Shale Gas Fuels Expansion of Commodity Chemical Plants -- And Challenges

The valve and pump industry stands to benefit mightily from the U.S. shale gas revolution via a surge in petrochemical production that the Boston Consulting Group (BCG) calls "a once-in-a-century opportunity."

The payoff for valve and pump manufacturers and suppliers lies in capacity expansions and new pipeline infrastructure for a number of commodity chemicals whose production will benefit from low-cost supplies of natural gas and precursors of natural gas liquids as a result of the shale gas revolution.


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The chemicals cited in an April report from BCG are methanol, ammonia, ethylene and ethylene derivatives, and on-purpose propylene. In the report, "Seizing the Opportunity in U.S. Petrochemicals," BCG states that more than $70 billion of capital expenditures for production and distribution of these materials by 2020 have been announced, and the total could exceed $100 billion by 2023.

The report focuses on companies and investors, both U.S. and foreign, that plan to build production and distribution facilities. But these businesses face challenges that may also affect process equipment suppliers and contractors, in such areas as project management, construction deadlines, availability of equipment and skilled workers, and profitability. Problems in any or all of these areas will affect the bottom lines of suppliers.

In methanol, for example, BCG expects that planned capacity will be built. This will transition the United States from a net importer to a net exporter of the chemical, as a result of increased supply and lower prices on the global market due to less expensive precursors and production costs.

One key to maximizing business opportunities here, the consultant notes, is speed: "The first plants to launch will likely be able to sell their output domestically, capitalizing on strong existing demand." Valve and pump suppliers and contractors, consequently, will need to make certain their inventories and delivery and installation schedules meet construction deadlines.

In greenfield plant construction, cost will be a major issue, since new facilities entail high expenditures. Also of concern is capacity planning that meets realistic market projections without overbuilding. Ten greenfield, brownfield, and debottlenecking projects are slated in ammonia production between now and 2018, representing 10.9 million metric tons (24 billion lb) of added capacity.

This surge in capacity could drive construction costs higher, BCG writes, and impact profitability. The prospect of reduced returns might lead to a scaling back or canceling of projects, especially if rival facilities - and their capacity - threaten product margins. Margin concerns among these chemicals makers could exert downward price pressure on valve and pump suppliers.

The market for ethylene and derivatives points up another challenge: balancing market demand with acceptable returns. Companies and investors have announced 10 million metric tons (22 billion lb) of new ethylene production in coming years. While U.S. ethane supply is forecast to exceed domestic demand through the decade, the U.S. market for common derivatives is only growing 1 to 2 percent annually. As a result, BCG advises new chemical supplier entrants to consider partnerships or joint ventures to mitigate investment risks.

A somewhat similar situation exists in on-purpose propylene supply. Although there has been a reduction in propylene production owing to greater use of ethane in steam crackers and shuttering of capacity, demand for propylene derivatives is high. So much so that U.S. polymer-grade propylene prices, historically less expensive than ethylene, were up to 1.65 times higher in 2013, BCG states. Propylene, in fact, hit $1,740/ton in February 2013 and was above $1,620/ton last February. In contrast, propylene averaged $1,330/ton in 2012.

As a result, plans have been announced for construction of five propane dehydrogenation units in the United States. While BCG did not disclose capacities, it notes that this creates a "potential for overbuilding of production capacity and for rising propane prices [that could narrow this [propylene price spread over time, reducing the financial incentive for additional investment." Hence, as with any plan that involves investment in commodity chemicals, calculating the right balance of supply and price and being first to market will determine profitability.

Margins will also be influenced by project size and management. BCG estimates that 75 percent of "megaprojects" across all industries "are beset by delays, budget overruns, or quality problems." These issues "can reduce a project's net present value by fully 75 percent and increase necessary capital expenditures by as much as 5 percent," the consultant advises.

Among the recommendations BCG makes to chemical producers in order to optimize profitability is maximizing the standardization of large plants. Customizing smaller plants has little or no cost penalty, but with megaprojects, it means "exponentially greater complexity and cost" -- a strong argument for process equipment makers to promote the value of standardized valves and pumps.

The consultant also urges companies to move with timely, transparent, and informed decision-making. This may seem obvious, but not doing so can reduce capital intensity by 20 to 35 percent, BCG writes.

The coming years should be very good for valve and pump manufacturers. But as the report notes, challenges exist and equipment suppliers need to understand how they relate to their operations and adjust accordingly.

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