19 January 2016

Gulf petrochemical firms face weak oil prices, rising costs and increased competition.

Petrochemical producers in the Gulf Arab region are facing many uncertainties amid prolonged weakness in crude oil prices, signs of slowing demand in some export markets and rising costs as regional governments cut energy subsidies.

Earnings of several Gulf petrochemical companies have been hit by a decline in product prices, which are closely tied to the price of crude oil. Most petrochemical products have seen their prices drop 20-40 percent over the past year.

Saudi Basic Industries Corp (SABIC), one of the world's largest petrochemicals groups, announced a 29.4 percent drop in fourth-quarter net profit on Sunday, while Saudi Arabian Fertilizers saw its fourth-quarter net profit fall 51 percent from a year earlier.

The sharp decline in oil prices has also led to the cancellation of some high-profile petrochemical projects and restructuring at some regional producers.

 "Many of the certainties that have governed Middle East petrochemicals in the last 25 years - for example cheap gas justifying new investments - no longer apply," according to a McKinsey & Co. report. "In the last twelve months the fall in oil price has done more than exacerbate the existing challenges. It has created a 'new age'."

Gulf producers have enjoyed a cost advantage over global peers thanks to subsidised energy and feedstock, allowing output in the region to climb to 136.2 million tonnes in 2015 from 53.4 million tonnes a decade ago. The sector's cumulative annual output growth rate of 10% is second only to China, which grew by 13% during the period.

But Gulf Arab governments have moved to cut energy subsidies to deal with shrinking oil export revenues and widening budget deficits. The reforms could raise the costs of some petrochemical producers depending on the share of natural gas, propane and butane in their feedstock.

MARGINS CONTRACT

The Saudi government has raised natural gas prices from a fixed subsidised rate of USD 0.75 per million British thermal units (mmbtu) to USD 1.25 per mmbtu and USD 1.75 per mmbtu of ethane feedstock, according to Al Jazira Capital.

"Due to year-on-year decline in crude oil prices, along with the Saudi government decision to increase subsidised feedstock prices, the costs for Saudi petchem players who rely mostly on ethane feedstock would be the most effected in their margins," it said in December.

SABIC has said its operating costs would increase after the government reduced price support for natural gas feedstock and raised electricity tariffs, according to Reuters.

Saudi Fransi Capital has said it expects the 10 biggest Saudi petrochemical companies to collectively post a 14 percent decline in net profit in the fourth quarter to reach SAR 5 billion, compared to the same period last year.

"Given a volatile product price environment, while earnings volatility is unsurprising, it can be exacerbated by plant shutdowns in case of SIIG (Saudi Industrial Investment Group), Sipchem and Chemanol," said Saudi Fransi in a report.

Last year, SABIC shelved plans to build an acrylonitrile complex at Al Jubail, while Qatar and Royal Dutch Shell said they would not proceed with the USD 6.4 billion Al Karaana project. Qatar has also stopped work on the USD 6 billion Al Sejeel project.

COMPETITIVE EDGE

JP Morgan said that despite the increase in feedstock cost, Saudi petrochemical firms still maintain their competitive advantage. "Saudi petchems remain at the lower end of the cost curve and competitive advantage remains intact, in our view."

Gulf Petrochemicals and Chemicals Association (GPCA) believes Gulf producers would inevitably feed the drag from slowing demand from China, which accounted for around 20 percent of the region's chemicals exports of 67.2 million tons in 2014.

"China's self-sufficiency in some petrochemicals and polymers is also increasing," GPCA Secretary-General Abdulwahab Al-Sadoun said in remarks published recently.

 "But despite these challenges, GCC (Gulf Cooperation Council) exports have continued to perform well and in the long run, there will still be substantial room for petchem imports to China," he said, adding that by 2020 Chinese polypropylene production was expected to reach around 24 million tons against consumption of some 28 million tons.

Global demand for petrochemicals is expected to rise at an annual average rate of 4 percent over the next 10 years, with two-thirds of the demand coming from non-OECD countries, especially China and India.

But GCC export markets are increasingly becoming self-sufficient, with some forecasts suggesting China may be producing 90 percent of its petrochemical products demand. Other competitors are also emerging, as technologies allow the tapping of shale oil and natural gas reserves across the world.

Gulf producers also suffer from lower equipment efficiency, underutilization and project delays. Operational costs are 35-40 percent higher than those of Chinese producers and up to 10 percent higher than American producers

SABIC said in October it was restructuring to become a more "agile, cost-effective" organization, focused on technological innovation. The company's plastics unit will be split and reallocated to other divisions.

"The future of the commodity line will depend heavily on innovations around advancing feedstock technology," the firm said in a statement. "Specialty products face separate technology challenges, including the need to seek out technology acquisitions and partnerships or joint ventures that can enrich SABIC's existing portfolio."

McKinsey said in its report that additional value could also be captured from higher integration with refining. "Informed decisions, backed up by bold actions, can help the regional industry sustain its global competitiveness over the next 25 years," it said.

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