Maintaining a winning edge

31 May 2004 00:01  [Source: ACN]

How can the Middle East and, in particular, Iran, remain competitive if the current high-crude-price scenario disappears, eroding the region’s feedstock advantage? The answer could lie, among other things, in a long-term strategy to shape the region into an exporter of finished goods. But in the near term, the Middle East is likely to continue its efforts to strengthen its position as a dominant exporter of bulk petrochemicals. Report by Prema Viswanathan

GIVEN the historic highs crude and US natural-gas prices have touched in recent weeks (West Texas Intermediate crude was over US$41/bbl and US natural gas was still hovering above the US$6/mmbtu mark last week), one would not have been surprised if the mood at the Iran Petrochemical Forum (IPF) at Tehran in early May had been self-congratulatory.

But thankfully, that was not so. Several speakers at the IPF underscored the need for introspection and caution, warning that the good times might not last forever, and that it was imperative to prepare for a low-crude-price scenario, which could erode the competitiveness of petrochemical players in the Middle East.

Contending with such a constantly changing market environment calls for considerable ingenuity and agility. How will the Middle East, and Iran in particular, meet this challenge? This was the question that was uppermost in the minds of those attending the IPF, which was co-organised by Iran’s National Petrochemical Co (NPC) and the Iranian Inc for Contemporary International Conferences & Fairs.

The most intriguing suggestion to emerge from the conference was the viewpoint that the Middle East should consider, in the longer term, exporting finished goods in addition to petrochemical intermediates.

Andrew Pettman of CMAI posed the somewhat provocative question : ‘Will it be more cost-effective to convert polyethylene [PE] in China or in the Middle East?’

The suggestion was not as far-fetched as it would seem on first hearing. Although currently Chinese exports of finished goods, especially plastics, would appear to be too low-cost to allow any other region to compete, this could change in the future.

The increase in logistics costs, especially freight charges, from East Asia to destinations such as Europe, and the increase in labour costs within China alongside GDP (gross domestic product) growth, could offer countries with a feedstock advantage such as Iran a competitive edge in finished-goods exports in the not-too-distant future. Provided, of course, the rise in labour costs in the Middle East does not erode that advantage.

Realising the potential of the finished-goods export and domestic markets, and their importance in strengthening Iran’s economy, and providing jobs for the country’s escalating workforce, Iran Petrochemical Commercial Co (IPCC), the marketing wing of Iran’s NPC, has launched a scheme to train the country’s 4000-5000 fabricators and converters in quality control and best-management practices.

‘Since last year, we have been offering these services free of charge, and also reimbursing the cost of subscriptions to publications that would be useful in upgrading their knowledge base,’ says Mohammad Ehtiati, IPCC’s chairman and managing director.

In addition, IPCC has offered to pay 50% of the cost that would be incurred by these downstream companies for obtaining an ISO (International Standards Organisation) certificate.

IPCC has also agreed to bear half the cost of any research and development (R&D) activity that the fabricators and converters may undertake to achieve international standards and enhance their export competitiveness.

Another move that is being undertaken by the IPCC to meet the challenge of maintaining Iran’s competitive edge is encouraging partnerships with foreign companies in the end-user segments, with a view to upgrading the quality of the products.

Such initiatives are already underway, but much more needs to be done, emphasises Ehtiati.

For instance, in the area of PE bags for agricultural and chemicals packaging, a fast-growing segment, one European player, Bischof + Klein (B+K), is already in negotiations with local players to set up a joint venture in Iran to supply not just the domestic market but also export to other countries in the Middle East.

B+K will use the proposed new joint-venture plant in Iran mainly to supply the Iranian market, but also to back up the company’s exports from its existing plant in Saudi Arabia to markets in the Gulf Cooperation Council (GCC) countries and in Asia.

GCC countries are currently promoting the setting up of downstream facilities in this sector, with petrochemical companies being encouraged to meet their packaging requirements from the domestic markets. This is increasingly limiting export possibilities of PE bag companies into the GCC countries.

Moreover, demand growth for packaging material in Iran is highest among the GCC countries, making it an important market for this sector.

Demand for PE bags for industrial packaging in Iran was 5000 tonne in 2003, but is set to grow to 20 000 tonne by 2007, in tandem with the start-up of new petrochemical projects. The strongest demand in the region currently, in Saudi Arabia, is 40 000 tonne/year. The remaining countries of the Middle East, including Kuwait, Oman and Qatar, have a consumption of 30 000 tonne/year.

Currently, Saudi Arabia has six to seven fabricators in the industrial PE bags segment, Iran about three, and Qatar and Kuwait each have two.

An economically viable plant would have to have a capacity of at least 10 000 tonne/year, says Karsten Wamhoff, director of B+K Asia. This makes it difficult for smaller players in the Middle East to survive, unless they join hands with a foreign equity partner.

Another advantage local players in Iran would gain by establishing a foreign joint venture is access to speciality raw materials. ‘For instance, in our Saudi joint venture, most of our PE feedstock is sourced domestically, but we need to import the speciality additive from Europe. Although this has become expensive lately, thanks to the strengthening of the euro, the lower cost of PE balances the costs,’ says Wamhoff.

Feedstock availability is set to improve in the region in the next few years, with an additional 15m tonne of cracker capacity coming onstream between 2002 and 2010, and a further 15m tonne between 2010 and 2020 – what CMAI’s Pettman describes as the Middle East’s third and fourth waves.

Although exports of finished goods may be a long-term solution to Iran’s and the Middle East’s competitiveness dilemma, in the near term, bulk petrochemicals are likely to be the main export items.

Given the low-cost ethane feedstock base that Iran and Saudi Arabia enjoy, it is no surprise that these countries are expected to dominate the export market in the years to come.

Exports of ethylene derivatives from the Middle East are forecast to increase to 10m tonne in 2006 and 18m tonne in 2010, up from 7m tonne in 2004. The bulk of this would be PE exports, followed by ethylene glycol, forecasts Pettman. Exports of PE from the Middle East are forecast to rise to 12m tonne in 2010, from 5m tonne in 2004.

The expected growth in volume of PE exports would largely take care of the 10.4m tonne of additional PE capacity coming onstream in the Middle East (42% of it in Saudi Arabia and 32% in Iran) between 2002 and 2010.

Underpinning these forecasts is the expected growth in global PE demand at 4.9%/year over the next five years, and at 3.6%/year in the subsequent five years.

Major threats to PE demand growth are unlikely, says Pettman, although inter-polymer competition, recycling, down-gauging and the emergence of new challengers such as novel polymers in niche markets may offer minor competition.

In the case of monoethylene glycol (MEG), too, the competitive advantage passed on from the hydrocarbon side is still substantial for Middle East players in an oil scenario above US$20/bbl for Brent crude, says Paul Clarke of PCI Xylenes and Polyesters. However, Clarke says this doesn’t necessarily apply against MEG made in China itself.

MEG has been a very profitable derivative in recent years, especially in comparison with PE. Its growth potential is higher than that of PE, and it is also easier to move and market. However, MEG also has important by-products (diethylene glycol and triethylene glycol) that also need to be sold at the best available prices in order to improve overall contributions. ‘This is a further opportunity for IPCC,’ adds Clarke.

However, in terms of the regional demand-supply balance, the relatively low population and lack of an established weaving and clothing industry with a cheap source of labour restrict opportunities for investments succeeding on polyester filament and fibre, says Clarke. What this means is that, at the level of the polyester industry or further downstream into fabrics and clothing, there is little or no advantage left.

The picture is more promising in the case of polyethylene terephthalate (PET). ‘The growth of consumerism in most markets, especially the consumption of bottled water and carbonated soft drinks, would lead to rapid market growth. Provided adequate market preparation takes place, a sizeable increase in domestic consumption of PET can be predicted when the local plants start up in Iran,’ says Clarke.

However, to expect to export large volumes of resin successfully, especially to the West, is perhaps optimistic, he feels, although exports to other Middle Eastern countries would be feasible. A further challenge to the Middle East’s export competitiveness is shipping and logistics costs.

According to Rizwan Sheikh, of Nexant Chem Systems, these costs are more challenging for the Middle East owing to the large dependence on exports. ‘The cost of delivering products to key markets constitutes a major proportion of the total costs, making the overall profitability of the petrochemical plants quite vulnerable to this one cost that the producer has no control over.’

The costs include packaging costs, container rentals, inland transportation costs, port handling charges, marine insurance, import tariffs and other port dues.

These subject petrochemicals producers in the Middle East to considerable cost exposure, sometimes subverting cost efficiencies in other areas. However, some producers in the region are seeking to establish some control over logistics and shipping costs, through investments in this sector.

For instance, IPCC hopes to commission a local shipbuilding firm next month to build its first vessel for shipping NPC’s methanol output to destinations such as China and India. The vessel is expected to be ready in the next two years, says Ehtiati.

Proton Shipping Co (PSC), IPCC’s shipping joint-venture which began operating early this year, has issued tenders for the shipbuilding contract..

In addition, PSC hopes to build at least three more vessels in the next five years – one each for ethylene, liquefied petroleum gas and ammonia.

Ehtiati also hopes the IPCC-led initiative to forge a Middle East marketing and production alliance will take off in the next few years, helping the region achieve the cost efficiencies and demand-supply balance it so badly needs to maintain global competitiveness. The initiative, whose incubation has been rather slow, received a fillip recently when Kuwait’s Equate expressed interest in participating in it, the second regional player to do so, the first being Sabic (ACN 17 May2004).

A further boost to the Middle East petrochemical industry, especially in Iran, is likely to come from the burgeoning of domestic demand – inevitable in a country with a population of 70m, 70% of which is below the age of 30.

Take the case of polypropylene (PP), the main demand driver of which is the automotive industry, which is largely government-controlled. Production of PP is set to grow to 920 000 tonne/year by 2006, from 120 000 tonne/year in 2003.

And PP consumption is expected to increase by 7.5%/year in the next five years..

The projections of robust demand growth for PP look set to be achieved, going by the growth of the automotive sector in Iran. According to Frost and Sullivan, the automotive sector has been one of the significant contributors to the country’s economic growth. The total number of registrations had catapulted to 450 307 in the financial year 2002-03, up from 339 896 the previous year, and 163 715 in 1997-98.

The easing of capital-investment norms has led to a growing interest among foreign investors to participate in Iran’s automotive industry, says the consultancy.

According to NPC’s ten-year ‘prospective vision 2005-2015’, the company hopes to achieve, by 2015, a production of 12m tonne/year of ethylene, 10m tonne/year of polymers, 5m tonne/year of MEG, 7.5m tonne/year of methanol, 8m tonne/year of urea, and 4m tonne/year of aromatics.

Whether NPC will achieve this target and how profitably it can market the products will hinge on a number of factors, best exemplified by the list of pros and cons drawn up by Dia Research Martech Inc’s (DRMI’s) Makoto Takeda.

Among the positives in Takeda’s list are the abundant and cheap availability of feedstock, a large domestic market characterised by a broad product slate, a skilled workforce, and the government’s policy of giving priority to the petrochemicals industry.

However, alongside the positives are also several negatives, which include the vagueness of the Foreign Investment Promotion and Protection Act, the country risk posed by American economic sanctions against Iran, and delays in plant construction because of the rule stipulating 51% local content.

MH Peyvandi, NPC’s director of planning and development, is fairly optimistic that Iran will be able to iron out these problems. Peyvandi and others are also confident that the region will continue as the dominant exporter of commodity petrochemicals.

Other industry players, especially those from Europe, are somewhat more circumspect. As one analyst put it: ‘Hope is a commodity that is not in short supply in the Middle East. What we would like is to moderate it with large doses of caution.’

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