Gulf petrochemicals sector to gain from consolidation

08 February 2009
As the sector contracts in line with falling global demand, the region’s producers are in a strong position to overtake their more established international rivals through mergers and acquisitions.

Using their oil and gas resources as a base to expand into petrochemicals industries has been high on the agenda for Middle East states for years, with some success. Companies such as Saudi Basic Industries Company (Sabic) and Saudi International Petrochemical Company (Sipchem) are now major global businesses.

Overall, however, the region is still a relatively small player. But that could change over the next two years, if analysts’ predictions of consolidation in the industry are correct.

Because of the collapse in demand and prices for chemicals commodities, the profits of petrochemicals firms around the world are falling. But while Middle East petrochemicals companies are feeling the pinch, their lower feedstock costs, greater access to funding and lower levels of debt mean they are increasingly in a position to benefit from the global financial crisis.

Testing times

Few Middle East firms currently rank among the world’s leading petrochemicals companies, with Sabic and Sipchem the largest, followed by Iran’s National Petrochemicals Company.

However, larger companies from other regions are finding the market tough. In December 2008, the US’ Ineos was given a debt covenant waiver by its creditors. It ended the year with e7.5bn ($9.75bn) in debt after writing down the value of its inventory by more than e1bn in the fourth quarter of the year.

Netherlands-based LyondellBasell announced on 6 January that the company’s US operations and one of its European divisions had filed for bankruptcy protection. Tough trading conditions in the fourth quarter had left the company incapable of servicing its debt, which is thought to total about $26bn.

Dow, the second-largest chemicals company in the world, is also struggling after the collapse of its $17.4bn K-Dow joint venture with Kuwait’s Petroleum Industries Company (PIC). The $9bn payment it was due to receive from PIC as part of the deal would have helped it acquire US specialist chemicals maker Rohm & Haas, and the loss of the payment means Dow’s financial and strategic feedstock position is increasingly precarious.

Middle East companies have not completely avoided the downturn. Sabic, for example, suffered a 95 per cent fall in net profit in the final quarter of 2008 compared with the same period in 2007, with full-year profits down 19 per cent. But Sabic is still profitable, and has few of the debt problems that are hitting its global rivals.

The market is likely to get tougher for most firms. In a report published on 18 January, Citi Investment Research & Analysis, a division of the US’ Citigroup, outlines its forecast for the chemicals industry over the coming 18 months. It predicts companies will continue to reduce their stock levels, a process they began in the fourth quarter of 2008, to improve their cash positions.

“By the end of [2009], market share wars are likely to have begun due to expected weak demand,” says the report. “This should test business models.”

The report goes on to say that within 12-18 months, the market will enter a period of consolidation, with some companies acting from a position of weakness while others have an opportunity to buy cheap assets.

Market observers agree that in such an environment, Middle East chemicals firms are in a strong position to take advantage of their competitors’ weaknesses. The question is whether they will do so and how.

“We will see companies go [out of business],” says John Sfakianakis, chief economist at Saudi bank Sabb. “The likes of Sabic will be able to stay above the water. This is a chance to showcase its advantages. It is the lowest-cost commodity producer in the world. It will be able to expand market share on this basis. In a few years, Sabic is going to gain a lot of market share.”

In December, Florian Budde, director of European chemicals practice at US business consultant McKinsey & Company, told MEED “now is a good time to buy if you look at the valuation of chemical companies”.

However, it is not clear whether Middle East firms will attempt takeover deals in the short term. Sfakianakis says he does not see Saudi companies making any major acquisitions soon.

“In the case of Saudi Arabia, you will not see appetite [for acquisitions] in the coming 18 months, because Sabic is coming to terms with its shareholders and its fourth-quarter results,” he says, referring to the 95 per cent drop in the company’s fourth-quarter profits. “If you wait two quarters it would make sense. Although it makes sense now for Sabic and similar companies to act aggressively, they might hold back.”

However, Nigel Davis, director of insight at ICIS, says the Gulf’s sovereign wealth funds could still be a good source of finance, if presented with the right deal.

One Cairo-based economist agrees that the sovereign funds could back some deals. “They have a lot of reserves from higher [oil] prices,” he says. “The governments do have funds available for economic stimulus.”

Even though the amount of credit available has fallen substantially in the Middle East, the economist says, local companies are still in a better position than their competitors from other regions. “If you are talking about Egypt, you have a lot more liquidity in the system,” he explains. “In the GCC, there is not the same crisis as in the US, but the market is a lot more constrained.”

Pat Rooney, managing director for the Middle East at US-based chemicals industry consultant Chemical Market Associates, agrees that Gulf companies could be in a position to attempt acquisitions, given the right deal.

“We think it is very possible,” he says. “In terms of Middle East players being more involved in the global industry, they could be very interested. What you are going to have is the guys who are in the chemicals industry making earnings at a time when the rest of the world is not.

“You can envisage that most of these companies are looking for marketing and technology, which would require partnerships. But beyond that, there could be wholesale acquisitions.”

For now, joint ventures or working partnerships are still the most likely type of deal for the regional chemicals industry, and good deals will be available in the current climate. “If you look at the way things have gone, the preferred route is big joint ventures,” says Davis.

Among the recent deals that have gone ahead, the UK/Dutch Shell Group and Bahrain’s National Oil & Gas Authority (Noga) signed a memorandum of understanding to develop gas initiatives on 2 February.

“Technology and marketing partnerships are definitely high on the agenda,” says one Bahrain-based industry executive.

Even companies whose deals have failed, such as Dow, say they are keen to pursue more Gulf partnerships in the future, and there is still interest in deals from local companies.

Following PIC’s cancellation of the K-Dow joint venture, Andrew Liveris, chairman and chief executive officer of Dow, said his company was pursuing other options in the region. “Prior to signing the definitive agreement with our Kuwaiti partners about the K-Dow joint venture, we had other options and partners to consider,” Liveris said in a statement issued on 6 January.

“Some of these discussions were active as recently as November [2008], and we have already been contacted by other interested parties and have begun discussions. This can be done on an accelerated timeline, due to the considerable groundwork that has already been established in anticipation of the K-Dow joint venture.”

Joint ventures

Analysts and contractors in the region say it is unlikely that Dow will be able to secure the same terms as had been mooted for the K-Dow deal, and that local players will now be in a stronger position to bargain.

Beyond advantageous terms on joint ventures, there is an opportunity for local firms to increase their market share because they can continue to make a profit at prices far lower than producers elsewhere in the world.

Petrochemicals companies in the Middle East are largely integrated with local refineries and crackers, and often pay little more than cost price for their feedstock. US and European producers, which dominate the global market, usually have to pay the higher price set by the markets.

At the end of 2008, they had to contend with stocks of chemicals produced on the basis of oil at more than $100 a barrel when both demand and prices were tumbling.

Middle East companies, while still susceptible to market fluctuations, are more concerned by demand than prices. “Sabic is always going to be in a strong position as a low-cost producer,” says Sfakianakis.

“The region overall is going to play a major role as the main global producer. They need partnerships to capture market share and new technology. We are going to get out of this [recession] eventually, and they are well positioned to take advantage of that as the current decline in oil prices is temporary.”

As petrochemicals projects edge ahead after significant delays, and with international companies in increasingly poor shape, it seems that 2009 and 2010 could be the years when the Middle East establishes itself as the dominant force in the global petrochemicals market.

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