Petrochemical companies need to shift gears if they are to remain competitive

The fall in oil prices means GCC players have lost a key competitive advantage – low-cost feedstock, writes MR Raghu.

Because of low oil prices, GCC petrochemical companies need to change their methods of operation.

The fall in oil means GCC players have lost a key competitive advantage – low-cost feedstock – that they have long held over major players in the US and Europe.

Global players reduced their prices in line with the cost of feedstock, leading to a decline in petrochemical prices. Despite being aware of oil’s volatility, GCC’s petrochemical groups were underprepared to face such prolonged low oil prices. Most major players failed to develop risk-mitigation strategies and adopt newer technology, despite having the capability to fund and build megaprojects.

The outlook is challenging. The oil price is not expected to return to US$80 to $120 a barrel in the next two or years. Oil prices at $30 to $60 a barrel might increase the supply of petrochemicals, as US and European operators would be keen to cash in on this scenario. Another major development is the $130 billion merger of Dow Chemical and DuPont, two of the world’s largest petrochemical producers, which is expected to create the world’s largest petrochemical entity – a formidable rival for GCC players.

In reaction, GCC petchems need to overhaul their operations to suit naphtha-based crackers. They are currently using ethane crackers because of subsidies. Naphtha crackers are more efficient and the output produced is of higher quality.

Overall the GCC players need to optimise operations and inculcate efficiency in production – optimisation being more along the lines of reducing time (by integrated plants) and efficiency by actions such as improving skills and bringing in new technology.

Downstream integration must be the focus of GCC players. It would help in capturing not only downstream producers but also end-product manufacturers.

Downstream integration of oil refining, petrochemical production and producing further downstream products such as paints is an area where GCC producers can invest. They can take cues from major international players such as Du Pont and Dow Chemical, which produce thousands of products using downstream manufacturing.

Currently, GCC companies that are entering into joint ventures with international players must look beyond capital and technology transfer in these ventures. Skill development, building organisational efficiencies as in US and European players, and improving their functional and technical expertise will help petrochemical companies cruise the hard waters ahead.

Major integration projects in the GCC, such as Al Zour refinery being constructed in Kuwait, will help them improve efficiency of production. Government ownership in these companies will be the major supporting factor in the coming years.

The impetus for change is clear, as a few numbers will show.

Global prices of key petrochemicals such as propylene, benzene and ethylene declined by 60, 56 and 40 per cent, respectively, from March 2014 to September 2015. An oil supply glut in the global markets and the resultant low oil-price scenario coupled with lower demand for petrochemicals from Asian countries such as India and China are reasons for the drastic decline in petrochemical prices. Cheaper oil also resulted in increased production of petrochemicals in US and Europe. This has severely affected petrochemical players in the GCC region. Earnings at Saudi Basic Industries Corporation (Sabic), the largest petrochemicals producer in the Middle East, fell by 19.3 per cent last year.

The current market dynamics indicate that GCC petrochemicals will face an even tougher situation in the coming years.

Asia (excluding China) accounts for about 35 per cent of petrochemical exports from GCC. China alone accounts for 15.3 per cent. Asia’s petrochemical import volumes are estimated to fall by 50 per cent in 2015 and 2016 because of lower demand in the Asian markets for products such as polyester and purified terephthalic acid (PTA).

The impact of the Chinese slowdown and devaluation of the yuan, which made imports costlier, affected exports from the GCC last year. That could be magnified this year and in 2017. China is aiming to achieve self-reliance in petrochemicals production. Self-sufficiency in ethylene production is expected to be achieved by 2018.

India is another major importer of petrochemicals from the GCC. Its paints industry, which uses more than 150 petrochemicals, is reeling from the threat of slowdown, after real-estate activity in the country declined by 3 per cent last year. With the low oil price, India has reopened one of its petrochemical plants to reduce its import bill.

MR Raghu is the managing director of Marmore Mena Intelligence, a research house focused on conducting Mena-specific business, economic and capital market research