Quarterly Business Analysis Quarter4 2006

Introduction

Quarter four was the most profitable quarter of 2006 for the global petrochemical industry. All regional producers experienced a significant reduction in feedstock costs following an easing of crude oil prices after a sustained period of relentless price rises. Crude oil prices stabilized at $60 per barrel in the final quarter of 2006, after rapidly falling more than twenty percent from mid year highs.

Tight European markets offered the strongest gains in profitability. Cracker outages maintained European olefin markets extremely tight, restricting feedstock to derivative markets. Steady demand allowed producers to restrict reduction in petrochemical prices, reclaiming some margin lost in the early year escalation of feedstock prices. Olefin margins soared to an all time high and average profitability of the Western European industry climbed to its highest for two years.

Long markets in the United States supported very modest gains in profitability. Demand slowed as consumers worked down large inventories built up in the first half of the year, fearing a repeat of supply disruption seen in 2005 hurricane season. Petrochemical prices collapsed, reducing sales revenue and offsetting much of the feedstock cost savings. Average Industry margins remain very favourable, recording the second highest margin of the last decade.

Asian producers generally managed to capture some of the feedstock cost savings in slightly higher margins. Domestic demand stalled, after prices surged record highs in the third quarter. Consumers minimised purchases through quarter four, anticipating lower prices in the New Year, driving prices rapidly down.

Regional Cash Margin Index
(Petrochemicals and Polymers)

Western Europe

Profitability of the West European petrochemical industry increased steadily through 2006, with particularly strong gains in the last quarter. Tight olefin markets and easing feedstock costs boosted the profitability of olefins production. Derivative markets tightened as demand remained steady whilst production was restricted by maintenance turnarounds and scarce feedstock from short olefin markets. Average return on capital for the West European petrochemical industry strengthened to 18 percent, its best performance since the first quarter of 2005.

Frequent cracker outages, for maintenance turnarounds and technical difficulties shortened olefin markets through 2006. Ethylene production for the last year is estimated at 21.3 million tons, a drop of almost two percent from the previous year. Sparse olefin feedstock supplies restricted production of derivatives through 2006, with average industry operating rates consistently depressed to about 87 percent. With steady demand, European markets moved increasingly tight through the year.

Petrochemical Industry Sector Cash Margin
(North West Europe)

Olefin markets contributed the greatest increase to overall industry profitability. In tight olefin markets, ethylene contract prices rolled over, whilst propylene and butadiene prices both strengthened to new highs. Lower feedstock costs, as naphtha prices eased to the lowest for more than a year further bolstered cracker profitability. Revenue form highly valued olefin co-products maintained the naphtha cracker as the lowest cost source of ethylene. Snug olefin markets propelled the profitability of European naphtha crackers to an all time high, with returns close to forty percent. Extensive cracker outages kept propylene supplies short, strengthening on-purpose production economics for propylene. Margins for propane dehydrogenation and refinery splitters climbed to all time highs in the fourth quarter. In the polymer sector, high monomer costs depressed the profitability of non integrated producers. Integrated producers benefited from a share of strong cracker margins, enhancing integrated production economics. Rationalisation of polystyrene capacity intensified with the closure of four plants totalling 215 000 tons per year, yet this failed to revive flagging margins. In the aromatics sector, short benzene markets in the United States supported global benzene prices. Toluene prices eased, following gasoline prices down at the end of the peak summer demand season. The widening spread between toluene and benzene supported incremental benzene production from toluene hydrodealkylation and disproportionation, much of which was shipped to the United States. Products in the vinyls chain were amongst the most profitable of the petrochemical intermediates. Unexpected strength in demand for PVC in the construction industry delayed the slowdown in vinyls consumption which is typically seen through winter months.

United States

Average profitability of the United States petrochemical industry remained steady in the final quarter of 2006, preserving the strong gains made in quarter three. Petrochemical feedstock prices eased considerably, following crude oil and energy markets down. Many producers failed to reap the benefit of reduced feedstock costs as petrochemical prices slumped amidst slow demand and a widening supply base. Average returns for the United States petrochemical producers remained close to twenty percent for the second consecutive quarter.

Domestic demand for petrochemicals stalled through quarter four, following a slowing US economy. The housing, construction and automotive industry sectors were particularly sluggish, depressing fundamental consumption of petrochemicals. Drawdown of extensive inventories further squeezed demand. Many converters purchased heavily in the first half of the year, fearing a repeat of last years supply disruption to supplies through the hurricane season, and little disruption actually materialised. As prices collapsed from mid year highs, many converters opted to restrict purchases, anticipating further price falls towards the year end. As prices in the United States eased back towards other regional markets, export opportunities became more abundant. Demand for export cargoes increased as the dollar weakened against other currencies.

Olefins markets in the United Sates lengthened considerably through quarter four. Demand from derivatives eased whilst supplies were more abundant as crackers returned from earlier maintenance turnarounds. Ethylene spot prices slipped to open a sizeable discount to contract prices, placing further downwards pressure on contract price negotiations. United States propylene markets weakened markedly during the final quarter of 2006. Domestic demand for propylene derivatives stalled as consumers delayed purchases in anticipation of lower prices. Gasoline markets softened considerably, depressing the refinery grade propylene contract price a record 11 cents per pound in November. Polymer and chemical grade prices followed refinery valuations down, restoring propylene prices below ethylene.

Polyolefin markets moved increasingly long through quarter four as demand dried up. Slow demand resulted from extensive inventory drawdown as well as a fundamental weakening in the U.S. economy. Polyethylene margins fell for both integrated and non-integrated producers. Polypropylene producers benefited from a major reduction in the price of propylene relative to ethylene monomer, allowing them to preserve steady margins.

Numerous outages in the United States pushed benzene contract prices to a record high in October, attracting imports from Western Europe and Asia. Toluene and mixed xylenes prices eased for the first two months of the quarter following gasoline blend values down. The lower value of reformate to gasoline blenders considerably increased aromatics extraction margins.

U.S. styrene prices remained firm supported by steady exports. A weakened U.S. dollar made exports competitive, especially to a tight European styrene market. Rising benzene costs were offset by reduced ethylene costs, preserving margins at historic lows. Polystyrene producers reclaimed some margin in quarter four as resin prices were maintained despite easing feedstock monomer costs, but overall market fundamentals remain extremely fragile .

Asia Pacific

Profitability of the Asian petrochemical industry generally improved in the final quarter of 2006. Feedstock costs eased considerably, following easing crude oil and energy markets down. Asian naphtha prices slumped to their lowest for more than a year, easing almost twenty five percent from mid year record highs, depressed by ample supplies. Integrated producers made the biggest gains, benefiting from a share of strong cracker returns. In Japan, producers continued to return weak margins, suffering from inertia in negotiation of domestic petrochemical contracts.

Asian markets lengthened considerably through the final quarter of 2006. Domestic demand waned after prices surged to record highs in quarter three. Consumers delayed purchasing for much of the quarter as petrochemical prices slumped. Towards the year end, demand remained very thin, as many consumers anticipated further price erosion around the traditionally slow New Year period. Supplies became more abundant through the quarter as plants returned from maintenance shutdowns, and investment in new capacity continued across the region, compounding already long markets.

Olefin prices slumped through October, before renewed strength in naphtha stabilised prices late in November. Steady demand for propylene derivatives helped maintain propylene markets tighter than lacklustre ethylene markets. Propylene prices slipped but erosion lagged behind the large drops in ethylene price, restoring the more usual premium of propylene to ethylene prices in the region. South Korean cracker profitability surged to a record high in the final quarter of 2006 as reduced feedstock costs more than offset the lower revenue from olefins.

Asian polymer demand collapsed in the fourth quarter due to a seasonal slowdown and consumers delaying purchases in anticipation of lower prices in the New Year. Polyolefin prices swiftly fell from the record highs achieved in the third quarter. Japanese polyolefins producers experienced no significant margin changes as prices remained stable, but in South Korea and South-East Asia where markets are more responsive to market changes, producers achieved strong margin improvements.

South-East Asia benzene import prices averaged higher for the quarter following tight U.S. market prices. Toluene and mixed xylenes spot prices, however, fell sharply over the quarter following gasoline prices downward. The widening spread between benzene and toluene prompted some hydrodealkylation plants to restart, exporting marginal production to the United States

Styrene prices increased on strong demand while declining feedstock costs boosted styrene margins for all Asian producers in quarter four. T he onset of a traditionally quieter demand season for polystyrene made it difficult to maintain polymer margins. Polystyrene producers continued substitution from other polymers restricting opportunities to raise polystyrene prices.

Nexant’s “Quarterly Business Analysis reports” review regional trends in production economics for commodity petrochemicals and polymers in Western Europe, United States and Asia Pacific. The reports are published as part of ChemSystems/Petroleum and Petrochemical Economics Programme (PPE). Subscriptions to the programme are available from www.chemsystems.com. For further details please contact Andrew Powell at +44 207 950 1576 or email to apowell@nexant.com.