INSIGHT: Scaling back expansion as growth falters

12 September 2008 14:22  [Source: ICIS news]

By John Richardson

SINGAPORE (ICIS news)--A drowning man will grab hold of any floating debris - even a plastic bag made from standard-grade Chinese polyethylene (PE).

Hence, last Friday a statement by Wang Tianpu led to a few days of excited speculation about the cancellation of several Chinese cracker projects.

The president of Sinopec Corp, the Hong Kong-listed arm of the Chinese refining and petrochemical giant, was quoted in press reports as saying that projects that had already been postponed would be suspended indefinitely.

He also reportedly said the pace of other projects would be adjusted.

“Fantastic,” said a Singapore-based executive with a Western polylefins producer. "At last we are seeing some commonsense."

Sadly, though, only a few days later, Tianpu amplified his statement by saying that 2008 petrochemical expenditure would be cut by only $675m - amounting to much less than the cost of one cracker.

The excitement that greeted his first statement was the result of concerns over just how bad conditions could become over the next few years.

The hope was that a much bigger budget cut might take place - affecting the timing, or even the continued existence, of projects slated for commissioning in 2009 and beyond.

ICIS plants and projects estimates that 21% of global ethylene capacity additions in 2008-2012 will be accounted for by China.

The Middle East will be responsible for a further 36%, resulting in worldwide C2 capacity increasing to 156.3m tonne/year from 135.5m tonne/year.

Further project delays seem inevitable because of the current tight equipment, construction and labour markets.

Earlier this week, Rabigh Refining & Petrochemical Co (PetroRabigh) announced that some units in its project will start up in the first quarter of 2009 rather than the fourth quarter of this year.

The Saudi Aramco/Sumitomo Chemical joint venture (JV) at Rabigh on the Red Sea cost has incurred a $300m cost overrun.

Market talk is also circulating of two more cracker delays in the Middle East - pushing the start-up of 2.6m tonnes/year of ethylene from the second half of 2008 into next year.

But without a significant recovery in global demand over the next few years, the odd delay and cancellation might amount to little more than re-arranging the deckchairs on the Titanic.

Evidence continues to emerge of just how badly growth is being damaged, not only by weaker exports to the West from Asia, but also by high and volatile food and oil prices.

Two new studies by the World Bank and the Asian Development Bank (ADB) have raised the bar on definitions of poverty, largely as a result of rising food prices.

The ADB, for example, believes that there are 20.1% more people in poverty in Indonesia and 15.9% more people in the Philippines than it had previously thought.

India has an estimated 455m people living on less than $1.35 a day, according to the World Bank. This means a lower speed limit for petrochemical growth in an economy already hindered by terrible infrastructure, poor irrigation and low literacy rates.

Inflationary pressures might have peaked for the time being as a result of the fall in crude. For example, consumer prices in China rose at their slowest pace for 14 months in August.

But as Norbert Walker, chief economist at Deutsche Bank, says: “Owners of commodities will enjoy a bonanza for ten years or longer. Consumers will pay dearly. Only fast and comprehensive adjustment (s) will help to control costs.”

Oil supply is finely balanced against demand in healthy economic times with the arrival of Peak Oil perhaps as near as the middle of the next decade. Gas supply will take longer to peak, but its pricing seems inextricably tied to crude.

Coal has huge potential, but there are the technical and cost challenges of replacing a significant percentage of oil-based transportation fuels. Emissions levels are another hurdle.

Renewables are only likely to account for a small percentage of the total energy mix for the next decade at least due to all the economic and technical barriers.

So heavy reliance on crude will remain, meaning there is a possibility that as soon as each economic recovery arrives, a crude cost-surge will nip it in the bud.

Demand would dip again, allowing everyone with short-term memories to forget the need to conserve - leading to another short-lived rebound.

The consequences for petrochemicals would be more of what we are seeing at the moment - whole supply chains choked with inventory as a result of businesses making wrong forecasts about the direction of crude.

Alternatively, buyers of chemicals might learn their lesson by constantly acquiring smaller lots in order to keep inventories at low levels.

It remains to be seen whether sellers and buyers will also ramp up activity on futures exchanges in an effort to hedge risk.

Crude might start fluctuating between an ever-widening pricing band because of the precarious long-term demand and supply balance.

Imagine how difficult it would be to run a chemicals business if that band extended from $80/bbl to as high as $200/bbl at times of major geopolitical or weather-related supply disruptions.

“We estimate that the short-term correlation between crude and polyolefins pricing is anywhere between 30% and 80%,” says an industry source.

Just think what further effect such a wide range in crude prices - with all the attendant uncertainties about direction – would have on the polyolefins business.

Might this all mean that Sinopec will be forced to make deeper budget cuts in future years? Could PetroChina be similarly affected?

First-half 2008 net profits at Sinopec fell 77% on heavy losses resulting from the high cost of imported oil and controls on refinery-product prices.

The government has said, however, that it plans to further liberalise pricing controls, perhaps eventually bringing them into line with international prices. This is all part of the push towards a greener economy.

Building new worldscale crackers to replace older sub-worldscale units, and upgrading some of the smaller plants, is also about better economies of scale and improved energy efficiency.

Petrochemical investment might be given another boost by integration to “virtual” domestic oil supplies.

The only way foreigner companies can get into China cracker JVs these days is by offering oil and/or technologies.

Several deals involving foreign oil supply into cracker-refinery JVs are already in place with at least two more rumoured to be under negotiation.

And the 10,000 bbl gorilla waiting outside the room and banging on the door demanding to be let in is coal-to-chemicals.

If water consumption and CO2 emission concerns can be dealt with, making olefins out of coal-based methanol would tick both the energy security and environment boxes.

“The knowledge society will strike back – eventually," adds Walker in his Asia Trip Report 2008. "Energy efficiency and renewable energy will be rewarding projects.”

So if you are not in the Middle East or China and are not moving up the innovation curve, it’s about time you started; either that or sell your business during the next up cycle - but be quick because the recovery might not last long.

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By: John Richardson
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