Petrochemicals review: Where we are now and where we’re going

This year’s trajectory for petrochemicals has been marked by softening demand, increased capacity online, historically low earnings across various chemical value chains, and slowing growth in circularity.

However, we expect moderate improvement in the near term, particularly toward the end of 2024.

By contrast, 2023 unfolded against a backdrop of fluctuating trends in the aftermath of the COVID-19 pandemic. In 2020, demand uncertainty ultimately led to resilience as consumers shifted the bulk of their spending from services to goods purchases. The subsequent years saw record earnings for many value chains, fueled by strong demand coupled with supply chain disruptions. In late 2022, however, the situation reversed: supply chains reopened, retailers scaled back on building inventory, and inflation accelerated. At the same time, the Russian invasion of Ukraine affected energy costs and local demand for European producers, and strong China-led demand recovery was noticeably absent.

Despite these challenges, conditions may now be in place for a more typical recovery cycle, albeit one that plays out over several years. Forecasts show demand growing to match existing and in-progress capacity in some chains, and supply chains maintaining somewhat “normal” price linkages among regions.

Looking back

In 2023, the petrochemical industry saw a challenging period marked by slow demand growth and surplus capacity. Although many of these changes occurred in Europe and Asia, this downturn reveals four major themes shaping the global industry’s current situation.

Global economic weakness and destocking drove demand deceleration

The global economy experienced less growth in 2023 than in the previous year. This was primarily because of sluggish macroeconomics in the European Union and lower-than-expected growth in China, and it contributed to a challenging economic environment leading to lower end-market demand. Based on quarterly growth and the consensus view, GDP globally and in the European Union reached some of the lowest levels of the past decade (excluding 2020), falling to approximately 2.6 and 1.0 percent, respectively. And China’s GDP growth slowed to around 5 percent, weaker than average prepandemic annual growth of 6 to 8 percent.

In addition to weakened GDP growth, a number of petrochemical players noted major slowdowns or even declining demand, in many cases linked to downstream inventory (destocking). On this point, retailers built up inventories from 2021 to the first half of 2022 after supply chain disruptions caused by the pandemic left them at low levels. During this time, demand for chemicals was strong because consumer demand was geared toward goods.

Starting in the second half of 2022, however, supply chain disruptions subsided and interest rates rose, which led retailers and other businesses to trim their elevated inventory levels. In terms of demand, this created a headwind for upstream products, such as consumer goods and packaging. Similar to a “bullwhip effect,” demand loss was higher in magnitude further upstream—particularly affecting chemical players.

Although destocking has continued at the retail level since the second half of 2022, end-market sectors still face elevated inventory levels compared with before the pandemic. For example, players in consumer packaged goods and plastic-and-paper packaging saw inventory levels 15 to 20 percent above pre-COVID-19 levels, which could indicate a headwind for demand in 2024 (Exhibit 1).

Even so, there is reason for some optimism in 2024. Production in some industries remained strong in 2023; for example, production of light vehicles increased by 1.8 percent in third quarter 2022 compared with third quarter 2023, according to our analysis. More recently, GDP outlook has remained positive with rising expectations for a “soft landing” in the economy. And retailers are approaching normalized inventory levels and are likely to return to normal order patterns.

Waves of new capacity led to historically low operating rates

On the supply side, 2023 saw a significant increase in capacity coming online. In ethylene, for example, approximately ten million metric tons per annum (MTA) of additional cracker capacity reduced utilization to approximately 80 percent. This situation will likely persist in the near term despite market challenges, progress on current builds, and continuing project announcements, such as new permits in China.

Other petrochemical value chains are experiencing a similar trend, with 11 MTA of propylene capacity and 12 MTA of benzene and para-Xylene capacity coming online in 2023, resulting in utilization rates dropping to ten-year lows. The oversupply has also affected downstream intermediates and commodity chemicals further down their respective value chains, resulting in historically low utilization rates for propylene oxide (PO), ethylene glycol (MEG), polycarbonate (PC), and acrylonitrile (ACN) (Exhibit 2).

These market conditions could drive more rationalization—by which we mean reducing capacity to improve operating rates—in Europe and Northeast Asia, partially offsetting oversupply. On this point, Europe has seen a number of recent plant-shutdown announcements because of pressured market outlook, cost competitiveness, asset attractiveness, and sustainability. In addition, with tightening environmental regulations in China (in 2020, President Xi Jinping pledged to reduce the country’s emissions by 65 percent by 2030), the government has announced plans to accelerate the retirement of naphtha crackers with capacities of less than 300 kilotons per annum (KTA).

Petrochemical returns remained challenged relative to the broader market

In the second half of 2022 and into 2023, shareholder value in the petrochemical industry remained relatively flat. In fact, average TSR from the first quarter of 2022 to the third quarter of 2023 dropped by approximately 10 percent, diverging from the MSCI World Index (Exhibit 3). This highlights persistent challenges amid market headwinds and lower EBITDA margins. In Europe, companies grappled with worsened market conditions because of decreased prices and volumes from supply chain recoupling and high energy prices. In Asia, substantial overcapacity and weak demand led to negative margins for major value chains, such as ethylene, polyethylene (PE), and polypropylene (PP). And in North America, feedstock advantages in ethylene were partially offset by lower marginal producer cash cost as naphtha in Asia was priced low because of the combination of weak gasoline and cracking demand, and stable diesel demand kept refinery run rates stable.

To navigate these challenges, chemical companies implemented cost-cutting measures such as operations and supply chain improvements, turnaround and small-project optimizations, workforce reorganization, and procurement enhancement. At the same time, restructuring programs, including asset shutdowns in Europe and divestitures in less-core assets, show the industry’s commitment to fortifying positions amid challenging market dynamics.

Circularity initiatives persisted, although the rate of investment decelerated

Announced capacity for advanced recycling dropped to less than one MTA in 2023 from higher project announcements in 2021 and 2022. In addition, various factors, including virgin-market pressures and diminishing premiums for high-quality recycled content, led to the delay of several large-scale pyrolysis projects.

Despite this moderation, the average recycling capacity of announced projects more than doubled in 2021–23 compared with projects announced in 2018–20. Players largely transitioned from specific technology providers to larger multinational chemical companies focusing on waste feedstock securities and offtakers, signaling a strategic evolution in the sector.

Overall, the industry continued to advance the energy transition through sustained investments in decarbonization. In Europe, the diminishing availability of free allowances under the EU Emissions Trading System and the increasing clarity of carbon pricing underscored the growing relevance of decarbonization efforts. Meanwhile, several industry players disclosed intentions to retrofit existing petrochemical assets using available lower-carbon technologies, such as hydrogen for crackers, to curtail their carbon footprints.

Looking ahead

We anticipate a modest improvement in market conditions, with demand growth at or slightly above 2023 levels. Global GDP growth in 2024 is expected to be similar to 2023 growth, but destocking headwinds could subside as markets reach normal inventory levels halfway through the year (retail destocking was mostly completed by the end of 2023). The upside scenario entails strong demand-growth recovery in China, which has been tepid since 2020, but expectations here are relatively muted.

On the supply side, new capacity is still scheduled for start-ups to come online, especially in the PP and polyethylene terephthalate (PET) chains. Globally, the industry is expected to add another nine MTA of propylene capacity and eight MTA of PET capacity (around 6 percent of global capacity), mainly in China. The wave of ethylene expansions is finally receding (for now), with capacity growth of 3 percent in 2024, in line with expected demand growth. However, all eyes are on the second wave of Chinese crackers, announced for 2027–29.

Beyond the major polymer chains, significant capacity additions are also expected in PO (although offset by closures of chlorohydrin capacity), PTA, PC, and the acetate and vinyl acetate monomers (VAM) chains. As a result, the oversupply situation could continue past 2024, with moderate improvement possible in select chains, such as PVC.

Four areas illustrate the uncertainty of—yet material impact on—industry profitability over the coming year: petrochemical demand growth in China, industry rationalization, price increases for naphtha versus crude, and new trade barriers and duties.

Petrochemical demand growth in China

China represents almost half of global petrochemical demand, and the consensus GDP outlook is for similar growth to the previous year, at approximately 5 percent, in the near term. That said, China’s destocking process is nearly complete, with inventory levels of industrial finished goods dropping to historical lows, which could help to restore the link between end-market growth and chemical demand (Exhibit 4). Stronger petrochemical demand in China could potentially improve operating margins for Chinese producers, which in turn would lift pricing globally for most petrochemicals because of trade linkages, and support higher—or less negative—margins (potentially $50 to $150 per metric ton).

Industry rationalization

Given the low margins seen in many chemical chains, there is active public discussion of rationalization in chains such as MEG and PET. In the past decade, the industry has sometimes kept assets running for longer than expected, with limited plant closures, in large part because margins were broadly attractive (Exhibit 5). As the pendulum swings toward a prolonged low-margin environment, uneconomic capacity could be at risk of closure, particularly in Europe and Northeast Asia. The latter, in particular, has significant capacity serving the Chinese market. However, utilization of that capacity is declining as China becomes self-sufficient.

In addition, recent government pushes toward higher-efficiency and lower-carbon footprints (such as Japan’s Revised Act on Rationalizing Energy Use) are likely to accelerate the closure of older assets, either because of direct intervention (such as China’s ban on chlorohydrin technology for PO production by 2025) or indirect pressure (such as the phaseout of free allowances in the European Union). Although the European Union’s Carbon Border Adjustment Mechanism (CBAM) will likely protect domestic industry decarbonization investments, some producers are expected to shut down marginal plants rather than make capital investments on top of decarbonization investments. On this point, decarbonizing older, less efficient plants will be more expensive than decarbonizing newer ones or simply building greenfield net-zero units. The immediate impact would incur costs but could also improve the global supply–demand balance and hasten the return to zero margins in China.

Price increases for naphtha versus crude

Although crude oil is predominantly used in transportation fuels, some of the naphtha portion of crude oil is used in the production of petrochemicals (including plastics via ethylene cracking). This means that naphtha pricing is affected by both transportation fuel markets and demand for petrochemicals. For the past 18 months, naphtha prices in Asia have been at a discount compared with crude oil (an average of $18 a barrel or $85 per metric ton between Singapore Full Range Naphtha and Brent). Oil refiners have been processing crude oil to satisfy strong demand for diesel, but gasoline boiling range material (including naphtha) is coproduced, and demand has not grown as quickly. In turn, the consumption of light naphtha for chemicals has been limited by slow demand growth, leading to oversupply and depressed prices.

In the near term, some improvement is expected in both the consumption of light naphtha for chemicals and gasoline demand, which could serve to tighten the naphtha market and move pricing back to its historical parity with Brent. This would increase the cost of production of naphtha-based routes to chemicals, which could benefit cost-advantaged producers (those that do not rely on naphtha-based routes for production of the same chemicals, such as gas-based crackers in North America or the Middle East). In the case of PE, the impact for those producers could be on the order of $100 to $150 per metric ton (assuming a similar oil-pricing regime).

New trade barriers and duties

With global overcapacity, high energy costs, and demands to decarbonize, European producers are acutely aware of their disadvantaged positions. In late 2023, Europe imposed provisional anti-dumping duties on PET imports from China, with a European Commission investigation concluding that low interest rates and government-owned companies constitute an unfair government subsidy. Consequently, producers of other commodities under threat of low-cost international imports are likely to explore similar actions, potentially targeting imports from other regions with strong government support for cheaper feedstocks. The immediate impact of the duties on Chinese PET are likely to be minimal, as the country does not export significant volumes of PET to Europe, but extension of anti-dumping duties to PVC, for example, could limit Chinese imports and raise margins for domestic producers by $50 to $100 per metric ton.

The case for cautious optimism

Given these factors, there is a basis for cautious optimism in the near term, especially for well-positioned producers (those with low costs, technological advantages, or modern or newly revamped assets) in North America and the Middle East.

  • North America. Margins in North America are expected to gradually improve as naphtha pricing is anticipated to rise relative to crude, improving ethane cracking advantages. In addition, there will be limited additional new capacity in the region in the near term, which will provide time for the market to absorb 2023’s new capacity additions, particularly in PE.
  • The Middle East. Similar to North America, margins are expected to gradually improve. The region is expected to continue moving downstream, suggesting increased construction of crude-to-chemicals and downstream derivatives refineries.
  • Europe. Although the industry continues to face challenges driven by slow economic growth, high energy volatility, and decarbonization requirements, as well as significant transformation and rationalization, well-positioned producers could potentially benefit from movements from net export to net import or regulatory actions. In addition, new circularity legislation and Carbon Border Adjustment Mechanism implications could enhance European competitiveness in select areas.
  • Asia. Pressured margins will likely continue as new and competitive capacity comes online in China, especially in PP and PET. Rationalization of older and smaller assets is likely to accelerate, but the balance between those rationalizations and new-capacity additions, as well as the evolution of demand growth in China, will determine whether there are near-term improvements.

Regarding key petrochemical value chains, continued oversupply is expected.

  • In ethylene/PE, supply and demand are both expected to grow at approximately 3% in 2024, thus keeping global utilization at approximately 82%. It is possible that margins in China will improve slightly, but a change in selling behavior is challenging to predict. The combination of discounted Russian crude oil and a high degree of both up- and downstream integration has kept Chinese margins below cash cost for much of the past 18 months. And with China being a net importer of PE, this new capacity will continue to back out marginal capacity in Northeast Asia, unless rationalizations happen quickly.
  • In propylene/PP, an additional 6% of supply could come online with demand growing by 3%, thus exacerbating an already oversupplied market with negative margins in China. It’s unclear how much lower propylene prices in China can go, however, as they are already at variable cost from the marginal production route.
  • In PET, there has been more PET (14%), PTA (13%), and MEG (4%) capacity coming online in 2024, which is pulling down global utilization. With China already a net exporter and trade barriers being established, it is unclear where this volume will go, potentially creating a bifurcated market with different price levels (China at or below cost, and the United States and the European Union importing from Northeast Asia).
  • In PVC, the value chain is likely to see some improvement in utilization rate with moderate demand growth of approximately 2% and more cautious new builds (1%).

With these points in mind, petrochemical companies may want to evaluate their participation and capabilities. Although there is some improvement relative to the recent past, a major upswing in margins is not expected. There could be differentiated pressure in commodity versus specialty grades (most new capacity in China is commodity grade), driving value from the highest grades, especially for polyolefins. Now is the time to ensure businesses are meeting their full potential, repositioning for the next decade (including considerations regarding circular economies and decarbonization), and moving strategic assets toward first-quartile performance.

A continued focus on cash preservation and cost optimization is also expected, but as the industry heads into its second year of reduced margins, many of the so-called easy actions (such as postponing capital investments) have already been taken, and now it’s time to look for more extensive programs. Thus, companies can evaluate whether additional value can be unlocked through a fundamental rethinking of their operating model, supply chain configuration, operating costs, capital deployment (maintenance capital), and procurement excellence. Digital and generative AI also present emerging opportunities to increase EBITDA in a cost-effective way.

Best-in-class operators can create value by consolidating assets, rapidly closing the marginal ones, and investing in or improving what remains. In addition, continued deployment of digital and AI can enable companies to drive additional margin from existing assets, with an uplift of 3 to 5 percent fundamentally changing decision making around capacity footprint.

Finally, straight M&A may not be the highest priority for most petrochemical companies because of high interest rates. Therefore, it may be time to think more creatively about consolidation through transformative asset swaps, merger-divestments (such as two companies spinning out their assets into a joint company), or Reverse Morris Trusts. As an alternative, companies with strong cash flow (such as oil companies) may find the current environment ideal for straight acquisitions, with potential focus on acquiring derivative technologies rather than just operating assets.

Demand deceleration and oversupply have created a persistent challenge for the global chemical industry that will likely extend in the near term. Players will need to go beyond preserving cash and tap into their strengths. This will enable them to lay a solid foundation for sustained growth and resilience in the ever-evolving industry landscape, and to prepare for a medium-term recovery as global utilization improves.

(Written by: McKinsey & Company)

For more articles and information, visit mckinsey.com

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