The midstream industry expected that ethane demand from petrochemical producers would be down much of the first half of this year due to scheduled turnarounds at many of the Gulf Coast's ethane crackers. What wasn't expected was when these facilities came back online that demand would remain stagnant.

But that is what happened. Looking ahead, forecasts project less price volatility during 2013 and a long-term need for additional infrastructure to serve new manufacturing capacity, says Michael Greenberg, chief executive of The Plastics Exchange, the Chicago-based market for commodity-grade resin.

This year's stagnant demand "caught a lot of people off guard. Rather than ethane really catching a bid from higher demand, we had an abundance of propane show up due to the really warm winter. I don't think a lot of traders expected propane to be as abundant as it was, but the stocks were there," says Greenberg.

At the start of the cracker turnaround season, ethane was by far the favored feedstock by petrochemical producers—as it had been for years. Ethane has traditionally been the favored feedstock in North America because of the comparatively high amount of ethane found in the continent's natural gas production.

However, demand fell dramatically during the first quarter as the crackers were taken offline for scheduled maintenance. Beginning in April, propane became a favored feedstock of petrochemical producers as prices fell dramatically since the market was unable to clear propane out during the mild 2011-12 winter heating season. This remained the case even as the crackers came back online, which kept ethane prices under pressure.

Ethane rejection

Throughout the first half, ethane prices dropped at both the Mont Belvieu, Texas, and Conway, Kansas, hubs. The decrease in demand for ethane resulted in the product being rejected, or returned to the methane gas stream, by processing plants in the Midcontinent and Rockies. This resulted in Conway's price turning negative in late spring and throughout much of the summer.

While ethane prices began to improve during the summer, propane prices remained competitive for petrochemical producers. Greenberg says that if heating demand had been at normal levels last winter, or there had been another outlet for propane, the market might have been better supported, and it is likely that propane would not be competing aggressively with ethane as a favorable feedstock.

"Ethane would have continued to be used heavily when the crackers returned to production until ethane prices were driven back up to the point that it was no longer cost effective. Propane is a good substitute for cracking so long as it's cost effective. For the most part, petrochemical producers are after ethylene and would prefer to crack ethane for the better direct yield.

"I don't think producers expected propane to be as plentiful as it was or the price to collapse like it did. Ethane was already cheap so propane really needed to fall apart in order for crackers to say, 'Let's use propane also,'" he adds.

The higher-than-normal propane inventories and weak prices helped to support petrochemical cracking margins during and after the cracker turnarounds. When the crackers came back online, ethane found a market that was already plentifully supplied, keeping this feedstock cost pressured.

2013 prices

While the front end of the curve is depressed, there is only a modest recovery priced into the ethane market through 2013. As long as downstream ethylene and polyethylene prices hold up, supply-chain margins can stay strong.

This outlook includes less price volatility, according to Greenberg.

"Prices along the supply chain in 2013 are currently expected to be more stable. I would expect volatility to be reduced dramatically. I don't see the market whipping around like it did this year. Because there was anticipation for so many crackers going down, it encouraged downstream players to produce and buy more polyethylene ahead of time and add to inventories as a buffer," he says. The price declines in resin were also extreme on the backend when crackers returned and resin inventories were drawn down.

It is likely that petrochemical producers will retain their buying power into at least early 2013 because of the large supplies of both ethane and propane available— and they are expected to remain abundant.

"With regard to resins, the producers also have momentum, and they're driving it. It's been a good five months since they had pricing power downstream. After a first-quarter rally, the second quarter was a buyer's market, and customers drew down resin inventories because there really was no fear of the market taking off to the upside," he adds.

However, the situation has recently changed. The resin export market has improved, helping resin producers to reduce inventories, creating a slightly short market. It has been enough to start implementing new price increases and begin reversing the steep price declines from the second quarter, which saw polyethylene contracts slide 14¢ per pound and polypropylene lose 25.5¢ per pound.

High operating rates for the production of resin is critical to keep the flow of monomer and natural gas liquids (NGLs) flowing rather than backing up and creating oversupply. If resin prices were to rise greatly and slow exports, then more ethane and propane volumes would remain in the U.S. According to Greenberg, producers do have enough capacity to handle an increase in available feedstock in the near-term, although it would upset the fragile supply-demand balance downstream.

Operating rates during the first seven months of 2012 averaged 91.2% for polyethylene and 87% for polypropylene.

Despite a bright outlook for the petrochemical market in 2013, he says that going forward, the industry will need further investments in infrastructure to match the aggressive cracker development plans through 2017. This includes increasing the capacity to export growing volumes of resin and to produce petrochemicals and plastics in more regional markets.

"If you could produce resin in the Mid-Atlantic, where fresh NGLs will be sourced, you could satisfy Northeast customer demand there and limit freight costs versus the current practice of generally producing and shipping from the Gulf Coast. There will also be a need for additional infrastructure to export material out of the Mid-Atlantic and Northeast.

"We need to recognize that over the next three to five years as more petrochemical complexes—including crackers and resin reactors—are built that the products will not just be for domestic consumption. It's not possible for the U.S. to consume all of the volumes coming online, and it is not practical to ship ethylene and propylene monomers overseas. I think that the industry is eyeing most of this new capacity and production ultimately for resin export," Greenberg says.

Plastics export facilities, including rail spurs, packaging lines and warehouses also need to be built, but they don't require the lead time that is necessary for forthcoming midstream projects. The logistics facilities can be built on shorter notice than securing government approval for many petrochemical construction projects.

These polyethylene exports would largely be shipped to China and India, which remain the high-growth manufacturing centers of the world. The U.S. is expected to experience a boost in activity as more petrochemicals are produced domestically; however, Greenberg cautioned that unless the U.S. feedstock cost advantage is passed along to the manufacturer of (semi) finished goods, the U.S. could still struggle to compete globally.

"Ethane-to-ethylene margins are massive—around 47¢ per pound—and polyethylene prices are kept as high as possible with resin surpluses being exported to keep the market tight, Greenberg says "Fully integrated resin producers are making their money between ethane and ethylene."

He adds that it is the producers' prerogative to maximize profits, but they could also loosen the screw a little bit to help out their long-term U.S. customers.

The current incentive for U.S. producers is to turn their cost-advantaged NGLs into resin pellets and sell them on the global market. However, in certain situations and in the future as more supplies become more abundant, it might make more sense for producers to export the product as liquefied natural gas.

"Right now, that is not a realistic high-volume option since the infrastructure isn't in place yet," he says.

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