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US Petrochemicals: The Way Forward

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By John Richardson on 04-Nov-2014


By John Richardson

ANYBODY out there prepared to make a guess? How long are these fantastic earnings for US petrochemicals companies in the key polyolefins space going to last? Six months, 12 months, 18 months or perhaps even longer?

The question then becomes how financial analysts, investors, stock markets and therefore companies will respond when earnings begin to return to their historical average .

Cut costs and export like crazy? Sure, that might be the reflex response, especially if pressure builds from active investors desperate to squeeze as much “value” out of petrochemicals companies. This might, with a lot of luck, result in one or two more quarters of improving financial results.

But  this approach would very soon be counterproductive because:

  • China would be delighted to import very cheap US polyethylene (PE), as this would enable it to re-export lots of very, very cheap finished plastic products back to the US.
  • This would destroy sales of domestically made PE as US converters struggle, and, of course fail, to compete with state-subsidised plastic processors in China.
  • The US might then respond by imposing antidumping and other duties to protect its local converters. “What is the point of, in effect, exporting our big advantage of very low cost shale gas when the whole point was to create jobs at home?” would be an understandable response.
  • But China might then impose its own trade barriers against US resin, and instead decide to raise its PE imports from the Middle East and/or rapidly expand its domestic production. How China improves its export position for finished plastic goods is really just an academic question, as it simply has to improve its export position. It has to improve its export position in order to compensate for lower growth at home – and that lower growth will last for at least the next five years.
  • The option of exporting to developing countries other than China won’t do the job either, because China’s consumption dwarfs just about all the other Asian developing markets put together.
  • And, anyway, other developing countries, such as in Southeast Asia, are busy building their own petrochemicals industries as a mean of adding their own value to local oil and gas supplies. Further, these petrochemical investments are, like the US, also designed to create lots of jobs downstream. Such countries will not hesitate, for one second, to erect trade barriers if their growth models are threatened by a sudden surge in low cost exports from the US.
  • Europe then? No, as Europe must also protect local jobs. And European petrochemicals producers are highly cost efficient and have some great opportunities to further improve these cost efficiencies. 
  • Export most of the surpluses to Latin America then? This will not work in isolation because its markets  are not big enough to absorb all of the potential surpluses. On paper, there are 17 new PE facilities planned for the US. This represents 8.1m tonnes/year of capacity, a 53% increase in the existing US capacity base, according to an ICIS analysis.

And so what should US petrochemicals companies do instead?

They should, first of all, review investments. Only six cracker complexes are under construction at the moment. Building work on a further six has yet to start.

They should also look at the work of  the strategic planner and thinker, Michael Porter, starting with this statement from Porter:

Firms have focused on enticing consumers to buy more and more of their products. Facing growing competition and shorter-term performance measures from shareholders, managers resorted to waves of restructuring, personnel reductions and relocating to lower-cost regions, while leveraging balance sheets to return capital to investors.

The results were often commoditisation, price competition, little true innovation, and no clear competitive advantage….Companies have overlooked opportunities to meet fundamental societal needs….Our field of vision has simply been too narrow.

Companies should then think about the implications of an Asian Development Bank (ADB) report, published in March, which reached the following conclusions:

In the most populous countries, including China, India and Indonesia, inequality has risen sharply. In China, this is largely because of the gap between those living in cities and those stuck in the countryside. In India, by contrast, inequality has risen sharply among city-dwellers.

Nor do countries in Asia appear to have done enough with the growth they have generated. In about half Asia’s countries, including China, India, Indonesia and the Philippines, spending on education is less than 4% GDP, compared with an average of 5.2%  in advanced countries. The ADB also found that health outcomes had  generally lagged behind economic performance.

Politicians the world over want to keep their jobs.

And in the developing world, the best way for politicians to  now keep their jobs is to deal with the challenges highlighted by the ADB. India’s Prime Minister, Narendra Modi, is a good example of this approach.

Why this new emphasis? Politicians in developing countries didn’t have to worry as much about these challenges in the very recent past. They do now, though, because the withdrawal of central bank money has fully exposed the faults with their growth models.

And so how do US petrochemicals companies help governments in the developing world solve the “societal needs” that Porter identified?

Here are just  a few suggestions, mainly around building “strategic corridors” for your PE exports:

  • Help fund the development of local conversion industries, in return for guaranteeing supplies of low cost resin from your US plants. These conversion industries are going to develop anyway, and so you might as well take part and secure off-take in the process.
  • Further build relationships with overseas governments by helping fund hospitals, schools, roads, sanitation and healthcare. This will help “seed” demand growth for petrochemicals. People can only escape absolute poverty if they have these basic essentials. This goodwill will further help support your PE exports, along with, as I said, raising the local demand for your products.
  • Provide US shale gas technologies to developing countries, either through your own company or by working with other US companies. This will help these countries develop their local oil and gas reserves. In the medium term, this might, again, help you export more of your surplus resin. It might even eventually give US petrochemicals companies the opportunity to participate in cracker and derivatives projects downstream of these overseas shale gas reserves. One might well argue that this would be throwing away a huge US competitive advantage. But, as we described above, that advantage is in danger of being given away, anyway, through a flood of imports of very cheap manufactured goods. It makes much more sense to therefore export this competitive on terms that can be largely dictated by the US.
  • Provide other expertise to developing countries, such as better water treatment chemicals and improved irrigation techniques – again from either within your own company or from other US companies that you partner with. This will help address two of the biggest megatrends confronting the developing world: Providing enough potable water and food to sustain growth. This would again, of course, prove to be a win/win, as it would also boost your exports of PE.

These suggestions just scratch the surface, of course, and so we shall return to this theme in later blog posts.