WHITE PAPER. Bringing Transparency to the Petrochemical Markets. January 16, By David Hanna Platts Global Director of Petrochemicals

Transcription

1 Bringing Transparency to the Petrochemical Markets January 16, 2007 By David Hanna Platts Global Director of Petrochemicals

2 Copyright 2007 Platts, All Rights Reserved

3 Bringing Transparency This is one in a series of occasional discussion papers examining price discovery issues and commodities markets. VOLATILITY TAKES CENTER STAGE Managing the impact of high price volatility has become a critical issue for the global petrochemical industry. Petrochemical markets have witnessed an unprecedented level of volatility since the run-up in energy and commodity prices started over three years ago. Moreover, volatility is here to stay. Gone are the days of comfortable predictability in price trends. We have entered a new era of sustained high volatility. Mitigating the risk associated with fluctuating prices will continue to dominate the industry s agenda for years to come. There have been a number of drivers behind the increase in volatility. These include: More competition: Traditional importing countries such as China have embarked on world-scale capacity expansions while the Middle East has entered a massive capacity expansion phase of its own based on competitively cheap gas feedstocks. Although the Middle East accounts for only 10% of global ethylene capacity, the region has the single largest capacity surplus and accounts for most of the new incremental capacity that has come on stream this decade. In 2007 alone, the Middle East is expected to add some 4- million mt/year of new marginal ethylene capacity. Moreover, a growing emphasis on share holder value at the corporate level has added pressure for companies to improve their bottom line on a quarter-by-quarter basis, further exacerbating the competitive environment. More trade: Chinese plastics imports, a barometer of global petrochemical trade activity, have been growing about twice as fast the Chinese economy at large, or roughly four-times faster than global GDP growth, according to Platts estimates. Increased sensitivity to oil: Petrochemical prices have become increasingly sensitive to changes in upstream oil prices as players who have traditionally ignored the oil markets are now taking their cue from the crude complex. Prices for benzene, for example, have been far more erratic than benchmark Brent crude oil since Measured as the absolute standard deviation as a share of the mean, the volatility of European benzene during the period has averaged 42%, about 1.2 more pronounced than the volatility of Brent, which averaged 34% (see Figure 1). Small markets: Volatility is also tied to a number of structural factors. By definition, the petrochemical market is about one-tenth the size of the oil market, as petrochemicals represent only one of several outlets for oil use. As a result, the impact of any given transaction in this relatively small market space tends to have a disproportionately large impact on the overall market. Opacity: This is further exaggerated by the fact that, compared to oil, the petrochemicals market is relatively opaque and closed. This, in turn, can be traced to the fractured nature of this market which consists of numerous small niche segments as well as the conservative mind-set of its participants. The lack of transparency creates an environment of uncertainty, and under such conditions prices tend to overreact to news events. Figure 1: Petchems even more volatile than oil Jan 00 NWE Benzene v = 42% Brent v = 34% Sep 06 Source:Platts Bringing Transparency to the Petrochemical Markets Page 3

4 Bringing Transparency THE NEED FOR TRANSPARENCY AND PLATTS RESPONSE With volatility comes uncertainty and greater exposure to risk. Platts believes that this risk can be mitigated by transparency both in the marketplace and in the way that prices are assessed. Based on this principle, Platts assesses petrochemical prices using the Market on Close, or MOC system, in which assessments represent the market value as of the close of the trading day or week. This contrasts with assessment systems based on an average or range of prices during the course of the trading period. Throughout each day, Platts reporters post bids, offers and transactions on the Platts Petrochemical Alert (PCA) real-time price and news platform. This information serves as the basis of the final assessments. In 2005, Platts upgraded the MOC system for the Asian and European aromatics markets by introducing an end-of-day 30 minute trading window in which fully transparent bids and offers are considered for the assessment. Platts has also started to lay the groundwork for the introduction of a similar mechanism in the US aromatics markets in the second half of Since the first phase rollout of the MOC window in Asia in June 2005, the number of transactions, bids and offers posted on PCA page 5 the Heards page has more than doubled to an average of 200 per day. The MOC window effectively creates a pool of liquidity by concentrating activity toward the end of the day. But it has also generated more overall liquidity by ensuring that all credible market participants have a voice in the price discovery process. MARKET ON CLOSE ASSESSMENT (FOB USG BENZENE) 10:00 am 280 cts/gal 1:00 pm 285 cts/gal 4:15 pm 290 cts/gal Assessment = cts/gal Assessment = cts/gal The success of the fully transparent MOC window in the Asian aromatics market has also fostered an environment in which over-thecounter swaps contracts have reemerged to provide the market with greater hedging opportunities. For any financial derivative instrument to function well, it must be based on a reputable underlying physical benchmark. The MOC system for Asian aromatics has provided this reliability by eliminating the subjective element of the assessment process. Assessments are based on testable transactions, not hear-say. As a result, in 2006, trading of swaps contracts by brokers, traders and producers has taken off, particularly for paraxylene, benzene and toluene. During a typical trading week, it is now common to see 1-4 swaps deals a day. Figure Heards Players Full transparency 60 Daily average trades Unnamed but firm bids/offers Window participants 0 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Jan-06 Mar-06 May-06 Jul-06 0 Source:Platts Page 4 Bringing Transparency to the Petrochemical Markets

5 Bringing Transparency THE LOGIC OF MOC Why does Platts employ the MOC system? Why not an average or range of daily prices? There are three key reasons for this: Platts believes that price is a function of time. An average is an artificial mathematical construction that does not reflect actual market activity. Market participants tend to take their cue from where the market left off during the previous trading session. The first bid, offer or deal of the day is likely to be based on the price level at which the market closed the previous day. This means that, in a scenario in which prices are rising on an intra-day basis for example, an assessment based on an average of the day would have a bearish bias. LOOKING AHEAD Petrochemical markets are becoming increasingly integrated internally among the various geographic regions and product chains, and externally with the energy complex. As a result, consistency of approach in assessing prices has become that much more important to the industry. It is for this reason that Platts is bringing greater transparency to markets through the MOC system. Part of being transparent is having an open methodology available for the global community to see and comment on. We invite the industry to visit our website and share their thoughts with us as we continue to work for greater transparency in the markets we cover. Paper markets such as futures and swaps are already based on an MOC system, so employing MOC for physical assessments creates a seamless connection between the paper and underlying physical markets. This is required for hedging instruments to function properly. Bringing Transparency to the Petrochemical Markets Page 5

6 For almost a century, the energy industry has looked to Platts for its expertise in oil, natural gas, electricity, nuclear energy, coal, petrochemicals, metals, and energy shipping. Today, from its 15 global offices, Platts is the industry leader in news, analysis, benchmark pricing, risk management, analytical tools, and energy conferencing for the markets it serves. For more information contact your nearest Platts Office Telephone PLATTS8 (toll free) Web support@platts.com 2007 Platts, a Division of The McGraw-Hill Companies, Inc. Reproduction of this publication in any form is prohibited except with the written permission of Platts. Because of the possibility of human or mechanical error by Platts sources, Platts does not guarantee the accuracy, adequacy, completeness,or availability of any Platts information and is not responsible for any errors or omissions or for the use of such Platts information. Platts gives no express or implied warranties, including, but not limited to, any implied warranties of merchantability or fitness for a particular purpose or use. In no event shall Platts be liable for any direct, indirect, special, or consequential damages in connection with subscribers or others use of this publication. The McGraw-Hill Companies