The recent drop in global crude oil prices could negatively affect chemical company financials, according to Fitch Ratings, although we expect ethane crackers to maintain a cost advantage in the long term despite the increased competitiveness of naphtha feedstock. Some downward pressure on cash flow is anticipated and challenges are also expected under a condensed expansion construction schedule, however.

With the sharp drop in global crude oil prices, naphtha prices have declined further than US ethane feedstock prices, putting downward pressure on ethylene cracking margins in the US. However, with the decline in naphtha prices and corresponding decline in ethylene prices, naphtha-based co-product 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 per barrel range long term. US crackers' cost advantage should expand again as the spread between naphtha and ethane widens, but not back to the peak levels of 2012.

Fitch estimates projects totaling 16 million tonnes per year of additional capacity, or 58% of current annual US capacity, have been announced. A vast majority of the capacity expansions are still slated to come on line 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.

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