Calmer times as markets seek stability

26 April 1996

PETROCHEMICALS are heading back into calmer conditions after a stormy ride in 1995. In the first quarter of last year, polymer prices and industry operating rates soared to some of the highest levels since the peak of the boom in the late 1980s, only to come crashing back to reality in the second half. With steady, rather than spectacular world economic growth expected this year, petrochemical producers are looking forward to a more even performance over the coming months.

'We don't perceive there will be a further reduction in profitability. It should level out over the next two quarters, says Arvind Aggarwal, an analyst with Chem Systems in London. Demand is expected to continue to grow during the year and prices, barring exceptional events, should not be so volatile. The one area for continued worry is polymers, which, after the crash in 1995, have fallen to some of the lowest rates on record.

'Things can't get any worse for polymers,' says Aggarwal. Operating rates tumbled as producers ran down their stocks in the final quarter of 1995 to clear the backlog. Promisingly, the profitability index for polymers has picked up slightly since then and there are, as yet, no plans for shut-ins.

The industry hopes that the bad brew of factors that contributed to the market collapse in 1995 will not be repeated. Floods and plant shutdowns conspired to squeeze supply and drive prices up, but it was the sudden withdrawal from the market of China that brought them back down again. 'If they stop importing product it has to find a home elsewhere,' says Aggarwal. China's purchasing plans remain unpredictable and because it is such a big buyer it can drive prices up very rapidly when it places major orders and cause a price collapse when it withdraws.

Despite perceptions that market conditions and demand in Europe should improve over the course of the year there are no announced plans for new grassroots projects on the continent. The cost of a new cracker is so prohibitive that any capacity gains will come from the debottlenecking and revamping of existing facilities, for which there is ample scope.

This restraint in Europe compares with busy activity in the Middle East where investment in new capacity continues at a heady rate. Saudi Basic Industries Corporation (Sabic) reported record results in 1995 and is in the midst of yet another expansion programme. Both Kuwait and Abu Dhabi are pursuing grassroots world scale ethylene projects with foreign partners (see pages 15-17).

The Gulf expansions are predicated on the strong growth in world consumption of petrochemicals, proximity to the vast markets of India and the Far East, and the chance to earn more by developing export-oriented industries based on hydrocarbons.

There are subtle differences in the latest wave of regional investment, however. The export-to-production ratio of the Gulf petrochemical industry is about 80 per cent, against a global average of 25 per cent. For some products, such as linear low density polyethylene (LLDPE) and methanol, it is over 90 per cent.

This makes the regional industry exceptionally dependent on exports. To reduce this reliance and boost diversification, much of the new capacity in Saudi Arabia will feed growing domestic demand. Sabic's exports of some basic chemicals are actually set to fall as new derivative capacity comes on stream in the kingdom.

Foreign partners will also play a pivotal role in the new projects, which will be commercially financed rather than relying on heavily subsidised state funds, such as those made available to Sabic companies by the Saudi Industrial Development Fund in earlier days. In Kuwait, Union Carbide has a 45 per cent stake in the Equate scheme; Abu Dhabi's partner will get a 40 per cent share.

The region continues to enjoy enormous comparative advantages. Most of its petrochemical plants are large scale, use stateof-the-art technology and have had low capital costs due to subsidised loans. By far the most striking advantage is the low cost of feedstock, which in the case of Saudi Arabia is held at 40 per cent below prevailing international prices.

This huge subsidy is anti-competitive under the codes established under GATE and the WTO and will have to be adjusted when the WTO rules come into effect. Saudi Arabia has made some effort to rationalise costs in the industry by raising domestic prices closer to international levels, but Sabic and the new private sector petrochemical ventures may not be able to rely on cheap feedstock indefinitely.

The regional industry has expanded by exporting bulk petrochemicals to Asian markets, which are now creating their own petrochemical industries at a rapid rate. The new Asian industry will have a different cost structure as it does not rely on cheap natural gas, but uses naphtha which reflects oil prices. Although the fixed and variable costs of Asian producers may be higher than those prevailing in the GCC, the cost of transport and protective tariffs will put pressure on Gulf petrochemicals in these markets.

Asian challenge

The new Asian producers will themselves be seeking export markets as there will be a time lag before domestic downstream capacity is created for their basic bulk chemicals. As the Asian capacity comes on stream the market share achieved by Gulf suppliers is certain to shrink in percentage terms, although the continued rapid expansion of the Asian economies should ensure an increase in gross volumes. Another factor to consider is the new competition from within the region as Abu Dhabi and Kuwait will be looking for export opportunities in the same markets when their new plants come on line towards the end of the decade.

Gulf producers enjoy domestic cost of production advantages across the whole range of basic and intermediate products, but the scale of their advantage declines further along the production chain. For PVC sheets, for example, Chem Systems calculates that GCC costs are the same as those that apply in Western Europe.

Analysts argue that the regional industry should start to explore export markets other than those in the Far East and look at the opportunities for import substitution and downstream development in their domestic markets to counter the erosion of their advantage in the Asia/Pacific region. After a charmed childhood the regional industry faces a growing array of challenges as it approaches adolescence.

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