Will Rising Oil Prices Hit Saudi Arabia's Petrochemical Margins?
Published on 05 Jul, 2016
The Kingdom of Saudi Arabia’s petrochemical sector could see a dip in their margins post 2Q if oil prices keep rising.
Prices of Brent crude rebounded to USD48.9/bbl in June from its lowest level of USD27.9/bbl in January. This is bad news for Saudi Arabia’s petrochemical sector, as rising oil prices have a cascading effect on the prices (and profitability) of downstream petrochemicals.
Naphtha Prices More Sensitive to Movements in Oil Prices
With most downstream products produced directly from crude or its immediate derivatives, oil is a major cost driver in the petrochemical industry. Naphtha — a key precursor for a number of downstream products — is particularly susceptible to fluctuations in oil prices. Japanese naphtha prices (a key indicator) are highly correlated with those of oil, as evident in the chart below. A correlation of 0.99 between 1Q FY10 and 2Q FY16 is indicative that naphtha prices closely follow movements in oil prices. On the other hand, the correlation between the prices of Brent crude and other petrochemicals were lower than that of naphtha and oil prices, an average of 0.77 during 1Q FY10–2Q FY16.
Oil Prices Could Hit USD47.0/bbl by the End of 2016
Based on the short-term energy outlook released by the U.S. Energy Information Administration (EIA) in June 2016, Brent oil prices are expected to average USD44.8/bbl in 2Q FY16. They’re expected to be higher than 1Q’s USD35.3/bbl, touch USD46.0/bbl over 3Q, and likely hit USD47.0/bbl by 4Q FY16E. This would spike naphtha prices faster than those of downstream petrochemicals, leading to a contraction in spreads.
While most petrochemical prices have increased during 2Q FY16 as several producers recorded a healthy turnaround across most key regions, normalization in petrochemical supply would dent product prices in 2H16.
Petrochemical Margins Will Shrink Significantly Over 2016
Most petrochemical companies in Saudi Arabia use naphtha and natural gas (ethane) as feedstock for downstream products. There are fixed ethane supply contracts in place (at around USD0.75/mmbtu) for the near future, an effective buffer against contracting PE-naphtha spreads for now.
While gross margins would remain unfazed in the short term, most such contracts would get over during or after 4Q FY16. Thus, any drastic increase in oil prices would impact petrochemical margins in 2017. Moreover, a contraction in PP-naphtha spreads could dent the gross margins of petrochemical companies in Saudi Arabia.
Saudi Arabia’s petrochemical companies still have room to breathe, with the impact of rising oil prices deferred due to existing supply contracts. Nonetheless, profit margins are expected to shrink after 2Q FY16 or 3Q FY16 for a while, stumbling the sector’s Bull Run during the oil glut.