Effective integration delivers superior returns

Stephen D. Pryor
President, ExxonMobil Chemical Company
CERAWeek Downstream Plenary
March 8, 2011

It is a pleasure to be here with all of you on the 30^th anniversary of this executive conference. While many things have changed in three decades, one has not: Economic growth and improvement in living standards depend on access to affordable, reliable supplies of both energy and chemical products.

Today, I would like to offer the perspective of a global petrochemical company on how effective integration of refining and petrochemicals can improve financial performance and help companies weather industry challenges. I will also address the opportunity presented by unconventional natural gas liquids as a petrochemical feedstock.

Refining challenges
Refining has always been a tough business with declining margins punctuated by brief periods of relief. But recent trends are making the business even tougher.

• First, shifting demand patterns are changing the shape of the barrel. Global demand for distillates and chemical feedstocks continues to grow while gasoline is expected to remain essentially flat. And, from a geographic perspective, non-OECD countries will account for all of the growth in liquids demand through 2030.
• At the same time, refining capacity has been growing faster than demand. As a result, global capacity utilization has fallen to a level not seen in 25 years.
• In addition to these supply and demand factors, industry dynamics are increasingly shaped by ever-tightening regulatory requirements and the growing presence of financial investors.

Beyond that, unprecedented swings in crude and product prices have created additional uncertainty. In the past 10 years alone, we have seen crude prices range from $16 to $144 per barrel and the "Golden Age of Refining" come and go. The same has been true in the cyclical petrochemical business, where margins have gone from bottom of cycle to top, to bottom and back to top again. And, today’s robust business environment is marked by striking regional disparities, with North American margins buoyed by increasing production of unconventional natural gas and gas liquids, while the fast-growing Asian markets are still absorbing unprecedented capacity additions.

This ongoing turbulence reinforces our belief that success in these capital-intensive commodity businesses requires a disciplined, long-term approach that does not change with short-term swings in prices and profits.

So I’d like to talk about a long-term approach for integrating petrochemicals with refining — one that steers a steady course through the ups and downs of the market, and increases shareholder returns.

The value of petrochemicals
In his landmark book, The Prize, Daniel Yergin accurately characterized plastics and chemicals as “the bricks and mortar of contemporary civilization.”

Today, chemicals touch more than 95 percent of manufactured goods and virtually every sector of the modern economy, from basic human needs like food, water, clothing, housing and transportation all the way to the latest advances in health care, communications and information technology. And every facet of the energy industry — including alternative energy — depends on the products of modern chemistry.

That's why petrochemicals is a growth business, particularly in Asia, a region that already accounts for more than half of the world's primary petrochemical demand. Over the past 10 years, worldwide demand for the three largest primary petrochemicals — polyethylene, polypropylene and paraxylene — has grown by about 5 percent a year, which is 2 percentage points faster than GDP. And we expect similar growth over the next decade, as chemical products continue to replace traditional materials such as metal, glass and cotton due to their superior performance, as well as economic and sustainability benefits.

Petrochemical products such as strong-but-lightweight plastics and synthetic fibers help manufacturers and consumers conserve resources, save energy and reduce greenhouse gas emissions. A recent industry-commissioned, independently validated study found that for every unit of carbon dioxide emitted by the chemical industry over the product life cycle, more than two units of carbon dioxide are saved through the use of these products and technologies.

The value of integration
So how can refiners capitalize on growth in petrochemicals to enhance downstream returns?

We at ExxonMobil see integration of petrochemicals with upstream and downstream operations as fundamental to generating superior returns. But capturing the benefits of downstream integration requires more than simply co-locating petrochemical and refining operations. Indeed, there are many examples in our industry of companies that have gone that route and failed to generate attractive returns; some of them subsequently de-emphasized or exited the petrochemical business.

What ExxonMobil has learned over the years is that the key to success is effective integration. Effective integration of refining and petrochemicals is achieved through site-wide optimization of feedstocks, products, costs, capital and people. Let me explain each of these elements in more detail:

• First, optimizing feedstocks means having the flexibility to process a wide variety of feedstocks, and selecting the feed slate that generates the highest value for the entire complex. It also entails adjusting process conditions and product mix — in real time — to extract the maximum value from every molecule. What it all boils down to — no pun intended — is what we call “molecule management.”
• Optimizing products means choosing the highest-value combination of fuels, lubes and chemical commodity and specialty products for the integrated complex, with each produced at competitive-scale facilities.
• Optimizing costs means capturing economies of scale through common systems and services in areas where refining and petrochemicals have similar needs, such as safety and environment, maintenance, procurement and business services. The challenge is to capture these cost synergies while maintaining resources dedicated to the unique requirements of each business.
• Optimizing capital means capturing the benefits of joint facilities planning, engineering, construction and shared infrastructure.
• And, finally, optimizing human resources means using a unified approach to recruiting and development. At ExxonMobil, leadership development is built on rotational assignments in both downstream and chemicals, starting early in one's career, because we want men and women who understand both sides of the business and whose capabilities and perspectives are as integrated as the operations they support. This helps foster a culture that rewards pursuing the general interest, rather than focusing solely on the success of an individual business. I am proud to say that every member of our chemical leadership team — including myself — has had extensive experience in both the downstream and chemicals.

This integrated business model provides a high degree of efficiency, enabling all product lines — fuels, lubes and petrochemical commodities and specialties — to benefit from lower costs. That’s why at ExxonMobil, 90 percent of our operated petrochemical capacity is integrated with refining or upstream gas processing. This is in sharp contrast to prevailing petrochemical industry practice, where chemical companies tend to gravitate either to high-volume commodities or specialties produced at numerous stand-alone sites.

So that, in a nutshell, is what I mean by effective integration. It is easy to describe, but hard to do well. Success requires a disciplined, long-term approach, supported by a steadfast commitment to leading–edge technology. We focus on technologies that reduce energy use, emissions and costs in our own facilities and deliver products that enable consumers to do the same.

The last point I’ll make about integration is that it's never complete. My company has been at it for decades and every year we find new synergy opportunities. This constancy of purpose has enabled our downstream and chemicals businesses to generate a combined average return on capital employed of 20 percent from 2000 through 2010.

The evolution of petrochemical feedstocks
Having discussed integration of petrochemicals with refining, let me now turn to an emerging opportunity for the U.S. petrochemicals industry and one that reinforces my point about the need for feedstock flexibility ... that is, the growing availability of unconventional natural gas liquids as a petrochemical feedstock.

To put this opportunity in perspective, a brief look at history is instructive, because the petrochemical industry has always been driven by the search for more attractive feedstocks.

The modern chemical industry was born in Germany in the early 1900s using coal-based feedstocks such as coal tar and coke oven gases. In the 1930s and 40s, the industry's center of gravity shifted to the U.S Gulf Coast, where the burgeoning refining industry provided an abundant source of advantaged petrochemical feedstocks that were safer and cleaner to process.

The next step in this evolution was the shift to ethane-based petrochemical feedstocks derived from natural gas, as ethane was taken out of flares and upgraded to ethylene and derivatives. This process started in the U.S. Gulf Coast in the 1960s and 70s; and in the 1980s, it enabled the emergence of the Middle East petrochemical industry, capitalizing on the region’s abundant supply of advantaged ethane associated with oil and gas production. Meanwhile, most of Europe and Asia continues to crack naphtha, which of course is tied to the price of oil.

And today, we see ethane re-emerging as an advantaged feedstock in North America, reflecting the growing production of unconventional natural gas and the increasing importance of gas in the future energy mix.

The growing role of unconventional natural gas
Natural gas is the world’s fastest growing major fuel, propelled by strong demand for power generation and by policies that encourage reduction in CO₂ emissions and, hence, a shift away from coal. ExxonMobil projects that by 2030, natural gas will have overtaken coal as the world's second-largest fuel.

In the United States, the world's largest gas consumer, unconventional natural gas supplies have driven a 20 percent growth in U.S. gas production over the last five years.

This production growth has, in turn, increased U.S. ethane production by 25 percent over the same period, providing a significant feedstock cost advantage for U.S. petrochemical manufacturers with light-feed steam cracking capabilities. In 2010, this ethane advantage drove strong U.S. margins in the ethylene chain, a further lightening of steamcracking feed slates and increased exports. The current strength of the U.S. market contrasts with the conventional wisdom just a few years ago that U.S. petrochemical production would decline, steamcracking feed slates would get heavier, and the U.S. would become a net importer of petrochemicals.

Growth in U.S. ethane production is clearly a positive development in the ongoing search for advantaged petrochemical feedstocks. But will it drive new investment in ethane cracking in North America?

The short answer is yes, but we believe, at least in the near term, this investment will be incremental in nature.

The level of ethane cracking investment will depend, in part, on the pace and pattern of North American ethane supply growth which, in turn, will depend on multiple factors, including: the location and rate of gas development; the liquids content across geological plays; and the construction of infrastructure to strip, transport and store NGLs.

Given the uncertainties about ethane supply and its long-term price advantage, we would expect to see quick-payout projects to debottleneck existing light feed crackers as well as limited conversions of heavy feed crackers. Just as in refining, incremental investments in feed flexibility and capacity creep are the most efficient ways to meet growing demand in a mature market like North America.

On the other hand, major investments at full grassroots costs would be subject to significant risks relative to long-term oil and gas prices, export economics, and gas developments around the world that could provide feedstock for competitors overseas.

The bottom line is that the relative attractiveness of ethane or any other feedstock will vary over time. As such, we believe that the most successful companies will be those that maintain the flexibility to process the lowest-cost feedstocks. This feedstock flexibility is a critical element of a disciplined, long-term approach to the business that captures the full benefits of integration and is enabled by a steadfast commitment to leading-edge technology.

So to summarize, we believe that unconventional natural gas presents an opportunity for both petrochemical and energy producers in North America and, potentially, other regions of the world. For petrochemicals, the dimensions of this global opportunity will be shaped over decades to come, just as today's feedstocks have evolved since the birth of the modern petrochemical industry nearly a century ago. And, as one of the world's leading oil, gas and petrochemical companies, ExxonMobil looks forward to helping to shape that future.

In closing, as we navigate today's turbulent times in the energy and petrochemicals arena, we would do well to keep in mind the technique used by sailors during storms at sea. They will tell you that to avoid becoming seasick, you must not look at the churning waves, but instead fix your sights on the steady line of the horizon.

For ExxonMobil, that line on the horizon is our commitment to creating value for our shareholders. For more than 125 years, we have found that by maintaining a long-term perspective — coupled with investment discipline and operational excellence — we can weather the market's shifting tides, remain steadfast in our commitment to shareholders, and deliver the energy and petrochemicals that improve the lives of people around the world.

Thank you for your attention.