PEP Review 2008-9
Fuel and Petrochemical Price Relationships in High Crude Oil Price Environment
Published: December 2008
Petrochemical and refined fuels prices are, of course closely tied to the price of petroleum crude oil from which they are derived. It has long been considered an acceptable practice to tie contractual sales price terms for many finished fuels and petrochemical derivatives to the posted prices of crude oil based on formulas using absolute differentials to crude oil prices. Forecasters often also use such constant differentials in projecting chemical and fuel prices into the future.
The recent nearly ten-fold rise in crude oil through the first eight years of the current century (2000 – 2008) provides a unique opportunity to test these historical well used relationships over a much wider range of crude oil prices. SRIC has undertaken a review of historical price relationships between crude oil and finished fuels and has found that the formulas based on simple differentials are not as reliable in projecting prices as are more complex formulas based on the ratios as well as absolute differentials. For finished fuel products absolute differentials to crude oil, which were reliable through most of the pre-2000 time period no longer reliably predict the price of the finished fuels. Formulas tied to product/crude oil ratios are needed to describe the price relationships in the post-2000 time period.
The accuracy of such relationships using both additive (differential) and multiplicative (ratio) empirically determined parameters is extraordinarily high throughout the entire 25-year time frame from 1985 forward that was considered in this study. Even more surprising, is the fact that such relationships are almost as accurate in predicting first line major base commodity chemical prices such as ethylene, propylene, butadiene, benzene, toluene and o-xylene. We conclude that a sufficiently large volume of the production is derived from petroleum based naphtha to maintain the price relationship, which is also demonstrated by the good fit for ethane, propane and naphtha.
Second line hydrocarbon derivatives such as HDPE, LDPE, polypropylene and polystyrene do not track crude prices well however. These products can be accurately forecast by considering the manufacturing cost from the first line derivatives. This methodology yields the most accurate back-cast match of historical crude oil priced relationships available for almost all petrochemicals and therefore can be expected to yield the most accurate forecasts into the future.