Fleeing forward: Rejuvenating the European chemicals industry by writing off assets

Last week was not a particularly good one for the European chemicals industry: We had not one but two major announcements of large-scale closures of ethylene-producing naphtha crackers from SABIC and ExxonMobil. Exxon explicitly called out the uncompetitive economics of naphtha cracking in Europe compared to ethane feedstocks in the U.S.; SABIC emphasized its commitment to more circular plastics. This comes on the heels of Indorama’s closure of purified terephthalic acid and polyethylene terephthalate facilities and LyondellBasell’s announcement that it will review its EU footprint. Beyond local economics, oversupply has played a huge part in these closures: Olefins are already oversupplied due to aggressive capacity expansions, primarily in China and the Middle East, and the issue is only going to get worse as capacity increases throughout the decade. In addition, demand growth is simply not there: The industry has enjoyed 4%–5% annual growth in plastics demand for so long that it's seemingly forgotten how to operate in an environment where growth is modest, and demand could easily turn flat or negative for primary polyolefins if mechanical recycling activity continues to grow. These dynamics are not a surprise: I called out all these issues last year in our Lux Forum in Amsterdam. But what should the European chemicals industry do about it?

The answer is as simple as it is radical: Accelerate the pace of cracker closures. European crackers are old, inefficient, and extremely underutilized, with recent data pointing to utilization rates as low as 60% over the last six months. There's really no conceivable future where any of these factors turn around for European crackers: The supply of U.S. ethane is not going away, the crackers themselves are only going to get older and less efficient, and a huge turnaround on demand is unlikely given the regulatory pressures facing plastic packaging and encouraging more recycling. The kind of geopolitical rupture needed to disrupt flows of plastics from the Middle East or China to Europe would certainly carry negative externalities severe enough to offset any positive impact on demand for European production. The obvious solution is the right one: Shut down the crackers. How much? Why not 30% of European production? Why not 40%? Trying to figure out exactly how much capacity should (or will) be shut down this decade is a fool’s errand, but it’s undoubtedly a big number.

It sounds dire, but I can't help but think this is a good thing. Painful, obviously — there are certainly going to be some consequences (loss of jobs chief among them). But large-scale chemicals production has a lot of negative externalities, and the fact that the chemicals industry as a whole has mismanaged the supply and demand of olefins and historically underinvested in recycling are inevitably going to lead to problems. Big picture: It's totally unreasonable to expect that every refinery and cracker will make the jump to a decarbonized future. It's painful now, but ultimately, it's much better to be shutting down 45-year-old facilities in Europe than trying to compete with brand new crackers in China in a permanently oversupplied market. In the longer term, other regions might run into even worse pain: possibly having to shutter relatively new crackers in the face of permanent oversupply.

Instead, the EU has an opportunity to get ahead of this transition by building new, transformative approaches to chemicals production. Investments in circular technologies, primarily mechanical recycling but also complemented by some amount of plastics pyrolysis, are a good bet. The European Packaging and Packaging Waste Regulation should give stronger support for both approaches with increased collection of plastic waste and more recognition of pyrolysis. Biorefining and fermentation-based production are also important routes, although for very different chemicals. I'd avoid heavy investment in e-chemicals like methanol however: As I’ve discussed in this newsletter, e-methanol is likely to face a very tough road ahead of it, and I don't think the EU has the policy or the resources to pull it off. I'm also looking askance at investments like Ineos’ Project One; I think the project itself is fine in isolation, but it's simply not a path forward for the entire European chemicals industry, as increased competition for feedstocks and declining demand will make those types of megaprojects extremely difficult to run at scale. Recycled and biobased products should have more durable margin opportunities in the EU over the next decade (in no small part due to regulations) and are better suited to the lower level of European demand going forward. However, the chemicals industry will have to get comfortable with smaller scales and more diversified supply chains addressing different types of feedstock volatility.

For more on #sustainable #innovation,?check out the Lux Research Blog and the Innovation Matters podcast. The opinions expressed in the Innovation Matters newsletter are my own and do not reflect the views of Lux Research.