Coal-based olefins face challenges in an era of low oil prices: shrinking cost advantages – what lies ahead for the major players?

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Coal-based olefins face challenges in an era of low oil prices: shrinking cost advantages – what lies ahead for the major players? Author/Source: Modern Coal Chemical Industry Date: 2020-08-26 Clicks: 8 With crude oil prices at relatively low levels, the cost advantages of domestic coal-to-olefins projects, which require investments in the tens of billions, have diminished, and these projects are now facing profitability challenges. “Currently, the international oil price (Brent crude) is around $45 per barrel, and some domestic coal-based olefin manufacturers have already fallen below their break-even point. ”Recently, an energy sector analyst at Huachuang Securities noted. There are mainly two routes for producing olefins domestically: the oil-based route (using petroleum as raw material) and the coal-based route (using coal as raw material). Which route is more profitable depends on the levels of oil prices and coal prices. In April this year, due to the impact of the pandemic, international oil prices experienced an unprecedented plunge, with negative oil prices appearing for the first time in history. Sharp fluctuations in oil prices have placed considerable pressure on the coal-to-olefins industry. In the first quarter of this year, affected by factors such as a decline in both the volume and price of olefins, the revenue generated by China Shenhua’s (601088, SH) coal chemical business segment dropped by nearly 30%; its gross margin fell from 24.6% to 7.1%, a decrease of 17.5 percentage points. Although oil prices have currently risen to $45 per barrel, China Shenhua expects its coal chemical business to remain in a downward trend during the first half of the year. The decline in oil prices has put pressure on the coal-based olefins industry, but currently, domestic energy giants remain enthusiastic about investing billions of yuan in such projects. “Currently, there is still a significant shortage in the domestic supply of olefins. ”An executive at a leading domestic company in the coal-based olefins industry told reporters from the Daily Economic News that last year China’s imports of olefins reached 20.15 million tons, with a dependence on foreign imports exceeding 33%. Strong market demand serves as a key driving force for giants to increase investment in coal-based olefins. However, domestic imports mainly consist of high-end olefin materials. With falling oil prices, the cost advantage of coal-based olefins has diminished. In March and April of this year, the sharp drop in international oil prices put the coal-based olefins industry in a difficult situation. “According to our calculations, an oil price of $50 per barrel represents the break-even point for most coal-based olefin manufacturers. ”An analyst at Huachuang Securities told reporters that the previous sharp drop in oil prices caused many coal-based olefin manufacturers to fall below their break-even point, putting significant pressure on their operations. Olefins (ethylene, propylene) are among the most important basic chemical raw materials; through polymerization reactions, ethylene and propylene can be converted into polyethylene (PE) and polypropylene (PP). Polyethylene is commonly referred to as plastic in everyday life, but different types of polyethylene have various uses – it can be used for ordinary packaging and furniture, as well as in industries such as automobiles, military applications, and aerospace. Polypropylene is similar as well. At the beginning of the year, affected by the pandemic and the failure of OPEC+ production cut negotiations, Brent crude oil prices plummeted from around $70 per barrel to a low of about $21 per barrel by the end of March this year. In April, international oil prices experienced an \"epic collapse,\" with some crude oil futures contracts dropping to negative values. Until the end of April, as the impact of the pandemic gradually subsided, Brent crude oil began to rise; after June it remained above $40 per barrel, and currently it is around $45 per barrel. In contrast, fluctuations in domestic coal prices are much smaller. According to Wind Information, the settlement price of domestic thermal coal was around 560 yuan per ton at the beginning of this year; it dropped to about 480 yuan per ton in April before rising rapidly again. Currently, the price of domestic thermal coal is around 570 yuan per ton. Changes in oil and coal prices have led to significant variations in costs for the two production methods: oil-based olefins and coal-based olefins. “The sharp drop in oil prices has led to a significant reduction in costs for the oil-based olefins industry. ”An industry insider pointed out that previously, the cost of coal-based olefins in China was significantly lower than that of oil-based olefins. The domestic olefins industry is primarily dominated by oil-based olefins, whose production costs are directly linked to crude oil prices. “For every $10 drop in the price of a barrel of crude oil, the cost of olefins derived from oil decreases by about 800 yuan per ton. ”Bai Yi, deputy director of the Petroleum and Chemical Industry Planning Institute (formerly the Planning Institute of the Ministry of Chemical Industry), said. Coupled with the weak demand for olefin products during the pandemic, which caused olefin prices to plummet, domestic coal-based olefin manufacturers are faced with even greater challenges. In the first quarter of this year, the volume and prices of China Shenhua’s olefin products both declined; the company’s revenue from its coal chemical business dropped by nearly 30%, while its gross margin fell from 24.6% to 7.1%. The company’s overall net profit decreased by 22.1%. On August 20, China Shenhua announced that from January to July this year, sales of its olefin products had declined. From January to March, the average selling price of CNCE’s (601898, SH) olefin products dropped by 20.8%, but sales volume remained roughly the same as in the same period last year. Companies with a cost advantage will still be able to remain profitable. \"In the coming period, oil prices are likely to fluctuate around the mid-to-low range of $50 per barrel to $70 per barrel; there will be a significant surplus in the international energy market, which will put pressure on oil prices to fall.\" ”Recently, Bai Yi told a reporter from the Daily Economic News. Since 2018, domestic olefin prices have declined significantly. According to Wind Information, from 2018 to 2019, the settlement prices of domestic linear low-density polyethylene (LLDPE) and polypropylene futures showed an overall downward trend. Among them, the price of LLDPE dropped from around 10,000 yuan per ton at the beginning of 2018 to around 7,500 yuan per ton by the end of 2019 ； During the same period, the price of polypropylene dropped from 9,500 yuan per ton to around 7,600 yuan per ton. Since 2020, affected by the pandemic and falling oil prices, LLDPE and polypropylene have shown a V-shaped trend. Among them, the price of LLDPE dropped from 7,500 yuan per ton to 5,500 yuan per ton, before rising rapidly; it is currently around 7,200 yuan per ton. Polypropylene, which dropped from 7,600 yuan per ton to 5,700 yuan per ton, has now risen back to 7,650 yuan per ton. With oil prices remaining at low levels, the cost advantage diminishes; coupled with falling sales prices for olefins, how should coal-based olefin manufacturers respond? “Cost accounting is very important! ”An industry insider noted that amid low oil prices, coal-to-olefins companies with cost advantages such as Baofeng Energy (600989, SH) can still remain profitable. Baofeng Energy is located in the \"Golden Triangle\" of China’s energy and chemical industry – specifically in the core area of the Ningdong energy and chemical industry base, which is one of the regions in Ningxia’s Ningdong area, Yulin, and Ordos. This region is rich in coal resources, with coal production accounting for about 1/3 of the country’s total coal output. The abundant coal and water resources provide ideal conditions for the development of coal-to-olefins production. Baofeng Energy’s semi-annual report shows that in the first half of this year, the company achieved revenue of 7.52 billion yuan, a year-on-year increase of 15.35%; its net profit attributable to the parent company was 2.092 billion yuan, representing a year-on-year increase of 10.75%. Why has Baofeng Energy been able to achieve growth against the trend? On one hand, in the first half of this year, all of Baofeng Energy’s projects funded by fundraising were put into operation, resulting in a significant increase in production capacity ； On the other hand, compared to its peers, Baofeng Energy has a cost advantage. Industry data shows that in 2019, the average price of Brent crude oil was around $62 per barrel. At that time, Baofeng Energy’s production cost for olefins was 3,994 yuan per ton, while China Shenhua’s cost was approximately 5,274 yuan per ton, and China Coal Energy’s cost was 5,475 yuan per ton. The cost of oil-based olefins is even higher, generally ranging from 5,800 yuan/ton to 6,100 yuan/ton. “Generally speaking, when the price of Brent crude oil ranges from $45 to $50 per barrel, it represents the break-even oil price for the profitability of coal-to-olefins production. ”An energy sector analyst told reporters that Baofeng Energy’s break-even point corresponds to international oil prices of around $30 per barrel to $35 per barrel. “When Brent crude oil is at $30 per barrel, the cost of olefins produced from oil is around 4,900 yuan per ton; Baofeng Energy’s cost is 3,400 yuan per ton, giving it a cost advantage. ”Liu Yuanguan, president of Baofeng Energy, explained that this is mainly due to the company’s investment costs being more than 30% lower than those of its competitors, and its operating costs being about 35% lower. “The company’s production facilities are generally located next to coal mines, and the coal is transported using tracks, which reduces transportation costs ； The integrated layout also saves a significant amount of operational costs. ”Sources related to Baofeng Energy revealed. At the same oil prices, the profitability of the coal-based olefins industry varies. In terms of the capital market, as of August 20, Baofeng Energy’s stock price had risen by more than 40% since the beginning of the year. **Energy groups, Sinopec, and others are frequently launching new projects. Currently, international oil prices have rebounded to around $45 per barrel; however, this remains at a relatively low level compared to last year’s average price of over $60 per barrel. Regarding the trend of international oil prices, Bai Yi believes that for some time to come, they will fluctuate at a mid-to-low level between $50 per barrel and $70 per barrel. “Affected by various factors such as the global economy and supply-demand imbalances, as well as the combined effects of the ‘long-term impacts’ of the pandemic and geopolitical tensions, international oil prices are likely to remain volatile at low levels. ” PetroChina Machinery (000852, SZ) stated in its recently released semi-annual report for 2020. Even when oil prices are at relatively low levels, many energy giants still seek to expand in the field of coal-to-olefins. In March this year, the environmental impact assessment for a 700,000-ton/year coal-to-olefins project jointly developed by **Energy Group Ningxia Coal Industry Group Co., Ltd. and Saudi Basic Industries Corporation was approved by the Ministry of Ecology and Environment; the total investment in this project amounts to 22.04 billion yuan. Not long ago, Baofeng Energy announced its intention to establish a coal-to-olefins plant with an annual production capacity of 4 million tons in Ordos. The first phase of this project, with a capacity of 2.6 million tons, has already been approved by the Inner Mongolia Development and Reform Commission; it is now awaiting approval from the environmental protection authorities. Baofeng Energy stated that it will complete all the approval procedures prior to commencing operations as soon as possible. In addition, Sinopec’s two major coal-to-olefins projects, which involve investments of 23.8 billion yuan in Ordos and 22.1 billion yuan in Zhijin, Guizhou, are also under construction. Why are energy giants increasing their investment in coal-based olefins? The characteristic of our country’s resource endowment is \"low oil reserves, limited gas, and abundant coal.\" Data shows that last year China’s crude oil consumption was 700 million tons, of which 500 million tons were imported, making it the world’s largest importer of crude oil. Its dependence on foreign crude oil imports exceeds 70%, while its reliance on imported natural gas exceeds 40%. “The degree of dependence on the outside world is likely to continue rising in the coming years. Such a high degree of external dependence has always been a **major hidden danger to energy security. ”In August this year, Huang Qifan, vice chairman of the China Center for International Economic Exchanges, pointed out in an article. In contrast, our country is rich in coal resources. “For a certain period of time, coal remains the truly reliable primary energy source; it is the ‘ballast stone’ for China’s energy security. ”Bao Xinhe, an academician of the Chinese Academy of Sciences, believes that to ensure China’s energy security, it is difficult to rely solely on the petrochemical industry. Utilizing coal to produce chemicals—that is, developing modern coal chemical industry (including coal-to-olefins)—is a practical choice in line with China’s national conditions. On the other hand, the modern oil industry has been around for over 160 years since its inception in 1859. Throughout history, the trend of international oil prices has been volatile, heavily influenced by factors such as geopolitics. With oil prices experiencing sharp fluctuations and the international political and economic landscape becoming increasingly complex, developing the coal-to-olefins industry, which uses coal as a raw material, plays a positive role in reducing China’s reliance on crude oil imports and ensuring energy security. The industry still needs to innovate and upgrade; shifting towards high-end production capacity is the way forward. In 2019, China’s consumption of olefins reached 60.66 million tons, of which 20.15 million tons were imported, accounting for nearly one-third of the total. From the perspective of import substitution, the olefin industry still has considerable room for development. However, according to reporters from the Daily Economic News, China’s imports mainly consist of high-end olefin products, while there are already signs of overcapacity in the production of low-end olefins. “China’s olefin products are mainly of mid-to-low quality, and this structural issue in the industry has existed for decades. ”Bai Yi said. In recent years, domestic energy giants have been increasing their investments in coal-to-olefins capacity. Meanwhile, low oil prices have spurred the expansion of oil-based olefins production. As a result, competition in the domestic olefins market has intensified, placing significant pressure on the absorption of excess capacity. “Now, the olefin industry is showing signs of overcapacity. ”An energy industry analyst told a reporter from Daily Economic News that domestic olefin production capacity will continue to grow over the next two years. Take polyethylene as an example. In August this year, Shenwan Hongyuan Securities released a research report predicting that the growth rate of domestic polyethylene production capacity would reach approximately 26% in 2020 and 20% in 2021. According to statistics, China’s polyethylene production capacity will reach 33.59 million tons in 2022, an increase of 87.97% compared to 2018. The additional production capacity is primarily concentrated in the coal chemical industries in the northwest, as well as in the regions where crude oil refining and processing are integrated in North China, East China, and South China. In contrast, from 2017 to 2019, China’s consumption of polyethylene increased by an average of about 2.83 million tons per year, while the consumption of polypropylene rose by an average of 1.58 million tons per year. “Although currently the annual increase in domestic consumption of polyethylene and polypropylene exceeds the growth in production, this situation may soon reverse. ”An industry insider pointed out. Under the pressure of capacity digestion, where lies the future path for enterprises? As for high-end olefin products, they still have good prospects for development. In fact, optimistic about the development prospects of high-end olefins in China, overseas giants are investing heavily in this market. In April this year, the ExxonMobil Huizhou ethylene project in Guangdong, with a total investment of around $10 billion, officially commenced construction; this project is primarily aimed at producing high-grade PE (polyethylene) and other products ； In May this year, the CNOOC Shell Huizhou Phase III ethylene project was signed, with a total investment of $5.6 billion; it will mainly produce α-olefins, high-end synthetic alcohols, and metallocene PE. “It is essential to change mindsets, shifting from merely meeting market demands in the past to using product innovation to drive the upgrading of the consumer market, by providing solutions for customers and focusing on research in niche markets. ”Bai Yi believed. To enter the high-end olefin sector, it is essential to master core technologies. “Core technologies cannot be acquired through purchase, as foreign countries will not sell them; they can only be developed through continuous innovation by one’s own efforts. ”An expert in the coal-to-olefins industry noted. Currently, some companies in the coal-to-olefins sector have already recognized this issue. In the first half of this year, Baofeng Energy established the Baofeng Shanghai Research Institute, investing more than 65.7 million yuan in research and development expenses, a figure that represents a growth of over 12 times compared to the previous year. “In the first half of this year, the company developed several new products, including melt-blown materials that are in high demand in the market, which generated additional profits of over 80 million for the company. ”An executive at Baofeng Energy said that the company will continue to increase its investment in research and development to create high-end products such as metallocene PE.