SIMON SAYS: Spreading LPG against naphtha is not for the feint hearted!

Submitted by Simon Hill on Tue, 11/26/2019 - 17:00
Spreading LPG against naphtha is not for the feint hearted!

After a few years in the wilderness, and I do mean living on the Isle of Wight by the way, I was quite taken aback one day when two industry jargons were used in a flourish, as if I should have known exactly what they meant, one was “PRONAP” and the other was “FEIMOPJ”. Once I had worked out what they represented, I was then fascinated to know how they traded in the market. Up till then I had been an old school LPG trader, remembering the days when Europe, with the likes of Dow in Terneuzen, ICI in Tees, and Esso Europe in Stenungsund, were building flexible olefin crackers in order to switch between LPG and naphtha. The rule of thumb at the time was to say, if propane went below 90% of the naphtha price in North West Europe then you would get propane buying interest from one or more of the petrochemical buyers. It wasn’t too long before there seemed to be this sudden liberty, where the LPG trader was able to sell based on a percentage of the naphtha index, to a Dow or ICI, then go to what seemed to be extremely clever naphtha brokers, who could lock in a price for you by hedging the naphtha.

Today we keep our eye on the petrochemical sector by staying abreast of the ProNaps in Europe and FEIMOPJs in Asia. In the U.S. it appears it’s more a play across the NGL slate, from ethane to natural gasoline, trying to decipher which feedstock provides the petrochemical user with the best margins at any one time. I think we are all a little guilty of only casting an eye on the complexities of the product slate, more interested in ethylene and propylene percentages and prices, and hopeful that the calculations in the simple models we use are working.

The four main regions are North America, followed by Northeast Asia, Middle East and Western Europe, accounting for three-quarters of the worldwide petrochemical feedstock consumption. The majority of heavy naphtha produced is used as reformer feed for the production of high octane/ high value motor gasoline and aviation fuels, as well as aromatics, such as benzene, toluene and xylene. Traditionally light naphtha is the preferred feedstock for the petrochemical sector for the use in steam crackers to maximise ethylene production. However, with the drive to find natural gas in the 1990s and beyond, NGLs have become increasingly available, as a result of the development of natural gas fields in the Middle East, especially in Qatar and Abu Dhabi, followed by the shale gas revolution in the U.S. that’s been developing over the last decade. We’ve therefore seen a swing in the feedstock slate to the lighter feeds, with ethane being the new favourite of the petrochemical buyer. The theory is based on a lot of excess ethane being around, and investment decisions are driven by perceived low costs of feedstock and the high sales price of the main product derivative, namely ethane and ethylene, respectively.

As LPG traders, we are fascinated with the complexities of the petrochemical world, but we try and keep it simple. Yes, we are keen to understand the drive to producing olefins closer to the feedstock supply source, i.e. in North America and the Middle East, which together supply half of the world’s ethylene requirements. In addition, there are efforts being made by the Chinese government and its petrochemical industry to move up the chain by producing their own olefins, instead of simply buying them from the international market, while the propane dehydrogenation (PDH) plants producing propylene are of more interest in the LPG supply/ demand calculations, than really understanding the balances in the propylene sector. As a trader, all we really need to know is whether the economics are good for LPG, how good, and what impact this will have on the market when it comes to feedstock buyers purchasing more LPG or not.

Generally, the petrochemical feedstock buyer prefers to have the power of being able to switch in and out of light naphtha or LPG, especially at the margin. To some extent, in the last few years that power has been taken away, not out of choice, but as a result of the continued growth of shale production materializing in such a short period of time in the U.S., and with it the need to find an instant consumer to ensure barrels keep flowing. This has basically meant that the petrochemical buyers have been running at pretty much full pelt on LPG, with the only seemingly measurable switch being whether they can throw in a bit more butane and a little less propane. The new olefin crackers in the U.S., and to some extent in the Middle East, don’t get the choice, as they were built to run ethane. This has actually taken a lot of the petrochemical buyers influence away, although I’m sure they will probably disagree with me on this, and with it a lot of the larger swings in the market and price corrections. This role in recent years appears to have been taken over by the ARB and its ability to theoretically, and for that matter practically, open and close. Therefore, given the contractual mechanism to cancel export cargoes, this was “sparking-up” the equilibrium process. However, even this is becoming less influential, as we all have to jog our memories as to when the last cancellation actually took place. I’m struggling with that one!

The market I still consider having the potential for greater market disequilibrium, and market price movement, is Europe, and it still is influenced by petrochemical feedstock buying (and for that matter selling). As a result, I think the “ProNap” still offers a trading opportunity, although it is tied into a far more complex decision-making process. Let’s take last month where we saw a large jump in the buying of LPG in the northwest European petrochemical sector, with over 500,000 Mt heading mainly to Dow in Terneuzen, Le Havre, Stenungsund, Tees and Antwerp. Ineos at Rafnes are pretty much lost now to ethane imports. Nearly half of this demand was covered out of the U.S., not the local North Sea and Russian supplies. Then the trader element kicked in, as there were five VLGC imports matched by the same number of exports. The market had been in contango, as more supply had put pressure on the sellers to find homes, while buyers were more relaxed, but as soon as two VLGCs were rumoured to be leaving the region, the market moved into backwardation for the balance of the month. The ProNap swung between $108/ Mt and $153/ Mt. Now that is exciting for the trader, as playing the spreads on the ToTs market and window trading, sometimes feels as if you have to jump a big gate just to get into the arena.

In October European naphtha was tight, and started to trade by itself, not in tandem with Brent crude oil. There was a $20/ Mt jump during the month, while Brent crude oil moved up less than a $1/ bbl in October. Certainly European motor gasoline demand was pulling naphtha up, while the petrochemicals were less influential, especially as a result of an extended period of cracker turnarounds. The market tightness pushed the October/ November backwardation above $10/ mt. With the continued impact of less condensate from Iran and the drone attack on Saudi Arabia, forcing Asian buyers to mop-up any spare volumes out of Europe, coupled with the shutdown of Algeria’s Skikda refinery, Europe was only heading in one direction. Storage volumes ended up being released to try and dampen the shortage.

For me there is more logic in trading the propane/ naphtha crack spread, than trying to venture into ties with crude oil, and for Trade Secret we’ll explore a few possible plays that will show the potential upside. However, there is one thing the LPG trader has to become accustomed to, that’s the higher volatility when it comes to anything related to naphtha. You just can’t be hesitant!