there are two pending dehydrogenation projects in Saudi Arabia, where, as in the case of ethane, there is an abundance of propane. National Industrialization Co. of Saudi Arabia has a 450,000-metric-ton unit scheduled to come onstream in 2003, and Alujain Corp. recently announced it would build a 350,000-metric-ton unit for start-up in 2004.

"Saudi Arabia is one of the largest exporters of propane in the world. I would imagine it could support several propane dehydrogenation units," CMAI's Zinger says. "But the advantage that the Middle East brings to the propylene chain isn't as strong as the advantage for the ethylene chain."

Walthie doesn't think dehydrogenation can work economically, even in Saudi Arabia. He says the major difference is that propane isn't trapped like ethane. It can be exported and sold into energy markets. "You can refrigerate propane, put it on a ship, and send it to fantastically interesting markets," he says.

Even with capacity coming onstream and high energy prices around the world, petrochemical markets will do what they always do: recover. "It's a pity that we have too much capacity coming on," Walthie says. "But it isn't disastrous by any means." Most in the petrochemical industry agree that 2001 won't be the petrochemical industry's best year, but they are confident as they can be that things should start to improve in 2002.

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