THE NEXT FEW YEARS are shaping up to be some of the worst the North American petrochemical industry has ever seen. The financial crisis and economic recession are creating an unprecedented drop in demand, prices, and profitability for ethylene and its derivatives. And even if the economy recovers soon, it will take time for the world to absorb the large amount of new production capacity being readied on foreign shores.
Because petrochemical projects are planned many years in advance, observers have long known that supplies from new facilities being built in the Middle East and Asia were going to push the industry into a downturn. These facilities, they assumed, would flood the market with product, depressing prices and pinching profits. What experts didn't anticipate was that a recession, likely the worst since the Second World War, would hit petrochemical demand at the same time.
Compounding the industry's hardship has been the financial crisis, which is leaving companies scrounging for cash to meet debt obligations. Already, one major petrochemical company, LyondellBasell Industries, has filed for bankruptcy in the U.S. And Nova Chemicals agreed to sell itself for $2.3 billion.
The escalation of oil prices over the past several years finally became too much for the economy to bear, says Mark Eramo, executive vice president of Houston-based consulting firm Chemical Market Associates Inc. (CMAI). "For three years we sat there and said the economy can't handle $40- to $50-per-barrel oil, but it did," he says. "And then from $50 on up to $100 a barrel, the global economy was still growing. We watched in amazement and asked, 'How can these economies continue to grow in an environment where all commodity prices are running to historically high numbers?' There was this feeling that at some point something has got to give."
Something finally gave in July 2008, when oil prices reached their peak of $147 per barrel. With the housing market collapse and worrying financial news added, confidence finally ran out. Consumers at the end of the supply chain became afraid to spend money. Retailers stopped ordering, and eventually, manufacturers stopped producing. "By the time you got to October, November, and December, everybody was slamming on the brakes," Eramo says.
Meanwhile, oil prices started dropping, ending the year at less than a third of what they were in July. When oil prices drop suddenly, consumers of chemicals, such as the plastic molders that use polyethylene, stop buying because they expect chemical prices to decline in kind.
Chemical prices indeed fell sharply. After North American contract ethylene prices hit a peak of 74.5 cents per lb in July, pushed by record oil prices, the drop in oil prices and the collapse in demand combined to push prices down to 28.5 cents by December, Eramo says. "The industry has never seen a 46-cent drop in ethylene prices in a six-month period," he observes.
Other commodities also saw steep price drops. Albert Chao, the chief executive officer of petrochemical maker Westlake Chemical, told analysts last month that polyethylene and polyvinyl chloride prices declined by 41 cents and 20 cents per lb, respectively, over the last three months of 2008, which is "an unprecedented drop in prices for one quarter," he noted.
When prices drop suddenly, consumers of chemicals also have to worry about the declining value of their own inventories. Their best option is to get those inventories out the door as soon as possible in the form of finished products. "You are sitting on high-cost inventory and you have one directive, and that is to cut production and drop inventories," Eramo says.
THE CREDIT CRUNCH also exacerbated the situation, says Grant Thomson, Nova's president of olefins and feedstocks. With credit hard to come by, rapidly liquidating inventories became an inventive way for cash-strapped firms to raise funds. "All companies were really focused on preserving cash," he says. "That drove everybody to take inventories down to very low levels throughout the supply chain.
"This is certainly different than anything I have ever seen before," Thomson says. "In other periods credit may have tightened a little bit, but it was certainly still available."
With companies up and down the supply chain reducing their inventories, petrochemical makers saw little need to pump out more product. They aggressively throttled back on manufacturing.
Flint Hills Resources, the petrochemical arm of Koch Industries, began permanently shutting down its Odessa, Texas, ethylene and polyethylene complex in November, a process that it intends to complete in the first half of this year. The company also idled its Port Arthur, Texas, ethylene complex.
LyondellBasell shuttered its Chocolate Bayou, Texas, ethylene cracker in December and laid off 220 workers at the site. The company's La Porte, Texas, facility was off-line from October to January. Elsewhere, Chevron Phillips Chemical idled an ethylene line at its Sweeny, Texas, plant, and Westlake temporarily shut down a Lake Charles, La., ethylene facility.
As a result, the North American industry's plant operating rates tumbled at year's end. According to Eramo, effective ethylene cracker operating rates—a measure of output versus capacity not off-line for maintenance—were at healthy levels of more than 90% during the first half of 2008. By the end of the year, they had declined to 80%. At the worst point in 2002, during the industry's last downturn, they were down to 85%. "It is worse now," he says.
Not surprisingly, earnings of petrochemical makers declined sharply during the fourth quarter. For example, Westlake, a U.S. producer of ethylene, polyethylene, and polyvinyl chloride, lost $110 million during the quarter. It earned $19 million in the same quarter in 2007.
"The fourth quarter was characterized by two major factors: falling prices, which were led down by falling energy and feedstock costs, and low operating rates that came about as a result of poor economic conditions and turmoil in the financial sector," Chao told analysts.
The effects were most dramatic with Nova and LyondellBasell. Nova reported a loss of $214 million in the fourth quarter versus profits of $126 million in the year-ago period. The company's olefins and polyethylene segment, the fifth-largest business of its kind in North America, reported a loss of $264 million versus profits of $253 million the year before. Purchasing some of its raw materials when energy prices were higher had a $364 million impact on Nova during the fourth quarter alone.
Otherwise, the year for the Nova business wasn't so bad. The company had profits of $363 million for the entire year, versus $784 million the year before. Thomson says fourth-quarter performance dragged down the whole year. "Through September, we were on track for a year of record earnings for Nova Chemicals," he recalls. "But at the beginning of October, it fell off the edge of the cliff. Sales were down significantly, and then prices and margins also declined dramatically."
The results couldn't have come at a worse time. Credit analysts questioned whether Nova could raise enough cash to meet debt obligations coming due in 2009. The company was forced to sell out to International Petroleum Investment Co., owned by the government of Abu Dhabi (C&EN, March 2, page 13). The sale price of $6.00 per share, or $2.3 billion, was for a hefty premium over its stock price, which had been battered down to nearly a dollar. However, company officials put its replacement value at more than $10 billion.
The quarter drove LyondellBasell's U.S. subsidiaries into bankruptcy. They are mostly the old Lyondell Chemical, which Basell purchased in 2007 for about $19 billion. According to Kyle Loughlin, a credit analyst with Standard & Poor's, the decline in demand coupled with the need to liquidate inventories forced the debt-laden company underwater. "The rather precipitous decline in the company's liquidity underscores the risks associated with highly aggressive capital structures in business that are vulnerable to economic and business cycles," he recently wrote to clients.
Even without the recession, ethylene and its derivatives would still be in a funk because of a large amount of capacity that is coming onstream. When there is too much supply, prices remain low until demand growth rebalances the market. According to CMAI, the world had about 120 million metric tons of ethylene capacity in 2008. Nova expects some 25 million metric tons of capacity to be added from 2008 through 2011, nearly all of it in the Middle East or Asia.
IT DOUBLY STINGS petrochemical makers that the period of overcapacity is being kicked off by a recession, says Theodore J. Wojnar Jr., senior vice president of basic chemicals, synthetics, and intermediates at ExxonMobil Chemical. "Most everyone in the industry was quite aware of the capacity that was coming," he says. "I don't think very many people foresaw the sequence of events that got us to a real demand dip."
The petrochemical industry's woes today are almost all due to weak demand rather than the new capacity that is coming on-line, says Dan Carlson, commercial manager for lower olefins at Shell Chemicals. "The impact of the new capacity has yet to fully play out and probably won't until 2010 or 2011," he says.
Carlson cautions that the petrochemical industry downturn might turn out to be one for the record books. "The downturn that we are seeing now is worse than the last two—the ones in 2001 and 1991 to 1992," he says. "Some say it is as bad as we have seen since 1983."
Yet the impact of the downturn might be softened, according to Eramo, because some of the new projects will be postponed—especially the ones scheduled for 2011 and beyond, for which construction might not yet be in full swing. "Beyond 2010, it seems like a delay is the prudent thing to do," he says.
One incentive chemical producers have to delay projects, Wojnar notes, is that thanks to the economic downturn, construction costs are coming down. The financial crisis is also having an impact. "Those who need credit backing to get these projects are having a very difficult time," he says.
Nevertheless, the coming years will see a record addition of production capacity to the world market. Thomson says the impact on the North American industry will be indirect. The new output generally won't be sold in the region; rather, it will make it hard for North American producers to export. In the Middle East, producers pay much less for natural-gas-based feedstocks than North American producers do, giving them a cost advantage in the export market. "There is no doubt that the Middle East capacity is going to take some of that volume away in Asia and back up some volumes in North America," he says. But he notes that North America will need more supply when the economy rebounds.
But there is a silver lining. North American producers are getting a lift from low natural gas prices, which, at about $4 per million Btu, are cheaper on an energy content basis than oil. Because nearly 80% of North American producers rely on natural-gas-based feedstocks, they are cost effective against those companies—most of the industry outside of the Middle East—that use oil-based feedstocks, Shell's Carlson says. "Low natural gas pricing relative to crude is making U.S. ethylene competitive compared with Europe and Asia, so U.S. exports may not be impacted as much as some had expected."
Another plus for the North American industry, observers say, is that business can only get better than it was late last year. "It feels like we are going in the right direction, as opposed to the fourth quarter, where as an industry we were going in the wrong direction very quickly," Thomson says.
Industry executives say sales volumes have started to bounce back as customers try to rebuild inventories. In a conference call with analysts earlier this month, Dow Chemical CEO Andrew N. Liveris was optimistic about short-term improvement in polyethylene. In December alone, it saw a record reduction of about 500,000 metric tons of inventories in the U.S. and Canada, but the trend won't last, he maintained. "This is a product that we all use every day, and therefore, it is resilient to recessionary environments like the current one," he said.
In addition, Liveris pointed out that operating rates at Dow's polyethylene plants were above 90% in February. "We have seen demand improve," he said. "Restocking is occurring."
Furthermore, Westlake's Chao takes it as an "encouraging sign" that the polyethylene industry appears to have implemented a 7-cent-per-lb price increase in January. "We do expect to see some demand improvement in the first quarter of 2009 with very low inventories in our industry," he said. "Energy and feedstock prices appear to have leveled off, and we expect to see some increases in demand for our olefins products."
BUT CONSUMER DEMAND will still prove to be weak after inventories are rebuilt, Carlson acknowledges. "With employment, housing, and auto sales still declining, we may not have seen the bottom yet," he says. "I think everyone agrees that 2009 will be a very tough year. It's hard to predict the recovery, but we can probably say that 2010 should be better than 2009."
ExxonMobil's Wojnar says the task ahead for the industry is running plants in an efficient, cost-effective manner and waiting for demand to catch up to supply. "People are hopeful that the economy will return to trend-line kind of growth, but that will be mitigated because of the capacity that is coming on-line," he says.
Eramo cautions that even if the ethylene market returns to growing at its customary global rate of 4 to 5% per year by the end of 2010, the industry won't start recovering until 2012. Peak plant operating rates of more than 90% will have to wait even longer. "It won't be until 2013 to 2014 before we get to that kind of level," he says.