By John Richardson
ALBERT EINSTEIN knew a thing or two about data, including searching for entirely new data sets that led to a revolution in our understanding of space and time. Nevertheless, he once wrote this on a blackboard: “Not everything that counts can be counted, and not everything that can be counted counts.”
Hear, hear. So it goes with petrochemicals markets, to paraphrase the great science fiction writer, Kurt Vonnegut. A constant temptation is to try and reduce the behaviour of our industry to mathematical formulas when most of the behaviour of this industry cannot be reduced to any sets of numbers.
Let me give you an example from history to prove my case.
South Korea’s “all of society” approach to petrochemicals
South Korea’s petrochemicals industry took off 1980s, driven by state investment that did not only consider feedstock advantage and the economic boundaries defined by a petrochemical complex or a refinery-to-petrochemical complex. In fact, cost-per-tonne economics were barely on the mind of the country’s Ministry of Finance (MOF).
The MOF instead wanted to create jobs for people in downstream washing machine, electronics and auto factories through the guaranteed supply of local raw materials. The number of new jobs that were going to be created couldn’t be predicted with any reasonable degree of accuracy. In fact, most of the time, nobody bothered with forecasts as it was accepted that supply security was just a good thing by itself.
Then came something called regulatory capture, the period from the 1990s onwards when the leaders of the chaebol, the big industrial conglomerates, were able to influence the approvals process. Government approval was won for petrochemicals plants that demand forecasts said were unneeded. The old saying was, “if you owned a chaebol and had an auto plant, you wanted a petrochemicals plant as well.”
But, despite the claims of overcapacity and cracker shutdowns (with the South Korean industry said to be further hampered by South Korea’s need to import all its oil and gas), the South Korean petrochemicals industry has been extremely successful.
What the mainstream consultants missed was the tremendous hard work and ingenuity of the South Koreans. They also overlooked that the fact that defining the economic boundary as either a petrochemicals plant or a refinery-petrochemicals complex simply doesn’t work in the South Korean context.
Petrochemicals businesses have been supported through subsidies from fellow chaebol companies, with the subsidies going the other way when petrochemicals businesses have performed better than say a steel or an electronics plant. The vision has been long term and not based on short-term economic cycles, estimated on individual industry supply and demand balances.
Yes, there have been some major petrochemicals-specific competitiveness issues that have had to be fixed, for instance, the changes in ownership that occurred after what South Korea rightly calls the “IMF Crisis” in 1998 (not the Asian Financial Crisis because I share the view that it was IMF policies that made the economic problems in South Korea a lot worse than they should have been).
But these disadvantages have been fixed not just at the individual company or plant level. The South Korean government has, for example, supported petrochemicals and other industries through successfully pursuing free trade agreements (FTAs), the most recent being South Korea’s membership in the Regional Comprehensive Economic Partnership (RCEP).
The huge, long negotiated trade deal, which was signed on 15 November, will give South Korea even better access to the critical Chinese market. Its access to China had already been improved by the China-South Korea FTA that came into effect in 2014.
Those who accurately forecast the continued success of the South Korean petrochemicals industry adopted what I call an “all of society” approach. They understood local history, culture and politics. Sorry to sound like a big head, but I place myself amongst the winning analysts here.
Understanding local history, culture and politics involves a great deal of thinking about intangibles that cannot be built into any spreadsheet. But this kind of understanding also leads to new data sets, such as studying the role of present and future FTAs in shaping petrochemical trade flows. We need to conduct such a study into the RCEP.
China’s “all of society” approach
Let us also look at the South Korea-China relationship from a Chinese perspective. China wants to move closer to South Korea because it is a highly developed economy.
The RCEP presents China with a very interesting opportunity in this respect. As The Economist writes, the RCEP breaks new ground in harmonising the “disparate rules-of-origin provisions in ASEAN’s various FTAs, and setting regional-content rules so that intermediate goods can be sourced from any of the 15 countries.”
High value semiconductors might flow from South Korea to China in greater quantities. The new rules of origin mean China will be able to export finished electronics to the RCEP’s 15 member countries, which represent 30% of the global economy, at reduced tariff rates. This may help to mitigate the damage done to its supply of semiconductors because of new US export restrictions, one of the outcomes of the growing US-China split.
Let’s extend this kind of thinking to petrochemicals. Why, given its split with the US, which seems likely to continue under the Biden administration, would China want to buy any of its petrochemicals from the the US, regardless of the cost efficiencies of US plants? Why shouldn’t China instead buy more from South Korea, especially now that the two countries have moved closer together as a result of joint membership of the RCEP?
Ethane feedstock advantage may matter not a jot in the coming years as the US and China move further and further apart. The US has made some headway in the China market this year. But I would not be surprised if, eventually, no petrochemicals are exported from the US to China.
Let me give you one more example of China’s “whole of society” approach. This illustrates how cultural, social and political factors can end up shaping plant economics:
- China used to build lots of coal-to-olefins (CTO) plants in remote rural areas that had high capital costs and only just about worked on a feedstock cost basis for job creation reasons. It also had lots of sub world-scale plants throughout the country that it would not shut down because it wanted to preserve jobs.
- But in 2015, a decision was made to switch from coal-based to refinery-based feedstocks as the main route to petrochemicals self-sufficiency, as it was decided that the environmental impact of the CTO process outweighed job-creation advantages.
- At the same time, Beijing decided to shut down lots of small petrochemicals and chemicals plants which, because of increased urbanisation, had ended up next to major population centres. The plants were both uneconomic and, again, bad for the environment.
- Here we are today. In the same way that European government subsidies got renewable energy off the ground to the point where it is now more cost efficient than natural gas, oil and coal, the Chinese government has created world-leading state-of-the-art petrochemicals capacity. China’s new plants have excellent integration with refineries, are world-scale, have strong technologies, great logistics and are in petrochemicals industry parks with shared, and so low cost, logistics.
- China’s new capacity therefore ticks the box of adding value to the country’s manufacturing capacity as China tries to escape its middle-income trap. And for supply security reasons in a very uncertain geopolitical world, it makes so much sense for China to build many more modern petrochemicals plants – and run them at high operating rates once they are on-stream.
Climbing out of our silos
Gillian Tett’s brilliant book on the Global Financial Crisis, Fool’s Gold, is once again instructive here. She talked about how regulators, financial analysts, hedge funds and big banks all lived in silos, with the walls separating different areas of knowledge. Because all these institutions couldn’t see above the walls of their silos, they missed the signs that a crisis was coming.
The same applies to the petrochemicals business, which is why I believe you need to employ experts on local history, culture and politics – and also crucially today, geopolitics as well, due to the end of the post-Berlin Wall period of benign global markets.
This kind of analysis, as the examples of South Korea and China so clearly show us, has always been essential. But now it has become even more important as we move into a world of much greater ambiguity and uncertainty due to the four new megatrends, which, in no order of importance are: demographics, sustainability, geopolitics and the pandemic. Watch this space for “whole of society” analysis of the megatrends.