OVERVIEW: Growth through specialisation in downstream petrochemicals

23 November 2007
As the Gulf increasingly moves into downstream petrochemicals industries, new projects aimed at producing speciality products will give a much-needed boost to the sector.

Every three years in Dusseldorf, Germany, the plastics industry holds its showcase event, the K Show. For the industry, it is an opportunity to show off products, impress clients and clarify intentions to the 500,000-plus attendees.

On the back of one of the sector's best ever years, the 2007 event, held in late October, was the most buoyant yet. For an industry that is notorious for failing to connect to the end-user, this was the perfect opportunity to highlight the role petrochemicals and plastics play in everyday life.

The show has grown in importance for Middle East producers. As production strategy shifts downstream from base petrochemicals production to plastics and speciality chemicals, the need for a greater focus on customers and the market has increased.

All of the region's major producers were at the event. Kuwait's Equate Petrochemical Company, National Petrochemical Company of Iran, Abu Dhabi Polymers Company (Borouge) and Qatar Petrochemical Company (Qapco) each had prominent stands as they tried to attract new customers.
Saudi Aramco also attended as a guest of the US' Dow Chemical Company, with which it is developing the massive $25bn Ras Tanura integrated refinery and petrochemicals complex. It displayed a multitude of chemical end-product applications ranging from swimwear and textiles to insulating material and bedding.

At the heart of the show was Saudi Basic Industries Corporation (Sabic), staffed by a large contingent of employees from Sabic Innovative Plastics, the new name for US-based GE Plastics, which Sabic bought for $11.6bn in May.

“It is important for Sabic to show its commitment to GE Plastic's former customers,” says an industry executive. “They want to know that the company is going to invest in their products, that it is going to provide the right service and that it is going to invest in its acquisition.”

Sabic's purchase of GE Plastics marked the beginning of a new era for the region's petrochemicals industry and confirmed Sabic as the first multinational Saudi company. But, while it has become a dominant base chemical producer, the Gulf has yet to make a real impact in downstream chemical and plastic production.

This is set to change as new projects creating speciality products come to the market. The most advanced of these is the $9bn Jubail-based Saudi Kayan Petrochemical Company complex, which will produce several new products in the kingdom, including polycarbonates and phenols.

Gas shortage

Other planned downstream schemes include the estimated $8bn Saudi International Petrochemical Company (Sipchem) olefins and derivatives complex, also in Jubail, and Dow/Aramco's Ras Tanura megaproject, which will introduce more than 30 products to the region.

The downstream shift has been driven by a growing shortage of cheap gas feedstock in the region. But with so many crackers being built in the Gulf, countries are running out of allocations of ethane. Sipchem was the last recipient of an allocation in Saudi Arabia more than 18 months ago.

Only Qatar, endowed with the world's largest offshore non-associated gas field, can claim to have any meaningful remaining allocations, even with the moratorium on increasing production from its north field.

As a result, developers are relying on heavier, more readily available feedstock, such as propane, butane and naphtha. This, in turn, will help to facilitate the development of enhanced downstream processes for conversion into alternatives to the traditional polyethane and polypropylene.

State encouragement

Many Gulf states are prioritising downstream investment because it is more labour intensive. With 50 per cent of the local population under the age of 20, job creation is a priority.

For example, the Ras Tanura and Petro-Rabigh megaprojects, implemented by Saudi Aramco with a foreign partner, come with an associated conversion park to encourage the establishment of a local manufacturing base where private firms can turn Ras Tanura's chemicals into a range of materials, from plastics and food additives to medical products.

The result is that developers wishing to obtain any type of feedstock allocation must prove to the government they will create jobs.

“Going downstream is a compulsion more than a choice for many Gulf states,” says Sanjay Sharma, project manager at the Dubai office of US consultant CMAI.

This has not been without problems, however. While downstream processes do diversify the product slate and create more job opportunities, they also dilute the cash-cost advantage of the cheap feedstock allocated to them, with each processing step diluting the advantage by about 20 per cent.

“Additionally, you are adding the capital and fixed operating costs of the extra processing steps, and you have a long chain of plants to build,” says Phillip Leighton, director of petrochemicals at the US' Jacobs Consultancy. “On top of that, you are doing it in markets that are relatively small.”

The disadvantages of downstream development have been intensified by the rapid rise of engineering, procurement and construction (EPC) costs. “We have seen a 20 per cent a year increase in costs over the past three years,” says Leighton. “Projects cost a lot more than they used to.”

For example, Oman Petrochemical Industries Company (Opic) has been forced to review and delay its Sohar olefins project because of rising costs. The Petro-Rabigh scheme in Saudi Arabia is another example: its initial budget of just over $4.8bn has doubled to nearly $10bn.

Innovative contracting strategies can be used to share risk between the developer and contractor and to obtain a better idea of overall cost, after front-end engineering and design is completed.

Increased competition from contractors will also help, with developers seeking to introduce Chinese and Indian contractors, which are often perceived as more competitive in terms of pricing.

“Developers have always tended to look west for their contracting requirements, but they also need to look east,” says Sharma. “This will not eliminate the problem but it will make it look better. The other thing to do is simply wait until the project market cools down.”

Rising costs come at a time when credit is also more expensive and difficult to obtain following the summer global credit crunch. Sabic's delayed efforts to find $1.5bn to fund its Saudi Kayan complex are well documented, while Qatar Fertiliser Company (Qafco) has had issues with the financing of its fifth train expansion.

The sponsors of these schemes are effectively quasi-government entities with good track records and healthy finances. For the private sector, which has to cope with less state support, obtaining project finance will be more difficult.

“The key on a lot of these megaprojects is to obtain government assistance through quasi-state lending bodies such as the Public Investment Fund,” says the consultant. “Additionally, getting a wide diversity of contractors allows for some funds to be extended by their respective export credit agencies, such as Eximbank.”

Expensive credit

As borrowing costs increase and banks become more reluctant to lend for higher-risk projects, the limit of what can be borrowed has been lowered. Some financiers tell MEED the maximum a project today is likely to receive in terms of conventional project finance is $2-2.5bn, with Islamic finance adding a further $1bn. Taking a standard 70:30 debt/equity ratio, this is not enough to fund some of the projects.

“It has become harder for those projects at the margins to obtain finance,” says Darren Davies, head of project and export finance for the Middle East and North Africa region at HSBC.

“However, the overall effect on the market seems to have been on pricing more than capacity. Provided borrowers are willing to accept higher pricing, the capacity is still there to do major deals. In terms of capacity, there is no major change to what we would have seen as possible earlier in the year.”

Even if financing and development costs are resolved successfully, producers may want to think twice before going for new capacity. After a profitable five years, most industry observers predict the sector will slow down in 2009 as supply begins to outstrip demand.

“The peak has lasted a lot longer than we expected,” says Sharma. There is a lot of capacity coming to the market and we are set to see some softening over the coming two years.”

“The year 2009 is when it all starts looking sticky because of all this new capacity,” says Leighton. “You have six crackers in the Gulf alone coming on stream, plus the Iranian projects. Someone will have to stop producing. And, although it won't be in the Middle East, prices will still have to fall.”

The Gulf, with its substantial feedstock advantage, will survive. But as its production becomes more diversified and prone to business cycles, it will have to become much less reliant on its cost advantage.

Going downstream may be a necessity, but it will not be easy.

Key fact

$128bn is the value of petrochemical projects planned or under way in the region.

Producing petrochemicals - fact file

  • UPSTREAM: Crude oil and natural gas are separated through refining or gas processing into more useful components such as ethane, liquefied petroleum gas (LPG) and methane. These are, in turn, processed (cracked) to create olefins (ethylene, propylene and C4 chemicals) and aromatics (benzene, toluene and xylene).

  • DOWNSTREAM: Downstream processes are the conversion of these products into other chemicals and plastics.

  • Benzene: Benzene is the simplest aromatic hydrocarbon and is used to create ethylbenzene, styrene, polystyrenes, phenol, acetone, cumene, cyclohexane, nitrobenzene, alkylbenzene, nylon and solvents.

  • Toluene: Also known as methylbenzene or phenylmethane, this can be a solvent or precursor for other chemicals. It is used in the manufacture of other chemical reactants, rubber, printing ink and disinfectants.

  • Xylene: This is used as a solvent or to produce other chemicals and products such as polyesters, polyethylene terepthalate, terepthalic acid, pthalic anhydride and paraxylene.

  • C4: Chemical derivatives include butadiene, synthetic rubbers and epoxy resins.

  • Propylene: Is converted into polypropylene (thermoplastic polymer used in packaging, textiles, loudspeakers and ropes); polymerised propylene; isopropyl alcohol - 2-propanol (used in solvent or rubbing alcohol); acrylonitrile (plastic monomer); propylene oxide; and propylene glycol (also used in engine coolant).

  • Ethylene: Ethylene is converted into products such as polyethylene, a versatile plastic commonly used as high-density polyethylene (HDPE) or low-density polyethylene (LDPE); ethanol (alcohol); ethylene glycol (engine coolant); vinyl acetate; and vinyl & polyvinyl chloride (PVC).

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