09 December 1996 00:00 [Source: ACN]
Justification of back-integration is no longer the issue. The question now is how will it affect Asian markets. Mary Heathcote reports
IS BACK-INTEGRATION justified? This is the question that has dominated Asian polyester fibre and textile producer circles. However, it is a question which may already have outlived its relevance, as became obvious at the recent World Fibres and Feedstocks conference, held in Singapore by Asian Chemical News and European Chemical News in association with PCI Consulting Group. The extent of back-integration now underway in Asia appears certain to change both Asian and world PTA and polyester market structures.
Aggressive investments by world PTA majors including Amoco, ICI, Mitsubishi Chemical and Mitsui Petrochemical Industries will have to weather difficult times in the next few years, leaving such producers questioning the wisdom of heavy-capital PTA investments by fibre and textile majors.
Leading fibre and textile producers point to the clear margins between naphtha and polyester in recent years, regardless of the pricing peaks and troughs of the intermediates along the chain.
If the logic seems infallible on both sides of the argument, it is because the opposing cases are founded on different assumptions - and on different realities for the companies involved. PCI consultant David Hart points out key differences between the traditional development of the textile industries of the US, Europe and Japan and the structure of the now-dominant Asian textile sector.
In a European, US and Japanese context, the early synthetic fibre manufacturers tended to enjoy dominance within the pipeline. This led to enhanced profitability. Their technology skills, R&D and active guidance to textile producers gave them a leading role, reinforced by the channelling of profits into high-profile marketing schemes which captured consumer loyalty, Hart explains.
'The large chemical companies were therefore able to exert significant authority in the market at both ends of the pipeline,' he says. 'In Europe and the US, this tended to restrict vertical integration by fabric or garment manufacturers into fibres or raw materials.'
Development in Asia outside Japan has followed different lines for a number of reasons. The introduction of synthetics has often occurred on a rolling basis of import displacement, starting at garment level, then fabric, then fibres and lately raw materials. 'This ensured that a proven market already existed, together with the knowledge of how the products should be utilised downstream,' Hart says.
Secondly, the size and resources of many Asian textile operations are often significant, he points out. 'Major business groups are more prepared to integrate downstream than their US or European equivalents, who felt that fibres was already far enough,' he says.
'The increasing size of Asian fibre-textile-garment companies has given them the critical mass to contemplate integration, even where the unit size of the new production process is too large.
'The financial resources and scale of Asian textile concerns, plus their parent groups, means they are fully capable of financing synthetic fibre plants and even intermediates,' Hart says.
Reliance Industries senior executive vice-president Subodh Sapra illustrated the argument for back-integration with an analysis of the deltas between intermediates through the polyester chain from 1988 to 1996.
The deltas between naphtha and paraxylene and between naphtha and ethylene have fallen below the minimum required for profitability in 12 quarters out of 35. That between PX and PTA has fallen below the minimum for 17 out of 35 quarters, and that between ethylene and monoethylene glycol (MEG) for 21 out of the 35 quarters. The delta between PTA/MEG and polyester staple fibre (PSF) has fallen below the minimum in 14 out of the 35 quarters. However, the delta between naphtha and PSF has remained above the minimum threshold level throughout the period.
'Back-integration reduces the impact of large fluctuations and protects deltas from reducing below acceptable levels when the total polyester value chain is considered,' Sapra says.
Reliance has pursued a strategy of back-integration since the 1980s. By 1998, it will have 1.625m tonne/year of PTA, 1.38m tonne/year of PX, 750 000 tonne/year of ethylene and a 15m tonne/year refinery to support its 600 000 tonne/year of polyester fibre production. Next year, it will hold 43% of the Indian market for polyester fibre, with the remaining 57% shared by 38 producers.
Indonesia's Polysindo has similarly followed a strategy of proactive back-integration to enhance margins and ensure earnings growth, finance director Steve Simpson says. In 1991, the company set itself the target of growing revenues from US$120m to US$1bn within six years. In 1996, it is the leading textile producer in Indonesia, with US$1.2bn market capitalisation on the Jakarta Stock Exchange and a US$645m expansion close to completion. Further PTA investment is now on the drawing board.
Its 340 000 tonne/year PTA plant, due onstream next year, has been built at optimum cost compared with competitive plants in Asia, Simpson believes. He claims a cost of investment of US$780/tonne of PTA, compared with US$920/tonne for Amoco's Malaysian plant and Mitsubishi Chemical's lndonesian facility, US$1000/tonne for ICI's Pakistani plant, and US$1230/tonne for Indorama's Indian facility due onstream in 1999.
The result, he believes, will be additive margins through the production chain resulting in a 35% margin on fabric at current prices. Polysindo will also enjoy margin protection throughout the pricing cycle, he says. Estimated pro forma 1998 sales for Polysindo would be US$852m at current prices and US$1.23bn at peak 1995 prices.
ICI Polyester commercial operations director Linda Shum points out that integration is not the answer in every situation. Nonetheless, the availability of technology has irreversibly changed the market structure of PTA, allowing newcomers to enter the industry and accelerating commoditisation, she says.
'The technology is particularly attractive to those polyester producers who wish to integrate vertically, hoping to dampen the cyclical effect and limit exposure to market forces,' Shum says. 'Some of this integration is rational, some is not. Most integrated producers, however, enjoy the full support of a large conglomerate. They are willing to be patient with their investments, are market-share orientated, and often enjoy government protection.'
Integrated producers have the advantage of being able to react to market changes more rapidly than a single-layer producer, she acknowledges. They have the freedom to adjust margin on each layer such that the overall margin is maximised. 'This behaviour tends to disrupt the traditional supply and demand trend where the pattern could be predicted using a simpler model of growth, supply and demand balance and reinvestment economics for each layer of the chain.'
Shum expects a considerable structural change in the next ten years in the Asian PTA market. Once Asia has achieved self-sufficiency or oversupply, Middle Eastern and Southeast Asian supply will pour in.
'US producers who enjoy good fundamental economics are disadvantaged by freight and may be discouraged from exporting to Asia,' Shum anticipates.
'We then have a scenario where Asian supply is dominated by producers who may be split roughly into two large groups - one which enjoys the cheapest feedstock, and the other, integrated polyester producers with relatively high cost but whose integration allows margin roll through the chain.
'It is perhaps reasonable to assume that the latter group, with different intentions and objectives to those of the traditional merchant producers, will react far more rapidly and strongly to the market pressure, creating a sharper swing of the cycle.'
The result will be an acceleration of industry rationalisation producing 'a global structure where only a few key players with the essential fundamentals of technology and integration prosper,' Shum says.
PCI's Hart points also to the changing consumer patterns as retail outlets intensify efforts to maximise sales. 'The dilemma is whether to pursue basic cost-competitiveness which has been a fundamental economic force and retains strong validity, or whether to dedicate to the search for added value through stimulating the consumer with choice and service,' he says.
'Consumer choice and sophistication is likely to become a more significant feature of the advanced economies over the next decade and will require a rethink of the operation and structure of the textile pipeline.'
Reliance's Sapra agrees: 'Standalone units are likely to lose market share to fully integrated producers as they face more demanding end-users.'
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