Wow! How the U.S. petrochemical world has changed! The shale gas “revolution” has made the production of ethylene from ethane so profitable that a downstream integrated ethylene producer can now “donate”( well, actually sell, but under favorable conditions) some of his profits to investors in a new Master Limited Partnership(MLP) that will own the olefin production facilities and will sell the ethylene to the owner of the downstream facilities (polyethylene, PVC), on a cost plus basis. Westlake MLP has just filed a registration statement that people familiar with the industry may want to read.
Profits from production of ethylene used to be highly cyclical, depending on the state of the industry: High margins (though nothing like today’s) when there was a shortage and little or no profit at other times. Ethylene prices are set by supply-demand considerations and the cash cost of the marginal(highest cost) producer.. With naphtha the dominant global feedstock and high U.S. natural gas costs, the U.S., before the fracking era, had little competitive advantage. The above graphic shows how things have changed. The U.S. and the Middle East are now the lowest cost ethylene producers and the world ethylene price is set by Europe and Asia, the marginal producers, which continue to use naphtha feedstocks. Under current conditions, U.S. ethylene producers have a profit margin of around 40 cents per pound at relatively stable year/year ethylene prices around 55 cents per pound, based on naphtha feedstock from $ 100 per barrel crude oil. The proposed Westlake MLP will sell its ethylene to Westlake Chemical at cost plus a fixed margin of 10 cents per pound, allowing the chemical company to retain most of the margin. Nevertheless, investors in the MLP should enjoy a good return with relatively little risk. And the principal Westlake Chemical owners will, no doubt, be substantial investors as well as general partners in the MLP (as was the case in another highly successful MLP in the fertilizer area created a few years ago when Terra Nitrogen MLP was spun off from Terra Chemicals after a merger).
An article in the June 2nd edition of Chemical and Engineering News discusses the recent rapid growth of MLP’s (see graphic) which offer substantial tax advantages as they avoid the double taxation (to corporations and investors) inherent in corporate dividends and because some or most of the dividends are treated as return of capital.They have been used for energy assets used by firms that generate 90% of their income from extracting, transporting, processing or selling natural resources, mainly natural gas and oil. Recently, ethylene plants were added to the list of eligible assets for MLP’s.
Time was, as they say, when petrochemical producers thought about (but didn’t) spin their (high investment/uncertain profitability) ethylene plants off as “utilities” that would guarantee investors a small (taxable) profit for delivering and selling ethylene to their downstream operations. That way, the uncertain financial performance of their ethylene plants would come off the company’s books. With successful MLP’s paying dividends substantiall higher than those offered by large utilities and tax free to boot, this idea has been realized in a manner that seems like a win-win situation for everybody.
A number of other petrochemicals producers (e.g. Methanex, Dow, Lyondell) are studying the possibility of creating MLP’s. As a long-time investor in successful MLP’s (not all are doing well for various reasons), I will be taking a close look at the Westlake MLP when it comes out. It’s true that other countries will sooner or later have shale gas, but short of an economic collapse of the petrochemical industry it will be a long time before the global price for ethylene (i.e. with crude oil-based plants as marginal producers) will change, making the Westlake MLP an interesting proposition if the dividend is attractive.