The oil majors posted mixed results when they revealed their earnings for the second quarter, despite an increase in production in many cases. The danger is that one of the few areas where they see enormous demand growth has suddenly run into trouble, leading to disappointing results.
The majors have lifted production for both oil and gas almost across the board even as they pursue different strategies. ExxonMobil and Chevron are all-in on the Permian, and both reported huge increases in output, including a 90 percent year-on-year increase for Exxon. The European majors, meanwhile, have made large bets on natural gas and the global gas trade.
But in the second quarter, refining margins were down and natural gas prices were also depressed, two areas that have provided insulation for integrated companies in the past few years as the oil market went through bouts of volatility and low prices.
Importantly, the market for petrochemicals has also taken a hit, taking away another source of profits and growth.
Royal Dutch Shell, which has made a large wager on petrochemicals and plastics as a growth industry, was particularly downbeat about the state of the market. The company’s earnings were down in the second quarter, due to lower oil and gas prices, but also “weaker industry conditions in Downstream, particularly in refining and even more so in petrochemicals,” Shell’s CEO Ben van Beurden said on an earnings call.
If “there is volatility and if there is value to be had, we will do that through our trading operations, but we can’t offset a meltdown in petrochemicals,” van Beurden said.
The problem, van Beurden feared, was due to macroeconomic factors. A slowing global economy and the potential onset of an economic recession was showing up in weak demand for petrochemicals. “It’s incredibly hard to predict a recession. And although it’s not particularly hard to predict the beginning of a recession in petrochemicals, what tends to happen, particularly if it’s a synchronized recession, which is a little bit what we are seeing here in markets and particularly when it hits China, is a massive destocking of the entire supply chain, and that is what is happening,” van Beurden said in response to a question about demand.
But the industry is also at risk of overinvesting in petrochemical capacity. “The ethylene market is in the midst of a step change in production capacity growth that will persist into the early 2020s,” Bank of America said in a June 2019 note. “After growing at a rate of 3.4 million metric tonnes (mmt) per annum during 2013-16, annual ethylene capacity growth doubled to 6.8mmt over 2017-19E and we expect it to average 10mmt during 2020-22.”
Supply could be expanding at a torrid pace just as demand begins to slow. Demand for plastic tracks GDP growth pretty closely, so an economic slowdown “has increased the likelihood that the trajectory of petrochemical demand growth resets this year,” Bank of America said.
“Plastics margins have compressed over the past three years and a worsening macro environment may cause a collapse to the prior lows realized in 2008 and 2012,” Bank of America added.
Even a resolution to the U.S.-China trade war would not rescue companies heavily invested in petrochemicals. The huge expansion in plastics capacity “could still take several years to absorb, limiting margin upside,” BofAML concluded. And that grim assessment is even true if tariffs were to suddenly disappear.
But the trade war is heading in the opposite direction – escalating, not de-escalating. The recent announcement from President Trump to hike tariffs by 10 percent on $300 billion of Chinese imports beginning in September could put another dent into GDP growth, and thus, demand for petrochemicals. Retaliatory tariffs from China could also directly hit polyethylene and other petrochemical products. U.S. producers could search for markets elsewhere, and already have begun to do so, but dumping products around the world has only depressed prices. In June, German chemical giant BASF announced plans to eliminate 6,000 jobs because of the petrochemical downturn. Earnings from other chemical companies also continue to disappoint.
The extraordinary buildout of plastics manufacturing and the worsening glut of capacity comes just as the crackdown on plastics is building momentum. Bans on plastic bags are proliferating. The European Union approved a ban on single-use plastics that will be phased in by 2021. Canada announced a similar measure just a few months ago. The San Francisco airport just announced a ban on plastic bottles.
The plastics industry has fought hard to head off such policies and have promoted recycling as a way of keeping consumption growing. Demand is still inexorably rising, and all signs point to years of growth, but policies are beginning to cut into that growth.
The main threat, at least in the short run, is a global economic slowdown and the overbuilding of petrochemical capacity. Even as margins have deteriorated, the industry keeps speeding ahead. In May, ExxonMobil announced another $2 billion investment to expand capacity at its Baytown chemical plant – the same one that suffered an explosion and fire that injured 37 people on July 31.
“The golden age is behind us,” Robert Stier, senior lead of global petrochemicals at the research and pricing firm S&P Global Platts, said in June, according to the Houston Chronicle. “The times of exceptional margins are over.”