INSIGHT: With Saudi gas, a question of cost and availability

31 January 2011 17:00  [Source: ICIS news]

By John Richardson

PERTH, Australia (ICIS)--It will only be a question of making a large amount of money, rather than a huge amount, if you only take into account the relatively minor increases being forecast for Saudi Arabia’s petrochemical feedstock costs.

The cost rises would have been far more dramatic if Saudi Aramco had got its way in a debate with the country’s chemicals producers, HSBC said in a report published last week.

Saudi Aramco had wanted to increase gas costs to bring them quickly in line with current US levels of $4-5/MMBtu. But HSBC said: “We believe policy makers are in favour of a phased approach.”

If the bank is correct, this could have implications for investment decisions both in the US and Saudi Arabia.

The rise of shale gas has made the US a possible location for new capacity, a dramatic turnaround from just a few years ago, when all the talk was of feedstock cost-driven plant closures.

US producers would still be comfortably to the left of correct if HSBC is right. But based on raw material costs only, Saudi Arabia is forecast to remain in the most advantageous of all positions.

HSBC's estimated cost increases are as follows:

HSBC Saudi Arabia feedstock pricing assumption

  2011e   2012e  2013e  2014e  2015e
 Gas price, new (US$/MMBtu)  0.75  1.25  1.50  2.00  2.00
 Gas price, old (US$/MMBtu)  0.75  0.75  0.75  0.75  0.75
 Propane discount, new  28%  27%  26%  25%  25%
 Propane discount, old  28%  28%  28%  29%  28%

Current implied ethane costs in Saudi Arabia are just $47/tonne, according to HSBC. An increase in the gas price to $2/MMBtu by 2014 would therefore not make that much of a difference.

It is not just about feedstock pricing, though, as construction costs in the Middle East in general can fetch a premium because of expensive labour.

Petrochemicals markets might become more regional as a result of a rise in trade protectionism.

Fortunately, there hasn’t been a dramatic increase in trade barriers since the economic crisis. But as long as deep-seated economic problems in the west continue, this danger will persist.

Saudi Arabia, despite its efforts to grow domestic downstream consumption, is likely to export most of its petrochemicals for a long time to come. It therefore benefits a lot from low import tariffs.

The debate about Saudi Arabia's future competitiveness compared with the US and elsewhere could be a side issue, however, if the Kingdom cannot resolve its current shortage of gas.

Extensive naphtha cracking is an alternative to using ethane, propane and butane. But industry observers argue that the economics of using naphtha in Saudi Arabia are a lot weaker.

The very well-documented shortage of ethane in Saudi Arabia is a factor behind the dearth of new cracker complexes currently planned for start-up in the country after 2011.

Saudi Aramco is making strenuous efforts to boost gas supply in order to supply not only petrochemicals but also the electricity generation, desalination and fertilizer sectors, adds HSBC.

This is a double-edged sword. While these efforts might reap more feedstock for petrochemicals, they also reflect the rising alternative values for natural gas  one of the main reasons why the price of gas is expected to rise. 

Fifty percent of all Saudi offshore platforms are now devoted to gas exploration compared with 20-40% in the past, says HSBC. Saudi Aramco has set itself the target of delivering 4-7 trillion cubic feet of additional non-associated gas supply each year.

The reason, as we have said, is the rise in demand for gas from non-petrochemical applications  most significantly electricity.

Unless supply increases are concurrent with the growth in gas demand over the next two decades, more than 60% of Saudi Arabia's total energy production would have to be diverted to meet local needs, said HSBC.

This would result in a big revenue loss for the country through a reduction in oil exports, and global crude prices would rise.

So the race is on to meet ambitious growth targets for natural-gas extraction as the scale and nature of these investments places upward pressure on pricing.

Saudi Aramco is to devote 10% of its total capital spending on developing six offshore gas facilities over the next five years, the bank said.

This will be non-associated gas, so the economics are very different from associated gas, which comes as a byproduct of oil production.

Foreign investors also have to be attracted to these dedicated gas fields, as prices charged for output from the wells have to be high enough to meet their rates of return.

In the old days, back in the 1970s, when the Saudi petrochemical industry was first established, life was a lot simpler.

There was less competing demand for gas and so there were fewer alternatives to providing feedstock to the industry at very attractive prices. (Before 1998, ethane costs were only 50 cents/MMBtu).

A feature of the gas-cost debate appears to have been unexpectedly high oil prices over the past few years.

These are viewed as having created exceptional profits and a cost advantage in “excess of what had been implicitly guaranteed when the [petrochemicals] industry was established”, writes HSBC.

What level of profitability will be deemed as acceptable in the future? How will this decision affect confirmed future gas prices and overall government support for petrochemicals?

Read Paul Hodges’ Chemicals and the Economy blog
Read John Richardson and Malini Hariharan’s Asian Chemical Connections blog
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By: John Richardson
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