Northeast cracker projects to see good margins despite higher capex

Total project costs for a 1.25 million tonne per annum (mtpa) cracker construction project in the US Northeast are estimated to be about $91.46 million higher than for an identical project on the U.S. Gulf Coast in the current market environment, according to Petrochemical Update’s US Ethylene Complex Construction Costs Report 2016.

Total project costs for a 1.25 mtpa ethane cracker on the Northeast would total about $1.839 billion in a base-case scenario, compared to $1.748 billion on the Gulf Coast, according to Petrochemical Update estimates.

Of the six ethylene plant projects announced for the US Northeast/Mid-Atlantic, two – Shell’s proposed 1.5 mtpa project in Pennsylvania and PTT/Marubeni’s proposed 1.0 mtpa project in Ohio – are likely to be built before 2022 if they reach a final investment decision (FID) in 2016 or early 2017, according to Petrochemical Update estimates (See Figure 1 below).

The capital cost – including construction and detailed design costs – to invest in a 1.25 mtpa cracker in the Northeast in 2020 is forecast to be about $100 million higher than on the U.S. Gulf Coast, the report says.

A cracker built in the US Northeast would have higher average labor rates and a higher number of man-hours, as well as higher payroll burdens and indirect costs.

Total construction costs for a 1.25 mtpa cracker in the Northeast are estimated to be about $103.64 million higher than on the Gulf Coast in the current marketplace, but lower detailed design/engineering, project management & controls and Procurement - Subcontracts & P.O. costs in the Northeast would offset some of the difference in total actual project cost, according to the report.

Figure 1

"Other costs" comprise project management & controls, procurement – subcontractors & P.O.’s, EPC Warranty and EP Fee. Source: US Ethylene Complex Construction Costs Report 2016.

The highest bulk material costs for a 1.25 mtpa cracker in the Northeast are associated with piping systems, which have the highest materials cost, as well as the highest labor cost.

Of the indirect costs, the majority are associated with labor expenses, but heavy lift cranes and other construction equipment still carry a significant materials cost. Of the major equipment costs, the biggest are associated with columns c/w trays.

Figure 2

Source: US Ethylene Complex Construction Costs Report 2016.

These cost estimates exclude extensive site preparation and logistics for a greenfield location – such as rail sidings and rail cars – as they greatly depend on the topography of the site. Assuming that there are no major impediments, the site development could add another $1 billion to the cracker project cost.

Northeast projects

There are some distinct benefits to locating in the Northeast despite the relatively higher plant construction costs compared to the US Gulf Coast.

Shell’s proposed steam cracker and three polyethylene units would be located very close to ethane supplies and gas processing infrastructure in the heart of the “wet” Marcellus/Utica natural gas liquids production region, which will provide a significant feedstock transport cost advantage versus Gulf Coast crackers, even if ethane prices rise in the next few years.

Ethane transportation costs from the Marcellus/Utica to the Gulf Coast are about 14-20 cents/pound, said Rick Stouffer, energy editor at Kallanish Energy.

PTT/Marubeni’s proposed $5.7 billion, 1.0 mtpa ethane cracker in Belmont County, Ohio, will also use shale gas from the Marcellus region and will be located near off-taker facilities to boost the project's logistical efficiency.

The Marcellus has about 7,600 MMcf/d of gas processing capacity — more than 40 new plants built in the past six years, most of them built by MPLX (MarkWest) at eight major processing centers across the region. There are still more planned gas processing plants. Similarly, there’s currently about 500 Mb/d of fractionation (C3+ or full range) and another 240 Mb/d of de-ethanization capacity, according to RBN Energy.

Much of the announced ethylene capacity in the Northeast will be used to supply polyethylene derivatives domestically.

The proximity to the end user market is another advantage since the primary base of the downstream customers, such as plastics processors and fabricators, is in the Midwest, and some 75-80% of the industrial base of the United States is located within 500 miles of central Ohio, Kevin Swift, chief economist and managing director of the American Chemistry Council (ACC), told Petrochemical Update.

Shell CFO Simon Henry said during an earnings call on May 4 the company’s proposed cracker project in Pennsylvania has a diverse set of associated market exposures and risks and provides portfolio resilience relative to the other big and small opportunities the company is considering. However, Shell's decision whether to proceed with any of the projects will come down to finding the best way to retain and maximize value.

Henry said Shell could make a final investment decision on the projects within the next 12 months, though it’s “highly unlikely” that more than two will actually go ahead in that timeframe.

Oil and gas prices

Decisions to invest in megaprojects in the Northeast will be based not only on the magnitude of the investment and alternative opportunities, but also largely on the current and projected prices for the related commodities or products.

Projected growth in U.S. ethylene capacity was based largely on the expectation that natural gas prices would stay significantly lower than crude oil prices.

The key ratio of the crude oil price ($/bbl) to the natural gas price ($/mmbtu) – which measures the competitiveness of ethane cracker production vis-à-vis naphtha crackers – has shrunk as oil prices over the last year have fallen from about $60 per barrel to around $40 per barrel in early 2016.

U.S. ethylene derivative exports are largely competitive at oil-to-gas ratios well above 7-8: 1. The average ratio in in the first four months of 2016 was 17.4, down from about an average of 18.76 in 2015, but remains positive. The spread between naphtha and ethane prices has also narrowed since 2015 but is still favorable.

Figure 3

Ethane-based export derivative competitiveness at various oil and gas prices. Source: US Ethylene Complex Construction Costs Report 2016.

Crude oil supply scenarios in the near term will depend largely on whether Saudi Arabia and Iran, or both, cut back on production and on the GDP demand forecasts for the Chinese market. Short of a geopolitical event in the Middle East, most future scenarios do not have oil returning to $80 to 100 per barrel.

The most prevalent oil and gas forecasts see oil prices remaining at $35-45/b for the rest of 2016 and into and through 2017, with the chance of increasing to $50 and slightly above thereafter. The overall probability for this forecast is about 60/40, according to Petrochemical Update’s report.

Brent crude oil prices are projected to average $41/b in 2016 and $51/b in 2017, according to the Short-Term Energy Outlook (STEO) released by the U.S. Energy Information Administration (EIA) on May 10.

Meanwhile, gas price forecasts in the short term are for the most part on the conservative side, with prices mostly ranging between $2/MMBtu and $3.50/MMBtu in the next few years.

Henry Hub natural gas spot prices are forecast to average $2.25/MMBtu in 2016 and $3.02/MMBtu in 2017, compared with an average of $2.63/MMBtu in 2015, according to the EIA.

Figure 4

Source: US Ethylene Complex Construction Costs Report 2016.

At least in the short term, oil-to-gas price ratios will continue to keep shale-based North American ethylene derivatives very competitive (ratio 15 to 20:1) compared to ethylene produced from naphtha.

Should the oil price ever return to $80-100/b, shale-based ethane derivatives in the US and Canada would be substantially more competitive than higher-priced naphtha-based derivatives.