Petrochemicals producers wait for recovery

25 November 2009

Growing competition from China and reduced demand following the global economic downturn is hitting the profits of Gulf petrochemicals firms

Since the start of mass production in the petrochemicals industry in the 1950s, the sector has been susceptible to global fluctuations in demand. But the damage to the Gulf petrochemicals industry from the economic downturn that hit the region in October 2008 is causing particular concern for industry executives.

The effects of the global crash hit the petrochemicals sector at the start of 2009, but the scale of the damage only became clear when state-run petrochemicals giant Saudi Basic Industries Corporation (Sabic), the world’s largest petrochemicals producer, announced on 19 April that it had made a SR974m ($259m) loss in its first-quarter earnings. By comparison, the firm made a net profit of $1.85bn in the same period in 2008.

Sabic’s first deficit in seven years resulted from a combination of a collapse in global demand for petrochemicals and a fall in prices (see chart). The company has since returned to profit, reporting a second-quarter profit of $479m. By the end of the third quarter, its profits had doubled to $959m. However, even this figure was just half the $1.9bn profit the company achieved in the same period in 2008. Sabic’s net profit for the year to September 2009 was down 79 per cent at $1.2bn year on year.

Recovery hopes

Sabic’s performance since reporting its first-quarter results offers hope that the region’s petrochemicals industry is recovering.

The company’s total production in the first nine months of 2009 reached 44 million tonnes, an increase of 4 per cent compared with the same period in 2008, on sales of 34.5 million tonnes of petrochemicals, an increase of 3 per cent on the same period last year.

Since December 2008, however, Sabic has shed more than 1,000 jobs from the 9,500 workforce at its Innovative Plastics division. This would be unthinkable within Saudi Arabia, given the kingdom’s job creation priorities, so most of the cuts have been in the company’s US and European operations.

While Sabic’s performance is important because of the size of the company, it is not the only petrochemicals firm to have had a tough 12 months. Industries Qatar (IQ) posted a 47 per cent drop in profits for the first nine months of this year, with net income down to QR3.8bn from QR7.2bn a year earlier.

Saudi International Petrochemical Company (Sipchem) reported third-quarter net profits of $14m against $36m last year.

Petrochemicals companies are hoping a rise in commodity prices will lead to a return to healthy fourth-quarter profits for 2009.

According to data from the UK’s Jacob’s Consulting, spot ethylene prices in Europe peaked at $1,807 a tonne in July 2008, before plummeting to just $510 a tonne in January 2009. There has been some recovery since then, with prices rising to $1,000 a tonne in September.

The price of linear low-density polyethylene (LLDPE), a derivative of ethylene, has followed a similar path, falling from a peak of $2,400 a tonne in July 2008 to a low of $800 a tonne in February 2009. As with ethylene, the recovery has been slow but steady, with the price of LLDPE reaching $1,300 a tonne in October.

Despite Gulf petrochemicals producers enjoying a significant cost advantage over European producers (see bar chart) because of their access to cheap gas feedstock, their margins have been hit by the downturn, although not to the same extent as their European, Asian and US counterparts.

“Petrochemical prices have improved more than expected and demand is expected to pick up as the year comes to an end in line with expectations of a slowly recovering global economy,” says one Dubai-based petrochemicals analyst.

According to the Petrochemicals Industries Index GCC Sector report published in October by Kuwaiti investment bank Global Investment House, regional growth in petrochemicals sales in the third quarter of 2009 is mainly a result of the improvement in average prices of petrochemicals. “The role of volumetric growth remains limited, in the range 4-5 per cent,” says the report.

“Real demand is not the kind we saw in the second quarter – filling up warehouses on cheap credit”

Dubai-based analyst

In 2010, the global petrochemicals industry is likely to be battling oversupply, with further production capacity due to come on line in the Middle East and China.

Global petrochemicals demand is set to fall by 2 per cent by the end of this year, to about 115 million tonnes, the same level as in 2006.

The majority of the Gulf’s petrochemicals products are exported, most notably to China, where demand has improved after a difficult first half of the year. Despite the Chinese government’s $586bn economic stimulus programme announced in November last year, its economic growth is not expected to return to the 2007 level of 11.7 per cent until well into 2010, meaning demand for petrochemicals in the country will remain suppressed.

The importance of the Asian markets to the Gulf’s petrochemicals companies is illustrated by the ongoing dispute between the Gulf Petrochemicals & Chemicals Association (GPCA) and China, India and the EU. China and India have attempted to introduce regulations to prevent Gulf producers exporting large volumes of low-cost petrochemicals to other markets – a practice known as dumping. Gulf producers are attempting to resist the new rules, claiming they are protectionist.

“The GCC and our industry will not accept the application of anti-dumping regulations against exports of petrochemicals and chemicals from the Gulf,” said Abdulwahab al-Sadoun, secretary general of the GPCA, in a statement released on 12 October. “We have seen a surge in protectionist actions brought against countries to block imports. These cases are baseless and violate international rules.”

Export deals

The GPCA’s members are backing the association strongly in its bid to expose China and India’s alleged behaviour, especially given their production expansion plans. Once new production comes on stream in the Gulf states, producers will want to secure export contracts with clients in Asia and Europe.

Sabic plans to boost annual petrochemicals production by 12 million tonnes in the next two years by expanding foreign ventures and domestic plants. In July, Prince Saud bin Thunayan al-Saud, chairman of Sabic, said the increase in production would mainly come from a joint venture with China Petroleum & Chemical Corporation (Sinopec) and from units in Saudi Arabia.

In August, Sabic and Japan’s Mitsubishi Rayon Company agreed to set up a $1bn joint venture in Saudi Arabia to make materials used for cars, competing with US and European rivals including Germany’s BASF.

In September, Sabic affiliate Yanbu National Petrochemical Company (Yansab) announced the first shipment of ethylene glycol from its plant in Yanbu Industrial City.

On 7 October, Anas Kentab, general manager of operations at Sabic, said Sabic affiliate Eastern Petrochemical Company (Sharq) would start a 1.3 million-tonne-a-year ethylene cracker project by the end of the year.

Despite the impact of the slowdown on the Gulf’s petrochemical sector, the region would have been considerably worse off without its access to competitively priced feedstock.

Buying ethane at $0.75 a million BTUs, a Saudi producer can make ethylene – a basic building block for the petrochemical industry – for as little as $200 a tonne. Ethylene production costs for US and European firms is between $535 and $915 a tonne. The figure is even higher for Asian producers.

While the Gulf has a clear cost advantage in producing ethylene derivatives from ethane, which is stripped from natural gas, it does not have the same advantage for other petrochemicals. And even with ethylene, the advantage for new Gulf producers is constrained by the availa-bility of ethane feedstock, a problem that is exacerbated by the growing shortages of associated gas in the region.

In Saudi Arabia, no new ethane allocations have been made since 2006, which is putting the brakes on any petrochemicals expansion plans beyond those already announced.

To date, access to cheap ethane has allowed the region to build a significant export industry for commodity polymers. But with new firms entering the market, Gulf producers will increasingly have to battle for market share.

Protectionism is likely to remain a problem until demand from the construction, automotive and other sectors returns.

“Real demand is not the kind of demand we saw in the second quarter, which consisted of filling up inventories and warehouses with polyethylene on cheap credit,” says one Dubai-based analyst.

When demand will return is difficult to predict, with few petrochemicals industry executives willing to discuss the issue. Ahmad al-Ohali, chief executive officer of Sipchem, says the financial effect of the economic crisis will last for at least another 18 months before the industry can expect to see clear and healthy growth in demand and prices.

He is not alone in predicting the recovery is still a long way off. When reporting third-quarter results, petrochemicals industry executives were concerned about the outlook for the industry. “Do not count on material improvements in market conditions,” said Andrew Liveris, chairman of the US’ Dow Chemical.

Some reasons for optimism can be drawn from the steadily rising spot prices for ethylene, and the concurrently rising ethylene cash margins. From lows of $225 a tonne in February, Middle East ethylene cash margins have risen to $769 a tonne. These improved figures will feed into the end-of-year results that will be announced in early 2010. These are expected to show a significant improvement on the difficult January to March period at the start of 2009.

Key facts

  • $769 a tonne - Average ethylene cash margin for Gulf petrochemicals producers
  • 79 per cent - Drop in Sabic’s profits in January-September 2009, compared with same period in 2008

Source: MEED

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