Throughout 2004, the overriding theme for the plastics industry was that of rising raw material costs and continuing material shortages, underpinning a considerable rise in polymer prices.

Customers in Europe are reluctantly adjusting to the producer price hikes as some suppliers have reportedly closed their order books because stocks are so low. Polystyrene registered the biggest gains in second half 2004, with prices rising by more than 15 per cent, up by €200/tonne in a single month. The rise, in September 2004, resulted in high-impact grades becoming more expensive than bottle-grade polyethylene terephthalate (PET). Linear low density polyethylene (LLDPE) was in very short supply in fourth quarter 2004, resulting in considerable price rises, as was high-density polyethylene (HDPE). The price of polypropylene (PP), PVC and PET also rose during the course of the year.
With crude oil prices rising in 2004 and rocketing in early 2005 to hit a record US$57 per barrel for Brent crude in April 2005, there seems to be little prospect of relief for crude oil customers this year. Raw material availability, already tight in 2004 and seemingly
in near crisis by the middle of second quarter 2005, is likely to remain troublesome for some time to come.

In the EU, polyolefins converters continued to be under pressure in December 2004, while major cracker plant outages brought increasing pressure to bear on a tight monomer supply situation. This caused spot ethylene prices to increase significantly and led to a response by polyethylene producers to implement price increases of e40/tonne. PP prices increased by e30/tonne over November. PVC producers held on to their earlier price gains in December 2004, while PET continued to increase in price due to tight supply in key feedstocks.

The critical supply situation in 2004 led to the UK Packaging and Industrial Films Association (PIFA) to warn of significant price increases for UK buyers of all plastic film products. The warning, published in mid-September 2004, was designed to prepare producers and converters to make price increases aimed at recovering their rising raw material costs this year. In 2004, both converters and producers were reluctant to pass on these rising prices to their customers, in the hope that the raw material cost increases would be temporary.

However, towards the end of 2004 – and with some polymer prices rising by as much as 27 per cent compared with 2003 – it became abundantly clear that raw material prices were going to escalate still further. Production problems at the polymer crackers, coupled with some manufacturers instigating force majeure and allocation control, compounded the supply/demand situation. The PIFA concluded that until either there is a significant shift in the high prices of feedstocks or a slowing down of the global economy and related demand for plastics, price levels will continue to remain high. It should be noted that polymer prices depend upon the price of oil, ethane, propane, gas and naphtha, capacity utilisation and the demand-supply balance.

The reasons behind the rise in raw material prices have been as much to do with soaring demand for plastics as high oil prices. Demand from Asia has risen significantly in recent times and the petrochemical industry has struggled to keep pace. Recent figures from the Association of Petrochemical Producers in Europe (APPE) show a steady rise in the production of ethylene, propylene and butadiene in recent years (Table 1).

Polymer pricing – a function of demand or oil price?

With polymer prices seemingly spiralling out of control, plastics processors as well as end-users and allied industries are understandably concerned about the effect on demand and their margins. Rising oil prices have been blamed for the rise in polymer prices, which are currently lingering at record levels.

However, as indicated earlier, higher oil prices were but one factor in the rise of polymer prices last year and demand is also a significant factor. Higher oil prices lead to a rise in feedstock prices, creating a mothball effect on polymer prices. It follows from this that oil price hikes should precede polymer price hikes – however, feedstock prices started rising in first quarter 2004, increasing by 10 per cent or more after a long period of oil price stability from January 2003 until April 2004.

It should also be noted that when oil prices rose by 10 per cent in second quarter 2004, the polymer price hike slowed and did not begin its rapid upward spiral until the beginning of third quarter 2004. Indeed, during the key second and third quarter periods last year there was only a minimum correlation between the increase in the price of oil, naphtha and other feedstock and the increase in the prices of polymers. It is therefore pertinent to ask whether the increase in the price of polymers is more a factor of the increase in the prices of oil, feedstocks and polymers or of booming demand.

Analysis of the movement of oil prices against a range of products between January 2003 and October 2004 shows that while there was indeed a rough correlation between the movements of crude oil prices and those of ethylene and propylene during the course of the period, it cannot explain the price spikes of both ethylene and propylene at the beginning of 2004 or indeed in the third quarter and the beginning of the fourth quarter.

The movement of LLDPE, LDPE and HDPE against crude oil during 2003 and 2004 also fails to give a clear-cut correlation between the rise in price of oil and plastics. As with ethylene and propylene, there appears to be an unexplained spike in the price of HDPE, LLDPE and LDPE in January 2004 and in the third and fourth quarters. Figure 1 shows the price movements of polyethylene against the rise in oil prices, propylene and naphtha.

A similar picture can be seen with regards to PP and polystyrene. In the case of PP, we also see a spike in February 2004, at a time when oil price are rising only gently. We also see a rise in July 2004, when oil prices are falling, and a sharper rise in September 2004.
In the case of the price for both styrene and polystyrene, the spike between July and August 2004 almost seems to be off the scale compared to oil price behaviour. By October 2004, we also see a significant drop in the price of styrene and a slight decline in the price of polystyrene at a time when the oil price climb is beginning to accelerate. Figure 3 shows the movement of styrene and polystyrene against the oil price, ethylene and naphtha.

Polymer pricing trends into 2005

Chemical companies across the globe have been forced to increase the price of polyethylene. Dow, for example, raised the price of all grades of its low-density polyethylene (LDPE) resins and high-density polyethylene (HDPE) resins by e120/tonne for May 2005 and other producers have been forced to follow suit with 5¢/lb increases. Polyethylene producers have the highest feedstock costs in the plastics-producing world and these high ethylene prices have driven up PE prices.

PP prices went up 5¢/lb in 2005. DuPont Engineering Polymers raised its price of PET, PBT and Hytrel copolyester TPE by 12¢/lb on 15 March. BASF Corp. lifted the price on PBT resins by 7¢/lb and PET by 5¢/lb on 15 March. Unsaturated polyester prices are also rising and in March 2005, Reichhold, AOC, Interplastics, CCP and Ashland raised polyester resin by prices 4¢/lb.

The May 2005 increase by Dow follows the 1 October 2004 rise of e220/tonne for its liquid, solid, solid solution and standard brominated epoxy resins that has been in place since, and is in addition to the previous increases, announced in August 2004, of e170/ tonne for liquid and solid epoxy resin grades and e120/tonne for solid solution and standard brominated epoxy resins.

Table 2 shows the price movement since January 2005 for polyethylene and polypropylene in the UK in £/tonne. It shows that much of the price increases took place at the beginning of the year, carrying on from 2004, with a price decline setting in for a PE in mid-March. However, the expectation is that with oil prices refusing to drop, the effect will feed through and PE prices will once again surge upward.

Feedstock and petrochemical capacity In the first half of 2004, oil prices remained fairly stable at $32/barrel. However, in mid-August they rose to beyond $45/barrel around and by the end of September they had peaked at about $50. The rise in the oil price can almost exclusively be attributed to rising demand from Asia and the US as it accompanied an increase in oil production by OPEC countries.

The global feedstock share for ethylene production is naphtha (53 per cent), ethane (30 per cent) and propane, butane, gas oil (17 per cent). The feedstock share varies according to where ethylene is produced. In the Asia-Pacific region, almost 80 per cent of the ethylene capacity is naphtha-based. By contrast, in the Middle East close to 70 per cent ethylene capacity is ethane-based.

The bottleneck and subsequent over-capacity in the supply and demand of polymers is a common feature of the petrochemicals industry, as the petrochemicals cycle tends to peak about every seven years. As product prices increase, the manufacturers increase capacity, which in time leads to overcapacity and a decline in prices. The growth in demand last year has led to an increase in capacity utilisation of polymer plants, which is only expected to come down when more capacity comes on stream towards the end of 2005. Between 2005–08, about 13 million tonnes of polyethylene capacity will be installed globally, of which over 70 per cent will be in the Middle East and Asia Pacific.

Until 2006, when the impact of higher capacity will start to be felt, polymer prices are expected to remain high, but even after 2006 there is still a risk of high polymer prices. Forecasts made in 2004 anticipated that oil supply would be more stable in 2005, leading to oil prices settling at the lower range of $35–40/barrel, which would have a positive impact on the prices of polymers. Under this scenario, polymer prices would decrease by at least 15 per cent from the highs of 2004 by early 2005. But these forecasts failed to take into account the rise in second quarter 2005 oil prices to close to $60 per barrel and the ominous predictions by some economists in the wake of the spring 2005 oil price rise of a spike of over $100/barrel.

Major capacity increases are in train in China, where plastics consumption is around 20–22 million tonnes and still continues to grow at about 7 per cent each year. This level of increase heralds a big gap between demand and supply.

Major petrochemical manufacturers have moved into China and started up ethylene plants. China Petroleum and Chemical Corp (Sinopec) and China National Offshore Oil Corp (CNOOC), the state-owned petrochemical companies, are promoting mega petrochemical projects in collaboration with multinationals such as BASF, BP and Shell. Sinopec had a $2.7 billion contract with BP Chemicals to build a petrochemicals complex, which produces 900,000 tonnes per year of ethylene. The complex was opened in June 2005. It is the largest of its kind in Asia. BP Chemicals will control 50 per cent, Sinopec 30 per cent and the subsidiary Shanghai Petrochemical Co. the remaining 20 per cent.

Other developments include a $4 billion project by CNOOC in Guangdong Province to produce 800,000 tonnes per year of ethylene by 2005 and a $2.65 billion integrated petrochemicals site to turn out 650,000 tonnes of ethylene. This project is a 50/50 joint venture between Germany’s BASF and Sinopec, in the process creating China’s third-largest petrochemicals plant. With the completion of these projects, China will have an annual capacity of 5.5 million tonnes of ethylene.

However even after these projects are on stream, China is still expected to continue importing petrochemicals, partly due to the lower import tariffs in place resulting from China’s entry into the WTO.

LME polymer contract – creating market volatility or stability?

In addition to the likelihood of higher average oil prices in 2005 than in 2004, there is a further factor in the shape of the London Metal Exchange (LME) polymer contract, which could yet play havoc with the polymer market, at least in the short-term.

On 27 May 2005, the LME launched its futures contracts for PP and LLDPE. The exchange sees the $120 billion thermoplastics markets as being sufficiently similar to its core non-ferrous metals market to warrant the launch.

The rationale behind the new contract is that it will help reduce the inherent price risk that occurs in the plastics consumption chain – the reason being that raw materials are priced intra-day, while end products are often subject to annual pricing. The method whereby risk can be avoided is called hedging, which is a technique used in futures markets, whereby a financial position is taken to offset price risk inherent in a firm’s physical operations.

The LME believes that the plastic consumption chain, from the polymer producer to the end consumer via the polymer resin converter and distributor/trader, could derive hedging benefits from the contract:

• For the polymer producer, the benefits include the ability to hedge unsold inventory in a declining market, offer long-term fixed sales prices and hedge physical purchases in times of production difficulty.
• For the converter, the contract offers the ability to lock in a forward purchase price of PP or LLDPE, the possibility of a long-term fixed sales prices and hedge time differences between purchases and sales.
• For the end consumer, as well as the ability to lock in a forward purchase price, the contract enables the provision of a long-term fixed purchase price if the supplier is not in a position to offer a fixed price.
• The distributor/trader/merchant can protect their physical stock position against price falls, hedge time differences between purchases and sales, and swap physical material on location and brand bases.
  

However, as with many in the non-ferrous industry who voiced concerns in the 1980s and 1990s about the launch of the LME primary aluminium and aluminium alloys contracts, some in the plastics industry are also concerned that the LME contract may open the door to speculation and thereby price volatility.

Some polyolefin suppliers have said they will not support this futures launch, while others argue that with the tightness of both PE and PP, the timing of the launch is not ideal. ExxonMobil Chemical is not interested in participating, saying the contract does not add any value to the relationships it has with its customers. The company also said it does not encourage “third-party intervention” in the relationship it has with its customers.

However, about one-third of producers, representing about 30 per cent of world capacity for the production of PE and PP, are believed to be very enthusiastic about using the LME. Other producers are either neutral or sceptical and will wait to see what happens after the launch. In general, most of the support is likely to come from converters and major end-users. However, while the support of resin producers and processors is welcomed by the LME, it is not so essential to the success of the new plastics futures as the support of financial intermediaries and the investment banking community. BP believes that the liquidity will depend on the financial community, who account for at least 70 per cent of participants in commodities futures trading. As most of them do not want to take delivery of the product, there does not have to be an actual physical market, which is precisely what those who express concerns about the dangers of speculation in the plastics market appear to fear the most.

Plastics consuming industries

Per capita consumption of virgin plastics in Western Europe is rising and was 100kg in 2004, up from 96.6kg in 2002 and 98.1kg in 2003. However, the European plastics industry is facing one of its most difficult and challenging periods as a result of the 2003 war in Iraq and high raw material prices in the latter half of 2004. Ongoing tensions in the Middle East and highly volatile crude oil and petrochemical feedstock prices are impacting on to the global economic situation in 2005.

Yet despite these challenges, the plastics industry remains relatively robust with consumption in Western Europe rising steadily to over 40 million tonnes in 2004 – an increase of close to 6 per cent on 2001. The increase in plastic consumption reflects the growing recognition of plastic’s strength and flexibility, combined with both affordability and durability, which make them suitable for applications ranging from packaging to construction and telecommunications to electronics equipment.

Figure 4 gives an indication of the relative growth of plastic compared with steel and aluminium, competitor materials for key consumption sectors, over a 30-year time span, showing how the growth in plastics output began to surge ahead of steel and aluminium in the early 1980s.

Packaging

Much of this growth is due to packaging, which is the largest consumer of plastics in Europe, accounting for about 15 million tonnes, or just over 37 per cent, in 2004. Plastics remain the materials of choice for packaging, increasingly substituting other more traditional materials, because they are lightweight, flexible and easy to process. However, due to innovation, although over half of all Europe’s goods are packaged in plastics, by weight these plastics account for only 17 per cent of all packaging.

Building and construction

The building and construction industry uses plastics for a range of applications, from insulation to piping, and window frames to interior design. Despite the economic downturn, building and construction consumed 7.4 million tonnes of plastics in 2004 and accounted for 18.5 per cent of total plastics consumption in Western Europe, making it the third largest user after the packaging and domestic sectors. However, the relatively low industry growth in plastics consumption since 2002 is indicative of the negative impact of the broader economic recession and reduced house building.

Automotives

The new generation of lightweight plastics is providing solutions to the quest for high performance, combined with comfort, safety, fuel efficiency and minimal environmental impact. The automotive sector has seen relatively high growth rates since 2002, with the 3.3 million tonnes of plastics used in Western Europe – about 8 per cent of total plastics applications in 2004. New automotive innovation, such as Daimler Benz’s Smart car and the development of lightweight fuel cells, have placed the new generation of plastics in the vanguard.

Conclusion

Whether the plastics industry will be able to cope with the various blows of historically high crude oil prices, strong demand, particularly from Asia, and the launch of the LME futures polymer contract, with its attendant risk of speculators entering the market from end-May 2005 onwards, is yet to be seen. It is clear that rising raw material costs and continuing material shortages were major factors underpinning the rise in polymer prices. Although oil and polymer prices did not always move in lock step in 2004, there is no doubt that a period of high crude oil prices will be harmful to the polymer market and if, as seems increasingly likely, oil prices are fated to remain in a $50–60/barrel range this year, then polymer prices will stay strengthened and consequently so will plastic products. Indeed, the PIFA warning of “significant price increases” for UK buyers of all plastic film products may even turn out to be something of an understatement.

Eventually, the market will correct, although it is fairly certain that this will not happen until 2006 at the very earliest. Price levels will continue to rise until there is either a significant shift in the high prices of feedstocks or a slowing down of the global economy and related demand for plastics. The growth in demand is leading to an increase in capacity utilisation of polymer plants, particularly in Asia. However, these are not yet on stream and their effect will only begin to be felt on the market from 2006 onwards.

As such, there is a degree of uncertainty over what will happen to polymer prices. The expectation in 2004 was that polymer prices would stabilise in 2006 following hikes this year. However, that was predicated on a $35–40/barrel oil price in 2005, and with oil prices expected to be well above that range, the indication must be that polymer prices could stay high well into 2006 and possibly beyond. Although significant capacity increases are in train in China, much of this will go towards satisfying domestic demand. Indeed, even with the new capacities in place, China will remain a substantial importer of plastics.

Beyond all of this lies the threat of speculators entering the market following the launch of the LME futures contract. Although the LME is keen to dismiss these fears as scare-mongering and points to the success of the aluminium contracts, there is no denying the fact that speculators have in the past played a significant role in previous LME spikes, such as copper in 1995 and the other non-ferrous metals at various times. It remains to be seen how successful this contract will be in enticing trade from members of the plastic industry.