Rising oil prices cloud outlook for the Gulf

09 May 2011

The Gulf’s petrochemicals manufacturers have had a good start to the year, reporting increased first-quarter profits, but high oil prices could hit the fragile recovery

In numbers

50million t/y: Predicted rise in petrochemicals production capacity between 2009 and 2015

71per cent: Year-on-year increase in Industries Qatar’s first-quarter net profits for 2011

Sources: GPCA; MEED

After a difficult few months following the global downturn of 2008-09, petrochemicals demand is on the rise thanks to sustained economic growth worldwide, particularly in China.

Stable oil prices during 2010 and a pick-up in demand have been driving this recovery. This year so far has been kind to Middle East producers. In April, the region’s largest petrochemicals maker, Saudi Basic Industries Corporation (Sabic), announced net profits of SR7.69bn ($2.05bn) for the first quarter, up 41.6 per cent from SR5.43bn for the same period in 2010.

Global petrochemicals production (percentage)
Source: ChemSystems

Industries Qatar posted a 71 per cent year-on-year increase in its first-quarter net profits, which rose to QR2.1bn ($574m). Revenues, meanwhile, were up 46 per cent to QR4bn.

Saudi Aramco’s joint venture with Japan’s Sumitomo Chemical, Rabigh Refining & Petrochemical Company (PetroRabigh), announced first-quarter net profits of SR698.5m, up 157 per cent from the SR271.5m reported for the same quarter in 2010.

Petrochemical production increases

The companies all attributed the improved performance to an increase in production and sales volumes, as well as higher sales prices.

“They have already benefited from the increase in demand, which has been accompanied by prices that, although not at the record levels of 2008, are still at historical highs. This is an important point, I think, as ethane-based producers have hardly seen input costs rise,” says one London-based industry analyst.

The combination of destocking with a downturn in [end-user] demand can have a devastating impact

Paul Hodges, International Echem

Despite a substantial recovery in 2010, there are still turbulent times ahead for the global polyolefins industry as it continues to grapple with the residual effects of the economic crisis of 2008 and 2009. Oil prices are once again above $100 a barrel because of the political instability in North Africa and the Middle East. This is putting pressure on petrochemicals prices and could hit the still fragile recovery in demand.

Brent crude oil prices have been about $125 a barrel for the past month, but some analysts say there is no justification for them being so high.

“Unlike 2007 or 2008, there is no shortage of spare capacity,” says Paul Hodges, chairman of UK-based consultants International Echem. “Equally, inventory levels have been consistently at comfortable levels. Of course, China has been consuming more, but this has not been sufficient to put the global market under any major strain, especially as demand in the Western economies has been slow to recover.”

The Middle East has become an increasingly significant player in the petrochemicals export market

A large part of the problem stems from the enormous liquidity in the world’s banking community. Much of this has simply gone into speculative trading activities, often focused on crude oil markets, which are seen as a surer bet than speculating on currency exchanges. Economic stimulus packages have been wound down and real market demand remains weak in the US and Europe, particular in the vitally important automotive and housing sectors. It is against this backdrop that new polyolefins production capacity additions continue to come onstream and this could undermine the sector’s recovery.

China’s spectacular growth spurred much of the recent capacity building in the Middle East, but the country is now on a drive to become more self-sufficient. An estimated 9 million tonnes a year (t/y) of ethylene capacity is set to come onstream by 2015.

China launched its 12th five-year plan in April, sketching out the country’s economic path for the next half decade. After years of double-digit growth, the document signifies a major shift in planning, with China seeking to contain its growth to give it time to deal with the environmental, social and economic problems associated with the rapid growth it has experienced.

Differing opinions on the petrochemicals sector

The US petrochemicals major Dow Chemical’s chief executive Andrew Liveris spoke positively about the outlook for the sector in an earnings call at the end of April. Liveris told analysts: “Any indications of high inventories [in China] are likely to be transitory.” He added that demand was robust. However, others are more sceptical.

“We now have a position, for the fifth time in the past 40 years, where the price of crude oil has been above $50 a barrel for a sustained period of time. The previous four times have been followed by an economic downturn, and there is no reason to believe this time will be different,” warns Hodges.

The effect of higher oil prices is to reduce consumers’ disposable income, leaving them less able to spend on other products and services. But this is unseen while crude prices rise, as companies have to buy ahead to protect their supply position.

The higher prices may not necessarily lead to demand destruction, however, argues Hassan Ahmed, founder and director of New York-based Alembic Global Advisors.

“We saw oil prices rise to over $140 a barrel back in 2008 and ethylene prices rose to above $1,600 a tonne, compared to $1,200 a tonne currently. We did not see any demand destruction back then, despite high prices. It was only when the financial crisis happened that we saw demand slow down,” says Ahmed.

“But once prices peak, we risk seeing major destocking all down the value chain.”

Hodges argues there is growing anecdotal evidence from chemical buyers and the major retailers that prices may have reached a peak, at least temporarily.

“Markets, of course, have a habit of surprising. But, as we saw most recently in 2008-9, the combination of destocking with a downturn in [end user] demand can have a devastating impact on the chemicals industry,” says Hodges.

Margins slashed

This was evident in July 2008 when crude oil prices fell from record highs above $147 a barrel to lows of under $40 a barrel in February 2009 and US consumer petrol prices crashed from more than $4 a gallon to less than $1.60 a gallon during the same period. Refining margins were slashed and it looked like selling oil directly into international markets would be more profitable.

Petrochemicals produced from gasoline products, such as naphtha, suffered similar issues. Basic plastics produced from the natural gas ethane – typically priced at $0.75-1.25 a BTU in the Gulf, as opposed to as much as $9 a BTU elsewhere, and used to make the chemical building block ethylene – faced major oversupply against a backdrop of falling demand.

The focus over the past few years has been on feedstock-advantaged capacity additions and fast-growing markets. The Middle East has become an increasingly significant player in the petrochemicals export market. It has led the investment in commodity chemical capacity additions over the past decade and accounted for more than half the new supply brought onstream in recent years.

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.

As the Middle East resolves its problems with securing feedstock, it will start to look for new export markets, moving away from its traditional reliance on Asian demand. Analysts now see Europe as the likely arena for competition between producers with low-priced feedstock, namely the US and the Middle East.

Europe is likely to become a net importer and a competitive ground for Middle Eastern and Chinese exports over the next five to six years as new large-scale plants come online. US exports might decrease, but it is unlikely to become a net importer.

The Gulf’s petrochemicals producers will have added almost 50 million t/y of new petrochemicals production capacity between 2009 and 2015, equalling the market share of the US and Europe, according to the Dubai-based Gulf Petrochemicals & Chemicals Association. Total petrochemicals output is set to rise to 153.2 million t/y from 105.7 million t/y today, an increase of 44.9 per cent.

The region currently accounts for 16 per cent of the world’s petrochemicals production. This will grow to 20 per cent by 2015.

Asia, which accounts for 31 per cent of global production, will also increase its share to 36 per cent by 2015. North America and Europe, meanwhile, traditionally the dominant centres of production, will see their influence waning, with their shares falling from 25 per cent to 20 per cent and 23 per cent to 20 per cent respectively.

Integrated mega-refinery and petrochemical schemes

With the last of the new ethane-feed plants coming online, the trend is now to invest in integrated mega-refinery and petrochemical schemes, such as that planned by Saudi Aramco, Dow and France’s Total at Jubail in Saudi Arabia, but these represent a much riskier venture. Things are about to become much tougher for the Middle East’s producers.

Total joined the scheme as an export oriented venture, but it now looks like some of the output will be earmarked as feedstock for the downstream Dow petrochemicals project.

“It can’t be a particularly interesting business proposal from Total’s point of view,” one Dubai-based industry source says.

“On the other hand, the Saudi Arabians will have to adjust to the fact that if they want most of the world’s petrochemicals industry to locate to the Gulf and [use] its cheap feedstock, the company strategies and politics will also move down to the Gulf with them”.

Besides the headache of having various businesses competing on the same site, there could be other undesirable effects. If competition for projects heats up, large integrated refining and petrochemical firms may well shift from their traditional attitude to the region. Instead of trying to maintain good relations with all the national oil companies, it is likely the firms will strike strategic alliances with state oil companies for petrochemicals projects, effectively pitting countries against one another.

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