The article below, from Sean Milmo of ICB, makes the case that the Middle East will not be able or willing to lead pricing in Europe during the next downturn because of the control that European producers will be able to exert on their home market.
EUROPE'S PETROCHEMICAL players will soon see profits wither as new capacity in the Middle East and in Asia dumps a glut of product into the international market. In contrast with previous downturns in the cycle, however, the sector will probably be in a better position to withstand the effects of excess.
Margins already appear to be weakening as the market begins a gentle slide. The trough will probably occur around 2010-2011.
By then, about 20m tonnes/year of additional ethylene capacity will have come on stream in the Middle East, most of it destined for Asia, especially China.
However, as much as 6m-10m tonnes/year of new ethylene capacity could come on stream in China itself, almost doubling the country's total capacity to around 14m-18m tonnes/year and sending ripples across the global market.
"It will mean a slowdown in the growth of Chinese imports of some ethylene derivatives - or even a complete halt to the growth - at a time when a lot of new Middle East ethylene crackers will be starting operations," says Paul Hodges, chairman of UK consultancy International eChem.
Shell Chemicals estimates that by 2010, China's self-sufficiency in polyethylene (PE) will have risen from 50% in 2005 to 64-74% in 2010, in monoethylene glycol (MEG) from 20% to 30-54% and in styrene monomer (SM) from 35% to 68-87%.
"Although new ethylene capacity construction in the Middle East and elsewhere is experiencing some delays, the likelihood is still that we will see a supply overhang and a downturn in operating rates in the next two or three years," Colin McKendrick, venture manager at Shell's Nanhai petrochemicals complex in China, told a petrochemicals conference in China this summer.
"While China's growing appetite for petrochemicals is pretty astonishing, [its] market will not be able to swallow all the capacity currently aimed at its plate," he continued. "This is likely to mean additional export orientated output being moved to Europe and North America, which will increase both competition and pressure to reduce production costs."
While China becomes more self-sufficient, some European petrochemicals segments will be less so because investment in new capacity has failed to keep pace with demand. Domestic supply will actually decrease in certain product categories because of the closure of outdated plants.
Gaps between domestic supply and demand should be easily filled by imports. In sectors where there is an equilibrium between regional capacity and consumption, the ready availability of imports could weaken prices and squeeze margins.
Europe: a difficult market
The impact may be less severe than expected, though. Europe could be a more difficult market to penetrate than in previous periods of global petrochemical over-abundance. In recent years, petrochemical producers in Europe have been slowly upgrading their products to build up strong positions in a variety of segments. Much of this strength has come from the forging of close ties with customers.
Furthermore, many of the leading players in Europe also have capacity in the Middle East and Asia. The biggest of these is SABIC, which is now firmly established in the European market after its takeover of DSM's petrochemicals activities five years ago and Huntsman Corporation's petrochemicals business in Europe at the start of this year.
For several products, including some polymers, exports into Europe will take a relatively minor part of the market," says Tony Holloway, a principal with consultancy Nexant ChemSystems. "For these, production in Europe will still be setting the prices, and Middle Eastern producers should be motivated to benefit from attractive margins rather than disrupting the market."
European-based companies will be able to exert this control over large sections of the market, partly because of the move into specialty grades or into customized products. A larger proportion of their products are tailored to meet the needs of specific customers.
This trend will accelerate, so that the European petrochemicals sector will come into line with the remainder of Europe's chemical industry, where there has been a swing away from commodity products toward faster-growing, higher-value chemicals.
The European Chemical Industry Council (Cefic) reckons that from 2006-2008, petrochemicals production growth will average 2%/year compared with 3% for specialty chemicals, 4% for consumer chemicals and 5.9% for pharmaceuticals. Basic inorganics will average 1.9%, and petrochemical-derived polymers only 1.1%. The overall average growth for the whole industry, excluding pharmaceuticals, will be 2.4 %/year.
As petrochemical operations have transferred a higher proportion of their product portfolio to specialty grades, they have tended to concentrate on sectors like packaging, automotive, pipes and cables, fibers and construction, where there is scope for innovation and opportunities for creating niches.
"Our strategy is to create value through innovation by focusing on innovative solutions in our key market segments - infrastructure, automotive and advanced packaging," says Mark Garrett, Borealis's executive vice president for polyolefins.
"This is the opposite of a strategy based on the commoditization of plastics," he continues. "Our polymer research and product development focuses on high-performance, cost-effective and differentiated products. More than 10% of our workforce makes up our technology organization, which strives to minimize the time to market for new products. This gives us the edge when it comes to innovation."
In March, Borealis announced a €370m ($510m) investment to build a 350,000 tonnes/year low density polyethylene (LDPE) unit at Stenungsund, Sweden, to bolster its position in the wire and cable market, where it is strong in the upper end of the sector.
Like some other bulk polymer producers, the company has also been expanding its range of products in the fibers sector. It has recently introduced a new series of polypropylene (PP) fiber grades for carpets and upholstery. It has also become a leading supplier of PP fibers for the fast-growing nonwovens segment in Europe.
"Some of the PP producers are particularly active in the spun-bonded sector of the nonwovens market, which is growing at around 7-8% annually," says Colin Purvis, director general of CIRFS, the European man-made fibers trade association. "Standard resins are available to make standard spun-bonded nonwoven products. But certain PP producers are improving the quality of nonwovens by doing some clever things to upgrade the properties of their resins."
In the manner of specialty chemical operators, the PP producers in the nonwoven markets have been combating competition from makers of biofibers by conducting life-cycle assessments (LCAs) on their own products. Total Petrochemicals did an LCA on its nonwoven materials to show that products made from polylactic acid (PLA), the main biofiber used in the sector, consumed more energy and had higher greenhouse emission levels than PP.
In the construction market, BASF has been adopting a high-profile marketing strategy in the fast-growing insulation segment to promote expandable polystyrene (EPS) granules for reducing heat loss in buildings. This is at a time when the polystyrene (PS) sector is declining in Europe, triggering closures of a number of PS plants.
The granules are promoted under the Neopor brand, which BASF is trying to establish among manufacturers of insulation materials as a high-performance product. This marketing is backed by an eco-efficiency assessment, comparing Neopor with other insulation materials, including glass fiber. "This shows the environmental and economic differences of the various alternatives," says Peter Saling, head of BASF's eco-efficiency analysis team. "Composite insulation with Neopor is most eco-efficient while use of mineral fiber results in the largest environmental impact, as well as the greatest costs."
The trend to higher-value products in petrochemicals has been accompanied in Europe by a spate of acquisitions that has led to a restructuring of businesses. There has been a flurry of activity in Central and Eastern Europe typified by the moves of OMV, the Austrian oil company with a stake in Borealis, to take over MOL, a Hungarian oil and petrochemical company and a major player in Eastern Europe's petrochemicals market.
"Once companies own a larger number of petrochemical assets, their greater geographical spread gives them more scope for rationalization and to increase their economies of scale," says Holloway.
"It is easier for them to scrap and build to create competitive assets and greater flexibility in the supply chain, which is something the smaller operators do not have."
The concentration of assets under fewer companies and in fewer locations to create more clusters of petrochemicals production, especially close to refineries, is likely to continue as the pressure from low-cost imports intensifies.
Coal chemicals, hot markets
In the longer term, the European petrochemicals sector is faced with the possibility that the threat from imports could become far worse. This time the danger will not come from Middle Eastern but Asian, particularly Chinese, producers.
Shell calculates that in 2010-2020, up to 20m tonnes/year of ethylene capacity could be built in China. "A significant part of this total could be manufactured by a new generation of plants producing petrochemicals from one of China's most abundant and cheapest energy resources - coal," says McKendrick. "By 2020 China plans to spend CNY 1,000bn ($130bn, €96bn) on some ambitious projects to develop its coal-to-chemical sector."
Chinese producers could then start to export with a much less disciplined approach to pricing than their Middle East counterparts. As a result, the European petrochemicals sector will have to become even more consolidated to drive down costs and protect its dominance of specialty grade segments in the domestic market.
THE SLIDE BEGINS
Petrochemical producers have been reporting strong sales and profits for the first half of 2007, but beneath the impressive figures lie the first signs of a cyclical decline.
"We could well have gone past the peak in margins in this cycle, possibly in the first quarter of this year," says Paul Hodges, chairman of the UK consultancy International eChem. "Operating rates will stay above the important 90% mark for the rest of this year, but they could slide into the upper 80s next year, when the high-cost plants could start to make losses."
Shell Chemicals reported record first quarter earnings of $480m (€346m), 3.5 times higher than the same quarter in the previous year and 75% higher than those in the fourth quarter of 2006. Second-quarter earnings rose to $494m, but were only 42% higher than a year ago, with the company warning about the impact of higher operating costs.
Dow Chemical's second-quarter earnings were static, mainly as a result of a surge of almost $700m in feedstocks and energy costs, which the company claimed was the highest ever sequential increase.
The European Chemical Industry Council (Cefic) has forecast that output of petrochemicals in Europe will rise by 2.6% this year, double the level in 2006, but will then slip back to 2% in 2008. In both 2007 and next year, the growth in petrochemicals will be below that for the chemical industry as a whole and lower than the projected increases in consumer and specialty chemicals.
The German chemical industry association VCI is predicting an opposite trend, with petrochemicals output falling to 0.5% this year after reaching 2.4% in 2006. But the sector will bounce back next year with a 2% increase.
"Petrochemicals producers in Germany have been suffering in 2007 from the effects of a build-up of stocks among customers at the end of last year," says Henrik Meinche, senior economist at VCI. "Sales are now beginning to pick up, but not enough to pass on the rise in naphtha prices, which is resulting in lower margins."