Exporting Shale – A More Logical Perspective
SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES
Graham Copley / Nick Lipinski
December 10th, 2013
Exporting Shale – A More Logical Perspective
- US Exports of bulk chemical intermediates make most economic sense in a low cost US natural gas and NGL world. Exports tied to local European production cutbacks make sense for producers on both continents, but also for buyers of these raw materials in Europe.
- While shipping costs favor the movement of liquids over gases and solids, liquids are generally inefficient at shipping ethylene in the form of derivatives as it is only a portion of the molecule. While shipping ethylbenzene/styrene will make sense for many European consumers, the more obvious material to ship is probably ethylene dichloride (EDC).
- The US has a cost advantage in chlorine manufacture and shipping a liquid material composed of both ethylene and chlorine should generate the greatest value. Europe has high cost integrated EDC producers, but also has independents who buy local ethylene and chlorine – both groups should look at buying EDC from the US and making PVC in Europe.
- Those companies that have sufficient conviction about the long-term US cost advantage to build or expand ethylene facilities in the US and have demand for ethylene in Europe, should be exploring this option – DOW, LYB, Ineos and Shell. We would feel more positive about these US investments if they were tied to specific rationalization actions in Europe.
- In our view, the ethylene stocks in the US reflect all of the opportunity and not much of the risk at this point, and we struggle to see further upside, particularly in LYB, but increasingly in WLK. For DOW, much will depend of the structure and timing of the chlorine divestment(s).
Note – The cost difference is “per ton” of ethylene – not the feedstock or derivative.
We have written a couple of pieces on the issue of exporting increased volumes of shale gas based chemicals from the US. It is a complex issue, as we could face a situation where US domestic pricing is negatively impacted as much if not more than prices in target markets, which could ultimately undermine the feedstock advantage for US producers. This report touches on one perspective, but there are many, and each has a set of complex implications and follow-up questions. We continue to do basic research in this area and would expect to publish follow-up pieces in the coming weeks/months to address other perspectives and other possible ramifications of the unique situation that exists in the US today.
Essentially, as companies invest to exploit the abundant shale based natural gas and crude oil in the US, those involved are doing so in North America, which does not grow anywhere near quickly enough to consume the likely available molecules. In the best case they displace imports (the most meaningful opportunity for crude oil), good for national energy independence and balance of payments, but ultimately there are going to be a lot of exports (also good for the balance of payments but also good for jobs).
But exports of what? The liquid products find logical economic homes displacing US imports, mainly of transport fuels, but the options for natural gas are many and complex; some want to export the natural gas itself as LNG, others want to ship the ethane and propane and others want to export chemical products and plastics. While we can talk about what is in the best interest of the country, what will happen is what is in the best interest of the companies, which may or may not coincide. The LNG proposition is straightforward; North American gas competing with Russian Gas in Western Europe and with Middle East exports in East Asia. It is the other products where the logic is less clear.
The target countries (those with higher costs) have a great deal of infrastructure and assets on the ground and this will dictate their behavior and reaction to any export moves from the US. It is unlikely given the volatility of ethane and propane prices that anyone would build new facilities in Europe to consume NGL’s from the US, so, aside from some special situations, which we will discuss later, the scope here is limited.
If you move to the other end of the value chain and try to export more sophisticated products, such as polymers (both commodity and specialty) and other complex chemicals you will hit a variety of hurdles:
- Diverse customer bases in your target markets – to sell 100,000 metric tons you might have to find 20-30 customers. Many more in the case of specialty products.
- The product specifications and customer support become more important – SG&A costs rise.
- You will be going head to head in many cases with somewhat desperate incumbents – keen to stay alive and thinking about variable rather than full costs.
- Even if you sell through a third party, such as one of the bigger trading companies, the effect on the broader market will likely be the same.
- If the balancing mechanism for the world is to force closure of the older and less efficient facilities, this approach chips away at several producing platforms rather than targeting one or two.
We have written previously about our view that it will be difficult for the US to simply push basic chemicals and plastics into the broader export market without seriously impacting domestic pricing. A more targeted approach might be better. Rather than try and sell plastics or chemicals in other regions of the world and compete head to head with the locals, a few US producers might be better served engaging in long term contracts to supply low cost intermediates to derivative producers in Europe or Latin America, allowing them to shutdown high cost basic chemical capacity, but also allowing them to maintain their end-product sales and marketing presence locally.
The three most obvious products to ship from the US are EDC (ethylene dichloride), ethylene glycol and styrene because they are liquid at ambient temperature and consequently inexpensive to move in bulk. However all three are relatively inefficient ways to move ethylene because ethylene is only a portion of the molecule. EDC, while only 30% ethylene is the most obvious export opportunity in our view as the other 70% of the molecule is chlorine and US chlorine production economics are also advantaged versus many countries and regions, given that the major variable cost component is electricity. We would argue that a US ethylene and chlorine producer has more chance of making a good return moving half a million tons of EDC to one or two select overseas customers (allowing them to close expensive capacity) than it has trying to sell the equivalent volume of PVC to countless different customers, particularly if the company does not already have a marketing presence in the target countries/regions. Some similar arguments can be made for ethylbenzene/styrene and ethylene glycol, but in the case of glycol, Europe is mostly supplied from the Middle East today and that might not be a competitive fight worth picking.
Dow – or the Dow spin off of the future – has significant chlorine and EDC capacity in Germany, where the ethylene is either made locally from crude oil fractions or shipped into the site. Importing more EDC from the lost cost base in the US might make more sense for Dow than producing locally.
On the flip-side, European or Latin American producers of PVC, polystyrene (or other styrene derivatives) should be looking at the possibility of long-term supply contracts from the US as part of any re-evaluation of strategy for the medium to long term. This could be a better solution than importing propane and ethane from the US, given the additional shipping expense.
Exporting US Ethylene
Whether you are shipping ethane, propane, ethylene glycol, PVC or polyethylene from the US to Europe, Latin America or Asia, what you are really doing is shipping the lower ethylene feedstock costs in the US to other regions. If we look at everything on an ethylene basis, you need to ship 1.2 tons of ethane to Europe to move a ton of ethylene; you only have to move one ton of polyethylene; but you have to move 3.4 tons of styrene. Rough ratios are summarized in Exhibit 1.
Source: SSR Analysis
As always, nothing is as simple as it looks. The by-products generated when making ethylene from ethane and propane have a value in Europe and that needs to be accounted for. For the products, the other components of the molecule have a cost of production in the US and a cost of production in Europe – these differences also have to be taken into account.
Lastly, as we have stated already, the shipping costs are very different based on the properties of the products. We run through each one in turn.
This is the route chosen by Ineos and is, in our view, specific to Ineos. No one else in Europe has this opportunity. It is very expensive to ship ethane – and estimates suggest that the trip will cost Ineos more than $200 per metric ton of ethane. However, given that the production cost delta between US gulf ethane based production and mainland Europe production is around $500 per ton, the opportunity looks attractive. Ineos already has ethylene units configured to consume ethane (though not yet the facilities to import ethane by ship) and is almost uniquely positioned (the Shell/Exxon facility in Scotland could in theory do the same, but appears to have ample ethane supply). The primary motivation for Ineos is to replace declining supplies of ethane from the BP legacy forties system in the North Sea and so it is not an “imported ethane versus naphtha” decision. In Scotland, the newer Grangemouth ethylene unit was designed to handle light feed from the North Sea, so in this case it is import or not produce.
The process needs around 1.25 tons of ethane to make a ton of ethylene and the by-product is mostly hydrogen which generally has a fuel value on site. Given that natural gas prices are higher in Europe than they are in the US, this by-product will be beneficial to Ineos versus what they are paying for it – we estimate (and this really is a guess because the economics are specific to the site) that the benefit is around an additional $50 per ton of ethylene.
Propane is more easily consumed in a conventional European ethylene plant, with only minor modifications, and several of the coastal facilities have capacity to consume propane already and have done so opportunistically for many years. Dow Chemical has the most meaningful infrastructure to import large parcels of propane in the Netherlands, but also has similar capabilities in Spain. Others are limited by logistics, given the need for coastal storage (not overly expensive) and the added expense of barging to inland locations, which will likely make the economics much more marginal. US propane prices suggest a direct ethylene cost advantage of around $250 per ton, but we should also credit the facility for the co-products, such as propylene and butadiene which are higher priced than they are in the US. We estimate that after paying shipping costs, a coastal consumer of propane in Europe could be benefitting by as much as $100 per ton of ethylene versus consuming local naphtha. This quickly shrinks to zero if you need to build import facilities and then ship inland, but others on the coast will likely invest to increase consumption of propane.
This dynamic should help support the price of propane in the US well above ethane, ensuring that ethane remains the preferred feedstock for ethylene in the US. It should also keep US propylene prices well above ethylene prices for the medium term, an important subject for US propylene consumers and one which we will discuss in future research.
The Liquids – EDC, Ethylbenzene (or Styrene) and Ethylene Glycol
This is where we think it gets much more interesting and where the real opportunity to add value lies – particularly for EDC.
It is significantly more efficient to ship a bulk liquid than it is to ship gases or polymers or more specialty liquids – Exhibit 2 shows the freight costs for a ton of product and the cost for the contained ton of ethylene for a variety of options.
Source: SSR Analysis
But for each product we have to consider the production costs versus the cost in Europe holistically rather than just looking at the ethylene.
EDC – is 30% ethylene and 70% chlorine. Chlorine is manufactured by passing an electric current through a solution of brine and electricity is the largest cost component – we estimate that US chlorine production variable costs are roughly half the costs that they are in continental Europe, and when you factor that into the overall equation, the benefit of shipping EDC to Europe versus manufacture in Europe is the most compelling of the opportunities we have examined. There are pockets of competitive chlorine in Europe where the electricity is either hydro-electric based, or heavily subsidized, but this is not the case in Germany, Belgium and the south.
On a per-ton of ethylene basis we see a cost saving in excess of $600 per ton. However, we have not looked at the impact on the European caustic soda balance of closing European chlorine capacity, but this could be resolved by shipping more from the US and these freight costs would not materially alter the opportunity. On the flipside, we have also not taken into account the positive effect of lower energy (ex-power)/labor costs in the US in the manufacture of chlorine and EDC.
Ethylene Glycol – is a more efficient way to ship ethylene, but the other raw materials are oxygen and water and we are assuming that the costs are similar in Europe and the US, so there is no benefit akin to the chlorine benefit discussed above. There are other costs of manufacturing benefits to making the product in the US because of lower energy and labor costs and these could add $25-45 per ton to the equation. However, most glycol production in Europe has already been displaced by imports from the Middle East, with local ethylene oxide production focused on derivatives other than ethylene glycol. Ethylene oxide is very hard material to handle and is usually used in-situ, which is why we do not talk about shipping oxide in this analysis.
Ethylbenzene/Styrene – only 29% of the styrene molecule is ethylene and the balance benzene, which is likely to be similarly priced in Europe unless we see a surge in refining in the US as a consequence of crude availability. However, despite the dilution from benzene, a styrene consumer or ethylbenzene consumer (ethylbenzene is a step between ethylene and styrene) in Europe, buying ethylene, benzene or styrene at European contract prices, would be well served to look at longer term supply contract from the US.
The Polymers and the Specialty Chemicals
These are more expensive to ship, in part because of higher branding and packaging costs. At face value, shipping polyethylene with a $500 per ton ethylene cost advantage looks good even if you are paying $100-150 per ton in shipment costs. But, in this case you are adding availability to the European market – you are trying to sell product in a market already well supplied in most cases, in competition with many incumbents, who really do not want you there. There will inevitably be an impact on prices and this may change the economics meanigfully.
This approach is unlikely to result in the closure of inefficient European capacity, unless it is a closed loop – i.e. Dow or Lyondell shipping polymer from the US to replace their own production in Europe.
A bilateral agreement to supply a European consumer of a liquid chemical intermediate gets around many of the issues that we highlighted previously – one customer; allows the customer to cut expensive manufacturing of the intermediate; no complex marketing; no real impact on end product pricing because of oversupply.
In the exhibit below we try to summarize the approximate cost benefits we have discussed above on a per-ton (metric) of ethylene basis, assuming that the current crude oil/US natural gas delta persists.
Source: SSR Analysis
Just looking at Europe, there is plenty of capacity to manufacture EDC (and VCM), and Ethylbenzene (Styrene), which must look economically challenged today based on the high costs of the ethylene and the energy input. EDC, VCM, Styrene and Ethylene Oxide (the precursor to Ethylene Glycol) are all fairly energy intensive processes. Exhibit 4 shows the capacities for each product in Western Europe and the US (in thousands of tons) in ethylene equivalent. For both EDC and Ethylbenzene there is surplus capacity on both sides of the Atlantic.
Source: SSR Analysis
Self Help May be The Most Obvious First Step
Perhaps the most obvious opportunity is for producers with footprints in both Europe and the US to look at their own internal strategies. Dow Chemical, LyondellBasell, Ineos, and Shell are the companies impacted as they have advantaged ethylene economics in the US and demand for liquid ethylene derivatives in Europe. The opportunity for Ineos looks greater than for others – Exhibit 5. Some of Ineos’ EDC is very competitive as it is based on chlorine using hydro-electricity as a power source, but this is only a portion of the capacity.
Source: SSR Analysis
For these companies there is not the added complication of negotiating with a third party. If it is cheaper to ship from the US than it is to make in Europe then the opportunity is fairly obvious.
Clearly there are additional costs associated with the permanent closure of assets in Europe, but these bulk chemical facilities tend to employ few people per ton compared to the more value added products.
European Independents Should Also Pay Attention
There are a number of European basic chemical and plastics manufacturers who are not integrated into larger global petrochemical businesses and who rely on purchased raw materials. This has generally not been a great place to be in the value chain and we have seen a series of restructurings and bankruptcies over the last decade and a half. Names have changed and some of the less efficient capacity has been closed, but there remain 10-15 companies who should be looking at as many options as possible with respect to securing longer-term raw materials as cost effectively as possible.
In the same way that Ineos is looking to the US for ethane, these companies should look to the US for ethylene in some form. The alternative to not adopting such a strategy is to accept that US producers will likely try to move products into your end market and by so doing squeeze prices and margins locally.
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