Korea's petrochemical industry, which has embarked on voluntary business restructuring to break out of a structural slump caused by excess supply from China and weak demand, has hit the obstacle of a sharp surge in global oil prices. When global oil prices jump, petrochemical corporations face a double burden of higher costs and weakened demand. In particular, domestic petrochemical corporations mainly use the naphtha cracking center (NCC) process, which relies on naphtha derived from crude oil, making them highly vulnerable to oil price swings.
Global oil prices are soaring as Iran effectively blocks the Strait of Hormuz, a strategic chokepoint, following U.S. and Israeli airstrikes on Iran. On the 3rd (local time), West Texas Intermediate (WTI) jumped 6.28% from the previous day to close at $71.23 per Barrel. Dubai crude and Brent crude also rose more than 6%, finishing around $76 and $77, respectively. Swiss investment bank UBS warned that if the closure of the Strait of Hormuz is prolonged, Brent could top $120.
The Strait of Hormuz is a key shipping lane through which about 25% of the world's seaborne crude flows. Most export volumes from major oil producers, including Saudi Arabia, Iraq, Kuwait, the United Arab Emirates (UAE) and Iran, head to Asia, Europe and the United States via this route. Immediately after the strikes, Iranian semi-official media reported that the strait was effectively closed. With reported cases of attacks on civilian vessels, shipping companies are canceling transits one after another. It is uncertain how long the disruption will last.
The domestic petrochemical sector is concerned about an immediate increase in cost burdens. The price of naphtha, a basic feedstock for petrochemical products, moves in step with oil. When global oil rises, naphtha prices also jump. If corporations cannot immediately pass higher costs on to final products such as plastics and fiber feedstocks, profitability deteriorates.
The problem is that it is difficult to pass higher costs on to product prices as oversupply of basic olefins such as ethylene worsens due to China's massive capacity additions. Profitability indicators for petrochemical products are determined by the spread—the product price minus feedstock costs—and the spread is already in negative territory. The breakeven point for the ethylene spread is typically $250 to $300, but recently prices have been set below $100.
Last year, the combined operating loss of major petrochemical corporations reached about 1.5 trillion won. Lee Jin-ho, an analyst at Mirae Asset Securities, said, "Recently, the ethylene spread fell below $100, raising significant concerns about worsening earnings," adding, "This situation could further deteriorate the performance of domestic petrochemical corporations."
Product demand is also more likely to worsen. If consumers' purchasing power weakens due to high oil prices, demand for chemical products falls in downstream industries such as autos, home appliances and construction. The time gap between when feedstock is purchased and when products are sold is another variable. When oil prices spike, companies can incur losses if they cannot sell products made from expensive feedstocks at appropriate prices.
The NCC process used by domestic petrochemical corporations is particularly vulnerable to oil price volatility. Feedstock costs typically account for 70% to 80% of NCC operating expense. By contrast, the United States and the Middle East use the ethane cracking center (ECC) process, which uses ethane as a feedstock with little price fluctuation.
Transportation costs are also a burden. According to the Korea International Trade Association, 29% of total production of six basic olefins, including ethylene and propylene, was exported last year. Rising transportation costs due to geopolitical risks can weigh on petrochemical corporations with high export ratios. When global oil prices rise, ship fuel costs increase immediately.
In the petrochemical industry, which is carrying out business restructuring, companies are watching oil price trends closely. An industry official said, "We still have existing naphtha inventory, so we expect the short-term impact to be limited," but added, "If the situation drags on, we expect naphtha prices to rise and are reviewing response strategies." The official added, "Even if global oil prices surge, the industry's common stance is that structural reform must proceed in good faith."
Meanwhile, on the 25th of last month, the government approved a plan to provide 2 trillion won in financial support and about 100 billion won in cost-saving benefits to the Daesan petrochemical industrial complex, the first "No. 1 project" of business restructuring. It plans to approve business restructuring for the Yeosu and Ulsan complexes in the near future.