Petrochemicals: Managing volatility

25 April 2003
Life has not been easy for Equate Petrochemical Company recently. The threat of an Iraqi missile attack on its Shuaiba production facilities has been very real, while restrictions on civilian movements have meant that a skeleton staff has been in charge of running the jewel in Kuwait's petrochemical crown. But despite the fears and constraints, Equate has managed to keep the show going, maintaining production and despatching its polyethylene and ethylene glycol products to overseas customers.

Like its petrochemical counterparts elsewhere in the Middle East, Equate has had a strong commercial incentive to keep its plant operating. Between November 2002 and March 2003, polymer prices rose sharply, with polyethylene and polypropylene bound for China recording increases in the range of $150-200 a tonne. Strong global economic growth was certainly not the main factor behind the jump. Rather, it was more a question of product prices reacting to the surge in the oil price (see figure 1).

The oil price continues to have a strong influence on the petrochemical industry. In Europe and Asia, where the industry is built on the refined product of naphtha, oil market volatility has an almost immediate effect on the pricing of feedstock. Invariably, producers attempt to pass on any feedstock increases in the form of higher product prices to customers, which in turn often buy beyond their requirements for fear that prices will go up even further in the future.

It is at times of high oil prices that Middle East capacity comes into its own. With the exception of a handful of propane crackers in Saudi Arabia, virtually all regional capacity is based on ethane, which is priced under long-term contracts. As a result, Gulf producers can enjoy high product prices without being hit by inflated feedstock costs.

The comparative feedstock advantage enjoyed by Gulf producers has been highlighted in recent months. According to the UK's Jacobs Consultancy, margins on linear low-density polyethylene (LLDPE) produced by Saudi ethane crackers and sold into the Far East on a carriage and freight basis climbed to about $400 a tonne in March. This compares with a margin of about $200 a tonne for Korean product and a loss of up to a $100 a tonne for North American producers, which were hard hit by a sharp spike in gas prices in March (see figure 2).

Since the outbreak of war in Iraq on 20 March, oil prices have fallen back from above $30 a barrel to $25 a barrel. Polymer prices have also begun to soften, a reflection of not only the crude price but also some uncertainty over the demand outlook.

The demand picture remains very mixed. While much of Europe and the US are battling a sharp economic downturn, Asia is recording steady growth. Critically, there are few signs that the Chinese economy is running out of steam. Says Philip Leighton of Jacobs: 'The big driver in demand is China, accounting for about a third of the growth in product demand in any one year. A lot therefore hinges on what happens there, although so far there has been no evidence that events in the Middle East are derailing its economic activity.'

On the supply side, the outlook is clearer. 'There is no new significant capacity coming to market at the moment: the next cracker will be olefins 6 in Iran, which is scheduled for the fourth quarter,' says Andrew Pettman of Chemical Market Associates (CMAI). 'The general message is that new capacity will come in due course, but it is a couple of years away.'

With European and US producers having virtually given up on steam cracker new-builds, the investment focus is firmly fixed on the Middle East and, to a lesser extent, China. In the region, ethylene production capacity is forecast to double to an estimated 20 million tonnes a year (t/y) by 2010. With the exception of the Jubail United Petrochemical Company (United) plant in Saudi Arabia and a couple of new crackers in Iran, nearly all the projected capacity is scheduled to come on stream after 2006. As a result, global operating rates are set to increase over the next two years.

The new round of regional investment in petrochemicals is being driven by a host of upstream gas developments, which will deliver substantial volumes of ethane feedstock. In Qatar, the $3,500 million Dolphin gas project and the Al-Khaleej gas development, formerly known as the enhanced gas utilisation (EGU) project, will produce sufficient feedstock for the proposed 1.2 million-t/y cracker at Ras Laffan, which will in turn feed new downstream units at Mesaieed. It is a similar story in Iran, where the development of the South Pars gas reservoir is underpinning a planned tripling in capacity over the next 10 years. In Egypt, a 10-fold increase in gas reserves over the past two decades has prompted the government to draw up a petrochemicals masterplan, which envisages over 10 million t/y of new capacity by 2010.

The need for more ethane feedstock was one of the key drivers behind the gas initiative in Saudi Arabia. However, with negotiations between the government and the core ventures now at a virtual standstill, it is now likely to be left to Saudi Aramco to fill the gap in ethane supplies. Until more ethane becomes available, new investment in the kingdom will be driven more by the private sector looking to use available propane or methane feedstock, than Saudi Basic Industries Corporation (Sabic), the region's largest petrochemical producer. 'There is quite a lot that can be done by the private sector in terms of filling in areas which are too niche for Sabic,' says Leighton. 'At one point, Sabic would have said it would do all that. But as it has progressed, it has realised that there is little point in doing the entire chemistry book.'

In any case, Sabic has more pressing goals to address as it seeks to become a truly global petrochemical company. Over the past year, it has established a permanent presence in Europe through the acquisition of DSM Petrochemicals of the Netherlands, and remains on the look-out for new capacity overseas. It has also stepped up its pursuit of technology, acquiring in March a 50 per cent stake in US technology provider Scientific Design Company.

The acquisitions can be seen as logical steps in Sabic's development. When it was established in 1976, the company had little option but to form joint ventures in Saudi Arabia with international petrochemical companies, which could provide much-needed technical and marketing expertise. By the late 1990s and the establishment of Jubail United, Sabic was in the position not only to implement the $1,500 million project on its own, but to supply technology - for the alpha olefins unit - which it had jointly developed with Germany's Linde. By 2002 and the acquisition of DSM, the wheel had turned full circle, with Sabic directly competing against some of its international joint venture partners in Europe.

How much impact Sabic's rapid growth has had on its relations with existing joint venture partners is difficult to tell, although in the case of one - the US' ExxonMobil Corporation - times have certainly been better. In March, Sabic announced that it was to appeal a US court decision, calling for it to pay $417 million in damages to ExxonMobil. The award related to the latter's claim that Sabic had overcharged licensing fees for their joint venture companies, Yanbu Petrochemicals Company (Yanpet) and Al-Jubail Petrochemicals Company (Kemya).

The court case has prompted a flurry of speculation as to why the dispute has ended up the courts. At one extreme, some say it is a natural and inevitable consequence of Sabic's pursuit to become a truly international petrochemical company. At the other end, there are those that have focused on ExxonMobil and concluded that the court case would not have been pursued if the gas initiative, in which the company is a major participant, was proceeding smoothly. Whatever the real reason, one thing is for certain: it would have been unimaginable for such a dispute to have been played out in public a decade ago.

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