Managing Director & Senior Partner
The boom in shale oil and gas has given North American chemical companies a feedstock advantage relative to their competitors in other regions. The recent plunge in the price of crude oil has led industry participants and market observers to consider whether the feedstock advantage is sustainable and long lasting. We believe that this advantage will continue and that the market dynamics promoting the North American Chemicals 2020: Capturing Opportunities in the Revitalized Industry will not be significantly affected.
The attractiveness of North America–based production of major chemical building blocks and their derivatives, especially methane and ethane derivatives, is based on two somewhat interdependent factors:
These factors combined to create a substantial advantage for U.S. chemical production—for example, U.S. ethylene producers using ethane enjoyed cash margins of nearly $1,000 per ton. (See the exhibit, “North American Ethylene Producers Enjoy a Significant Feedstock Advantage.”) These pricing dynamics spurred a tremendous amount of investment in gas-based production capacity, as product prices globally continued to be set on the basis of utilizing heavy-feedstock capacity in production.
From the last quarter of 2014 through the first quarter of 2015, the price of crude oil declined rapidly and sharply, by more than 60 percent from its highs. Natural gas prices also declined, and the ratio of oil price to gas price decreased toward 3 to 1. Some in the industry feared that construction of gas-based production capacity in the U.S. might be halted even before the first new units became operational.
Around the globe, some petrochemical projects were canceled or delayed indefinitely, including several greenfield projects and expansions in the Middle East and North America and a gas-to-liquids project on the U.S. Gulf Coast.
In our view, the recent plunge and volatility in the crude-oil market may cause new investors to reconsider or delay announcing new projects or put off initiating construction. However, we believe most projects that have already broken ground, or are close to doing so, are likely to proceed.
Two reasons support our conclusion.
First, although we do not expect a significant, sustained recovery in oil prices in the near to medium term, the low prices reached in January 2015 are not likely to be sustainable over the long term. (See “Lower, and More Volatile, Oil Prices: What They Mean and How to Respond,” BCG article, January 2015.) In the medium term, prices below $50 per barrel for Brent crude support only 34 percent of planned production additions through 2020. In the long term, reinvestment economics require that oil prices exceed $70 to $80 per barrel, depending on how the cost structure within the entire energy industry evolves. Many OPEC countries are running budget deficits at current oil prices, which is sustainable in the medium term but not forever.
Second, the long-term fundamentals supporting the opportunity for investors in new projects are still in place, including low-cost, abundant U.S. shale gas and NGLs:
It is also important to note that crude-oil prices appear to have stabilized above the price many analysts believed was the floor (approximately $40 per barrel). So, if projects have not been canceled yet, they are unlikely to be canceled in the future. Indeed, new project announcements have resumed as crude-oil prices have started to recover and stabilize. Moreover, many new projects are not expected to come onstream until 2017 or 2018. Depending on how quickly crude-oil prices recover, the low-price environment may not even affect these projects’ economics.