The price at the pump isn't the whole story

The myth that the price of plastic should correlate directly with the price of oil is a wide misconception, and one that needs to be debunked. Asset International's Dr Vasilios Samaras explains how other factors come into the equation.

It is a common belief in the water and construction industries that the price of oil dictates the price of plastic commodities and products, and therefore impacts on project costs. But the idea that the price of plastic should correlate directly with the price of oil is a wide misconception and one that needs to be debunked.

In many cases, it is the price of the feedstock, ethylene (in the case of polyethylene) that has the bigger impact on the price of plastic.

Plastic is derived from recuperated - or 'cracked' - naptha, a simple refining residue that once was just flared off. Ethylene is the building block of all types of polyethylene, the most common type of plastic, and is a by-product of oil so it is essentially putting a waste product to good use, rather than polluting the atmosphere.

Feedstocks have their own supply and demand and therefore their own market price. It is this market price that more directly affects the price of plastic as the feedstock price is the largest cost in producing the plastic raw materials.

So while the oil price has halved since its peak at $140 per barrel in September 2008, feedstock costs have remained relatively high sustaining polymer prices at high levels.

The situation is made worse by the fact that it is difficult to precisely control crackers to match demand. This can often lead to situations of over or under supply that can lead to rapid changes in feedstock and polymer prices.

This is the case at the moment when despite poor demand for plastics due to the global recession, feedstocks are tight due to cracker shutdowns or outages. The price of feedstock has therefore been rising, keeping plastic prices high.

Project costs
Yes, the price at the pump does have an effect on transportation costs, but that is way down the process production line, and has marginal impact on project costs. While it is easy to see why the oil-plastic-pricing assumption exists when 99% of all plastics are derived from crude oil - only 4% of all crude oil produced is used to make plastics - in fact many other elements impact ethylene prices.

Today, the mechanical properties of plastic such as its robustness and abrasion resistance make it an essential product for everyday use such as packaging and carrier bags, and also for use in pipes that are tough enough to use in marine outfall projects and flood alleviation schemes.

With its use in a multitude of applications it is easy to see why there is, for the long-term, growing demand for plastic, and particularly polyethylene, in the UK and worldwide.

In 2008, all types of polyethylene experienced decline in consumption, with the second half showing an unprecedented demand crash, which can largely be put down to the current global economic climate.

As the demand for plastic has increased in recent years, particularly in China and the developing world, a situation of undersupply has arisen whereby the demand for plastics outstrips available supply. The long-term nature of petrochemical projects means that there is a lag before new plants come on stream to create additional supply to meet this growing demand. This shortage has led to historically high prices.

Factors outside of human control can have a huge impact on the supply of oil and this in turn will directly affect the supply of polyethylene. Factoring in the lengthy production cessation periods that environmental disasters can have on oil production, demand can rapidly overtake supply.

A good example is Hurricane Katrina, which struck US shores in August 2005. In preparation for her arrival to the US, 17.1 million barrels of oil were shut in and therefore the production of polyethylene was postponed.

The production of oil in the Gulf of Mexico fell by 1.4 million barrels a day. This accounted for 95% of the daily production of oil.

Two weeks after Hurricane Katrina struck the Gulf of Mexico more than 120 oil and gas platforms were still closed. Nearly 60% of the gulf's daily production of oil and gas remained blocked from the market due to the evacuations of personnel in preparation for Hurricane Katrina.

By September 2005, 21 oil refineries - a combined total of 47% of US distillates - were still not functioning. Six more of those refineries were re-lit within the following 30 days, but the remaining four refineries all suffered serious damage.

None of them returned to full capacity by the end of the 2005. The relighting and rebuilding processes would cause the US a deficit of 25% of the total supply. It is easy to see how quickly the shift from the over-supply to over-demand for polyethylene can happen by looking at the effect of Katrina. Throughout this period, demand for polyethylene dramatically exceeded supply, and as a result prices rocketed.

Weak currencies
This pattern can be seen across the globe following large-scale natural disasters. Similarly, this pattern appears during periods of political unrest and international conflict.

An added factor to the price of polyethylene is the weak performance of sterling against major currencies such as the US dollar and the euro. UK manufacturers are effectively paying more for the same amount for polyethylene now than they did even a year ago.

The ever and sometimes rapid fluctuation of polyethylene prices makes life difficult for UK manufacturers as Simon Thomas, managing director of Asset International, manufacturer of Weholite pipe, explains: "In the past year, we have seen polyethylene prices increase by as much 40% within a time-frame of two months, and despite the greater cost to us as a manufacturer, we have had to absorb those costs and honour previously agreed quotes rather than passing them on to our clients.

"This is not an ideal situation in the long-term, which is why we are constantly evolving and innovating our Weholite pipe designs to maximise the value to our clients and minimise the impact of plastic prices."

The good news is that supply and prices for ethylene will get better.

There are currently plans for a substantial amount of new oil production plants in the Middle East in the next five years, which means that the supply-demand ratio will swing dramatically in favour of the consumer.

With a competitive market comes more competitive prices, then. Industry experts expect economic growth to recover in the next few years, and as the world's industries demand more plastic, more polyethylene will be produced to meet consistent demand.

As Katherine White, of polymer distribution company Plastribution, says; "We should see the start of a wave of linear low-density polyethylene (LLDPE) and high density polyethylene (HDPE) capacity additions over the period 2009 to 2012.

"Polypropylene will also see unprecedented new capacity of over 5m to come on stream during 2009-2011. This is good news for manufacturers like Asset International and their clients in the water industry in the long-term."

Dr Vasilios Samaras is technical engineer at Asset International. T: 01633 273081

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