Saudi Arabia facing competition from the US

18 October 2011

The shale gas boom in the US has triggered investment in new petrochemicals projects, but schemes in Saudi Arabia will continue to benefit from cheaper feedstock and state backing

Key fact

About $42bn-worth of petrochemical projects are at the EPC stage or under construction in Saudi Arabia

EPC=Engineering, procurement and construction. Source: MEED Projects

When the contract to build Sadara Chemical Company’s $20bn petrochemicals complex in Jubail was signed by Saudi Aramco and the US’ Dow Chemical in October, observers said the petrochemicals industry would be the driver of Riyadh’s ambitious plans to diversify its economy away from oil.

Experts had previously predicted that the main competition to the kingdom’s burgeoning petrochemicals industry was likely to come from India and China.

An unlikely new challenger is now emerging that could eat into the future market share of all the major petrochemicals producing countries: the US.

The US has not been regarded as a major investor in the petrochemicals industry for several years due to the high costs of feedstock such as ethane and naphtha.

Shale gas

“What has been the major game changer in the US is shale gas,” says Matthias Stein, director global market development for Germany’s Linde Group. “When natural gas prices started to go down in 2008, the argument for the US to reignite its domestic [petrochemicals] industry became much stronger.”

“Investors are attracted to [the kingdom] for different reasons than they would be to the US”

Source based in Saudi Arabia

The US offers potential investors several major advantages and companies such as the UK/Dutch Shell Group are now considering building ethane-based crackers close to the shale gas fields, says Stein. Others are thinking about changing their higher hydrocarbons (or naphtha-based) crackers to ethane feedstock.

“Linde is operating a methanol plant in the US with [Netherlands-based] LyondellBasell.

I remember three years ago they were complaining that natural gas feedstock was too expensive and they were losing money,” Stein says. “Now, Linde wishes it had more methanol capacity [in the US], as it is such a good moneymaker.”

Germany’s Bayer is developing a site at the Marcellus shale gas field in Pennsylvania in the northeast of the US. The site is being offered to investors to build a chemicals park, which will start with an ethane cracker to make ethylene and other derivatives.

The US now has large volumes of gas available due to the successful exploitation of shale gas deposits. In the 1960s, proven gas reserves in the country were estimated at 290 trillion cubic feet. This dropped to 170 trillion cubic feet in the 1990s, but its reserves are now back up to a level of about 270 trillion cubic feet.

US shale gas costs $5-6 a million BTU to extract and is usually made up of methane, ethane and natural gas liquids (NGLs).

The primary driver for shale gas extraction in the US at the moment is the NGLs, with methane and ethane being secondary. In fact, some US shale gas field operators are flaring the methane and ethane.

“The NGL price is linked to the oil price and they can get it out of the ground much cheaper with shale gas,” Stein says. “While methane and ethane are regarded as secondary, this will change soon.”

Processing and selling methane and ethane is commercially more attractive. Methane prices in the US are currently about $4 a million BTU, with ethane at $11 a million BTU. At that price ethane is much more attractive than naphtha, which is linked to the high oil price.

Using naphtha as feedstock allows petrochemicals companies to produce a more diverse product mix, while ethane allows just for ethylene and hydrogen.

However, the higher cost of naphtha coupled with a dependance on volatile market prices means using naphtha could reduce a cracker’s profitability. “Ethane is cheaper and offers less risk than naphtha, which makes it attractive for producers,” says Stein.

Reduced imports

The amount of extra gas that is being produced in the US is reflected in the country’s liquefied natural gas (LNG) receiving terminals. The terminals were built when Washington anticipated that it would need to import gas from overseas to meet demand.

The terminal’s owner, the US’ ExxonMobil, is now considering changing the facilities into export terminals.

The US’ embrace of shale gas production is in contrast to Europe where significant shale gas deposits in countries including Germany have been met with strong opposition from the environmental lobby.

“Out of all the countries with significant shale gas deposits, I think only Poland is enthusiastic about exploiting them in the near future,” says Stein.

The increased activity in the US raises questions about Saudi Arabia’s own plans to massively expand its petrochemicals capacity.

According to regional projects tracker MEED Projects, there are $42bn-worth of petrochemical projects either at the engineering, procurement and construction (EPC) contract stage or under construction.

Saudi Aramco’s chief executive officer Khalid al-Falih has called this a golden age for Saudi Arabia in terms of unprecedented capital expenditure in the downstream oil and gas industries. The tens of billions of dollars being invested in the kingdom are mostly being spent on facilities that produce a diverse chemical mix, which can then be used to promote downstream industries. To make the kingdom competitive on the world market, Riyadh sells gas for industrial use at $0.75 a million BTU.

“This means that noone else in the world can make ethylene cheaper,” says an official from a Saudi Arabia-based petrochemicals company. “But it is also true that we need more ethane.”

Ethane allocations

Saudi Aramco has not made an ethane allocation since 2006. Analysts at the local Al-Rajhi Capital say ethane will still make up 65 per cent of the kingdom’s petrochemical feedstock in 2014.

The low feedstock prices mean that companies, such as state-owned Saudi Basic Industries Corporation (Sabic), have a lot more room to manoeuvre than international rivals.

In today’s market however, cheap feedstock is not enough. What is also important is having a downstream industry to sell products into in order to ensure profitability stays high.

Huge complexes like the Sadara Chemical Company are being constructed to supply developing industries such as automotive manufacturing.

Both Sadara and PetroRabigh on the Red Sea coast of the kingdom are encouraging downstream investment by building industrial parks next to their facilities.

A relatively close export market is also required and the kingdom has this in India and China. However, both countries are on a drive to become more self-sufficient and are trying to establish their own petrochemical industries.

“There are many questions that need to be asked when it comes to spending so much money and the first is whether or not you have a population that is going to support a large percentage of the offtake,” says the official from the Saudi Arabia-based petrochemicals company. “I think the kingdom’s population is growing fast enough to do this.”

The other vital factor in any successful industry is, if there is a surplus of product, a strong export market close by. Riyadh has always prided itself on its strong network for exports.

In the past, the general consensus was that the Middle East was a good resource for commodities such as crude oil, while developing nations including China and India possessed the cheap manpower to convert the crude in to products.

Anti-dumping levies

Both India and China are developing downstream industries and they buy huge volumes of base chemicals including propylene from the kingdom. This arrangement has worked well for the most part, but has also led to anti-dumping levies being applied to Saudi Arabia’s chemical producers.

There is no doubt that the US is re-emerging as a global player in the petrochemicals industry, but whether it will seriously affect Saudi Arabia is debatable.

Issues such as increased feedstock availability, ease of doing business and access to technology are all important positives that work in the US’ favour.

Saudi Arabia is a more bureaucratic place to do business than the US and has other problems such as a lack of indigenous technology to rely on.

But it does have some major advantages other than low-cost feedstock with cheap land available, as well as Riyadh’s complete backing in what is its largest industry.

“Investors are attracted to [the kingdom] for different reasons than they would be to the US,” says the Saudi-based source. “Any US investors there will still pay a premium whether they have shale gas or not. The bottom line is that huge investments are happening in the kingdom now and the US [petrochemicals] will not stop that.”

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