ANALYSIS-Naphtha mending after lower runs, further cuts risky

By Angela Moon and Seng Li Peng

SEOUL/SINGAPORE, Nov 25 (Reuters) - Asian petrochemical makers have slashed production to unprecedented levels, helping to nudge the slumping market into a nascent recovery, but deeper cuts or total shutdowns would cause more harm to the industry.

As signs emerged that the sector was weakening from a five-year upcycle due to faltering Chinese plastics demand and the global economic crisis, petrochemical firms began to cut naphtha cracker runs since March to 70-80 percent of capacity from 100 percent.

These cuts and halting of units have helped to remove more than 470,000 tonnes of ethylene output a month -- about a third of East Asia's total capacity, excluding China -- key to resolving the problem of low demand and the stubborn glut in the region.

But deeper cuts or total shutdowns of a cracking complex would upset the entire food chain and stop petrochemical makers from responding promptly to the first signs of a market upturn. "There are so many considerations, one of which is naphtha feedstock. You can't be deferring the shipments repeatedly," said a petrochemical maker from Northeast Asia.

Additionally, other than yielding olefins, which are currently in low demand, a cracker also produces other products such as butadiene, used to make synthetic rubber.

"Some of these products are still doing fine. If you stop your cracking complex just because of weak olefins demand, you disrupt the whole petrochemical cycle," the source added.

Some firms such as Asia's top ethylene maker Formosa Petrochemical have shut an entire 1.2 million tonnes per year (tpy) unit that is the region's largest, while South Korea's top ethylene producer Yeochun NCC halved overall runs at its 1.8 million tpy complex by also shutting an entire cracker.

Similarly, South Korea's top refiner SK Energy shut one of its two naphtha crackers in October for the first time in its 35-year operation, and will stay idled until next March or April to avoid losses in its petrochemical division.

TOTAL SHUTDOWN NOT AN OPTION

With the downturn seen lasting at least another six months, petrochemical companies are likely to maintain cracker runs at around 70 percent of capacity.

"A company may likely shut one of their many crackers during times like these, but they will keep output at units which are still operating at around 70 percent. Anything below 70 percent, is as good as shutting it," said one source based in Japan.

This is because running a unit below 70 percent will make it even more unprofitable because as utilisation costs remained high, output is lower, industry sources said.

While a company may shut one unit, it is unlikely to idle all its crackers at one go.

Many Asian petrochemical firms also must meet commitments to term customers.

"We are producing just enough to meet term supplies. This way, we don't have to worry about not being able to sell spot parcels," said a second source from Japan, whose company is keeping its naphtha cracking rates around 80 percent capacity.

More importantly, they must be quick and ready to restore full operations if China, Asia's top petrochemical importer, returns to the market from second-half 2009, or sooner.

"It's impossible to shut down all crackers," said Hwang kyu-won, petrochemical analyst at TongYang Securities in Seoul, adding that some recovery might be seen as early as February.

LIGHT IN THE TUNNEL

Some traders are already seeing glimmers of a market emerging from the doldrums, largely due to the reduced stocks caused by the cutbacks in naphtha cracking run rates.

"There is some slight improvement in the market, and we are keeping our fingers crossed that this can be sustainable," said a Southeast Asian trader.

Prices of ethylene, made mainly from naphtha in Asia, have persistently mire around $400 a tonne, cost-and-freight basis, this month.

This meant that producers of ethylene -- the key building block for plastics -- were suffering losses of more than $100 a tonne given that benchmark naphtha was at an average of $285.00 a tonne between Nov. 3 and Nov. 24.

However, a handful of buyers appeared more willing to fork out higher prices for ethylene late last week, as supply contracted due to the reduced output at crackers

A producer confirmed selling 6,000 tonnes of ethylene to a trading house at $430 a tonne for December lifting from South Korea, on a free-on-board (FOB) basis.

Although margins stayed in the red, a slight increase in price is still welcomed, traders added.

Discounts on naphtha cracks have narrowed sharply by about 55 percent to $86.90 a tonne on Tuesday, from a historical low of $189.75 a tonne on Nov. 4.

"You have to look further. Although margins for petrochemicals such as ethylene are in the red, the current feedstock naphtha prices are low," said the same Northeast Asian petrochemical maker.

"Should petrochemical buying interest recover in China, you will benefit, as you will be selling products made from the current low-cost naphtha." (Editing by Ramthan Hussain)