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28 March 2024

Gulf braces for huge petrochemicals expansion

Over the next six years, capacity growth in petrochemicals will outpace demand growth, says Alpen Capital. (AFP)

Published
By Shashank Shekhar

The Gulf is undergoing massive capacity expansion in petrochemicals and will soon account for a lion's share of world's ethylene production, investment bank Alpen Capital has said in its new report.

A growing shortage of ethane besides delay and cancellation of projects are two factors adversely impacting the petrochemical sector in the region, the report said.

"Some petrochemicals projects [in the Gulf] are behind schedule due to delays in project funding, feedstock shortages and subdued demand. Projects in the region may face delays of around one year on average. Moreover, if the global economic situation worsens, delays could prolong further, although it is unlikely that projects will be shelved," the Dubai-based investment bank said.

"Although the GCC countries account for more than 23 per cent of global gas reserves, the region is experiencing a shortage of natural gas due to increased domestic consumption in alternative areas such as electricity generation. Gas demand in the Gulf is estimated to grow at 6.6 per cent per annum, compared with yearly growth of 2.2 per cent projected for oil. The concern is that new plants and higher production capacities may not be matched by sufficient ethane supply," it said.

Besides, political and regulatory hurdles are having an adverse impact on the sector, the bank said.

"The Gulf petrochemicals industry is under significant threat from new protectionist tariffs in key markets, such as India and China. India is contemplating enforcement of an anti-dumping duty on polypropylene imports from Saudi Arabia, Oman and Singapore, while China plans to impose anti-dumping charges on methanol imported from Saudi Arabia, Malaysia, Indonesia and New Zealand," it added.

Cost advantage

Gulf petrochemicals have significant cost advantage over their western peers.

"Feedstock and logistics are the top two cost components of petrochemicals products; the Gulf enjoys an advantage over Asia and Europe on both accounts.

"First, feedstock cost is lower in the Gulf owing to its rich oil and gas reserves. The GCC countries procure ethane at $0.75-1.5 per million BTU (mmbtu), compared with a minimum $ 3.20 per mmbtu in Europe and the US.

"As ethane is expensive and scarce, Asian and European firms use naphtha as a major feedstock," the investment bank said.

"Secondly, the GCC's closeness to demand clusters – specifically India and China – offers a significant logistic cost advantage [second largest cost component after feedstock]. These cost advantages, coupled with increasing environmental regulation of petrochemicals companies in the West and rising margin pressure globally, offers a congenial environment for petrochemicals industry growth in the Gulf."

There is also a strong government support for the petrochemicals project, the report said. "In order to diversify economies away from oil and ensure broader economic, industrial and social growth, governments in the Gulf are taking initiatives in the petrochemicals space, particularly downstream. They are encouraging a shift from export-oriented petrochemicals production to manufacturing of value-added specialty chemicals for supply to domestic industries, automotive, appliances and consumer products. Moreover, significant tax advantages are offered to foreign partners to act as catalyst for capacity expansions and product diversification."

The region will undergo a massive capacity expansion in 2010, Alpen Capital said.

The pace of growth will depend on downstream sector growth, the global economic recovery and new supply initiatives overcoming feedstock, technical and human skill-set constraints.

"The majority of the world's petrochemicals capacity growth over the next six years will be concentrated in the Gulf, which now accounts for about 10 per cent of global supply. Saudi Arabia is taking the lead in the region with numerous petrochemicals projects being launched by the likes of Sabic, Sipchem and Saudi Aramco," the report said.

"The global petrochemicals industry is facing an avalanche of new capacity build-up and accordingly we project additional capacity expansion of 32 mmt and 23 mmt for ethylene and polyethylene over the next six years (2010-2015) from an estimated 139 mmt and 90 mmt respectively in 2009."

Ethylene demand

Though the demand for ethylene, the primary Gulf petrochemicals product, will increase moderately in the medium term, it will gain momentum from 2011.

"We forecast global ethylene demand to grow at a CAGR of 4.7 per cent over the next six years reaching about 153 mmt by 2015. The key emerging markets – China and India – remain the focus of petrochemicals demand growth. Although the demand situation improved in 2009, we expect it to pick up further in 2010 onwards."

Over the next six years, capacity growth will outpace demand growth, leading to a widening of the supply demand gap, Alpen Capital report said.

"The gap is likely to widen over the next two years and then gradually reduce as demand growth picks up. Excess capacity may peak at around 29 mmt in 2012- 2013 and then gradually reduce to around 18 mmt by 2015. This is bad news for marginal cost producers, but not necessarily so for Gulf producers with low cost advantage.

"High capital intensity and strong cyclicality are key characteristics of the petrochemicals industry. The reasons for this are the long lead-times in plant construction and the fact that petrochemicals plants are often commissioned as a by-product of oil exploration and refining and not necessarily based on standalone project merits," the report added.

Global capacity of ethylene and polyethylene to increase to about 171 mmt and 112 mmt by 2015 from 139 mmt and 90 mmt respectively in 2009.More than half of the expansion in 2009 to 2015 will be in the Gulf.

The global economic slowdown to continue to impact petrochemicals demand in the short term.

"With capacity expansion set to outpace the rise in demand, we envisage a situation of excess capacity to continue; excess capacity of ethylene and polyethylene may peak in 2012-2013 and then gradually decline to about 18 mmt and 22 mmt respectively by 2015," the report said.

Global ethylene demand increased sequentially from 2000 to 2007. However, it was affected by the global economic recession and the downtrend in oil prices in the second half of 2008, Alpen Capital said.

Demand for petrochemicals products declined by 1.7 per cent in 2008.

"The situation improved somewhat in the latter part of 2009 and we expect this to continue in 2010. Subdued demand has affected various petrochemicals projects worldwide, leading to project delays or cancellation. The majority of project cancellations took place in Western Europe and North America, as these regions were the most affected by the economic recession."

Implications of excess capacity to differ across regions and petrochemicals players, depending on the cost-arbitrage opportunity between ethane-based and naphtha-based production. Accordingly, operating rates will vary across petrochemicals plants and regions.

Petrochemicals demand has a high correlation with GDP growth.

Therefore, as the global economy recovers, world demand for polyolefin should also recover and gain momentum from 2011 onwards. Global demand is estimated to grow at around a CAGR of 4.7 per cent in 2010 to 2015, Alpen Capital said.

India and China have latent petrochemicals demand potential, as their per-capita polyethylene consumption is significantly lower than that of developed countries, Alpen Capital said.

"As the economies develop and quality of life improves, polyethylene usage is expected to increase which, in turn, should gradually diminish the existing difference in consumption rates vis-à-vis the developed countries."

Although petrochemicals demand is expected to pick up in 2010, it is unlikely to keep pace with projected capacity growth over the short to medium term, the investment bank said.

"We believe that the supply-demand gap will widen in the short to medium term, but decline in the long run, when the global economy picks up, and more downstream and petrochemicals application projects come on-stream."

The global petrochemicals industry is facing an avalanche of new capacity largely owing to cost-advantageous feedstock, Alpen Capital said.

"Based on the petrochemicals projects pipeline, we estimate additional capacity of about 32 mmt and 22 mmt for ethylene and polyethylene over the next six years (2010-2015) from 139 mmt and 90 mmt respectively in 2009."

"The region has a natural competitive advantage of cheap feedstock availability. In addition, the Gulf's proximity to the demand dense Asia region offers a significant logistics advantage."

Momentum is building up in downstream activities, (specialty chemicals and plastics) driven by the Gulf's strong intent to diversify its economies and expand the petrochemicals value chain, Alpen Capital said. "For example, Sabic has recently signed a letter of intent with Mitsubishi Rayon to form a $1 billion (Dh3.6bn) joint venture for a plastic plant.

The JV will manufacture methyl methacrylate monomer and polymethyl methacrylate. Moreover, the government is promoting the industry by introducing plastics processing zones across the Gulf. "

Plastic processing industry

The Gulf's plastics processing industry is expected to see a vast increase in supply of plastic resins over the next few years, said Alpen Capital.

"Plastics exports would comprise plastic resins and plastic products. Investments in engineering plastic resins production would widen the scope for production of both non-durable and durable goods.

"Furthermore, China would continue to feature prominently in plastics processing due to the sheer size of its industry. However, the new frontiers such as India and the Gulf are expected to record double-digit growth in plastics processing."

Why should one invest in Gulf petrochemicals?

The Gulf petrochemical industry is at an inflection point.

The region has enormous capacity expansion plans, which are set to change the global petrochemicals industry landscape, Alpen Capital said.

"Most of the leading global petrochemical firms are evaluating options of entering or expanding their activities in the Gulf through subsidiaries, joint ventures, or other innovative operating models. In 2007, a rapid surge in oil prices led to a corresponding rise in input cost for petrochemicals firms across the globe."

This played into the hands of the Middle East players, who used ethane (gas-based) as the major input rather than naphtha (oil-based), Alpen Capital added. "This advantage magnified with the rise in oil prices and led to global petrochemicals leaders shifting their focus from West to East for expanding their petrochemical production bases. The Middle East was chosen because of the input advantage and China because of proximity to large and growing end-market."

Gulf petrochemical plants will gradually displace plants in the West. "Although the global economic recession has affected the commodity markets leading to delays in some greenfield petrochemicals projects and expansion plans put on hold, we believe the pace at which advantageous petrochemicals production in the Gulf is displacing existing plant capacities in mature western markets will increase."

Varying growth prospects

Despite expectations of overall excess capacity build-up globally in petrochemical sector, not all companies will be impacted in the same way, said Alpen Capital.

The extent of the impact will depend on the nature of GCC petrochemical sector and the access of feedstock, the proximity and access to end markets and the technology in use.

First, plants in proximity to and with access to feeding industries are likely to fare relatively better. China, for instance, has been relying on imports to meet its petrochemicals demand of domestic plastic producers. However, with the significant ramp-up in petrochemicals capacity in the country, its dependence on imports is likely to reduce and it will become increasingly self-sufficient.

The second key factor determining the operating rate of plants is access to cheap feedstock.

The cost differential is primarily attributable to availability of ethane as feedstock for Gulf producers, vis-à-vis the use of naphtha as primary feedstock by the rest of the world. Given such a significant cost advantage, we believe that Gulf producers will operate at near to full capacity.

 

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