Speciality Chemicals

A big Gulf to cross

A falling feedstock edge is seeing Gulf chemical producers plot a course in specialities. Justin Pugsley reports

A move further downstream by Middle Eastern chemical producers has been mooted for some time and there is undoubtedly an attempt to get into areas such as speciality chemicals. However, it is a strategy born partly  of weakness. To penetrate the speciality chemicals sector successfully, Gulf-based organisations face a substantial rethinking of their corporate cultures and business models.

It could, according to some observers, take one to two decades before the Middle East is even able to develop a meaningful presence in the speciality chemicals space. And there is at least one in-between stage regional producers must first conquer, according to research from HSBC: higher value added downstream chemicals.

Middle Eastern chemicals producers, who mainly focus on bulk commodity petrochemicals, such as methanol, ammonia, urea, ethylene and its derivatives, at the moment, have been enjoying spectacular returns on their investment. That is now changing and primarily for two reasons.

The first is that most of the region's chemicals producers rely on natural gas as their feedstock. Much of that gas was being flared and was anyway trapped, due to a lack of infrastructure. It therefore represented a very cheap feedstock.

In addition, much of the gas is a by-product of crude oil production and the amount that can be produced is limited by OPEC quotas and there are also competing uses for gas, such as power stations. The opportunities for building extra cracker capacity are therefore disappearing and, as such, very few new plants are due to come onstream in the next few years.

Trapped gas has proved to be an amazing blessing. Some analysts have estimated internal rates of return (IRR) at over 35-50%, which is extremely high for companies making basic commodities. Then again, that is not overly surprising when the industry has been paying 70-80% less for the feedstock than its western peers.

To grow, those same companies will have to make do with more expensive naphtha. Although that enables them to broaden their product range and sell more expensive chemicals, it does mean their IRRs shrink to a more modest 12%.

"Using heavier feedstocks such as naphtha does open up a wider product range and enables a move into the C₃, C₄ and aromatics chains and then downstream into products such as nylon and rubber," says Paul Harnick, chemicals global chief operating officer with KPMG. The problem is that, unlike trapped gas, oil and its various derivatives are traded  internationally at world prices.

Harnick - Heavier feedstocks more versatile than trapped gas, but costlier too

Jobs, jobs and more jobs

The second reason for the big push downstream is political. Rapidly rising populations mean that there is a need to create new jobs quickly. The various sheiks and emirs who rule the region are only too aware of how dangerous to them high unemployment, frustration and poverty can be to their grip on power - a view reinforced by the Arab Spring revolutions that swiftly swept away the old guard in much of North Africa.

In Saudi Arabia, for example, over half of the18.5 million Saudi nationals are under 20 years old, with only three million people in employment. "A large ethylene cracker will produce one job for every $1 million invested. For the same amount invested in a styrene butadiene rubber facility roughly 20 jobs will be created," says Harnick, explaining the logic of the focus on downstream development.

In anticipation of these demographic trends, Saudi Arabia is building six economic cities, which are in effect special economic zones that are completely focussed on generating business activity. A recent example of the determination to grow beyond petroleum is the $20 billion project between Dow Chemical and Saudi Aramco to create Sadara Chemical, which is expected to generate revenues of $10 billion/year within five years.

The deal highlights Saudi Arabia's ambitions to add value to its hydrocarbon resources and to create a base for the growth of other domestically-based industries further downstream. These will consume up to 20-30% of Sadara's output initially and possibly more later on.

The idea, according to Riyadh-based Kevin Connor, a partner with legal firm Squire Sanders, is ultimately to move into manufacturing that will use these value added chemicals and create far more jobs. For instance Saudi Arabia is looking at building low cost cars, despite reservations over whether this can ever be economical.

Even if some of these manufacturing industries never really take off, much of the output from Sadara will probably find buyers overseas thanks to its cost advantage derived from economies of scale, technology and still favourable feedstock costs. The complex will contain 26 plants and produce higher margin chemicals and plastics, such as polyurethanes, propylene oxide, propylene glycol, elastomers, LDPE and LLDPE, glycol ethers and amines. It will also be able to use a mix of feedstocks.

Dow and Saudi Aramco signed their joint venture agreement in October

This is a case of Dow leveraging its technical expertise and its marketing network outside the Gulf while Saudi Aramco brings project management skills and relatively cheap and reliable feedstocks. According to analysts, the venture is the first of its kind in the region in terms of the scale of the transfer of unique proprietary technologies.

Though it represents an important step downstream, it probably will not trigger off a flurry of copycat deals any time soon. "It could be one of a kind for the next ten years," says Sriharsha Pappu, a Dubai-based chemicals sector analyst with HSBC. "It takes years to put these deals together. These two companies signed a memorandum of understanding back in 2007."

This is not the first time Saudi Aramco has done a joint venture with a foreign partner. Back in 2005 it set up Petro Rabigh with Sumitomo Chemical for an investment of just under $10 billion. This venture makes refined products such as LPG and naphtha, plus a range of petrochemicals such as mono ethylene glycol, propylene oxide, polyethylene and polypropylene.

However, Petro Rabigh relies on ethane feedstocks and does not have the same level of value-added focus that Sadara will have. These ventures currently do not represent high end speciality chemicals, though they could evolve into those areas later on, especially if a strong domestic user base evolves later on.

Different mindset required

KPMG, for one, believes that industrial clusters will play an important role in the development of speciality chemicals in the region. That is important, because, whereas commodity petrochemicals are best produced close to where hydrocarbon resources are located, speciality chemicals are best manufactured near their customer base, which is mostly in Europe, North America, Japan and increasingly China and India.

In addition, the difference between making commodity petrochemicals and speciality chemicals, are substantial and require different mindsets. HSBC argues that the days of 'easy' development are over for the Gulf's chemicals industry. As they move up the value chain they will find themselves competing on a more level playing field where customer service and IP are what defines success as opposed to just being the cheapest.

The Middle East is strong upstream but has far to go to be a speciality chemicals player

That said, Connor is an optimist. "Saudi Arabia has a deep well of highly qualified petrochemical engineers and chemists," he says. "I think they are well placed to make the shift downstream." KPMG sees an increase in overseas acquisitions, joint ventures and favourable incentives for foreign investors to develop a stronger R&D base, technology and know-how.

Sabic is at the vanguard of that transformation downstream. It makes steel, fertilisers, innovative and advanced engineering thermoplastics, polymers, and added value performance chemicals. Though much of its high end speciality products are made outside the Gulf, that is likely to steadily change as high end production is moved to Saudi Arabia.

Getting there has involved Sabic making several acquisitions, such as buying DSM's petrochemicals business in 2002 for €2.25 billion ($3.16 billion), Huntsman's European base chemicals and polymers business for $700 million in 2006 and GE Plastics in 2007 for $11.6 billion.

It has signed agreements with Sinopec for the production of 260,000 tonnes/year of polycarbonate and inked various other deals with the likes of Mitsubishi Rayon, Montefibre, Exxon Mobil, Lurgi and Asahi to produce chemicals such as methacrylates, polymethyl methacrylates, carbon fibre, elastomers and sodium cyanide. At a recent press conference, CEO and vice chairman Mohamed Al-Mady said that the group will continue to expand its presence in the speciality chemicals segment.

Abu Dhabi-based Borouge, established in 1998, could be another contender, given its collaboration with Borealis. Borealis supplied its technology for building a state-of-the-art polyethylene plant there in 2001. By 2013 it is on track to create the world's largest integrated polyolefins plant, with a capacity of 4.5 million tonnes/year. According to Pappu, that collaboration could make it player to watch in the future.

This move into more value-added production could see a consolidation among the Middle East's chemicals producers as smaller players lack the resources to make the transformation. According to HSBC, around 14 such companies are listed on the Saudi stock market, most of whom only have one plant.

The good news for Europe's speciality chemical producers is that the Middle East is unlikely to pose a major threat to them for at least a decade, particularly for very IP intensive or heavily customised products. In fact it could even represent an opportunity in terms of securing feedstocks and for developing new markets.
 

 

From Online Issue: February 2012