16:38 PM | April 16, 2020 | Vincent Valk
The demand shock created by the coronavirus disease 2019 (COVID-19) pandemic, along with the collapse in oil prices, is depressing profitability for chemical makers and scrambling industry supply chains, according to speakers at the 2020 World Petrochemical Conference (WPC) Online strategic dialogue forum held this morning. With the global economy mired in a sudden and especially steep recession, chemical companies are pulling back investment and facing an environment of sustained lower margins.
“Clearly we’ve entered a downcycle,” says Mark Eramo, global vice president/oil, midstream, downstream, and chemicals at IHS Markit. “It raises many questions about the survivability and competitiveness of assets around the world.”
Profits will almost certainly decline significantly, exacerbating a situation that predates the COVID-19 pandemic. A massive increase in global petrochemicals capacity in the late 2010s had already hit industry profits, which tumbled in 2019 from a peak in 2018. “We were starting to overbuild capacity in base chemicals and plastics,” Eramo says. “Profits started to decline already in 2019.” Further declines will occur in 2020 and 2021, with the scale of the profit contraction likely to be larger than existing forecasts by IHS Markit, he adds.
Investment in the industry is also likely to take a big hit. Firms up and down the chemicals value chain have announced cuts to capital expenditures in recent weeks. Investment decisions are being put on hold where possible, according to Eramo.
The economic fallout from the COVID-19 pandemic and related shutdowns will be severe. IHS Markit is forecasting a sharper GDP contraction than seen during the Great Recession, with global GDP expected to fall by 3.0% this year. GDP is expected to fall by 5.4% in the US, with a 4.6% drop expected for the eurozone and a 2.0% increase expected in China.
The GDP figures for the second quarter should represent the steepest declines, and will be “horrific,” according to IHS Markit chief economist Nariman Behravesh. IHS Markit is forecasting a 27% decline for US GDP in the second quarter. Growth will return late this year or early in 2021. “We expect to see light at the end of the tunnel later this year or early next,” Behravesh says.
For the manufacturing sector, a ‘v-shaped’ recovery is possible, due to an inventory drawdown and subsequent rebuilt. “Huge damage to global supply chains” complicates that picture, however, Behravesh says. For services, the recovery will be much slower. Consumer spending will remain at low levels for some time, limiting demand for chemicals. “The recovery in demand will be linked to consumer spending,” Eramo says. “Consumer confidence will take time to recover in a post-virus environment. The industry is in the process of experiencing a demand shock.”
Unprecedented drops in crude oil prices are also scrambling the cost curve for petrochemical producers. Naphtha-based assets are now competitive with ethane-based assets, a dramatic shift from recent years. “Assets viewed as high on the cost curve or noncompetitive have suddenly become very competitive,” Eramo says. Regional competitiveness has shifted, with Western Europe and Northeast Asia on a solid footing against the Middle East and North America.
This situation seems likely to persist, as oil prices are not likely to recover anytime soon. A deal brokered by the Trump administration has put the brakes on the Saudi Arabia–Russia price war, but the impact of production cuts is not likely to be felt until the second half of the year, according to Jim Burkhard, vice president/crude oil markets at IHS Markit.
Even if production is cut, prices will remain low until demand recovers. Crude oil demand is forecast to fall by 22 million barrels/day during the second quarter, the largest drop on record, Burkhard says. Transportation restrictions “have hit at the heart of oil demand,” he says. “Oil demand is collapsing.”
Indeed, maxed-out storage capacity could lead to some instances of ‘negative’ oil prices, in which producers pay consumers of oil to take supply off their hands. "In some locales, if companies don't have the storage, it is conceivable that they will have to pay someone to take their oil," Burkhard says. "Right now, we think May is likely to be the most severe time for oil prices as we'll have a brutal adjustment to lower demand." Last week saw the biggest increase in US crude oil inventories in history, according to the US Energy Information Administration (EIA; Washington, DC).
Few bright spots
Some parts of the chemical industry are seeing rising demand. “Nondurables are seeing some stimulus in demand,” Eramo says. Makers of ingredients for cleaning products and suppliers to the healthcare industry have reported big demand increases. Single-use plastics, which are seen as more sanitary than recycled plastics or reusable alternatives, are also in a good position.
But the overall outlook is bleak, at least for this year. Weak consumer spending, weak economic growth, and shutdowns in key end markets such as automotive mean that bright spots in areas such as cleaning products, healthcare, and single-use plastics will not be nearly enough to create demand growth on their own. “The jury is still out on the plusses and minuses, but we expect a sizable demand shock,” Eramo says.