Quarterly Business Analysis Quarter 2 2007

Surging Feedstock Cost Stalls Petrochemical Profitability

Petrochemical producers were struck with a renewed surge in feedstock costs through the second quarter of 2007, eroding margins for the second consecutive quarter. Intensely strong gasoline values and increased Asian demand for naphtha drove global naphtha prices to a record high, breaking through $700 per ton in May. Light gas feedstocks were considerably more competitive than naphtha through the second quarter, but these also traded at a record high. With fragile demand, in many sectors, producers struggled to immediately pass through the full feedstock cost rises to consumers, depressing profitability.

Crude Oil and Petrochemical Feedstock Prices

(Western Europe)

Rapid gains in crude oil prices seen in the first quarter continued into April, before stabilising in May. Brent FOB crude oil prices averaged US$67.5 per barrel through April and May, a rise of 17 percent over the full first quarter, supported by tight gasoline markets in the United States and continued disruption to production in the Nigerian delta. Petrochemical feedstock prices tracked crude oil markets upwards through the quarter, with particular strength being experienced in naphtha markets.

Tight gasoline markets in the United States at the start of the driving season supported global gasoline prices at an all time high . With large volumes of naphtha being consumed either directly in gasoline or converted into high octane reformate for gasoline blending, surging gasoline prices pulled naphtha prices up considerably over gains in the underlying crude oil markets. Naphtha prices escalated to a record premium of 31 percent to Brent crude oil. Increasing demand for naphtha in petrochemical applications, particularly in Asia to feed newly commissioned crackers, contributed further upwards pressure to naphtha prices. Average naphtha prices in Western Europe strengthened 20 percent over the first quarter, to post a new quarterly high of $675 per ton.

The rapid escalation of feedstock prices through the second quarter depressed industry profitability in all major production regions for the second consecutive quarter. Margins in Western Europe were particularly hard hit, due to the common use of quarterly contracts in olefin markets, and the heavy reliance on naphtha feedstock. Average cash margins across the West European petrochemical industry have now slipped almost 25 percent from their peak in the final quarter of 2006. Steady demand for petrochemicals in Western Europe, supported by consistent economic growth of around three percent has maintained strength in European markets, supporting prices and margins above other regional markets.

Regional Cash Margin Index

The drop in profitability currently being experienced by the global petrochemical industry, mirrors similar drops in the second quarter of 2005 and 2006. The second quarter of the last two years has typically seen a surge in gasoline prices push petrochemical feedstock prices higher at the expense of margins. In both previous cases, petrochemical producers retrospectively achieved a full pass through of costs to consumers once feedstock costs stabilised, restoring margins. Provided the global economy retains strength through the rest of the year, preserving petrochemical demand, margins should rebound as the pricing inertias works its way through to consumers.

Petrochemical Industry Sector Cash Margin

(North West Europe)

West European cracker operators supplying olefins markets were hit hardest by the rapid rise of naphtha and feedstock prices. Second quarter olefin contracts settled up modestly in mid-March, before naphtha prices escalated rapidly through April. Ethylene, propylene and butadiene quarterly contracts strengthened €35, €30 and €25 per ton respectively, reclaiming most of the ground lost in the opening quarter of the year. Higher product revenue from olefins was rapidly eroded by costs of acquiring feedstock. Naphtha cracker operators saw their average feedstock costs leap by almost €240 per ton over the full first quarter average cost. Profitability of West European naphtha crackers dropped to the lowest for a year, with the Leader basic naphtha cracker achieving a return of 16 percent. Ethane and LPG cracking offered a considerably lower cost route to ethylene, and European cracker operators maximised consumption of light gas feedstock. Nexant’s base petrochemicals margin index slipped 25 percent on lower cracker margins, falling for the second consecutive quarter to settle at 228 (Q1 1984=100).

The polymer sector achieved modest gains in profitability, defying downwards trends of the rest of the industry. Steady performance of polyolefin producers contributed to a ten percent rise in Nexant’s polymer cash margin index, lifting it to its highest since the third quarter of 2005. Polyolefin spot prices strengthened considerably as gains in third quarter olefin contracts are anticipated. HDPE remained the most profitable polyolefin through May. Polystyrene producers maintained prices stable against rising costs of styrene monomer, preserving margins near cash cost breakeven despite persistent strength of benzene feedstock costs.

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.