After a lackluster 2005, caused largely by the U.S. Gulf hurricanes, U.S. petrochemical output is estimated to have increased just 1.6% in 2006. Last year's output was curbed by slower economic growth and inventory draw-downs by end-users. But, with manufacturing activity now showing signs of improvement and stocks being gradually rebuilt, petrochemical volume rebounded in the first quarter of this year. We see volume picking up more steam in the coming months, albeit moderately, with average annual growth pegged at 2-3% through 2008.

Some caution is in order, however. While volume is up, the outlook for petrochemical markets is mixed. The downturn in housing construction and a cautious consumer continue to have negative implications for the production of home goods (furniture, appliances, and carpets), autos, and consumer products in general—most considered key markets for petrochemicals. On the other hand, nonresidential construction remains strong this year before weakening in 2008. Business spending on machinery and equipment has decelerated, but growth prospects are encouraging. The one market that has been steadily positive is exports. Indeed, with the U.S. dollar low and expected to weaken further, chemical exports are strong and promise to remain so for the foreseeable future. Moreover, while both natural gas and oil prices are significantly up, oil has increased at a faster rate this year than domestic gas, which has temporarily widened the United States' cost advantage over Asia and Europe along the ethylene chain. This has given an extra jolt to U.S. exports of ethylene derivatives.

The Middle East—in particular Saudi Arabia and Iran-and Asia have been rapidly expanding their petrochemical capacities to take advantage of Asia's vast and rapidly growing markets (mostly China, but also increasingly India) and the Middle East's access to abundant and cheap natural gas. A large amount of this new capacity is due on-stream in 2009–11, which we expect will result in a global petrochemical oversupply and significant price erosion.

In the long run, we see this flood of new capacity continuing to hamper U.S. exports of petrochemicals and derivatives and encouraging the importation of those products into the United States. In sharp contrast to the Middle East and Asia, the United States is barely expanding its domestic operations. The reasons for this are essentially twofold. First, notwithstanding the current natural gas/oil comparative cost advantage, the price of domestic natural gas has ballooned in recent years, which has seriously undermined the United States’ long-run ability to compete in global markets. Second, the U.S. market is maturing, and the opportunities for growth are rapidly migrating overseas, primarily to Asia.

Petrochemical prices have surged since 2003, posting double-digit growth every year: 13.0% in 2003, 18.6% in 2004, 16.8% in 2005, and 10.1% in 2006. In the last two years, however, prices have been particularly volatile. They soared to record highs after the 2005 fall hurricanes, dropped in the spring of last year, firmed in the summer, and then weakened again in the fourth quarter. This said, prices have rebounded almost across the board so far in 2007, fueled by higher energy prices and improving demand. We see prices remaining volatile but trending higher, with average growth of 2–4% forecasted for 2007 and 2008, before entering a period of cyclical declines as mentioned above.

Crude oil prices (WTI) fell to a low $50/barrel in January, but have bounced back to near $70/barrel as of June 28. Natural gas prices (Henry Hub) have increased as well, but at a slower rate, reaching $6.75 per million Btu from $5.70 in January. We expect oil to stay above $60/barrel and natural gas to range between $7-9 per million Btu through 2008.The downside risks for the petrochemical industry over the next two years center largely on the state of demand and energy prices. A weaker-than-expected business climate would be a drag on petrochemical demand and prices. Additionally, a new energy price shock amidst a weak demand environment would be very detrimental to margins. Supply is not a prominent downside risk factor during that period as the danger of an oversupplied petrochemical market is limited before 2009—unless, of course, the economy falls into a recession.

Frantz Price