Diminishing Returns From Middle East Projects

Downtown Riyadh

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By John Richardson

As my fellow blogger Malini Hariharan wrote last week “the projects environment in the Middle East has irrevocably changed” and with it the rather glib and outdated assumption still being frequently made that building capacity in the region represents a licence to print money.

First of all, as Malini pointed out, further supplies of advantaged gas feedstock are no longer available with high sulphur content meaning that extra processing costs could push non-associated prices to $4/mmBTU and above.

And as we reported earlier on, the issues around associated gas supply include exactly when we can expect world oil demand to return to normal. Plus there is the more long-term concern about existing associated gas supply becoming drier as it matures.

One well-placed industry observer told the blog over the weekend about another problem: Diminished revenues as a result of the ownership structure of projects in Saudi Arabia.

“These days you get to own only one-third of a project with the rest of the equity split between SABIC or Saudi Aramco and the general Saudi public (every new project has to these days undergo an IPO on the local bourse).

“So as a foreign investor you end up stomaching a large proportion, if not all, of the construction costs with a much smaller percentage of the revenues. Before IPOs were stipulated, projects were split 50:50 between the state-owned companies and overseas investors.

“At one time it was, indeed, a licence to print money if you had very cheap ethane feedstock and built only monoethylene glycol (MEG) and commodity grade polyethylene (PE) downstream of your cracker.

“But it’s been well-documented that governments across the region want diversification. The problem is that if you go for a wider range for derivatives, especially if these derivatives are based on liquids cracking, rates of return are dramatically lower.

“Building these kinds of derivative makes more sense closer to big consumption markets – i.e. in Asia.

“Governments might provide big incentives to lure foreign investors into ‘value-added derivatives’, but in Saudi Arabia’s case how will this fit with wanting to maximise returns for investors in IPOs?

“Investment incentives are one thing, but operating margins are entirely another matter – not only for stock market investors but, of course, also the foreign companies.” 

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