Middle East chemical projects face cash starvation

Running out of cash

12 November 2008 21:00  [Source: ICB]

The next wave of chemical projects is scheduled to come on stream in the next decade. Now, the financial crisis and plummeting profitability are jeopardizing their future

Malini Hariharan/Mumbai
and John Richardson/Singapore

THE APPETITE for risk - even in a region such as the Middle East with its huge feedstock advantages - has been significantly blunted by the global credit crisis.

There is a real chance, therefore, that petrochemical projects due on stream post-2012 could be substantially postponed or perhaps even canceled.

The problem isn't the amount of money within the region itself. Some of the big players could easily fund projects from retained earnings if they wanted to and governments that have long viewed petrochemicals as strategic are also awash with cash.

Doubts over financing for projects after the current wave of new capacity, due on stream over the next four years (see page 18) are instead the result of the global financial crisis, rising project costs and changes in feedstock availability, the destruction of emerging-market demand growth and lower oil prices.

MONEY IS TIGHT

A lending slowdown in the Gulf region began this summer when local banks had exhausted their available cash. And in September, the credit crisis went into overdrive, cutting off just about all sources of overseas funding.

Risk is also being repriced and lending standards have become much tighter, leading to far greater caution toward petrochemicals due to cost overruns and start-up delays.

For example, the PetroRabigh project, a joint venture between state oil company Saudi Aramco and Japan's Sumitomo Chemical, at Rabigh, in Saudi Arabia, will cost $300m (€238m) more than forecast. It will come on stream in the first quarter (Q1) of 2009, rather than the previously expected Q4 this year.

Bankers believe that projects facing the greatest financial risk are those led by private firms relatively new to the industry, where construction costs are $10bn and above.

The weakness of the US dollar hasn't helped either. Most of the Gulf Cooperation Council (GCC) countries peg their currencies to the greenback, with financing usually in dollars. And now there is a growing demand for local-currency financing, in excess of supply.

Bankers are also keeping a close eye on new project feedstock mix. With cost-advantaged ethane extremely short, many of the recent announcements post-2012 are naphtha-based and linked to refineries.

"The real concern now is economics. There is no advantage in making petrochemicals from naphtha in the Middle East and shipping product overseas. We might see projects struggling to give returns to sponsors," says Darren Davis, managing director, head of project and export finance at global investment bank HSBC.

There is still confidence, though, that well structured projects with strong promoters - such as state-owned companies or international chemicals majors - will get funding.

This includes the joint venture between Saudi Aramco and US-based Dow Chemical at Ras Tanura, in Saudi Arabia, one of the most expensive petrochemical projects to date, with a cost likely to be well over $22bn. It is expected to seek financing in 2009-2010.

But the one concern for these projects is that they will still require additional equity. This again raises the question of returns for shareholders who take on bigger risks.

DEMAND DESTRUCTION

Only a few months ago, nobody forecast that polyethylene (PE) and polypropylene (PP) demand growth in China would be at zero or even in negative territory in 2008 - but this is now the expectation of two major global producers. This would compare with 6.2% demand growth for PE and 14.6% for PP in 2007.

The decoupling theory has been well and truly discredited, as China's export processing sector suffers from the slowdown in shipments to the US and Europe.

And the speed with which conditions have worsened takes your breath away. For example, a Chinese polyethylene ­terephthalate (PET) resin producer had forecast 2008 polyester demand growth at 12% as recently as July, but now predicts that the industry will be lucky to get away with zero expansion.

This will make financiers less willing to commit to new capacity as the output from plants currently being brought on stream will take much longer to be absorbed than had been expected.

The good news is that cost overruns in any projects that do go ahead could be a thing of the past.

Steel prices have tumbled of late and the engineering and construction firms might suddenly find themselves with a great deal of time on their hands. Labor shortages could ease as building work in other sectors - such as real estate and infrastructure - slows.

But the fall in steel prices has been accompanied by equally steep declines in crude oil, seriously bad news for the Gulf region.

FALLING GOVERNMENT REVENUES

Crude prices would have to stay low for several years to really hurt the GCC, although countries such as Iran, with far less healthy government financing would be affected far more rapidly.

But according to global investment bank Merrill Lynch, Saudi Arabia would still enjoy a budget surplus as long as oil stays above $30/bbl.

This means the potential remains for government funding of infrastructure for new petrochemical investments - for instance, plans to build a second or even third industrial city at Al-Jubail on Saudi Arabia's east coast.

Budgets will still be depleted, though, if crude pricing remains depressed. A combination of weak demand-growth forecasts for petrochemicals - and perhaps growing concerns about the environment - might lead to countries focusing their more limited resources on power and infrastructure investments. Approvals may also become harder to obtain.

As for the companies, earnings forecasts are being thrown out of the window because of the collapse in oil.

Global petrochemical pricing is oil-driven and as pricing falls, so do the margins for producers with low and fixed feedstock costs - such as those in the Middle East. This will be a further reason for caution among bankers.

WHY BUILD WHEN YOU CAN BUY?

"I have a pile of files as high as my desk on Western chemical companies which have approached us asking us if we want to buy them," says the head of the financing arm of a major Chinese chemical producer.

The Chinese still have lots of cash, and so do their big Middle East competitors, thanks to low leverage and probably the best industry boom in history.

A lot of distressed assets could be available in the West, perhaps belonging to those companies that expanded through highly leveraged acquisitions over the past 12-18 months.

All the talk is also of converging economics between the Middle East and the West - because of the region's gas feedstock shortages, until recently high freight rates and the rise in project costs.

While freight rates have moderated, projects in the Middle East have become more expensive because of cyclical factors such as steel and labor and more complicated because of government demands for a wider range of downstream derivatives.

Another factor that could improve the economics of a well integrated refinery-petrochemical complex in, say, the US, is the decline in gasoline demand.

The economic crisis, improved fuel efficiency legislation and the rise of biofuels are behind the demand fall - creating the possibility that petrochemical feedstock will be cheaper over the long term.

Buying, rather than building, would also fit in with the ambitions of the Middle East companies to get closer to big consumption markets, and to gain better access to technologies and marketing and distribution networks. Available suitors are likely to be queuing outside their offices.

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