09 Jan 2019

Hedging Plastics: listen to the podcast

A special edition podcast on the petrochemical market. As well as explaining the nature and drivers of plastics and other petrochemical prices, we cover hedging and dealing with plastics and sustainability. 

Listen to this podcast

In this special edition podcast, we discuss risk managing petrochemical price risks with head of commodities, Callum Macpherson and expert in managing exposures to fluctuations in commodity prices, Jonathan Smith. Additionally we are joined by Investec’s co-head of sustainability, Teresa O’Brien, who shares her views about how plastics can be produced and used sustainably and how Investec’s involvement in the petrochemical market fits into this.
If you cannot play the podcast above, you can listen to or download it from Iono. Full transcript below.
 
Please note: these podcasts are provided for information purposes only and should not be construed as an offer, or a solicitation of an offer, to buy or sell financial instruments. These podcasts do not constitute a personal recommendation and are not investment advice.

It all starts with a conversation

Callum Macpherson

Commodities

Our people are our difference. Give me a call or complete our callback form to find out what we can do for you today.

Read the full transcript

Toby Brown: Hello and welcome to this special edition podcast. I’m very excited to be joined by a few people today to discuss a fascinating topic. We have recently been finding that a lot of our clients have been keen to find ways of managing exposure to petro-chemical price changes including plastics.

 

We are going to be talking about developments in risk managing petro-chemical price risks and the products we are able to offer. So to tell us a bit more on this is Callum Macpherson who is head of commodities and Jonathan Smith who is an expert in managing exposures to fluctuations in wholesale commodity prices. How are you both today?

 

Jonathan Smith and Callum Macpherson: Very well thank you 

 

Toby: We would also like to talk about how our involvement in the petro-chemical market is helping Investec to further its sustainability objectives. As a firm, Investec is keen to promote
sustainability throughout its business. How we work has had a particular focus to reducing plastic. To offer views on this is Teresa O’Brien. How are you Teresa and would you also like to tell us a bit about your role at Investec?

 

Teresa O’Brien: Sure, so I am the co-head of our corporate sustainability team. We have a team of 7 people. And I am also the environmental manager here since about 2008.

 

What is petro-chemical hedging?

 

Toby: Thank you for joining us and thank you to everyone for joining us today for what will be a really interesting chat. So I would like to start with you Callum - could you kick things off by telling us a bit more about the development of the petro-chemical market and what we can trade.

 

Callum: Certainly. If we start with crude oil – crude oil is a mixture of hydrocarbons which all have distinct boiling points and when those go through the refinery, that property is used to separate those elements out so we have what we call the light end of the barrel - gasses like propane and butane then other light products like Naphtha and petrol or gasoline.

 

Then in the middle of the barrel we’ve got jet fuel, diesel, and gas oil. And at the bottom of the barrel we have the fuel oil and bitumen. Now the petro-chemicals are things that are produced by the further processing of generally the lighter end of the barrel.

 

So in Europe the main element of the barrel that’s used to produce petro-chemicals is Naphtha and this is cracked to produce lighter hydrocarbons like Ethane which is then in turn cracked into Ethylene – which is a very important feedstock because it is used to produce polyethylene. Similarly propane is used to produce propylene with is then used to produce polypropylene.

 

In terms of the financial markets that are available in these products – for a long time there has been a futures markets in crude oil and particularly in the last 15-20 years there has been a pretty extensive market in a lot of the refined products – the ones that immediately come out of the barrel for example jet fuel and gas oil and those are very liquid and widely traded.

 

But the petro-chemicals, certainly in Europe, there’s been a lot less trading activity than there has in the refined products. This is starting to change a bit. Actually in the US there are quite a few financially settled products which have been available for a while on the petro-chemicals – things like ethylene and plastics and this market is starting to grow now in Europe as well so it’s very much something that is developing.

 

At Investec we have been particularly focussed on European markets where we are able to trade ethylene, low density polyethylene, high density polyethylene and also propylene and polypropylene. Those are the main ones that we are looking at for clients in Europe and we can to the same things for the US as well.

 

Toby: There is quite a range there. What would you say is driving the prices, is it just about oil?

 

Callum: No it’s definitely not just about oil; oil is obviously a big driver because that’s the origin of the petrochemicals - at least in the way that they are produced in Europe. In the US indecently etholyne tends to be produced from natural gas so it’s a little bit different.

 

But in Europe it’s from Naphtha - a refined oil product. So as a feedstock it obviously does have an impact on the petro-chemical prices but it’s by no means the whole story. Firstly you can contrast some of the elements of the chain going from Naphtha through to plastics say, Naphtha is a liquid so that’s relatively easy to store though they do need to have tanks to store it into.

 

Ethylene on the other hand is a gas so that’s much harder to store and to transport around. But at the other end of the chain you have plastics and that is extremely easy to store if you have a warehouse that is secure and some cash then you can store plastics. On top of that you have got certain amount of processing capacity that is available for producing these things.

 

So there are a number of constraints on production of petro-chemicals just from physical capacity that is available and there also logistical challenges around eliminating difference in prices and things like that, and you’ve got different properties as far as storing them is concerned. All these mean that the price, particularly of plastics, can vary in ways that isn’t necessarily fully connected with oil prices.

 

What often tends to happen is that when a lot of the large users of plastic are concerned when they feel that oil prices and petro-chemical prices are generally rather low they tend to stock up and put that plastic into storage, knowing that they can then use that if the prices rise. Perversely that has the effect of pushing up the prices of plastics that then when the prices of oil does rise, plastics go up further with that, that then rather than buying more plastics people start to rely on their inventory so that has a dampening effect on the price of plastic.

 

Then you have ethylene that gets caught in the middle of these two things. Because the production of ethylene is very energy intensive the value of ethylene is quite a lot higher than the Naphtha that is going in and because it’s a gas it’s difficult to move around. So the price of ethylene in the US is generally dramatically less than the price of ethylene in Europe but that’s because it’s very hard to move ethylene from the US to Europe economically – it can be done but the capacity to do that is limited. 

 

And it mirrors the difference in gas prices – gas prices in the US are very much lower than they are in Europe. So there is a lot of very different things going on and at the moment for example there are logistical problems in Europe connected with low water levels in the Rhine which is hampering the products being shipped into cracking units and this is causing disruptions and things going on with the price. That’s a very long answer to your question but generally yes the petro-chemical prices are broadly influenced by oil prices but there’s a lot more to it than just that.

 

Helping clients

 

Toby: OK thank you Callum – Jonathan over to you, how can we use those capabilities to help our clients?

 

Jonathan: Sure yes so as Callum explained these markets have developed relatively recently or certainly the financially settled market has developed relatively recently. It has been clear to us for many years that there are a great number of companies out there that have price exposures to specific end products in this market but the availability of hedging products is in that time been generally quite limited- specifically limited to more upstream products such as things like crude oil or Naphtha and things like that for the reasons that Callum explained.

 

The prices of the end products can often bear little resemblance to the price of the feedstock or upstream product that is going into it. Where we have looked at solutions for clients that have these price exposures where effectively you would proxy hedge it – that basically means they hedge a physical price exposure using financial contracts against a different product often it’s been the case that that’s not really need an appropriate solution because of what’s known as basis risk between the product you’re trading or hedging and the product that you are actually buying or selling.

 

The big drivers for the market looking ahead is going to be US production

Now what has really developed in recent years is that the end product markets have become a lot more liquid. It’s not necessarily solely the domain as it was of the large petrochemical producers and consumers, but there is a greater availability of these products to companies who might only be spending a few million pounds per year.

 

Now what this means is that once you have an appropriate hedging product or a financial market that you can hedge these products with, companies can then start adopting hedging strategies in them towards these products in a way similar to say how we might already manage currency risk or how companies have price exposures in more established commodity markets like industrial metals or crude oil and like that.

 

They can manage those risks in a similar fashion. So that might be something like putting in place a hedge to protect a budget or putting in place a hedge to protect a specific contract that we have with a client. So really it gives companies a lot more flexibility in terms of how the manage that risk.

 

What is going to influence the future of the plastics market?

 

Toby: Ok and looking to the future, what might you think could influence the market in years
to come?

 

Jonathan: Well I think that big drivers looking ahead is going to be US production. The US shale boom has led to a great deal of availability of light product in the US that’s both natural gas and also other light petroleum gas products, and that lends itself to producing petrochemicals. 

 

There’s a lot of development going on in the US of the new capacity to produce petrochemicals and so I think that the US is going to be a growing source of that kind of product which would tend to help to limit prices relative to oil. The other side of plastics is also very interesting, if you consider that the very long term for fossil fuels we would tend to expect that overtime we will see more and more of a shift away from using fossil fuels as a form of energy.

 

However it could be that fossil fuels, probably more gas than oil actually, continue to be a very important source of producing plastics and materials to build things with and package things and so on. There is also some work going on to try and use plastics as a way of sequestering carbon so actually taking carbon dioxide out of fire power plant and producing ethylene and being able to polymerize that so then actually making stuff out of plastic becomes a way of taking carbon dioxide that would otherwise go into the atmosphere.

 

Investec's approach to sustainable plastics

 

Toby: Ok and Teresa I know you have been sat here patiently, thank you for bearing with us. I would like to bring you in quickly to talk about Investec’s approach to this sort of thing and your your take on things. 

 

Teresa: So in our team, specifically on the environmental side, we look at trying to reduce our operational impacts on the environmental, so we are looking at our buildings, what we do in our buildings, behaviour within the buildings and we have an environmental management system in place which is the ISO140001 standard since about 20012 so we are trying to manage down our waste for example would be one of those focus areas, as well as energy and water and a few other things like that.

 

We have been very successful with how we manage our waste here, we are seen as a leader within the city of London. We have won the first member of the city awards scheme which is run by the corporation of London. We are the first to have won the top prize three times in its 20 year history. First and only. We also have the Carbon Trust Waste standard again since 2012 and it’s recertified every couple of years through a series of in depth questions, we have to show quantitative and qualitative responses to that.

 

We have, as I mentioned earlier, the ISO 14001 which looks at waste as well. We raise a lot of awareness amongst our staff with regards to waste, we have a team of environmental champions which I created back in 2006, trying to get staff involved with their behaviour within our buildings and the easy one to do would be waste I guess because everybody creates it, so we have a system in place where recycle about 84% of our waste in our London office, but also includes food waste which once it is separated in the office is turned into biofuel, through Biogen in Bedfordshire which is a really good place to put your waste as opposed to just burning it or putting it into a landfill.

 

 

We have been very successful with how we manage our waste here, we are seen as a leader within the city of London.

A couple of campaigns we did recently, specifically on plastic waste, we did a campaign around plastics, we targeted plastics – called ‘not just a drop in the ocean" - this was around just single use plastics, disposable plastic that just gets put in the wrong place. There’s nothing wrong with plastic, we recognise plastic is fantastic material it’s very durable and light and pliable it’s relatively cheap, and so it’s a very popular material.

 

It’s everywhere, we cannot live without it. What would we use instead of it? For us the biggest problem is just the quantity and volumes of single-use plastics and that is not put away in the right disposal stream. So we ran one campaign on that, focussing on advising people as to what they should do with plastic waste, and then we did another one around world water day in which we took a group of 20 volunteers and staff on the Thames with Hubbub which they have the Polymer - a plastics punt that is made from recycled plastic- single use plastic bottles just again to raise awareness around the issues with plastic being how we dispose of it rather than using it.

 

Toby: Absolutely. I know we are all incredibly proud of our approaches to it. So I’m going to throw this back to Callum and Jonathan to see how it matches up with you guys. What is your approach to assessing petro-chemical clients and how does it encourage best practice?

 

Callum: Well we decided to build a framework for vetting our customers in line with that, which
really has two steps to it; the first is that we look at the business model and we look at what it’s producing, and if its producing something that is durable then that’s inherently relatively low risk, because the problem that we can see is ultimately not necessarily with the company that we are dealing with, but what might happen to that plastic thing after it has been finished with by whoever it is sold onto. 

 

On the other hand we might have something that is being produced such as single use packaging and that’s a much higher risk. That’s the first stage. Then the second stage is, if it is one of these higher risk things, then we look into a little more detail. We look at things like - is
the product being produced in more detail at things like - is the product that is being produced recyclable, can it be separated, and whatever needs to be done to it easily and recycled, and secondly is recycled material being used to produce it in the first place.

 

It’s a relatively straight forward framework and and it’s a qualitative one rather than a quantitative one. The motivation behind us doing this as well as being obviously a reputational thing, but we think that by having that sort of system in place it does encourage people we deal with to ensure that they do encourage these practices. That’s really what is behind it.

 

It’s a relatively straight forward framework and and it’s a qualitative one rather than a quantitative one.

Jonathan: Just in terms of a more practical application, there’s not a huge amount to add onto what Callum said, but typically we do look primarily towards whether it is a durable good, so for a lot of the clients we have spoken to so far they may be involved in things like construction and making materials for that, and obviously that is a long term product that can be used for many years. 

 

Equally we are dealing with clients who are predominantly producing something that will be used in a fast moving consumer good, then it’s very much the focus to establish what sustainability initiatives that they uphold in their operations. Is there anything about that good which inhibits its onward recyclability. And things like Callum just said in terms of what level of recycled goods are they using. Generally speaking it’s been very clear from dealings with a number of clients on this that despite the press that plastic gets, there is a lot of work being done within the industry to reduce the impact of what people are doing basically.

 

Toby: Yes I think one of the key issues is the press that comes with plastic, and Teresa I know you have already touched upon the key things like single use plastic and disposing of it properly. Is there anything that you would like to add?

 

Teresa: I think this approach is fabulous really because the main issues around plastics, as was raised in the public’s mind with blue planet, is just the volume of disposable stuff and where it goes at the end, so I think by having a framework that looks at the recyclability of the materials is fantastic. The other one is the more recycled plastics we can use in our material because we try to look at the cradle to cradle kind of model rather than cradle to grave, and to be using a circular economy, so I am delighted that we have that approach to plastics.

 

Toby: Yes it’s great to hear this approach that we have. So, back to you guys again. I’m very interested to hear the initial feedback from the clients and the market itself, do you see this ncreasing popularity quite substantially or not?

 

Jonathan: Certainly yes, the initial feedback is been extremely positive, it’s certainly the case that for a lot of companies these plastics and different petrochemical products represents quite volatile cost inputs for them. Historically as I’ve said before, their ability to manage that has been relatively limited, so in terms of general interest, yes we certainly have been encouraged by the take up by clients on this. It’s also clear that a lot of these clients operate in industries where it’s not actually terribly easy for them to pass on price changes to end clients.

 

It’s certainly the case that for a lot of companies these plastics and different petrochemical products represent quite volatile cost inputs for them.

That might be because they commit to fixed price lists for a period of time in which case if they are committing to fixed pricing with their end clients for periods at a time and the underlying commodity that they are purchasing fluctuates then that clearly exposes them to a financial risk. Or it may also be that particular competitive dynamics in their sector is such that they feel that if they were to increase prices on the back of an increase of the material cost that would render them uncompetitive versus their competitor.

 

So certainly the feedback from clients has been positive and very interested to see what hedging products are available to them, and then a few are pleasantly surprised that these do actually exist. We look forward to continuing to work with them to show them the appropriate solutions.

 

Toby: Fantastic, thank you all for joining me. It’s been a really interesting discussion. To take everyone through a summary of what we have covered today, petro-chemical markets do have a linkage to oil prices, but not necessarily a strong enough one to hedge using oil. However, there are a lot of instruments available to manage petro-chemical price risk and plastics can be produced used and recycled in a sustainable way. And we at Investec are here to support that.

 

So thank you Callum, thank you Jonathan and thank you Teresa for joining me in this podcast today. I hope you found it as interesting as I have.If you would like to find out more about petro-chemical markets please do get in touch. 

Listen to more

 

It all starts with a conversation

Callum Macpherson

Commodities

Our people are our difference. Give me a call or complete our callback form to find out what we can do for you today.