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U.S. Ethane Margins Have Staying Power, Fitch Says

Despite the global oil price collapse, U.S. ethane will retain its long-term cost advantage over naphtha as a feedstock for ethylene production, Fitch Ratings said in a note published Tuesday.

With the drop in crude prices, naphtha prices have declined further than U.S. ethane feedstock prices, putting downward pressure on ethylene cracking margins in the United States, Fitch said. "However, with the decline in naphtha prices and corresponding decline in ethylene prices, naphtha-based co-product [benzene, butadiene and propylene] prices also declined, effectively putting pressure on cash margins of ethylene produced from the heavier feedstocks.

"Additionally, Fitch doesn't expect Brent crude prices to remain in the $50/bbl range long term. U.S. crackers' cost advantage should expand again as the spread between naphtha and ethane widens, but not back to the peak levels of 2012."

In the near term, the downward pressure on cracking margins in the United States has yet to show up in producer financial results due to contract lags, Fitch said, adding that it expects the effects to "flow through over the next few quarters."

Fitch estimates that cracker projects totaling 16 million tonnes per year of additional capacity, or 58% of current annual U.S. capacity, have been announced. A vast majority of the capacity expansions are still slated to come online around 2017 and are located in Texas, possibly creating a skilled labor and supply shortage in the region. The combination of significant construction cost overruns and lower cash flows may reduce balance sheet flexibility even further than previously expected, especially for the smaller companies that are currently building capacity, Fitch said.

In Pennsylvania, the ethane cracker project of Shell Chemical Appalachia LLC is advancing through the regulatory process (see Shale Daily, March 30).

Post-expansion, Fitch's view remains that the lack of U.S. ethylene and ethylene product chain demand growth, or of sufficient export demand, could cause a period of under-utilization. In a stress scenario of prolonged slump in ethylene margins, companies lacking product chain diversification would be most at risk. However, capacity expansions are seen by Fitch as a credit positive, all else being equal.

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