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    Changes in longitudes: Part 3 — more barriers to ethane exports

    Housley Carr, RBN Energy

    With US ethane prices low and ethane rejection expected to continue increasing, interest in exporting liquid ethane is ramping up. But there are significant barriers to these exports, including: (1) loading and unloading terminal infrastructure, (2) shipping, (3) pricing, and (4) petrochemical demand.  We examined the first two of these barriers earlier this week.  Today we wrap up this blog series, examining pricing and demand.

    The first episode in our Changes in Longitudes blog series reviewed the big growth in US ethane production over the past few years, the collapse of ethane prices in late 2012, and the rejection of ethane production (selling ethane as natural gas at fuel value rather than as a petrochemical feedstock) that has resulted from low ethane prices. We explored the new US ethane-based Gulf Coast cracking capacity being developed and discussed our view that the growing volume of ethane that gas processors could produce will continue to outpace the volume that the US petrochemical industry can consume. By our estimate, ethane rejection—that has recently been running at about 250 MB/d, will nearly triple over the next three years, to more than 700 MB/d in 2017.

    In Episode Two we considered two of the four major barriers to significant US ethane exports. The first barrier is the lack of loading and unloading infrastructure. At the loading end, chillers must be built to reduce the temperature of ethane to near-cryogenic levels so that it can be loaded onto ships. At both the loading and unloading end, near-cryogenic tankage must be built in locations that don’t have the advantage of nearby underground storage. Then there are the ships, or lack thereof – barrier number two.  Several ethane-capable vessels are on order, primarily to handle the deals to supply petrochemical company INEOS with US ethane from Marcus Hook, PA into crackers located in Norway and Scotland. But these ships are expensive and have long lead times. Many more ethane-capable ships will be required to move significant volumes of US ethane to overseas markets. 

    Pricing
    The third potential barrier is pricing – more specifically pricing arrangements acceptable to both US ethane sellers and overseas ethane buyers. The commodity price benchmark for US ethane is the Mont Belvieu purity ethane price. Except for a short-term run-up this past winter, ethane prices have been at or near natural gas BTU equivalent levels since late 2012 due to surplus ethane supplies which have pushed the price of ethane down to rejection levels.  Of course, it is those low ethane prices that have been driving overseas interest in US ethane in the first place.  But don’t forget, it was less than three years ago when ethane prices were well above 90 cnts/gallon (see Figure #1 below – blue line).  As shown in the graph, this unique NGL has the potential for significant volatility.

    Most overseas ethylene crackers use naphtha as their primary feedstock.  The cost of ethylene made from naphtha (as it is priced in the global market) is considerably higher than ethylene made from ethane priced in the US at Mont Belvieu. In effect, it is the spread between global naphtha prices and US ethane prices that is driving all of the interest in US ethane. But what if large-scale exports of US ethane were to drive the price of US ethane back to where it was in 2012?  Clearly that would be bad news for any company that made large investments in the tankage, chillers, ships and other infrastructure needed to move US ethane into overseas markets and use that ethane to make petrochemicals.


    For that reason, many international buyers pursuing U.S. ethane are trying to put together deals where the price they pay is not pegged to the US ethane price at Mont Belvieu, but instead is based on some formula tied either to global naphtha prices or in some cases to a surrogate marker price closely correlated with global naphtha prices – like the price of North Sea Brent crude oil. That is a perfectly logical strategy for the buyer.  With the ethane price indexed to the economics of the alternative feedstock using a pricing formula, the buyer can be guaranteed to get the benefit of lower prices, regardless of what happens to ethane prices at Mont Belvieu.

    Such an arrangement could be a big problem for the seller. If US ethane were to get tight and prices return to the pre-shale level, then the seller is stuck with prices indexed to naphtha or Brent.  Figure #1 helps put that in perspective.  The blue line is the price of ethane at Mont Belvieu, averaging 70 cnts/gal in 2011 through mid-2012, then oversupply drove prices down to an average of 28 cnts/gal since. The orange line is the price of ethane based on a formula of 15% of the price of Brent crude, shown as an example of the type of formula pricing which might be proposed by an international petrochemical buyer. The formula would yield a value well under the Mont Belvieu price before the ethane price crash, but since then it would generally provide a price premium of more than 10 cnts/gal.  That sounds like a pretty good deal for a producer, at least for right now.  But how about the future?  If we extend that formula price to 2020 using the Brent forward curve as our price, the formula price declines – simply because the forward curve of Brent is backwardated – future prices decline over time. That is one concern.  The much bigger risk to a seller is that growing exports tighten the U.S. ethane market, pushing prices back to that 70 cnt/gal average price where they were in 2011-12 (green dashed line), meaning that the seller would be giving up about half the value of the product to the buyer.

    Of course, there are all sorts of triggers and caps that could be baked into a formula to mitigate this risk. Then the question for the international buyer is whether those mitigating provisions transfer too much risk from the seller to the buyer.  Said another way, the big challenge for international buyers of ethane is to structure transactions with US ethane sellers to mitigate the risk of a deal that gets way out of whack with market values while at the same time providing enough of a price guarantee to warrant significant investment in ethane handling and processing infrastructure. 

    Petrochemical demand
    The fourth and final barrier to significant ethane exports is petrochemical demand – how much ethane could be used in international markets if the logistics are available to get it there?  Today, most ethylene crackers in both Europe and the Asia/Pacific region are naphtha based. Prior to the shale revolution, naphtha cracker margins were equal to if not better than ethane cracker margins. With naphtha and other feedstocks so much easier to handle than ethane, it certainly made sense to base the petrochemical industries in those regions primarily on naphtha. 

    When ethane surpluses drove down the prices of ethane in the US, those economics went out the window. But the problem for European and Asia/Pacific crackers is that it takes $ billions for most crackers to convert from naphtha to ethane, and even more investment if the cracker wishes to develop a multi-feedstock capability (run either ethane or naphtha depending on which has the lowest price). Thus the question is how much demand for U.S. ethane will develop in international markets if $ billions must be spent converting crackers to use ethane?  Many of these crackers have been losing money for years and they don’t have the $ billions laying around to make those investments.

    In a recent presentation (see Figure #2 below), Enterprise Products Partners provided numbers that help quantify some of the economics involved for European crackers.  According to the Enterprise data, as of now, about 70% of European ethylene capacity is naphtha-based, compared with 8% using ethane and 22% using propane or other feedstocks.  (The 8% ethane is locally sourced, mostly from North Sea producers). Ethylene based on $0.25/gallon ethane costs about $0.08/pound to produce, Enterprise says, while ethylene based on $2.50/gallon naphtha costs $0.48/pound, or six times as much.  (To see how these numbers are calculated, go to our Let’s Get Crackin series. RBN provides daily Spotcheck graphs of these values to our Backstage Pass premium customers.)

    Enterprise estimates that switching to ethane from naphtha would save a 1.5 billion ton per year (Bt/year) cracker $600 MM/year before logistics and transport are factored in. Enterprise suggest that more than a dozen European crackers may be candidates for a switch to US ethane (locations shown on Figure #2 map), and estimate that converting only 25% of northwest European  cracker capacity would absorb about 300 Mb/d of ethane from the US surplus.  That is a lot of ethane.

    Figure #2

     

    Source: Enterprise Products Partners

    Whether US ethane exports shift from being a small, localized activity to a major market with volumes totaling hundreds of thousands of barrels per day remains to be seen.  The four barriers that we have identified, (1) loading and unloading terminal infrastructure, (2) shipping, (3) pricing, and (4) petrochemical demand must all be overcome to make significant ethane exports happen. 

    Two issues are clear.

    1. Somebody will be spending billions to put the logistical and petrochemical cracker infrastructure in place to transport and use the ethane.
    2. Somebody will be taking on the risk that significant ethane exports could push US ethane prices back to the level of a couple of years ago.

    Here is our best guess as to how this all plays out.  Over the next 5-6 years, ethane exports will grow to somewhere in the 150-200 Mb/d range, with 4 or 5 crackers shifting some of their capacity to run ethane. Even combined with new ethane crackers being built in the US after 2016, that won’t be enough to absorb all of the ethane that US producers can make, so rejection will remain a part of the ethane landscape for the long run.  That means that the economics of exporting ethane will work out to be a good deal for both US producers and international petrochemical companies that get on the bandwagon. 

    A lot of things must happen right for this market to develop.  Stay tuned.

     

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