Prices will fall with energy costs

Slowing demand and moderating pressure on hydrocarbons bode well for buyers.

By -- Purchasing, 3/8/2001

It's a strange time to be a petrochemical buyer.

Adequate supply in most petrochemical markets, with more capacity expansions scheduled for this year and next, along with sluggish demand suggest that buyers should see lower pricing this year as the price cycle continues its downward trend following last year's price peaks.

So why are prices rising right now? While it's true that many factors are affecting the domestic petrochemicals market, energy costs are having the most profound impact on pricing.

Longer term, the situation looks better for buyers. Beyond April, lower energy prices are likely with the close of the winter heating season. And with the supply/demand balance favoring buyers in most of the petrochemical markets, pricing may be in for a swift, rocky downhill run.

Of course, the wildcard is the uncertainty that buyers and market observers are showing toward the performance of the U.S. and global economies in the coming year.

While the general consensus is for slower overall demand growth in 2001-most estimate 1%/yr to 2%/yr growth of the gross domestic product (GDP), compared to 5% annual growth seen last year-many sources disagree on whether the economy will see a soft landing or be plunged into recession, or whether the worst economic conditions have arrived or still lie ahead.

Petrochemical producers unleashed a slew of price increase announcements in most major petrochemical markets with the first of the year, followed by more announcements for additional support. For example, polyethylene (PE) producers scheduled price increases for Jan. 1 in the amount of 5¢/lb, as well as a 6¢/lb hike in February. In addition, polypropylene (PP) producers have announced a 5¢/lb increase for Feb. 1.

"The feedstock situation in the chemical market is very unusual at this time, says Dan Boivin, marketing manager for polyethylene markets at Chicago, Ill.-based Nova Chemicals. "The industry hasn't seen a situation like this in more than 30 years," he says, explaining that in the last year, natural gas costs have more than tripled and averaged more than $10/million BTUs in January. "When you consider that the cost to make ethane and butane has tripled, and that these are the primary materials used to make ethylene and propylene, you have a dramatic situation," Boivin says. "Whereas prices of PE and PP had been falling throughout the third and fourth quarters, we're now beginning to see a reversal of that," he adds.

Whether these increases and others in many of the petrochemical markets will actually show up in the marketplace as other than upward "blips" preceding a more pronounced price slide is still a topic for debate. Many buyers believe that these and other petrochemical price-hike announcements were made in an effort to keep prices from dropping, rather than with the expectation of any real gains.

In talking to customers and explaining the current market situation and the most recent price-increase announcements, Nova's Boivin says, "I don't think that the penny has dropped yet. Buyers' expectations are so different from what is actually going on that they're are having a difficult time 'absorbing' the idea of price increases at this time," he says.

"But these increases are necessary," Boivin insists. "If they don't go through, then there won't be any PE made because it won't be economical to make it." Already, he says that about 20% of domestic PE capacity has been removed from the marketplace.

Indeed the cost push from natural gas and crude oil pricing, along with slow demand for many petrochemical markets, has put producers in a difficult position. According to Bill Urquhart, vice president at The Pace Consultants Inc., a petrochemical market research firm based in Houston, Texas, "In many cases, sellers are caught between a rock and a hard place."

But are price increases necessary? Buyers don't necessarily agree. However, one buyer of PE resins and a variety of petrochemical-based solvents at a major consumer products company located on the East Coast says that when producers make a concerted effort to raise prices, "some of the increase usually winds up sticking."

PURCHASING FORECAST : Despite the short-term bumps, overall petrochemical pricing is poised at the edge of a downward slide. The question for many buyers is not if prices will come down in 2001, but when the trend will start and how much prices will fall. Answers to these questions will depend on energy prices and the performance of the economy.

Energy costs will abate

Crude oil prices have remained fairly high since their dramatic increase seen last year with the supply curtailments announced by the Organization of Petroleum Exporting Countries (OPEC). And though OPEC is considering further supply tightening, analysts are favoring changes in the natural gas situation as an indicator of lower petrochemical pricing. By all accounts, current natural gas prices of near $10/million BTUs are unsustainable, and must fall with an end to the winter season. While the normal $2.50/million BTUs level won't be seen anytime soon, the market will begin to see more moderate levels in the next few months.

Buyers will benefit from falling natural gas prices starting in the second quarter and continuing through the balance of the year, which will pull down the pricing floor on petrochemicals. Houston-based petrochemical firm Chemical Market Associates Inc. (CMAI) estimates that U.S. Gulf Coast natural gas prices will average about $7.35/million BTUs during the first quarter, a far cry from the $2.62/million BTUs seen this time last year, according to their data.

Pricing will fall to an average of $4.31/million BTUs in second quarter 2001 as warmer weather nears, and then fall as low as $3.37/million BTUs in the third quarter. CMAI forecasts an additional drop of about 30¢/million BTUs for the fourth quarter to about $3.06/bbl.

For crude oil, some sources see a slower price decline. Urquhart believes that the energy cost base will edge down in 2001. "Pricing for crude oil will edge down this year, to about $26/bbl," he says. "Not as low as many producers and buyers would like."

Crude oil price trends, forecast by the U.S. Department of Energy (DOE), also call for a slow, gradual price descent. According to the DOE data, West Texas Intermediate crude oil estimates currently will average slightly more than $29/bbl for first quarter 2001, a decrease of almost $3/bbl from the fourth quarter 2000 average of nearly $32/bbl. The DOE expects prices to average $29.49/bbl in the second quarter, with only minimal downward movement in the third quarter (only about 16¢/bbl). However, by this time next year, the DOE sees crude oil prices sliding below the $26/bbl mark (averaging $25.87/bbl).

Demand tracks economy

The U.S. petrochemical markets in terms of annual demand are highly dependent upon the performance of the chemical industry as a whole and on the U.S. economy. Most analysts are forecasting minimal growth in the economy this year, and based on this, demand from most petrochemical markets will follow suit.

According to Pace's Urquhart, his firm's demand outlook was slow in most petrochemical markets through fourth quarter 2000, and it is his belief that this trend will continue through much of the year, but demand will be particularly weak in the first half of the year.

While some analysts forecast a darker outlook for the 2001 U.S. economy and voiced concerns of recession, the story may be changing, especially with the recent interest rate cut by the Federal Reserve. According to Urquhart, this has the potential to spark demand, probably during the third quarter of this year.

"It takes a while for a cut in interest rates to find its way through the economy," says Urquhart. "If you look at what happened after the Fed increased interest rates in April of 2000, it took about six months for the effects to be felt in the economy," he continues. Urquhart believes that it will take at least as long for the current rate cut to show up in the petrochemical markets. "The underlying economic forces are still very strong in the U.S."

Nova's Boivin agrees and says that his company is taking an optimistic stance on the direction of the U.S. economy in the year 2001. "We think the first quarter will be the most difficult, and that maybe in the second quarter we will see some recovery," he says. "We're optimistic about the second half of the year because we believe that the economic fundamentals in the U.S. are still good. "We should see stronger demand for petrochemical products generally and for polyethylene products in particular in the second half of the year."

METHANOL/Look for cost/ price declines

STYRENE/Market still in the doldrums

Phenol/Energy costs delay price slide