Understanding the US Petrochemical ‘Feedstock Advantage’
The shale oil and gas revolution has given North American petrochemical companies a feedstock advantage relative to their competitors in other regions.
The term “U.S. feedstock advantage” has gotten a lot of play over the last several years and I continue to get questions about how the U.S. is advantaged (and a lot about how long the advantage will last). In response, I created a “simple” graphic that helps explain what the petrochemical advantage is and how it works. First, a couple of definitions:
- Break-Even Economics – Plant investment economics where the cracker is running at a level that just covers their costs. Any lower and the plant “should” shut down.
- Cracking Parity – The point where two different feedstocks deliver the same value of product for the same value of feedstock (i.e., $1 worth of ethane yields the same value of ethylene as does $1 worth of propane – accounting for co-product values).
- Freight Cost – The general cost of moving (terminal and transportation) a feedstock/product from one region to another should, in an equilibrium state, define the price differential between the two regions. If the price differential (between the regions) is greater than the cost of freight, then the arbitrage is said to be open. If the price differential is less, then the “arb” is closed.
- Fuel Value – The price where 1 BTU (British Thermal Unit, a measure of heating value) of a feedstock is equal to 1 BTU of natural gas.
- Marginal Producer – The highest cost producer that is still running or still able to run.
- New Cracker Economics – When the price of ethylene/polyethylene is high enough that the margin (and perceived future margin) exceeds the capital hurdle rate.
- Oil/Gas Ratio – Simply put, the ratio of the price of oil (Brent) in terms of $/bbl over the price of natural gas in terms of $/MMbtu (million BTUs). Since a barrel of oil generally converts to 6 MMBtus, a ratio of about 6 is said to be parity (i.e., fuel value)
There are three primary olefins feedstocks: light naphtha, propane and ethane. Others include butane, natural gasoline, distillates and even condensates/light crude. Light naphtha and propane prices tend to move in conjunction with crude prices. Since the marginal producer of ethylene/polyethylene tend to be the producers who use light naphtha as their feedstocks, ethylene/polyethylene prices also follow crude (directionally). However, since these markets are less liquid, the correlation is somewhat less and lagged in effect.
Ethane, by contrast, is more closely tied to natural gas. Since there are only two uses for ethane (one is as feed into the olefins petrochemicals process and the other as fuel) the connection to natural gas is easy to see. If the supply of ethane exceeds demand, then the price will drop until demand picks up or the price gets low enough that the value is at parity with natural gas. In this case, the ethane will be rejected (i.e., not recovered from the natural gas stream at the gas processing unit) and will get used as fuel. Once the price rises above fuel parity, recovery of the ethane resumes.
The oil/gas ratio is used as a “rule of thumb” indicator of the feedstock advantage since the wider the spread, the more advantageous ethane should be.
Back to the diagram, each commodity will trade within a band defined by its floor and ceiling price. Movement within the band is driven by local supply/demand constraints. In severe cases, the price of a given commodity can disconnect (i.e., rise above or sink below) from its traditional price bounds. The usual cause of this is some sort of infrastructure constraints or some isolated supply/demand disruption that results in the commodity being stranded or some amount of pent up demand.
The U.S. feedstock advantage is driven by having plenty of low cost ethane feedstock com to produce high value ethylene/polyethylene competing against a manufacturer of ethylene/polyethylene who only has access to high cost naphtha as feedstock. As crude prices rise, so do the price of naphtha and ethylene/polyethylene. This advantage will continue as long as crude prices remain high and gas prices low or until we overbuild ethane cracking capacity and start running short ethane.