the shale gas impact on c2 c3 and c4 downstream derivatives

CMR Chemical Market Resources, Inc.Tel: (281) 557-3320 Fax: 557-3310

Exhibit 1: Global Shale Gas Availability

Source: Energy Information Administration (EIA)

Shale Gas Impact on C2, C3 and C4 Derivatives Dr. Balaji B. Singh, Dr. J.N. Swamy Chemical Market Resources Inc. Houston, Texas, USA www.CMRHouTex.Com

Introduction

Shale gas, being popularly called Game Changer is the magic bullet needed for U.S petrochemical industry, The U.S petrochemical industry went through major downturn in the last decade and is positioned very well for a full recovery.

This article presents the current status of Shale Gas and how it will impact the major petrochemical products in (1) Ethylene Derivatives, (2) Propylene

derivatives and (3) C4 derivatives. The impacts on these three are different and will have major Global implications for players in different parts of the world led by U.S.

Most of these impacts may not materialize for another five years thus the market peak may be in 2017. The petrochemical planning cycle requires 3-5 years of planning, in addition to the current shale gas development of 2-4 years. The indirect impacts will be felt sooner because of potential supply issue: (1) people announcing and/or canceling plans, (2) individual plans on effective utilization, and (3) Global trade balances.

U.S Impact After a decade of no major investments, the traditional chemical/petrochemical industry in the U.S stagnated. The classic characteristics include: (1) No


Exhibit 2: Shale Gas Availability in US

new major investments, (2) reduction in number of Global players and innovation, (3) Feedstock/Asset light strategy justifying outsourcing and (4) moving to value added service businesses at the expense of potential liabilities, for short-term profits.

Exhibit 1 presents the Global locations of shale gas. Exhibit 2 presents the abundant shale gas locations in the U.S. The development of Shale gas access

via major developments in horizontal drilling and fracking methods in the U.S, have given the U.S a running start in monetizing shale gas. The companies are moving forward en masse to capture the opportunity. Most of the countries of the World are also assessing their shale potential and will be ready to play in this sandbox sooner than later.

The stage is set for this opportunity, as most companies are cash-rich. Financial


Exhibit 3: Announcements for New Cracker Investments & Expansions in US

Source: Chemical Market Resources Inc. based on announcements

FormosaPlastics PointComfort,TX 800,000 2016ShellChemical Appalachia 11.5million 2016AitherChemical Appalachia TBD 2016ChevronPhillips Baytown,TX 1.5million 2017DowChemical TBD/USGulf 11.5million 2017Sasol LakeCharles,LA 11.4million 2017Severalothersunderstudy

WestlakeChemical LakeCharles,LA 110,000 2012BASFTotal PortArthur,TX 100,000 2012DowChemical Hahnsville,LA 400,000 2012Williams Geismar,LA 270,000 2013Ineos Alvin,TX 150,000 2013WestlakeChemical LakeCharles,LA 110,000 2014LyondellBasell LaPorte,Channelview,TX 600,000 2014+DowChemical Plaquemine,LA/Freeport,TX 500,000 2014+WestlakeChemical CalvertCity,KY TBD 2014+

NewCrackerAnnouncements(Ethylenecapacityintons)

Expansions&Debottlenecking(Ethylenecapacityintons)

performance in 2011 has exceeded expectations and lacked investments, have made companies cash rich. The petrochemical downturn forecasted to come due to excess Middle East and Asian capacity has not occurred thus not impacting the internal consumption and export opportunities for the U.S market.

At the least eight companies that have either already announced or are looking

at major ethylene and ethylene derivative expansions (debottlenecking and new crackers) in North America. Exhibit 3 presents the current players who have announced shale gas based crackers or derivatives.

Polyethylene will be the dominant derivative for the shale gas, with EDC, and to a much lesser extent, EO/EG and selected alpha olefins as alternatives.

The emphasis on ethylene and derivatives in the U.S will continue. No one in the U.S announced plans on either propylene or C4 Stream derivatives to keep pace with ethylene derivatives

Impact on Ethylene Derivatives

Due to the presence of large volumes of ethane in shale gas, ethylene will be the clear beneficiary. With expectations of a secular trend of low natural gas prices in the medium to long-term, cracking NGLs


Exhibit 4: Oil to Natural Gas Price Ratios, 1990-current

Source: Chemical Market Resources Inc

will be the most advantageous for the cracker operators.

This trend is evident from the rapid shift to lighter feedstocks in the last 2 years due to the shale gas effects on natural gas prices relative to crude oil. Exhibit 4 presents oil and natural gas prices as multiples. The oil to natural gas price ratio is expected to be multiples above the threshold 6.5 which defines Natural gas advantage over naphtha for petrochemical production.

With these expectations, the US petrochemical industry is set to see

significant investments to monetize the shale gas advantage.

If and when all the projects come to fruition, the North American market cannot absorb all of the additional derivative capacity. Some or a large

portion of the production will be earmarked for the export market.

The US Gulf Coast will in some ways become the next Middle East of the world with a large amount of export-oriented capacity destined for countries outside of North America. Since Mexico will reduce imports substantially with the start up of the Braskem-IDESA in 2015, the opportunities for export will be outside Americas.

Internally, the products will have a logistics advantage to replace products

produced on the Gulf Coast. This could put even greater pressure on the Gulf Coast plants to export.

There could be some new entrants in the ethylene and ethylene derivative business. Reliance, for example, has an


equity position in three shale gas fields. SABIC has long been rumored to be interested in establishing a production base in the Americas. Braskem has a clear commitment to North America. Some of the ethane will be sent to Canada. NOVA has announced a new pipeline to transport Marcellus ethane to Sarnia.

Overall the activity in mid to Northeast America is poised to change the dynamics within the U.S.

Given these dynamics, a significant issue that emerges is whether all of these capacity announcements are justified and/or will they come to fruition. Companies tend to analyze new capacity in terms of its percentage of existing capacity. This makes the numbers appear more acceptable, especially when overlaid on projected demand growth. However a more critical measure is: what is the new capacity as a percentage of excess capacity as measured in relation to domestic demand and not total sales?

For 2016 startup scenario, three potential expansion scenarios exist: (1) The low product expansion case 4 Miilon tons of Ethylene capacity, (2) Medium expansion case of 6 million tons per year of new ethylene capacity and (3) High expansion case of 7.5 million tons per year of new ethylene capacity.

Exhibits 5 and 6 present the US Polyethylene Demand and Export Exposure: Pre-shale and post-shale under these three scenairos.

In the pre-shale scenario domestic demand would increase by about 3 million tons between 2010 and 2016 while total exports would decrease by about 1 million tons. This would require about 2 million tons per year of debottlenecking. Recapturing lost exports would add another 1 million tons to this.

The export opportunity in 2016 would be 1 million tons, 3 million tons and 4.5 million tons for the three respective scenarios. As the world would have more than enough capacity to satisfy demand in 2016 (based on the amount of new capacity forecast to be in place and demand growth), the additional US polyethylene would have to displace the existing export suppliers which would lead to turf wars. Extending the forecast to 2020, assuming that there will be some additional ethylene/polyethylene indicates that the USGC will continue to be export-oriented.

The excess US export volumes (export exposure) represent 3, 10 and 15 percent of global trade for the three cases respectively. If the US was the only country expanding this would be less of an issue, but there will be other countries expanding during this period as well. The export market could become a battlefield! In addition, having the ethane advantage does not necessarily mean that you can capture its full value.


Exhibit 5: North American Ethylene Capacity (Base and High Cases), KTA

Exhibit 6: US Polyethylene Demand and Export Exposure - KT


0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1995 2000 2005 2010 2016 - Base case 2016 - Speculative

Ethy

lene

Cap

acity

(KTA

)

Mexico

Canada

US

0

5,000

10,000

15,000

20,000

25,000

30,000

1995 2000 2005 2010 2015 E 2020 E

PE D

eman

d (K

T)

Exports to Others

Exports to Mexico

Domestic


One risk associated with being low-cost, export-oriented is the exposure to anti-dumping action. Should U. S. export prices be deemed too low, countries that have domestic production could institute anti-dumping action against U. S. imports (as they have in the past). Moreover, many existing high-cost producers (e.g., South Korean) will not simply walk-away and give up their export market at least not without a fight.

An added dimension to the problem is the relative market valuation of ethane vs. methane in the US domestic market The decoupling could be significant if the flatness in demand for methane persists forcing the gas producers to extract more value from the liquids (mainly ethane). This will largely depend on the overall scale of cracker expansions and deserves a more detailed investigation.

In summary, the shale gas will have its large impact on U.S polyethylenes. Some of the major players wish to focus on specialty/value added polyolefins not an easy task. See our Multiclient Study on Specialty Polyolefins Markets, Technologies and Trends.

Impact on Propylene & derivatives

While ethylene has been the clear beneficiary, other petrochemical streams have had to face a more difficult and volatile situation. With low natural gas prices and high oil prices

(with greater potential for further divergence) the industry has reapportioned its ethylene cracker mix from 70% ethane - 30% liquids to 87% ethane - 13% liquids. This has resulted in a drastic reduction in propylene production. About 1.5 million tons of new propylene capacity will be needed to replace the capacity lost to the NGL shift. At a 3% growth rate for propylene derivatives, another 2 million tons/year of new propylene capacity will be

needed to meet 2015

projected propylene derivative

demand.

Exhibit 7 presents the

price of propylene with time. The tightness in the US propylene market, relative to the ethylene supply, has led to a growing premium for propylene over ethylene. In Jan 2009, during recession, propylene prices dropped to nearly 20 cents/lb. But soon (by Jan 2010) due to the feedstock shift in the crackers prices rose to about 65-70 cents/lb. For most of 2010 prices were stable in the 50-60 cents/lb range mainly due to softer downstream derivative (PP, PO, AA, etc.) demand which compensated (or relieved) the supply tightness. But once the demand started picking up in 2011, the prices went to the range 75-90 cents/lb. Now the demand seems to be picking up more but the supply is at the same level. These levels of volatility will continue to be a characteristic of the US propylene markets in the short-term.

In the US nearly 50 percent of the propylene output has come from the

.The shale gas will help Ethylene Derivatives and Stimulate alternatives for Propylene.


Exhibit 7: Impact of Shale Gas on Propylene Prices (North America)


refineries with the remainder from steam crackers and some on purpose

production. Aa additional propylene from refineries is not likely, the on-purpose propylene production is the only alternative. Dow has recently announced a new world-scale propane dehydrogenation (PDH) plant. Some companies are also considering metathesis technology (if they can also get the C4s). Understanding PDH, Metathesis, MTP technologies and the related economics will become increasingly important.

The derivatives of propylene will continue to feel the pinch and feedstock will remain the major issue. Polypropylene accounts for the majority of the propylene consumption and will be impacted the most. Polypropylene, on the other hand will be exposed to some limited intermaterial substitution to HDPE, Polystyrene and PET

Other propylene derivatives such as acrylic acid, etc. will be in a better

position with the ability to pass the feedstock price increases to the customers, due to no known alternatives.

In summary, shale gas developments will adversely impact the propylene supply for the future. Of the propylene derivatives, polypropylene will see the most impact due to intermaterial competition. This will also increase the development of propylene alternative developments PDH and Metathesis.

Impact on C4 & Elastomers

Shale gas driven shift to lighter cracker feeds will also impact the C4 and elastomers business. The effect tightening butadiene supplies have had on the US markets is evident in the pricing. The US butadiene price climbed to record highs in June 2011 nearly $2,000/ton (about 60%) above the


Exhibit 7: Butadiene Price Trend in US (Historical & Expected)


0

500

1000

1500

2000

2500

3000

3500

2005 2006 2007 2008 2009 2010 2011 2012 2013

USD

/Ton

previous record high price set during the energy run-up of 2008.

Exhibit 8 presents the trends in the butadiene prices. The situation was similar around the Globe, with both Asian and European butadiene prices hitting record levels as supplies

tightened. At the time, the tight butadiene supplies were exacerbated by a significant run-up in the price of natural rubber, boosting demand for synthetic rubber downstream. Even with that higher demand, US butadiene derivative production has been scaled back because of a lack of feedstock which clearly was elevated by shift in cracker feeds.

With US butadiene consumers facing perpetually high prices, production options once thought unprofitable are starting to be discussed. In August TPC Group announced it was performing a

detailed engineering study of on-purpose butadiene production via dehydrogenation of Butane. Butane is an expensive feedstock in the first place due to limited supply and its alternative value in gasoline pool

In the short-medium term, butadiene is

imported both as butadiene and butadiene equivalents (SBR, PBR, or even tires) are expected to increase. The import exposure of US will continue to increase with one of the major sources being Korea. Asian producers will likely move more butadiene into the US. Additionally, there will be significant increase in the import of butadiene derivatives given the logistical difficulties of transporting butadiene.

With a scale back in production of butadiene derivatives and also tire production in the region, North America in the long-term is expected to remain a


net importer of these products. Given the pricing levels of butadiene the regrind economics have become attractive, which could also be a small reduction in the derivatives demand (SBR and PBR).

Conclusions

The decoupling of natural gas prices from crude oil, driven by Shale Gas, has made petrochemical investments in United States attractive after over a decade of stagnation.

The ethane advantage makes ethylene the clear beneficiary and polyethylene will be the number one derivative to be produced. North American markets will not be able to absorb all of the production from these assets and will lead to significant export exposure.

U. S. companies preference to sell into the domestic market rather than export, the companies will want to sell as much of their new production domestically as possible, thereby triggering a battle for market share. Since it is extremely difficult to buy market share, a downward movement in prices and margins is likely to occur.

Can companies position themselves to do better than their competitors if these scenarios occur? The answer is yes. It will be based on a combination of technology employed, product portfolio, market strategy (domestic and export), competitive intelligence and timing. As always, first movers will fare better than

followers (especially if it deters someone else).

Other petrochemical streams including propylene, butadiene and derivatives will face a more difficult situation which is already evident in the prices resulting from the recent shift to lighter cracker feeds. On-purpose technologies will become important and will prove to be economical under high price scenarios. Propylene will benefit from some the new on-purpose production projects announced or being considered. Butadiene on the other hand will likely continue to be under pressure and lead to increasing import exposure of butadiene and derivatives.

All in all, Shale gas will have a transformative effect on the US petrochemical industry leading to new investments, more jobs

and greater sense of excitement in the industry. Irrespective of whether some or all of the announcements come to fruition, the industry will see a better than expected (pre-shale times)

For further information and individual organizational strategies in product portfolios and plans contact CMR Inc. We have over 22 years of experience in product planning and technology development for all olefin derivatives, .

EMail: [email protected] Email: [email protected] Web: www.CMRHouTex.Com

..Shale gas, is the magic bullet needed for U.S petrochemical industry recovery.,

the shale gas impact on c2 c3 and c4 downstream derivatives

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