As 2002 unfolds, the European chemical industry sways between recovery and further decline and instability. Like many sectors, greater economic activity or otherwise will be a key factor in determining the direction of chemical markets in the coming months.

The chemical industry remains the great unknown. It nestles between oil and plastics in the refinery end-product chain. While most people have some inkling of what the oil or plastics industries are about, mention chemicals and a blank stare is the response. And yet BASF, the top global chemical company, recorded pro-rata sales of £23.8 billion in 2000. In the European Union, 11 chemical companies achieved sales of more than £7 billion in 2000. Despite its low profile, this is a successful and powerful industry that plays a key role in many national economies.

The German market is traditionally a driving force in the European chemical industry. The country is home to two of the most powerful global players: BASF and Bayer. Their market size and the concentration of capacity in the country also add to its importance, but the economy - national unemployment is more than four million - is struggling.

Many observers worry that the market will struggle with overcapacity and poor margins. The closest they come to consensus for the global market is for it to bottom out at some point this year.

Improved consumer confidence, matched by greater consumer demand for key products such as cars, housing, electrical goods, personal computers and kitchen equipment will fuel any recovery in the petrochemical sector. All these items contain a high percentage of plastics, which are the major derivatives of the building blocks of the petrochemical industry: ethylene, propylene, benzene and styrene.

On the most fundamental level, crude oil plays an important role in petrochemical markets. “Cracker” furnaces that split the crude oil derivative naphtha into basic petrochemical building blocks require a great deal of pressure, steam and cooling water - all energy intensive - as part of the production process.

So crude oil prices and energy costs are an important factor for the petrochemical industry. Crude oil prices have lurched between £7 and £21 a barrel for Brent Blend crude oil in the past two years, making it hard for industry strategists to plan and calculate for the long term.

Although oil prices are currently relatively stable - settling at around £12-14/barrel, thanks in no small part to efforts by the Organisation of Petroleum-Exporting Countries (Opec) to bring stability to the markets - experts question its capacity to maintain stability. If George Bush extends the war on terrorism to what he recently labelled “the axis of evil” of Iraq, Iran and North Korea, oil prices are likely to rocket and market confidence will be shattered. An Iranian official recently suggested that if the US attacked Iran, oil prices could top £35/barrel, which would be disastrous for the global economy and the petrochemical industry.

The other scenario is that Opec’s attempts to maintain price levels by controlling exports and production will become increasingly problematic. Although November’s agreement between Opec and non-Opec oil producers such as Russia, Mexico and Norway has steadied global output and sustained prices, it is debatable whether this rapprochement is sustainable.

The non-Opec countries account for a growing share of output and may be more reluctant to cut capacity. If the system of production quotas is undermined, maintaining higher prices will be difficult. This would bring back the possibility of the £7 barrel of oil.

Naphtha, the most fundamental petrochemical product, is primarily refined from crude oil. It provides the feedstock, or raw material, for more than 70 per cent of European crackers. The volatility of the crude oil market has been reflected in naphtha prices, which in recent weeks have swung from around £112-133/tonne.

Crackers split the naphtha primarily into ethylene and propylene. Last year, western Europe produced 19.6 million tonnes of ethylene and 13.1 million tonnes of propylene, most of which were destined for plastics production.

A number of key issues face the petrochemical industry. European crackers are running at reduced rates. This is important because operating rates are a key indicator of the health of the sector. The line put forward by many leading producers has been that operating rates were around 90-95 per cent of capacity in the second half of last year. Figures from the Association of Petrochemicals Producers in Europe suggest operating rates closer to 80 per cent.

If rates fall much below 80 per cent, a difficult situation could develop into a full-blown crisis, with producers having to make difficult decisions about the viability of certain units. Peter Blair, European chemicals analyst with Schroder Salomon Smith Barney, said recently that he did not expect operating rates to rise above 90 per cent before 2005.

Absorbing new production from two major European cracker expansions is not going to be easy. In early February, Dow Chemical completed the 600,000 tonne a year of ethylene and 300,000 tonne a year of propylene expansion at its Terneuzen plant in the Netherlands. Commercial grade material is expected in the market shortly.

Meanwhile, at the end of last year, BP opened up more capacity at its cracker in Grangemouth, Scotland. This will bring an extra 270,000 tonnes of ethylene on to the European market each year. In theory, growing demand in Europe should absorb this new material, but with countries continuing to revise growth figures for 2002 down, it could prove difficult to absorb.

Global reach

Globalisation has been an important feature of the petrochemical industry in recent years. It is now difficult for national producers to focus on local markets, which they could until the mid-1980s. A series of mergers, takeovers and consolidations has created larger companies with a global reach. Last year’s merger between Dow and Union Carbide Chemicals, now worth £20.7 billion, is the largest and best example.

Consolidation of assets, often driven by refinery and downstream ambitions, continues to be a feature of the ndustry. Last April, Shell announced that it aimed to purchase 50 per cent of RWE-DEA’s petrochemicals and refinery assets. And at the start of this month, BP bought a 51 per cent stake in E.ON’s Veba Oil subsidiary, which gives it 1.3 million tonnes of addition ethylene capacity.

Although the deals were approved by the European Commission, observers point to these developments as prime examples of the integrated player with refineries to produce everything from naphtha, to the petrochemical units giving olefins to the polymer units, making plastic resins. Such corporate developments are understandable in terms of economies of scale, having a variety of profit centres and controlling the supply chain, but others worry that petrochemical players with powerful roles as a producer and a purchaser could undermine the open marketplace.

A globalised petrochemical industry has seen the rise of the Middle East and Asia as major players and growing markets. Between 2001 and 2003, seven new Middle Eastern crackers are due to come on stream, offering more than four million tonnes a year of ethylene. Up to 80 per cent of this new material will be targeted at export markets, primarily as plastic resins. Producers export to both Asia and Europe, although greater opportunities in China fuel a great deal of this activity.

Another wave of Middle Eastern investment between 2004 and 2007 will further strengthen the region’s position. Its petrochemical industry is led by the Saudi Basics Industries Corporation (Sabic) and Iran’s National Petrochemical Company (NPC). Like most players in the region, their supply strategy is based on low-cost feedstock-based production and high export levels.

NPC has plans for up to four 1 million tonne a year crackers, due to be completed by 2007. Meanwhile, Sabic has plans for two 800,000 tonne a year units to be commissioned by 2005. By that time, the region is expected to export up to 30 million tonnes a year of petrochemicals and plastics. China is seen as offering rich opportunities.

European chemical players are also keen to make the most of openings in China, which expects its gross domestic product to increase by 7 per cent this year. But last December, its Ministry of Finance announced that petrochemical tariffs would come down by 25 per cent to an average of 7.9 per cent.

However, it has given increasingly clear indications that it will stop companies “dumping” produce on the market to protect itself after the old trade barriers come down. Despite this, great emphasis is being placed on export potential into China.

In the end, continuing global decline or resurgence in key global economies will shape the future progress of an industry which remains extremely sensitive to the winds of economic change.

Martin Todd is markets editor of European Chemical News

Information

Chemical world

• Crude oil prices play a pivotal role in setting chemical prices, because they are derived from naphtha, a derivative of crude. The other major factor affecting prices is energy costs.

• Overcapacity and poor margins blight the industry. The crackers, which extract chemicals from crude oil, are running at least 5 per cent below capacity.

• Despite this, Dow Chemicals has expanded its ethylene and propylene capability and BP has expanded its ethylene capability.

• Vertically integrated companies are becoming a feature of the market.

• The Middle East and Asia are growing markets and home to major chemicals companies, including Iran’s NPC and Saudi Arabia’s Sabic.

European Chemical News is available on the web at www.reedchemicals.com to subscribers. For subscription information, contact [email protected]. Opec’s website is at www.opec.org. The Association of Petrochemicals Producers in Europe is affiliated to the European Chemical Industry Council (www.cefic.be).