The integration of refining and chemical processing is breaking down

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This post was last edited by sdwfsgyykai on 2019-11-29 at 07:55. The main component of the chemical industry is the organic chemical industry that uses oil, gas, and coal as raw materials. Its gross domestic product amounts to approximately 15 trillion yuan; globally, this figure exceeds 37 trillion yuan. It is undoubtedly a cornerstone industry within the entire industrial system. Looking ahead, China’s organic chemical industry is witnessing an unprecedented scenario where all three major production routes—oil, gas, and coal—are being significantly expanded simultaneously. Firstly, with the **relaxation of regulations on entry into the refining industry, private capital has poured heavily into this sector; there are numerous new refineries with capacities of tens of millions of tons. There are even companies like Zhejiang Petrochemical, which plans to achieve a world-class production capacity of 60 million tons in the future ； Secondly, over the past two years, thanks to the maturity of new coal chemical technologies, there has been significant expansion in the production of olefins and ethylene glycol. For example, Baofeng Energy plans to raise its olefin production to 3 million tons within 5 years, a level that is equivalent to the olefin production capacity associated with 40 million tons of refining capacity ； Finally, as the shale oil and gas revolution gradually spreads to China, the planned production capacities for both propane dehydrogenation and ethane cracking are approaching 10 million tons. For instance, Wanhua Chemical, a leading enterprise in this field, has a total olefin production capacity of approximately 2.3 million tons from its two gas-based chemical plants; this is equivalent to the output of a large-scale refining and petrochemical complex with a capacity of 20 million tons. On the demand side, it is clearly impossible to absorb such an increase in supply, making overcapacity and severe restructuring inevitable. Moreover, the diversity of organic chemical raw materials inevitably leads to significant differences in costs among different production routes, while the products themselves are almost entirely homogeneous. It is therefore the route that offers lower costs for producing specific products that will determine which party will emerge victorious in the fierce competition ahead, and this undoubtedly presents huge investment opportunities! 1.1 Differences in routes present significant investment opportunities. Looking back at history, we can see that for the chemical industry, which has multiple raw material pathways, the choice of process is far more important than efforts invested in other aspects. Once the wrong route is chosen, it becomes very difficult to turn things around later on. For example, in the past few years, companies engaged in the production of olefins from methanol via overseas imports have been trapped in a situation where they incur cash losses when operating and depreciation losses when shut down. In contrast, even the least performing companies in the propane dehydrogenation industry are able to achieve solid profits. The reason the former chose to build an MTO along the coast is certainly not to deliberately incur losses in order to serve society; the key factor is that at the time of planning, oil prices were high while methanol prices were low, resulting in a considerable arbitrage opportunity between the two. But for cyclical chemical products, the only constant is that prices are always changing; therefore, basing judgments solely on current prices can easily lead to fatal mistakes. For complex systems in organic chemistry that involve multiple raw material sources, decision-making requires not only the traditional cyclical analysis framework based on supply and demand but also an integration with chemical principles. This involves determining, at the chemical level, which raw materials should be used to produce each product in order to optimize overall costs related to energy consumption, material use, and transportation. By taking into account the reasonable price ratios of oil, gas, and other resources over long periods, it is possible to determine which production process offers the highest profitability throughout its entire life cycle. From this perspective, coastal MTOs not only have no advantage over oilhead capacity but are also at a clear disadvantage compared to northwest MTOs; it can be said that making profits is accidental, while incurring losses is inevitable. Propane dehydrogenation is naturally more suitable for China’s coastal areas, so it’s not surprising that it has consistently been profitable. Since ancient times, modest wealth comes from hard work, while great wealth depends on fate. It’s not that the MTO companies located along the coast don’t work hard, nor is it that the propane dehydrogenation companies are particularly outstanding; the fundamental reason lies in the differences in the route choices they make at the outset, which lead to a huge disparity in the final outcomes. Overall, the organic chemicals industry is no longer a sector in growth phase; it is more about competing for market share among existing production capacities. However, given its large scale of output and the highly fragmented market, any company operating in this sector faces an almost infinitely large market. Even if a cost advantage is achieved simply through different raw material sourcing strategies, this straightforward logic alone allows for continuous expansion and growth. This is particularly evident in the case of East China Energy, a company operating in the propane dehydrogenation industry over the past few years. As a trading company with no prior experience in the chemical industry, it managed to increase its profits tenfold within just five years after entering this sector. At its peak, its stock price also rose by more than ten times. This clearly demonstrates the characteristic of cyclical industries: success depends on timing rather than individual efforts. As long as one grasps the overall trends, it is possible to move heavy stones as if standing at the edge of a deep abyss; any company can thus achieve significant excess returns. So although we believe that the overall cycle in the petrochemical industry will move downward in the future, growth opportunities in terms of investment in stocks will still arise, as the costs associated with coal and gas are significantly lower than those related to oil. In particular, significant technological advancements have been made in new types of coal chemical industries in recent years. China also boasts advantages in terms of resource endowments, offering great potential for development; it is likely to significantly encroach on the market share held by oil-based products in the future. It can be said that the global organic chemical industry system, which is based on integrated refining and chemical processing, is currently in the process of disintegration, and this will also create significant investment opportunities! 1.2 The integrated refining and petrochemical pattern is breaking down. From a chemical perspective, the main difference between oil, coal, and natural gas lies in their carbon-hydrogen ratios: coal consists almost entirely of carbon atoms; petroleum can be approximated as CH2, while natural gas is CH4. Hydrogen has a high calorific value and is more suitable as a fuel, while carbon is better suited as a structural material – that is, hydrogen for fuel and carbon for materials. Looking at the downstream uses of oil and gas, fuel consumption accounts for over 80%, while materials account for only 15–20%; thus, their energy-related properties determine their prices. Due to their different hydrogen contents, the energy density of oil and gas is significantly higher than that of coal, being about three times greater. Moreover, oil is in liquid form, and after simple processing it can be used in transportation sectors such as automobiles; its application areas are of higher quality and difficult to replace. Coal and natural gas, on the other hand, are mainly used for power generation and urban gas supply, which is why oil commands a higher price than gas. Overall, oil and gas are more suitable as fuels, while coal is more suitable as a raw material for the chemical industry. Yet in reality, global organic chemical raw materials have always been based on petroleum, to the point that they are often equated with petrochemicals. In the past two years, with the shale gas revolution in North America, the proportion of gas has increased significantly, while coal use is largely confined to our country. In terms of the proportion of raw materials in the highly competitive C2-C3 sector among oil, gas, and coal, China currently has a ratio of 69%:18%:13%, while globally it is 56%:5%:39%. In both cases, oil-based feedstocks hold a dominant position. Looking ahead, we believe that the organic chemical industry structure, which is centered around integrated refining and chemical processing, is in the process of breaking down, with gas-based chemical production, and particularly coal-based chemical production, accounting for a significantly larger share. In the long term, the United States will have an additional approximately 10 million tons of ethane available for ethane cracking, and thanks to the extremely low costs, this potential should be fully realized in the end. In the downstream liquid chemical products derived from propylene, propane dehydrogenation has advantages over oil-based chemicals in terms of lower investment costs and higher yields, and its market share is set to continue increasing. More importantly, in terms of total costs, particularly cash costs, Northwest China’s coal-based production of olefins and ethylene glycol has a significant advantage over the currently dominant oil-based chemical industry. Moreover, unlike the gaseous chemical feedstocks ethane and propane, which are produced as associated gases, the global supply for industrial use is only in the tens of millions of tons; this volume is not sufficient to fully replace petrochemicals, and rising demand will lead to continuous price increases. As a fundamental energy source, China’s coal production exceeds 4 billion tons. Even if oil were to be completely replaced by coal, the additional demand for coal would be only around 200 million tons, so the impact on the price system would be negligible. As a result, the coal chemical industry has virtually unlimited capacity for low-cost expansion. Therefore, we believe that in the future, downstream products of the oil and chemical industry will increasingly focus on aromatics at the C4 level and above. Apart from newly established private large-scale refining companies along the coast that have the advantage of a complete aromatics production chain, most high-cost refineries located inland will be forced to withdraw from the chemical industry and transform into pure oil refining enterprises. At that time, the polyolefins produced by the withdrawal of oil-based production methods will mainly be directed towards coal chemical industries, while the liquid chemicals derived from propylene will primarily be used in propane dehydrogenation processes. Ethane cracking, thanks to its low costs, will also occupy its rightful share of the market. As the decline in the proportion of light crude oil leads to a reduction in the supply of C4 and higher-grade products, the trend toward lighter products among oils aged 11–14 will recur, which represents a structural advantage for integrated refining companies that produce large amounts of aromatic hydrocarbons. At the individual stock level, we recommend paying attention to Baofeng Energy, which has the capability and willingness to expand at low costs in the coal-based olefins sector; Wanhua Chemical and Weisat Petrochemical in the gas-based chemicals sector; as well as Rongsheng Petrochemical, Hengli Petrochemical, and Hengyi Petrochemical, which benefit from the trend toward lighter materials in the oil-based chemicals sector. 1.3 Why are we optimistic about coal chemical industry? Since the beginning of this year, we have published several reports in which we have repeatedly emphasized our optimism regarding the coal chemical industry – an opinion that is undoubtedly quite unconventional in the current industry landscape. As mentioned earlier, the reason we are so optimistic about coal-based chemical industry is that, compared to oil and gas, coal is inherently more suitable as a material due to its hydrocarbon ratio, and it also has a significant price advantage; this results in the costs of coal-derived olefins and ethylene glycol being considerably lower than those of oil-based chemicals. More importantly, coal is the only basic energy source in our country that possesses global comparative advantages and allows for self-sufficiency. Developing coal chemical industry is beneficial to China’s energy security; if all polyolefins were replaced by coal-based products, oil consumption would be reduced by about 40 million tons, and import dependence would decrease by around 10%. Moreover, coal-based chemical processes possess a very strong inherent capacity for expansion. In the past few years, both MTO and coal-to-ethylene glycol industries in China have experienced explosive growth. Even after the sharp drop in oil prices in 2015, the pace of capacity expansion did not slow down. It can be said that coal is the most suitable raw material for the organic chemical industry in China. The significance of developing coal chemical industry for our country will be no less than the rise of gas-based chemical industry in the United States following the shale gas revolution. Coal chemical industry has not received much attention in the past, and in the past two years it has even faced numerous regulatory restrictions. The root cause lies in the strict controls on coal usage across various regions; as a chemical industry that relies on coal as a raw material, it is naturally prone to being restricted when there is no distinction between materials and fuel uses. Furthermore, coal chemical technology is highly complex, and too many unqualified companies have rushed into this industry. They have invested in projects such as coal-to-gas, coal-to-oil, and coal-to-methanol production in the northwest, projects that lack competitive advantages and are not economically viable. This has led to operational difficulties for these companies and has severely damaged the reputation of the industry. However, we believe that these issues are all improving. In particular, as development opportunities in the industry become concentrated among leading enterprises, China’s coal chemical industry is expected to give rise to world-class bulk commodity producers akin to Dow and LyondellBasell in the United States. In the long run, we believe that no one will restrict the development of their advantageous industries. Ultimately, coal chemical industry will differentiate between coal used as a raw material and coal used for energy purposes; thus, relaxing approval restrictions is an inevitable trend. Due to the high intensity of investment required in coal chemical industry and the elevated construction costs overseas, there has been a persistent lack of investment in this sector. As a result, its process maturity lags far behind that of the oil and gas chemical industries. However, with the rapid development of our country, progress in coal chemical technology is accelerating. Taking the historically oldest ammonia-alcohol co-production process as an example, there have been several advancements in this process over the past few decades. First, in the 1990s, the substitution of expensive anthracite with low-cost bituminous coal was achieved through the water-coal slurry process ； Furthermore, the slurry coal technology was upgraded through multiple nozzles and water wall cooling ； Thirdly, the daily coal input into gasification furnaces has been increasing continuously, from 750 tons in 2008 to 3,000 tons by 2014; the maximum capacity of a single gas production unit has now reached nearly one million tons. All these technological advancements have led to a significant reduction in costs. As for new coal-based chemical industries, the first set of Shenhua coal-to-olefins plants was put into operation just 10 years ago, and mature facilities for coal-to-ethylene glycol were only commissioned in the past two years; there is still much room for improvement in terms of technology. In the future, as costs continue to decrease, its competitiveness compared to oil and gas chemicals will further increase. As one of the few sectors in our country where the technology is on par with that in Europe and the United States, and where research and development capabilities as well as raw material supply are under independent control, coal chemical industry should enjoy faster development. 2 Cost comparison of the three major chemical production routes As mentioned above, the core competitiveness of the organic chemicals industry lies in cost. From the perspective of the composition of chemical industry costs, they mainly consist of raw materials, energy consumption, production expenses, and other related costs. Specifically for these three routes, the most important difference lies in the cost of raw materials. Behind this lies the fact that different raw materials used in the production of the same product result in varying carbon conversion efficiencies, meaning different tonnage consumptions; furthermore, there are also significant differences in the price per ton of oil gas. In terms of energy consumption, generally coal chemical industry > oil chemical industry > gas chemical industry; however, in terms of the degree of impact, it is far less significant than the impact of raw materials. Moreover, new coal-based chemical industries are mostly located in the northwest, where electricity and steam costs are very low. In contrast, oil and gas-based chemical industries are primarily found along the eastern coast; in many of these cases, electricity has to be purchased from outside. This is especially true for gas-based chemical industries, as they have only started operating in the past couple of years, and there is a lack of integrated heat and power generation facilities, so steam also has to be acquired externally. As a result, the difference in energy costs between these two types of industries is not significant. The main production costs are depreciation and labor, with the most significant difference lying in depreciation. Taking olefins as an example, the capital investment required for coal chemical industries is five times that of oil chemical and gas chemical industries, and depreciation costs are also much higher. Since the investment in chemical projects abroad is much larger than in China, it is not surprising that coal chemical production is concentrated in China worldwide. The key difference at the three-cost level lies in freight costs and financial expenses. Since coal chemical industries are generally located in the northwest, and their products need to be sold in the east, transportation costs account for a large proportion of the total cost. Although the proportion of shipping costs in the total product cost seems low for gas chemical products, since the raw materials are gases, shipping costs also account for a significant portion of the procurement costs. In terms of financial expenses, coal chemical plants require large amounts of investment, while oil chemical plants need associated upstream refining facilities; the investment in the entire industrial chain is also substantial, which results in relatively high proportions of financial expenses. The specific analysis is as follows: 2.1 Comparison from the perspective of carbon conversion rate. Oil is a complex mixture of long-chain alkanes and aromatics; therefore, through processes such as cracking or reforming, chemicals like ethylene, propylene, and PX can be produced, with a carbon atom conversion rate of over 90%. Natural gas chemical processing also involves no carbon chain transformation; basically, methane is used for the co-production of ammonia and methanol, ethane is cracked to produce ethylene, and propane undergoes dehydrogenation to yield propylene. The conversion efficiency of carbon atoms is also quite high. Since coal contains no hydrogen at all, to produce various downstream hydrogen-containing chemical products it must be converted through gasification reactions, in which one carbon atom replaces two hydrogen atoms, resulting in the formation of useless CO2 – which means that one carbon atom is wasted. If olefins are produced via dehydration reactions using methanol as a mediator, it amounts to an additional waste of one C atom. Therefore, from the perspective of carbon conversion rate, coal chemical processing is superior to oil chemical processing in producing C1 products such as methanol and urea through a single-step reaction, and it is equivalent to gas chemical processing ； If one additional reaction step is added to produce ethylene and propylene, then oil-to-gas chemical processing becomes completely equivalent. Consequently, the competition among the three routes also primarily occurs in this area, which we will analyze in detail later. In chemical processes of grade C4 and above, coal-based chemistry suffers from too high losses in carbon conversion rate, while gas-based chemistry has too low selectivity; as a result, aside from some benzene produced through coking of coal tar, oil-based processes dominate almost entirely. 2.2 Comparison from the perspective of transportation costs: Compared to cost comparisons among oil, gas, and coal, it is actually the cost comparisons within each process route that have a greater impact, which in turn affects the optimal location selection for various industries. As the most widely traded commodity, oil is transported using 300,000-ton VLCC tankers; even in intercontinental trade, the cost of transportation accounts for less than 5% of the total cost. However, downstream petroleum products are mainly liquid fuels such as gasoline and diesel, as well as coal, and there is also some gaseous liquefied gas, all of which result in high transportation costs. Therefore, the overall transportation cost at the place of consumption is much lower than that at the place of production. Even in a country with abundant resources like Saudi Arabia, there are very few refineries dedicated to export purposes. As a dry bulk commodity, coal has relatively low transportation costs. However, the issue is that the coal consumption per ton varies greatly among downstream products, and the proportion of freight costs in the total cost of these products also differs significantly. Therefore, it is necessary to analyze each specific product to determine whether it is more suitable to be produced in resource-rich areas or in consumption areas. In the case of producing urea or methanol through a single-step reaction, the coal consumption per ton of product is 1 ton and 1.5 tons, respectively. The transportation cost per ton for urea and coal at the product end is similar, while that for methanol is approximately 1.5 times higher. Therefore, building such facilities near either consumption areas or resource-rich regions yields essentially the same economic outcome. However, if methanol is further processed into polyolefins, the coal consumption per unit increases to 4.5 tons, and the cost of solid polyolefins is not much different from the shipping cost of coal; in this case, the advantages of resource-based enterprises in the northwest become very evident. The situation for coal-based ethylene glycol lies somewhere in between; it requires approximately 2 tons of raw coal per unit produced. Taking the transportation costs of the product into account, companies in the northwest have a slight advantage. However, due to the great technical challenges associated with maintaining stable operation, it is currently the technology-leading companies in the east, such as Hualu Hengsheng, that have the lowest costs. For gaseous chemicals, the need for low-temperature liquefaction during transportation results in high shipping costs. The temperatures required to liquefy natural gas, ethane, and propane are -161.5°C, -88.6°C, and -42.1°C respectively; therefore, the storage and transportation costs vary significantly. Taking the route from the United States to our country as an example, the freight cost per ton is 80 dollars, 120 dollars, and 80 dollars respectively; the proportion of freight cost in the current product price is 17%, 30%, and 16% accordingly. For the products urea and methanol produced by C1 Chemicals, the shipping costs from the United States to China are 60 and 80 dollars per ton respectively; given the low unit price of these products, their share in the total cost exceeds 25% each. Polyethylene and ethylene glycol, which are downstream products of ethylene, have transportation costs similar to those of urea and methanol; however, due to their higher unit price, their share has dropped to around 8%. The proportion of freight costs for polypropylene, which is a downstream product of propylene, is similar to that of polyethylene; the other products are liquid chemical substances, and some are even hazardous chemicals, resulting in extremely high storage and transportation costs, with virtually no large-scale intercontinental trade. Therefore, propane dehydrogenation plants are built near the consumption sites, allowing the disadvantage in transportation costs associated with raw materials to be easily offset by the advantage in transportation costs for the finished products. Therefore, overall, both propane dehydrogenation and petrochemical processing are suitable to be located near consumption areas. Particularly when considering construction and labor costs, China’s aforementioned production capacities hold a greater advantage compared to those in resource-rich regions. Natural gas chemical processing and ethane cracking are suitable for being built in resource-rich areas due to the high proportion of costs associated with transporting raw materials. In the coal chemical industry, coal-to-olefins plants are best situated in resource-rich areas in the northwest. For other products such as urea, methanol, and ethylene glycol, both locating them in consumption areas and in resource-rich regions have their respective advantages; thus, an analysis based on the specific circumstances of each enterprise is necessary. 2.3 Comparison from the perspective of unit investment: There are many types of chemical products associated with oil-based production capacity. Taking ethylene, which is the most standard example on a million-ton scale, as an example, the corresponding chemical products include 1 million tons of ethylene, 500,000 tons of propylene, 300,000 tons of C4 compounds, and 700,000 tons of aromatics. The total investment required is generally around 10 billion yuan, which means the investment per ton of olefins is 4,400 yuan. In terms of gas-to-chemicals capacity, the product range is relatively limited. For a standard 1.2-million-ton ethane cracking plant, the output mainly consists of 900,000 tons of ethylene and 300,000 tons of other products such as C3 and C4 compounds. Based on a total investment of 5 billion yuan, the investment required per ton of ethylene production amounts to 4,500 yuan ； In a standard 600,000-ton propane dehydrogenation plant, the output is primarily 450,000 tons of propylene. Based on a total investment of 2.4 billion yuan, the investment per ton of propylene production capacity amounts to 4,600 yuan. The main products of the Northwest Coalhead MTO plant are 300,000 tons of ethylene and 300,000 tons of propylene; the investment required per unit capacity for producing these olefins is 30,000 yuan. For MTP, due to its lower overall yield, the investment per unit capacity is even higher. The investment scale for 200,000 tons of coal-based ethylene glycol (equivalent to 120,000 tons of ethylene in pure form) is 3 billion yuan, resulting in an investment of 25,000 yuan per unit of olefin production capacity. Based on the assumption that the aforementioned investments are depreciated over 10 years, with 70% of the financing coming from debt at an interest rate of 7%, the financial cost per ton of olefins for oil head, ethane cracking, propane dehydrogenation, MTO, and coal-based ethylene glycol is 656 yuan, 671 yuan, 685 yuan, 4470 yuan, and 3725 yuan respectively. It should also be noted that for oil-based production capacity, it is necessary to have upstream refining operations with low profits, which means that the investment required doubles. As for ethane cracking, due to the very small scale of global trade in this area and the extremely inadequate infrastructure, those entering this industry must address the shortcomings in upstream infrastructure and specialized vessels; these are all hidden costs that cannot be ignored in these industries. 2.4 Comparison from the perspective of raw material prices Compared to the above three points, what is undoubtedly more important is the assessment of the future price relationship between oil, gas, and coal. As for oil prices, there are not significant differences across the world. Although in the past two years the WTI price has been significantly lower than the Brent price due to the shale oil revolution in North America, it is expected that the gap between the two prices will narrow again by the end of the year, as new export pipelines come online; we use the most representative Brent price as our benchmark. Global gas prices vary greatly from region to region; prices in resource-rich areas are generally low. However, due to high transportation costs and significant export constraints in the United States, which is the largest source of such resources, these issues cannot be resolved in the short term, making intercontinental arbitrage very difficult. Compared to transporting North American natural gas to our country, there is at least the logistical possibility of exporting urea and methanol. Therefore, in what follows we will still use North American prices as a benchmark, and based on this determine whether urea and methanol from North America are cost-competitive for export. For coal, we have chosen 5,500 kcal thermal coal from Qinhuangdao as the price benchmark for raw materials used in the production of urea and methanol in the eastern region ； As for the coal chemical production capacity in the northwest, since the investors are all resource-based companies such as Shenhua, China National Coal Group, and Shaanxi Coal Industry, their goal is essentially to realize the value of upstream resources through coal chemistry, earning profits from the entire industrial chain that spans from coal to chemical products; therefore, the benchmark for raw material prices is the price of coal at the mine entrance. Current ethane cracking mainly takes place in North America, and since the bulk of it is used as fuel, its price remains stable at around 1.15 times the price of natural gas in North America, based on calorific value comparisons. Propane dehydrogenation mainly takes place in China, where it accounts for nearly 50% of the chemical industry’s output; therefore, the pricing is half based on oil and half on gas. Following the sharp drop in oil prices 15 years ago, the price per ton of oil and gas in our country became relatively consistent; accordingly, the price ratio between propane and naphtha has also converged to 0.97 since 2016. Therefore, we selected North American natural gas *1.15 and China’s naphtha prices as substitutes for forward ethane and propane prices. Currently, the prices of oil, coal, and propane along China’s coast, as well as natural gas and ethane in North America, are 59 dollars per barrel, 575 yuan per ton, 3,584 yuan per ton, and 0.52 yuan per cubic meter, respectively, as well as 1,916 yuan per ton. Based on the average prices over the past 10 years, the prices of the aforementioned products are 81 US dollars per barrel, 557 yuan per ton, 4,571 yuan per ton, and 0.82 yuan per cubic meter, as well as 2,452 yuan per ton. Given the fundamental changes in the global oil and gas supply structure and cost curves following the shale oil and gas revolution in North America, the average prices over the past 10 years have been systematically overestimated. At present, shale oil and gas producers, which represent the main source of marginal capacity, continue to experience negative free cash flows, and in the long term the current prices may also be systematically underestimated. Therefore, based on calculations by the major shale oil and gas companies under reasonable profit conditions (assuming an ROE of 10%), the corresponding oil and gas prices are 55 dollars per barrel and 0.8 yuan per cubic meter, while the prices for propane and ethane are 3,350 yuan per ton and 1,300 yuan per ton respectively. Regarding coal prices, we tend to believe that the current supply-side reforms in China have led to somewhat inflated prices; therefore, 500 yuan per ton is likely to be a more reasonable long-term estimate for coal prices in the eastern region. The coal price at the mine entrance is mainly determined by costs, remaining relatively stable at 200 yuan per ton. Under the aforementioned pricing system, the cost comparison of ammonia-alcohol co-production in North America and in our country, as well as the cost comparison of polyethylene, polypropylene, and ethylene glycol—products for which competition among oil, gas, and coal is most intense—are shown in the tables below. 3 Analysis of the landscape of various chemical products: Based on the analysis presented above, we believe that global C1 products will mainly come from coal-based chemical manufacturing and gas processing in resource-rich regions. Although gas-based production is less costly, it is not feasible to export such products on a large scale to China when transportation costs are taken into account. In terms of acetic acid and caprolactam in the downstream market, China has a greater cost advantage, and its global market share is even expected to continue rising. In C2 chemical manufacturing, the production capacity based on polyethylene sourced from local gas sources offers the greatest cost advantage. In China’s northwestern region, coal-based chemical production is slightly more competitive than oil-based chemical production when calculated using market coal prices, but the cash cost advantage is evident. If calculated based on the coal price at the mine entrance, the full cost advantage is also evident. Therefore, the new production capacity from gas projects in North America and coal projects in China’s northwest will further erode the existing share of oil project production capacity. Although ethylene glycol is the key product in this round of simultaneous expansion of oil and gas production, at the current extremely low prices, in the long term the production capacity based on gas in the Middle East is likely to be shifted toward the production of polyethylene, which offers better profitability. Meanwhile, the new oil-based production capacity added by domestic private refineries tends to squeeze market share from existing oil-based producers; as a result, the proportion of production capacity based on coal will continue to increase significantly. With the sharp drop in ethylene prices, PVC produced via the ethylene method in the east will regain its cost advantage and become the main source of additional production capacity in the future. The pattern of polypropylene in the C3 chemical industry is similar to that of polyethylene, except that China has an advantage in gas-based production capacity compared to regions with abundant resources. As for other liquid chemical products derived from propylene, the high proportion of shipping costs associated with these products means that competition will mainly take place between coastal refineries and propane dehydrogenation facilities. However, the price difference between the two in terms of raw materials is not significant; at this point, a company’s technical capabilities and its integrated supply chain become even more crucial. Overall, under the pressure from coal-based and gas-based producers in the C2-C3 segment, the profitability of oil-based production capacity will depend more on its competitiveness in high-carbon-chain products at the C4 level and above. By then, private polyester giants that possess advantages across the entire aromatic hydrocarbon value chain are most likely to emerge victorious from this reshuffle, and to reap the structural benefits resulting from the improved profitability of C4 and higher-grade products due to the shift toward lighter raw materials. 3.1 Various C1 chemical products: The main products of C1 chemistry are urea and methanol, which are produced through the combined synthesis of ammonia and alcohol. Other products include acetic acid and butyl octyl alcohol, which are obtained via carbonylation reactions. Lastly, caprolactam is produced as a derivative of synthetic ammonia. The competitive advantages of each production route are analyzed as follows: Urea: The global production capacity is 230 million tons, with the majority of this production located in China and the Middle East – 70 million tons and 45 million tons respectively. A large amount of this urea is exported, with India being the largest importer. From a cost perspective, the production costs in the resource-rich regions of the Middle East and North America are the lowest, at 760 yuan and 1050 yuan respectively. When transporting these products to India, the landed costs are approximately 865 yuan and 1299 yuan. In China, the average landed cost for sending such products to India is around 1478 yuan. Although the Middle East has a clear cost advantage, the cost of building new production capacity is extremely high and the construction pace is slow; moreover, there has been a lack of new gas supply in recent years, so capacity expansion has come to a standstill. Although China’s low-cost water-coal slurry has certain cost advantages on a global scale, it is difficult for it to see growth in the short term due to strict restrictions on the addition of new production capacity in the country. The problem in the United States is its distance from major consumption areas, resulting in high transportation costs. Therefore, although there has been capacity expansion in the past two years, it has mainly been aimed at meeting domestic demand through import substitution. In the future, it is unlikely that there will be any large-scale export capacity targeted at the Asia-Pacific region. Methanol: The global production capacity is 150 million tons, with the majority located in China, the Middle East, and North America – 92 million tons, 18 million tons, and 7 million tons respectively. China is the largest importer, while the latter two regions export a large amount of their production to China. From a cost perspective, the production costs in the resource-rich regions of the Middle East and North America are the lowest, at 758 yuan and 1038 yuan respectively; the landed costs upon delivery to China are 968 yuan and 1248 yuan respectively. In China, the average cost of producing coal water slurry and in fixed beds in the eastern region is approximately 2,000 yuan and 2,600 yuan respectively, with an average of about 2,300 yuan. Although the cost advantage of gas-based production capacity remains quite evident in the Middle East and North America at present, a large amount of newly built methanol capacity in China’s northwest region is designed to serve downstream MTO projects. This has significantly reduced overall transportation costs. As a result, the cost disadvantage compared to North American capacity is no longer significant. Similar to urea, there are few expansion plans for methanol capacity in the Middle East as well. Therefore, in the future, as a large amount of offshore methanol-to-olefins capacity in China is phased out, China’s coal-based production capacity is expected to replace imports and increase its global market share through the development of integrated olefin production projects in the northwest region. Acetic acid, butanol and octanol: The global production capacity of acetic acid is 16 million tons, with the majority concentrated in China and North America. The limited production capacity in the Middle East is mainly due to the greater technical complexity of acetic acid compared to methanol; moreover, as a product derived from the further processing of methanol, its capital investment is also higher than that of methanol. Therefore, it is not as advantageous for them to produce acetic acid as to utilize their resource advantages by producing the simpler-to-produce methanol. In a comparison between China and the US, leveraging its advantages of low construction costs and management expense ratios, China’s representative company Hualu has costs that are roughly on par with those of Meisen, a major North American enterprise. Additionally, the main markets for acetic acid are also in Asia; after accounting for shipping costs, China’s overall cost advantage becomes even more evident. The industry landscape for butyl acetate is similar to that of acetic acid, and China also has a clear advantage in this area, so no further analysis is needed. Caprolactam: Global production capacity is 7.5 million tons, with China accounting for nearly 50% of this total. Its production process involves using one ton of benzene, one ton of synthetic ammonia, and other gasification products as well as sulfuric acid to produce one ton of caprolactam and one ton of sulfuric acid (a fertilizer); it is a typical example of a product derived from coal. In terms of ammonia synthesis, although costs are lower in the Middle East and North America, the chemical industry there focuses on gaseous products, resulting in very low benzene production. The United States is the world’s largest importer of benzene; the Middle East not only lacks benzene but also faces difficulties in utilizing the cheap sulfuric acid AN produced as a by-product within its own agricultural sector. In Europe, as well as in countries such as Japan and South Korea, where the chemical industry is dominant, benzene production is decent, but the capacity for synthetic ammonia is limited and the costs are high. China, on the other hand, enjoys advantages in both benzene and coal chemical industries. In particular, its sources of benzene are extremely abundant; they include not only petroleum-derived benzene but also the coking benzene process, which is unique to China. More importantly, caprolactam is primarily used in the production of nylon, and China is a major country with a complete textile industry chain; both polyester and its upstream raw material PTA account for over 70% of the global market share. Based solely on the advantages of raw materials, China’s competitiveness in the production of caprolactam is even greater than that of PTA, which relies on crude oil as a feedstock; therefore, it is likely that production capacity will continue to concentrate in China in the future. 3.2 Various C2 chemical products The main product of C2 chemicals is polyethylene, followed by ethylene glycol (EO), styrene, and PVC. The proportion of ethylene used in their production is 64%, 24%, 5%, and 3%, respectively. The competitive advantages of different production routes are analyzed as follows: Polyethylene: The global production capacity is around 120 million tons; currently, production relies mainly on oil-based and gas-based feedstocks, while China has some production capacity using coal-based feedstocks. From a cost perspective, the ethane cracking capacity in the Middle East and North America has the lowest costs, at around 3,700 yuan and 3,900 yuan per ton respectively. The costs for oil-based MTO capacity worldwide are similar, estimated at 6,100 yuan. The average cost per ton for coal-based MTO capacity in China’s northwest region when transported to the east is 5,700 yuan, while the cost for MTO capacity in the eastern coastal areas is above 8,500 yuan. The potential cost per ton for domestic ethane cracking capacity is estimated to be 4,700 yuan. From the perspective of supply and demand, China is the largest importer. When calculated based on delivery to China, the tonnage cost in the Middle East and North America is 3,950 yuan and 4,300 yuan respectively, which remains highly competitive. Furthermore, the cash cost of coal chemical industries in China’s northwest is very low, at only 4,000 yuan; therefore, compared to those based on oil, they not only possess a certain advantage in terms of total costs but also have strong resilience in highly competitive environments. Ethylene glycol EO: The global production capacity of ethylene glycol is approximately 39 million tons, with oil-based, gas-based, and coal-based methods accounting for 54%, 33%, and 13% respectively. From a cost perspective, the Middle East and North America have the lowest production costs due to their use of ethane cracking; the cost per ton is 3,100 yuan and 3,200 yuan respectively, while in China the cost per ton for ethane cracking is 3,800 yuan. The production costs for oil-based feedstocks are similar around the world, estimated at 4,300 yuan. The average cost of transporting coal-based feedstocks from the northwest of China to the east is also 4,300 yuan, but the cash cost is only 3,400 yuan. For representative companies in the east, such as Hualu Hengsheng, the total cost is even just 4,000 yuan. From the perspective of supply and demand, China is the world’s largest consumer and importer. Based on costs for delivery to China, the costs in the Middle East and North America are 3,450 yuan and 3,800 yuan respectively. Although there is still a cost advantage, it is not economically viable to produce ethylene into polyethylene and then export it to China; therefore, export capacity to China is not expected to increase significantly in the future. China’s coal chemical industry, thanks to its lower overall costs – particularly cash costs – is expected to significantly displace oil-based production capacity in China and East Asia. Since EO is a hazardous liquid, it is hardly possible to trade it over long distances; the main sources of production for consumer areas in eastern China will still be oil-based processes as well as potential domestic ethane cracking capacity. Styrene: Global production capacity is around 34 million tons. Its production process is similar to that of caprolactam, as in both cases benzene must be combined with another substance. Therefore, although the Middle East and North America have cost advantages in terms of ethylene production, the overall advantage is not significant due to insufficient supplies of benzene. Globally, production still relies mainly on capacities based on local oil sources. As a major consumer and importer, China is expected to see a significant reduction in imports of styrene from countries like Japan and South Korea—which also possess oil-based production capacity—following the commissioning of this batch of privately-owned large-scale petrochemical complexes equipped with styrene production facilities. Furthermore, the potential domestic coastal ethane cracking capacity will also provide some incremental output through the purchase of benzene from external sources. PVC: Global production capacity is approximately 56 million tons. There are two main production routes: the coal-based calcium carbide method and the oil- or gas-based ethylene method. From a cost perspective, the most significant cost component for coal-based production capacity in China is electricity, which accounts for as much as 37%. For ethylene-based production capacity, the main costs are ethylene and electricity, accounting for 64% and 23% respectively. In the era of high-priced ethylene, the world’s most competitive production capacities are concentrated in northwestern China and North America. However, if ethylene prices fall to 5,900 yuan in the future, as we anticipate, the cost per ton for producing PVC from imported ethylene along China’s coastlines will decrease to 4,300 yuan. In contrast, the cost for coal-based production in the northwest region remains at 4,400 yuan per ton. Considering that the transportation disadvantage of northwest producers relative to eastern firms—which translates into an additional cost of roughly 500 yuan per ton of PVC due to co-produced caustic soda—eastern production capacity is expected to regain its cost advantage, and its market share is likely to increase as well. Since global caustic soda consumption is primarily concentrated in our country, aside from countries such as Japan, South Korea, and Taiwan that are in our vicinity and can rely on us to absorb the excess caustic soda, any other regions that expand their PVC production via the ethylene process will face the challenge of figuring out what to do with the caustic soda produced as a by-product. Moreover, another low-cost region, North America, relies primarily on local ethane cracking capacity to produce low-cost ethylene; essentially, its costs are determined by the price of ethane, and it does not benefit from declines in market-driven ethylene prices. Therefore, outside East Asia, there should be no significant expansion in ethylene-based production capacity worldwide. 3.3 Various C3 chemical products The main product of C3 chemicals is polypropylene, which accounts for nearly 50% of the total output; competition exists among the production capacities related to oil, gas, and coal. As for other downstream applications of propylene, they mainly involve liquid chemical products, for which transportation costs account for a large proportion; therefore, production capacity is generally focused on meeting consumer demand. Not only is the production capacity of coal in the northwest rarely involved, but it is also expected that cross-border long-distance trade will account for a small proportion in the future. Therefore, for our country, the main competition will focus on the capacity between eastern naphtha and propane dehydrogenation. As we will analyze later, the cost difference between the two is not very large. Moreover, many downstream products of propylene involve high technical barriers; therefore, compared to choosing a raw material-based approach, a company’s technical capabilities and its integrated industrial chain are far more crucial. Looking at polypropylene, which involves competition among three production routes and represents the largest volume of production, global capacity is currently dominated by oil-based production, with some capacity also coming from gas and coal sources. Unlike the high proportion of gas-based ethylene, the global capacity for gas-based propylene is not significant, and it is mainly concentrated in consuming regions such as China, rather than in resource-rich areas in the Middle East or North America. The main reason for this is that the shipping costs of downstream products derived from propylene are generally higher than those of the raw material propane; in addition, China has an advantage in terms of construction costs. As a result, its gas-based production capacity remains highly competitive on a global scale, with the total cost of polypropylene being around 6,100 yuan. In our country, the production capacity for olefins comes mainly from by-products of oil refining and from the co-production process associated with ethylene cracking, with each accounting for roughly 50% of the total. Among them, the former not only has low costs but also features a relatively stable output as a by-product. In terms of the price of raw material naphtha, that of the latter has been roughly on par with propane over the past two years. However, due to its lower yield, its overall cost is slightly higher than that of propane dehydrogenation; the corresponding cost per ton of polypropylene is approximately 6,300 yuan. However, the biggest difference between the two is that the downstream products of propane dehydrogenation are more limited, whereas those of ethylene cracking are more diverse. Therefore, the former has a greater elasticity to propylene prices, while the latter is more balanced; it can be said that each has its advantages under different price systems, with no absolute superiority or inferiority. In China’s northwest, the production capacity for propylene via MTO combined with coal feedstock, as well as that via MTP, results in polypropylene costs of around 5,900 yuan and 5,700 yuan per ton when transported to the eastern region; whereas in the eastern coastal areas, the costs for MTO and MTP are above 8,500 yuan and 8,300 yuan respectively. Therefore, future competition will primarily focus among coastal naphtha plants, propane dehydrogenation facilities, and MTO coal-based plants in the northwest; other production capacities are likely to be phased out gradually. 3.4 Products of C4 and above: Chemical products with carbon chains of C4 and higher are produced through gasification, but the carbon conversion rate loss is too high, resulting in a lack of economic viability. Moreover, there are no suitable feedstocks derived from gas sources for products above C4; therefore, oil-based feedstocks have been used primarily, with very little capacity based on gas or coal sources. Mainly, in previous years, there was a temporary uptrend in the oxidative dehydrogenation of butene to produce butadiene, as well as in coking benzene, which is characteristic of China. But the problem with the former is that its cost is much higher compared to butadiene produced as a by-product of traditional refining processes; it is not economically viable unless butadiene prices are very high. Although the cost of the latter is very low, as a by-product of coking, its output is constrained by that of the main product, coke; thus, there is limited room for increasing its production. In fact, the same problem exists in the production of C1 chemical products such as methanol and urea from coke oven gas, which is also a by-product of coke making. Although the production cost is low, the output cannot be controlled at will. From an investment perspective, the profitability of coal coking enterprises ultimately depends on coke; thus their flexibility in the chemical industry is very limited, and there is little value in exploring this area. Oil-related projects such as coal-to-oil, coal-to-gas, and coal-to-ethanol are essentially forms of internal conversion of primary energy. Without considering the strategic value of technological reserves, they lack economic viability and investment appeal. From an investment perspective, what deserves the most attention is the shortage in supply of C4 and higher carbon-chain products that will arise as oil-based production capacity is phased out. This situation is undoubtedly a long-term advantage for newly established private large-scale refining and chemical plants that are rich in aromatics and possess a strong competitive edge in the polyester industry chain. 4 Investment recommendations: The scale of investment in the refining and chemical sector this time is too large; from a cyclical perspective, a decline in prosperity is inevitable. Therefore, unlike the investment logic of the past few years during periods of economic growth or at least stable high levels, in the future the solidity of the income statement and balance sheet will be even more important. Therefore, we highly recommend paying attention to Baofeng Energy (600989, unrated), a coal-to-olefins company in the Northwest that has both the desire and the capability for expansion. Next are Wanhua Chemical (600309, Buy) and Saturn Petrochemical (002648, Buy) from the petrochemical industry. Finally, there are Rongsheng Petrochemical (002493, unrated), Hengli Petrochemical (600346, Buy), and Hengyi Petrochemical (000703, Buy) from the oil chemical sector.