Pressure grows on Gulf petrochemicals

After years of plain sailing for the Gulf's petrochemical industry, rain clouds are starting to gather over once clear skies.

Jubail Industry City in Saudi Arabia. The country has led the way for the region to become a hub for petrochemical production. Ali Al Mubarak / arabianEye / Corbis
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After years of plain sailing for the Gulf's petrochemical industry, rain clouds are starting to gather.

Driven by cheap feedstock and rampant demand in the East, the sector has expanded rapidly in the past decade, leaving established western players in its wake.

Small, outmoded plants in Europe and the United States have proved no match for the massive, state-of-the-art facilities built in the GCC. Led by Saudi Arabia, the region has become a hub for the production of basic petrochemicals. Companies such as Saudi Basic Industries Corporation (Sabic), the world's biggest petrochemicals manufacturer, are testament to this trend.

But this rosy picture is starting to change, with pressure mounting from both east and west. Last week, Sabic said it planned to cut 1,050 jobs in Europe and close some operations there because of a decline in consumer spending before reporting lower first-quarter earnings yesterday.

In North America, the shale gas boom has sent the gas price crashing, leading many to predict a renaissance of the petrochemicals industry in the United States and Canada.

"The shale gas boom in North America promises to provide fresh impetus to petrochemical producers there," said Abdulwahab Al Sadoun, the secretary general of the Gulf Petrochemicals & Chemicals Association (GPCA).

Low energy prices will equip US producers with the same means as Gulf petrochemical players, which rely on cheap natural gas allocations from their governments.

"There will be more pressure and its competitiveness will be challenged," said Richard Pott, a board member at the German chemicals giant Bayer.While gas production in North America is surging, the GCC is heading for a gas crunch, as the heavy reliance on natural gas in power generation, coupled with the rising use of electricity and water, is putting pressure on domestic supplies. The petrochemical sector is no longer the only industry in the Arabian Gulf, with energy-intensive aluminium and steel production on the rise.

"Looking at the overall demand fundamentals, the pressure is really coming from the region's demographics, economic growth and very robust power and desalination growth," said Alex Munton, an analyst at the research consultancy Wood Mackenzie, about gas supplies in the Gulf.

Demand growth in the region is well above the global average. Saudi Arabia recorded a 13 per cent increase in gas consumption last year, second only to China, at a time when the use of gas around the world had reached a plateau.

The growing discrepancy between supply and demand is not reflected in reserve statistics. According to the BP Statistical Review, the region holds almost 1.5 trillion cubic feet of gas.

"The most worrying problem of all is also the most ironic," said Mr Al Sadoun.

While the Gulf holds about 20 per cent of global reserves, it pumps only 11 per cent of worldwide output, according to the GPCA. The low gas prices that have provided a competitive advantage for petrochemicals producers are also limiting the commercial viability of gas projects, so restricting supply.

The gas squeeze is threatening to undermine an impressive growth story. Production capacity of Gulf petrochemical producers grew by 13.5 per cent in 2011, said the GPCA, while sales rose by 29 per cent.

"Such impressive growth might be compromised if a natural gas supply squeeze at home is compounded by increased access abroad," warned Mr Al Sadoun.

To add to these long-term woes, there are signs that economic growth in China, the main recipient of petrochemicals from the Gulf, is flagging. GDP there declined to 7.7 per cent in the first quarter, cutting short a recovery that started towards the end of last year. European economies have long been under the sway of the euro-zone crisis, limiting their value as an export market.

The development of the regional petrochemical sector is also hampered by difficulties in expanding further down the products chain. Basic petrochemicals can be produced in the Gulf and then shipped to markets in Asia, much like the region's crude finds its way to those markets. But governments in the GCC have prioritised job creation in the aftermath of the Arab Spring and have placed their hopes on more specialised petrochemicals production.

The petrochemicals value chain begins with oil and gas, which are refined into products such as naphtha or ethane, feedstocks that are then turned into olefins and aromatics chemicals. These basic petrochemicals are used to produce more complex plastics.

Some inroads have been made with polymers producers such as Saudi Arabia's Tasnee or the Abu Dhabi Polymers Company, known as Borouge. But for the most part, specialised plastics production is not a feature in the region yet. The Gulf's downstream push is inhibited by the higher cost of transporting more complex products and by the limited scope of its internal market.

"You have to be clear that the market is not really here at the moment," said Mr Pott.

Instead, the shale boom has turned North America, with its huge consumer base, into an interesting investment opportunity for chemical companies such as Bayer.

"Five years ago, no one seriously considered production in the US. This picture has changed because of the completely different situation regarding energy prices," said Mr Pott.

Sabic has already voiced interest in establishing a foothold in the US, and some Gulf companies are building production sites in Asia. The next push for growth may increasingly see GCC petrochemicals players head for foreign shores.