Extra capacity puts a squeeze on the margins

29 November 1996

PETROCHEMICAL producers are finally enjoying a period of relative stability after two years of sharp price fluctuations. Analysts are generally confident that this new-found price stability will persist for the next two years, but some have voiced fears that the addition of new capacity will have an increasingly negative impact on margins by the end of the decade.

Conditions over the past five years have been extremely difficult for petrochemical companies. The global economic downturn at the start of the 1990s reduced demand for products across the whole industry, from base chemicals to derivatives. In late 1994, as the first signs of a global economic recovery came into view, operating rates shot to 95 per cent of capacity as plants rushed to satisfy the sudden surge in demand. 'For six-nine months the industry was running at full capacity,' says Tony Potter, senior consultant at Milan-based Parpinelli Tecnon. Operating rates for polymer producers in the first quarter of 1995 soared to their highest levels since the mid-1980s.

However, the boom was to prove short lived. By the second quarter of 1995, it had become clear that the industry had over-estimated the strength of the recovery and surplus production was pushing prices back down again. Problems were compounded by China's unpredictable buying habits. Beijing, which imports about 8 per cent of world polymer production, unexpectedly suspended imports in the middle of 1995, putting further downward pressure on prices. 'China is the real engine of Asian demand, but is very unpredictable,' says David Glass, an analyst with Chem Systems in London.

Prices have rebounded this year, with propylene peaking at $570 a tonne in mid-April. Prices have since flattened out to about $500 a tonne. Potter believes that current prices are sustainable for the next two years. 'I am not expecting any roller coaster prices like we had in 1994 and 1995,' he says.

There are concerns that the start-up of new production capacity will put pressure on prices towards the end of the decade. However, the expected squeeze in margins will hit European and US producers far harder than their Middle East counterparts, who enjoy an average discount to international prices of 40-50 per cent for their feedstock.

But cheap feedstock or not, the price crash of last year has still eaten into the revenues of the Middle East's petrochemical producers. In late October, the region's biggest producer, Saudi Basic Industries Company (Sabic), announced earnings of SR 3,420 million ($912 million) for the first nine months of the year, down 30 per cent on the same period in 1995.

Despite the drop in earnings, Sabic managed to boost production by 4 per cent over the corresponding period and enjoyed a 24 per cent rise in domestic demand for petrochemicals and plastics. Confident of future demand, Sabic affiliates are now pressing ahead with new expansion projects. These include Arabian Petrochemical Company's (Petrokemya's) new olefins complex, Eastern Petrochemical Company's (Sharq's) ethylene glycol plant, and a Petrokemya/Saudi Petrochemical Company (Sadaf) joint venture styrene plant.

Saudi derivatives

The growth in domestic demand in Saudi Arabia reflects the expansion in the domestic production of derivative products. This strategic move into derivatives by Sabic is regarded with scepticism by some analysts. They argue that the region is only competitive in the production of base petrochemicals, as cheap feedstock gives the region's producers an overwhelming advantage over US and European producers. However, the further the region goes down the derivative production chain the less competitive its products become as high labour and transport costs influence the price structure. 'There are moves in the region into derivative manufacture,' says one analyst. 'But it remains highly questionable whether the Middle East can maintain its competitive advantage.'

The first moves into derivative production have been largely limited to Saudi Arabia, which has the most established petrochemical industry in the region. Most other states in the region are only making their first tentative steps into petrochemicals. The new Equate joint venture complex in Kuwait will come on stream next year, and new grassroots projects in Oman, Egypt and the UAE are expected to begin production by the end of the decade.

For all these new producers, as well as the more established ones in Saudi Arabia and Qatar, the most important market for base products will be Asia. According to Parpinelli Tecnon, 74 per cent of Middle East ethylene and derivative exports in 1995 went to Asia, where the biggest markets are China, Japan and Taiwan.

This dependence on the Asian market has prompted fears that the region's petrochemical industry could be badly hit by the growth in Asian domestic production capacity. Yet, analysts argue that Middle East producers have little to fear from Asian producers since the growth in demand is still outstripping the rise in domestic production in all the major Asian markets. 'It will take them much more than 10-15 years to meet demand through domestic production,' says Potter. 'They don't have the feedstock supplies in Asia either. Middle East producers will always have the advantage of being close to cheap feedstock.'

In the coming years, Middle East states will become an ever increasing force in the global petrochemical industry. The 1990s have demonstrated once again just how volatile the petrochemicals market can be, but the region's producers are confident that their access to cheap and abundant feedstock and the seemingly insatiable Asian appetite for their products, should see them profitably into the next millennium.

A MEED Subscription...

Subscribe or upgrade your current MEED.com package to support your strategic planning with the MENA region’s best source of business information. Proceed to our online shop below to find out more about the features in each package.

Get Notifications