South Korea's petrochemical industry faces downturn, but may be more insulated

Bracing for the downturn

04 February 2009 00:00  [Source: ICB]

The South Korean petrochemical industry has modernized capacity and restructured. But can it survive the downcycle?

ON PAPER, South Korean companies appear to have fully prepared themselves for a downturn in the petrochemical cycle. Debottlenecking and capacity expansions were undertaken during the last three years to boost competitiveness. New markets were identified to reduce reliance on the key China market.

But in the end, these measures were not enough to adequately insulate companies from a sharp drop in demand in the second half of 2008, as a result of a rapidly weakening global economy.

To be fair, Korean companies, like others worldwide, had prepared for a supply-driven downturn in the industry. But no one had expected the economic crisis and the rapid fall in crude oil and petrochemical prices.

"We understood there would be a downturn [in the petrochemical cycle] from the second half of 2008, but on top of that, there was the sudden economic crisis. The market situation was exceptional. I do not think any company had prepared for this downfall," says a senior executive at Samsung Total Petrochemicals.

Certainly, market developments in the last few months have left most players bruised and battered as aggressive production cuts had to be implemented to keep inventories under control.

A MATTER OF SURVIVAL

There is consensus among Korean petrochemical industry players that 2009 and 2010 will be challenging years.

"It is going to be a matter of survival," explains a senior executive from Honam Petrochemical.

Hopes are being pinned on a recovery in market conditions and prices in the second half of the year, but much will depend on the how quickly the global economy rebounds and Chinese demand returns.

China remains a key destination for Korean exports and producers may have little option but to cut back production if Chinese demand shrinks. Expectations for domestic demand also remain weak (see table).

For instance, PVC demand is estimated to have declined by 8% in 2008 to 865,000 tonnes and is projected to fall by another 4% in 2009 to 830,000 tonnes. Demand for other commodity polymers is also projected to fall this year.

Sector operating profit is expected to decline sharply with one brokerage estimating a 30% fall in 2009 and another 10% drop in 2010.

Honam Petrochemical is widely cited as being most sensitive to the downturn because of its heavy exposure to core petrochemicals.

Upstream petrochemicals is the worst place to be in and Honam is most exposed, says an analyst from an international brokerage firm.

Hanwha Chemical, LG Chem and SK Energy are in a better position thanks to their more diversified product portfolios.

Hanwha's future prospects had been in question as as parent company Hanwha Group was mulling whether to go ahead with its Won6500bn ($4.7bn) acquisition of a 50.4% stake in Daewoo Shipbuilding & Marine Engineering Co. (DSEC), which is owned by Korea Development Bank.

Hanwha Group emerged as the preferred bidder for DSEC in October 2008, but had been struggling to find money to fund the deal.

In late January, Korea Development Bank rejected Hanwha's revised offer to buy its DSEC stake in stages and seized its Won300bn ($216m) deposit. Hanwha has now vowed to file a lawsuit to recover its deposit from the bank.

Hanwha Chemical is one of the most profitable companies in the Hanwha Group stable.

"The acquisition offers no synergy," said one financial analyst before the deal fell apart. "Hanwha Chemical being an affiliate is being punished."

While it is unanimous that business conditions in 2009 will be tough, there is also some hope that local producers will not be as badly hit as some northeast Asian companies or overleveraged European and US producers.

"Most Korean producers have already prepared for this situation. We expanded our capacity to reduce production costs. I think we can survive the next trough better than the Japanese, small Chinese and European companies," says a second source from Honam.

The company completed a major cracker expansion last year from 350,000 tonnes to 1m tonnes at Daesan to become one of Korea's largest ethylene producers. It expanded its polyethylene (PE) plants and started up new monoethylene glycol (MEG) polypropylene (PP) plants.

"We think east Asian companies are less competitive than those in the Middle East. But compared to the Japanese, Korean plants are new. So I think Korean companies will fare a little better," says a source from Yeochun Naphtha Cracking Centre (YNCC), the olefins joint venture between Hanwha Chemical and Daelim Industrial.

YNCC added capacity at its No 1 cracker in 2007, but without any capacity increases downstream. As a result, the company is the largest South Korean olefins exporter. The company is mulling the capacity expansion of its No 2 and No 3 crackers.

Other Korean companies that jumped on the expansion bandwagon include LG Chem and Samsung Total. Both expanded their crackers at Daesan cracker in 2007.

BOOSTING COMPETITIVENESS

SK Energy is trying to cut costs, change its feedstock slate and optimize processes at its plants, says a company source.

Samsung Total is investing in energy savings and strengthening its position in major products such as polypropylene (PP), styrene and paraxylene (PX). To differentiate itself, Samsung Total had decided a few years back to concentrate on high-value grades of PP.

"Competitors will find it difficult to copy. To a certain degree, there is an obstacle to getting into this market. High value and differentiated product providers have a more stable market position than commodity players," he points out.

However, this strategy is not helping as the automotive and electronic sectors, key end-users of high value PP grade, are also suffering from deteriorating demand.

"Unfortunately, there is nothing much we can do about declining demand in the auto and electronics industry. We just have to wait," he says. "But these producers are under significant pressure to reduce costs, so we will work with them for replacing engineering plastics or steel with PP compounds. There is a good opportunity for us to do this kind of material substitution."

Financial analysts concur that expansions have helped Korean companies improve their competitiveness.

They also draw attention to the relatively healthy balance sheets and low level of debt at these companies.

"We are going to see bad business conditions in Q1 and Q2, but companies have enough cash to endure," says another financial analyst. "Most of the revamping and debottlenecking projects were carried out with limited capital expenditure. This should be helpful."

Another plus is the restructuring that has taken place after the 1997 financial crisis, which has cut down the number of players and streamlined operations.

In January, Honam fully merged its subsidiary Lotte Daesam Petrochemical into the company. Honam acquired Lotte Daesan from Hyundai Petrochemical in 2003.

LG Chem integrated its business with LG Petrochemical in 2007, while in the previous year it consolidated subsidiary LG Deasan Petrochemical, also acquired from Hyundai in 2003.

ACQUISITION OPPORTUNITIES

A healthy balance sheet gives room for Korean companies to participate in acquisition opportunities over the next couple of years.

Buying rather than building is likely to make more sense during a downturn and there is certainly not much room to add volumes in Korea, given a slow-growing home market.

Some analysts believe that it would be advisable for Korean companies to focus on Asian assets as they have more business experience in this region, rather than look at troubled European or US plants.

As for more restructuring within Korea, it is probably still too early to say if and when this will happen.

"We will really have to look at what happens in the first half of 2009. If it is like the fourth quarter of 2008, then the pressure to restructure will increase," says the first analyst.

But there could be some obstacles for further consolidation. While companies know that they need to be bigger to survive, government antitrust regulations could come in the way.

Companies will have to convince the government that the industry is a global one and Korean players will need to build up scale to effectively compete with international producers.

The other hurdle could be the strong cash position that most companies enjoy now. "Everyone wants to be a winner and not a loser," points out the first Honam source.

Ultimately, companies may not have much of a choice, especially if the downturn turns out to be an extended one.

SOUTH KOREAN ETHYLENE AND POLYMER PRODUCTION, IMPORTS, EXPORTS AND DEMAND

  2008 (E)* 2009 (P)**
Prod. Imp. Exp. Demand Prod. Imp. Exp. Demand
Ethylene 7,162.3 119.9 781 6,501.3 7,240 115 685 6,670
4.9% 9.4% 8.4% 4.6% 1.1% -4.1% -12.3% -2.6%
LDPE 1,770.9 38.4 742.4 1,066.9 1,850 50 850 1,050
-2.9% -6.8% -3.8% -2.4% 4.5% 30.3% 14.5% -1.6%
HDPE 2,024.7 9 1,147.1 886.6 1,990 10 1,120 880
2.2% 19.8% 1.8% 2.9% -1.7% 11.5% -2.4% -0.7%
PP 3,258.9 24.5 1,959.9 1,323.5 3,410 26 2,126 1,310
5.7% 36.1% 9.4% 1% 4.6% 6.3% 8.5% -1%
PS 989.8 33.1 589.5 433.4 950 27 557 420
(EPS included) -8% -7.8% -12.1% -1.6% -4% -18.4% -5.5% -3.1%
ABS 1,240.7 7.6 1,098 150.2 1,210 7 1,072 145
-9% 19.8% -9.8% -2% -2.5% -7.9% -2.4% -3.5%
PVC 1,343.7 25.6 504.5 864.7 1,380 23 573 830
-2.4% -2.8% 9% -8% 2.7% -10% 13.6% -4%
NOTES: Absolute numbers are '000 tonnes. Percentages are changes from previous year.
* Estimated. ** Projected.
SOURCE: KOREA PETROCHEMICAL INDUSTRY ASSOCIATION

Honam Petrochemicals surprised industry watchers when it signed an agreement with Qatar Petroleum in 2005 for a 30:70 joint-venture cracker complex at Messaied, Qatar, for start-up in 2010.

The plan was to build a 900,000 tonne/year cracker and plants for polypropylene (PP), styrene, polystyrene (PS) and mixed xylenes,

The move was a bold step for Honam, once known as one of South Korea's most conservative petrochemical companies. It was also the first time that a South Korean company had ventured overseas for a cracker project.

However, despite commitment from both sides, the $2.6bn project was slow to take off and the start-up date kept getting pushed back, first to 2011 and then to 2012.

So a recent decision by the two companies to defer a final decision on the project to the second half of 2009 has not surprised many.

"We are not sure how long it will take to resume [project activity]. We need project financing, and that depends on the global financial environment," explains a Honam source.

A second company source points out that it was not easy to find investors in today's market. "There is business uncertainty and risk. So our management wants to wait and see if the circumstances will change," he adds.

But the first source emphasized that Honam remains interested and committed to the project, although the company is not in a position to give a revised start-up date.

Honam and Qatar Petroleum were in the middle of the bidding process for the cracker when they decided to put the project on hold.

"We had received commercial bids, and they were higher than expected. But we had not started negotiations," says the Honam source.

While Honam remains optimistic on the project, there are others who doubt that it will materialize.

"I can't imagine when Qatar Petroleum and Honam will resume discussions. It is not likely for the next year. They had not started construction the project was really at an early stage. It would be easier to cancel," says one financial analyst. "I think instead of investing in a new project, it would be better to look at M&A," he adds.

Part of the analyst's skepticism stems from the mixed feedstock slate of the cracker project, which weakens the economics of the project.

Unlike other crackers in Qatar, the Honam and Qatar Petroleum project was based on ethane and naphtha rather than 100% ethane.

Critics of the project had earlier said that the high cost of construction in the Middle East also undermined project economics.

The global economic crisis will at least bring down construction costs, but the project's viability remains in question, especially if oil prices continue to fall.

"The advantage of gas-based projects has dissipated as crude oil prices are so low. The attractiveness of this project has declined now," points out a second analyst.

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By: Malini Hariharan
+65 6780 4359



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