Can U.S. petrochemical makers stay on top?

For half a decade, North American petrochemical producers have enjoyed high profits and a big cost advantage over competitors across the oceans. Now they face a series of challenges that will determine whether they keep their position atop the global industry.

The first is lower oil prices. Over the past couple of years, cheap petroleum has leveled the playing field for foreign rivals and even made a few companies reconsider their plans to build U.S. chemical plants.

A flood of new Gulf Coast capacity, which is starting to hit the market, is another big test. The millions of tons of petrochemical output hitting the market all at once from the same location have the potential to crush prices and destroy profits.

A third, still emerging, challenge for the industry is sustaining the boom long-term. Whether companies can continue to build multi-billion-dollar North American chemical complexes into the 2020s will depend on whether enough inexpensive raw material is available to support them.

Company executives claim to be confident they will clear these hurdles. They expect the industry to remain profitable despite low oil prices and the coming flood of production. And they argue that the feedstocks will be there to allow them to build even more plants after the current fleet of big complexes comes on-line over the next few years.

All petrochemical managers closely watch the interplay of oil and natural gas prices. Chemical companies in Asia and Europe primarily make the key building block ethylene by cracking naphtha, which is a by-product of oil refining. Their counterparts in North America mostly make ethylene from ethane, which is extracted from natural gas or, increasingly, comes out of the ground as a by-product of oil drilling.

North American chemical makers didn’t always have it so good. At times during the 2000s, it was more expensive to make petrochemicals from ethane in North America than it was from naphtha abroad. U.S. producers closed older, inefficient plants.

But hydraulic fracturing saved the U.S. industry by unlocking massive amounts of natural gas from shale. By 2011, the U.S. was considered one of the most competitive places in the world to make petrochemicals. Firms enjoyed swelling profits. Rather than shutting uncompetitive capacity, they were restarting and expanding plants. And for the first time in more than a decade, they unwrapped plans for brand-new ethylene cracker complexes.

This happy narrative is now being challenged by the global oil glut, which by the end of 2015 drove oil prices down to their lowest levels since the early 2000s. Just two years ago, oil was about $100 per barrel and nearly four times more expensive than natural gas on an energy content basis. By the beginning of this year, oil was down to $32 per barrel, and the ratio had narrowed to two.

North American chemical producers still have an edge and are still profitable, but not by as much as before. At the same time, Asian and European chemical makers, buoyed by strong end markets, have seen their own profitability return.

As oil prices fell, some executives developed doubts about the North American advantage. Last year, Braskem said it would reconsider a proposed project to build a cracker and polyethylene plants in West Virginia. Axiall’s chief executive officer put off deciding on a Louisiana project with South Korea’s Lotte.

After hitting bottom in February, oil prices have rallied by 50%, though they are still half what they were in 2014. Encouraged that oil is rising again, the industry is regaining confidence, says Naushad Jamani, senior vice president of olefins and feedstocks for Nova Chemicals. Moreover, strong demand and unplanned outages at chemical plants have tightened the market, pushing prices and profits higher.

“That leads me to believe we are in pretty good shape in North America,” Jamani says. “We feel better about margins at this point in time than we did six months ago.”

Companies are breathing easier about their expansion plans, too. For example, Axiall and Lotte broke ground in Louisiana earlier this year.

However, Braskem ended up putting the West Virginia project on hold. “With the change in the energy outlook and the crude-to-gas price ratio, we felt this was not the right time to make that step,” says Mark Nikolich, CEO of Braskem America.

The next test for North American petrochemical makers will be whether they can handle all the new capacity soon slated for completion. A few plants are already opening. Although Braskem shelved plans for the West Virginia cracker, the company did start up a new ethylene and polyethylene joint venture in Mexico earlier this year.

Nova completed a new polyethylene reactor in Joffre, Alberta, adding about 450,000 metric tons per year in capacity. “It feels good to be ahead of the pack,” Jamani says.

But the big slug of capacity will arrive next year when five petrochemical complexes, with a combined annual capacity of more than 5 million metric tons, are scheduled to start up on the Gulf Coast—a more than 18% increase in North American output.

Steve Lewandowski, senior director of global olefins for the consulting group IHS Chemical, expects some of these plants, even if construction is completed next year, will face delays as they try to start up. “Things can become a bit more difficult on start-up than one would hope,” he says. “That is just the nature of these machines. There are so many moving parts.”

Lewandowski isn’t alone in this view. “I believe what happens on paper and what really happens are going to be meaningfully different,” says Doug May, Dow Chemical’s president of olefins, aromatics, and alternatives business. He stresses that it has been more than two decades since most companies opened new crackers on the Gulf Coast. “Even for the stalwarts of the industry, there is a learning curve,” he notes.

May should know. Perhaps the most intricate project to start up on the Gulf Coast next year will be Dow’s. Next spring, the company will start a cracker in Freeport, Texas, plus polyethylene and elastomers plants in Freeport and Plaquemine, La. This follows the recent completion of Dow’s $20 billion Sadara joint venture in Saudi Arabia with Saudi Aramco, which did face months of delays because of pipeline infrastructure issues. The lessons learned are being applied to the Freeport plant, May says.

Some chemical firms have admitted to delays already. Sasol has delayed start-up of some of the derivatives plants that are part of its new Lake Charles, La., chemical complex by a year largely because of construction difficulties at the site. Those same issues drove the capital costs of its plant up by $2.1 billion.

IHS’s Lewandowski expects the Gulf Coast plant start-ups will be delayed six to nine months on average versus what companies are now saying. Thus only 1.5 million to 2 million metric tons of new capacity will start up in 2017, less than half of what’s scheduled. Lewandowski predicts that 2018 will be the boom year, with about 4 million metric tons of capacity coming onstream on the Gulf Coast.

By giving the market time to catch up with the new production, the delays should blunt its blow, Lewandowski says. Demand for ethylene derivatives increases by 3% to 4% annually, meaning that the world needs about 6 million metric tons of new output every year, he explains.

And observers point out that few petrochemical plants are being built outside of North America. Sadara is the main event in the Middle East. Planning and feasibility for Chinese coal-to-olefins projects, Lewandowski says, are being put on hold. These were to be a potent source of capacity, but lower oil prices have made it harder for them to compete with naphtha crackers in the region.

“There aren’t really that many plants coming on in the next little while outside of North America, and yet global demand continues to be strong,” Nova’s Jamani says. “I think there will be room for the product that gets produced.”

Lewandowski does expect the new U.S. output to precipitate a mild downturn. Operating rates will decline from about 88% today to about 86% in 2018, he says. But in previous downturns, operating rates went as low as 80%.

And longer term, if North America is to continue to be the world’s center of new petrochemical capacity, additional projects—and the raw materials to feed them—will be needed.

Today, so much is ethane being pulled out of the ground that it is being “rejected,” Lewandowski says—left in the natural gas stream and burned as fuel instead of being turned into chemicals. “Most of that rejection will probably stop with the first wave by the end of 2019,” he says.

To support growth beyond the cracker projects already under construction, U.S. oil and gas producers will need to keep adding output, according to Dow’s May. “We think it will be there,” he says of production.

Observers are taking it as a good sign that big-name companies are still announcing projects. ExxonMobil is looking at a second new ethylene plant on the Gulf Coast, this one in partnership with Saudi Basic Industries. After years of studying, Shell finally approved its project in Monaca, Pa., the first of the major ethylene builds outside of the Gulf Coast.

Nova is considering a 50% expansion of its Sarnia, Ontario, ethylene cracker and a new polyethylene plant. The company already imports ethane from Pennsylvania for its Canadian operations and will need even more if it expands.

Although Braskem has shelved plans for a U.S. ethylene cracker, the Brazilian firm is growing its U.S. polypropylene business, which Nikolich says is competitive because of an abundance of shale propane. The company, which has to import polypropylene from Brazil to meet U.S. demand, is evaluating building a polypropylene plant, either in La Porte, Texas, or Marcus Hook, Pa.

A handful of more speculative projects are under consideration. Last year, Formosa Petrochemical said it is studying a nearly $10 billion complex in Louisiana, though it hasn’t followed through with a final go-ahead.

Another firm, the start-up Badlands NGLs, is trying to develop two large projects. One would be in North Dakota, where the company expects a massive buildup of by-product ethane from local oil drilling and Western Canadian natural gas fields. “This is a tsunami that is going to materially adversely impact North Dakota if we don’t have a local use of ethane,” says William Gilliam, the former industry executive who is promoting the project. The other project is slated for somewhere else in the U.S., at a site Gilliam has codenamed “Shangri-La.”

The petrochemical market probably doesn’t have enough room for every multi-billion-dollar idea. Some companies won’t be able to secure the raw materials. Others will give up if they conclude that profits won’t be good enough.

In the future, most observers say, the chemical industry will likely take a more measured approach to building than today’s all-at-once frenzy. “It won’t be six units at one time,” Lewandowski says. “It will be paced a bit differently.”