Natural Rubber Vs Synthetic Rubber – The price relationship and demand switchability
By Matthew Harder
The price relationship and demand switchability between NR and SR are far more complex than initially meets the eye. Yes, the two polymers are competitive and substitutable to a degree. However, there is a tendency in commodities for participants to overestimate (assume) the level of demand price elasticity. In the case of NR and SR technical factors and end product specifications limit the degree in which NR and SR can be substituted. In fact, there are some properties of NR (tensile strength for example) that SR cannot replicate. In the case of tyre (passenger car, truck, bus etc) production there are certain amounts of both SR and NR required, with each rubber type performing specific functions.
To understand the price relationship let’s look firstly at how the production of NR and SR varies. NR is an agricultural product tapped from a tree by farmers where supply is subject to weather and price fluctuations. As it is a plantation crop, there is a 5-7 year lead time for the development of new plantations to become productive. Immediate supply response to price via tapping intensity or a longer term response via plantation investment. Conversely, the feedstock for the main SR type (SBR) is butadiene, an industrial by-product from the C4 steam cracking process of a hydrocarbon, predominantly Naphtha or Natural Gas (Ethane/Propane). The feedstock type used in cracking affects the amount of butadiene yielded, 5% for heavier Naphtha and 1.4-2% for Natural Gas. Therefore, butadiene supply is subject to refining capacity, feedstock usage and planned/unplanned maintenance.
Secondly, the price discovery process is very different for the two polymers. NR is determined by markets with three main pricing venues being futures SGX, TOCOM and SHFE, along with an active physical market for both spot and forward cargos. Major consumers also utilise average price contracts to secure monthly volume known as long-term contracts in the industry. SR, on the other hand, is priced more like an industrial product on a cost-plus basis and the majority is sold via long-term contracts to major consumers. This is mostly due to the feedstock butadiene, as mentioned earlier being a by-product, is priced on a monthly basis by refiners to the producers of SR. SR is then sold on to consumers on a butadiene + cost (including margin) basis. Typically, this pricing arrangement results in much less price volatility for SR.
Looking at current pricing, there is a significant cost advantage of consuming NR over SR. Common grade TSR20 at 1350usc/MT FOB SE ASIA vs SBR 1502 common grade at >1800usd/MT FOB SE ASIA. Since Sept 2017 I would put NR at a discount of between 200-550usd/mT. Vs SBR 1502. Given this price spread, it would be fair to assume NR incorporation has been maximised.
In China (the largest consumer of NR and SR), we estimate approximately 8% of NR demand is switchable to SR. Based on today’s NR-SR spread this amounts to 500kmt/yr of addition NR demand in China alone, with much of the switch occurring in the general rubber goods sector rather than tyres. India and Eastern Europe are other price-sensitive markets and with reports also in the US of rubber users maximising NR incorporation rates, we can estimate up to an addition 500kmt/year of NR demand at current price levels.
Historically the price correlation between NR and butadiene has been strong at almost 80% as you would expect. Typically, NR has been the price setter and the price of butadiene has followed albeit with a lag. However, there are periods where the correlation breaks down and we see a divergence in pricing. There are several extremes worth noting:
2008 – GFC, when NR collapsed to 1000usd/mT.
2011 – NR at record level post-GFC and China stimulus
Late 2016/Early 2017 – BD supply squeeze (planned and unplanned outages)
In the past two years, we are starting to see a spike in BD price volatility and greater divergence in the price between NR and butadiene. So what has changed?
We can’t ignore the relationship with crude, as BD feed stocks are typically Naphtha, a crude oil derivative, the price fluctuations in the crude oil market are one main factor. Particularly recently as OPEC successfully cut output and global crude stocks fell. More importantly, there has been a shift over time of the feedstock used in steam cracking to lighter natural gas yielding less butadiene resulting in relative supply tightness. At the same time, NR shipments remained strong and inventories increased, notably in China. The pre and post-GFC commodity price boom and low interest rates triggered significant investment in supply which we have been experiencing in NR.
Is the status quo sustainable? I would argue no. There is clear evidence of a supply response in NR to lower prices, notably in Indonesia. At the same time, NR demand will continue to be maximised vs SBR where possible. With tight SR margins producers will slow down production as much subject to existing contract commitments, which should put downward pressure on butadiene.
Bottom line – NR appears undervalued vs SR. Should we see any supply issues in NR, then we could see a rapidly tightening NR market.