Will propane dehydrogenation create value or destroy it in the future?

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The last edit to this post was made by yinkuilin6868 on 2015-11-20 at 11:22. 1. Propane dehydrogenation used to be the jewel in the crown of the petrochemical industry (Zhao Chen, lead analyst at Orient Securities for the petrochemical sector). Over the past few years, our research in the petrochemical industry has focused on the propane dehydrogenation sector: In 2011, we published a report titled “Analysis of the Impact of the Shale Gas Revolution on the Chemical Industry,” in which we were among the first in the industry to argue that the shale gas revolution would lead to a shift toward lighter petrochemical feedstocks worldwide, thereby significantly reducing the supply of propylene – an explanation for the sharp rise in propylene prices in 2011； In December, a report titled \"The Shale Gas Revolution Benefits the Propane Dehydrogenation Industry\" was published, which was one of the first in the industry to point out that the shale gas revolution would result in a massive increase in propane supply, thereby helping to keep propane prices low and establishing a cost advantage over the naphtha route ； At the beginning of 2015, a report was published titled \"Propane dehydrogenation is likely to experience a period of strong growth,\" which was again one of the first in the industry to suggest that the sharp drop in oil prices would significantly delay the start-up of coal-based chemical plants for producing propylene, thereby benefiting the propylene industry. It can be said that since 2011, the propane dehydrogenation sector has indeed become the brightest star in the petrochemical industry, giving rise to outstanding stocks such as Donghua Energy, Haiyue Co., Ltd., and Weixing Petrochemical. In particular, the leading company Donghua Energy has seen its stock price increase by nearly 10 times in just a few years. As one of the first sellers in the industry to identify investment opportunities in propane dehydrogenation, we have a deep affection for this sector. Yet even so, at this point in time, we must re-examine the propane dehydrogenation industry in order to give a serious answer to a crucial question: will propane dehydrogenation create value or destroy it in the future? We believe that a major turning point in the investment logic of this industry has arrived, and it requires our utmost attention! Both core issues that determine the investment value of the propane dehydrogenation industry will change, namely whether propane dehydrogenation is a growth-oriented industry or a cyclical one If it is a cyclical industry, will the future cycle be upward or downward? We will conduct an in-depth analysis below: 2. Does the propane dehydrogenation industry still have growth potential? Over the past few years, in the propane dehydrogenation industry, aside from Saturn Petrochemicals, whose main business in acrylic acid generated good profits and thus kept its valuation within a reasonable range for cyclical stocks, many other companies had valuations that remained at around 100 times PE and nearly 10 times PB for extended periods – levels far above those typical of cyclical stocks. The reason for this is that the market tends to classify pure propane dehydrogenation-related companies as growth stocks rather than cyclical stocks. There are mainly two reasons for this, as we analyze it: 1. China’s self-sufficiency rate in propylene is relatively low, and there is still significant room for growth on the demand side ； 2. Due to the availability of cheap propane supplied by shale gas in North America, propane dehydrogenation offers a significant cost advantage over traditional naphtha-based methods. As a result, even in an industry that is already saturated, it is possible to achieve rapid capacity expansion at low costs, while still maintaining high profit levels. Therefore, companies that are able to expand their production quickly can undoubtedly enjoy a substantial valuation premium. But at this point, we believe that both of these key assumptions are likely to fail in the future; as a result, the propane dehydrogenation industry will shift from being a growth-oriented sector to a cyclical one, which will undoubtedly have a significant impact on the overall investment logic! 2.1 It has been difficult to further increase the self-sufficiency rate of propylene in recent years; China’s reliance on imports of propylene is close to 20%. In 2014, the total consumption of propylene was 18.05 million tons, with 3.05 million tons coming from imports. Moreover, the import volume of downstream derivatives of propylene is even greater; it was consistently above 7 million tons before 2013, which means that propylene’s equivalent import dependence reached 40%. However, this year the cumulative new production capacity of propylene exceeded 4.7 million tons, far exceeding the import volume of 3 million tons. The downstream products have also experienced rapid growth over the past two years; by 2014, import volumes had already declined significantly. If we take into account the new production capacity added this year as well, it is clear that there is an excess of capacity in virtually all major downstream sectors, meaning that imports are no longer necessary in theory. Moreover, considering that many of our imports are in fact irreplaceable – for example, the acrylic acid used by Formosa Plastics must be purchased from Formosa Plastics in Taiwan – a similar situation exists with many companies in Japan and South Korea; as a result, there is very little room left for further import substitution of acrylic acid in our country in the future. Table 1: Consumption and imports of propylene and its derivatives in China over the past two years (in ten thousand tons)
Year | Item | Polypropylene | Butanol | Octanol | Propylene oxide | Acrylic acid | Acrylonitrile | Propylene
2013 | Imports | 483 | 41 | 27 | 44 | (8) | 55 | 264 |
Consumption | 1420 | 137 | 162 | 224 | 113 | 324 | 1720 |
Import dependence | 34.0% | 29.8% | 16.7% | 19.8% | -7.5% | 16.9% | 15.4% |
2014 | Imports | 489 | 19 | 14 | 46 | (3) | 52 | 305 |
Consumption | 1579 | 143 | 150 | 235 | 165 | 175 | 1845 |
Import dependence | 31.0% | 13.3% | 9.3% | 19.4% | -2.1% | 29.6% | 16.5% |
Capacity growth rate for 2013–2014 | 30.3% | NA | 47.3% | 28.4% | 36.6% | 9.2% | 20.0% |
New capacity added in 2015 | 418.8 | 22.4 | 205 | 7.5 | 32 | N.A. | 470 | 2.2 |
Compared to propane dehydrogenation using oil-based feedstocks, this method no longer has a cost advantage. More significantly, the sharp drop in oil prices has an impact; although it limits the development of coal-based chemical industries to some extent, in the long run it undermines one of the key advantages of oil-based chemical production, namely its cost efficiency. By 2013, over 90% of China’s propylene production capacity came from the petrochemical industry. Therefore, as long as propane dehydrogenation holds a cost advantage in the petrochemical industry, even if there is no growth in the sector in the future, the potential for substitution opportunities for companies engaged in propane dehydrogenation remains virtually unlimited. But with the sharp drop in oil prices, the cost of propane dehydrogenation has become less competitive compared to that of petroleum. Moreover, in the medium to long term, as large-scale production of propane dehydrogenation occurs in China, the price elasticity of propane will be much higher than that of oil; it seems that the advantage in the long-term competition will once again lie with oil-based products. Therefore, once the large-scale expansion of propane dehydrogenation leads to an oversupply, it will inevitably result in price wars and a significant reduction in industry profits. 2.3 Conclusion In summary, it can be inferred that the propane dehydrogenation industry will gradually return to being a cyclical industry; its profits will depend more on the supply and demand conditions of propylene and propane themselves, rather than exhibiting characteristics of continuous growth regardless of economic cycles. 3. The fundamental issue with propane dehydrogenation lies in its massive scale of expansion. As analyzed above, the future profitability of this process will depend on the medium- to long-term supply and demand dynamics for propylene and propane. From the perspective of supply and demand, the most destructive force on the industry’s prosperity comes precisely from its own massive expansion of production. Since there are no high technical barriers in this industry, all process packages are imported from overseas companies such as UOP or Lummus. There are already 6 units in operation in China, so it is not difficult to replicate such production capacity. Looking at its profits this year, its net profit per ton has remained above 1,000 yuan. Given a selling price of around 6,000 yuan, the net profit margin is over 15%, ROA is as high as 30%, and ROE even reaches 100%! Such high profit levels are indeed unimaginable to be sustained in the long term for a manufacturing industry that does not have high barriers to entry. This will harm profitability from both the propylene and propane sides, until the exorbitant profits are eliminated. Therefore, the question going forward is no longer whether profits will start to decline, but rather when that will happen and by how much. 4. There is a risk of a medium to long-term surplus in propylene. In China, the consumption of propylene in 2014 was 18.05 million tons, while the total production capacity was 21.55 million tons, resulting in a basic balance between supply and demand; however, the consumption growth rate has been above 10% in recent years. However, due to its good processability, it is mainly used in industrial products, and it is greatly affected by the decline in automobile consumption; therefore, its demand is likely to grow at a rate consistent with that of GDP, namely 6-7%. From the supply side, the additional supply from propane dehydrogenation is expected to be 5.3 million tons in the next three years, while the capacity from coal-based chemical processes will be as high as 5 million tons, even if we consider only the plants that are already in operation. As a result, the total capacity is likely to reach 31.85 million tons by 2018, whereas the total demand will be only 22.78 million tons, leading to a supply surplus in this industry. 4.1 Propane dehydrogenation capacity is set to reach an end by the end of 2015, with China expected to add a total of 4.45 million tons in such capacity. As mentioned earlier, the industry is still in a phase of sharp decline at present; companies within the industry are opting to expand their production capacity, and even companies outside the industry are continuously establishing new production facilities to enter this sector. Based on the capacity already disclosed, the planned capacity for the next few years is as high as 5.44 million tons; even if not all of this capacity is put into use, the impact on supply will still be significant. Table 2: Statistics on Propane Dehydrogenation Capacity in China (in 10,000 tons)
Capacity status of regional companies:
Zhejiang Shaoxing Sanjin Chemical – 45 units in operation
Zhejiang Pinghu Satellite Petrochemical – 45 units in operation
Zhejiang Ningbo Ningbo Haiyue – 60 units in operation
Tianjin Tianjin Bohua – 60 units in operation
Jiangsu Zhangjiagang Yangzi Petrochemical – 60 units in operation
Shandong Yantai Wuhan Chemical – 75 units under construction
Shandong Shandong Shenchili – 20 units under construction
Fujian Fuzhou Meide Petrochemical – 80 units under construction
Total: 445

Zhejiang Pinghu Satellite Petrochemical – 45 units under construction
Jiangsu Zhangjiagang Donghua Energy – 60 units under construction
Zhejiang Ningbo Donghua Energy – 132 units under construction
Caoferdian Donghua Energy – 120 units under construction
Shandong Binzhou Jingbo Petrochemical – 11.5 units under construction
Jiangsu Dafeng Haili Chemical – 50 units under construction
Shandong Wudi Senle – 75 units under construction
Hebei Hengshui Haiwei Group – 50 units under construction
Total: 543.5

4.2 The impact of coal-based chemical industries on propylene is greater than that on ethylene; due to the strong demand for propylene over the past 11 years, the proportion of propylene produced by coal-based olefin plants that have been put into operation in recent years is much higher than that of ethylene. By the end of 2014, China had launched 13 coal chemical projects, resulting in an additional production capacity of 1.89 million tons of ethylene and 3.81 million tons of propylene. The 6 coal chemical projects that came online in the first half of 2015 added an ethylene production capacity of 600,000 tons and an propylene production capacity of 1.19 million tons. In terms of numerical values, propylene’s production capacity is roughly twice that of ethylene; however, when it comes to downstream consumption, propylene’s usage is actually less than that of ethylene. Therefore, the impact of coal chemistry on the supply side of propylene is undoubtedly much greater than that on ethylene. The coal chemical projects planned for the long term will add an additional propylene production capacity of up to 12 million tons, though the progress on these projects remains to be seen. Overall, however, the commissioning of coal chemical facilities cannot be underestimated. Table 3: Ethylene and propylene production capacity (in 10,000 tons) of coal chemical projects in operation in China. Region, Company, Ethylene Production Capacity, Propylene Production Capacity, Commissioning Date: Inner Mongolia Shenhua Group – 300, 300; 2010. Henan Sinopec Zhongyuan Petrochemical – 100, 120; 2011. Zhejiang Ningbo Fude Energy – 300, 400; 2013. Jiangsu Huisheng Nanjing – 120, 180; 2013. Shaanxi Yanchang China Coal – 300, 300; 2014. Shaanxi China Coal Energy – 300, 300; 2014. Shandong Shenda Chemical – 170, 200; 2014. Ningxia Ningxia Baofeng – 300, 300; 2014. Shaanxi Pucheng Clean Energy – 300, 400; 2015. Zhejiang Zhejiang Xingxing – 300, 90; 2015. Ningxia Shenhua Ningmei Group – 500, 200; 2011. Inner Mongolia Datang International – 460, 2012. Ningxia Shenhua Ningmei Group – 500, 2014. Shandong Yuhuang Jinyu – 100, 200; 2014. Shandong Luqing Petrochemical – 150, 2014. Shenyang Shenyang Luhua – 100, 2015. Shandong Huabin Chemical – 150, 2015. Shandong Ruichang Petrochemical – 520, 2015. Shandong Longgang Chemical – 100, 2015. Total: 2,495,000. Of the additional 5 million tons of propylene produced in China in the past two years, 1.72 million tons came from coastal MTO facilities, while 3.18 million tons came from integrated facilities in the northwest region. For coastal MTO projects, the technology is relatively mature, and starting up such projects is not difficult. The operating rate depends mainly on whether the costs are competitive, and the key factor in determining costs is the price of methanol, the raw material used. Currently, the cost of methanol in East China is around 1600 yuan; based on this figure, the cost of MTO-produced propylene is 5700 yuan. Looking ahead, we believe this segment will become the main marginal capacity; although its utilization rate may not be very high, it will act as a ceiling that limits propylene prices. Table 4: Cash cost of propylene from MTO in East China (in yuan/ton), under different methanol price assumptions. Methanol prices: 1400, 1600, 1800, 2000, 2200, 2400; Cash cost of propylene: 5180, 5700, 6220, 6740, 7260, 7780. As for the integrated propylene production in the Northwest, the process itself is not yet mature, so it is difficult to maintain a high operating rate during the initial stages of operation for most of the production capacity. Moreover, there are significant differences in the cost of coal across different projects; however, the fixed costs are particularly high, with depreciation per ton being over 2,500 yuan on average. Therefore, the cash cost is actually not high as long as operations proceed smoothly, typically around 5,500 yuan. Therefore, if the process issues are resolved in the future, it will have a significant impact on the prosperity of the propylene industry in the long term as well. Table 5: Cash cost of propylene in the Northwest under different coal price assumptions (yuan/ton). Coal price: 50, 100, 150, 200, 250, 300; Cash cost of propylene: 486, 250, 645, 267, 546, 956, 725, 874. 5. The medium- to long-term supply of propane is not optimistic. The demand for propane in China mainly comes from use as fuel and in propane dehydrogenation processes, with additional demand arising from propane dehydrogenation ； The main import regions are the Middle East and North America, with the increase in supply coming primarily from North America. It is estimated that an additional 9 million tons of supply will be added there over the next 3 years, representing a growth rate of around 60%. But the problem is that global demand for propane is also set to experience explosive growth, with an additional demand of around 10 million tons expected. Moreover, in 17 years, as the United States begins to export large amounts of natural gas, its natural gas prices will rise as well, which will systematically increase the prices of all gases in North America. Therefore, its medium-term trend is likely to be stronger than that of oil prices. 5.1 Demand for propane in the U.S. chemical industry is set to grow rapidly. In the United States, petrochemical companies focused their efforts over the past couple of years on developing the ethane dehydration industry, which offers better profits. However, with the large-scale expansion of ethane dehydration capacity, some companies have shifted their attention to propane dehydration as well. The new capacity planned for future deployment is expected to reach around 3.5 million tons (including capacity that will come online by 2016), a significant amount that will drive domestic demand for propane to near 4 million tons. Table 6: Statistics on future additional propane dehydrogenation capacity in the United States. Company capacity (10kt/a), time of commissioning, location: Dow – 752015, Freeport, Texas; Ascend – 117.32015, Alvin, Texas; Enterprise – 752015, Mont Belvue, Texas; Formosa – 65.82016, Point Comfort, Texas; RexTac – 302016, Odessa, Texas; Dow – 752018, Freeport, Texas; Enterprise – NANA, Texas; BASF – 47.52019, Freeport, Texas. U.S. demand for propane exports is set to experience explosive growth. Over the past few years, as propane prices abroad have been significantly higher than those in the United States, North American propane has also been exported in large quantities starting from 2012, with export volumes having doubled. Looking ahead, as China’s propane dehydrogenation plants with a capacity of 5 million tons each come online, the additional demand is expected to reach as high as 6 million tons, which will significantly consume the additional supply available in the United States. 5.3 The supply and demand balance of natural gas in North America will reverse. The shale gas revolution has led to a significant increase in propane production on the one hand, while simultaneously causing natural gas prices in North America to plummet; this has also reduced the proportion of propane used as a fuel in that region. However, production in North America is expected to increase by only 40 billion cubic feet over the next 5 years, representing a cumulative growth of around 5%. Exports, on the other hand, are set to rise significantly after 17 years – by 700 billion cubic feet by 2020 – which will far exceed the increase in production. This will greatly alleviate the surplus supply of natural gas in North America, and gas prices are likely to strengthen in the medium to long term. This will also raise the central price of all gaseous energy sources in North America; therefore, it is difficult to expect further declines in propane prices in the medium to long term. 5.3 The two major price disparities will be eliminated in the future. We believe that global propane trade will exhibit two main trends in the future: 1. The price disparity between North America and the Middle East will gradually disappear. This trend has already been quite evident over the past few years, with the gap between the prices of these two regions continuing to shrink. As they are completely homogeneous commodities, it is only a matter of time before the law of one price takes effect. Therefore, relying solely on importing cheap goods from North America as a way to make profits is difficult to sustain in the long term ； 2. Since over 90% of propane in our country was used for domestic purposes 13 years ago, the price difference between peak and off-peak periods is quite significant, remaining at around 1,000 yuan per ton or more. However, 16 years later, the share of propane used in industrial applications will rise to 70%. Given that demand for industrial use is quite stable, the fluctuations in demand during peak and off-peak periods for propane will be largely smoothed out, which will also significantly reduce the marginal benefits of stockpiling during these periods. 6. Investment advice: As we can see, as long as the propane dehydrogenation industry continues to generate excess returns compared to the overall petrochemical industry, massive expansion of this sector is inevitable. This will lead to negative changes in supply and demand for both propylene and propane, thereby harming the industry’s performance until those excessive profits are eliminated.