The Fuse

Oil Industry’s Gamble on Plastics Looks Increasingly Risky

by Nick Cunningham | August 20, 2020

The pandemic and market downturn blew a hole in global oil demand forecasts, confining hundreds of millions of people to their homes, at least for a period of time. While the lockdowns were brief, the economic fallout will not be. There is now a very contentious debate among market analysts over whether or not the world has already hit peak oil demand.

Gasoline demand has bounced back while aviation could take years to recover. To some, the pandemic has accelerated the energy transition, to others, crude demand will bounce back and continue to grow. But one of the oil industry’s most promising growth markets – petrochemicals – is showing signs of trouble. The problems pre-date the pandemic, but the economic slowdown has exacerbated the weakening trend.

The explosion of oil and gas drilling over the past decade, particularly in the U.S., led to a tidal wave of investment in petrochemicals.

The explosion of oil and gas drilling over the past decade, particularly in the U.S., led to a tidal wave of investment in petrochemicals. The surge in output, particularly natural gas liquids such as ethane, led to skyrocketing supply of the key building blocks of plastic. As a result, between 2010 and 2018, more than $200 billion was funneled into more than 340 petrochemical projects in the U.S.

That investment trend corresponded with a critical strategy pursued by the oil majors. A few years ago, as concerns about slowing demand for crude oil in the transportation sector began to rise, plastics grew in importance in terms of a growth strategy. In the International Energy Agency’s 2017 World Energy Outlook, for instance, the agency projected in its main scenario that petrochemical demand would absorb an additional 6.2 million barrels of oil per day (Mb/d) through 2040, while road transportation would only see 3.3 Mb/d of growth. The oil industry’s future would be paved with plastic.

The rosy outlook for plastics is starting to sour.

The rosy outlook for plastics is starting to sour. On the one hand, demand for plastic packaging has not declined during the pandemic, with so many people continuing or even increasing their online ordering for consumer goods. Roughly 36 percent of plastic demand is concentrated in packaging, the largest single source, followed by building and construction at 16 percent. The drop off in construction has been mostly offset by an increase in packaging use, resulting in plastic demand that stays flat this year, according to Bank of America Merrill Lynch.

However, prices for polyethylene, the main building block for plastic, has been declining for years. The reason has much more to do with supply than demand. Part of the reason is directly related to the gargantuan levels of investment in petrochemical capacity, which brought a wave of new production online, undercutting prices. Prices for polyethylene have fallen by around half since 2012-2013.

“We’re seeing a deterioration of the plastics market right before our eyes,” Tom Sanzillo, finance director at the Institute for Energy Economics and Financial Analysis (IEEFA), said at a conference in July.

The wave of petrochemical construction continues despite the souring market.

The wave of petrochemical construction continues despite the souring market. “[Polyethylene] capacity expansions in China, the Middle East, and the US will likely continue to press ahead, even though demand has stalled and margins are weak,” Bank of America warned in a recent note. For example, Royal Dutch Shell’s massive ethane cracker in western Pennsylvania, which aims to turn Marcellus shale gas liquids into polyethylene, continues to go forward, despite narrowing margins and even a string of Covid-19 infections at its construction site.

With capital tied up in projects that have already received the greenlight, they will likely be completed despite the economic headwinds. But additional capacity will likely result in even weaker margins.

The investment bank predicted that the growth in polyethylene supply will exceed demand in China for another two or three years. That’s a problem since producers everywhere have China at the center of their growth forecasts. As a result, exporters in the U.S. and the Middle East “could be squeezed out” of China, Bank of America said.

To make matters worse, China often pursues strategic objectives that go beyond market economics. “China’s desire for self-sufficiency means that import displacement could occur even if [polyethylene] import economics are superior,” Bank of America added. Essentially, China will favor domestic plastic producers over imports, even if it is more costly. That leaves less room for American plastic. “Ultimately, if it comes down to production cuts between Middle East and US PE producers, we expect Middle Eastern countries would win out due to superior economics and also deeper integration than their North American competition,” Bank of America predicted.

In July, PTTGC America LLC and Daelim Chemical USA delayed a final investment decision on their ethane cracker planned for Ohio, the second in a string of projects (after Shell’s PA cracker) that have been central to the industry’s plans to build a petrochemical hub in Appalachia. Daelim backed out of the project, a serious blow to the project’s viability.

Meanwhile, upstream natural gas production has actually been declining since late last year. With U.S. natural gas prices stuck below $2/MMBtu for much of the past 9 months, gas drillers threw in the towel. Lower production is now pushing prices back up (aided by a slowdown in associated gas output in the Permian). Higher prices might be welcome by gas drillers, but they further narrow the margins for petrochemical producers.

The energy transition is already beginning to hit crude oil and natural gas, with renewable energy capturing a growing share of the electricity pie and electric vehicles not too far behind in the transportation sector. Alternatives to plastics will be a much more difficult nut to crack. But just because plastics will be difficult to displace, that does not mean that petrochemicals will be the growth industry that oil executives had hoped.