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Crude oil prices have fallen recently due to a number of factors including monetary tightening in China and banking regulations in USA apart from easing of winter chill. But even amidst this scenario the Bank of America-Merrill Lynch (BofAML) believews that increased petrochemical demand suggests a recovery ahead for energy complex.

A surge in petrochem demand and a steeply backwardated naphtha market suggest that, in absence of major external shocks, a cyclical recovery for the broader economy is around the corner. Historically, demand for naphtha, a key input into petchem processes, has led demand for other petroleum products. It should be no different this time. With more demand and low refinery capacity utilization, global naphtha stocks are drawing quickly. Currently at $2.10/bbl, front-month NWE naphtha cracks are above the seasonal norm, and backwardation in naphtha and other petchem feeds such as propane or butane could continue in the near-term. Tight now, liquid gas supply is increasing in second half of 2010, BofAML analysis said.

BofAML analysis said that there could be an 8.6 million tons/year increase in ethylene cracking capacity this year, suggesting that the market will be craving for incremental feedstock. However, a potential increase in OPEC NGL supply of 600 thousand b/d this year should temper propane prices, limiting the upside on naphtha as these new barrels enter the petrochemical stream. Thus, with the end of winter reducing demand for liquid gas and petrochemical units going into maintenance in early March, the strength in the very light ends could start to fade as other parts of the barrel like gasoline and middle distillates start to pick up some steam.

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The fiscal situation in Greece is cause for concern but a cyclical upswing in economic activity is likely in Europe led by the need to replenish depleted finished good stocks. Outside the OECD, particularly in China, demand has accelerated in the last few months. In spite of the recent sell-off, BofAML still believes that tighter money supply in China is a net positive for commodities as long as it occurs through a stronger Chinese Yuan (CN)Y and not through higher interest rates.

Historically, petrochemical consumption has led oil demand. BofAML analysis shows that demnad for naptha, a key input into petrochemical processes, has teneded to lead demand for other petroleum products as petrochemical plants rushed to supply plastics and other products to manufacturers in the early phases of an economic recovery.

The surge in petrochemical utilization rates is being partly masked by the rapid increase in petrochemical processing capacity around the world. Global ethylene production capacity increased by 4 million tons/year in 2009 even as other industries contracted. Ethylene capacity around the world is now forecast to grow by 6.5% in 2010, according to CMAI. This newly added capacity is the largest in recent memory and should increase demand for traditional petrochemical inputs going forward, including naphtha as well as liquid gas.

…but capacity utilization is still running very high…
Thus, capacity has already started to increase and will likely continue to expand over the coming weeks and months. But despite the ongoing capacity increases, petrochemical demand continues to run strongly. Global utilization rates at ethylene crackers and other petrochemical units have increased to very high levels in various parts of the world. It is important to note that both advanced and emerging economies are experiencing increased demand for petrochemical products. According to the Fed and Ministry of Economy, Trade and Industry Japan, aggregate chemical sector capacity utilization rates in the US have
recovered to 76%, while in Japan utilization rates have reached 89.5% in the last month.

…as Asian demand for petrochemical products is robust
No doubt, Asian petrochemical demand has increased at a phenomenal rate in recent months on the back of a rapid recovery in orders at early cycle exporting nations such as South Korea and Taiwan. With petrochemical demand on the rise in Asia, demand for naphtha across the region has surged to very high levels. In particular, China’s demand for products related to the petrochemical sector, including LPG and naphtha, surged by 250 thousand b/d or 17.5% in 2009 compared to the previous year. In fact, half of China’s oil demand growth last year was linked to these two very light end product group.

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