RELATIONSHIP WITH THE PETROLEUM INDUSTRY

Despite its tremendous range of products, the petrochemicals industry is primarily designed around five basic feedstocks. Without assured availability of ethylene, propylene, butenes, aromatics, and synthesis gas, the industry is not secure.

These five feedstocks are currently supplied from natural gas, natural gas liquids and a number of oil refining intermediates and byproducts-specifically naphtha, gas oils, and refinery gases. Important as these materials are to petrochemicals products, however, they represent only about five percent of the oil industry's crude oil input, and their disposition is not of governing importance to oil refinery operation.

Although not governing, petrochemicals are important to oil refineries, for they represent opportunities for adding value-and therefore profitability. As a result, the oil companies all operate in the petrochemicals area either directly, or through joint ventures, or as suppliers of feedstocks to chemical companies.

Most petrochemical production facilities are either in oil refineries or across the fence from them. This has been economically beneficial because ethylene from natural gas or refinery gases has been more economical than ethylenes from naphtha or gas oils, for example, and aromatics from catalytic reforming, a gasoline-oriented process, are less expensive shipped across the fence than to some more distant point. Further the combination oil and chemical operation provides great flexibility for finding uses for all the various tars, oils and other by-products.

On the other hand, most petrochemical feedstocks can be produced from naphtha and/or gas oils, both of which are transportable and are common articles of commerce. As a result, some petrochemical companies are not associated with oil refineries, although they must have either crude oil, natural gas, or liquid petroleum fractions (or some combination of these) available to them.

Since World War II until about 1970, the relationship between the crude oil supplier, the refiner, and the petrochemicals producers was remarkable in the commonality of interests among them. Crude oil was plentiful and cheap, refining capacity was ample, demand for gasoline and petrochemicals was growing rapidly, and competition was based on prices.

Price was a function of processing costs, and processing costs were affected by the scale of operations. Thus, the petrochemicals industry kept building bigger and bigger plants, there was continuing overcapacity, and prices were consistently declining, thus adding to demand.

About 1969, however, petrochemicals producers began to modify their philosophies and began to abandond the "volume only" approach. Profits were low, thus discouraging capital investment. What was spent included occupational and environmental protection as well as capacity increases. The ability of process improvements to cut costs

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declined, and raw material costs began to rise. Prices began to increase, as did capacity utilization as a result of continued market growth.

Experience in the petroleum industry was similar. There was very little refinery construction in the period 1969-74. As a result, domestic refining capacity is beneath demand for refined products and domestic naphtha is in tight supply, as is capacity to separate aromatics from catalytic reformate.

These reductions in investments for capacity were beginning to be felt in 1973, when demand began to outstrip capacity for a number of petroleum and petrochemical products. Prices began to rise in response, as petrochemicals producers began to scramble for feedstocks. The double dollar devaluation reversed the domestic-foreign price relationships, making imports even more expensive and exports more attractive.

The Arab oil embargo produced a real supply crunch, of course, but it was based on crude oil supply limitations rather than on production capacity limitations. Prices went wild, as people fought fiercely for the limited materials available.

INDUSTRY OUTLOOK

At this writing, some six months after the Arab embargo was lifted. the wild bidding for spot supplies of acutely short feedstocks and intermediates has subsided. There is lots of crude oil available in the western world (one common estimate is an excess of 2 million barrels a day) but petrochemical feedstocks, and hence some petrochemical intermediates, continue in tight supply.

The major reason for this is continued market growth, particularly for plastics and resins, and the recent five-year hiatus in capacity expansion. The short term result has been a sharp increase in prices. starting with the basic feedstocks (ethylene is now three times the price it was in 1972) and rippling through the various intermediates to the plastics and other petrochemical products.

Major petrochemical feedstock producers have begun to announce new plans for expansion, based on prospects for plentiful oil fractions and on expectations that the sharply increased prices currently being negotiated will hold when these contracts come up for renewal in the future. An additional factor is the lack of firm evidence of buyer resistance to the higher product prices. This has led to industry projections of continued increases in demand.

The petrochemical industry leaders maintain that the wave of expansions currently being announced will not lead to a new period of excess capacity and oversupply. One major reason is that inflation has reduced the amount of capacity a producer can afford to build, while closings of no longer economic older facilities will reduce net additions to capacity. In addition, some experts predict that some of the announced expansions will be quietly cancelled, as their sponsors here second thoughts about the impacts of inflation and other costs increases. The industry consensus is, therefore, that its markets will continue to grow rapidly, that prices will stay high and generate profits to provide capital to invest in additional capacity, and that continuing inflation will limit capacity expansion enough to prevent overbuilding. particularly in light of the fact that the economies of scale have about all been realized so that plant sizes will not continue to get bigger.

In addition to this economic outlook, the industry is turning its attention to raw materials sources it has spurned in the past as too expensive-naphtha and heavier oil fractions and even crude oil itself in one case, with coal in the least advantageous economic position of all. Historically, the heavier the starting material (except for priceregulated natural gas) the less expensive it is per se but the more it has cost to build and operate the plants needed to process it.

As natural gas becomes increasingly unavailable, the values of oil fractions are beginning to change as well, because chemical demand for them is increasing. When naphtha supplies can be assured, it is the preferred starting material (other than gas).

There is considerable speculation in the industry about the ultimate economics of using heavier oil fractions, crude oil itself, or coal. The trade press reports with increasing frequency on these speculations, as well as on the announcements of planned feedstock capacity increases and the raw materials to be used.

An educated guess would be that coal will not, in the foreseeable future, be used as a chemical raw material unless it is subsidized. It cannot compete economically in the real world with oil. On the other hand, the demand on oil for chemicals could conceivably raise the price of oil fractions enough for coal to slip in under them for fuel use in stationary facilities. In such a case, coal would not need a subsidy to become economic enough to replace many of oil's energy uses. In addition to the foregoing, the petrochemicals industry is considering two other side bets as hedges-direct contracting with midEast producers for on-site chemical production and direct purchases of crude oil for use as a petrochemical raw material. Studies of the economics of mid-East petrochemical production made before the recent increases in world crude oil prices were not encouraging, despite the economic advantage of on-site crude oil. Construction costs in the mid-East are high, transportation costs for refined products are high, and there are no nearby markets for many low-value by-products like tar. Nonetheless, the option cannot automatically be discounted in the face of so many new economic relationships.

Direct purchase of crude oil for chemical purposes can also not be discounted in light of Union Carbide's willingness to build a plant to make feedstocks direct from crude. Clearly, however, both of these side-bets are aimed at the 10-20 year time frame, whereas selection of distillate fractions for feedstock is aimed at current needs plus the current wave of planned expansions.