South Korea's chemical industry threatened by political instability and slowing export markets

An uncertain future

15 July 2008 17:11  [Source: ICB]

South Korea has invested heavily in expanding petrochemical capacities. But domestic political instability and faltering export markets may jeopardize the industry's prosperity

John Richardson/Singapore

The political chaos affecting South Korea could not have come at a worse time for a country already hampered by soaring crude oil prices, tougher export markets and a weakening domestic economy.

People in South Korea love to demonstrate. On my first visit there in 1998, somebody came up to me and said, "Here's a banner. I know you can't read a word of it because it's in Korean, but please join in with our demonstration - it will be fun". She was very attractive, so I said yes, but to this day, I have no idea what I was demonstrating about.

South Koreans are equally enthusiastic about going on strike hence all the recent disruptions to petrochemical production.

But this political crisis is serious and not just one more passing example of enthusiasm for taking to the streets.

The problems facing President Lee Myung-bak could have long-term ramifications for a petrochemical sector badly in need of further restructuring.

His approval rating had slumped to less than 20% in June from 75% in February, as a result of protests over US beef imports.

Surging crude and industry-specific competitiveness issues, compounding structural weaknesses in the overall economy, were already hard enough to deal with by themselves.

HOPE REPLACES DESPAIR

The great hope that Lee's election raised in February has been replaced by despair over the former Hyundai Construction boss either being forced out of office or becoming a "lame duck" president.

"We need legal reforms to make restructuring easier. But even if the reforms are in place, restructuring might still be a long and drawn-out process," says a man who should know. This industry executive was heavily involved in protracted talks for a major merger in 19982000 that came to nought.

A complex web of regulations makes mergers and acquisitions difficult to execute, adds the executive.

"Even if these are removed, you cannot discount the importance of ego. Numerous lawsuits would be inevitable from the various different interested parties."

His cynicism may be colored by his experience. While his efforts might have failed, others were successful.

The country's Hanwha Chemical and Daelim Industrial, for example, swapped polymer assets and formed a cracker joint venture (JV). Compatriots LG Chem and Honam Petrochemical jointly acquired the former Hyundai Petrochemical naphtha cracker at Daesan.

But since the radical reordering of the industry in the aftermath of the Asian financial crisis, the industry has heavily invested in raising output.

The YNCC cracker complex - the JV between Hanwha and Daelim - underwent a big expansion two years ago.

Samsung-Total - a JV between South Korea's industrial group Samsung and French oil company Total - and South Korea's Lotte Daesan Petrochemical are raising ethylene capacity at Daesan in 2008.

Lotte recently brought a monethylene glycol (MEG) plant on stream using Anglo-Dutch major Shell's cost-advantaged Omega technology.

Further capacity additions planned for this year include synthetic rubber and bisphenol A (BPA) in South Korea and vinyl chloride monomer (VCM) and polyvinyl chloride (PVC) at LG's complex in Tianjin, China.

WHY, OH WHY?

One might ask the question: "Why has South Korea undergone such an aggressive wave of expansions in commodity chemicals, when it knew that the latter part of this decade would see some very tough conditions?"

The answer is the China factor, which lured other Asian countries with no feedstock advantage into investments. Demand growth beyond expectations in the world's most important market led to the belief that the future would be the same as the past.

Few predicted the depth of the global economic crisis or the sudden decline in China's reexport market. However, the rise in Middle East capacity has been on the cards for a number of years.

You can make an argument for BPA because the Middle East is not, as yet, a producer. Ethylene-based vinyls in China have also become more competitive because of higher coal costs and the environmental restrictions placed on carbide-route plants.

Synthetic rubber, too, looks attractive, because of strong demand and a global shortage of butylenes (C4s) that has restrained investment.

But part of the rationale for the South Korean expansions was that credit was easily available at the time that the plans were signed off by boards of directors. The old truth remains that you need to expand when the money is available in order to maintain economies of scale.

COMPETITIVE WEAKNESSES

The first weakness that needs to be addressed is a lack of refinery-petrochemical integration.

Naphtha self-sufficiency is below 60%, according to the Korea Petrochemical Industry Association (KPIA). Refineries, other than in the case of South Korean energy and petrochemical group SK Energy, are also under separate ownership from the petrochemical companies.

The next step would be further mergers of the petrochemical companies themselves, followed by a scrap-and-build program to shut down non-worldscale plants.

But even if President Lee had been able to execute his mandate, funding restructuring would still have been an issue.

Global credit grows ever tighter and South Korea's GDP is expected to expand by 4% this year. This might seem healthy by the standards of a developed economy, but President Lee had promised 6% earlier this year.

Why growth in the home market matters so much for petrochemicals is a heavy dependence on exports, particularly to China. Out of 3.56m tonnes of polypropylene (PP) produced in 2007, for example, 2.27m tonnes was exported, says the KPIA.

The triple squeeze confronting South Korea is lower demand at home, meaning more pressure to export. This is occurring as Middle East capacity increases and China's manufacturing industry struggles with the US slowdown and higher costs.

NEED FOR AN EXPORT BOOST

As recently as May this year, the KPIA was forecasting in a report circulated at the Asia Petrochemical Industry Conference in Singapore that exports would need to rise by 9.3% in 2008 to keep the sector in a reasonable shape. This might now be difficult to achieve.

Domestic demand stayed flat or grew only very marginally last year, when the economy was in a lot better shape.

South Korea's high labor and other costs have undermined manufacturing, with petro­chemical consumption closer to Western than developing world levels.

Synthetic fiber and synthetic resin demand grew by 0.3% and 2.9% respectively in 2007, according to the KPIA. Even before conditions worsened, the association was predicting a very modest 1.8% increase in resin demand in 2008.

South Korea's heavy reliance on oil imports and lack of integration is adding to the burden.

Aromatics producers have been cutting operating rates with the benzene sector facing yet another problem. The US is crucial for South Korea, being the traditional export destination when Asian demand is weak.

The first quarter of this year saw big volumes shipped to the US, but the second quarter was weaker, as gasoline demand has fallen. A big wave of new benzene capacities is also being added in Asia during 2008, particularly in China and Thailand.

This all sounds depressing, but South Korea has been here before and is adept at confounding its critics through an enormous national will. Not only did restructuring take place post-1997, but firms also focused heavily on innovation - for instance, at Samsung-Total where considerable work has been done in PP development.

It would be wrong to assume that the industry will fail to reinvent itself again. But it will take some tough decisions - in hopefully a more supportive legislative environment - to restore profitability.

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By: John Richardson
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