Petrochemicals are expected to underpin global oil demand growth in the future as growth in transportation fuels demand is set to slow with the increased use of electric vehicles, the International Energy Agency (IEA) said in March in its annual Oil 2020 report with projections until 2025. But are petrochemicals really profitable?
“Petrochemical feedstocks LPG/ethane and naphtha will drive around half of all oil products demand growth, helped by continued rising plastics demand and cheap natural gas liquids in North America,” the IEA said in March when the COVID-19 pandemic was already upending global oil demand growth projections for this year.
Before the pandemic, oil majors had already bet big on petrochemicals, expecting demand in the sector to continue driving oil demand growth.
But with the coronavirus crisis shocking every major industry, analysts are now questioning the economics and long-term rationale of Big Oil’s ‘safety bet’ on petrochemicals, especially in view of the energy transition and continued drive toward reduced use of plastics in developed economies.
Even before the pandemic, some parts of the petrochemical value chain were already overwhelmed with overcapacity, with profits in the segment shrinking as a result.
COVID-19 has heightened the pressure on profits for petrochemical players, Wood Mackenzie’s petrochemicals analysts said last month.
“Petrochemicals is now the fastest-growing share of the barrel”
Still, “Petrochemicals is now the fastest-growing share of the barrel,” Kelly Cui, Principal Analyst, Petrochemicals, at WoodMac, said at the end of April.
The crude-oil-to-chemicals (COTC) integrated approach is the way forward for the downstream, considering that EVs are set to slow transportation fuel demand, which is currently the majority of end-use for crude oil, Cui said.
A number of oil producers and refiners are targeting chemicals, especially olefins and aromatics, which is set to add more capacity and “likely lead to national and international oil companies steadily increasing their stake in the petrochemical market,” according to WoodMac’s analyst.
Big Oil Bets On Petrochemicals, With One Exception
Indeed, NOCs and IOCs have increased their bets on petrochemicals, which they expect to support their profit margins and downstream businesses in a future of increased electrification of transport.
However, the pandemic has caused some majors to pause and defer investments.
For example, Chevron (NYSE:CVX) Phillips Chemical Company (CPChem) – a joint venture of Chevron and Phillips 66 (NYSE:PSX) – has deferred the final investment decision for its U.S. Gulf Coast project, Phillips 66 said at the end of July.
But others are doubling down on petrochemicals.
Saudi Arabia’s oil giant Aramco (SE:2222) sees chemicals and petrochemicals as a key focus area of development as it aims to become “the world’s preeminent integrated energy and chemicals company.”
Aramco announced in mid-July a downstream reorganization, which Abdulaziz M. Al Gudaimi, Senior Vice President of Aramco Downstream, described as helping to “streamline our operations and reinforce our position as a major global energy and petrochemicals player.”
But one European major is getting out of the petrochemicals business.
BP (NYSE:BP) is divesting its global petrochemicals business to UK’s Ineos for US$5 billion as part of the next strategic step in BP’s metamorphosis from an oil and gas company to an energy company that could compete in the energy transition.
“While most of the oil majors and NOCs are focusing on strengthening their petrochemical integration, BP has divested the last of its standalone petrochemical assets,” Steve Jenkins, vice president of Wood Mackenzie’s petrochemicals team, said, commenting on the deal.
“This is a significant move, signaling its switch to focus on new energies,” Jenkins said.
While BP is moving away from petrochemicals, most of the other oil majors continue to bet on the industry.
Some analysts, however, are questioning Big Oil’s choice in relying on petrochemicals for growth in the coming years.
Is The Petrochemicals Industry A Safe Bet For Big Oil?
According to Kathy Hipple, an analyst with the Institute for Energy Economics and Financial Analysis (IEEFA), petrochemicals was “a poor bet” even before the coronavirus crisis.
“We call it the last frontier for the oil and gas industry,” Hipple told CNBC last week.
IEEFA’s director of finance, Tom Sanzillo, and Bruce Robertson, IEEFA’s LNG/gas analyst based in Australia, said in a podcast in June that “Banking on oil, gas and petrochemicals is a defensive strategy unlikely to work.”
The world is looking to alternatives to petrochemicals, which will make the profit picture even more difficult than it is now, they said.
IEEFA’s Sanzillo and Hipple said in a report in June that Shell’s petrochemical complex northwest of Pittsburg, Pennsylvania, faces a combination of risks that weaken its anticipated financial performance. The complex, expected to open in 2021 or 2022, will be less profitable than originally planned, and Shell (LON:RDSa) owes a more complete explanation to shareholders and the people of Pennsylvania of how it is managing risk, the authors said.
“The profitability of the complex is weakened not by a few negative trends, but by a cumulative set of missed revenue and profit targets, as well as an oversupply of plastics, unpredictable costs, lost market share, diminished growth, and increased competition,” Hipple said.
A recent report from the Center for International Environmental Law (CIEL) warning against investment in oil and gas said that “Petrochemicals and the plastic they produce do not offer oil and gas companies a way out of their economic troubles.”
“Dovetailing trends of lowered plastic resin prices, increased plastic regulation, and decreased capital spending threaten the fundamentals of the petrochemical industry, on which many oil and gas companies have staked their future growth,” CIEL said in the report.
The future of petrochemicals is not black and white, and large petrochemical integration could help refiners remain competitive in the next decade.
Nevertheless, the COVID-19 crisis and the new bust in the oil price cycle have highlighted the cautionary tale that Big Oil would be wise not to put all their eggs in one basket.