Viewpoint: US ethylene margins to remain narrow in 2023

The margin for cracking ethane in the US into ethylene is likely to remain historically narrow throughout 2023 as ethane feedstock costs remain elevated and demand for ethylene may remain weak on downgraded domestic and global GDP forecasts.

US ethylene's premium to ethane is highly likely to remain low in 2023 and should mostly oscillate within the historically narrow range that has already emerged since the middle of 2022 of between -3¢/lb to +4¢/lb. Where cracking margins fall within this range in 2023 will depend mostly on the daily price volatility of US ethane.

One of the largest factors that drove this narrowing of ethane cracking margins in 2022 was the rise of US ethane prices, which themselves were largely following US natural gas prices higher amid the global energy shock triggered by Russia's invasion of Ukraine in February. Ethylene in the US is tied largely to natural gas and ethane prices, while in Europe and Asia pricing is more tied into crude oil and naphtha costs.

Ethylene is used for a variety of functions, but most prominently it is polymerized to make polyethylene (PE), the most common plastic. Ethylene is also oxidized to make ethylene oxide used in anti-freezes, paints and solvents. Ethylene also undergoes chlorination to form ethylene dichloride (EDC), the main component of polyvinyl chloride (PVC) pipes. Ethylene is also akylated with benzene to form ethylbenzene (EB), the main building block of styrene, which forms styrofoam.

US ethane prices rose an astounding 95.5pc in the first half of 2022, from 34.0625¢/USG to 66.625¢/USG. This doubling in ethane feedstock costs unsurprisingly eroded US cracking margins significantly in the first half of 2022.

Ethane's margins are likely to remain on the positive side of this range in 2023, as they have since the start of September, as the US cracker fleet can always tactically scale back run rates to retaina modicum of profitability. US Gulf coast crackers are currently estimated to be running at rates in the mid-to-high 70pc range, much lower than rates in the high 80pc to low 90pc range during more favorable supply-demand conditions for ethylene.

Combined with lower cracker run rates, a period of destocking for ethylene should continue to the middle of 2023 at least as the market tries to work down inventory. US ethylene inventories hit a historic high in the first quarter of 2022 and have lessened gradually in the second and third quarters. US ethylene inventories stood at 1.45mn metric tonnes (t) in the first quarter, according to data from the American Fuel & Petrochemical Manufacturers (AFPM) and then fell to 1.24mn t in the second quarter and 1.16mn t in the third quarter. This downtrend is likely to continue into 2023.

With ethylene producers making less product and purposefully working down inventory, ethane cracking margins should continue hold the line at barely positive, but no significant margin improvement is likely until either US ethane costs decline to more historic levels or demand for ethylene derivatives like polyethylene increases.

While US ethane prices did post a significant, 45pc decline through late September from late August this year, current ethane prices are still roughly double where they were at the end of 2019. Prices are unlikely to fall back to the 15-20¢/USG late 2019 range next year as natural gas markets are likely to remain historically volatile, as an unlikely cessation of hostilities in Ukraine next year would almost certainly not lead to an immediate unwinding of Western sanctions on Russia's energy complex.

To highlight how much margins for ethane cracking have narrowed in 2022, the gross spot cash margin for cracking ethane at US crackers averaged a historically healthy 19.75¢/lb in the first quarter of this year, according to an Argus generic cracking model. After Russia's invasion of Ukraine increased the volatility in global natural gas prices, including those in the US, which in turn drove US ethane cash costs higher, ethane margins averaged a sharply lower, 3.94¢/lb in the second quarter. The third quarter saw ethane cracking margins dip into negative territory and averaged slightly positive at 0.8¢/lb.

Demand for ethylene's derivatives is not likely to help improve margins in 2023. Inflation, particularly wage inflation, remains more persistent than many economists had initially thought. Aggressive interest rate hikes from the Federal Reserve this year aimed at quashing inflation at four-decade highs are having the desired effect of slowing inflation as 2022 draws to a close.

The question for 2023 is how sharp will the hit from rising interest rates be to the labor market and the overall economy. A sharp drop in economic activity would certainly further impact demand for ethylene's derivatives, particularly used in non-staple PE packaging and PVC piping, used in housing construction.

By Michael Camarda