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The U.S. industry was knocked down hard last year; what's getting back up is a more inward looking sector, less reliant on exports

Industry goes through its occasional slumps, but 2001 was an expecially bad year

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[C&EN, March 19, 2001]

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March 18, 2002
Volume 80, Number 11
CENEAR 80 11 pp. 21-26
ISSN 0009-2347
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SCALE Capacity at Dow Chemical's cracker in Terneuzen, the Netherlands, was expanded by 1.3 billion lb last February.


Most observers agree that the U.S. petrochemicals business couldn't get worse than it was in 2001. The year began with natural gas costs at record highs and ended with a recession much more severe than most people expected. Moreover, massive capacity expansions started up over the past year and a half in North

America and the Middle East, digging a hole too deep for U.S. producers to climb out of.

The situation was so bad that roughly 6 billion lb of U.S. ethylene capacity lay idle last year, according to Mark Eramo, an ethylene analyst at the consulting firm Chemical Market Resources Inc. (CMAI). In fact, three ethylene crackers--too old and unproductive for further investment--will be decommissioned.

To many observers, 2001 was reminiscent of the early 1980s, the last time U.S. ethylene producers faced such severe capacity rationalization. The observers warn that, like then, more crackers will be closed.

In fact, many experts question the very future of the U.S. ethylene industry. They see the center of gravity shifting from the Gulf of Mexico to the Persian Gulf, where feedstocks are cheaper. Some change in the U.S., they conclude, is inevitable.

Last year began with natural gas trading at about $10 per million BTU--four times higher than at the beginning of 2000--because of a cold winter and a natural gas supply shortage. This made natural gas a much more expensive source of energy than crude oil, which at the time was about $30 a barrel. The natural gas price is critical for the U.S. ethylene industry because most ethane, the feedstock for about two-thirds of North American operations, is derived from natural gas.

Though producers knew $10 gas was only temporary, many feared that gas would chronically trade at $3.00 to $4.00, about twice as high as it traditionally has been. However, natural gas fell in 2001 as quickly as it rose the year before, ending the year at just over $2.00, its lowest level in two years. Meanwhile, crude oil prices declined by a third, to about $20.

MORE MENACING than natural gas prices to producers was demand. By midyear, a recession worse than most observers expected hit the U.S. economy and was exacerbated by the Sept. 11 terrorist attacks. In the end, Eramo says, U.S. ethylene demand fell a record 10% last year and global demand rose by only 0.5%.

In 2001, according to Bruce Bush, general manager of natural gas liquids and olefins for Chevron Phillips Chemical, the U.S. lost about 8 billion lb of ethylene demand out of the 55 billion lb it had the year before. "We went back to 1996 levels," he says. "We lost all the growth we had in 1997, '98, and '99--which were huge years."

Like many other industry observers, Earl Armstrong, with DeWitt & Co., says the decrease in demand came from the domestic economic decline and the disappearance of the export market for most of the year because of high energy costs.

Armstrong explains that natural gas is priced regionally and is traditionally cheaper in the U.S., on an energy content basis, than heating oil, which has a price based on globally traded crude oil. As a result, the hydrocarbon content of ethane and propane is usually cheaper than that of crude oil.

The relative position of the two feedstocks shifted, Armstrong notes, with the rise and fall in prices over 2000 and 2001. "Natural gas and crude oil hydrocarbon are now fairly equal," he says. "The biggest market is the Asian market, and prices there are being set by Middle East-derived material. The U.S. has had a hard time stacking up against that. It is not an absolute blockage as it was at the beginning of last year, but it is still a very difficult market to sell into."

In addition, U.S. producers say, some volumes were lost because of destocking of inventories of plastics and other derivatives. Furthermore, a flood of finished goods made from petrochemicals and plastics was imported last year.

The business climate last year was too much for some older ethylene units to handle. In December, Chevron Phillips closed a 400 million-lb line--built in 1957--at its Sweeny, Texas, complex.

Theo Walthie, business group president for hydrocarbons and energy and ethylene oxide/glycol at Dow Chemical, says crackers in Seadrift and Texas City, Texas--spoils of the Union Carbide acquisition--will eventually be closed. He says Seadrift is being affected by legislation against volatile organic compounds; Texas City is being closed because of inefficiency at the unit and potential nitrogen oxides (NOx) regulation in the Houston area. "We cannot run much beyond 2005, and potentially, we can shut down earlier," he says.

The company will replace the two crackers with another that will be built in either Seadrift or Freeport, Texas. "This is a shut-down-and-make case," Walthie says. "But we will replace with less than what we shut down."

Walthie doesn't believe these will be the last plant closures in the ethylene industry. "We expect many people will have the same dilemma," he says. "Are you going to invest sizable amounts of money in facilities which are either too small or too old to be competitive anymore?"

In addition, Walthie says other crackers are threatened by regulations being proposed by the Texas Natural Resource Conservation Commission (TNRCC) that would reduce NOx emissions 90%, in stages, by April 2007. "On the U.S. Gulf Coast, there will be a need for renewal, and maybe a need for more consolidation and phaseout," Walthie says. "There are a lot of vintage ethylene plants that don't have eternal life, in particular, when they are confronted with legislation on NOx."

Chevron Phillips' Bush says the regulations factored into his company's decision to scrap the unit in Sweeny.

Richard V. Pisarczyk, senior vice president of basic chemicals for ExxonMobil Chemical, calls the NOx regulations "draconian reductions, for which technology has not been demonstrated," and favors a moderate approach that is more achievable. "We have been involved with the business councils, EPA, and TNRCC to help put in a logical and rational set of regulations for ozone and NOx in Houston," he says.

"The market is in balance today, so we have hit the bottom. The question is, Will prices move back up again? It depends on whether the economy recovers."

IN ADDITION TO the permanent closures, several other ethylene units were idled for most of last year, although their owners say they will eventually be restarted. Equistar has had its 850 million-lb Lake Charles, La., unit down since February 2001, but the company expects to start it again.

Huntsman Corp. idled its 400 million-lb line in Port Neches, Texas, last May, according to Doug Culpon, Huntsman's vice president of petrochemicals. "We still believe the unit is viable in the long term," he says. "We are planning to restart it by Dec. 1, assuming economic conditions justify the restart."

Chevron Phillips has had a 650 million-lb unit down since last year at Sweeny. Bush says the company will evaluate restarting it when there is enough demand.

Yet capacity has been added in the U.S. ethylene market as well. A joint venture between BASF and Atofina finished a cracker in Port Arthur, Texas, last October; started it up in late December; and was operating it at 80% of capacity by the end of February. The unit has a capacity for 2 billion lb of ethylene and 1.2 billion lb of propylene, making it the largest single-train naphtha-based cracker in the world.

"Market conditions did not delay the plant," says Paul Nornes, olefins business director for Atofina in the U.S. "For a grassroots cracker, it was a reasonable start-up. We have been working on getting the rate up."

Carl A. Jennings, executive vice-president at BASF Corp., says the key economic advantages of the cracker are its scale, integration with Atofina's nearby refinery, eventual metathesis of low-cost butene and ethylene into propylene, and flexibility to use different grades of feedstocks. "We think these four factors contribute $100 million in annual savings compared to a smaller scale nonintegrated cracker without metathesis," he adds.

Formosa Plastics started up its 1.8 billion-lb ethylene cracker in Point Comfort, Texas, last month. The unit was originally completed in July. It also started up polypropylene and polyethylene units downstream.

Another massive expansion that had an impact on the market last year was the 2.8 billion-lb Nova Chemicals/Dow ethylene cracker in Joffre, Alberta, that started up in late 2000. The unit is already the largest ethane-based cracker in the world, and Dow's Walthie would like to see it expanded even more--to about 3.1 billion lb, and likely more--through improvement projects.

The sharp decrease in demand had a severe effect on operating rates in 2001, DeWitt's Armstrong says. "Normally when we go though a steam-cracker expansion phase, it is characterized by a bottom operating rate of maybe 88 or 89%," he says. "This time, we've been down another 10%."

However, profit margins for ethylene only declined to 8.9 cents in 2001 from 10.5 cents per lb in 2000, according to CMAI's Eramo. "One phenomenon you saw here is that energy costs pushed everything up at the beginning of the year, and then energy corrected itself at a much faster rate than ethylene did, so you end up with margin expansion in a year that was miserable in terms of supply-and-demand fundamentals."

However, the reasonable profit picture didn't extend to ethylene derivatives, which also faced overcapacity and declining demand. This weakness, Eramo says, is what drove producers to throttle back capacity later in the year, whereas natural gas prices were the cause earlier in the year.

By way of comparison, European and Asian ethylene markets fared better than those in the U.S. "Europe held up reasonably well in 2001," ExxonMobil's Pisarczyk says. "We lost some margins in 2001, but not as much as the U.S.," he says, noting that Europe maintained operating rates of about 90% until the fourth quarter, when a seasonal slowdown and unease over the Sept. 11 attacks depressed the market somewhat.

DOW'S WALTHIE says the ethylene industry in Europe typically runs at higher operating rates than in the U.S. "European producers, after 1982, made the decision that they would adjust their supply because of Middle Eastern production and the reality that Europe would become a net importer of ethylene derivatives," he says. In fact, Dow's own 1.3 billion-lb addition in Terneuzen, the Netherlands, in February, is the only recent major European capacity increase.

Like ethylene, propylene faced a severe downturn in demand, according to Steve Zinger, an analyst at CMAI. Demand dropped by 4% in the U.S. and increased only 0.5% globally. "Prices dropped in 2001, so from a producer standpoint, it was a really bad year," he says.

Zinger says the problems faced by U.S. ethylene makers caused volatility in propylene last year. With high natural gas costs, producers opted for heavier feedstocks, which led to more by-product propylene coming from crackers and a fall in prices.

The decrease in prices, Zinger explains, led refiners to use propylene for energy purposes instead of chemical markets. But by midyear there was a propylene shortage as energy prices eased and chemical makers cracked ethane again. Propylene extraction for chemical markets looked good to refiners once more.

Following Formosa and BASF/Atofina, only smaller expansions will occur in North America. Shell is restarting a cracker in Deer Park, Texas, that it decommissioned in the early 1980s. Arie Hoogenboom, planning manager for lower olefins at Shell Chemicals, expects the project to start up in 2003 with 1.1 billion lb of capacity.

ExxonMobil is making improvements at its Baytown, Texas, unit--including the installation of new furnaces--that will increase capacity by about 250 million lb later this year. Likewise, BP is considering expanding its Chocolate Bayou, Texas, plant by 550 million lb through improvement projects.

Middle East and Asia account for large share of world ethylene capacity

North America 19,604 40% 34,813 33%
Western Europe 14,215 29% 22,113 21%
Northeast Asia 7,055 14% 19,700 19%
Middle East 643 1% 8,770 8%
Southeast Asia 322 1% 5,729 5%
South America 1,289 3% 4,468 4%
Former Soviet Union 2,210 5% 3,916 4%
Indian subcontinent 248 1% 2,626 3%
Eastern Europe 2,655 5% 2,520 2%
Africa 320 1% 1,510 1%
TOTAL 48,561
Source: Chemical Market Associates Inc.

MOST PRODUCERS expect some improvement in the U.S. ethylene industry sometime during the second quarter of 2002, depending on the timing and strength of the rebound in the U.S. economy. There will then be a relatively steady recovery in 2003 and 2004, with the next peak in the profit cycle occurring by the end of 2004 or beginning of 2005.

"I'm cautiously optimistic," says Andrew Mackenzie, vice president of North America for BP Chemicals. "Indications are we've hit the bottom."

Some producers say ethylene oxide and glycol will be the first ethylene derivatives to improve, because no new capacity is on the horizon. "Ethylene glycol is starting to see some recovery in demand and prices in the U.S. and Asia," Huntsman's Culpon says.

DeWitt's Armstrong says ethylene operating rates have already climbed to as high as 83%. But a return to normalcy in ethylene markets depends on the economic recovery and how much additional capacity gets shut down.

"We are at the point where the U.S. has one of the best opportunities to rationalize capacity," Armstrong says. "Whether or not that happens will have a lot of impact on how quickly we see a recovery."

BASF's Jennings is more bullish on the recovery, estimating that by the end of the year, the ethylene market will return to an annual growth rate of 5 to 7%. "Nevertheless, with 10% of demand lost, it will take at least a year and a half to get back," he adds.

CMAI's Zinger expects propylene to follow a similar pattern, with its next peak occurring in 2004 or 2005. "The market is in balance today, so we have hit the bottom," he says. "The question is, Will prices move back up again? It depends on whether the economy recovers."

Even though the worst is likely behind the U.S. petrochemical industry, fundamental shifts in the global market do not work to its favor, and its ability to export to Asia-Pacific is likely to fall. "Gradually, the proportion coming from the U.S. manufacturing base will go down," Shell's Hoogenboom says. "China will fill its needs both by inland construction and by increasing its imports. Those imports, to a smaller extent, are coming from surrounding countries, and to a larger extent, from the Middle East."

Spending for some chemical makers reflects the change. For example, BP Chemicals will reduce capital spending from $1.2 billion in 2001 to $800 million in 2002, with investment focused on completing projects in Asia. "This is not going to be a particularly big spending year in North America, but so far nothing has been canceled," Mackenzie says. He notes, however, that the upgrade at Chocolate Bayou is being studied and may be approved later this year.

IN ALL, five European and U.S. chemical producers--BASF, BP, Shell, Dow, and ExxonMobil--have six ethylene joint ventures with Chinese companies planned over the rest of the decade. ExxonMobil is planning two ethylene ventures in China. Last year, it also started up an integrated cracker in Singapore.

The first of the China projects will likely be BASF's, which is already under construction. Observers have doubts about the rest. In fact, last year, Chevron Phillips canceled plans with PetroChina for a cracker in western China. Dow's Walthie predicts that none of this capacity "is going to be built on time." He says Dow's cracker is tentatively slated for 2008 or 2009, which is what Dow has been saying for several years.

Western companies are also pouring capital into the Middle East. In late 2000 and early 2001, ExxonMobil started up two crackers in Saudi Arabia with partner Saudi Basic Industries Corp. ExxonMobil says Asia is a primary market for these and other crackers like them. "Product has tended to flow toward Asia in 2001," Pisarczyk says.

Other start-ups include Borealis' Borouge joint venture with Abu Dhabi National Oil Co. in the United Arab Emirates at the beginning of this year. The $1.2 billion complex has 1.3 billion lb of ethylene and 1 billion lb of polyethylene capacity. Chevron Phillips is opening a 1.1 billion-lb ethylene joint venture later this year in Qatar, and it plans another cracker for 2006.

CMAI's Eramo says the trend will change the ethylene market in the U.S. "What you'll see is more of an inward focus in North America, a self-supplying situation rather than an export scenario," he predicts.

Dow's Walthie agrees. "It won't make sense for a country like the U.S. to import raw materials to process and export them to China, when China can import the same raw materials," he says. "It makes much more sense for the U.S. to consume its own goods rather than export again. It is natural: a coming of age, so to speak. The model will move gradually to a more European model."

An exception, Walthie notes, is Canada, which will continue to have the ability to export to the Far East because of its new, large plants; an efficient supply chain for export; and cheap ethane.

ExxonMobil's Pisarczyk, in contrast, contends that the U.S. may continue to be an exporter in the long run. "Asia will become more self-sufficient, but that will take a substantial amount of time, and there are closer markets, such as South America," he says. "In the foreseeable future, the U.S. and Middle East will continue to be significant exporters to those areas. I'm not ready to concede to Middle Eastern plants," he says.

MOST EXPERTS AGREE the one lesson that the U.S. industry has surely learned from the past year is to be less dependent on ethane as a feedstock. "The North American market was built up on the assumption that natural gas would be readily available and low cost," Eramo says. "We hit a point where there was a major issue in terms of gas supply. In the future, producers will really need to think through their feedstock selection."

Pisarczyk also sees these changes. "We need a cost structure that is competitive in the export market," he says; this requires feedstock flexibility and economies of scale. "A competitive ethane-based industry is not something you can count on."

Many U.S. producers have these kinds of projects under way. Dow is investing in its Gulf Coast operations to increase feedstock flexibility. In addition, its new cracker will be more flexible than the smaller units it is replacing. "We will build ethane plus propane," Walthie says. "We don't want to be forced to use ethane."

Armstrong still believes that ethane-based plants will be part of the ethylene equation in the U.S., in part because they are cheaper to build. "If you're fully integrated and you have a reasonable supply contract for your feedstock, you might find the argument leading you to go to a pure ethane cracker and take the lean years when they come and enjoy the investment savings."

Most experts agree that propylene production in the U.S. will remain competitive globally because, unlike Europe and Asia, the U.S. has abundant refinery capacity that produces propylene as a by-product. "U.S. propylene is still competitive because other people are forced to make most of their propylene as a by-product of ethylene cracking," Zinger says.

Indeed, the U.S. propylene sector may be able to fill the gap caused by all the new plants in the Middle East, which are ethane-based and make little propylene, according to Armstrong, who says all this ethane-based capacity may lead to a global propylene shortage. "The U.S. will be called up to meet these shortages. Thus, the U.S. could likely turn toward heavier faced stocks," he says.

Though some fundamentals may have slipped away from the U.S. industry, most experts don't foresee a repeat of 2001 anytime soon. It was one of the worst years that industry observers remember. If they are sure that 2001 was the trough, it is because the market can only get better.

EXPANDING Formosa Plastics' new ethylene cracker in Point Comfort, Texas. FORMOSA PLASTICS PHOTO

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