What type of relationship exists between prices of Crude Oil and Polyethylene?

In collaboration with Saravanan Vaithi, Lead Analyst – Packaging Polymers.  Statistical analysis done by Krishna Bhimavarapu and Indraja Jaiswal, Research Analysts — Forecasting

Polyethylene is derived from Crude oil; this important polymer can also be extracted from natural gas and coal. However, popular belief links crude with polyethylene more than any other feedstock.

It is logical to say that prices of crude oil, polyethylene and ethylene are related to each other. But what sort of relationship do they follow? Is it linear? Do they have high or low correlation?  Or are they related at all?

It is important for sourcing managers who operate at various levels of crude value chain to know the strength of such price relationship — because the price of crude will invariably work its way into purchase contracts of various polymers that go into a variety of end use products.

Alkarim Shamsy, CEO of CANEI Corp (Polymers) said that in the past, WTI and Brent did not move in tandem.

“However, over the last 18 months, we have seen them move with a higher correlation, especially once President Obama passed the bill allowing export of U.S. oil.  If you map the correlations between Ethylene, PE & Oil, it is very high. Therefore, a significant change in price in Ethylene and PE comes from changes in oil prices,” Shamsy said.

He also added that supply and demand play a big role. “U.S. Ethylene and PE have been moving in different directions than Asian Ethylene and PE because of supply and demand concerns as well as logistics,” he said.

However, Paul Cherry of Officium Projects said that in the past 18 months, PE prices globally have not fallen as much as crude “reflecting that the market is structurally tight due to a lack of new investment in recent years following the financial crisis. This effect has been more pronounced in the U.S. due to the barriers of entry for imported products from regions such as the Middle East and Far East.”

Paulo Moretti of PM2 Consult said that over the past 10-15 years, it is clear that Ethylene prices follow Crude Oil prices, even though it can be produced from natural gas.

“So in recent years where the Crude oil price was around $100/barrel, the PE producers (mainly in the U.S.) enjoyed a very good margin, because they used natural gas (which was cheaper) to produce Ethylene, however, the Ethylene price followed crude oil,” Moretti said.

He also added that regions with more dependency from Crude Oil like Europe and Asia did not enjoy such high margins.

For its part, Beroe conducted a test of significance between PE and WTI prices using Regression analysis. And this was our observation:

PE prices have some correlation with WTI prices (as indicated by the p value of 0.0344; we have a correlation when the p value is lower than 0.05).

However, it is a weak correlation (signified by low coefficient for WTI prices of 0.0975)

Also, we can notice that the intercept value is 66.24 and that its p value is very small (4.06E-25). This means that the relationship between WTI and PE prices are being affected by a few other parameters that are not being included in the model. They all are being shown in the equation in the intercept (which has a strong significance).

The model shows that there is some relationship between PE and Crude prices in the U.S. region – but not all of it can be explained from the point of view of crude prices.

Given that the prices of WTI doesn’t overly impact the price of Polyethylene (though this may change in the days to come), then does it make sense to incorporate crude price in calculating the purchase price?

Shamsy agreed that framing right contract clauses is not without challenges since getting to a value that is agreeable to everyone is tricky.

“It does make sense for contract prices to be based on oil, natural gas and ethylene but perhaps, there could be an addition with supply and demand being taken into account,” Shamsy said.

On the other hand, Cherry said that given the tightness in polyethylene market globally and the infrastructure barrier to imports, it would be better for PE buyers to link prices to oil, natural gas or ethylene if possible.

“To minimize risk over the long term, I would advocate trying to have a balance of price links to ALL of crude, natural gas, ethylene and PE,” Cherry said.

Big PE consumers have contract in place with formula pricing linked to Crude Oil, Moretti said.

“During the economic cycles, the buyers are protected against highest prices and during the trough, suppliers are protected against lowest prices. Those PE consumers without contracts will suffer (or enjoy) the spot prices: higher prices than contract in the peak (or lower prices in the trough),” Moretti said.

All these dynamics play out in the north side of the Crude supply chain.  And this brings us to a larger question whether end-use buyers (of products derived out of PE) have negotiation power in this market? Or is it suppliers who call the shots?

Paul Cherry of Officium Projects had this to say: “I think PE sellers hold the power in the U.S. market. The global tightness will reduce as new plants come up in the years ahead and even more so in the U.S. where many plants are being built, which should move the power more towards the buyers.”

Alkarim Shamsy, CEO of CANEI Corp (Polymers) said that this is a sellers’ market.

“However, with more and more capacity coming online, we could see the PE market move in the direction of the PET market, where there is oversupply and prices continue to remain depressed,”Shamsy said.

Paulo Moretti said that end-users of PE are more fragmented and have less purchasing power than the PE producers, who are more concentrated.

“However they also understand the PE price follows Crude Oil, so they will push PE producers to decrease the PE price when Crude oil is low,” Moretti concluded.

And the show goes on.

Key Takeaways

• Polyethylene is a polymer that is derived from coal, crude oil, and natural gas.
• The price of polyethylene and ethylene price have a correlation with crude oil.
• Sourcing managers need to understand the price effects by operating at the crude oil value chain. 
• The price of crude oil affects the prices of polymers which are used in numerous applications. 
• Brent and WTI initially did not work together closely. However, this has changed post a bill that was passed by President Obama to enable exports of U.S. oil 
• The supply, demand, and logistics play a critical role in the US ethylene price and polyethylene. 
• Paul Cherry stated that the polyethylene price chart shows the price has not fallen too low because of low investment ever since the financial crisis hit the market.
• The U.S. has restricted easy entry of imports from the Middle East and the Far East which has further contributed to the effect.
• The polyethylene producers enjoyed larger profit margins in the U.S. during the past few years as they utilized natural gas in production. This is indicated in the polymer price chart.
• This helped the U.S. producers cut costs and enabled them to produce Ethylene. The ethylene prices eventually caught up to those of crude oil. 
• Asia and Europe did not enjoy such high margins as they were heavily dependent on crude oil. 
• According to Beroe’s Regression analysis, the polyethylene price index had some correlation with WTI prices albeit a weak one.
• Beroe’s analysis states that although a relationship between crude prices and PE is evident in the U.S., there are other factors at play that are dictating the prices.
• Experts disagree when it comes to how polyethylene prices are calculated.
• The contract can help the buyer when the prices are skyrocketing and it can help the supplier when prices drop. This can impact the LDPE procurement.
• Those without a contract who consume PE will either be at a disadvantage or an advantage. For example, if prices are higher than in contract then they will need to pay higher but if the prices are lower then they will get to save.
• In the U.S. market, the sellers of polyethylene are the ones holding the power at present and the market is tight globally.
• As plants are being built across the U.S., the power can move to the buyers who will end up having more control in the future.
• A transition worth noting is how everything is moving online now and will continue in the future. This can push the PE market in the direction of the PET market.
• At present, the PET market has an oversupply which means the PET resin price index and PET resin price chart shows it is always low 
• According to Mr. Moretti’s observation, PE end-users are fragmented while the producers are concentrated which gives the end-users less purchasing power.