There is a tentative air of optimism over the prospects of the Middle East petrochemicals industry, and confidence is beginning to return after a tough 18 months. '1999 is far from being a vintage year,' says Florent Chevrier of Trichem Consultants. 'But things are looking a lot better than they were six months ago.'

Improvements since March in the prices of the chemicals produced in the region have been reassuring, relieving the pressure on margins that was the dominant theme in the industry last year. The main drivers for the upturn have been an improvement in demand, and the recovery in the price of oil. Since March it has almost doubled, forcing up feedstock costs and returning the advantage to the relatively low-cost producers in the Middle East. 'Margins in most sectors of the industry have turned the corner in the third quarter [of 1999] and have moved from negative territory into the neutral or positive,' says Chevrier.

'The time-lag factor is still in play,' says Arvind Aggarwal, a senior analyst at Chem Systems. 'The rate of increase of petrochemicals prices is still behind the oil price rises and, as a result, some of the producers are yet to recover their costs.' Since April, the European spot price of ethylene has nearly trebled to $730 a tonne, and the contract price of propylene has soared 125 per cent to $550 a tonne from $245.

Middle East producers with cheap feedstock are the first to benefit from petrochemicals price hikes. Saudi Basic Industries Corporation (Sabic), by far the largest producer in the region, and a major world player, suffered last year from the coincidence of low oil and petrochemicals prices, and the collapse of its major Asian markets. With the cracking of ethane to obtain ethylene as its core activity, the drop in oil prices undermined Sabic's advantage as the naphtha cracking operators in the US and Europe saw their feedstock costs tumble. A rare competitive advantage was handed to the naphtha-based plants. However, resurgent oil prices are beginning to restore the old order. Although European naphtha contract prices have been flat at $465 a tonne since July, spot prices have increased by 38 per cent in the same period.

Virtuous circle

Petrochemicals prices have responded accordingly. Analysts say a virtuous circle has been evident since April, particularly in the European markets. 'As prices have moved up, then so have levels of stockpiling, as people have moved to build up inventories at what are perceived to be comparatively good prices,' Charles Fryer, managing director of consultancy TECNON UK.

And yet the sustainability of current demand patterns and prices is difficult to predict. The move towards stockpiling, which has itself supported the firming of prices, has been reinforced by concerns over the Y2K problem. 'Contingency stock building is continuing to underpin demand, as consumers move to bypass the danger of any Y2K-induced problems with supply networks,' says Aggarwal. 'Prices are, in some cases, going higher than expected because of this increased demand.' He says de-stocking in the first quarter of 2000 can be anticipated. 'There is a certain psychology in the market and at present there is a strong trend towards defensive views and defensive positions, and the market remains fairly nervous and fragile.'

The recovery in many of the Asian economies that are the major markets for Middle East producers - between 60-70 per cent of Saudi output is sold in the Far East - has further supported the improvements in petrochemicals prices. But the situation in Asia is far from uniform and, despite the upturn in demand, the market remains fragile. 'While South Korean gross domestic product (GDP) growth is expected to reach about 7 per cent this year, the period of double-digit growth has passed. The Indonesian market is still severely troubled and Thailand and the Philippines are somewhere in between,' says Fryer. 'China continues to be up and down, with third- quarter purchases increasing, but they've flattened off again recently.'

Despite the improvements in recent months, analysts expect petrochemicals markets to remain fairly soft next year. Strengthening demand, built on Asian economies staggering to their feet and firmer oil prices, will not be enough to fuel any boom. The supply side is more likely to gradually erode the market as fresh capacity comes on stream in the US and the Middle East, analysts say.

Projects conceived in the mid-1990s, when the cyclical petrochemicals market was last near its peak, are now close to coming on-line. In the Middle East, the appetite for expansion was strong, with projects such as the Sohar facility in Oman and Al-Jubail Petrochemical Company (Kemya) in Saudi Arabia. It was also matched, particularly in Saudi Arabia, by growing enthusiasm for downstream projects, such as the expansion of the polypropylene capacity of Saudi European Petrochemical Company (Ibn Zahr) and Arabian Petrochemical Company (Petrokemya).

Progress with these projects has been mixed. The government of Oman has seen BP Chemicals pull out of the Sohar joint venture, and analysts say it is unlikely the project will go ahead. Ibn Zahr has run into financing difficulties which are yet to be resolved, and the aromatics plant planned for Ruwais by Abu Dhabi National Oil Company has been put on hold. However, a number of other projects are gathering momentum. Finance has been put in place for Qatar Chemical Company's new polyethylene complex at Mesaieed, and the massive expansion of ethylene capacity and additions of polyethylene, ethylene glycol, and polypropylene lines of Saudi Yanbu Petrochemical Company (Yanpet) is due to be completed next year.

'There is going to continue to be over supply,' says Chevrier. 'But things are getting better in Asia which should freshen up business. The worst of the over-supply cycle has been experienced.' With markets likely to be volatile for some time to come, over-supply an ongoing factor, and a number of new facilities close to going into production, competition will remain fierce. 'Sabic has, despite its status as one of the lowest cost producers in the world, generally been responsible: it hasn't gone in and ruined markets,' says Fryer. 'But with its new facilities it is going to have to chase market share, and it will be aggressive in doing this.'