Petrochemical Investment – Doing the Right Thing for Yourself But Possibly Ruining It For Everybody

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In a research report that we published yesterday we discussed the likelihood of over-investment in petrochemicals globally as a result of the apparent feedstock opportunity in the US.  We paint a bearish picture of possible oversupply, in part fueled by some significant additions to manufacturing capacity both within and outside North America – see chart.

UntitledAll forecasts are fraught with risks, but we have an obligation to try.  In the research we went into detail about our more conservative demand growth projections and the logic behind the assumptions.  However, one of the most significant assumptions/forecast elements in the analysis is how much new manufacturing capacity will be added globally.  These are very high dollar facilities involving long construction and planning periods, permitting, technology agreements and often peripheral work to ensure that you have feedstock when you are ready and someone to consume the product when you start-up.  Some of the more complex components require years of assembly in specialized facilities.

Twenty years ago I was working for CMAI, a chemical industry consulting company, specializing in petrochemical market data (CMAI is now part of IHS).  We prided ourselves on having the best data in our industries, and while we knew we were not perfect, we were pretty sure that no-one could do better.  Almost every owner of every facility in the then “free world” was a client, which made the job of collecting the data more straightforward, but still involved trekking around the world to meet everyone – look them in the eye and try to assess whether expansion plans were real, real in size but not in timing, or a pipe dream.

About 10 years ago I decided to put CMAI’s data to the test.  Then as a research analyst at Bernstein and a client of CMAI, I was able to get hold of every 5 year capacity forecast that CMAI had made for global ethylene since they started publishing in the mid 1980s.  Comparing this to what happened I ended up with about 12 years of data.  The result; they were accurate in aggregate, but less so in detail.  The totals were right – and consequently, if they are forecasting significant expansion over the next 5-7 years, I am going to give them the benefit of the doubt in this analysis.

But the details were interesting.  The more speculative builds that we thought at the time would be delayed, either because the plans were too ambitious or because the funding was questionable, etc., did for the most part get delayed and in some cases abandoned.  But we missed expansions that companies kept to themselves and the net result was essentially the same total.  I have not checked the data and the accuracy for the last ten years.

In the current environment, people are looking at the capacity additions and dismissing some of them as speculative, perhaps using an expectation that others will “blink” or “get cold feet” as a justification to invest for themselves.  What the anecdote above suggests is that some probably will “blink” – some of the capacity on the planning table today will not get built.  However, some we are not watching will get built and the outcome will possibly be the same – if we are lucky!

More concerning, is that IHS is more sophisticated today than when I was there (at least you would hope so) and that more time is spent risk adjusting the projects (look at the work they have done on the China coal to chemicals plans).  They may have the new build totals right this time, but they may still have missed the incremental expansions.

If all the capacity gets built, the industry will suffer a period of very low profitability, but no one company or group of companies is to blame.  Faced with the feedstock dynamic and competitive threats/opportunities, many companies are making the right decisions for themselves in isolation of the actions of others.  It is appropriate to exploit the feedstock advantage, but it is also appropriate to draw up plans to protect yourself from new competitors.  It is the sum of the collective actions that creates the potential problem.

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