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Welcome to another special topic episode of Olefin’s Weekly Wrap-up. Today is Thursday, September 1st, I am Haya Batniji and this week our special topic episode will introduce our executive director for Olefin’s Europe and the Middle East, Matthew Thoelke, who will be discussing the energy crisis in Europe. Your hosts today are Pablo Giorgi and Luka Powell.

Hi, my name is Luka Powell, your host for today I’m joined by Matthew Thoelke, executive director for EMEA and Middle East at Chemical Market Analytics. Welcome to the podcast, Matthew.

Thank you, Luka.

Thank you for taking the time to talk to us today. So, before we get into our conversation, can you tell us about your background? What do you do when you are not with Chemical Market Analytics?

So my background is living the life of a consultant. So, I started with what was chemical market associates back in the late nineties and have been covering various markets, mainly focused around the Olefins sector a lot of time in c4 s and then since 2010 is focusing on ethylene and propylene. Geographically more focused on Europe and the Middle East but obviously we all sit in global markets, so have a pretty big interest in the global picture as well. So, what do I do when I’m not working? Well, I’m, always working. I’ve three little girls at home, so, there’s no rest. When the day job finishes, I’m into the evening job and that’s keeping me pretty busy. We have quite a bit of travel as a family so we enjoy and then do stuff with the kids. I’m trying to get them to all be cyclists like myself so that’s taking up some time with a few tumbles and falls and shouting and crying. But this is the joy of being a parent, looking after little kids.

So, Matthew, you’re based in Germany, right? I hear the beer is good there.

Yeah, I am based in Germany. My background is from the UK, but I moved here over 10 years ago, and the beer is pretty good here. That’s right. I come from the UK so I’m used to slightly warm and flat beer, which may be good in the world we live in. I hear there are some issues with carbon dioxide availability in Europe but yeah, the beer is pretty good here in Germany, that’s for sure.

Okay, so let’s frame the issue. The gas situation is all over the place in Europe at the moment. So, I want to unpack, how did we get here? Firstly, what are some of the drivers of the natural gas market? Why is Germany in trouble and are there any alternatives to the Russian gas supply? And if so, what do we expect from demand?

There is a lot to unpack here so let’s try and sort of unravel things a little bit. Natural gas is really very simple, relatively clean energy source, and it’s really dominating European domestic energy consumption along with electricity. So, we see a lot of gas demand in the private sector for home heating, and water heating in homes as well as demand for industrial applications for energy for power generation. The chemicals industry to some extent is reliant on gas as everybody else. It was a relatively low-cost and abundant source of energy but in some cases, in Europe, we do see natural gas acting as a sort of feedstock into chemical processes.

There are no real alternatives if I think about the current situation, but you have to roll back a bit over a year or you could roll back several years and Russia’s been building up to this position where Europe is effectively tied very closely to Russian hydrocarbons, particularly to gas. During this whole period last winter, we saw Russia, gradually squeezing the gas supply, reducing the availability of gas & making a lot of threatening noises about gas availability. We saw the markets start to respond & last December we saw prices hitting a peak well above any historical norm and that’s really continued following the invasion.

Now we see Russia basically moving towards turning the gas off the markets which I think pretty much means that there will be very little or no Russian gas during the winter. Different countries in Europe have different exposures. There is a gas grid, so we’re seeing gas pricing across Europe in trouble. Quite extreme pricing dynamics over the last couple of weeks tied into the sort of core central European, so Germany, the Netherlands you could include in that, but down to Austria and to the east towards Poland, you know, prices there are all very closely linked together. We do see a little bit of a gap between like the UK, and French pricing and what’s happening a little bit to the east. Germany is one of the countries which has been wholly committed to Russian gas supply, roughly half of German gas has historically been sourced for Russia.

The challenge for Germany is that it’s reliant on gas pipeline connections with its neighbors. It has no alternative sources of gas, it can’t import LNG and because it’s such a big gas user and you look at other countries, they have similar or even greater exposure than Germany, but they’re not as significant consumers. This leaves Germany very exposed to gas supply from Russia. If the gas supply is turned off, it is very difficult to see how Germany is going to struggle through that. Certainly, there are going to be very significant impacts and enforced reductions in German consumption of gas. These are already being reflected in the moves that the general consumer is making like trying to reduce their use of gas. Industrial users are also making significant moves to try and be linked to gas if possible.

The alternatives are really limited. The LNG market globally would be big enough to fill the gap, but LNG demand isn’t just about Europe. You know, we see that demand elsewhere. So those contracts in place and the infrastructure in Europe to re-gasify the gas, to take it from a sort of minus 180 – 90 degrees Celsius and bring it back to a usable temperature just don’t exist. There are a lot of import locations in the UK, Spain, and Italy, and think in Belgium and the Netherlands as well but we don’t have enough capacity as a continent to replace Russian gas. So, you know, the exposure to Russian gas is large and the impact of Russian gas being cut off, which is pretty much where we are now is going to be very significant.

So, Matthew, it seems like it’s a really troublesome picture. To help our listeners understand the impacts on the petrochemical industry, can you talk a little bit about how much of the capacity is concentrated in Germany, olefins, ethylene, propylene, and some of the derivatives?

It’s quite varied and we did some analysis just recently looking at detail, not just on where the capacity is based, but where different processes and technologies sit. And if you look at the olefins industry, as a commentator on the olefins market, I’m not really that concerned about steam crackers. You know, the average steam cracker in Europe actually is a net gas producer. There are several crackers, you know, least less efficient crackers, which are net gas consumers. So they do face challenges, but you know, within a steam cracker, particularly liquids crackers, you have a lot of tools to redirect streams. The Ethane recycle streams typically, which are fed into furnaces can be redirected not into the feedstock section but into the fuel section of furnaces, and boiler operations can be moved away from natural gas.

So, there are a lot of levers that are being pulled to adjust steam cracker exposure. Where we do see more of a sort of one-way route from an energy perspective is into the derivative sectors. There aren’t really alternatives from natural gas or electricity for PVC production or propylene oxide production and when you look at the main polymers, polyethylene and polypropylene, there is still exposure to electricity consumption, and that invariably is tied into natural gas pricing. So, I would say a lot of the concern sits on the availability of affordable electricity for derivatives and for some natural gas pricing. For the steam crackers themselves, a little bit less of an issue. There are definitely, you know, a number of crackers that are exposed, but not the majority. I would say if you look at the sort of spreads, Germany is the big hub over 20 – 25% within a lot of spaces that production is based in Germany.

But the real critical issue for Europe is the gas flow. Unless we see a kind of nationalization of gas systems and effectively these pipelines across borders being closed down, we’re going to see this impact hitting everybody. When you look at the Olefins sector, Germany’s already put in place sort of phases of rationing, and I think we’re already sort of moving into some of those phases. There’s really a lot of pressure on industrial users to reduce gas consumption and they may well be curtailed. There’s some natural curtailing happening already because the gas price is so high. Just to put this in context, TTF which is the sort of the main reference, it’s a Dutch reference, but it’s very comparable to pricing for gas in Germany or in Austria or in central Europe and has been trading above 300 Euros per megawatt hour. Just to give context to our American listeners, that’s sitting or not quite sitting at a hundred dollars a million BTU. So, you know, the kind of pricing dynamics that you’ll see in terms of the gas markets is unprecedented. With this kind of pricing level, you’re really looking at every single possible opportunity to push gas back into the gas network and to use LPG or liquid fuels or any other products that have energy, that has a calorific value if you like. So, there’s really a lot of pressure on the industry from an economic perspective to move. To put this into context, if you were looking at a steam cracker operator, a naphtha-based steam cracker, and you had the capability, they don’t, but if you had the capability to switch from natural gas as your furnace feed to LPG auto fuel oil, you are looking at, you know huge savings way in excess of a thousand euros, a ton saving.

These are the kind of numbers where people start looking at significant changes in operations, even if they’re just very short-term. You could be looking at paybacks of weeks and months, not even years for some of the changes to shift your energy in position. So, producers in Europe are very busy trying to figure out what they can do and how they can secure themselves. From a steam crack operating perspective, that’s where we see most of the potential changes. For the derivatives, it’s really just a case of bearing what you can. At points, you’re now starting to see some extreme pricing dynamics where I think one caustic soda producer is looking at increasing the price by 200% from one month to the next. So, these kinds of dynamics are going to really be very difficult for the downstream industries to deal with it.

From a chemical perspective, I would say the pressure point in the Olefins industry sits really with the derivatives. The key derivatives that are big energy consumers, acrylonitrile through ammonia as one of the feedstocks. The polyethylene and polypropylene production processes are much less energy efficient, so we’re not so concerned about those. When you look at oxo alcohols, typically natural gas as a precursor into the syngas process, some players have a little bit of flexibility to the other feeds, and so they’re more protected. But the base load of production is from natural gas. Propylene oxide, the traditional epichlorohydrin root and also the direct oxidation route, are very big energy consumers and so quite exposed to higher pricing. The co-products roots of PO/TBA and PSM are not as exposed. Then, of course, the big electricity consumption that goes into the caustic soda and chlorine production. And that feeds through into PVC. So, PVC also has significant exposure to a high gas and high electricity pricing.

So, Matthew, you mentioned a little bit about the potential for using other fuels in the furnaces in steam crackers. Other than that, do you expect other producers too, you know, have the incentive to find some alternatives to the use of natural gas, or even for electricity production in power plants? Do you see the potential for gas prices to ease? How do you see those high prices incentivizing companies and market participants to find some other alternative?

Yeah, so there’s an adage in the oil industry that says the solution for a hundred dollars crude oil is a hundred dollars crude oil. The reaction in terms of supply, and the reaction in terms of demand will bring the market back into balance. And, you know, I think in the environment that we are at in Europe in natural gas, the impact of loss that we see, it is comparable to the world losing Saudi. The rationale this would be the same kind of impact where we effectively move into a period of severe demand destruction to try and get the market to rebalance. I would say that the current gas pricing is one where the supply picture is pretty well understood. There will be some additional supply coming from LNG. We see the loading of LNG into Europe is at a very high level.

Germany is going to build some floating import capability that will be ready already this year, and we’re going to see some more structural moves toward energy import capability. But this isn’t really going to solve the 2023 winter issue, which is we need gas and storage. Now, most countries are actually in line or ahead of their requirements, and they’re working really, really hard to meet the sort of government targets of how much gas storage, how full the gas storage capacity will be by the end of October and that’s probably one of the reasons why the gas price is quite so high at the moment. There is a push to try and fill up storage as well as the ongoing usage of gas. And, you know, this is really pushing pricing levels to an extreme. But we’ve only had these kinds of gas prices as high as we see right now in August.

I mean, in July they were not as high, and if you roll back, even though last winter, they weren’t as high. But you now move into an environment where expectation through the coming winter is that we’re going to be sitting in this, you know, $50 million BTU plus gas environment for several months. And I’m, sure if you push that too, you know, the US Gulf Coast industry and say, this is the gas price you’re going to have to deal with, what are you going to do about it? There would be huge changes, not necessarily, significant energy savings. They take more time, but you can look at changing of the fuel mix. And so, I think that the incentive to move to away from natural gas you know, if you compare the pricing dynamics, liquid fuels are sitting in the $10, $15 a million BTU range.

Natural gas is a hundred dollars a million BTU. There’s a huge amount of money sitting on the table for anybody who can make those shifts. Now, if you look at power generation, it is not that straightforward to make a shift in power plants to get the volume of energy into those systems. But if you look at the refining industry, you look at the petchem industry where there is a mix of natural gas and various different liquid feeds coming in the shift of feeds into boilers, those probably already are being made the potential shift to actually look at not necessarily the feedstock side of the supply but energy supply that comes into the chemical industry. The incentive to make those moves is very, very high.

Even within the cracker, you produce a series of products, and fuel gas is one of those. Hydrogen is another product. You also produce fuel oils along with ethylene. You produce a lot of Ethane traditionally that Ethane is just simply recycled crackers and feedstock but there’s quite a significant volume, and if that is used as a furnace fuel or pushed back onto the power grid, you are looking at really, really large numbers in terms of incentivization to do that. Probably even now to the point where for small gains of efficiency and small gains of, you know, energy shift away from natural gas towards liquid fuels, you could justify bringing your own cracker offline. And, you know, these are not cheap units to bring offline, but, we really are in an environment where the cost incentive is huge.

I mean, it’s unprecedented, I would say within the energy industry to see this level of cost and rationale for reducing cost. If you look at industrial usage of gas, it is significant, but the real key driver is going to be pushing your consumer. You know, that makes up a big proportion of gas usage away from natural gas and just simply uses less energy. I’m already trying to get my kids to have quicker showers and turn the temperature down. And, you know, ultimately if enough effort people don’t put their heating up during the winter as high, maybe cut the temperature by, you know, a couple of degrees Celsius, this is going to really quickly start to add up to very significant demand reductions. And I think that you know, a combination of these factors will be necessary to get the European continent through the winter.

Ultimately the challenge is going to be how do you ensure that those who can’t necessarily afford to pay for these gas bills are going to be able to manage. But I think with enough demand correction this winter will be solved. And as we look at you know, the forward winter, I think we are going to see a less stressed position because there will be more energy available. And you know the reality is the European industry is expecting Russia to basically be frozen out of the market. So even if Russian gas is available, there are going to be alternatives that have been put in place to effectively try and ensure that Russia never again has the same position where they can blackmail the European economies.

So, to hit you with another broad-ranging question, let’s talk about some of European competitiveness. Where do you think most of the impact will be felt and how a market replay is responding to this? Do we expect import opportunities to increase here?

Yeah, so I think in the olefins space, you know, if you work through some of the changes that probably are going to happen you may well end up in an environment where, you know, the liquids cracking position in Europe because it’s a net on average, as a net gas producer that does compensate for the energy consumption into the sort of easy derivatives polyethylene & polypropylene where you have a much lower energy consumption. And, so I think actually the potential is that it’s going to become more and more difficult for importers to compete for a big chunk of the European market for sure. There will be producers where cost structures, their efficiency is low and they’re going to struggle to keep operating. But once you move into this sort of net gas positive and more and more producers will be working as hard as they can to get into that position it’s going to actually become more challenging for Ethane based cracker operations outside of Europe to compete in Europe because the consequence of high European gas prices is a very elevated demand for LNG.

We are already seeing an impact on the US markets where gas prices in the US are being supported by what’s happening in Europe, and this is pushing our costs up. So, I think the reality is it doesn’t say, you know, the European industry is going to stop operating. There are derivative sectors so if you look at propylene oxide, PVC, and oxo alcohols, these derivative sectors are definitely at risk from a European perspective, from imports. Then the question will be whether those imports make sense from the US markets or from Asian markets, which are seeing, you know, different cost dynamics and a much weaker position. So, I think it’s, it’s not a simple solution. There are definitely derivative sectors and other parts of the industry. If you look at ammonia production, if look at some of the metals production work, big energy requirements are seen and those will clearly struggle in the current environment.

We’re seeing a lot of assets being idled and turned off but for the olefins industry, it’s a more complex picture. It’s not one where there’s a simple solution. Even if you look at the Ethane cracker in the north of the UK, which is running off North Sea Gas, Ethane as a byproduct of that gas production is a feedstock. You know, traditionally you look at that ethane valuation against fuel value plus some extraction fee. Well, the reality is that crackers shouldn’t be running that. They should be selling all the Ethane into the gas system. But the truth is, if you do that, you can’t actually run the gas production because you have too hot a gas that the energy content is too high. So, there’s a need to actually pull that Ethane out to ensure you can produce the gas from the gas system.

So even where you see these specific situations where probably, you know, the economics on that plant-based on whatever contracts are in place, don’t look at all attractive they’re still going to be run because the consequence of turning them off is too severe. So, we are seeing, you know, limited risk of impact on European olefins production, but we do see some of the derivative sectors and that will have a knock-on impact on ethylene and propylene demand really struggling in the current environment. And, you know, that’s probably going to stay as bad if not get worse as we move through the winter.

So, Matthew, interesting. I mentioned the operation of the crackers and you had mentioned before, you know, all the different tweaks that operators can do in the severity, they’re cracking the feedstock and so many other little things that can be adjusted. I mean, our crackers running at this point to make guesses are, is that why we’re seeing cheap problem flowing, flowing on this side in the US?

Well, I think if you look at the numbers in August, what you’d find is that actually, a steam cracker has a higher revenue stream, if you like, from gas production than they do from ethylene or propylene production. So, you know, we are in a very bizarre environment, you know, particularly if you look at, you know, a propane cracker where you get a particularly high yield of gas. But the reality is to run that cracker you need to feed a big chunk of that gas back, into your furnace system. So, until crackers have effectively regressed 20 years and undone the shift away from fuel oil as a furnace feed towards natural gas until that’s reversed, you’re not really going to see the sort of extreme where, you know, crackers are being totally optimized for fuel, gas and hydrogen production.

But to be sure, when you look at, you know, cracker LP systems, you know, there is a very, very strong weighting towards pushing gas outputs, fuel, gas, hydrogen production output as high as possible to run as severe as you can. And you know, this is, you’re still running for ethylene because ethylene so far, I haven’t picked up anyone using ethylene as a fuel. But the reality is that you know, the ethylene market, the derivative sectors with the exception of PVC are less energy intensive than propylene. And therefore, we’ve seen, you know, a bigger impact on propylene, whether that’s OXO or PO and to some extent, polypropylene linked into the challenges for the automotive sector and consumer goods. So, propylene is seeing a bigger demand challenge than ethylene, and this is really pushing the propylene markets to such length that it makes sense to displace US exports of propylene with European volumes into Mexico and Columbia. And, you know, if things get really bad, then you might even see European products coming into the US market. So there are very few signs of relief for propylene sellers in Europe. And so, we’re seeing these, you know, extremely low spot valuations.

As you implied before, Matthew, we could talk about this all day. It’s clearly a very multifaceted issue. But thank you for taking the time to be with us today. It has been a pleasure to have you on.

It’s been great to chat Pablo and thank you for your time and this opportunity. We are trying to keep on top of what’s happening so I’m sure I’m going to be dragged back for another discussion on this, as the AUT fall and winter progress.

Thank you, Matthew. Don’t forget to subscribe to our podcast on SoundCloud, Spotify, or wherever you get your podcasts, and give us a like or leave our review if you enjoy it

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