Oil – The Big Uncertainty For US Chemicals
Oversupply in the oil markets has driven pricing lower over recent weeks with Brent hitting lows not seen in many months, and breaking below previous resistance levels. Oil is the big risk for the recovering US energy and chemicals sector as it is the price difference between oil and US natural gas that drives all of the competitive advantage in the US and is driving the high levels of investment.
Oil can fall much further before most of the initiatives in the US begin to look much more marginal and investment returns are driven to lows that would cause pause for some of the investors. However, there is a hierarchy of returns already based on the nature of some of the investments and the ones that require the most significant oil/natural gas spreads are probably already being questioned.
We have written extensively about the production costs opportunity in the US, the opportunity for European producers looking to exploit US costs and more recently on the potential advantage of building chemical capacity in the Marcellus rather than the US Gulf.
As oil falls relative to natural gas, not only do we risk the returns, simply from a relative price perspective, but we also risk natural gas production itself as the key incentive to drill in the Western Marcellus, for example, is based on the co-product values of both propane and butane, both of which are priced relative to an export netback, driven by international crude prices. The most recent data in the chart showed the crude/nat gas ratio expanding as natural gas fell from its winter peak. The last data point reflects Brent at $98 per Barrel. This ratio needs to remain above 3.0 for every proposed investment to make sense – including exports of Ethane to Europe. However, as the ratio falls we would expect US producers to lose margin. For many products, global markets are oversupplied and it is only the US cost differential that is supporting US profits.