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

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By: Sakthi Prasad --

06 March, 2016

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

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:

  Coefficients Standard Error t Stat P-value
Intercept (PE) 66.24201128 3.948398659 16.77693085 4.06E-25
WTI Price (USD/BBL) 0.097535018 0.045130418 2.161181375 0.034429

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.