Strong Petroleum Markets Drive Up Petrochemical Production Costs
Concurrent strength of crude oil prices and refinery margins has propelled prices of petroleum products to record highs. Many industry sectors have experienced a dramatic increase in operating costs as energy and raw material costs escalate. The petrochemical industry has been particularly hard hit, due to its reliance on key petroleum based feedstocks. Naphtha prices have increased more than three fold over the last five years, recently breaking through $750 per ton, pushing feedstock costs of a typical naphtha cracker above $2000 per ton of ethylene!
With petroleum markets heavily influencing the performance of many downstream operations, a thorough understanding of the main influences on petroleum product pricing and their likely long term development is essential. The petrochemical industry has generally been very successful at passing through recent feedstock cost increases in an efficient manner, maintaining strong profitability. But for how long is this sustainable? Are today’s record high petroleum prices here to stay? Or could petroleum prices collapse as rapidly as the present peak built up?
The latest petroleum profitability forecast reports published by Nexant in September 2007 analyse historic profitability of the oil refining industry and provides long term projections of prices for petroleum products out to 2025. The detailed study of petroleum markets presented in this report forms a critical input to Nexant’s analysis of petrochemical industry production economics and profitability forecasts.
Crude Oil Scenarios
The cost of acquiring crude oil is the primary driver of petroleum product pricing and has a fundamental influence on refinery profitability. The global refining and petrochemical industry are currently exposed to an environment of increasingly volatile crude oil and energy markets. Annual average Brent crude oil prices have explored a vast range over the last decade, from a low of $12 per barrel in 1998 to the present high of $65 per barrel.
Major uncertainty from many sources including political, market, technological and sociological renders attempts to forecast a single definitive future of crude oil markets and the refining industry futile. Nexant does not claim to forecast the future development of crude oil and petroleum prices. Rather it forecasts global refinery profitability and presents the petroleum product prices which would support this profitability under alternative self consistent scenarios, each with distinct assumptions of crude oil price trajectories and the global macroeconomic environment.
Brent Crude Oil Price Scenarios
(FOB Sullom Voe)
Brent crude oil has traded at an average of $65 per barrel over the last year, more than twice the average price of the previous decade. The second half of 2007 has seen Brent crude oil prices at record highs in excess of $80 per barrel, considerably above the cost of production from even the most marginal production sources. The market is not expected to sustain average crude oil prices at the current peak in the long term. High costs will eventually erode demand whilst very lucrative margins would encourage major investment in new production. Crude oil prices will ease in the future, but it remains uncertain as too how quickly and by how much they will fall.
Three alternative scenarios have been developed, each of which would drive very different long term out looks for relative crude oil prices. The average prices over the scenario period in current dollars for Brent FOB crude oil are:
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High oil scenario: Average $65.6 per barrel (2008-2030)
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Medium oil scenario: Average $45.6 per barrel (2008-2030)
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Low oil scenario: Average $29.8 per barrel (2008-2030)
Refinery Margins
Global refinery margins climbed to a peak in the early 1990s as the Gulf War raised fears of supply restrictions to refined products. A slowing global economy depressed demand growth though the mid-1990s, while investment in new global refining capacity lengthened the supply base. Long refined product markets depressed refinery margins to a prolonged trough which was sustained for almost a decade.
Global refinery margins have strengthened considerably since 2002 as rejuvenated Asian demand, led by voracious demand in the surging Chinese economy, has supported strong growth in global demand for petroleum products. After a decade of low returns, which deterred investment in new global refining capacity, refined product markets moved back towards balance. Refinery margins climbed to a peak in 2005 as petroleum markets tightened considerably. Heavy demand, particularly for gasoline coincided with extensive storm damage to refineries in the United States which severely restricted the supply side.
Global FCC Refinery Cash Cost Margins
Demand for petroleum products, especially light distillates has thus far remained robust despite relentless price rises as crude oil costs are passed through to consumers. United States gasoline consumption continues to be strong, with imports required from Western Europe and Asia to meet demand. Global refinery operating rates have remained very high following many years of restricted investment in new capacity in developed economies. Extreme tightness in global petroleum markets is expected to maintain strong margins through 2007 despite the exceptionally high cost of acquiring crude oil.
Global margins are not expected to be sustainable at current peak levels in the long term, as the associated high cost of petroleum products will eventually dampen long term demand growth. Margins are expected to ease from their current peak over the next five years. Global refined product markets will support average margins considerably higher than the average achieved over the last decade. With global light oil product demand forecast to rise faster than residual fuel oil use, trend-line global upgrading margins will settle above the deep trough of 2002, but below the peak experienced in recent years.
Petroleum Product Price Projections
Refined product prices have very closely followed volatility in crude oil prices. Whilst Brent crude oil prices have explored a vast range, from a low of $13 per barrel in 1998, to $65 per barrel in 2006, the ratio of given refined products relative to crude oil has been constrained to a narrow band.
Western Europe
Refined Product Price Projections
(medium crude oil scenario)
Refined product prices will to continue to follow the trajectory of crude oil prices. Petroleum markets are not expected to be able to sustain prices at current record highs in the long term. Under the medium crude oil scenario, prices of crude oil and refined products are expected to remain firm for another year, preserving the peak built up through 2006 and 2007. Beyond 2008 petroleum markets enter a transition period through which prices steadily ease to adopt a long term trend price by 2012. Post 2012, prices of refined products will reflect changes in the underlying cost of acquiring crude oil, which are expected to grow modestly as low cost wells are depleted.
Frequent international trade in large volume cargoes of refined products maintains close convergence of regional prices. In order for product to flow consistently from regions of surplus to regions that are in deficit, there has to be some price differential to encourage the flow. Inter regional price spreads are closely analysed in Nexant’s forecasting methodology to ensure they are consistent with projected trade flows.
Key Inter-product price relationships are also examined. The position of individual products within the refined product pricing spectrum is influenced by the relative value of products in competing end use sectors and relative supply demand balance for each product.
The report “ Petroleum Profitability Forecasts” is published by Nexant as part of its ChemSystems program. For further details please contact Andrew Powell at +44 207 950 1576 or at apowell@nexant.com.
©2007 Nexant, Inc.
