Gulf looks along the petrochemicals value chain

19 October 2010

The Middle East is moving on from low-cost commodity chemicals and turning to more specialised products. But the transition will not be easy

Petrochemicals in numbers

39kg per capita: Consumption of plastics in the Middle East in 2010

40 per cent: The Middle East’s share of global petrochemicals capacity additions, 2008-11

Source: GPCA; MEED

The Middle East is becoming an increasingly significant player in the petrochemicals export market, leading the investment in commodity chemical capacity additions over the past decade and accounting for more than half the new supply brought onstream during the period.

The further down the chain you go, the further you get from the cheap feedstock advantage

Hassan Ahmed, Alembic Global Advisors

Most of the investment has been focused in the ethylene value chain. But the cycle of olefin capacity building is now drawing to a close. The Middle East will account for more than 40 per cent of global capacity additions between 2008 and 2011, but beyond this it will contribute little.

Project pipeline in the Middle East

The region is expected to add only two new ethane crackers over the next five years – a sharp drop from the peak, which has seen eight crackers added in the past 12 months.

Saudi Arabia has no new crackers planned between 2012 and 2015. Iran, the only other country with the potential for ethylene capacity expansions, is struggling under the burden of increased sanctions and international isolation, making the prospects for a new set of Iranian crackers unlikely.

Average per capita consumption of polyethylene 
North America24
Middle East and North Africa12
Russia and CIS6
Southeast Asia8
Latin America10
Sources: Alpen Capital; CMAI

Iraq, with its projected increases in oil output and associated gas production, has been touted as the next big player to enter the petrochemicals market. But this remains a distant dream for now as political stalemate and security issues continue to hinder progress in the country.

Having already seen their margins severely squeezed by lower-cost Middle Eastern competitors, producers in Europe, North America and Asia will breathe a sigh of relief. Nonetheless, the long-term trend of global petrochemical supply migrating away from traditional production centres in Europe and North America towards the Middle East and Asia will continue.

But the evolution of the Middle East petrochemicals sector is now reaching an interesting juncture. The region is starting to look beyond its traditional strengths of low-cost commodity chemicals, such as polyethylene, and turning to more specialised products.

But it will not be an easy task. Moving down the value chain, from the basic building blocks of the chemical industry of ethylene and polymers to higher-value chemicals, will require a new set of feedstocks and skills.

The transition is being driven by three main factors, says Sriharsha Pappu, a Dubai-based chemicals industry analyst at UK bank HSBC. The first is the Gulf’s continued shortage of ethane gas feedstock, followed by government initiatives to focus on job creation rather than exports and, finally, the desire to diversify economies away from oil.

Despite accounting for almost a quarter of global gas reserves, the GCC is struggling with a shortage of natural gas due to increased domestic consumption. The pinch has been particularly felt in Saudi Arabia where power cuts during the summer peak have been common in the past few years. Long the home of low-cost ethane-based chemicals, the landscape in the kingdom changed in 2006, when the Ministry of Petroleum & Mineral Resources granted its last ethane allocation to Saudi International Petrochemical Company (Sipchem).

The simplest way for the region’s producers to deal with the lack of feedstock is to shift downstream, but there are limits as to how far they can go.

“The biggest opportunities for future investment in the kingdom lie in the areas of downstream petrochemical derivative clusters, value-added speciality and performance chemicals further down to the product chains, plastics and energy-intensive industries, such as minerals and metals,” says Alaa Nassif, general manager for strategic planning and investment development at the Royal Commission for Jubail & Yanbu.

Broader mix of feedstocks for Saudi petrochemicals

As the inexpensive natural gas liquid feedstocks become less available, Nassif anticipates the utilisation of a broader mix of feedstocks for the Saudi petrochemical industry, including liquid feedstocks such as naphtha and condensate. “Since naphtha is a more versatile feedstock, it can lead to the development of a wide range of aromatic-based chemicals and derivatives,” he says.

Newer projects are already cracking heavier feedstocks, such as butane, propane and naphtha, to offset the limited ethane supply.

Sabic’s share of global ethylene capacity 
Sources: CMAI; HSBC

Growth in this area will not be easy, however. Pappu states in an August report on the petrochemicals sectors: “The move towards true speciality chemicals, such as dispersants, fragrances and catalysts, is probably the better part of one to two decades away. However, commoditised specialities and intermediate chemicals, such as adhesives, coatings and engineered plastics, can be made in the Middle East.”

Speciality chemicals are generally produced in low volumes since they are designed to perform specific functions for their customers. Speciality chemical producers therefore tend to locate their facilities close to their customers, unlike commodity chemical producers, who can affordably ship vast quantities of their product globally.

But the big constraint for GCC petrochemicals producers looking to target these products is the limited size of the local market.

“Consumption of polyolefins is determined by per capita gross domestic product (GDP) and places like Egypt don’t do well,” says Paul Hodges, chairman of consultants International Echem.

Slow process of demand for polyolefins

In the developed world, where per capita GDP is more than $40,000, the average person uses 40 kilogrammes of polyolefins a year. In contrast, the developing world’s two largest emerging economies, China and India, both have per capita GDP of less than $5,000 and use barely 10kg of polyolefins.

Despite their superior population sizes, total demand from the developing world is much less than in the developed world. Of course, no one expects this situation to remain unchanged.

Emerging nations can expect to see major increases in plastics demand as their populations become richer, but it will take decades. “It is a process of education, changing habits, wealth creation, the building of a middle class – something that is several decades in the making,” says Hassan Ahmed, founder and director of New York-based Alembic Global Advisors.

“You can rule out most of the Gulf as the population is not there. Only Saudi Arabia has the population to [drive chemicals demand]. Outside the Gulf, there is Egypt and Iran.”

According to data from the Gulf Petrochemicals and Chemicals Association (GPCA), the consumption of plastics in the Middle East has grown over the past decade to 39kg per capita in 2010, from 19kg a person in 2000, matching levels seen in Japan.

Demographics in the region are also changing. High birth rates and a young population have created a policy nightmare for countries whose economies have been tied to oil for the best part of a century. Generating enough jobs for this booming potential labour force has been a central pillar of governments’ economic policies, but they continue to struggle.

The problem is most acute in Saudi Arabia, says Pappu. More than half the kingdom’s 18.5 million nationals are under 20 years old, while only 3 million are in employment. The export-orientated petrochemicals sector will not provide sufficient jobs to raise employment levels.

“Moving downstream will help job creation, but the further down the chain you go, the further away you get from the cheap feedstock advantage,” says Ahmed.

At the same time as building up their capacity locally, Gulf producers have been looking for overseas assets to increase their global footprint. The first of these forays overseas was launched by petrochemicals giant Saudi Basic Industries Corporation (Sabic), with its acquisitions of DSM and Huntsman in Europe, followed by the $11.6bn purchase of the US petrochemicals producer GE Plastics in 2007.

“It is no coincidence Sabic bought Huntsman in Europe and GE Plastics in the US. They realised they had to grow beyond Saudi Arabia into larger demand countries,” says Ahmed.

The industry is beginning to move beyond its cost-focused roots. But Pappu says the production of speciality chemicals remains a step too far and differentiated commodities are the way forward.

These have clear commodity characteristics, such as being produced in high volumes and easily transportable, but also offer the opportunity to add value to pricing. Polycarbonates are one such example. These are used in optical media for compact discs and the chemical offers a wide scope for customisation.

Sabic also has a 35 per cent stake in local petrochemicals firm Saudi Kayan, which is due to begin commercial production at its integrated production site at Jubail industrial city in mid-2011. The complex will include a 240,000-t/y polycarbonates plant.

The acquisition of GE Plastics allowed Sabic to gain access to the higher margin market of the US, while maintaining the company’s low-cost base. Saudi Kayan will be able to build on the existing customer base of the former GE Plastics, now named Sabic Innovative Plastics.

More recently, Sabic launched a joint venture project with China Petroleum & Chemical Corporation (Sinopec) for a petrochemicals complex at Tianjin in China, giving it access to large, fast-growing markets in Asia. Sabic plans to increase the proportion of speciality chemicals it produces to 30 per cent of total sales by 2020. The firm needs to move downstream in order to continue to grow, but petrochemicals further down the supply chain tend to be less profitable.

Lower margins for Middle East firms

“Gone are the days of 60 to 70 per cent Ebitda [earnings before interest, tax, depreciation and amortisation] margins,” says Ahmed.

“Sabic realised this several years ago. In buying GE Plastics, Sabic was able to grow its business and delve into the downstream market, producing polycarbonates, but it has come at the cost of lower profitability,” he says.

The company now has Ebitda margins ranging between 20 and 30 per cent.

The Middle East has lead the race for new petrochemicals capacity in recent years, but the easy growth is nearing completion. The next phase of expansion, limited by the competing demands on natural gas, will not be so straightforward. The move towards producing higher-value chemicals will require a strategic shift from the sector’s leaders as they learn about new products, markets and business models.

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