Viewpoint: Uncertain times for EU polyolefins

Several factors are influencing the 2019 outlook for the polyolefin markets. Globally, the polyethylene (PE) balance is changing as the programme of US capacity additions continues. In Europe, buyers of PE and polypropylene (PP) anticipate reduced incremental availability and potential shortages in the unusually heavy spring and autumn turnaround seasons.

But concern is mounting about the health of the manufacturing sector, with the Purchasing Managers Index (PMI) at the lowest since February 2016 and business confidence at its weakest for six years.

Ten major cracker turnarounds will take place in 2019, split between the spring and the autumn. Argus estimates the loss of ethylene and propylene capacity will be the most severe since 2013, when lower prevailing operating rates meant the market had more flexibility to cover a production deficit. The turnarounds will inevitably affect feedstock supply to PE and PP units.

Polymer producers are preparing, including building feedstock and polymer stocks and agreeing swaps, to enable them to keep up contractual supply during maintenance seasons. But a spate of production issues at the end of this year mean many are building from a below-average starting position, and the rebuilding process is likely to support a tighter market balance from the first quarter onwards.

The risk for PP supply is more severe than in PE, partly because the turnarounds are likely to affect the propylene market balance more than ethylene. Propylene is structurally tighter than ethylene in Europe, as refinery closures and increased use of light feedstocks at coastal crackers have cut production in recent years, while demand has steadily increased. At the very least, a lack of feedstock is likely to make impossible, or prohibitively expensive, incremental PP production to cover any unplanned supply gaps during the spring and autumn.

The turnaround season will be challenging logistically for ethylene — particularly in case of unplanned issues — but the structural market balance is longer and Europe can cut back on ethylene exports to Asia-Pacific to cover the tightest periods.

PP buyers are more dependent on domestic production, even though some have diversified their supply portfolios in recent years. The EU-28 region has been a marginal net importer of PP — combining homopolymer and copolymer — on an annual basis since 2016. But the volume of inbound trade is far lower than in PE, where imports serve almost exclusively some large-volume markets.

In particular, PP copolymer buyers have quite limited import options to cover reductions in European production. Combining random and block grades, copolymers make up more than half of the European PP market. Europe imports a small volume from the Middle East, and a growing volume from South Korea, but the majority of supply still comes from local producers. A fragmented market, with many different grades in each group, means converters often have to buy from a fairly small number of certified suppliers.

PE buyers have far more options to cover supply gaps from overseas, making them more relaxed about possible supply constraints. Europe has been a net importer of high-density polyethylene (HDPE) and linear low density polyethylene (LLDPE) grades for years — mainly from the Mideast Gulf — and capacity expansions in the US are adding another dimension to the global picture. Europe is not the natural target for new US material: China and southeast Asia offer much stronger growth, and South America provides logistical convenience. But an overbuild of capacity in one region, with a view to export, inevitably lengthens the global market, particularly if the trade dispute between China and the US continues to create issues for US exporters.

European PE buyers may therefore be less concerned about shortages than in PP, but a repeat of the oversupply — that allowed them to pressure margins down in the spring and early autumn of 2018 — is unlikely. PE margins have fallen significantly during the past two to three years, but the turnarounds have likely undermined further efforts from buyers to take the pricing initiative next year.

PP margins fell during 2018, as patchy demand made it difficult for producers to maintain the premium over their propylene costs. But production losses in the fourth quarter afforded sellers an opportunity to regain a significant portion of these losses in December — even though most buyers were able to bridge gaps in their supply. Tightness during the 2019 cracker turnaround seasons, particularly if there are delays or unplanned shutdowns alongside the planned stoppages, would likely have a similar effect.

A question remains about fundamental underlying demand, for PE and PP. In addition to the broad-brush measure of PMI, there has been lacklustre demand in individual sectors, such as automotive and PE films, in the second half of 2018.

The automotive market has been one of the most important drivers of PP growth in recent years, and companies in the chemicals and plastics industry are starting to express caution about the outlook. German chemical firm BASF — although not a direct polyolefin producer — mentioned lower expectations for sales to the automotive industry as it gave a profit warning for 2019 in December.

Car production in Germany and the UK — the first and third largest European markets respectively — was down by a combined 15pc year-on-year in June-October 2018. The introduction of new emissions regulations in September was responsible for some production delays, but there are signs consumer uncertainty about environmental legislation — particularly with respect to diesel cars — is slowing demand growth. There are also concerns about the Chinese market, where car sales have slowed in recent months and about US threats to impose tariffs on European car imports.

Sedate PE film demand in the second half of 2018 was partly weather related, as an unusually cold spring — followed by an unseasonably warm and dry autumn — played havoc for the agricultural industry. This will have limited demand for agri-film, and possibly lowered consumption of packaging for produce, although this may not be the full story. The Eurostat index for production of plastic packaging materials has plateaued this year, after growing almost continuously since the 2008 economic crisis. Some question whether increased focus on sustainability is leading consumers to limit their use of plastic packaging — and designers to simplify their packaging products — with an impact on demand.

The commodity polyolefin industries have a history of being cyclical, so market participants will not be particularly surprised to see a slowing from the exceptionally strong manufacturing sector growth of 2016 and 2017. In the short to medium term, a slower pace of growth may help to balance the European market during the turnaround season.

Uncertainty about demand definitely seems to be making participants more relaxed about potential shortages than they may have been three to four months ago. In the long run an economic slowdown, should one emerge, would extend the period needed for the market to absorb new global PE capacity, and during which European polyolefin margins are likely to remain under pressure.