INSIGHT: Costs keep rising, projects keep coming

20 May 2008 15:25  [Source: ICIS news]

By Nigel Davis

DUBAI (ICIS news)--Mainstream petrochemical and polymer players are, by now, prepared for the impact of new capacities due on stream in the Middle East over the next few years. A critical point then is what happens post 2011 when the new capacities are likely to have been fully absorbed?

INEOS Olefins European CEO Tom Crotty stressed on the sidelines of this year’s NPRA meeting in San Antonio that the sector was not seeing the expected second wave of investment in the region. 

Projects had been postponed because of rising costs in a tightening engineering and contractor marketplace.

“We see this recession but we will come out of it in relatively short order,” Crotty added. The investment wave, he said, had passed.

So if a second wave is not to be expected, can the sector look forward to a steadier implementation of new project plans or, indeed, a period, once more, of market tightness.

One would expect a major olefins and polyolefins producer to retain some optimism in the face of what has been described as a ‘mountain’ of new production capacity.

Crotty said he expected the industry trough to run through 2009/2011 and for the business to experience an upturn in 2012/2013.

The timing of the upturn will depend on demand but its arrival will be determined by supply. In the face of sharply increased costs, projects to supply significant new quantities of chemicals have been postponed.

Capital cost increases, particularly, have risen strongly. A flavour was given last week by the publication by Cambridge Energy Research Associates (CERA) of its quarterly downstream capital costs index (DCCI).

The costs of building new refineries and petrochemical plants reached a new high in the first quarter of this year, CERA said. In six months, its year 2000-based DCCI had risen from 166 to 176 points, a mark-up of 6%.

Put another way, a piece of capital equipment that cost $100 in 2000 would cost $176 today.

It isn’t going to stop there. “Unless there is a sudden and dramatic change, industry activity and market pressures should keep the DCCI at these levels, if not higher, for the next six-12 months,” said CERA researcher Jackie Forrest.

The continued rise in commodities - the price of iron ore, for instance, has risen by 65% this year alone - will add further upward pressure. The high cost of oil will also feed through the system.

Project cost increases in petrochemicals have been significant with the bill for a grassroots cracker complex almost doubling over the past five years. The cost increases have led to some delays and put pressure on project profitability forecasts.

The timing of any capacity addition in chemicals is important, if not critical. Bring a plant on stream at the right time and payback on the investment can be quick. Hit an extended trough, however, and the outcome can be very different.

Few companies want to start up a major project - or commit significant capital investment funds to it - at the wrong time.

Wait a few months, a year or more, perhaps, and the projected returns over the lifetime of the investment could look very different. Locking in high capital costs at the start also locks in a structural disadvantage.

The cost increases have given some project partners in the Middle East cold feet or at least tempted them to wait awhile. Not so some of the Middle East players themselves, which appear keen to proceed with capacity when they can.

Everyone knows that costs in the energy-intensive industries rise with the price of oil.

If high oil and commodity prices are sustained, then the cost of building petrochemical plants and developing project infrastructure will only continue to increase.

Some are optimistic. Consultant Chem Systems believes that capital costs are moving towards a peak in 2009 and that post-2009/2010 they will come down.

But don’t expect a drop to pre-2006 levels, it warns.

Seizing competitive advantage in a feedstock-rich region like the Middle East is becoming more difficult but that will not halt investment. There are constraints, certainly, and timing is important, but the momentum behind the business is strong.

The centre of gravity in petrochemicals will continue to shift, the upside from the all-but sold-out construction market being being that more constrained capacity expansions will work to the advantage of sector-wide profitability.

To discuss issues facing the chemical industry go to ICIS connect

By: Nigel Davis
+44 20 8652 3214

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