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August 11, 2014
Exploiting Big Bang Disruption in Chemicals
By: Paul Bjacek

After years of successful development in fracking and horizontal drilling, the risk-takers in hydrocarbons have caused a period of unconstrained growth, triggering a “big bang” disruption in the oil, gas and petrochemicals industries. Following the “big bang” will be a “big crunch”, a pattern observed in other industries with similar disruptions1. The choke points, risks and follow-on implications of this must be weighed by chemical producers in order to ensure longer term positive performance. The background to this is outlined in the Appendix.

Selling to the well-supplied market
As indicated in our recent past analysis 2, there will be a US domestic over-supply of olefins derivatives of up to 20 million mt by 2023 if the entire list of speculated plants came to fruition. A similar oversupply will likely occur in other gas-based chemicals, such as methanol. Although this would not necessarily represent over-capacity on a global level for all products, it does raise concerns on the domestic level. While petrochemical companies have been focusing on securing construction labor, equipment, financing and other resources to build large scale olefins and methanol plants in the US, a less amount of effort has been dedicated to selling and moving the resulting chemical products. For instance, according to an ICIS/Accenture survey, most chemical companies planning to invest in North America are targeting their additional capacity towards serving the local market. However, the domestic market is highly demanding in terms of product performance and services and, consequently, some will be forced to export, as outlined in a recent past blog.

Figure 1: US Construction Spending

Setting a course for supply chain efficiency
Rising US manufacturing investment related to both the increased competitiveness of US manufacturing in general (due to mainly to innovation) and the hydrocarbon advantage has not been matched with infrastructure investment, as shown in Figure 1. In addition, truck supply is getting tight, with some chemical producers reporting difficulty scheduling plant pick-ups. The Cass Truckload Linehaul Index confirms this, with freight rates rising by 16% between June 2009 and June 2014. Furthermore, according to the Federal Railroad Administration, total accidents/incidents on US railroads increased by 2.5% in 2013, after two years of decline (related to the sheer volume of traffic rather than the incident rate, which has improved).

Export points for chemicals/plastics may be changing as well. While US Gulf Coast ports provide excellent access to Latin America, east and west coast ports may be more advantaged for serving Europe and Asia. The container balance for Houston (where about 70% of Gulf Coast container shipments occur) was a 257 thousand TEU s (twenty foot equivalent units) outbound container surplus in 2012, while Los Angeles had an inbound container excess of 2,198 thousand TEU3s (see Figure 2). Empty ships leaving Los Angeles or going to Houston do not represent the ideal logistical scheme and adjustments are likely to occur as the US Gulf Coast provides an increasing amount of export material.

Figure 2: Top 15 US Port Container Balance

At the same time, the expanded Panama Canal is set to open in early 2016 and will accommodate ship capacities of up to approximately 13,000 TEU, nearly three times the capacity of current vessels4. This represents a significant opportunity for direct Gulf Coast - Asia trade. The vessel size increase can reduce the cost of moving a container by almost half, according to our discussions with carriers. However, further investments may be needed to allow Gulf Coast ports to take full advantage of these larger vessels, in terms of breadth, depth and port equipment/infrastructure.

Therefore, competition between railroads, ports and carriers will define a new logistics flow over the next few years and chemical companies with foresight will be actively engaged with local and federal entities in the development of ports, roads and other infrastructure. Close collaboration and planning with carriers will also be important. They should also start deliberate planning of packaging, storage and other needed ancillary investments.

Navigating the Big Crunch
Clearly, chemical companies must manage the risks associated with current the “big bang” and follow-on “big crunch.”  For more of our analysis, also covering future market structure and the need for agility, please download our study, “Exploiting Big Bang Disruption in the Chemicals Industry,” here.


Appendix
The Evolution of the Hydrocarbons Big Bang
Horizontal drilling started in the 1920s, but only became commercially feasible in the 1980s.  In North America, oil wells in the Austin Chalk of Texas had major increases in well productivity using this method. The incentive to take risks with new technologies in the 1980s was energy independence, as well as high oil prices in the beginning of the decade. In this environment, thousands of horizontal wells were drilled.  Fracturing techniques (called “fracking”) to achieve higher oil and gas output began to grow in the 1950s, although experimented with as early as the 1800s.

In 2000, it became apparent that gas was moving into short supply in the US, when natural gas wellhead prices more than doubled between December 1999 and December 2000, reaching a level of US $5.77/MSCF5, providing incentive for further gas development. Along with improvements in materials, equipment and information technologies for drilling, horizontal drilling and fracking combined enabling large scale shale energy development, starting with Barnett Shale in Texas, around 2000, with other shale formations following. As a result, dry shale gas production in the US climbed from 0.3 trillion cubic feet in 2000 to 9.6 trillion cubic feet (40 percent of US output) by 2012, with gas prices declining to US $3.35/MSCF. During that time, patent filings in this field grew by over 400%, as producers raced to defend their technology positions. By late 2008/9, with oil prices climbing and natural gas prices falling, along with rising natural gas supply, it became apparent that a structural shift had occurred in the oil/gas price ratio. At that time, the first of many gas-based chemicals capacity expansion plans were announced.


1 http://www.accenture.com/microsites/bigbangdisruption/Pages/home

2 Bjacek, “Preparing for a Changing Petrochemical Supply Landscape,” Accenture, October 2013.

3 A TEU is a nominal unit of measure equivalent to a 20’ x 8’ x 8’ shipping container.

4 Joseph Bonney, “Panama Canal, contractors confirm agreement to keep work going,” Journal of Commerce, August 4, 2014.

5 US Energy Information Administration (EIA)”

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