Tuesday, August 09, 2022 | Muharram 10, 1444 H
overcast clouds
weather
OMAN
31°C / 31°C
EDITOR IN CHIEF- ABDULLAH BIN SALIM AL SHUEILI

Impact of high oil prices on petrochemical and chemical sector

2066287
2066287

Aparajith Balan


Global Practice Leader, Chemicals & Materials, Frost & Sullivan


Diya Menon


Consulting Manager, Chemicals & Materials, Frost & Sullivan


About two years ago, oil prices fell below zero for the first time in history. The crash of oil prices was something that the industry had never predicted or witnessed before. Through the resilience of governments all over the world and initiatives by oil companies, economies began to recover as demand across sectors witnessed strong improvement.


However, with changing geopolitical scenarios, oil prices increased above $110 per barrel in March 2022. From a positive outlook predicted at the beginning of the year, concerns regarding inflation and overall global economic slowdown have started to grow. In the US, more than 1.3 million bpd of refinery capacity has been shut down since 2019 due to the impact of Covid-19 on demand, damages due to hurricanes, stricter regulations, and higher operating costs, among others.


With the current sanctions, fear of shortage is further impacting the volatility of crude oil prices. But how have these changes impacted the chemicals segment?


Substantial changes in oil prices have always resulted in significant implications for the petrochemicals and chemicals sector.


The world underestimates its dependence on chemicals and, therefore, on oil.


For example, apart from the more obvious transportation fuels, the food that we eat is grown using fertilisers, a chemical segment that heavily depends on coke formed from the refining of oil to produce products such as ammonia.


Plastic packaging that is extensively used across sectors such as food and beverage and consumer products is also derived majorly from crude oil, and paints require various raw materials that are petroleum based.


Overall, the increasing price of oil results in a cascading effect on the production cost of chemicals and petrochemicals.


With the rise in oil prices, there has been a significant increase in inflation. Inflation leads to increased prices for products that are used by consumers, which results in reduced spending and therefore slowing demand.


However, the impact on each product varies depending on the demand-supply dynamics for end sectors where these chemicals are used.


About 40 per cent of polypropylene is used in the production of white goods and automotive components, both of which will witness sluggish growth with higher inflation. Polyethylene, on the other hand, is majorly used for packaging film, food and beverage packaging and grocery bags, among others, which are less impacted.


With rising inflation, investment in real estate has also slowed down, thus impacting products such as paints and plastics used in the construction industry.


Along with rising oil prices, China particularly has witnessed the dual impact of “common prosperity” policies aimed at the real estate sector to reduce the wealth gap between different regions within the country.


China’s real estate sector has been in decline, with a threat of a crisis since 2021, when China Evergrande Group, one of the largest real estate companies, officially declared to default on its debt. With the growth of the real estate and construction sectors in question, demand for chemicals related to the industry, such as polymers, would be at risk. This would be further accelerated by the implementation of China’s “Zero Covid Policy,” which brings about uncertainty regarding strict lockdowns, quarantines and travel restrictions, which would further weaken demand.


While the decline in consumer confidence has impacted demand, it represents just one variable in the equation. The rise in prices of end products has not been proportional to the increase in production costs for chemical companies.


In March 2022, Bloomberg reported that while ethylene was being sold for $1,200 per MT during the first week, the cost of production with naphtha as the source was $1,200-1,300 per MT.


Europe, another region that is highly dependent on naphtha (of which ~50 per cent is sourced from Russia), would witness major production disruptions. About 10 per cent-13 per cent of the total European capacity for ethylene and 10 per cent-12 per cent of total European propylene capacity depend on refineries located along the Druzhba pipeline, which would be impacted by increasing sanctions.


This would result in downward pressure on margins for producers in the region. Germany, the Netherlands and Austria plan to revert to coal to hedge against the possibility of a reduction of imports of natural gas from Russia.


Another significant impact of high oil prices on the chemical industry is the rise in transportation and freight costs that were already substantially higher in 2022 than pre-Covid levels.


This was due to various factors, including the lockdown in Shanghai, rising crude prices, shortage of container ships in Asia and shortage of drivers in Europe, among others. In February 2022, it was estimated that buyers of diesel in Europe were spending ~40 per cent more on fuel compared to December 2020.


According to the International Monetary Fund, the increase in shipping costs is a vital driver of inflation. Its impact is much more long term, generally peaking after one year and lasting up to 18 months. With the current state of affairs globally, this would increase the complexity of economic recovery.


With the fear of global recession looming and lockdowns in China, oil prices dropped below the $100 per barrel mark in the first week of July 2022. However, there is increasing scepticism regarding what the future might hold. Tightening sanctions, Chinese demand, inflation, supply risks, and the probability of hurricanes in the US would be paramount in influencing crude oil prices and global demand for chemicals across end sectors over the next few months.


Petrochemical margins would differ regionally based on the impact of these factors combined with the dominant source of raw material, which would dictate the price that can be passed on to the consumer.


In such an uncertain and constantly evolving environment, it is critical for producers to analyse various possible outcomes and plan for disruptions to target the right markets and adapt to changing trade dynamics that may arise. (Courtesy: GPCA)


SHARE ARTICLE
arrow up
home icon