Most current and planned petrochemical investment in the U.S. is targeted at expanding production capacity for methanol, ammonia, ethylene and ethylene derivatives, and on-purpose propylene. These investments are being driven by specific considerations and present both risks and opportunities to new investors.
Investment in methanol is being driven by a number of forces. U.S. producers’ cost profile is benefiting from the low cost of domestic natural gas, which serves as both feedstock and fuel. Methanol demand, both in the U.S. and globally, is growing as a result of new applications, such as the use of dimethyl ether in fuels, and emerging technologies for converting methanol to olefins.
Assuming that announced plans for new methanol production capacity will materialize, the U.S. will move from being a net importer of methanol to being a net exporter. We believe that most of these projects will, in fact, be completed, given the price competitiveness of U.S.-produced methanol vis-à-vis methanol priced on global markets.
New investors in methanol development face several challenges. One is securing sufficient offtake; this may entail developing export-oriented marketing and sales strategies. Another is moving with speed: the first plants to launch will likely be able to sell their output domestically, capitalizing on strong existing demand. Finally, investors will have to wrestle with challenges related to capital project management as growing numbers of players compete for scarce engineering, procurement, and construction resources.
Like methane producers, ammonia producers are benefiting materially from low domestic natural-gas prices, which translate into a stronger bottom line and increased competitiveness versus non-U.S. players. Today’s newer, larger production plants are also much more efficient than the older, smaller ones, raising the financial incentive to build new capacity. Further, demand for ammonia-based fertilizer is rising, both in the U.S. and abroad, owing to the push to increase crop yields and to dietary shifts related to rising per capita wealth.
Given these forces, bullishness toward ammonia production is likely to remain strong. Plans to launch more than ten greenfield, brownfield, and debottlenecking projects between now and 2018, representing 12 million tons of capacity, have been announced. How many of these projects come to fruition remains to be seen, however. High capital costs could weigh on the prospects for some greenfield projects in particular. Global fertilizer prices will also obviously play a determining role. Ultimately, we can imagine the U.S. market balancing itself over the next few years with a slight shortfall of domestically produced supply, with world fertilizer prices being the main variable.
New investors seeking exposure to U.S. ammonia production will likely need to establish a presence in existing ammonia pipelines—or spend capital to convert ammonia into more easily transportable products, such as ammonium nitrate or urea. Investors should also recognize the risks of overbuilding: if new capacity results in the U.S. exporting ammonia, there is a chance that some investors will not be able to achieve attractive returns. Finally, greenfield ammonia plants are expensive. A surge in building activity could drive construction costs up even further, making it harder for investors to capture their targeted results.
Ethylene and Ethylene Derivatives
Investment in the production of ethylene and ethylene derivatives is being fueled by several factors. One is the low cost of ethane (a common feedstock for ethylene production), whose price hovered near historically low levels throughout much of 2013, reflecting a glut of domestic supply. This has given U.S. ethane-based steam crackers a strong cost advantage over their global competitors. In fact, only Middle Eastern ethane crackers, whose feedstock costs are subsidized, are more competitive.
A second factor is the high domestic and global price of ethylene. Ethylene prices are set by the economics of naphtha steam crackers (which are particularly common in Europe and Asia), and naphtha prices remain relatively high. For U.S. ethylene producers, the combination of high ethylene prices and low feedstock costs has led to a substantial widening of margins compared with margins for many non-U.S. producers.
Because of these factors, companies and investors have announced plans for the creation of more than 10 million metric tons of new ethylene production capacity. We expect U.S. ethane supply to exceed domestic demand for most of the decade. If ethane is temporarily in short supply and prices rise during that span, upstream and midstream capacity can and will likely be brought online within 12 to 18 months to reestablish the supply glut.
Stakeholders new to the U.S. ethylene market will face unique challenges. The U.S. market for common derivatives is growing at only 1 or 2 percent per year, making market entry difficult. The dynamics of the ethylene derivatives market—especially the market’s strong differences by region—can be particularly hard to understand and navigate, even for players with considerable market experience elsewhere in the world. Hence new entrants will need to hire the right sales and marketing staff. And the cost of recruiting these personnel, who are in short supply, will be steep. To mitigate the risks, aspiring market entrants should consider partnerships or joint ventures with existing U.S. producers.
Investment in on-purpose propylene is being driven primarily by a shifting balance between supply and demand. The growing use of ethane and other NGLs in U.S. steam crackers has resulted in a material reduction in propylene production. The domestic supply of propylene has been further reduced by the closure of several refineries. Simultaneously, strong demand for propylene derivatives is pushing propylene’s price higher: it reached $1,740 per ton in February 2013 and remained above $1,620 per ton in February 2014, compared with an average price of approximately $1,330 in 2012. Propylene’s price has also remained high relative to that of ethylene: although propylene has been cheaper than ethylene historically, contract prices for polymer-grade propylene were 1.35 to 1.65 times higher than those for ethylene in 2013.
To date, investors have announced plans to build more than five propane dehydrogenation units to boost U.S. propylene supply. How many of these plants are ultimately completed will hinge to a large extent on the spread between propane and propylene prices. The potential for overbuilding of production capacity and for rising propane prices could narrow this spread over time, reducing the financial incentive for additional investment. Hence projects that are last in line to be built, or that have not secured committed buyers and fixed-price contracts for the plants’ output, are less likely to be completed.
For new investors, a major challenge will be gaining access to feedstock. Investors will need to spend capital to construct pipeline connections to fractionation facilities. They will also need to negotiate skillfully with hydrocarbon owners to obtain competitively priced feedstock. Another challenge will be to secure contracted offtake. Without a deep knowledge of the U.S. Gulf Coast olefin market, specifically, owners may find it difficult to “sell out” their plants or obtain advantaged pricing. A final challenge for investors is the propylene market’s potential for extreme volatility, as evidenced by price swings in the past few years.
At the end of 2013, U.S. ethane-based ethylene producers’ margins stood at approximately $0.30 per pound versus a historical average of $0.10 to $0.15. Their production costs were two to three times lower than those of their Asian and European counterparts.