Tales of The Shale Crescent
This is a blog post written by our partner, Sean O'Leary. His professional take on the outlook for the Ohio cracker is a must-read for all Ohio Valley citizens.
My wife suggested that I title this, "Tales of The Shale Croissant" (… because, while it's tasty to politicians, it's mostly air and has almost no nutritional value). But, decorum requires otherwise, so "shale crescent" it is -- a phrase that, to proponents of natural gas and petrochemical development in the Ohio Valley and Western Pennsylvania, connotes an industrial boom beginning with an already accomplished explosion of natural gas production, soon to be followed by a buildout of petrochemical processing on a scale comparable to that of the Gulf Coast, and concluding with a blossoming of plastics and polymer manufacturing businesses that will provide tens or even hundreds of thousands of new jobs. But, just as many regional policymakers averted their eyes from the devastating effect the fracking boom would have on the coal industry, they now avert their eyes from the cancellation of the proposed ASCENT cracker in Wood County, West Virginia; the now annual delays (most recently two weeks ago) in a final investment decision for the proposed Belmont County, Ohio cracker; and clear economic indicators, which show that their vision of petrochemical prosperity is likely to be a pipe dream. In this series, we'll explore those indicators, which suggest that:
The much-ballyhooed buildout of four to five ethylene crackers in the Marcellus/Utica region will almost certainly not happen. In fact, it's doubtful that any more Appalachian crackers will be constructed following completion of the Shell facility in Beaver County, Pennsylvania.
If the crackers are not built, the economic rationale for support facilities like the nearly-as-ballyhooed Appalachian Storage Hub, largely evaporate.
And, even if the crackers and storage facilities are built, they're very unlikely to give rise to "game-changing" increases in manufacturing and jobs.
For these reasons, hundreds of millions of taxpayer dollars being spent on efforts to bring about the petrochemical boom are likely being squandered. Meanwhile, more feasible and sustainable economic development strategies are ignored and in some cases actively resisted because they are perceived as threats to the imagined petrochemical nirvana. So, if concerns about the damage pollution and greenhouse gas emissions would do to people in the region and to the planet are the reasons a petrochemical boom shouldn't happen in the Ohio Valley and Western Pennsylvania, the economic and technological concerns presented here are the reasons it won't happen, or at least it won't happen on a scale that will deliver anything like the promised growth in jobs and prosperity. Why the petrochemical boom is an economic non-starter Visions of petrochemical prosperity in the Ohio Valley and Western Pennsylvania are built on two deeply flawed assumptions:
Ethane derived from the region's natural gas will maintain a large and permanent cost advantage over alternative feedstocks for the manufacture of ethylene and polyethylene, the raw materials for the manufacture of plastics and other substances.
Most of the ethylene and polyethylene produced by crackers in the region will be consumed by nearby manufacturers who will flock here in order to be near their source of supply.
Here's why the assumptions are flawed. Under foreseeable economic conditions, additional crackers won't be sufficiently profitable to warrant the multi-billion dollar investments required to build them Proponents of the "shale crescent" vision talk as though there is a seamless and symbiotic relationship between natural gas producers on the one hand and petrochemical and plastics manufacturers on the other. There is not. One industry's revenue-generating product, ethane, is the other industry's cost-generating raw material. Ethane producers want to maximize the price of their product and petrochemical and plastics manufacturers want to minimize it. Markets generally resolve this kind of conflict by establishing an equilibrium price at which the producer makes an adequate profit and their customers can charge prices for their value-added products that are well in excess of the cost of raw materials. The problem is that, in this particular market, there are two additional players -- oil companies and ethylene cracker operations in other parts of the country and the world -- whose actions can make a price that makes it impossible for both buyers and sellers of ethane in the Marcellus region to earn adequate returns. That's precisely what is happening right now and it's likely to keep happening. Prospective investors in potential Appalachian crackers are seeing immense growth in competition Due to the recent plunge in the price of oil, crackers along the Gulf Coast and in other parts of the world that process oil-based naphtha into ethylene and polyethylene are taking market share from ethane crackers. When the price of oil is well above $50/barrel, ethane holds a substantial cost advantage for the production of ethylene and polyethylene. But, when the price of oil drops into the $30's and $40's (never mind less than $20, where we sit right now) the cost advantage diminishes to the point that margins may not be sufficient to motivate investors to make the $5 billion-plus investments required to build new ethane crackers. The best estimates suggest that the price of oil will return to only about $40/barrel in 2021. And, if the recent economic crisis and infighting in OPEC+ has permanently damaged the cartel's influence, then prices may not get that high. Prospective investors must also consider the fact that, regardless of the price of oil, oil companies are planning to invest more heavily in the petrochemical market as they see a flattening of demand for fuels. The International Energy Administration recently projected that petrochemicals, which currently consume about 14% of oil production, will represent over 30% of the industry's growth over the next decade. Another source of increased competition for new Appalachian crackers is the immense growth in ethane crackers in other places. In just the last few years, ethane cracker capacity in the US, principally along the Gulf Coast, has increased by 50%, creating a condition of overcapacity that the Institute for Energy Economics and Financial Analysis (IEEFA) doesn’t see closing until 2026. The global buildout is even greater, with Wood Mackenzie forecasting a “meteoric expansion” of ethylene capacity in China over the next five years surpassing even the US expansion. This intensifying of competition is also reflected in IHS Markit's forecasts of a coming plunge in global cracker utilization rates. Not only will ethylene from oil and from other ethane crackers compete for market share, thereby driving down prices and profit margins, but the expanded fleet of Gulf Coast ethane crackers could also compete with Appalachian crackers for ethane coming out of the Marcellus region, which would have the effect of driving up costs and further squeezing profit margins. That kind of regional competition for ethane will arise if, as many observers expect, the ongoing shakeout in the oil industry causes major shut-downs of oil and gas wells in the Permian Basin forcing the crackers that have already been constructed on the Gulf Coast to look to the Marcellus region for feedstock. The demand side of the equation is also in doubt Although they are not as severe as the competitive pressures that would confront any new Marcellus region cracker, there are also significant doubts about whether demand for plastics will be sufficient to warrant added capacity. First, no one is certain how quickly economies and the plastics sector will recover from the current economic crisis. But, in addition to general economic pressures, the plastics market is also especially susceptible to national and regional government actions to combat plastics pollution and climate change and, since the arrival of the Trump administration, unanticipated swings in trade policy. Petrochemical and plastics manufacturing are highly greenhouse gas intensive activities, which means they are highly vulnerable to emissions reduction policies such as carbon pricing and cap-and trade-schemes. At the same time, both national and regional governments, including recently China, are enacting single-use plastic bans, bag bans, and other measures. None of these factors, either individually or collectively, is expected to reverse growth in the market for plastics, which is being driven by developing countries in Asia and, to a lesser extent, in Africa and South America. However, looking forward from our present state of overcapacity, which is expected to last for another five years are so, even a slowdown in expected growth would have an outsize effect on decisions about adding yet more capacity.Next Installment: Part 2 - Why "the shale crescent" can never become "the new Gulf Coast"