Petrochemical sector facing headwinds from COVID-19

Mirko Rubeis, Managing Director & Partner at Boston Consulting Group (BCG) and Marcin Jedrzejewski, Partner & Associate Director at BCG spoke to Julian Walker about what the future holds for the petrochemical industry in a post COVID world.

What impact has COVID-19 had on the petrochemical sector?

At present, the full impact of COVID-19 on the petrochemical sector is yet to be determined, especially when considering the second wave’s severity in areas such as Europe. In truth, we may not know the full extent of the ramifications for some time yet, although it is clear to us already is that the impact is multi-fold and can be observed along three primary dimensions.

Firstly, the impact on petchem demand and production has been hindered, with an expected 5 – 10 percent decline based on the ICIS’s Global Petrochemical Index (IPEX). Secondly, the sector’s competitive dynamics have also been affected with the Q1’2020 oil price crash resulting in lower feedstock prices, such as naphtha into low-cost ethane feedstock territory. Thirdly, petrochemical companies’ financial results and valuations have been hit, resulting in an acceleration of portfolio restructuring and transactions, with examples including the recent agreement between BP and INEOS, as well as the Sasol – LyondellBasell Lake Charles deal.

It is also important to note that the impact of petchem demand is not uniform. There are vast differences by end industry segments, with deep structural demand decrease in aerospace and automotive for example, while others such as the packaging segments are in a better position.

While naphtha pricing plunged below $ 200/t for the significant part of Q2’2020, making them competitive with ethane-based cracking, the consequences of low-oil price are broader, with many intermediates like benzene, paraxylene, or ethylene dichloride (EDC) facing extremely low prices in 2020.

The impact was further reinforced by fuel demand drop and adjustments to refinery product mix as well as coincidental commissioning of significant crude-oil-to-chemicals (mostly paraxylene) installations in China. Closure of Indian ports due to the pandemic, limited import options on shallow EDC trade market, further harming overall margins. The combination of these factors demonstrates, that players with open value chain positions on intermediates face a higher level of risk during a major disruption.

What challenges does the petrochemical industry face in the long- term?

The pandemic has demonstrated several profound challenges in the industry. The sustained availability of refinery-based feedstocks is among the most pressing as the refinery industry has been hit harder than the petchem industry, where closures of refineries will accelerate and refinery-based feedstocks (although very attractively priced during COVID-19), will become a less sustainable supply source long-term.

Another challenge is the risk associated with maintaining open positions in selected chains. As an example, benzene, PX, and EDC markets have been hit particularly hard due to the pandemic. This has demonstrated a clear need to reconsider value chain positions and move closer to end-products such as a polymer.

In addition to these challenges, others that lay ahead include having the agility to follow supply-demand fluctuations in terms of product and grade adjustments (the example of sudden demand growth for certain packaging grades, for certain periods up to 250 per cent year-on-year, and strong price differentiation by grades), regionalising supply chains due to possible port closures and other unforeseeable circumstances, and achieving a geographically diversified portfolio, by players with global aspirations.

Building on the point above, especially regarding the portfolio of steam cracking and underlying ethylene economics, which is the main margin “bearer” in petrochemicals. Under normal market conditions, there are two main pathways for the selection of geography/feedstock combination, either select a naphtha cracker in proximity to demand or select an ethane cracker in proximity to preferential ethane feedstock (specifically relevant to the Middle East, the United States or Russia).

2020 has demonstrated that the ideal portfolio should include both naphtha and ethane-based ethylene in optimally selected geographies. By doing so, it provides an additional level of resilience to the portfolio and we have seen the impact on the overall performance of players that have managed to build such a portfolio. We may also see further efforts in this area, both through organic build and inorganic M&A/JV activities.

What impact will the move towards a lower-carbon energy system have on the Petrochemical sector?

Contrary to some industry expectations, decarbonisation’s importance and relevance during the pandemic have remained and gotten stronger. In line with this, analysing CAPEX structure and adjustments, which is done by virtually all petrochemicals players during the pandemic, has provided us with some interesting insights.

Firstly, sustainable CAPEX – supporting decarbonisation and eco-friendly products – has remained untouched whereas short-term CAPEX cuts have been common. Secondly, many players have announced either a new strategy or at the very least strategy updates, in recent times. Those to whom this applies have demonstrated a profound role in pursuing sustainable investments, which have, in turn, accelerated carbon trace reduction along the value chain. Thirdly, most corporate communication and PR activity is now focused on sustainable products and solutions, with a prominent example being the recent announcements on bio-phenol shipments in Europe.

There are strong foundations for these trends. For some of the players, specifically in Europe, rising emission costs before the pandemic had demonstrated how costly carbon footprint can be. The pandemic was a temporal respite as it is seen by a quick recovery of EUA emission allowance unit to levels 26-30 EUR/t in H2’2020. Also, many players approach the end of free emission allowances and grace periods, as a consequence of the new EU ETS legislative framework for the 4th trading period (2021–2030).

Finally, the financial markets have also given a very clear signal – offering a valuation premium for companies with “green” portfolios or restricting credit action for certain portfolios is not green enough. This is profoundly visible through the PCAF (Partnership for Carbon Accounting Financials) initiative, which aims to assess and disclose loans and investments relating to greenhouse gas emissions. With global majors such as Bank of America, Citi and Barclays already having a vested interest, it will not be long before a material impact is translated to the petrochemicals industry.

How important will integrated petrochemical plants be in the future?

The concept of close plant integration is not new in the industry. Mastered by BASF at the flagship site of Ludwigshafen, the Verbund concept aspires to utilise every molecule and unit of energy through close integration of all production facilities at any given site.

The integrated plant will continue to be important and will evolve towards a new level of integration with COTC (crude oil-to-chemicals), as we have already seen in China, Singapore, and in the future in the Middle-East. As such, the potential is huge. From a Middle East perspective, there are opportunities ahead as the world’s biggest industrial cities are located here, including Al Jubail in Saudi Arabia and Ruwais in Abu Dhabi.

Chemical production will be essential for refining assets to remain profitable, so we expect that among the several refinery closures, the integrated sites will be the ‘last refinery standing”. In times of low oil price, besides the synergies of integration, integrated sites will also enjoy lower feedstock costs.

Which regions will be major petrochemical hubs in the future?

When attempting to project the major petrochemical hubs of the future, it is important to note that historical feedstock demand in terms of close proximity has always been important and this will not change. The Middle East and Asia will continue to be very important hubs. We also expect the US to continue to grow based on shale gas availability as well as India (with strong demand growth, large refining base, ability to import competitive feedstock, etc.) and China. It would also be important to follow and pay attention to gas discoveries locally (e.g. Russia and Egypt).

Besides these examples, though, India is well-positioned to be the real gamechanger in terms of future petrochemicals hub because the country already boasts the capabilities in terms of geography and infrastructure. The country’s huge domestic market, driven by population growth and wealth, proven capability to bring attractive feedstock such as US ethane, and the existence of strong and established industry majors such as Reliance Industries Limited, constitute strong foundations for a hub.

What must the petrochemical industry do to adapt to the new energy landscape?

The short answer is the agility to adapt to the new energy landscape. After all, 2020 has demonstrated how quickly things can change and agility is, therefore, paramount. Significant demand shifts across application industries, including huge feedstock price volatility, supply chain disruptions, and naphtha cracking emerging as a strong competitor to gas cracking, have collectively demonstrated that a quick response is critical to stay afloat.

The level of disruption we have seen this year, together with competitive shifts, have never been seen before. Many producers, especially exposed to intermediate petrochemicals, were much better-off by stopping production and fulfilling the contracts by leveraging market access. Further emphasis to access to the market is vital. Staying close to the buyers of products and the end industries behind them allows for much quicker recognition of changing demand patterns, coming challenges (such as logistics disruptions or force majeure), and registering price shifts.

This year has demonstrated that agility is critical to run the petchem and chemicals business, where better digital tools are needed for information circulation, scenario modelling, and decision support. Digital will also be critical, by providing tools to optimise pricing and access to clients, particularly at times of social distancing (e.g., digital/remote inbound/outbound marketing, centralised sales, etc.). COVID-19 has demonstrated the relevance and importance of digital ways of working.

As the pandemic continues, it is important to continue to adapt to this new reality by introducing advanced analytics and digital tools for scenario modelling, digital control towers for decision making support, and digitalising further commercial interactions in the channels.

Mirko Rubeis

Marcin Jedrzejewski