The US now has an energy surplus that will likely be sustained for years, if not decades. The same development is also taking place outside the US.  And we can expect the issue of fossil fuel surpluses to be further highlighted at December’s UN Climate Change Conference in Paris.  Already the G7 group of the world’s richest nations have committed to achieving “the decarbonisation of the global economy”, whilst Saudi Arabia (the world’s leading oil producer) accepts that “it will no longer need fossil fuels”. 


Fosil Fuel Graph.jpg

 

US developments in the 3 major fossil fuel-based energy sources highlight the sea-change now underway:

 

  • Coal has been under major environmental pressure in recent years, and at the same time its competitive position has been undermined by increased supplies of natural gas due to shale gas developments.  As a result, recent estimates suggest that 500 million tonnes of annual production is owned by companies in financial distress.  Coal still provides over a third of US power, and this position is likely to continue over the next decade.  But companies in financial distress tend to have little pricing power, and so we can expect to see coal prices remain close to their $3 - $4.50mn Btu cost of production.
  • Gas is the new fuel on the market, at least in its current volumes.  The problem is that much of the new production was supposed to be exported. Companies currently have licences to export 9bn cu/d of Liquefied Natural Gas (LNG), roughly an eighth of current US production of 72.4bn cu/d.  But as the Energy Institute reports, strong competition in Europe and Japan means local prices for new business are in the $7-9mn Btu range.  These might appear attractive for prospective US exporters, given the US gas price of around $3mn Btu, but this advantage is outweighed by the $6mn Btu cost of  liquefaction and transport.  Equally challenging is the fact that global growth in LNG demand was just 2.4% last year, making it even harder for all the planned new capacity to find a home.
  • Oil is the 3rd major component of the energy mix.  Its prices have halved over the past year, and the International Energy Agency reports that there is currently a 2mbd surplus of production over demand.  The result has been record levels of US and European inventories, and increased price volatility as producers and consumers struggle to determine a market-clearing price for the product.  It doesn’t take much imagination to suggest that prices may fall still further, back to their historical levels around $30/bbl, where oil would have roughly the same energy value as gas and coal (on the historical 10x natural gas price formula). This, of course, would create even more intense competition in the US domestic market.

 

Unsurprisingly, the US petrochemical industry suffers from exactly the same competitive dynamics as its upstream suppliers.  It has made windfall profits in the past few years, but these are already declining now that oil prices have tumbled.  And despite this advantage, US production of ethylene and its major derivatives has remained below the peak levels seen in 2004-7.

   

The problem is highlighted in the chart, based on American Chemistry Council data. US ethylene, PVC, styrene and ethylene glycol production peaked back in 2004, and polyethylene production in 2007. US ethylene derivative exports have also been in decline in recent years, as global demand growth slows and former importers such as China expand their own production.  It is very hard to see how the new production from the planned $145bn of new ethylene capacity will find a home.

 

This is all part of the move into the New Normal world.  Companies and investors are slowly having to come to terms with the fact that access to cheap feedstocks no longer guarantees competitive advantage. Instead, successful companies in the future will be those that are demand-led.

 

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Paul Hodges is chairman of International eChem (www.iec.eu.com), trusted advisers to the chemical industry and its investment community. He is a member of the World Economic Forum’s Industrial Council on chemicals, advanced materials and biotechnology, and presents the ACS ‘Chemistry & the Economy’ webinars.