Bitumen markets around the world are struggling. Declining infrastructure spending has significant slashed bitumen demand. Supply has struggled and continues to produce bitumen in excess. Price declines have come rapidly with the outlook being uncertain. In such an environment, stakeholders have to recognize that bitumen markets are at a tipping point and develop appropriate business strategies.
Declining infrastructure spending impacts bitumen demand
The anemic growth in global GDP – an average of 2.6% over the past five years (2011-15) as compared to 3.5% over 2000-07 just before the global financial crisis – has impacted infrastructure development around the world. Infrastructure spending in the United States dropped from 4.2% of GDP in 2009 to 3.2% in 2014. Over the same timeframe, the European Union cut infrastructure spending from 3.6% to 2.7%. Larger cuts have occurred in Asia and, more significantly, can stay at lower levels in countries such as China and Japan for structural reasons.
China overinvested in infrastructure at an average of 8.8% during 2008-13 and can meet demand by dropping it as low as 3.3% through 2030. An aging population allows Japan to get away with infrastructure spending as low as 1.5% of GDP. Bright spots exist but are fewer. India and South Africa both need to invest as much as 5.7% and 5.9%, respectively, on infrastructure but are only spending 5.2% and 4.7%.
These cuts in infrastructure spending impact a number of industry segments with one being bitumen markets. Nearly 90% of bitumen demand is for the construction and maintenance of roads and other infrastructure projects. As a result, bitumen demand is strongly correlated to infrastructure spending cutting which has significantly dampened overall bitumen demand.
Declining bitumen demand shifts slowly to emerging economies
Bitumen has a number of applications but its use for construction and maintenance of roads either directly or through asphalt accounts for nearly 90% of all demand. Bitumen is used as a binder for aggregates to produce asphalt as a hot mixture which is transported to the field for paving roads. There are a number of bitumen grades for varying road construction and surface paving applications and performance specifications.
Key bitumen types for road applications including paving grades, cutback bitumens, and bitumen emulsions. Hard, oxidized, and blown grades, and mastic asphalt are used for paints, sealants, adhesives, enamels, waterproofing, electrical products, flooring materials, back carpet tiles, land and marine pipe coatings and numerous other non-road applications. Polymer-modified bitumen (PMB) is a recent innovation that is finding growing application in both paving and non-road applications.
Although there are numerous non-road applications for bitumen, they consume small volumes and road paving is the primary application. As a result, infrastructure cuts described earlier have significantly impacted global bitumen demand. For example, annual bitumen demand in Europe has dropped for nearly 16 million tons in 2011 to a little less than 12 million tons in 2016.
Of the top five bitumen-consuming nations in Europe – France, Germany, United Kingdom, Spain, and Italy – all save U.K. have seen significant declines in bitumen demand. Italy and Spain have suffered the most significant declines over the past five years. Finally, bitumen demand has fallen across all grades. For example, PMB, which is an innovative new grade, has fallen 35% over the past five years – more than the fall in overall market presumably due to higher prices.
Similar declines in bitumen demand have occurred in other developed economies. Emerging economies continue to grow but at slower rates due to the anemic growth in infrastructure spending described earlier. Even so, emerging economies in Asia, Latin America, Middle East, and Africa are where the best prospects for bitumen demand are likely going forward.
Bitumen is oversupplied and suppliers are consolidating
Bitumen has traditionally been a refining by-product although several refiners have focused and specialized in producing it from carefully selected crude oils. Such bitumen refineries have optimized their unit operations to produce bitumen grades with tailored properties and specifications for specific performance and application needs. This includes blending multiple crude oils to produce the desired bitumen product grades. Declining bitumen demand as well as regional declines in fuel and refined products (e.g., Europe) have led to an oversupply of refining capacity including bitumen production. Bitumen is today oversupplied in spite of significant refinery closures since the Great Financial Recession especially in Europe. For example, nearly 25 refineries have shut down in Europe cutting refining capacity by more than 2 million barrels per day (bpd).
Another 3 million bpd of refining capacity is at risk of closure in Europe through 2019. These refinery closures are coupled with a strong shift within refineries to conversion units that produce higher margin gasoline and diesel fuels. As a result, bitumen supply will moderate but will still outstrip demand over the next several years. In light of this outlook for chronic oversupply coupled with declining demand, bitumen refineries are consolidating with additional impacts on supply in the medium term.
Prices have been challenged across all grades
Given these supply and demand trends, bitumen prices have fallen or stagnated over the past few years notwithstanding modest levels of regional and temporal volatility. Even premium bitumen grades, e.g., PMB, has suffered significant price declines.
Historically, bitumen has been treated as a by-product of refining and has not correlated well to crude oil pricing. Historical price analytics show that bitumen pricing can be explained to a certain extent as a lag to heavy crude oil pricing although the correlation has not held up in all regions. Similarly, bitumen pricing after separating out supply and demand effects can correlate to high-sulfur fuel oil pricing. However, that correlation is weakening primarily due to supply-demand impacts on both fuel oil and bitumen markets.
In the long term, as fuel margins improve and strengthen and supply rationalizes to demand, bitumen pricing will have to be competitive with crack spreads to incentivize refiners to produce bitumen. In the short term, however, oversupply and declining demand suggest that bitumen prices will stay weak posing several challenges to suppliers.
Suppliers will have to develop new commercial models
ADI Analytics’ experience advising industry players in such difficult and uncertain markets suggest that bitumen suppliers and customers will have to adjust rapidly to these market dynamics. There are at least four key commercial implications for stakeholders in the bitumen value chain:
- Bitumen is evolving from a local to a regional if not a global market. Bitumen markets have traditionally been local in terms of both supply and demand. With bitumen demand falling in the OECD nations and growth outlook being strongest in emerging economies (e.g., Africa, Asia, Middle East, and Latin America), and oversupply concentrating in Europe and Americas, trade is likely to grow at a regional if not a global level in order to clear supply and meet demand.
- Suppliers will have to develop trading and commercial capabilities. Bitumen suppliers struggling with excess production will have to develop business and relationships with emerging economies. Historical reliance on resellers to facilitate sales and provide the storage infrastructure will no longer be sufficient. Suppliers will have to either invest in or lease storage infrastructure along with cultivating relationships with a wider range of customers to effectively place their product.
- The bitumen supply curve will become important. As a local market where bitumen was primarily priced as a by-product, marginal cost of supply was not always critical to the bitumen business. That will change in a market that is oversupplied and broadening with a strong regional flavor. Bitumen transportation costs will rise and suppliers will have to absorb them in an increasingly competitive market. Therefore, the marginal cost of supplying bitumen will become important and suppliers will have to understand their position on the curve and find ways to improve their economics.
- Finally, the bitumen industry will have to innovate new products and demand centers. New bitumen grades such as PMB have been too few and infrequent. In a difficult market, bitumen suppliers will have to invest in innovation to both develop new applications and demand as well as develop new grades and formulations that expand the market.
In ADI Analytics’ experience, industry players that succeed in such markets (1) rapidly recognize such industry disruptions, (2) deploy business strategies from a wide range of players in analogous markets, and (3) adopt rigorous processes around operational excellence, innovation, and strategic discipline.