GPCA: Middle East petrochemical producers seek to diversify output for Asian middle classes

12 December 2011 00:00  [Source: ICB]

Petrochemical producers in the Middle East are looking to diversify into downstream products for the growing Asian middle classes and to provide manufacturing jobs for the region. But the move downstream will involve new technologies and business models, and will have to be achieved without cheap ethane feedstocks

Petrochemical producers in the Middle East have reached a stage where economic and social circumstances are forcing them to make radical changes to their strategies.

For around half a century, the economies of the Gulf countries have been based on the production of crude oil and natural gas from what amounts to close to 60% of the world's oil reserves and 40% of natural gas reserves.

 Asian middle classes

The fast growing Asian middle classes will be the main customers for the Middle East's downstream products

Over the past three decades, earnings from oil and gas sales have been supplemented by revenue from bulk petrochemicals, of which the region has become a leading global producer.

Now the Gulf countries are embarking on a process of adding greater value to their hydrocarbon resources through economic diversification by expanding into making higher-performance downstream products.

"Nations do not sustainably raise their living standards by only selling commodities," says Khalid Al-Falih, president and CEO of Saudi Aramco, Saudi Arabia's state-owned oil and gas company, which in recent years has been moving into petrochemicals.

The region needs thriving downstream industries to become less reliant in the longer term on crude oil prices, which determine levels of public expenditure. At times of low oil prices, governments can quickly run into problems with budget deficits.

Above all, the region needs buoyant downstream manufacturing sectors to provide jobs for a rapidly growing young population. In Saudi Arabia, which has an indigenous population of around 20m, the average age is close to 25 years with about 47% of the population under the age of 18.

However, this economic diversification will have to be achieved without cheap ethane feedstocks, which have provided a platform for the global competitiveness of the region's commodity petrochemicals. Instead, the downstream business will use raw materials derived from heavy liquid feedstocks that will have, at best, only a limited price advantage over international competitors.

"The Arabian Gulf petrochemical and chemical industry stands at an historic crossroads," explains Paul Harnick, chemical global chief operating officer at the management consultancy KPMG, which has just issued a report on the downstream expansion of the Middle East chemical industry.

"The Gulf countries have been highly successful at developing a commodity petrochemical-based chemical sector from advantaged feedstocks, economies of scale and the world's leading process technologies," he says.

"Now the next step is to move into more specialty products of higher value which require different skills and expertise not just in operating chemicals plant and handling new process technologies but also in R&D, sales and marketing and other requirements along the whole supply chain to the end user."

The Middle East Gulf region, including the six Gulf Cooperation Council (GCC) states (Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the United Arab Emirates (UAE), and Iraq and Iran, has the chance to become the global hub for the development and processing of high-value and high-end downstream petrochemicals derivatives, particularly polymers.

Iraq is seen as having the potential to become a massive force in oil and gas because of its large reserves that have the tremendous advantage of being relatively easy to bring to the surface. The Iraqi government has announced plans to increase the present oil output from around 2.7m bbl/day to 12m by 2018.

The country would then have the financial and hydrocarbon resources to expand downstream into refinery products and base petrochemicals. So the region could soon have yet another major force in the global market for commodity chemicals and later downstream materials.

The Gulf and its adjacent areas provide a market of around 200m people. However, the main outlets for higher-value products would be the fast-growing middle classes of China, India and the remaining emerging economies of Asia, which are predicted to soon reach 2.5bn people.

The current rapid enlargement of the Gulf's commodity petrochemicals sectors will continue for at least several more years.

In 2010 alone, around 6.6m tonnes/year of ethylene capacity was added by GCC producers. Half of this was in Saudi Arabia, where the biggest project was Saudi Kayan in which SABIC is the controlling shareholder.

Gulf capacity for polyolefins - mainly linear low density poly­ethylene (LLDPE), high density polyethylene (HDPE) and polypropylene (PP) - also went up by about 6m tonnes/year, according to KPMG.

The Dubai-based Gulf Petrochemicals & Chemicals Association (GPCA) estimates that between 2009 and 2015, GCC petrochemicals capacity will have gone up by nearly 50m tonnes/year. This will enable chemicals output to rise by around 45% to more than 150m tonnes/year.

The Gulf's share of global petrochemicals production will rise from around 16% in 2011 to 20% by the middle of the decade, equalling the individual world output shares of petrochemicals in Europe and North America.

The region's strong position in bulk chemicals will continue to rely on a considerable but decreasing advantage in feedstock costs, most of it from cheap ethane, but also the relative efficiencies of its plants and logistics, particularly in its main markets of China and the rest of the Far East.

As much more of its petrochemicals output is shifted from exported commodities to domestically made downstream products, a much bigger role will be played by local plastics converters, which, at present, process only around 10-15% of the GCC's bulk polymers.

New supply chains will have to be created along distribution channels stretching into a wide range of local markets in Asia and, to a lesser extent, in other emerging economies and areas with mature downstream sectors, such as Europe.

"The task of making and marketing downstream products is much more complex," says Andrew Horncastle, a Gulf-based consultant with management consultancy Booz & Co.

"The concept of exporting the output from crackers using low-cost ethane to make ethylene and polyolefin derivatives is a straight-forward value proposition which at current gas prices is guaranteed to provide a good return on investment.

"The move downstream involves a different business model, which is not based on market pull as with petrochemical commodities but a market-push model," he says. "You need to be able to run in an integrated complex different streams all with different market dynamics."

Among the major barriers to the full realization of a downstream strategy in petrochemicals is access to gas feedstocks. After a period of plentiful supplies of gas feedstocks, mainly as associated gas with oil production, the region has been hit by severe gas shortages.

Abu Dhabi, the major gas supplier in the UAE, has to import gas from Qatar, the only GCC country without big gas-supply problems. Kuwait has been bringing in shipments of liquefied natural gas (LNG) from Belgium.

The availability of gas supplies has been determining the viability of downstream petrochemical projects. Some have been delayed or abandoned altogether because of a lack of ethane feedstocks.

For Saudi Arabia, the issue of gas supplies is being linked to the low industrial price for its domestically produced ethane. For many years this has been set at $0.75 per million British thermal units (BTU), which compares with a world average price of $4.5/m BTU and a price at the upper end in Japan of $10/m BTU.

"It is widely expected that Saudi Arabia will soon be putting up its ethane price but the big question is by how much," says one gas analyst. "It is likely that the increase will be a gradual one rather than a steep immediate rise. Nor will the Saudi authorities want the increase to be so high that it seriously undermines the competitiveness of its commodity petrochemicals."

The costs of producing gas from Saudi Arabia's Karan field, which is due to come on stream next year, are reported to be at least $4/m BTU.

Higher gas prices for industry and consumers are needed in the region as an incentive to encourage foreign companies to participate in the exploration and production of gas that is tightly stored in deep rock formations throughout the region.

International oil companies such as BP are preparing to make long-term commitments to the exploration and production of tight gas in the Middle East if they can gain adequate returns. BP has been negotiating a $15bn (€11.1bn) investment deal in Oman to exploit tight gas reservoirs 4,500-5,000m underground.

Abu Dhabi has problems with reservoirs of sour or sulfur-rich gas that requires expensive processing. Occidental Petroleum recently entered a deal from which ConocoPhillips had earlier withdrawn to exploit the Shah sour-gas field in Abu Dhabi, which has a high level of natural gas liquids (NGLs) and condensates.

In Abu Dhabi and Saudi Arabia a lot of the raw materials for downstream producers will be coming from integrated refinery and petrochemical sites. These will also provide fuels, demand for which is growing at 6-7%/year and of which the GCC countries are net importers.

Saudi Arabia has the most ambitious building program for integrated refinery/petrochemical projects. It is planning to expand its PetroRabigh complex, a joint venture between Saudi Aramco and Japan's Sumitomo Chemical, to produce an additional 3m tonnes/year of naphtha.

Saudi Aramco is also planning two new integrated refineries in joint ventures with Total and Sinopec at Jubail and Yanbu respectively, each with a 400,000 bbl/day capacity. A third, new integrated refinery with a similar capacity is planned at Jazin, and will be wholly owned by Saudi Aramco.

Abu Dhabi is expanding its refinery at Ruwais, while the state-owned International Petroleum Investment Company, Abu Dhabi's main investment vehicle for downstream operations, is planning a $3bn refinery in the UAE emirate of Fujairah. It is also considering an integrated refinery and petrochemicals project in Oman.

Unlike with ethane, the prices of the heavy feedstocks from integrated refineries have to be fixed at levels that comply with international trade regulations. This gives the Gulf countries a substantially less competitive price advantage. Under the rules of the World Trade Organization, Saudi naphtha, for example, has to be priced at a minimum of 30% below Japanese naphtha.

On the other hand, integrated refineries provide feedstocks like aromatics with a much wider range of molecules than those derived from ethane so that a much greater variety of chemical products can be made from them.

 Petro Rabigh

The Petro Rabigh complex is being expanded to produce an additional 3m tonnes/year of naphtha

As well as feedstocks, the Gulf's move downstream will also need technology. "Clearly, the Gulf countries will require a different set of technologies than those needed for the commodity chemicals they are making at the moment," says Harnick. "Gaining access to some of these technologies will not be easy because other emerging economies will be needing them as well. There will be intense competition for a limited number of technologies in some sectors."

The types of technologies required will depend on what the Asian middle classes, who will be the main customers for the downstream products, will be wanting. This is likely to be dictated by their levels of disposable income.

"Their incomes will probably continue to be low compared with the current income levels of the Western middle classes," says Paul Hodges, chairman of the London-based consultancy International eChem. "They may not be wanting high-value products so much as more modest, moderately priced ones."

The main route to downstream technologies for GCC countries will probably be through joint ventures. The biggest example so far is Sadara Chemical Co., a $20bn partnership set up recently by Saudi Aramco and Dow Chemical. It will comprise 26 manufacturing units using ethane, propane and NGLs to make more than 3m tonnes/year of high performance products. "Many of these will not have been made before in the Gulf," says Harnick.

The output from complexes such as Sadara will be channelled into industrial parks and clusters in the region, in which the majority of the companies would be SMEs involved in sectors like packaging and electronics. Saudi Arabia is planning to build cars and commercial vehicles as well as the components that will go into them.

In the longer term, the GCC countries will be able to generate their own technologies through their universities and research centres. "This could take some time so initially they will have to rely on getting access to technologies through joint ventures and acquisitions," says Harnick.

SABIC, which is investing heavily in research and development (R&D) while also putting funds into its own venture capital arm, has been setting up a series of joint ventures with Western and Japanese companies in chemicals like acrylonitrile, sodium cyanide, carbon black, methyl methacrylate (MMA) and polymethylmethacrylate (PMMA) and carbon fibre.

Nonetheless, production processes and related activities further downstream will have to be more labor- rather than capital intensive. Investments in commodity chemical projects create relatively little employment, costing around $200,000 per job, according to KPMG figures. In a polymer-conversion chain, around $50,000 has to be invested per job, and in high employment sectors, such as textiles and apparel, $22,000 needs to be invested per job.

"The objective should be to develop technologies and processes that provide high performance products but that are labor intensive," says Hodges. "The GCC countries are aware of this requirement. They know they have a massive opportunity to create new technologies and ways of conducting R&D into them, which will provide a much quicker means of developing and commercializing innovations."

By: Sean Milmo
+44 20 8652 3214

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