Middle East producers are looking for Western technology so they can move downstream from the cracker

Choose your partners

15 November 2010 00:00  [Source: ICB]

The dramatic events of the past two years have forced petrochemical producers in Europe and the Middle East to re-evaluate some of the basic assumptions underlying the way they see the sector developing.

The economic and financial crises in late 2008 and early 2009 had a big impact on producers in both regions. So too has the decline in ready availability of advantaged ethane feedstocks in the Middle East.

But with a significant recovery through 2010 bringing the industry back to trend growth, and demand in Asia still expanding strongly, companies are once again looking at how and where they can invest.

Leading industry executives met in Brussels in October to discuss how the two regions are responding to these changing circumstances at the third ICIS/Booz & Company CEO Roundtable on European Petrochemicals (see panel).

A degree of optimism was evident from all participants on the business environment going forward. There was also agreement on the fact that there is once again plenty of scope for mutual development between leading Western and Middle East producers.

European players are seeking ways to capture the growth in global markets, offering their technology as a way to forge joint venture partnerships, while Middle East companies are looking for strategic partners to help them expand downstream from their now well-established ethylene and first-line derivative asset base.

Continuing with the past strategy of focusing on greenfield ethane-fed cracker projects is mostly no longer an option for the Middle East; producers there, especially in Saudi Arabia, are looking to drive more value from their assets through integration and optimization and from the wider feedstock slate they are increasingly being forced to consider.

The move downstream is also being promoted by governments in the region, keen to create manufacturing jobs for their fast-growing, youthful populations.

Tom Crotty, group director of INEOS, commented that the downturn had a big impact on the company, but that the measures it took in 2009 mean that it is now well structured and "feeling good".

"There were benefits from the downturn. It drove us to examine our cost base, which was low anyway, but it is surprising what pressure can do. We now have a lower cost base than in 2008, lower working capital and lower stock levels and are determined to hold on to this position now there is an upturn."

Crotty believes that the downturn has had a positive impact in Europe by strengthening businesses for long-term survival. In the short term, things are looking stable, with petrochemical demand returning to underlying growth rates of around 2-3%/year for commodity polymers, for instance.

"The pace of recovery [in 2010] was not sustainable and we are now back to more normal growth rates. For 2011 we need to overlay the normal cycle and ignore 2008 and 2009 as a blip. Then 2009 and 2010 can be viewed as the bottom of this cycle and 2013 and 2014 are still there as the next peak."

During the downturn, Crotty added, European players balanced the lack of domestic demand by exporting much more product than they usually do, notably to China. He notes that China is going to be the major engine for the next several years at least.

"There will be a lot more scope for strategic developments and partnerships. We want to establish positions in China and the Middle East but for INEOS, being very EU and US focused, it is difficult to go it alone on developments here." However, he believes INEOS' strong technology base will be instrumental in attracting partnership opportunities. INEOS is, for instance, currently pursuing a phenol project in China with Sinopec.

Abdullah Bazid, in charge of strategy and planning at SABIC, noted that the downturn hit his company hard and led to much restructuring in the US and Europe. A third of SABIC's sales are now made outside Saudi Arabia, through its interests in Europe, North America and now China. But he too sees demand returning to normal patterns of growth.

"In the short term, attention in the Middle East is being focused on getting value out of what [assets] you have", commented Bazid, referring to the lack of major investments going forward on the grounds of high project costs and also limited feedstock availability.

He points to two objectives for the region: first, delivering on a number of specialty and performance products in partnerships chosen to delivery win-win situations; and second, to grow the local market for these materials in partnership with players in the market.

In the longer term, the challenge is to come up with a business formula for a Middle East with limited or even without gas availability. In this case you should not look just at the Middle East but at the global scene, he said.

"If you invest without advantaged feedstocks you might as well ask why not invest in other regions of the world. We [SABIC] will be in China and elsewhere. We will increasingly invest in other markets as we have to invest in added value." Bazid cited Latin America and particularly Brazil as one area SABIC is keen to invest in, given the growth rates being seen and the rise of Braskem in the country.

One big challenge, said Bazid, is the extraordinary capital intensity in these projects and the need to derive a minimum internal rate of return. The situation is made worse by the need to crack heavier feedstocks and include more downstream products. "We are trying to understand this - is [the high cost] in the specification [we use] or in the degree of integration of the plants?"

In its home market, said Bazid, SABIC will drive competitive advantage through its gas feedstock and invest to make its assets even more competitive through energy reduction, deeper integration and plant optimization. These were built initially, he explains, "for a different energy game. Now we are looking at energy conservation and reductions in manpower costs." He believes better integration at SABIC's assets could cut costs by up to 20%.

Saleh Al-Nazha, chief operating officer at Saudi Arabia's largest private chemical company Tasnee, agreed that there is a move to downstream investment in the Middle East.

Tasnee, which operates a large ethylene cracker complex and a large propane dehydrogenation (PDH)/polypropylene (PP) unit, is looking to derive added value by moving downstream into acrylics and super­absorbent polymers, in partnership with Dow Chemical and Evonik, respectively.

"We need to get into products that bring added value and income to the country," he said, and can help fight the high unemployment rates in Saudi Arabia, especially amongst the fast-growing young population. "The biggest challenge for Tasnee is where can we benefit from our feedstocks and where we go from here."

"I believe there is an opportunity again for Western players to get involved in Middle East partnerships and benefit one more time." But this time, he explained, it's not just about access to cheap feedstocks but also [about] gaining access to the local market and leveraging their technology base.

"The region can be a workshop for European requirements. We have availability of material, workforce and infrastructure and so offer an opportunity for investment. In China, things are going a little the other way, with tightening environmental requirements adding additional costs."

Ralf Kuhlmann, until recently head of base chemicals at ExxonMobil Chemical Europe and now with his own consultancy, stressed that producers need to take a global approach in today's market. But when looking at partnerships, he advised that it was essential to define the value added in these deals and also the payback on both sides. "We need to see they are long-lasting partnerships and that they get value out of the chain."

Kuhlmann believes that firms with established operations in Europe need to focus on three key areas: integration, energy efficiency and innovation. But even in the Middle East, as advantaged feedstocks disappear, there is a growing need to look at further efficiencies.

It is critical, he explained, especially with new ownership of businesses and newcomers in the market, that we ensure the focus on fundamental industry knowledge in such key areas as feedstock integration and energy efficiency is maintained. "We have to ensure the global industry uses energy and resources in the most efficient way possible."

The petrochemical industry in Europe is, he added, still an integral part of the global business and needs to remain strong as it the backbone of manufacturing industry in general in the region. But, he warned, it must address the question of how to make money at lower capacity utilisation rates than previously the case.

"Rates of 90-92% cannot be guaranteed for the future, but it is feasible to make money at 85% operating rates. Even with the possible closure of 2-3m tonnes/year of olefins capacity - which he admitted was a difficult task in Europe - these rates look set to be more likely the norm than not.

Bazid reinforced the point that older plants in Europe need to be closed. "Many assets date back to the 1960s and 1970s and we have to accept some are too old. SABIC is already looking at assets to close, but you have to come to really hard decisions and shut smaller units and build new efficient capacity - the challenge is always what is the return."

Crotty added that two factors combine to distort the situation in Europe: government interference that stops some capacity closing, and the fact that over the last year smaller, heavier feed units have become more profitable due to the value of C4s and C6s produced. As a result, "decisions get postponed that would have otherwise been taken".

The current upswing in C4 values may well not be sustainable, as the next wave of global cracker projects swing back to heavier feedstocks, away from the C2 and C3-based crackers that have featured strongly recently. This shift back to naphtha cracking begins to open up the interesting question of where future plants might be situated.

As Bazid pointed out, if you go to cracking liquids and naphtha in the Middle East, it makes export business less profitable, which will lead to greater regionality in the market. Richard Verity of Booz & Company added that "in the long term, beyond 2020, feedstock advantages might be less important. We could then imagine a world in which each of the main regions achieves a supply-demand balance using locally sourced product. In this scenario, Europe, for example, will continue to need a strong petrochemical base."

The loss of the gas advantage is also true as you move more to downstream products, Bazid pointed out, again creating implications for what products you decide to pursue and where these will be marketed. "This will be a challenge local customers will still be relatively modest in number."

This point of view was also emphasised by Al-Nazha: "You have to be selective on the products you are making downstream." For Tasnee, he added, being in bi-oriented PP (BOPP) film was a good position. He too felt a lot of Middle East downstream production would still have to be export-oriented, but that gradually regional customers will become more numerous as industrial parks are created for local converters and customer industries.

Kuhlmann also picked up this interesting point, suggesting that for future investments in ethylene capacity the right location for a naphtha cracker from an integration point of view might not necessarily be the Middle East. Where the market growth lies may be a greater factor in the decision.

This view was supported by Crotty, who said that INEOS is looking at both China and the Middle East for downstream investments. "If you have good technology you can get a good market position. A lot of the Middle East production will be export-oriented, while if you go to China, it will be for the local demand - INEOS will do both."

Crotty outlined INEOS's current thinking on phenol expansion as an example. "A lot depends on where the customer base is," he explained. INEOS is the largest producer of phenol in Europe and North America, but sells a lot into China, which is a major and growing importer as it seeks to satisfy massive demand for polycarbonate production.

"We want to supply locally and are working with Sinopec on a project proposal. But this would not stop us putting a plant in the Middle East if we could get the right raw material base. That's the calculation."

Returning to the discussion on opportunities for partnerships between European technology providers and Middle East producers looking to expand downstream, Bazid said there was a degree of complementarity in their aims. "The technology is there but how do we go about getting it right? Is it just about importing technology into the Middle East or do we go beyond this and try to set up global alliances? The challenge is to cut a win-win deal."

For Kuhlmann, an important issue is that these partnerships need to exchange best-in-class technology and not hold back the best as in the past. And for Al-Nazha, it is important that the two partners structure the deal so they are not competing in the same markets. This is especially the case in specialty products, he added.

Al-Nazha noted that one model would be for the Middle East partner to provide the infrastructure and shared services for the jv investment, with the Western partner providing technology and marketing expertise. The local producer, however, might well have marketing rights in domestic markets. "There is no logic in bringing in someone from outside if you can market locally, but you don't want to create a major impact on the marketing structure of your partner. They will probably have global key accounts with pricing on a global basis and you need to respect this."

Bazid agreed, commenting that marketing is very challenging if you want to create a win-win situation in specialties. "You have to accept an evolution, so you come in gradually over time. Alliances or joint marketing might be an alternative solution." The goal should be to create a partnership that has sustainability built into it, he added.

But whatever the challenges, the Roundtable participants agreed that partnerships are the likely way forward. "There is an appetite in the West [for partnerships], commented Crotty. "The financial aspects are OK and there is still investment available for good projects, many of which will be cooperative ventures."

Whether these will be in China or the Middle East depends on the complex mix of factors discussed above. No doubt both will be favoured by continuing investment, as producers seek to meet petrochemicals demand growth put at around 5%/year globally.


A diverse region in development terms

Andrew Horncastle of Booz & Company in Dubai writes: 

The Middle East has been emerging as a chemical production power house over the past decade or so despite stability (political rivalry) and sustainability (lack of diversification, low labor productivity) issues. However these challenges are being addressed through large infrastructure and education investment but it will take time to see the full impact.

From a Western perspective the Middle East is often seen as a single region not realizing the countries are at different stages of evolution, each presenting different opportunities and risk profiles

                    Saudi Arabia is the “heavy-weight old guard” player trying to create breakaway growth strategies while dealing with cultural and governance constraints

                    Abu Dhabi’s “young entrepreneurial leadership” has charted a comprehensive vision for future economic development and diversification and is working hard to implement despite the fragmented power base

                    Qatar is the “small newcomer” learning from the others experiences and developing a coherent growth vision along with a credible implementation approach

                    Iraq bears the potential to become a “re-emerging heavy-weight” due to broader base of human and natural resources

                    Iran is a “trapped power” that could emerge to its former glory, but not without the risk of a violent discontinuity.

Chemicals development in the Middle East now faces constraints by prevalent gas shortage and partial political pressures will not allow to continue the cracker+1 game. On the other hand there is aspiration for extended value chain coverage and stronger integration that opens up new opportunities for more value added JVs between Middle Eastern, Western and Asian players. However value potential and mode of cooperation must be carefully studied.


Taking part in the Roundtable

Saleh Al-Nazha, president and chief operating officer, Tasnee

Abdullah Bazid, executive vice president,­ corporate strategy and ­planning, SABIC

Tom Crotty, director, INEOS Group

Ralf Kuhlmann, proprietor, Dr Kuhlmann International

Also present

Richard Verity, Booz & Company

Andrew Horncastle, Booz & Company

John Baker, ICIS

For more information on Booz & Company, ­go to http://www.booz.com/global/home/what_we_do/industries/chemicals

By: John Baker
+44 20 8652 3214

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