Ethane cash cow a red herring for European petchems producers …
In the next few weeks the first ship bringing US shale gas to Europe will arrive on the southern shores of Norway, marking an end to Ineos search for cheap feedstock to power its European petrochemical assets. Plagued by $100/b oil, European petrochemical producers in 2012 were struggling with margins and started looking abroad for cheaper feedstock options. The contracting European margins coincided with plentiful and inexpensive supplies of ethane-rich natural gas in the United States.
Ineos $2-billion deal to build ships and storage facilities to import US gas for its flagging assets in Europe looked like a no-brainer. At the time, NWE naphtha was trading at a premium of $720/mt to Mont Belvieu,Texas, ethane, according to Platts data. This price differential was more than enough to cover the high logistical costs associated with moving volatile ethane some 3,500 miles across the Atlantic. Fearing being left behind, Borealis, Sabic and Reliance rushed across the Atlantic to sign similar deals, pledging hundreds of millions of dollars to charter the as-yet unbuilt ships to transport the gas.
But as Ineos first so-called Dragon-ship docks at Rafnes steam cracker in Norway this quarter, the cruel irony is that the ethane cash cow has turned into a red herring as profits from bringing ethane across the Atlantic are now lower than simply cracking more traditional domestically produced naphtha. According to Platts calculations, and using Mont Belvieu gas price of $113/mt and assuming logistics costs of $100/mt, the variable cost of landing US ethane in Europe minus the cost of selling any co-products associated with cracking the gas in Europe is $134/mt. The same calculation for European naphtha is $56/mt. This means that for the first time in history the marginal cost of producing plastics in Europe will not be determined by the value of crude oil, but by the price of US gas.
It s a remarkable turnaround and the shift in the petrochemical merit order has everything to do with crashing oil prices and nothing to do with the price of gas so far. So will it last?
Those that signed the deals have two defenses to claims that ethane purchase deals may be a bane rather than a boon for them. The first is that the low oil price is temporary while ethane purchase deals stretch out for more than a decade. While it is undoubtedly true that most analysts expect oil prices to rise, many expect US gas to rise at the same time.
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One metric to see ethane s competitiveness to naphtha as a cracker feedstock is the crude-to-gas ratio. US ethane has had a close link to gas, while naphtha has a historically high correlation to crude oil. Therefore, a high ratio between the two products would indicate that naphtha is relatively expensive to ethane, and this would support ethane utilization over naphtha. The ratio between crude oil and natural gas in the US averaged 29 in 2012 and the outlook was for crude prices to remain relatively strong to ethane. But the ratio has now fallen to around 15, a level not seen since 2009, when gas and ethane prices were much higher.
The outlook is for the ratio to rebound from current levels over the coming years but not reach the levels seen when ethane export agreements were first being signed. The ratio should average 21 in 2016 but fall to 17.2 in 2020, according to Bentek s forecast for North American gas and Brent crude prices. Furthermore, this shift is not a recent phenomenon. Naphtha has remained below the cost of landing ethane once all the co-products have been taken into account for about a year. It just hasn t been relevant so far because exports haven t started. The second defense is that the landed cash cost of gas used in the chart above is not the same price that Ineos, Sabic, Borealis and Reliance paid for the ethane.
Company sources have said many of these deals were signed at a naphtha-related price, and as such may still be profitable as naphtha prices have collapsed. Indeed, one Ineos source said last year that providing oil doesn t fall and stay below $40/b for a long period of time their deals will be profitable. It s currently a little over $34/b and analysts are split over whether it s heading to $20/b or rising to $65/b. Perhaps the biggest test as to whether the gold rush for US ethane is over is whether European producers will sign more deals to buy US ethane. At these economics, it s not going to happen. And if they are in the future, they are unlikely to be structured at a discount to naphtha.