Puzzle Solved?: Plastics economics are favorable

14:06 PM | April 30, 2018 | Francinia Protti-Alvarez

Given healthy economic growth worldwide, the commodity plastics industry is enjoying a particularly favorable business environment and operating in a sellers’ market. However, as the pieces of the plastic puzzle fall into place, even for the polyvinyl chloride sector, uncertainties remain. These include doubts over feedstocks, substitution, and recycling.

The various pieces are fitting together to create an auspicious period for commodity plastics as robust economic growth around the world ensures healthy demand. For polyethylene (PE), firm margins illustrate that the market is experiencing an extended, and unanticipated, up-cycle. Delays to the ramp-up of new plants, as well as harsh weather, have seen demand growth outpace supply, overturning previous fears of overcapacity. Meanwhile, for polypropylene (PP), uncertain feedstock economics and the ensuing limited investment have tightened the supply outlook, perhaps supporting higher prices. Similarly, for polyvinyl chloride (PVC), demand appears to be finally catching up with supply, which is also tightening the market faster than had been anticipated.

A brighter economic outlook

World GDP growth is expected to be 3.4% in 2018, up from 3.2% last year—the fastest pace of growth since 2010, according to IHS Markit data. Through the end of this decade, the world economy is likely to post the strongest back-to-back growth rates since the mid-2000s, the same data show. Amid this synchronized economic expansion, worldwide demand for chemicals and plastics is set to strengthen this year, IHS Markit says.

The chemical sector in the United States is benefiting from the ramp-up of new steam crackers as well as strong growth in the overall manufacturing and business investment, IHS Markit says. Recently-passed tax reform and an aggressive deregulation drive in the country are expected to boost earnings.

Meanwhile in China, enforced capacity reductions—a side effect of the government’s stricter environmental policies—have eased “cut-throat price competition” for the domestic chemical industry, IHS Markit says. This has improved profitability in commodity markets such as ammonia, caustic soda, soda ash, and PVC, says Lucas Casolino, associate director/economics at IHS Markit.

Some major petrochemical projects were announced for Europe during 2017—ending a period without significant capital investment there—and these plans should start taking shape in 2018. “The region entered 2018 at its most optimistic in more than 10 years. Almost all the region’s big economies are growing strongly, and forecasts for the chemical industry are equally bright,” Casolino adds.

As the price of oil flirts with $70/barrel, one trend worth watching for the plastics industry is raw-material inflation. “However, if producers can raise prices as fast as or faster than the climb in energy prices, their margins should be alright,” Casolino says. Against this backdrop, the picture looks positive for commodity plastics.

Polyethylene beating expectations

Integrated margins for PE producers have been at elevated levels for some time, according to IHS Markit data. An anticipated flood of new material has, for now, been avoided, extending the up-cycle that the PE industry has been enjoying.

“If you look at 2015–17, even on a non-integrated basis, PE in and of itself has delivered more than 50% of total margins. It’s exceptional—we have never seen this before,” says Nick Vafiadis, vice president/plastics at IHS Markit. “The monthly margin contributions of the average non-integrated North American linear low-density PE [LLDPE] producers during the 2015–17 period is almost 20 cents/lb. For Western Europe, it is closer to 9 cents/lb—roughly $200/metric ton. Southeast Asia is the outlier with average negative margins of 3.3 cents/lb—about $70/metric ton—not usual. However, during this period, Southeast Asia LLDPE non-integrated margins were positive over 10 months compared with two months over the July 2009–December 2014 period,” Vafiadis notes.

Margin strength in recent years is due to robust worldwide demand coupled with start-up and ramp-up delays of new capacity in North America and the Middle East, which have delivered favorable conditions for PE producers around the world. Last year alone, Chinese demand for PE grew 10.2% YOY, contributing more than 60% of overall PE demand growth, according to IHS Markit data. “Continued, strong growth in [PE demand in] China is critical to the ongoing health and growth of the overall PE industry,” Vafiadis says. “The impact of China’s environmental policy, the country’s move to natural gas and away from coal, as well as an increasing number of consumers turning to online shopping—which requires flexible packaging—are likely to continue to drive Chinese PE demand.”

In the period 2012–17, total worldwide PE demand grew by about 20 million metric tons (MMt), according to IHS Markit data. This growth was largely driven by China, which represented 10.8 MMt, or 54%, of total demand growth over this period.

However, worldwide demand growth is only part of the reason why PE margins remained strong during the 2015–17 period. Unrealized margin potential because of delayed capacity start-ups also played a significant part.

North American producers have struggled to bring on-line new capacity that was scheduled to start up last year. Even when capacity was brought onstream on schedule, producers faced difficulties ramping plants up to full production in a timely fashion, IHS Markit says. Some of that capacity is still being ramped up. In addition to these technical issues, Hurricane Harvey further delayed North American producers’ plans.

“North American producers recorded a deficit, versus expectations, of 915,000 metric tons less of PE in 2017,” Vafiadis says. Meanwhile, China led a spike in Asian PE demand: Consumption was 1.12 MMt above expectations, which was largely met by 1.08 MMt of ramped-up production, also in China. “[These dynamics] supported prices and margins at a higher level than they would have been otherwise,” Vafiadis says. “The spate of delays witnessed is unlikely to stop [into 2018 and through 2023], limiting the technical oversupply that had been expected.”

Adjusting to tighter markets in polypropylene

Initial PP oversupply concerns a year ago have evolved into a rather different scenario, in which the PP market is tight. As with PE, undercurrents in China’s PP market are central to the overall PP market dynamics.

Between 2017 and 2018, there will be about 1.9 MMt less PP available in the market as delays hinder new capacity coming online, according to IHS Markit forecast. China dominates the PP capacity additions worldwide in 2017–19 and beyond. “While these capacity additions will represent a smaller portion of global demand—from 70% in the 2012–17 period to about 50% in the five years that follow—it still represents a major part of the supply puzzle,” says Joel Morales, senior director/polyolefins, Americas at IHS Markit.

As delays reduce the speed at which new PP capacity comes online, demand in 2018 and 2019 is expected to be higher than previously forecast. Overall, there will be about 1.1 MMt of additional PP demand in the 2017–19 period, IHS Markit data show. China’s substitution of imported waste for recycling and a strong economy drive most of this additional demand, IHS Markit says.

China’s resin imports for recycling have evolved over recent years, and the imports made sense in the context of the high oil prices of 2010–12. Since then, the situation has been reversed by lower crude prices as well as by policy decisions. New Chinese government policy reduced the amount of plastic waste and scrap imports in 2017, and the government has moved to ban those imports in 2018. This has resulted in more demand for virgin plastic in 2017, since converters have had to supplement their supplies of recycled plastic with virgin product. This trend is expected to continue in the near term until alternative options are developed.

“Focusing on the near term, through 2019, and we consider the capacity we took out and the additional demand, the market has swung tight, to the tune of 3.3 MMt,” Morales says. As a result, PP operating rates will likely be above the 86% average annual rate recorded in 2012–17, IHS Markit data show.

PP margins reacted to increases in propane cracking in North America in 2015 coupled with the start-up of sizeable propylene capacities in Asia—based on coal or propane dehydrogenation (PDH)—resulting in downward pressure in propylene prices versus pre-2015 levels, according to IHS Markit’s 2018 Propylene World Analysis. These healthy margins are forecast to continue, owing to favorable supply and demand conditions through the next few years.

However, “there will be a battle between margin-sharing of propylene and PP, as both are very tight through the end of the decade,” Morales says. “This is expected to vary region by region. Sensitivities to our base case include the possibility that the upside potential could be significant, and demand destruction resulting from substitution to other plastics or materials,” he adds.

Reductions in spare capacity spells need to invest in polyvinyl chloride

Even PVC is expected to tighten in the years to come, highlighting the need to invest in additional capacity, analysts say.

The worldwide vinyls industry is in a very different place compared with just two years ago. After bottoming out at 72% in 2012, operating rates have climbed steadily to an anticipated 82–83% in 2018–19, IHS Markit data show. “The market is tightening, and at a faster rate than many had anticipated,” says Henry Warren, director/inorganics group at IHS Markit. “Several factors have contributed to this shift. Lower crude prices have improved economics in naphtha-based producing regions. The caustic soda side of the [chlor-vinyls] business has, meanwhile, witnessed a resurgence. And demand, albeit reduced, has grown steadily for several years, exceeding capacity additions.”

Northeast Asia is at the core of international supply and demand for PVC. Worldwide PVC capacity was 53.8 MMt last year, and China alone represented 28.7 MMt. North America was a distant second with 9.3 MMt. Demand-wise, northeast Asia represents about 48% of the world total despite slower Chinese growth. Greater Asia is expected to account for the bulk of PVC demand growth going forward, IHS Markit data show.

Spare PVC production capacity—production that is less than the achievable or optimal amount—is currently 10 MMt, down from 15–16 MMt of spare capacity 2–3 years ago. This is expected to halve over the next five years. “Excess production too is halving, and exports will be the first to feel the impact as the market tightens. New capacity additions will be needed soon,” Warren says. “Chinese producers are still adding capacity, but on average it is at a slower rate than demand growth. If no additional hypothetical capacity is added by 2021, PVC run rates could move from the mid-80% to the mid-90%.”

Whether the anticipated higher run rates will be sufficient to encourage further investments remains uncertain. “Investments in integrated chlor-vinyl facilities have historically been higher than those in PE, reducing the return on investment, and existing business models tend to be more geared toward integration in the ethylene-PE chain,” Warren notes. “Additionally, while caustic soda demand is experiencing a resurgence, it has not always been the case. Securing finance for what would be an exports-based investment is another obstacle.”

Historically, vinyls have not been a priority for ethylene suppliers due to poor integration and better margins available from other derivatives. This is changing, and there are initiatives across the world to integrate better to ethylene and/or gain access to more competitive feedstocks, IHS Markit says.

“[A] very supportive caustic soda market, negative chlorine costs, and sustained higher PVC margins—reflecting the balanced-to-tightening market—means PVC will be much more favorably placed to compete for [ethylene] feedstock,” Warren adds.

Product substitution remains, as always, a risk for PVC, since new PE capacity can suppress high-density PE netbacks relative to nondiscounted PVC. Substitution could affect PVC applications such as pipe, although the risk is expected to be quite narrow, according to IHS Markit. Converters need to consider aspects other than price, such as product life-cycle, tensile strength, maintenance and reliability, and installation.

Demand destruction because of the growing role of recycling could also threaten PVC in the coming years. In Western Europe, the proportion of recycled PVC relative to virgin resin rose from 0% in 2003 to about 10% in 2016. Assuming PVC recycling targets and supply-demand fundamentals, this is expected to increase to 14% by 2020, according to IHS Markit data. More significantly, China’s stricter environmental stance will also impact overall fundamentals for virgin as well as recycled PVC (p. 25).